31 August 2006

BIS paper: Do accounting changes affect the economic behaviour of financial firms?

This study examines whether accounting changes result in changes in the economic behaviour of financial institutions. It examines banks' response to recent changes in accounting for Trust Preferred Securities that effect how these securities are reported in the balance sheet but do not change the calculation of Tier 1 capital. This provides a good setting to examine whether accounting changes induce changes in banks' economic behaviour in the absence of an effect on regulatory capital.

Five hypotheses related to banks' decisions to issue Trust Preferred Stock during the period from 1997 through 2004 were tested. Specifically whether there was an overall decrease in banks' propensity to issue these securities after the accounting change, whether publicly traded banks and those that access the external debt markets were more likely to issue these securities before the accounting change but not after, and whether banks with low regulatory capital ratios and with high marginal tax rates were more likely to issue these securities both before and after the accounting change.

The results suggest that accounting changes can lead to changes in banks' economic behaviour even when the change in accounting does not affect regulatory capital calculations. This is consistent with bank managers acting as if they are concerned with the markets' response to the numbers reported after the accounting change.

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