Articlegreen2022

Asset Reclassifications and Bank Recapitalization During the Financial Crisis

Jannis Bischof · Ulf Brüggemann · Holger Daske

18 citations0/0 files storedManagement Science

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Banking stability, regulation, efficiency Auditing, Earnings Management, Governance Accounting Theory and Financial Reporting

Abstract

Regulators frequently relax accounting rules during a financial crisis as a means of regulatory forbearance. The new accounting options provide banks with an opportunity for an accrual-based increase in their regulatory capital. The use of such an accounting option helps reduce the costs of government interventions such as bailouts and avoid the dilution of existing shareholders’ ownership rights. We examine the introduction of the reclassification option for financial assets during the 2008 financial crisis and study the position of accrual-based options in the pecking order of banks’ recapitalization measures. The findings suggest that the accrual-based increase in regulatory capital is temporary and does not provide permanent relief. Consistent with the long-term costs of accrual-based measures, investors perceive the accounting choice as a negative signal. If banks do not complement their use of the accounting option by other corrective actions that result in a real capital increase and a liquidity injection, they continue to suffer from low capitalization and financial difficulties in the following years. Ultimately, government interventions in accounting regulation are unlikely to offer a sustainable solution to capital shortfalls in the banking sector if they are not supported by the concurrent enforcement of real corrective actions. This paper was accepted by Brian Bushee, accounting. Funding: The authors acknowledge financial support from Deutsche Forschungsgemeinschaft (Project-ID 403041268-TRR 266) as well as from IAAER and KPMG under the “Research Informing the IASB Standard Setting” grant. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4364 .

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1984Corporate financing and investment decisions when firms have information that investors do not have 2002Investor Protection and Corporate Valuation 2002Testing the pecking order theory of capital structure 2000The Economic Consequences of Increased Disclosure 2011Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management 1999Testing static tradeoff against pecking order models of capital structure1This paper has benefited from comments by seminar participants at Boston College, Boston Unsiversity, Dartmouth College, Massachusetts Institute of Technology, University of Massachusetts, Ohio State University, University of California at Los Angeles and the NBER, especially Eugene Fama and Robert Gertner. The usual disclaimers apply. Funding from MIT and the Tuck School at Dartmouth College is gratefuly acknowledged. We also thank two reviewers, Richard S. Ruback and Clifford W. Smith, Jr., for helpful comments.1 2009The Aftermath of Financial Crises 2011The Credit Crisis Around the Globe: Why Did Some Banks Perform Better?

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