Fair Value Accounting ( FVA ) has been accused as the chief cause of the planetary fiscal crisis by many fiscal establishments. The chief ground was the inordinate injection of unreal volatility into the fiscal markets and which lead to a lessening in investors assurance about the solvency of the fiscal establishments. Fiscal Institutions argued that down market monetary values, which are acquired from inactive markets and later used to mensurate Bankss fiscal instruments, can non reflect a true and just value of accounting publications. At the extremum of the fiscal crisis, the IASB issued exigency amendments to IAS 39 and IFRS 7 in an effort to loosen up just value accounting. The amendments left commercial Bankss that report under IFRS with the determination to retroactively reclassify their fiscal assets that were one time estimated at just value into categories which necessitated measuring at amortized cost. This determination was nevertheless alone to the IASB ‘s general scheme for fiscal instrument coverage ( IASB, 2008a ) and its staunch preliminary place against reclassifications. The board, however, capitulated to the strong political force per unit areas EU Commission and EU leaders who voiced concerns about the procyclicality that just value accounting may present. The petition was subsequently made for the alliance of accounting regulations for European Bankss to those of their US rivals since a similar reclassification option was already instituted under SFAS 115.
FVA ‘s execution has forced fiscal establishments to compose down their assets to reflect deformations in market monetary values. These write-downs exacerbated volatility in net incomes and contributed to market breakability. Scrutiny and reappraisal of a broad scope of fiscal merchandises were performed which included derived functions, mortgage-backed and asset-backed securities and recognition barters A direct effect was that information was no longer uniformed amongst investors that participated in these fiscal markets. This information dissymmetry led to some investors, who were knowing of pertinent market information, to gain at the disbursal of uninformed investors. Banks capitalized on the chance to waive generous write-offs of fiscal assets that became illiquid or whose market monetary values significantly plummeted during 2008. For case, the Deutsche Bank was able to raise its net income by 3.2 billion Euros in 2008 by merely reclassifying its illiquid assets which had a book value of 23 billion Euros.
The intent of this thesis is to through empirical observation analyze the function of just value accounting in the 2008 planetary fiscal crisis with a cardinal focal point on just value accounting ‘s association with information dissymmetry in the UK banking system. Although FVA has been used to measure assets and liabilities for many decennaries, this thesis focuses chiefly on just value measurings as delineated under the accounting criterion SFAS 157 Fair Value Measurements. This standard became effectual in November 2007 and provided a definition of just value as it related to fiscal coverage. It besides outlined a three degree measuring hierarchy that flatly ranks just value inputs on the premiss of their dependability. The standard seeks to categorise the most dependable inputs that are straight discernible and gettable from active markets every bit good as independent of the coverage organic structure ( Level 1 ) to the most undependable inputs that are subjected to the appraisals and premises of the coverage organic structure when active markets are non-existent ( flat 3 ) . The 2008 fiscal crisis provides a welcoming chance to analyze the relationship between information dissymmetry and just value measurings under SFAS 157 since there were widespread inaction of many markets for assets and liabilities.
Advocates of FVA such as the U.S Security Exchange Commission, the International Accounting Standard Board and the Financial Accounting Standard Board argued FVA measurings can supply investors real-time information that can heighten their comprehension of the economic sciences values associated with assorted types of assets and liabilities every bit good as the appraisal of suited portion monetary values. Fujioka et Al. ( 2008 ) proposed that investors and determination shapers are more inclined to utilize information based on just value measuring over that historical cost measurings due to its overall sensed transparence and equity. Ryan ( 2008: 1607 ) besides noted that the development of the subprime crisis into a planetary fiscal meltdown can be attributed to hapless operating, investing and funding determination devising every bit good as inefficient hazard direction and deceitful behavior by homeowners, investors and houses. However, with the permeant cases of inaction amongst fiscal markets for assets and liabilities and the accommodations to the market ratings of assets and liabilities, information became unbalanced and uninformed amongst market participants. This inherently led to the being of information dissymmetry amongst investors such that some profited due to the cardinal information made available to them. It is hence the purpose of this survey to analyze the relationship between just value accounting estimations, chiefly level 3 just value estimations and information dissymmetry.
