Information asymmetry of fair value accounting and loan loss provisions during the global financial crisis

Abstract

This thesis investigates whether U.S. banks’ assets and liabilities, reported using Fair Value Accounting (FVA) under SFAS 157 Fair Value Measurement, are associated with information asymmetry among equity investors during the 2008 Global Financial Crisis. Using bid-ask spread as a proxy for information asymmetry and controlling for bank size, profitability, default risk and capital adequacy, I find that bid-ask spread is positively and significantly associated with total fair value net assets and net assets measured using Level 1 inputs (unadjusted observable inputs in active markets), Level 2 inputs (other indirect observable inputs), and Level 3 inputs (unobservable inputs reflecting firm’s own assumptions and models), as specified in SFAS 157. On the other hand, the U.S. Securities and Exchange Commission (2008) has alleged that large loan loss provisions, determined based on managerial internal information and discretion, played a significant role in bank failures in the Global Financial Crisis. I, therefore, examine whether banks’ loan loss provisions, specifically Provisions for Loan Losses (PLL) appearing on the income statement and Allowance for Loan Losses (ALL) appearing on the balance sheet, are associated with information asymmetry. I find that both PLL and ALL are positively and significantly associated with bid-ask spread, with higher standardized coefficients than that of fair value net assets. As the economic condition kept worsening during the Global Financial Crisis, I also find that both fair value net assets and loan loss provisions are constantly and positively associated with information asymmetry across the four quarters of 2008. The results are robust using constant samples, analysing fair value assets and liabilities separately, using a sample of non-bank firms, and extending the dataset to the fiscal year 2009. In short, both fair value net assets and loan loss provisions are associated with information asymmetry among equity investors during the 2008 Global Financial Crisis, with loan loss provisions having the stronger of the two effects.