Measurement Model or Asset Type: Evidence from an Evaluation of the Relevance of Financial Assets

This study focuses on the operation of the Level 1, 2, and 3 measurement uncertainty hierarchy embedded in the SFAS 157 accounting for financial assets. Prior studies conclude the SFAS 157 fair value measurement model and prevailing financial market conditions are causal factors for the lower value relevance of the Level 3 financial assets. The contribution of our paper is to provide evidence on an additional, hitherto undocumented source of measurement uncertainty impacting the relevance of SFAS 157 financial assets to investors: the type of asset appearing in Level 3 financial assets as a result of asset securitizations and SFAS 140 securitization accounting. The paper also presents evidence that suggests the SFAS 166 amendments were unable to fully address informational transparency for financial assets arising from securitizations. The key contribution is evidentiary insights suggesting the prescribed measurement model has a relatively lower impact on measurement uncertainty and relevance of financial assets compared to the effects of the asset type.     

Voluntary fair value disclosures beyond SFAS 157’s three-level estimates

Some firms voluntarily make disclosures about the controls and processes in place to ensure the reliability of fair value estimates. Consistent with these disclosures being driven by investors’ concerns about the reliability of their SFAS 157 estimates, we find that firms with more opaque estimates are more likely to provide such disclosures. We then examine whether these disclosures improve investors’ perception about the reliability of fair value estimates. We find that they are associated with higher market pricing and lower information risk for Level 3 estimates. Further analyses of the disclosures reveal that the following types of information are particularly important to investors: discussion of the external and independent pricing of fair value estimates and their proper classification according to the SFAS 157 hierarchy. Overall, our results suggest that the voluntary reliability disclosures that firms provide beyond SFAS 157’s three-level estimates help reduce investors’ uncertainty toward the more opaque fair value estimates.     

Information Asymmetry and Voluntary SFAS 157 Fair Value Disclosures by Bank Holding Companies During the 2007 Financial Crisis

We hand‐collect SFAS 157 voluntary fair value disclosures of 18 bank holding companies. The SEC's Division of Corporate Finance likely targeted these entities in 2008 through their “Dear CFO” letters in which they requested specific, additional disclosure items. We collect disclosures that match the SEC recommendations and create eight common factor disclosure variables to examine the effect of such disclosures on information asymmetry. We find that disclosure variables about the use of broker quotes or prices from pricing services and the use of market indices and illiquidity adjustments are related to lower information asymmetry. However, disclosure variables about valuation techniques and asset‐backed securities are related to greater information asymmetry. We also document that disclosure complexity, and disclosure tone (uncertainty and litigious) is related to greater information asymmetry. These findings are consistent with criticism that corporate disclosures are voluminous; management may obfuscate unfavorable information which in turn increases market participants’ assessment of uncertainty associated with the fair value measures. We caveat that the setting of the financial crisis and a small sample size may limit the ability to generalize these inferences to other time periods or other financial firms.     

Corporate governance,SFAS 157 and cost of equity capital: evidence from US financial institutions

This study examines the association between fair value measurements and the cost of equity capital under different fair value valuation methods, and assesses the impact of corporate governance on this relationship for US financial firms. We find that firms’ cost of equity capital is negatively associated with more verifiable fair value assets and positively related to less verifiable fair value assets. Furthermore, the positive association between less verifiable fair value assets and the cost of equity capital is mitigated under better corporate governance. The differential impact between more and less verifiable assets becomes smaller for firms with stronger governance. Our findings contribute to the ongoing debate on fair value regulation by investigating the economic consequences of adopting Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157) and the importance of audit committee financial expertise on fair value reporting. We also provide evidence on the importance of board independence, internal control strength, auditor industry specialists, and audit committee financial experts in fair value reporting.     

Did crisis alter trading of two major oil futures markets?