This survey focuses on the information dissymmetry quandary among equity investors that was instigated by just value estimations. Key accent is on the UK banking industry during the 2008 planetary fiscal crisis. The motive for this survey stems from the undermentioned grounds:
Information dissymmetry typically among investors has been a critical empirical subject in the field of finance and accounting. Information dissymmetry among investors, where by some investors gain from information advantage over others, has been extensively accepted ( Copeland and Galai, 1983 ) . This is because informed investors may hold entree to undisclosed information or possess huge experience or cognition to proficiently measure complex information compared to their uninformed opposite numbers ( Mohd, 2005 ) .
Literature has should there are several effects that may result from information dissymmetry. Easley and OHara ( 2004 ) have shown that it can hold an impact on the cost of capital of house. Myers and Majluf ( 1985 ) pointed out that it can impact a house ‘s investing and fiscal determination devising and capital markets efficiency. Glosten and Milgrom ( 1985 ) noted that high information dissymmetry consequences in low market liquidness, lower societal benefits from trading activity and even take to market failure.
Literature and other empirical surveies have highlighted that information on bank assets such as fixed assets, loans, assets held in trading histories is opaque. Consequently, due to their complexness, many investors from the outside brush trouble to value them and find their possible degrees of hazard ( Morgan, 2002 ) . This information dissymmetry presents chances for informed investors to gain over other uninformed investors. These investors will non put when the information quality is hapless since this has an unfavorable consequence on the stock monetary values. In the heat of the fiscal crisis upturns in mortgage defaults have significantly reduced the market rate and liquidness of Bankss mortgages and underlying securities backed by these assets. Because the measurings obtained from inactive plus markets was deemed undependable, the employment of just value accounting, specifically flat 2 and degree 3, has been subjected to highly rough unfavorable judgment. The measuring of these assets was considered by equity investors as deformed, informational opaque and hazardous. Hence analyzing the information dissymmetry chiefly for degree 2 and level 3 just value measurings is overriding since they involve a big proportion of managerial intuition, discretions and premises.
Motivation besides stems for literature on accounting revelation. Harmonizing to Ertinur ( 2004 ) , dogmas of the Economic Theory proposes that increased degrees of accounting revelation can potentially cut down the private benefits associated with information assemblage and by extension cut down the information dissymmetry among equity investors. Uninformed investors may seek to widen the bid-ask spread in response to the informed trading advantage that some informed investors enjoy ( Bagehot, 1971 ) . However, ample accounting revelations can shut the spread between information advantaged bargainers and uninformed bargainers and at the same clip narrow the bid-ask spread ( Glosten and Milgrom, 1985 ) . The decrease in the bid-ask spread can increase the security ‘s liquidness ensuing in increased trading volume and stock monetary values ( Boone, 1998 ) . The FASB indicated that SFAS 157 can supply enhanced information to fiscal statement users on affairs associating to dependability, relevancy, hazards associated with assets and liabilities reported at just value. The board besides believes that such accounting revelations can potentially supply equity investors with improved information on how just value is employed to mensurate assets and liabilities, inputs employed to develop the measurings and the effects of those net incomes ( FASB, 2006 ) . It is the aspiration of this thesis to analyze whether the aim of proliferating just value disclosures under SFAS 157 have been attained by centering on the information dissymmetry concern.
This survey examines the relationship between information dissymmetry and just value measurings in the European Bankss. The accounting criterion SFAS 157 has outlined the mode in which just value ratings are to be applied to Level 1, Level 2 and Level 3 of fiscal assets. Hence, the research inquiry examines the nature of information dissymmetry in all of these three degrees of accounting informations.
RQ: Does an association between information dissymmetry and UK Bankss fiscal assets and liabilities exist? If so, are at that place distinguishable discrepancies in information dissymmetry in degree 1, degree 2 and level 3 just value ratings?
In order to comprehensibly reply this inquiry, quarterly informations of the FY 2008 for European Bankss will be used. In add-on, bid-ask spread will be utilized as the placeholder for information dissymmetry since it is good established and have been widely used in finance and accounting literature as a suited placeholder for information dissymmetry. Harmonizing to Glosten and Milgrom ( 1995 ) , knowing investors can work information advantages at the disbursal of uninformed investors when information dissymmetry among equity investors is high. In an effort to safeguard themselves against looming trade losingss, these uninformed investors would take to increase the bid-ask spread. Hence, a positive correlativity between information dissymmetry and the bid-ask spread can be straight observed.
