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Two essays on fair value accounting: The impact of fair value accounting on maturity structure and credit risk

Xiaoyan May Bao, University of Nebraska - Lincoln

Abstract

Prior research has focused on the impact of fair value accounting on equity markets. The impact of fair value accounting on debt maturity structure and credit risk has not been addressed in the literature. In essay one I investigate how the increased influence of the balance sheet approach on accounting standards is associated with the maturity structure for the most affected companies as indicated by the volatility ratio found in Demerjian (2011). I find that the balance sheet approach is associated with a higher portion of short-term maturity debt in a debt maturity sample, suggesting that short-term maturity debt is used to control the agency cost of debt arising from the balance sheet focus for the sample period from 1988 to 2012. These findings imply that the balance sheet approach, as one of the most significant trends in accounting standards, plays an important role in determining the maturity structure of debt, which is one of key elements of corporate financial policy. In essay two I examine the impact of fair value accounting on credit risk with the focus on Level 3 assets to investigate whether the disclosure of Level 3 assets provides useful information to debt markets. The characteristics that distinguish Level 3 assets from Level 1 assets and Level 2 assets are Level 3 assets' lack of an active market, either directly or indirectly, and the Level 3 assets more subject to management's manipulations. I find that higher amounts of Level 3 assets are associated with lower credit ratings. In addition, I find that larger amounts of Level 3 assets are associated with larger bond spreads for firms near a credit upgrade or downgrade. These findings have important implications because they indicate that fair value measurements may be useful to market participants in debt markets. Before the implementations of fair value measurements, the measurements of assets without active markets (Level 3 assets) have not been observable and so have been treated similarly to other components of assets that reduce the cost of debt at an aggregate level. This contributes to the debt valuation literature by providing evidence that market participants in debt markets distinguish assets without active markets (Level 3 assets) from the other components of assets once the measurements for Level 3 assets become observable.

Subject Area

Accounting

Recommended Citation

Bao, Xiaoyan May, "Two essays on fair value accounting: The impact of fair value accounting on maturity structure and credit risk" (2013). ETD collection for University of Nebraska-Lincoln. AAI3590967.
https://digitalcommons.unl.edu/dissertations/AAI3590967

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