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Queen Mary University of London BUSM143 Proposal

Relationship between Fair Value and Financing Cost

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Research proposal

Topic: Relationship between Fair Value and Financing Cost

1.           Introduction

The trend of international convergence of accounting standards characterized by fair value is unstoppable. However, due to the impact of economic and information efficiency, fair value accounting in measuring the financial status or operating results of banks may be due to the degree of development of a country's securities market, the legal environment, the market supervision effectiveness of banks or securities, and other series of institutional background characteristics. According to different measurement, the results are different (La Porta et al., 1998). Therefore, the estimated approach that relates the relationship between fair value accounting information and stock price in the highly developed capital market is applicable. Yet, given the unique institutional background in the transition, studying the contractual usefulness of fair value accounting will be more likely to achieve breakthrough discoveries in China (Liu Hao, Sun Wei, 2008)

Hence, based on the theory of expectation and the validity of contract, this paper studies the relationship between fair value accounting and the cost of equity and debt of listed commercial banks in China since the implementation of the new standard, and tries to carry out theoretical sublimation on the basis of empirical analysis. Studying the changes in the use of fair value accounting to the risks and benefits of banks, whether these changes will change investors' expectations of the bank's future operating performance and change the contractual issues between investors and bank management. The text will explore the interrelationship and internal mechanism of the equity cost, debt cost and fair value of listed commercial banks in the context of theoretical analysis and empirical testing. The conclusions of this paper will provide financial supervisors and accounting standards bodies with reference suggestions for improving the standards and promote the reform of China's financial instruments accounting standards.

1.1 Research question

This article intends to estimate the relationship between fair value and financing cost in China. Hence, the article will try to sort out the research questions as followed.

  • Does the fair value exist an impact on the commercial banks’ financing costs? If so, what kind of influence it will have, whether it is positive or negative?
  • To what extent does the fair value have useful information regarding to the financing costs of commercial banks?
  • Are there any differences of estimated results under different groups or in different year?   
1.2 Research method

In this paper, the main research methods used in the study of the relationship between fair value measurement and the equity financing cost and debt financing cost of listed banks in China are theoretical analysis and empirical research.

Theoretically, it analyzes the impact of the use of fair value accounting on the recognition, measurement and reporting of bank financial assets, and the impact on the information quality requirements of accounting information users. The paper analyzes the impact and changes of fair value measurement on bank investors' expectations and analyzes the relationship between fair value and commercial bank's equity financing cost and debt financing cost.

Moreover, based on the empirical research of previous research theories, this paper analyzes the related influencing factors affecting financing costs and constructs the research model of this paper. Taking the bank's equity financing cost and debt financing cost as the dependent variables, the ratio of financial assets measured by fair value to total assets and capital adequacy ratio are independent variables, with bank scale, return on net assets, operating income growth rate, and market. The net rate and book value ratio are the control variable construction models. And choose whether to use the fixed or random effects on the panel data samples for regression. Finally, through theoretical analysis and empirical results to prove the impact of fair value on the financing costs of commercial banks and explore its internal mechanism.

1.3 Content structure

The structure of this paper is organized as follows:

The first chapter is an introduction. Mainly introduce the research background, research purposes, research methods and so on.

The second chapter is a literature review. The literature review mainly summarizes the research on fair value accounting, financing cost, commercial bank's fair value accounting information content and fair value research on commercial bank financing cost.

The third chapter is theoretical analysis. Including the theory of expectation theory, contract theory, fair value and financing cost, and the impact analysis of fair value measurement on China's listed banks, focusing on the changes in information quality caused by fair value and the measurement of fair value of financial assets influences.

The fourth chapter studies hypotheses and model design. It includes hypothetical analysis derivation and presentation, model design and variable definition.

The fifth chapter is the empirical results and analysis. Includes descriptive statistics, correlation analysis, and regression of variables, results analysis and other content.

The sixth chapter is the research conclusions and policy recommendations. Including the conclusions, meanings, policy recommendations, limitations and further research prospects.

2.           Literature review

By consulting a large amount of literature, it is found that the theory of fair value research and corporate finance cost is relatively mature, and the data is rich. However, there are not many literatures on the research of financing costs of commercial banks. There are few researches on fair value and financing costs of commercial banks. In order to more clearly understand the predecessors' existing research on fair value and financing cost, the literature review part of this paper will be combed from the two aspects of fair value and financing cost.