The paper analyzes how traders in two major oil futures markets: New York Mercantile Exchange (NYMEX) and Intercontinental Exchange, reacted to the 2008 financial crisis, particularly whether they shifted their trading pattern and whether the relative information role of the two markets changed. Using trade-by-trade data, the paper analyzes several trading characteristics including trading volume, trade size, volatility, bid–ask spread, and relative information share. On average, NYMEX is characterized by greater volume, trade size and slightly greater spread. Before the crisis, NYMEX leads the process of price discovery, and volatility and trade size are significant factors explaining this leadership. However, following the financial crisis of 2008, the leadership role of NYMEX declines and trade size and volatility are no longer significant factors. Contrary to results of most equity market research, bid–ask spread is not a significant factor in information share and causality tests indicate that causality runs from spread to information share before the crisis but the opposite holds during the crisis period.     

Adjustment of valuation inputs and its effect on value relevance of fair value measurement

The fair value accounting standards; i.e., FAS 157, FAS 157-3 and FAS 157-4, specify the circumstances where firms need to adjust valuation inputs to fair value measurements in response to changes in market conditions. Such an adjustment inherently involves substantial management judgment and is accompanied with transfers of assets and liabilities among the different levels of the fair value hierarchy. We study the effect of adjusting valuation inputs to reflect market variations on value relevance of fair value measurements by comparing the value relevance of fair value assets between the banks that make transfers of assets and the banks that make no transfers. Overall, we find a significant increase in value relevance of fair value measurements for banks that transferred assets into/out of the Level 3 category. Our study examines a challenging situation in the application of fair value standards; i.e., determining fair value when there is a change in market conditions. Fair value measurement under such a situation involves substantial management judgment and potential estimate errors and manipulation. Our findings provide useful information for researchers, regulators and accounting professionals to assess the market’s perception of the reliability of fair value information when management exercises substantial discretion in adjusting valuation inputs under changing market conditions.     

Asset reliability and security prices: evidence from credit markets

We assess the relation between asset reliability and security prices. Concerns about asset reliability are increasing with the move to fair value accounting in general purpose financial reports. We provide pertinent evidence from credit markets. A key benefit of using credit market data to explore the capital market implications of asset reliability is the theoretical basis of Duffie and Lando (Econometrica 69(3):633–664, 2001). They show that asset reliability (measurement) concerns should be concentrated in short-term credit spreads. Thus a focus on credit term structure can facilitate a cleaner identification of the impact of asset reliability on security prices. We find that asset reliability issues, attributable to SFAS 157 disclosures of Level 2 and, especially, Level 3 financial assets for a set of US financial institutions over the period of August 2007 to March 2009, are a significant determinant of short-term credit spreads and the shape of the general credit term structure. Our findings are robust to a variety of control variables and research design choices.     

The association between firm characteristics and CFO's opinions on the fair value option for non-financial assets

SFAS 157 provides a common definition for fair value while SFAS 159 expands the applicability of the fair value option. This paper analyzes the responses of 209 CFOs of U.S. firms to a survey asking whether they would choose the fair value option for non-financial assets (FVONFA) and investigates the determinants of CFOs' responses to the option. One of our results suggests that CFOs in the U.S. are resistant to the FVONFA, consistent with prior studies based on firms in Europe and Australia. Our results also suggest that firm size, leverage, the amount of non-financial assets, and expertise in fair value measurements all positively affect the CFOs' responses to the FVONFA.     

Effects of large shareholding on information asymmetry and stock liquidity

Prior studies, such as Claessens et al.’s [Claessens, S., Djankov, S., Fan, J., Lang, L., 2002. Disentangling the incentive and entrenchment effects of large shareholding. Journal of Finance 57, 2741–2771], suggest that deviation between ultimate control and ownership decreases firm value (due to the entrenchment effects of large shareholding). Using a sample of Canadian firms, we study the relation of ultimate control and ownership with an important dimension of stock liquidity – bid–ask spread. We find that stocks with greater deviations between ultimate control and ownership have a larger information asymmetry component of their bid–ask spread and wider bid–ask spread. Our results are consistent with the notion that the ultimate owners of these stocks may have selfish agendas. To increase the probability of the agendas being implemented, the firms may have poor information disclosure, resulting in poor stock liquidity.     

