Agency Conflicts, Bank Capital Regulation, and Marking-to-Market

Forthcoming, Accounting Review

71 Pages Posted: 25 Mar 2019

See all articles by Tong Lu

Tong Lu

University of Houston

Haresh Sapra

Booth School of Business, University of Chicago

Ajay Subramanian

Georgia State University

Date Written: February 14, 2019

Abstract

We show how shareholder-debtholder agency conflicts interact with strategic reporting under asymmetric information to influence bank regulation. Relative to a benchmark unregulated economy, higher capital requirements mitigate inefficient asset substitution, but potentially exacerbate under investment due to debt overhang. The optimal regulatory policy balances distortions created by agency conflicts and asymmetric information, while incorporating the social benefit of bank debt. Asymmetric information and strategic reporting only impact regulation for intermediate social debt benefit levels. For lower social debt benefits in this interval, regulatory capital requirements are insensitive to accounting reports so bank balance sheets need not be marked to market to implement the optimal regulatory policy. For higher social debt benefits, however, capital requirements are sensitive to accounting reports, thereby necessitating mark-to-market accounting to implement bank regulation. Mark-to-market accounting is essential when bank leverage levels are high, and is more likely to be necessary as banks' asset risk or specificity increases.

Keywords: mark-to-market accounting; bank regulation; agency conflicts

Suggested Citation

Lu, Tong and Sapra, Haresh and Subramanian, Ajay, Agency Conflicts, Bank Capital Regulation, and Marking-to-Market (February 14, 2019). Forthcoming, Accounting Review. Available at SSRN: https://ssrn.com/abstract=3359565

Tong Lu

University of Houston ( email )

Houston, TX 77204
United States

Haresh Sapra

Booth School of Business, University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Ajay Subramanian (Contact Author)

Georgia State University ( email )

Depts. of Finance & Risk Management and Insurance
P.O. Box 4050
Atlanta, GA 30303
United States
404-413-7483 (Phone)

HOME PAGE: http://robinson.gsu.edu/profile/ajay-subramanian/

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