An Option for Lemons? The Fair Value Option for Liabilities During the Financial Crisis

61 Pages Posted: 1 Apr 2014 Last revised: 27 Nov 2018

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: July 31, 2014

Abstract

We test for the presence of adverse selection among firms adopting the fair value option for liabilities (FVOL) embedded in SFAS 159 during the financial crisis. 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. Although these findings suggest that the FVOL reduces comparability and information transparency, they also imply that accounting choice can be a valuable tool for standard setting inasmuch as it can induce firms to reveal their type.

Note: This paper was previously circulated under the title “Missed Distress Signals: Evidence from the Fair Value Option for Liabilities.”

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

JEL Classification: G30, G32

Suggested Citation

Wu, Wei and Thibodeau, Nicole and Couch, Robert B., An Option for Lemons? The Fair Value Option for Liabilities During the Financial Crisis (July 31, 2014). Journal of Accounting, Auditing and Finance, Vol. 31, No. 4, 2016. Available at SSRN: https://ssrn.com/abstract=2418459 or http://dx.doi.org/10.2139/ssrn.2418459

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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