It is end of this thesis to supply auxiliary apprehension into function played by just value accounting in the recent fiscal crisis with a cardinal focal point on information dissymmetry in the UK banking system. However, because the crisis is non to the full abated, there is still a meager measure of available literature to impart substantial support to its absolute function in the crisis in the UK. Nonetheless, by touching to and analyzing the conceptual and empirical basicss of just value accounting in the U.S. , it may be possible to pull illations and do appraisals on the ways in which just value accounting impacted on the recent fiscal convulsion.
This survey makes parts to the ongoing argument on just value accounting by showing a cross-sectional analysis of information dissymmetry of just value estimations. In so making it lends support to bing literature which makes connexions with the quality of accounting information to capital cost and liquidness of equity markets ( Leuz, 2010 ) . The survey may besides supply involvement to accounting standard compositors, bank regulators, accounting academe and equity investors.
The remainder of the thesis is organized in the undermentioned manner. Chapter 2 provides a literature reappraisal on just value measurings and summarizes the hypotheses based on the research inquiry examined in the survey. Chapter 3 discusses the research methodological analysis every bit good as sample choice procedure. The findings of chief trials are presented in Chapter 4. The concluding chapter comprises of the decisions of the survey.
Chapter 2 Fair Value Accounting
This chapter outlines the definition of just value with regard to U.K. accounting criterions specific to the banking industry. After a reappraisal of empirical surveies and literature on just value accounting, hypotheses are developed based on the research inquiry of this thesis.
Definition of Fair Value Accounting
Fair Value Accounting is non a fresh construct. In fact, the execution of just value measurings can be dated back to the early 20th century ( SEC, 2008 ) . During the early 1930s, Bankss and other fiscal establishments were required, for the intent of administrative grounds, to gauge their portfolios at market value. From so, there were many dictums on the usage of just value. Nevertheless, these basic criterions merely outlined what to mensurate at the just value but did non bespeak how to mensurate. In add-on, these dictums were contained many inconsistent and equivocal definitions of just value. For illustration, SFAS 107 Disclosure on Fair Value of Financial Instruments provided a definition for just value to mirror process and measurings for using unadjusted quoted market monetary values derived from an active market ( FASB, 1991 ) . Accordingly it declared thatfair value is the sum at which the instrument can be exchanged in a current dealing between willing parties, other than in a forced or liquidation sale ( SFAS 107: paragraph 5 ) . This definition is, nevertheless, deemed really equivocal and narrow. Harmonizing to Whittington ( 2007 ) , it is obscure whether the usage of the word sum alternatively of monetary value reflects the gross merchandising monetary value or the net realizable value that Sellerss would accomplish after doing tax write-offs for dealing costs. In add-on there is no general component for just value accounting such that it was identical as an entry value, an issue value or a value in usage. In the case of active and liquid markets, assets and liabilities measurement at these values would non show any complications. The concerns and application trouble surface in instances of illiquid markets. This is because the exchange values may non wholly reflect the indispensable assets and liabilities values and the three constituents of just value ( entry value, issue value and value-in-use ) are per se dissimilar from each other, therefore ensuing in low confusion and incompatibility in fiscal coverage ( Barth and Landsman, 1995 ) .
Consequently, the FASB has provided a clear definition of just value as an issue value and has besides outlined consistent ordinance on the application of just value in the revised criterion SFAS 157 Fair Value Measurements ( FASB, 2006 ) . This new criterion aimed at heightening homogeneousness and comparison in the application of just value. It defines just value as the monetary value that would be received to sell an plus or reassign a liability in an orderly dealing between market participants at the measuring day of the month ( SFAS 157: paragraph 5 ) . This definition underscores four indispensable constructions of just value that have non been identified in earlier dictums. First, just value is obviously recognized as an issue value that an organisation will get for sale of an plus or transportation of a liability ; and non an entry value or a value-in-use. Second, as noted by Whittington ( 2007 ) , the word monetary value is used in the position of sum which denotes that dealing cost is non considered in just value. Third, the sale of an plus or transportation of a liability is considered as a conjectural dealing by the measuring day of the month, alternatively of the impression of existent market dealing merely because of the usage of the term would ( Benston, 2008 ) . Finally, the look market participants connotes that just value reflect the position of the market more volitionally than that of a remarkable entity. This basically suggests that just value to be measured harmonizing to the premises that market participants would wish to use in order to value the plus or liability ( SFAS 157: paragraph 11 ) .
