How Does Fair Value Measurement under IAS 39 Affect Disclosure Choices of European Banks?

There is a considerable degree of heterogeneity in the way how European banks present their financial instruments in IFRS financial statements. We identify three major presentation formats that are currently applied: a presentation by measurement category, by product, and by purpose. We find the use of the measurement categories, which were originally designed by IAS 39 for measurement purposes, as line items to be the prevalent choice across countries. We analyze the factors that could explain this disclosure choice. We find that a corresponding regulatory recommendation has a strong effect on the choice. We further find that the disclosure of measurement categories is negatively associated with the relative book value of financial assets measured at fair value. This finding suggests discretionary disclosure management by banks. We conclude, based on behavioral theory, that banks expect investors to have a negative bias in the risk perception of assets measured at fair value.

Inconsistent measurement and disclosure of non-contingent financial derivatives under IFRS: A behavioral perspective

The accounting principle of decomposing hybrid financial instruments into their derivative and non-derivative components is widely accepted as it results in a consistent treatment of hybrid instruments and economically equivalent combinations of contracts. On the other hand, non-contingent derivatives and their economic equivalents are not treated consistently under the mixed accounting model underlying IAS 39. This calls for a critical assessment. The conventional criticism regarding such inconsistencies refers to the creation of opportunities for earnings management. The aim of this paper is to add another perspective by including the effects of the related disclosure rules on risk perception by analysts and investors. Thereby, we consider both the presentation on the balance sheet and the additional disclosure in the notes according to IFRS 7. From extant literature, we diligently develop the hypothesis that, due to availability effects, entities using non-contingent derivatives are perceived to be riskier than entities using economic equivalents, although in fact the latter are riskier due to their exposure to additional counterparty risk. This bias in the perception of disclosures might thereby alter an entity’s costs of capital in a way not intended by IAS 39. In particular, we expect individuals to valuate entities using non-contingent derivatives lower than identical entities using economically equivalent contracts instead. We expect this difference in valuation to result from a higher cognitive availability of negative associations with derivatives than with non-derivatives. The underlying assumptions are outlined as they build a framework of hypotheses that could be tested in future research, particularly in experimental survey studies.

Zur Fraud-on-the market-Theorie im US-amerikanischen informationellen Kapitalmarktrecht : theoretische Grundlagen, Rechtsprechungsentwickling und Materialien

On stock markets, there are regularly (at least) two different information sets: The set determining the market price is not necessarily the same as the one being available to the entity’s management. If the management has the ability to influence the first one, it consequently has the possibility to manipulate the market price. It is sought for conditions under which the general premises of civil law for shareholders’ entitlement to damages are fulfilled taking into consideration an economic capital market theory. Hereby, the first premise is the existence of a damage. The second premise is the damage being caused by the liable party. The prove of the premises is incumbent on the plaintiffs. The fraud on the market-theory facilitates the prove of the first premise: Instead of proving that the investor relied directly on the manipulative statement (or concealment) of the management, it is sufficient to prove that he relied on the integrity of the (manipulated) market price. The fraud on the market-theory obviously influences the conditions sought after. U. S. courts have already accepted the theory in the 1970’s. But not until 1987, the application of the theory was confirmed by the Supreme Court: A chemical company denied negotiations with a competitor about a merger, thereupon shareholders sold their stocks. However, in spite of the denial, the success of the negotiations was announced just a few weeks later and the market price rose. The shareholders claimed for damages resulting from the artificially deflated market price at the time of their selling. The Supreme Court judged: “Because most publicly available information is reflected in market price, an investor’s reliance on any public misrepresentations […] may be presumed.” Though this presumption was made in order to streamline securities fraud litigation, the Supreme Court also (implicitly) demanded the verification of the derived theoretical conditions

Zur Fraud-on-the-market-Theorie im US-amerikanischen informationellen Kapitalmarktrecht: Theoretische Grundlagen, Rechtsprechungsentwicklung und Materialien

