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Global Issues in Accounting Conference 2010

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Global Issues in Accounting Conference 2010 Powered By Docstoc
					Jannis Bischof, Mannheim / Ulf Brüggemann, Lancaster / Holger Daske, Mannheim *

Relaxation of Fair Value Rules in Times of Crisis:
An Analysis of the Economic Benefits and Costs of the Amendment to IAS 39

INTACCT Paris
1 July 2010




                                       * Area of Accounting & Taxation
                                       University of Mannheim
                                       D-68131 Mannheim
                                       Tel.: +49 (0)621 181 2352
                                       Fax: +49 (0)621 181 1694
                                       E-mail: daske@bwl.uni-mannheim.de
 Relaxation of Fair Value Rules: Introduction                                  –2 –

                                                SETTING

      In the heat of the financial crises, in October 2008, the IASB
       forwent any regular due process to issue emergency
       amendments to IAS 39 and IFRS 7

      Option to retroactively reclassify financial assets previously
       measured at fair value into amortized costs, i.e. suspend fair
       value measurement (“reclassifications”)

      Option introduced under severe political pressure, most notably
       from EU leaders, e.g. French President Nicolas Sarkozy

     Banks make ample use of option to forgo substantial write
      downs
      E.g., Deutsche Bank boost income by 3.2bn Euro
INTACCT Paris, 1 July 2010                                Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Introduction                                     –3 –

                                                MOTIVATION

      Official reasoning: Competitive disadvantages vis-à-vis U.S.
       banks due to reclassification options in SFAS 65 & 115

      Amendment was probably politically perceived as cheap way to
       put pressure off the banking sector due to link between
       accounting numbers and regulatory capital

      Two alternative political strategies
           Relaxation of regulatory capital requirements
           Relaxation of accounting rules

      We investigate key economic consequences of the decision to
       relax fair value rules

INTACCT Paris, 1 July 2010                                   Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Introduction                                           –4 –

                                        ANALYSES AND RESULTS (1)


(1) Descriptive evidence on reclassification choice and effects

(2) Economic and political drivers of the reclassification choice

(3) Stock price reactions to reclassification announcements
    Expected reclassification effects around regulatory events
    Realized reclassification effects around firm-specific
       announcements

(4) Long-term effects on information asymmetry


INTACCT Paris, 1 July 2010                                         Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Introduction                                           –5 –

                                        ANALYSES AND RESULTS (2)

      41% of IFRS banks reclassify, saved profits 22bn Euros in total,
       only 1/3 in full compliance with IFRS 7 requirements

      Choice can be traced to regulatory costs, political costs, …,

      At least some banks benefit from reclassifications by avoiding fair
       value write-offs and, thus, forgoing regulatory costs (contracting
       role of fair value accounting)

      In the long run, the suspension of fair value accounting comes at
       the cost of greater adverse selection if disclosure requirements
       are not complied with (informational role of fair value
       accounting)

INTACCT Paris, 1 July 2010                                         Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Introduction                                       –6 –

                                                CONTRIBUTION

 Regulatory debate: Relaxation of capital requirements vs. change
  of accounting standards (Laux/Leuz 2009; Bushman/Landsman
  2010, Barth/Landsman 2010 - Skinner 2008, Bernard et al. 1995)
    Analyze the effects of the link between regulatory capital and
      fair value accounting under IFRS in a cross-country setting

 Politics of standard setting (e.g. Watts/Zimmerman 1986)

 Informational role of fair values (e.g. Barth et al. 1996)
    Decrease vs. increase in fair value information
    Reliability concerns more severe internationally

 Comprehensive & hand-collected international dataset on
  fair values measurement, reclassification, and regulatory capital
INTACCT Paris, 1 July 2010                                     Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Institutional Background                               –7 –

              SEQUENCE OF REGULATORY EVENTS LEADING UP TO THE IAS 39 AMENDMENT
Summer 2008:                 Large banks lobby against fair value rules, strong
                             opposition by IASB
September 2008: US Congress grants SEC right to suspend fair value
                accounting
October 4, 2008: Barroso, Berlusconi, Brown, Merkel, Sarkozy call for
                 reclassifications
October 7, 2008: ECOFIN supports reclassifications
October 8, 2008: Commissioner McCreevy announces that the EU is
                 ready to adopt its own version of IAS 39
October 9, 2008: IASCF Trustees renounce due process
October 13, 2008: IASB adopts reclassification amendments
October 15, 2008: Official endorsement of the amendments in the EU
                  (other jurisdictions follow over the next days)
INTACCT Paris, 1 July 2010                                         Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Institutional Background                                       –8 –