Fair Value Accounting and the three-level hierarchy
SFAS 157 has established a three-level hierarchy aimed at ranking the inputs to rating methods used to mensurate just value on the premiss of their dependability. Alluding to paragraph 24 of SFAS 157, undue quoted monetary values derived from active fiscal markets for indistinguishable assets and liabilities are classified under Level 1 inputs. These inputs can be straight observed in liquid plus markets and are besides publically accessible with directions controls. These inputs are deemed the most dependable indicant of just value. The FASB is aware that certain assets and liabilities do non ever have active markets in being and even if markets do exists, they are non reliable to supply dependable and relevant information to mensurate just value due to their illiquidity.
In an attempt to work out this trouble, the FASB has introduced Level 2 inputs which are basically are inputs that are straight and indirectly discernible for assets and liabilities, other than quoted monetary values incorporated in Level 1. Degree 2 inputs can be subcategorized into three categories: quoted market monetary values for matching assets and liabilities in active markets ; quoted market monetary values for matching assets and liabilities in inactive markets and in conclusion, monetary values validated by market-based steps which are satisfactory to allow the just values to be estimated ( SFAS 157, paragraph 28 ) .
Degree 3 inputs are unobservable and are calculated by utilizing discounted hard currency flow methods, monetary value theoretical accounts or other attacks which reflect the coverage entity ‘s personal premises and tax write-offs ( SFAS 157: paragraph 30 ) . These inputs are less accurate, to a great extent subjected to disposals uses and integrate more information hazards. Subsequently, the FASB has restricted the usage of Level 3 inputs to merely fortunes when Level 1 and Level 2 inputs are unavailable.
Fair Value Vs. Historical Cost Accounting
Historical cost accounting was at the nucleus fiscal coverage during the early twentieth century. A company so stated the monetary value at which an plus was acquired and non its merchandising monetary value in the current or future market. The same regulation was applicable to accounting for liabilities ( Plantin et al. , 2008 ) .
Arguably, while historical cost accounting could hold potentially safeguarded Bankss and fiscal establishments from the considerable write offs of their fiscal assets values, it besides possessed built-in defects. For case, historical cost accounting did non allow equity investors and other users of fiscal statements entree to pertinent information on the establishment ‘s plus values. This meant that in the event of concern settlement, the assets would finally necessitate reappraisal and if assets were to be sold, their sale value would non be indistinguishable to their stated value at cost ( Ryan, 2008 ) .
Bernard ( 2009 ) contended that rating processs in accounting that underscores the significance of taging to market merely reflect the market ‘s volatility and is non a conducive factor. Financial assets owned by Bankss and other establishments experienced losingss on their value chiefly because of the addition in inactive markets for the securities. Fair value accounting processs forces constitutions to demo impairment losingss and write-offs of the plus and liabilities values. Since selling the assets can ensue in Bankss enduring losingss, fiscal assets were retained and investors were punctually informed through their issued fiscal statements about the alterations in the predominating market value of these assets. By comparing, under historical cost accounting methodological analysis, the chance for transparence in describing would hold been eliminated ensuing in equity investors unknowingness of the degree of fiscal hazards associated with these assets ( Bernard, 2009 ) .
However, Magnan ( 2009 ) reasoned that just value accounting is non, in itself a flawless methodological analysis for fiscal coverage and has the possible to carry through more than merely mirror the bing market information.
Arguments For and Against Fair Value Accounting
Associated with the execution of just value accounting processs, is a go oning argument on the advantages and disadvantages of just value accounting amidst the concern community, fiscal regulators and faculty members. This subdivision highlights some of the chief dogmas of this argument both in favor and disfavor of just value accounting.
Arguments for FVA
There is a shared position amongst the FASB, accounting faculty members and investor associations that just value accounting is preferred over other methods of measuring properties such as historical cost accounting for four chief grounds.
