Fair value accounting: Effects on banks' earnings volatility, regulatory capital, and value of contractual cash flows (original) (raw)
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Fair Value Accounting and the Predictive Ability of Earnings: Evidence from the Banking Industry
SSRN Electronic Journal, 2000
This paper examines whether fair value adjustments included in other comprehensive income (OCI) predict future bank performance. It also examines whether the reliability of these estimates affects their predictive value. Using a sample of bank holding companies, we find that fair value adjustments included in OCI can predict earnings both one and two years ahead. However, not all fair value-related unrealized gains and losses included in OCI have similar implications. While net unrealized gains and losses on available-for-sale securities are positively associated with future earnings, net unrealized gains and losses on derivative contracts classified as cash flow hedges are negatively associated with future earnings. We also find that reliable measurement of fair values enhances predictive value. Finally, we show that fair value adjustments recorded in OCI during the 2007-2009 financial crisis predicted future profitability, contradicting criticism that fair value accounting forced banks to record excessive downward adjustments.
Fair Values, Comprehensive Income Reporting, and Bank Analysts' Risk and Valuation Judgments
SSRN Electronic Journal, 2000
We investigate whether the measurement and reporting of comprehensive income in financial statements systematically affects commercial bank equity analysts' investment risk assessments and valuation judgments. In an experiment in which 80 buy side analysts specializing in banking and financial institutions participated, we vary whether a bank is exposed to or hedged against interest rate risk across three different comprehensive income accounting regimes-piecemeal fair value accounting with comprehensive income reported in the statement of changes in equity, piecemeal fair value accounting with comprehensive income reported in a separate statement of performance, and full fair value accounting with comprehensive income reported in a separate statement of performance. When fair value changes are measured and reported on a piecemeal basis, we find no investment risk or valuation judgment differences across CI reporting regimes. Although we find that the analysts' investment risk judgments are influenced by the banks' risk management strategies, their valuation judgments are not.
SSRN Electronic Journal, 2000
Fair value accounting (FVA) has been blamed for amplifying the recent financial crisis. We conduct an event study of policymaker deliberations, recommendations and decisions about FVA and impairment rules in the banking industry. If FVA was a key contributor to the financial crisis as some industry pundits and academic research suggest, we first should observe positive stock market reactions to proposals to curtail FVA and negative reactions when policymakers support FVA. Second, we expect especially positive reactions to the curtailment of FVA and impairment rules for banks that are relatively sensitive to pro-cyclical contagion. Third, we investigate cross-sectional reactions to factors that potentially contribute to pro-cyclical contagion, including relatively (i) low regulatory capital, (ii) more assets recorded at fair value, (iii) poor asset liquidity, (iv) larger potential impairments, and (v) more trading assets. Finally, we expect banks that have fewer alternative sources of information about fair values beyond those reported in financial statements to experience relatively negative reactions to potential relaxation of FVA and impairment rules.
Fair Value Accounting and the Cost of Equity Capital of Asian Banks
The cost of equity is a measure of the required return by investors. It is desirable for firms, especially banks, to lower the cost of equity. There are a number of factors related to the quality of information disclosed that could influence the cost of equity. The accounting regulators aim to improve the quality of information by requiring assets to be valued at fair value. However the application of fair value accounting potentially increases information asymmetry, especially if fair value is estimated and subjected to the judgment of the preparers of financial statements. This asymmetric information problem potentially lowers the information quality and increases investors' estimation risk and thus influences the cost of equity capital. Therefore, this research investigates the effect of fair value accounting on the cost of equity capital for a sample of Asian banks since banks hold a relatively larger proportion of assets at fair value. Using the generalized method of moment model for dynamic panel data, this research finds significant and positive relationship between assets at fair value and the cost of equity. The results found are similar for both quoted and unquoted assets. Thus although to regulators, fair value accounting provide relevant and timely information to investors, assets at fair value are perceived to be risky and as a consequence investors require higher returns.
Does fair value accounting contribute to market price volatility? An experimental approach
Accounting & Finance, 2013
This paper contributes to the debate on the impact of accounting measurement rules for financial assets. We examine the association between fair value accounting for financial assets and market price volatility for nonfinancial firms in an experimental setting. One group of participants was provided with financial statements where held-for-trading securities were reported at fair market value (FVA). Another group received financial statements with investments reported at historical cost (HCA). Controlling for accounting data, we find no systematic difference between FVA and HCA for three different measures of market price volatility, despite higher earnings volatility and marginally heavier trading under FVA.
Destabilizing Effects of Fair Value Accounting During US Banking Crisis
Review of European Studies, 2015
The aim of this paper is to analyze the pros and cons of the financial accounting standards rule, known also as Mark-to-Market Rule. Enacted November 15, 2007, required that all companies to be evaluated on the basis of prices reflecting actual market situation. We have shown this pro-cyclical rule significantly worsened the U.S. Financial Crisis of 2007. The article includes a discussion of reasons why US authorities adopted this rule for already third time in history, whereas the two preceding cases are also discussed. The US government did implement the discussed rule just on the eve of the recession or the financial crisis to relatively ease the rule during the period when the US economy was due for a rebound.
Fair Value Accounting and the Cost of Equity Capital: The Moderating Effect of Risk Disclosure
SHS Web of Conferences, 2017
Evidence thus far suggests fair value accounting poses risk and affects firms' returns in some ways. This research, on a sample of Asian banks, improves the understanding of the information risk effect of fair value accounting by examining the moderating role of risk disclosure in the relationship between fair value accounting and the cost of equity capital. The results from a generalised method of moments on dynamic panel data analysis, show that risk disclosure mitigates the asymmetric information problem. Thus the findings contribute towards the standard setters' effort in improving the practice of fair value accounting, and suggest that there are benefits in mandating disclosure especially for banks.