Working Paper: CEPR ID: DP16835
Authors: Viral Acharya; Saptarshi Mukherjee; Rangarajan K. Sundaram
Abstract: We examine the effects of fair-value accounting (FVA) and historical-cost accounting (HCA) regimes on the ex-ante financing of projects by external investors. We formulate a model highlighting the relative merits and demerits of each accounting regime, in particular the sub-optimal continuations under the HCA regime and contagion-induced sub-optimal liquidations under the FVA regime. We show thatunder homogeneous beliefs about future cash-flows, FVA regime is superior with greater ex-ante financing, even during periods of high market illiquidity, when the failure of some banks leads to adverse spillovers on surviving financial institutions. However, if disclosures under the FVA regime leads to distorted beliefs about future success probabilities, ex-ante financing may suffer under the FVA regime, andit may no longer be superior relative to the HCA regime. In this setting we also analyze the impact on ex-ante financing of (i) ex-post redemption gates, which restrict the extent of investor liquidation under stress, and (ii) government guarantees, which limit the spillovers ex post but may incentivize excessive risk-taking ex ante.
Keywords: Mark to Market; Financial Crises; Redemption Gates; Government Guarantees
JEL Codes: D21; G38; M41; M48
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Homogeneous beliefs about future cash flows (G40) | FVA regime is superior to HCA regime (G32) |
| FVA regime is superior to HCA regime (G32) | greater ex-ante financing (G32) |
| High market illiquidity conditions (G19) | greater ex-ante financing under FVA regime (G32) |
| FVA allows investors to distinguish between good and bad projects (G11) | improving efficiency in project continuation decisions (H43) |
| HCA leads to inefficient continuation of bad projects (G31) | tightening of the funding set and higher required returns (G32) |
| FVA disclosures lead to distorted beliefs about future success probabilities (G41) | worse ex-ante financing outcomes compared to HCA (G32) |
| Regulatory interventions (redemption gates and government guarantees) (G28) | mitigate adverse effects of contagion during financial stress (E44) |