Fair value accounting hierarchy, value relevance, quality of financial statements and procyclical leverage: an empirical analysis in context’
Tsadira- Pocha, Zoi
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The financial statements of European and Norwegian listed banks are examined for the period 2008-2016. The thesis discusses the effect of fair value accounting levels on various areas of accounting, examines the quality of financial statements and comments on issues of leverage. In its first part the research analyses the effect of the recently introduced IFRS 13 on the value relevance of financial statements. The specific Standard is mandatorily implemented in EU since year 2013; therefore, the evaluation of its implementation and the analysis of its implications to the market is a novel issue in the accounting related literature that interests primarily investors, financial markets and banks. More specifically, the study examines whether investors equally consider the fair value levels appraisals and estimates possible interaction of fair value estimations to the firm’s external and internal factors. The research contributes to the accounting literature by concluding that all levels of the fair valued assets and level 3 liabilities are found to be value relevant to investors’ decisions. Issues of misevaluations are found in all three levels but are more intense on the level 3 assets. There are two robustness checks performed to evaluate the effect of bank size and capital strength to the primary regression. Results show that both factors affect the original results. Results demonstrate that model-based evaluations are not taken under consideration by investors when the latter invest in small, medium and large banks but are highly appreciated when investing in very large banks. The bank’s capital strength parameter revealed that stronger banks’ investors primarily consider the fair value assets of level 1. Another interesting point demonstrated is that nor mispricing or value relevance have been improved over time. The study also examines the possible connection of corporate governance mechanisms to the accuracy of the fair value estimations. The strength of a bank’s corporate governance mechanism is value relevant to all levels and of particular importance to its level 3 valuations. Investors believe that high-quality corporate governance produces more value relevant fair value entries. The second group of hypotheses tested in the thesis relate to the question whether the quality of the accounting information has improved over time. The recent financial crisis enhanced the demand for accounting information of higher quality and to that direction standard setters have set various regulations and launched or modified Accounting Standards to secure increased trustworthiness of information. The thesis is the first to evaluate the contribution of those recently implemented accounting and regulatory factors to the quality of financial statements by conducting a before-and-after analysis in the European banking setting. The study provided evidence that quality of accounting information, measured using metrics of earnings management, timely loss recognition and value relevance, has improved in some areas but deteriorated in other. In more detail, the thesis suggests that in the postfair value hierarchy period the quality of some metrics has been improved compared to the pre-fair value hierarchy period. In particular, on the one hand, the quality has improved as regards small net income manipulation, more timely recognition of losses and higher value relevance of stock price and net income (when stock returns are positive). On the other hand, the quality has deteriorated with respect to earnings smoothing and value relevance of net income (when stock returns are negative). Another interesting part of the study analyses quality of financial information in the course of time in an effort to identify possible trend and connect quality to influencing factors. It has been observed that the quality of financial information follows the same direction fluctuations as the EU economic cycle; therefore, entries are influenced by the state of the economy. The third area of interest in the thesis is the research of whether there is a link between accounting and financial stability and the analysis of the factors that can threaten the financial system stability. The thesis examines first the existence of procyclical book leverage in bank’s financial statements and then connects it to the factors that can potentially influence it. Understanding the factors that can influence procyclicality i.e. the amplification of otherwise normal cyclical business fluctuations, means that the interested parties can predict drawbacks and be protected. The research is the first to provide a broad and comprehensive analysis of the determinants of procyclical leverage in the EU bank setting. With reference to the issues of procyclical leverage the study establishes a positive association between economic growth, asset growth and book leverage. Relevant association with market volatility is not observed. Fair value accounting is proved having a positive relation to procyclical leverage both in periods of expansion and of contraction. The importance of this finding lies on the interpretation of this result that wrong fair value estimates can be a threat to future crisis. The next area examined is the role of regulatory items on procyclical leverage. Statistical results reveal that lagged book leverage and risk weight are associated with stronger procyclical leverage, whereas regulatory capital ratio effect is not critical. Results show that well capitalized banks are less constrained to increase book leverage when they expand. Lastly, the relation between risk-asset weight and accounting leverage is proved to be negative. EU banks following the crisis are more conservative and maintain a low-risk profile following the newly imposed regulatory constraints. The thesis concludes that the reduction of risk asset weight in a bank’s portfolio increases accounting leverage procyclicality.