Amir Amel-Zadeh

Bank Failure, Mark-to-Market and the Financial Crisis

This paper is concerned with the allegation that fair value accounting rules have contributed significantly to the recent financial crisis. It focuses on one particular channel for that contribution: the impact of fair value on actual or potential failure of banks. The paper compares four criteria for failure: one economic, two legal and one regulatory. It is clear from this comparison that balance sheet valuations of assets are in two cases crucial in these definitions, and so the choice between “fair value” or other valuations can be decisive in whether a bank fails; but in two cases fair value is irrelevant. Bank failures might arise despite capital adequacy and balance sheet solvency due to sudden shocks to liquidity positions. Two of the most prominent bank failures cannot, at first sight, be attributed to fair value accounting: we show that Northern Rock was balance sheet solvent, even on a fair value basis, as was Lehman Brothers. The anecdotal evidence is augmented by empirical tests that suggest that mark-to-market accounting does not increase the perceived bankruptcy risk of banks.

Bank Failure, Mark-to-market and the Financial Crisis: Bank failure, Mark-to-market and the Financial Crisis

This paper is concerned with the allegation that fair value accounting rules have contributed significantly to the recent financial crisis. It focuses on one particular channel for that contribution: the impact of fair value on the actual or potential failure of banks. The paper compares four criteria for failure: one economic, two legal and one regulatory. It is clear from this comparison that balance sheet valuations of assets are, in two cases, crucial in these definitions, and so the choice between ‘fair value’ or other valuations can be decisive in whether a bank fails; but in two cases fair value is irrelevant. Bank failures might arise despite capital adequacy and balance sheet solvency due to sudden shocks to liquidity positions. Two of the most prominent bank failures cannot, at first sight, be attributed to fair value accounting: we show that Northern Rock was balance sheet solvent, even on a fair value basis, as was Lehman Brothers. The case study evidence is augmented by econometric tests that suggest that mark�?to�?market accounting has had only a very limited influence on the perceived failure risk of banks.

The Return of the Size Anomaly: Evidence from the German Stock Market

This paper examines the size effect in the German stock market and intends to address several unanswered issues on this widely known anomaly. Unlike recent evidence of a reversal of the size anomaly this study documents a conditional relation between size and returns. I also detect strong momentum across size portfolios. The results indicate that the marginal effect of firm size on stock returns is conditional on the firms past performance. I use an instrumental variable estimation to address Berks critique of a simultaneity bias in prior studies on the small firm effect and to investigate the economic rationale behind firm size as an explanatory variable for the variation in stock returns. The analysis in this paper indicates that firm size captures firm characteristic components in stock returns and that this regularity cannot be explained by differences in systematic risk.

The Economic Consequences of Financial Restatements: Evidence from the Market for Corporate Control

This paper investigates whether and how financial restatements affect the market for corporate control. We show that firms that recently filed financial restatements are significantly less likely to become takeover targets than a propensity score-matched sample of non-restating firms. For those restating firms that do receive takeover bids, the bids are more likely to be withdrawn or take longer to complete than those made to non-restating firms. Finally, there is some evidence that deal value multiples are significantly lower for restating targets than for non-restating targets. Our analyses suggest that the information risk associated with restating firms is the main driver of these results. Overall, this study finds that financial restatements have profound consequences for the allocation of economic resources in the market for corporate control.

The Contribution of Bank Regulation and Fair Value Accounting to Procyclical Leverage

Our analytical description of how banks’ responses to asset price changes can result in procyclical leverage reveals that for banks with a binding regulatory leverage constraint, absent differences in regulatory risk weights across assets, procyclical leverage does not occur. For banks without a binding constraint, fair value and bank regulation both can contribute to procyclical leverage. Empirical findings based on a large sample of US commercial banks reveal that bank regulation explains procyclical leverage for banks relatively close to the regulatory leverage constraint and contributes to procyclical leverage for those that are not. We also show that fair value accounting does not contribute to procyclical leverage by finding (i) the portion of comprehensive income attributable to fair value accounting, i.e., fair value comprehensive income, has a negative relation with change in leverage as expected for any increase in equity, (ii) no evidence of a positive relation between fair value comprehensive income and banks’ net purchases of assets, and (iii) the relation between change in leverage and fair value comprehensive income is more negative than that between change in leverage and change in equity.