On stock markets, there are regularly (at least) two different information sets: The set determining the market price is not necessarily the same as the one being available to the entity’s management. If the management has the ability to influence the first one, it consequently has the possibility to manipulate the market price. It is sought for conditions under which the general premises of civil law for shareholders’ entitlement to damages are fulfilled taking into consideration an economic capital market theory. Hereby, the first premise is the existence of a damage. The second premise is the damage being caused by the liable party. The prove of the premises is incumbent on the plaintiffs. The fraud on the market-theory facilitates the prove of the first premise: Instead of proving that the investor relied directly on the manipulative statement (or concealment) of the management, it is sufficient to prove that he relied on the integrity of the (manipulated) market price. The fraud on the market-theory obviously influences the conditions sought after. U. S. courts have already accepted the theory in the 1970’s. But not until 1987, the application of the theory was confirmed by the Supreme Court: A chemical company denied negotiations with a competitor about a merger, thereupon shareholders sold their stocks. However, in spite of the denial, the success of the negotiations was announced just a few weeks later and the market price rose. The shareholders claimed for damages resulting from the artificially deflated market price at the time of their selling. The Supreme Court judged: “Because most publicly available information is reflected in market price, an investor’s reliance on any public misrepresentations […] may be presumed.” Though this presumption was made in order to streamline securities fraud litigation, the Supreme Court also (implicitly) demanded the verification of the derived theoretical conditions.

Fair Value Reclassifications of Financial Assets during the Financial Crisis

At the peak of the financial crisis in October 2008, the IASB amended IAS 39 to grant companies the option of abandoning fair value recognition for selected financial assets. Using a comprehensive global sample of publicly listed IFRS banks, we find that banks use the reclassification option to forgo the recognition of fair value losses and ultimately the regulatory costs of supervisory intervention. Analyses of stock market reactions suggest that a small subset of the most troubled banks benefit from such reclassifications. However, analyses of related footnote disclosures reveal that two-thirds of reclassifying banks do not fully comply with the accompanying IFRS 7 requirements. These banks experience a significant increase in bid-ask spreads in the long run.Bank Regulation, Fair Value Accounting, Financial Crisis, IAS 39, IFRS 7

Inconsistent measurement and disclosure of non-contingent financial derivatives under IFRS : a behavioral perspective

The accounting principle of decomposing hybrid financial instruments into their derivative and non-derivative components is widely accepted as it results in a consistent treatment of hybrid instruments and economically equivalent combinations of contracts. On the other hand, non-contingent derivatives and their economic equivalents are not treated consistently under the mixed accounting model underlying IAS 39. This calls for a critical assessment. The conventional criticism regarding such inconsistencies refers to the creation of opportunities for earnings management. The aim of this paper is to add another perspective by including the effects of the related disclosure rules on risk perception by analysts and investors. Thereby, we consider both the presentation on the balance sheet and the additional disclosure in the notes according to IFRS 7. From extant literature, we diligently develop the hypothesis that, due to availability effects, entities using non-contingent derivatives are perceived to be riskier than entities using economic equivalents, although in fact the latter are riskier due to their exposure to additional counterparty risk. This bias in the perception of disclosures might thereby alter an entity’s costs of capital in a way not intended by IAS 39. In particular, we expect individuals to valuate entities using non-contingent derivatives lower than identical entities using economically equivalent contracts instead. We expect this difference in valuation to result from a higher cognitive availability of negative associations with derivatives than with non-derivatives. The underlying assumptions are outlined as they build a framework of hypotheses that could be tested in future research, particularly in experimental survey studies

IAS 39 and biases in the risk perception of financial instruments

There is a wide variety of reporting choices when presenting and disclosing financial instruments under IFRS. Behavioural theory suggests that the label under which a financial instrument is presented affects the risk perception of investors. We analyse in an experimental setting how and why the European reporting practice of presenting financial instruments by measurement categories affects non-professional investors’ risk perception. We find that risk perception depends on management’s choice of a measurement category and not solely on the dimensions of the underlying cash flows. This bias results from an interaction of availability and representativeness effects and calls into question the acceptability of a presentation by measurement category as allowed by IFRS 7

How does fair value measurement under IAS 39 affect disclosure choices of European banks?

There is a considerable degree of heterogeneity in the way how European banks present their financial instruments in IFRS financial statements. In a sample of 109 European banks, we identify three major presentation formats that are currently applied: a presentation by measurement category, by product, and by purpose. We find the use of the measurement categories, which were originally designed by IAS 39 for measurement purposes, as line items to be the prevalent choice across countries. We analyze the factors that could explain this disclosure choice. We find that a corresponding regulatory recommendation has a strong effect on the choice. We further find that the disclosure of measurement categories is negatively associated with the relative book value of financial assets measured at fair value. This finding suggests discretionary disclosure management by banks. We conclude, based on behavioral theory, that banks expect investors to have a negative bias in the risk perception of assets measured at fair value

Issues in fair value accounting under IFRS

The dissertation presents theoretical evidence for inconsistencies in fair value accounting under IFRS, experimental evidence for biases in risk perception of fair values and empirical evidence for discretion in banks' disclosure policies with respect to fair value measurement