The Effect of Mark-to-Market Accounting for Financial Assets and Liabilities on Financial Reporting Transparency and Information Asymmetry in Banks

Ray Ball, Sudarshan Jayaraman, Lakshmanan Shivakumar
2012 Social Science Research Network  
We examine the relation between mark-to-market (MTM) accounting for securities and information asymmetry among bank investors. Relative to the historical cost method, MTM accounting incorporates more timely information in the financial statements. The primary effect of more timely disclosure of information most likely is to reduce information asymmetry. Nevertheless, models in which accelerating the public release of underlying asset values triggers private information acquisition (McNichols
more » ... Trueman, 1994; Demski and Feltham, 1994; Kim and Verrecchia, 1991) imply some offsetting increase in asymmetry due to differential information production among investors. Furthermore, and incrementally to disclosure effects, we hypothesize that recognition (incorporating MTM gains and losses in earnings) can increase information asymmetry through a variety of channels. Finally, based on the reasoning in Ball, Jayaraman and Shivakumar (2012) , we hypothesize that MTM accounting for securities lowers the likelihood of analyst following and of management forecasting, further exacerbating information asymmetry. Consistent with the above arguments, we document an economically and statistically significant relation between banks' use of MTM accounting and their bid-ask spreads, analyst following and management forecasting. A difference-in-differences design at the introduction of mandatory MTM accounting by SFAS No. 115 reveals a significant increase in spreads for affected banks. There is no such increase for banks that previously used MTM on a voluntary basis. Further, we find similar increases for banks that previously disclosed but did not MTM their gains and losses in earnings, consistent with the hypothesis that information asymmetry arises primarily from recognition effects and not from investors receiving more timely information through disclosure. Similarly, banks exercising the option under SFAS No. 159 to widen their use of MTM accounting experience increases in spreads compared to non-adopters, though these results could be confounded by financial crisis effects. Overall, our results point to a previously undocumented adverse informational consequence of using MTM accounting relative to historical cost. These results should not be interpreted as advocating abandoning MTM accounting, but as highlighting the tradeoffs involved in choosing historical cost versus MTM rules. Barth, M.E., W.R. Landsman and J.M. Wahlen, 1995, Fair value accounting: Effects on banks' earnings volatility, regulatory capital and value of contractual cash flows,
doi:10.2139/ssrn.1947832 fatcat:p7wdfvnhlnh5zepytaqfwe5khi