Why and How Investors Use ESG Information: Evidence from a Global Survey

Using survey data from a sample of senior investment professionals from mainstream (i.e. not SRI funds) investment organizations we provide insights into why and how investors use reported environmental, social and governance (ESG) information. Relevance to investment performance is the most frequent motivation for use of ESG data followed by client demand and product strategy, bringing change in companies, and then ethical considerations. Important impediments to the use of ESG information are the lack of reporting standards and as a result lack of comparability, reliability, quantifiability and timeliness. Among the different ESG investment styles, negative screening is perceived as the least investment beneficial while full integration into stock valuation and engagement are considered more beneficial but they are all practiced with equal frequency. Current practices of different ESG styles, especially screening, are driven by product and ethical considerations. In contrast, integration is driven by relevance to investment performance. Future practices of ESG styles are driven by relevance to investment performance, bringing change in companies, and concerns about data reliability.

The Materiality of Nonfinancial Information: A Review of Theory and Empirical Evidence on Sustainability Disclosures, Corporate Social Responsibility and Responsible Investing

This study consolidates the existing body of knowledge on the theory and empirical evidence of shareholder value effects of social responsibility and the returns to socially responsible investing. In doing so, it draws from the literature in accounting, economics, finance, law and management with evidence from related disciplines. Based on the findings of the prior literature the study proposes a framework that distinguishes between the corporate view (CSR) and the investor view (SRI). In CSR it discriminates between three hypotheses of shareholder value effects of corporate social responsibility: Agency costs, delegated philanthropy and ‘doing well by doing good’. Within the latter it identifies four impact areas and several channels of influence to aid future researchers to answer more targeted research questions on the relationship between CSR and shareholder value. In SRI the study reviews the evidence how social responsibility affects investment returns and how CSR is incorporated into asset prices distinguishing between firm-level and fund-level effects. The study identifies differences by investment strategies and investor characteristics. Based on the proposed framework the study concludes with suggestions for future research.

Measuring Fair Value when Markets Malfunction: Evidence from the Financial Crisis.

In this paper we focus on fair value measurements in the Financial Crisis and its (continuing) aftermath. We consider different ways of measuring fair value; and we use the experience of economies under stress, and where markets deviate significantly from textbook models of symmetric information and perfect competition, to trace some perverse economic consequences of fair value measurement choices prescribed by accounting standard setters. We draw on anecdotal and case evidence from the banking crisis and its aftermath for the wider economy. The discussion focuses particularly on banks’ balance sheets and then on pension liabilities across all sectors.

Are All Insider Sales Created Equal? New Evidence from Form 4 Footnote Disclosures

This study is the first to analyse managers’ voluntary supplementary disclosures on insider trade filings with the SEC. Based on the content of the disclosures, we are able to distinguish between discretionary and nondiscretionary sales. We document significantly negative abnormal filing returns to discretionary sales while abnormal returns to nondiscretionary sales are essentially zero. Examining the motivations for supplementary disclosures with discretionary sales, we find evidence consistent with insiders strategically disclosing liquidity needs to disguise informed trading. Disclosures to discretionary sales are more likely when the legal risk of trading is high and when insiders offload a large amount of stock. Although investors react negatively to these disclosures, we also find significantly negative long-term abnormal returns over the subsequent months suggesting that investors under-react to the negative information in these sales. A long-short portfolio investment strategy that exploits this under-reaction earns an economically significant 16% risk-adjusted return per year. Consistent with insiders selling ahead of bad news, discretionary sales for which insider provide disclosures are more likely to precede analyst downgrades and negative earnings surprises.

Price Discovery and Accounting Under Stress

We develop a general equilibrium model to investigate the adverse effects of liquidity risk on price discovery and to examine the interaction of (externally or internally imposed) solvency requirements for financial institutions with the accounting measurement for financial assets in markets under stress. The model develops liquidity demand and supply curves generating two types of general equilibria: liquid and illiquid. We then investigate the adverse feedback effects in the illiquid equilibrium in response to banks selling risky assets to satisfy solvency requirements. Our model captures negative externalities of other banks responding to a liquidity shock with precautionary hoarding and predicts that the potential of bank runs reduces the motivation to hoard. Model results further suggest that applying mark-to-market accounting in the illiquid equilibrium can lead to loss spirals transforming a bank’s illiquidity problem to one of insolvency. We discuss several policy implications for the role of fair value accounting in linking liquidity and solvency problems of banks during times of market stress.