2.1 Research on financing costs 2.1.1 Research on financing preferences

Research on financing costs has found that the impact of different financing channels on financing costs is different. From the perspective of financing costs, some research found that financing has a financing preference, the so-called financing priority theory, corporate financing preferred preference for internal financing, followed by debt financing, and finally It is equity financing. (Laurent, 2005) Rresearch on corporate financing behavior also shows that in addition to financing costs, corporate financing behavior, corporate bankruptcy risk, liability constraints, agency costs and control rights also have an impact on corporate financing costs (Kalyebara and Ahmed, 2012)

2.1.2 Research on the factors affecting financing costs

The research on financing costs mainly studies the related influencing factors of financing costs. The research on financing cost factors mainly studies the level of corporate governance, independent director mechanism, investor protection, and information disclosure quality. According to the information asymmetry theory, the information risk brought by information asymmetry is indispensable. (Choi, Mao and Upadhyay, 2013). Corporate governance can effectively reduce information asymmetry, reduce information risk and reduce financing costs

Dempsey, (2002) studied the relationship between investor protection and financing costs. The results show that the protection of investor interests will have a relatively large impact on the company's financing costs. The better the investor's interests are protected, the company's financing costs. The lower it will be. Francis et al. (2004) used the data of US listed companies from 1975 to 2001 as a sample and found that under the condition of controlling the control variables such as company size and book value ratio, the company with the poor quality of information and disclosure has its equity financing. The higher the cost. Yoo, (2009)studied the marginal cost of equity financing from the perspective of information disclosure quality. They believe that the higher the quality of information disclosure, the lower the marginal cost of equity financing, indicating that the quality of information disclosure of listed companies will generate cost for their equity financing. positive influence. Ye and Zhang (2011)conducted research from the perspective of industry factors and divided the samples into industry research. The results show that there are significant differences in the equity financing costs of different industries. The equity costs of traditional industries such as textiles, construction, metals and non-metal products are relatively low. The equity cost of emerging industries such as communication culture and electronics is relatively high. They also believe that the stock beta coefficient is the main determinant of stock cost. The debt ratio, firm size and book value ratio are important factors, while business risk and letter J Relevant fundamental indicators of related companies such as asymmetry and agency problems are the main factors that do not affect the cost of equity. ZouHaas, (2002)adopted a two-level principal-agent model, arguing that the company's low financing costs would prompt the company's rent-seeking behavior, resulting in improper capital allocation.

2.2 Introduction of fair value accounting and research on bank financing behavior

Cheng, (2012) believes that mixed fair value accounting only requires the fair value of securities assets, and the accounting treatment of liabilities does not change, still using historical cost measurement, so it will make bank capital measurement the same as historical cost accounting, Carey (2007) Through empirical research, it is concluded that this new accounting model does not reduce the rate of bank failures. Beatty (2006) found that even if the introduction of fair value does not affect the calculation of regulatory capital, before adopting fair value accounting, listed banks are more inclined to issue Trust Preferred Securities (TPS) before the introduction of fair value accounting rather than after introduction. o Zhang (2009) found that SFAS 13 3 has the ability to inhibit the speculative use of financial derivatives. In addition, Palea, (2013)found that EU countries accepting international accounting standards can reduce the financing costs of banks.

Beatty (2006) studied the correlation between the average leverage ratio and return on equity of a bank and the proportion of securities invested by it during the implementation of US Financial Accounting Standards (SFAS115). The study found that when the leverage ratio and return on equity fell, the proportion of available-for-sale securities held by banks declined, and the duration of securities held was also shortened, proving the bank capital structure caused by US Financial Accounting Standards (C SFAS 115). Fluctuations in the return on equity will change the management of the bank's management of its portfolio assets. Bank portfolio management behavior is affected by the dual purpose of maintaining bank income elasticity and reducing reporting equity fluctuations.

GRIFFIN, (2014)analyzed the adverse effects of the implementation of fair value accounting on capital adequacy regulation and regulatory risk rating and believed that the adoption of fair value accounting measurement attributes weakened the effectiveness of prudent bank supervision. Some study used a general equilibrium model to study bank capital adequacy and financing costs. (Chakroun, 2017) The paper argues that the capital adequacy ratio system reduces the bank's moral hazard while reducing the bank's ability to create liquidity, resulting in a large number of Cost (welfare cost), but this article only theoretically discusses the cost of capital adequacy (welfare costs) and does not conduct empirical tests.