Liquidity and valuation in an uncertain world

During the 2007–2009 financial crisis there was little or no trading in a variety of financial assets, even though bid and ask prices existed for many of these assets. We develop a model in which this illiquidity arises from uncertainty, and we argue that this new form of illiquidity makes bid and ask prices unsuitable as metrics for establishing “fair value” for these assets. We show how the extreme uncertainty that traders face can be characterized by incomplete preferences over portfolios, and we use Bewley's (2002) model of decision making under uncertainty to derive equilibrium quotes and the nonexistence of trading at these quotes. We then suggest alternatives for valuing assets in illiquid markets.     

Fair value disclosures and crash risk

In response to the public criticism of the inadequate disclosures mandated by SFAS No. 157, Fair Value Measurements, the FASB issued ASU (Accounting Standards Update) 2010–06, Improving Disclosures about Fair Value Measurements, and ASU 2011–04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements, in an effort to increase the reporting transparency. We examine whether the increased fair value disclosures required by these two updates effectively decrease crash risk, defined as the frequency of extreme negative stock returns. In support of the hypothesis, we find that increased transparency from these updates reduces crash risk among U.S. banking firms and that the reduction is greater in banks that have a higher level of Level 3 financial assets.     

公允价值计量问题的国际进展及其在中国应用的思考

本文通过阐述美国财务会计准则委员会(FASB)2006年9月发布的《财务会计准则公告第157号》(FASB第157号公告)中关于公允价值定义、确定公允价值的级次等方面的规定,以及国际财务报告准则(IF-RS)中有关公允价值计量的规定和国际会计准则理事会(IASB)对第157号公告主要规定的看法,结合中国兼具新兴市场经济和转型经济国家的经济环境,提出国际上公允价值计量的新发展在中国应用可能存在的问题及建议。     

Do liquidity or credit effects explain the behavior of the BKBM–LIBOR differential?

This paper examines the evolution of the relationship between the onshore and offshore benchmarks for New Zealand dollar funding during the global financial crisis. In August 2007 the BKBM–LIBOR differential switched from positive to negative and then widened considerably following the collapse of Lehman Brothers in September 2008, before narrowing gradually as the turmoil in financial markets subsided. Our structural regression model and decomposition analyses show that changes in liquidity, proxied by bid/ask spreads, largely explain the changes in the BKBM–LIBOR differential over this period and that credit risk factors only played a minor role. However our analysis also shows that bid/ask spreads in the offshore market price information regarding counterparty credit risk, suggesting that our initial results could understate the role played by credit risk factors.     

The shortcomings of fair-value accounting described in SFAS 157

Analysis of the examples given by the FASB to show how fair values, defined as exit prices, should be determined in specified circumstances is revealing. Such prices require determining what hypothetical companies might pay for assets, a costly procedure at best. Even though SFAS 157 specifies exit values, several examples employ values in use and entrance values. Although transaction costs must be excluded, they often are not. Fair valuation of non-financial assets, required in certain circumstances (e.g., business combinations), is particularly difficult to apply. Furthermore, exit values of such assets as work-in-process inventories and special-purpose machines, as defined by SFAS 157, often are zero or negative. Importantly, assets and liabilities restated at exit prices yield balance sheets and income statements that are of little, if any, value to investors in ongoing firms. Further, the examples presented show that fair values could be readily manipulated. Implementation of SFAS 157, therefore, is likely to be costly to investors and independent public accountants.     

Fair Value Accounting and Debt Contracting: Evidence from Adoption of SFAS 159

We examine how fair value accounting affects debt contract design, specifically the use and definition of financial covenants in private loan contracts. Using SFAS 159 adoption as our setting, we find that a small but significant proportion of loans (14.5%) modify covenant definitions to exclude the effects of SFAS 159 fair values. Only a limited number of these modifications exclude assets elected at fair value (less than 7%), while all exclude liabilities elected at fair value. Notably, we document that covenant definition modification is unassociated with ex ante fair value elections. We find that covenant definition modification positively varies with common incentive problems attributed to fair value accounting and negatively varies with benefits attributed to fair value accounting. Our results suggest that fair value accounting is not uniformly detrimental for debt contracting and fair value adjustments are included when they are most likely to improve performance measurement.     

