Information Asymmetry of Fair Value Accounting and Loan Loss Provisions During the Global Financial Crisis

This paper investigates whether U.S. banks’ assets and liabilities, reported using Fair Value Accounting (FVA) under SFAS 157 Fair Value Measurement, are associated with information asymmetry among equity investors during the 2008 Global Financial Crisis. Using bid-ask spread as a proxy for information asymmetry, and controlling for bank size, profitability, default risk and capital adequacy, we find that bid-ask spread is positively and significantly associated with total fair value net assets and net assets measured using inputs of fair value Level 1, Level 2, and Level 3, as specified in SFAS 157. We also examine whether banks’ loan loss provisions are associated with information asymmetry, since the U.S. Securities and Exchange Commission (2008) has alleged that large loan loss provisions, determined based on managerial internal information and discretion, played a significant role in bank failures in the Global Financial Crisis. We find that loan loss provisions are also positively and significantly associated with bid-ask spread. In summary, our findings show that both FVA and loan loss provisions are associated with information asymmetry among equity investors during the 2008 Global Financial Crisis, with loan loss provisions being the stronger of the two effects.