3.           Research methods and Research design 3.1 Research methods

The text research method will provide a clear research idea and research method for further research on the correlation and mechanism between fair value and bank financing cost.

Based on a large number of predecessors' theoretical research and empirical research, this paper uses the data of China's commercial banks as a sample, uses panel data to carry out regression, and deeply explores the relationship between bank equity cost, bank debt cost and fair value and the internal mechanism. Based on the model of predecessor financing cost, the bank financing cost model is constructed. The research conclusions will have important practical significance for improving bank operation risk, reducing bank financing cost and rationally implementing financing decision.

3.2 Data 3.2.1 equity financing cost (qcost)

With regard to the calculation of financing costs, there are many researches and discussions in the theoretical and practical circles, including various theoretical assumptions and model construction. The main models include Capital Asset Pricing Model (CAPM), Arbitrage Pricing Model (APM), Dividend Growth Model, Residual Income Discount Model (RIM), Dividend Discount Model (DDM), etc. Each model has certain assumptions. And the conditions of use, of course, have their advantages and disadvantages. Among them, two types of models are used: one is the capital asset pricing model (CAPM ), which is a model for calculating the equity cost based on the general equilibrium hypothesis of Markowitz (1952) and Sharpe (1964); the second is arbitrage The Pricing Model (APT), which is an arbitrage pricing model proposed by Ross (1976) based on the general equilibrium assumption. The focus of the two models on the study of equity cost is whether the stock's beta factor is linearly related to the stock's average yield. In addition to the stock's beta factor, the stock's rate of return is related to which factors. The conclusions from empirical studies using these two models may be inconsistent, but the CAPM model or the APT model is often used as a starting point for the study of equity cost issues. From the investor's point of view, the capitalist's investment in the capital is the cost of the user's use of funds, so the investment yield obtained by the capital asset pricing model (CAPM) is the capital cost of the bank.

The most recently used method for studying the cost of equity is the residual income discount model (Gebhardt etx1.2003), but their research sample is a general business enterprise and the residual income discount model is to predict and estimate the future dividend income. The disadvantage is that the predicted estimates are subjective and may bias the estimates somewhat. Ginesti, Sannino and Tartaglia Polcini (2012)roughly divide the measurement methods of listed banks' equity costs into three types: accounting cost method (ROE, dividend discount method (DDM) and capital asset pricing model (CAPM). Although the methods are simple and practical, they all have some shortcomings: the problem of ROE model is the lag of accounting data. The defect of DDM model is that the uncertainty of factors such as dividend and expected return rate is too much, and the accuracy of calculation results is not The CAPM model can effectively avoid the defects of ROE method and DDM method. CICIRETTI (2014) used empirical research to prove the feasibility of using the capital asset pricing model (CAPM) for bank equity cost and conducted a robustness test. The Capital Asset Pricing Model (CAPM) is robust when estimating the cost of equity financing for banks. The Federal Reserve has officially used the Capital Asset Pricing Model (CAPM) to calculate the equity cost of member banks of the Federal Reserve System since 2006. This paper uses the Capital Asset Pricing Model (CAPM) model to estimate the bank's equity cost.

The essence of the Capital Asset Pricing Model (CAPM) is to discuss the relationship between asset risk and return. The theory holds that the price of assets such as stocks is mainly related to the size of the risks. It is further pointed out that risks include market risks (systemic risks) and the company's own risks (specific risks). The cost of equity, the expected return on stock, is determined by the sum of the risk-free rate of return and the system's systemic risk premium. The basic expression of the Capital Asset Pricing Model (CAPM) is:

(1)

Where: Eis the expected rate of return of asset i; is the risk-free rate of return; is the beta of asset i, ie the standard measure of risk added to the market portfolio by the asset; is the market expected rate of return on the portfolio. For this model, you first need to estimate the beta value, and then use the beta value to estimate the equity cost of asset i.