First, just value accounting can present precise and crystalline information to enable investors to grok the economic value of assets and liabilities. While directors may possess superior cognition about the fiscal public presentation of the organisations, such information may non needfully be disclosed to capital market investors. The execution of just value accounting has the ability to distill the information dissymmetry that is existing between direction and investors. The implicit in ground is that just value appraisal inputs are straight quoted from the plus markets. They are hence publically accessible and directions uses are significantly less. Because there is added market subject with just value accounting, debatably, it is more relevant and dependable to investors.
Second, just value accounting affords investors the latest information which can be pertinent to their determination devising. This accomplishes this by capturing information associated with market monetary values at all minutes in clip. Due to this timelessness characteristic and the inability of Bankss to modulate prospective jobs, information based on just value is dubbed as better preferred to the historical cost accounting measuring of information. This is because just value reflects a true and firm truer contemplation of predominating market information instead than supplying a deceptive imagination of better visual aspect ( Laux and Leuz, 2009 ; Muller et al. , 2008 ) .
Third, the execution of just value accounting can potentially forestall the impression of additions merchandising which can happen under historical cost accounting ( Laux and Leuz, 2009 ) . The usage of historical cost accounting to gauge assets and liabilities can bring forth inducements for Bankss to take part in inefficient plus sale ventures in an attempt to recognize premature net incomes ( Plantin et al. , 2008 ; Laux and Leuz, 2009 ) . This is referred to as additions merchandising. Thus the debut of just value can be associated with the motivation to avoid additions merchandising ( Schulz and Hollister, 2003 ) .
Fourthly, in some cases, a assorted accounting theoretical account is used to fiscal instruments measurings. Harmonizing to Barth ( 2004 ) , a mixed-accounting theoretical account is the chief beginning of excess volatility in fiscal statements. Many of the ordinary fiscal instruments such as sedimentations, debt and held-to-maturity securities are reported under historical cost accounting are prone to possible inefficiency write-offs for every accounting period. Contrariwise, other fiscal instruments under SFAS 115 such as available-for-sale and trading securities ; just value hedge derived functions reported under SFAS 133 ; and just value options reported under SFAS 159, are all reported on the balance sheet at just value. Additionally, unfulfilled losingss and additions ensuing from just value alterations may or may non hold an impact on reported income, conditional to their categorization.
Empirical surveies on the Fair Value Accounting in Global Financial Crisis
Chapter 3 Sample Selection and Research Design
This chapter examines the research methodological analysis and the informations sample that will be used to reply the research inquiry and hypotheses described in Chapter 1. The research worker will use a sequence of pooled time-series cross-sectional Ordinary Least Squares arrested development analyses to look into the information dissymmetry issue of just value estimates in the U.K. banking industry in 2008.
3.1 Data and Sample Selection
The BvD Bankscope Database serves as the primary beginning and get downing point for this survey ‘s sample choice. The survey examines the association of just value estimations and information dissymmetry by using Bankss quarterly accounting
3.1 Information Asymmetry and Bid-Ask Spread Proxy
Many types of variables are used as placeholders since information dissymmetry among investors can non be straight observed in equity markets. Clarke and Shastri ( 2000 ) noted that there are three classs of information dissymmetry measurings viz. :
1. Investing chance set steps
2. Analysts forecast steps
3. Market microstructure steps
However, a popular placeholder used in market microstructure literature is the bid-ask spread. This is chiefly because the bid-ask spread tackles the inauspicious choice quandary that stems from steadfast portions minutess in the presence of informed and uninformed investors likewise. Harmonizing to Leuz and Verrecchia ( 2000 ) the less inauspicious choice is brought out by less information dissymmetry, which in bend suggests a smaller bid-ask spread. Hence, in this survey the bid-ask spread will be used as the underlying placeholder for information dissymmetry due to its sound proficient development and widespread usage as a placeholder for information dissymmetry in many finance and accounting literature ( Bhat and Jayaraman, 2009 ) .
The command monetary value is the basically the recognized purchasing monetary value from traders and the ask monetary value is their recognized merchandising monetary value. The difference is the bid-ask spread. Bagehot ( 1971 ) was first to do a correlativity with information dissymmetry and the bid-ask spread based on the work of Demsetz ( 1968 ) who presented empirical literature on the theory of securities dealing costs. It was subsequently