The Impact of Fair Value Measurement for Bank Assets on Information Asymmetry and the Moderating Effect of Own Credit Risk Gains and Losses

Abstract

We examine whether the use of fair value measurement (FVM) for bank assets reduces information asymmetry among equity investors (bid-ask spread) and how this is affected by the recognition of own credit risk gains and losses (OCR). Our findings show that FVM of assets is associated with noticeably lower information asymmetry, and that this reduction is more than twice as large when banks also recognize OCR. In addition, we find that the bid-ask spread is incrementally lower for banks that provide more detailed narrative disclosures on OCR. The findings also indicate that the effects of asset FVM and OCR recognition on the bid-ask spread do not simply capture the differences in the characteristics of the banks and the quality of their information environments. Data Availability: All data are available from public sources.

Fair value accounting: Current practice and perspectives for future research

“…(2019) consider the amount of unrecognized intangibles assets, they find that DVAs are positively related to equity returns when the level of unrecognized intangibles assets is low. Using a sample of 104 IFRS banks from 23 European countries, Fontes, Panaretou, and Peasnell (2018) find that the fair value measurement of assets is associated with noticeably lower information asymmetry and that this reduction is larger when banks also recognize DVAs. This finding is consistent with DVAs providing investors with important information on how gains and losses are shared between equity holders and debtholders (Merton, 1974).…”

“Some fuzzy math”: relational information on debt value adjustments by managers and the financial press

“…Schneider and Tran (2015) find that information asymmetries between investors are not higher for firms that recognize DVAs compared to other FVOL adopting firms. Finally, Fontes et al (2018) find that fair value measurement of banks' assets is associated with lower information asymmetry among investors and that this reduction is noticeably larger when banks also recognize DVAs.…”

“…At the same time, recent empirical studies do not find that DVAs' perceived ''counterintuitiveness'' results in adverse capital market effects. Instead, the evidence suggests that investors perceive DVAs as value-relevant (Chung et al 2017), that investors understand the relation between DVAs and incomplete fair value accounting (Cedergren et al 2015), and that DVAs do not increase information asymmetry between investors (Schneider and Tran 2015;Fontes et al 2018).…”

“…Yet, the young stream of DVA literature provides little evidence on basic characteristics of DVAs such as their occurrence, size, and reporting. The scarce evidence in this regard comes mostly in the form of scaled measures (see, e.g., Schneider and Tran 2015;Fontes et al 2018) or from potentially incomplete samples (Cedergren et al 2015;Chung et al 2017). Prior evidence on DVAs' reporting stems from only two studies.…”

The Discount Rate At The Evaluation Of Fair Value Of Financial Instruments

“…Typically, the fair value of a financial instrument at initial recognition refers to the transaction price, that is, the fair value of the consideration given or received (IFRS 13). However, if a company decides that the fair value at initial recognition differs from the transaction price, it can use the discount method, and then the fair value of financial instruments will be the present value of all future cash flows which are discounted using the prevailing market interest rate for a similar instrument which has a similar credit rating (Fontes, Panaretou, & Peasnell, 2018).…”