Three essays on the crisis in transparency arising from the financial crisis of 2007-2008
Date
2012
Authors
Zhang, Ziyang (John)
Journal Title
Journal ISSN
Volume Title
Publisher
Abstract
A lesson learned by regulators from the 2007-2008 financial crisis is that the stability and efficiency of capital markets rely on the transparency of financial statements (Casey 2009; Shapiro 2010). The financial crisis of 2007 revealed a crisis in transparency. This thesis examines three important accounting Issues related to the crisis in transparency. Essay 1 examines the alternative accounting treatments for asset securitizations. Specifically, it compares the associations of off-balance sheet and on-balance sheet treatments of securitizations with credit risk in the Credit Default Swap (CDS) market. This study uses the period 2002-2009 to examine the impact of a recent business cycle. I find that the association between off-balance sheet securitization and the CDS premium significantly rises after 2007 when the economy declines, while on-balance sheet securitization's association with the CDS premium does not change with the onset of the recession. The findings are particularly relevant to regulators, who are concerned with the choice of appropriate accounting treatment for asset securitizations. In 2009, in the face of political pressure, the Financial Accounting Standard Board (FASB) relaxed fair value rules to give managers more discretion in measurement. Supporters argued that the accounting regulatory change would help convey managers' private information on the measurement of fair values, while critics of the change were concerned that the increased managerial discretion would be opportunistically exploited by managers to achieve regulatory forbearance. Essay 2 investigates these two assertions by examining the impacts of relaxing fair value rules on the quality of earnings and capital using a sample of United States (US) banks. I find that an increase in managerial discretion in fair value measurement is associated with a lower earnings response coefficient (ERC) during the three-day window around earnings announcements. An increase in managerial discretion in fair value is also associated with earnings management proxied by a higher probability of meeting or beating analysts' forecasts. The significant associations mainly occur during the period after the FASB's relaxation of fair value rules. Additionally, I find higher managerial discretion in fair value is negatively associated with the future quality of bank capital. Overall, my results indicate that the relaxation of fair value measurement rules adversely affected the quality of financial reporting by US banks. Essay 3 examines the relation between fees paid to auditors and the extent of window dressing of leverage in the banking industry. Prior research finds that fees paid to auditors are positively associated with banks' earnings management through loan loss provisions (Kanagaretnam et al. 2010). This study extends the prior research by investigating whetherauditor fees are associated with the extent of window dressing of leverage. As argued by agency theory, fees paid by clients to auditors give rise to an economic bond between auditors and clients. The economic bond created by fees paid by clients to auditors is expected to be influential in the specific setting of this study because window dressing of leverage is largely unregulated, accomplished through real transactions and, therefore, more difficult for auditors to constrain. Consistent with this argument, I find that the extent of window dressing of leverage is significantly and positively associated with unexpected total fees and nonaudit fees. I find that the significant positive relation between unexpected fees and window dressing of leverage mostly originates from banks that have frequent downward window dressing. The results suggest that measures of auditor fee dependence are associated with window dressing of leverage. Auditor fee dependence is a potential threat to auditor independence in the banking industry. The findings are relevant to regulators and policy makers contemplating more extensive disclosure requirements on window dressing of leverage and reviewing requirements related to auditor independence in the banking industry. Caution is needed when interpreting the results in the light of the limitation that audit fee measures do not directly capture the auditor independence construct.
Description
Keywords
Citation
Collections
Source
Type
Thesis (PhD)
Book Title
Entity type
Access Statement
Open Access
License Rights
Restricted until
Downloads
File
Description