Missed Distress Signals: Evidence from the Fair Value Option for Liabilities

Posted: 29 Jan 2014 Last revised: 3 Aug 2014

See all articles by Wei Wu

Wei Wu

Cal Poly Pomona

Nicole Thibodeau

Willamette University - Atkinson Graduate School of Management

Robert B. Couch

Willamette University - Atkinson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 31, 2012

Abstract

We test for the presence of adverse selection among firms adopting the fair value option for liabilities (FVOL) embedded in SFAS 159. The FVOL is a controversial accounting choice because it allows firms to increase earnings when credit quality deteriorates. We find that firms with higher credit risk, lower profitability, and negative abnormal stock returns are more likely to adopt the FVOL and that these firms exhibit negative abnormal stock returns over one- to three-year horizons after adoption. We conclude that adverse selection occurs among adopters. While a fair value option for financial liabilities can reduce comparability and information transparency, further tests suggest that this accounting choice effectively reveals private information about a firm’s financial vulnerability. This supports the argument that accounting choice is a valuable tool in standard setting.

This paper has been revised to "An Option for Lemons? The Fair Value Option for Liabilities" Available at SSRN: http://ssrn.com/abstract=2418459

Keywords: fair value accounting, adverse selection, private information, credit risk, financial vulnerability, fair value option, financial crisis, SFAS 159

JEL Classification: G30, G32

Suggested Citation

Wu, Wei and Thibodeau, Nicole and Couch, Robert B., Missed Distress Signals: Evidence from the Fair Value Option for Liabilities (December 31, 2012). Available at SSRN: https://ssrn.com/abstract=2387089 or http://dx.doi.org/10.2139/ssrn.2387089

Wei Wu (Contact Author)

Cal Poly Pomona ( email )

3801 W Temple Ave
Pomona, CA 91768
United States

Nicole Thibodeau

Willamette University - Atkinson Graduate School of Management ( email )

900 State Street
307 Mudd Hall
Salem, OR 97301
United States

Robert B. Couch

Willamette University - Atkinson Graduate School of Management ( email )

900 State Street
Salem, OR 97301
United States

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