                             THE NEWLY INTRODUCED RECLASSIFICATION RULES

 IAS 39 measurement-basis: FV through P&L, FV through OCI,
  Amortized cost – categorization at initial recognition of financial
  asset

 Types of IAS 39 reclassifications:
                                         Trading              Trading                 AFS
Effect on …
                                         to Cost              to AFS                to Cost
Net Income                                   Yes                Yes                     No
Retained Earnings                            Yes                Yes                     No
Tier 1 Core Capital                   National Law          National Law                No
Revaluation Reserves                         No                 Yes                    Yes
Tier 2 Capital                               No             National Law         National Law
INTACCT Paris, 1 July 2010                                                 Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Institutional Background                                       –9 –

                             THE NEWLY INTRODUCED RECLASSIFICATION RULES

 The IAS 39 amendments are accompanied by extensive disclosure
  requirements in IFRS 7

 Quantitative disclosures
  (1) amounts reclassified for each measurement category
  (2) current fair values
  (3) fair value gain or loss before reclassification
  (4) effect on net income and OCI
  (5) effective interest rate and recoverable amounts

 Qualitative disclosures
  (6) facts and circumstances of the rare situation

INTACCT Paris, 1 July 2010                                                 Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Conceptual Underpinnings                                    – 10 –

                                              MOTIVATION

 What are the economic consequences (from an equity investor’s
  point of view)?

          Economic Benefits                                       Economic Costs

 Avoidance of regulatory                                    Long-term increase in
  costs during crisis:                                        intransparency / opacity:

     Determination of regulatory                              FV information is useful
     capital is linked to IFRS-                               (relevant) for financial
     based accounting numbers                                 analysis

 Contracting role of fair                                   Informational role of fair
  value accounting                                            value accounting

INTACCT Paris, 1 July 2010                                                Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Conceptual Underpinnings                      – 11 –

                                             HYPOTHESES

(1) The reclassification probability increases with the size of a
    bank’s incentives to avoid regulatory costs, political costs, and a
    loss of customer deposits and decreases with the bank’s prior
    commitment to transparency

(2) Abnormal stock returns are positively associated with the size of
    the bank-specific reclassification benefits which are
     expected around regulatory events
     realized around firm-specific announcements

(3) Information asymmetry in the long term is increasing if banks
    reclassify, but do not provide full disclosures


INTACCT Paris, 1 July 2010                                  Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Data                                           – 12 –

                                        SAMPLE

 Global sample of all listed IFRS banks
      302 banks with English, Chinese, French, and German language
       reports (39 countries)
      Approx. 90% of market capitalization of all listed IFRS banks


 Manual collection
         IAS 39 reclassification amounts for each financial instrument category
         IFRS 7 notes disclosures
         Effect on regulatory capital
         Announcement dates


 Country variables (political FV debate, capital regulation,
  institutions)

INTACCT Paris, 1 July 2010                                   Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Descriptive Evidence                                      – 13 –

                         ACCOUNTING EFFECTS OF FAIR VALUE RECLASSIFICATIONS

 Reclassification choice




INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Descriptive Evidence                                      – 14 –

                         ACCOUNTING EFFECTS OF FAIR VALUE RECLASSIFICATIONS

 Effect on net income (% of variable before reclassifications)




 Effect on capital (% of variable before reclassifications)




INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                                  – 15 –

                              ECONOMIC DETERMINANTS AT THE FIRM LEVEL

 Capital management incentives
                   Unrealized FV
                                               Inclusion in regulatory capital …
                 changes (IFRS) …

                                                       100%, if negative
                       AFS Assets                 < 100% (haircut), if positive:
 Tier 2               (Revaluation                            asset type
                        Reserves)                         future tax charge
                                                         level of application


                    Trading Assets
                                                               100%
 Tier 1               (Retained
                                                      (positive and negative)
                      Earnings)

INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                                  – 16 –

                              ECONOMIC DETERMINANTS AT THE FIRM LEVEL

 Capital management incentives
               Unrealized FV
                                               Inclusion in regulatory capital …
            changes (IFRS) …
       Country-specific
       minimum capital
            ratio                                      100%, if negative
                       AFS Assets                 < 100% (haircut), if positive:
                                                    Country-specific haircut
 Tier 2               (Revaluation                           asset type
                                                    on unrealized FV gains
                        Reserves)                        future tax charge
                                                      (“prudential filter”)
                                                        level of application


                    Trading Assets
                                                               100%
 Tier 1               (Retained
                                                      (positive and negative)
                      Earnings)

INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                                  – 17 –

                              ECONOMIC DETERMINANTS AT THE FIRM LEVEL

 Minimum capital ratio (total capital)
   8% (Basel II): 27 countries
   10%: 7 countries
   12%: 5 countries

 AFS haircuts (debt securities)
   Average: 61%
   Minimum: 0% (8 countries)
   Maximum: 100% (3 countries)
   Additional tax haircuts in 12 countries



INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                                  – 18 –

                              ECONOMIC DETERMINANTS AT THE FIRM LEVEL

 Additional explanatory factors

Variable                       Direction Approximation
                                     +      Lobbying (IIF membership)
Political Costs                      +      Political intensity of the fair value debate
                                     +      Governmental shareholdings
                                     +      Zero Earnings (→ Private Depositors)
Earnings Targets
                                     +      Consensus Forecast (→ Analysts)
Commitment to                         -     Past earnings quality (ALLP)
Transparency                         +      Income Volatility
                                     +      Investment in Securities
Business Model
                                     +      Exposure to Market Risks (Financial Crisis)


INTACCT Paris, 1 July 2010                                              Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                                     – 19 –

                             ECONOMIC DETERMINANTS AT THE FIRM LEVEL: RESULTS




INTACCT Paris, 1 July 2010                                                 Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 20 –

                     STOCK MARKET REACTIONS (SHORT-TERM): REGULATORY EVENTS
 The univariate analysis of abnormal stock market returns around
  regulatory events leading to the IAS 39 / IFRS 7 amendments is
  severely confounded
    simultaneous economic stimulus packages
    extraordinary volatility
    extremely short time-frame

 In the cross-sectional analysis, we can control for investor’s
  expectations
  (1) about a bank’s reclassification choice
       - perfect foresight assumption vs.
       - prediction model (based on determinants analysis)
  (2) About bank-specific benefits from avoiding regulatory costs

INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 21 –

                     STOCK MARKET REACTIONS (SHORT-TERM): REGULATORY EVENTS




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 22 –

                     STOCK MARKET REACTIONS (SHORT-TERM): REGULATORY EVENTS




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 23 –

                     STOCK MARKET REACTIONS (SHORT-TERM): REGULATORY EVENTS




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 24 –

               STOCK MARKET REACTIONS (SHORT-TERM): FIRM-SPECIFIC ANNOUNCEMENTS
 Firm-specific announcement resolves the remaining uncertainty
  about the banks’ accounting choices as well as the resulting
  effects on accounting numbers and, thus, regulatory capital

 Therefore, we can replace our proxies for investor expectations
  by the realized effects




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 25 –

               STOCK MARKET REACTIONS (SHORT-TERM): FIRM-SPECIFIC ANNOUNCEMENTS




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 26 –

                     STOCK MARKET EFFECTS(LONG-TERM): INFORMATION ASYMMETRY

 Dependent variable = bid/ask spread

 Independent variables
    Reclassification dummy
    Magnitude of reclassification is captured by the effect on net
     income
    Disclosure quality is proxied for by compliance with all six
     requirements laid out in IFRS 7

 Differences in differences design




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Analysis                                               – 27 –

                   STOCK MARKET REACTIONS (LONG-TERM): INFORMATION ASYMMETRY




INTACCT Paris, 1 July 2010                                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Summary                                             – 28 –

                                   IMPLICATIONS AND CONCLUSIONS

 During the crisis, the relaxation of fair value rules granted crises-
  effected banks regulatory forbearance

 Short-term benefits may come at long-term costs

       Reclassifications increase opacity if they are not accompanied
        by full disclosures

       Interference of EU into IASB standard setting process poses
        major obstacle to convergence with U.S. going forward

 Alternative: relaxation of capital requirements
   But more complex coordination process, unlike IFRS,
      banking regulation nationally regulated
INTACCT Paris, 1 July 2010                                        Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Back-Up                                – 29 –

                                           BACK-UP




INTACCT Paris, 1 July 2010                           Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Back-Up                                                      – 30 –

                                 ECONOMIC DETERMINANTS AT THE FIRM LEVEL




Global Issues in Accounting, 4 June 2010                                   Bischof / Brüggemann / Daske
 Relaxation of Fair Value Rules: Back-Up                                                – 31 –

               STOCK MARKET REACTIONS (SHORT-TERM): FIRM-SPECIFIC ANNOUNCEMENTS




Global Issues in Accounting, 4 June 2010                             Bischof / Brüggemann / Daske

				
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