In the CAPM model, the risk-free interest rate is generally a one-year risk-free interest rate. Due to the lack of domestic government bond monthly yield indicators for direct use, the bank annual deposit interest rate is used (the data comes from the Chinese stock market capital asset pricing model in the CSMAR database). Database) Instead, as a risk-free rate Rf, choose a comprehensive monthly market return rate of Rm that does not consider cash dividend reinvestment, and choose a monthly return return rate of R that does not consider cash dividend reinvestment; The data period is selected as the monthly data from the first month of listing to September 2012. All data are from the CSMAR database.

3.2.2 Debt financing costs

The relevant literature uses Pittman et al. (2004) for the use of corporate debt financing costs. The debt financing cost is calculated by the total interest expense/average long-term and short-term debt, but because commercial banks are different from ordinary enterprises. Cannot directly adopt the methods of predecessors but can refer to their definition method. The definition of debt financing cost in this paper is the commercial bank interest expenditure item divided by the source of funds (including borrowing from central bank, interbank borrowing, and deposit taking).

4.           Empirical models

The equity financing cost qcost is derived from the capital asset pricing model CAPM. Based on the existing research on the cost of equity financing, the existing literature (Putry and Erawati, 2016), the return on assets and the size of its assets are important factors affecting the structure of bank capital rights. From the perspective of shareholders, the stronger the company's profitability, the higher the expectations of shareholders on the company, which makes the company's equity financing cost higher. Therefore, this paper adopts the company's scale size, book market value ratio BM, leverage ratio LEV and ROE as the control variables of the model; due to the special nature of the banking industry, the bank deposit reserve ratio prescribed by the state will be bank The financing cost has an impact, so join the large commercial bank deposit reserve ratio rate control variable, this paper also adds the operating income growth in the equity financing cost, as the impact of controlling bank growth on the model dependent variable. Debt financing cost is adopted by Zwcb. The relevant literature uses Pittman et al. (2004) method for debt financing cost. (Ghosh and Moon, 2010) The debt financing cost is calculated by (the total interest expenditure/average long-term and short-term debt total), but because of the commercial bank Different from the average enterprise, we cannot directly adopt the methods of the predecessors, but we can learn from their definition methods. The definition of debt financing cost in this paper is the commercial bank interest expenditure item divided by the source of funds (including borrowing from the central bank, interbank borrowing, absorption). Deposit) to indicate. The control variable is based on the control variable of the equity financing cost (including the company's size lnsize, book market value ratio BM, leverage ratio LEV, ROE, large commercial bank deposit reserve rate, operating income growth rate growth). The ratio of fixed assets to total assets in the market, FASR, as a measure of its encumbered assets and credit levels, banks with more fixed assets can provide more guarantees for repayment of debts. Deposit-to-deposit ratio CDR indicators are also regulated by commercial banks. An important indicator of supervision, if the loan-to-deposit ratio is too high, may result in insufficient bank payment capacity. Due to the particularity of the banking business, we use the loan impairment loss as the controlling variable of the loan balance to control the impact of the quality of the assets held by the bank on the ability to repay debts.

Model a:

(1)

Model b:

(2)

Variable name

Description

zwcb

Debt cost, divided by interest expense by borrowing capital, borrowing capital including borrowing from central bank, absorbing deposits, and borrowing funds

Cost of equity, returned by CAPM rolling

FV

Represents the ratio of fair value measurement assets to total assets, the sum of transactional financial assets and available-for-sale financial assets divided by total advisory assets

roe

Return on net assets net profit / balance of shareholders' equity

Company size, expressed in logarithm of total assets

LEV

Leverage ratio

rate

Large commercial bank deposit reserve ratio

BM

Book market value ratio= book assets / total market value

growth

Operating income growth rate, (this year's operating income is-the previous year) / the same period of the previous year

LPR

Loan impairment loss as a percentage of loan balance

CDR

Deposit-to-deposit ratio, the ratio of total commercial bank loans divided by total deposits

FASR

Fixed assets accounted for the total assets

5.           Conclusions

The proposal presents an introduction regarding the relationship between the relationship between the fair value and financing cost for the Chinese commercial banks. The layout of the proposal is as follows, the first chapter is the introduction, then goes with the literature reviews, including the researches so far with the financing cost, the information contents in the fair value, as well as their relationship.

The next chapter includes the research methodology and proposed quantitative approaches further. The variables and designed formulas of regression models are covered in the part.

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