美国公允价值计量准则评介

"公允价值计量"是一个国际性的财务报告难题。2006年9月FASB发布"公允价值计量准则"(SFAS157),制定了新的公允价值定义和计量指南。本文介绍SFAS157的主要理论:脱手价计量目标、市场参与者观和公允价值级次,分析这些理论的形成背景和现实意义,归纳SFAS157的主要特征并探讨它对改进我国新准则公允价值计量应用的借鉴作用。     

What Do FAS 157 “Fair Values” Really Measure: Value Or Risk?

FAS 157, the U.S. accounting standard that prescribes how fair values of assets and liabilities are to be measured when other U.S. GAAP standards require fair valuation, stipulates that fair values be measured as the exit values of assets and liabilities—the proceeds for assets hypothetically sold on the date of the financial report, and, correspondingly, the amount required to settle liabilities on the date of the financial report. This conceptual article argues that exit values do not reflect the value of the net assets of the firm to shareholders, which is best reflected by discounted cash flows to maturity. Moreover, exit values—biasing fair values downward when markets are illiquid—have a pernicious, systemic risk effect; specifically, they give rise to write‐downs that in turn cause contagion: prices of equities and other financial instruments of peers react negatively, leading to further write‐downs by those peers. This may have aggravated the recent financial crisis. However, while exit values are not proper measures of value to shareholders, they are useful measures of downside risk when prospects turn sour for a firm. Thus, both exit values and discounted cash flows should be presented in financial statements.     

INSIDER TRADING,REGULATION, AND THE COMPONENTS OF THE BID–ASK SPREAD

In this article we investigate the relation between insider trading regulations and the bid–ask spread. We decompose the spread into its components before and after the enactment of strict new insider trading rules in New Zealand. We find that the enactment led to a significant decrease in the information asymmetry component of the spread, which is observed mainly in illiquid and high prechange information asymmetry companies. These findings are robust to model specification. In addition, we find a decrease in the contribution of information asymmetry to price volatility.     

The financial reporting of fair value based on managerial inputs versus market inputs: evidence from mortgage servicing rights

This research examines whether the fair value of mortgage servicing rights (MSRs) based on managerial inputs (Level 3) better reflects the cash flow and risk characteristics of the underlying assets than the fair value of MSRs based on market inputs (Level 2). Using mortgage servicing fees as a proxy for the underlying cash flows, we find that the valuation multiples for MSRs based on Level 3 inputs are more positively associated with the persistence of future servicing fees compared with the fair value of MSRs based on Level 2 inputs. We also document that only the valuation multiples based on Level 3 fair values are negatively associated with proxies for risk factors. Our results suggest that, although unobservable inputs are subject to managerial discretions, managers can generate higher quality fair value estimates than market inputs due to their information advantage, especially when the market for the underlying asset is inactive.     

The relative and incremental value relevance of goodwill before and after SFAS No. 142

We explore the value relevance of goodwill against two benchmarks: other accounting information and long-lived tangible assets. Prior research suggests that fair value estimates for goodwill must be inferred from other available information because of the nature of goodwill, including its intangibility. Such inferences are highly discretionary and may limit the usefulness of reported goodwill estimates. Because Statement of Financial Accounting Standards (SFAS) No. 142 relies exclusively on fair value estimates to subsequently measure goodwill, reported values considering management’s increased discretion may be less reliable and less value relevant when presented in conjunction with other accounting information. However, the subsequent accounting measurement for goodwill is not dissimilar from the subsequent measurement for long-lived tangible assets, which are also subject to impairment. In general, impairment measurement is subjective; management may have greater insight, even in the presence of management incentives and other accounting information, that may help confirm or disconfirm investors’ own goodwill estimates. Using other accounting information and long-lived tangible assets as benchmarks for the value relevance of goodwill, we find that reported goodwill provides greater value relevance relative to other accounting information after SFAS 142 and that the difference between the value relevance of goodwill and other long-lived tangible assets is also significantly greater following SFAS 142.