Value information perspective of fair value accounting and performance of licensed commercial banks: evidence from an emerging market

Purpose This paper aims to consider whether fair value accounting (FVA) provides value information to improve the performance of licensed commercial banks in Sri Lanka. The value-generating hypothesis proposes that value information of corporate reporting affects one or both of two basic sources of the value of a firm as a result of reducing the cost of capital or improving future cash flows. On the other hand, higher-quality value reporting reduces agency problems and greater investment efficiency. Further, this study argues that external disclosures can also provide value information to improve performance. Design/methodology/approach Bank performance is measured using a novel risk-based approach, two nonstructural measures, return on assets and return on equity, and other bank-specific, industry-specific and macroeconomic control variables. The impact of fair value accounting on performance is estimated using the panel data technique under the generalized methods of movement. Findings The results reveal that the value generation hypothesis does not hold in terms of the FVA disclosures and supports the view that FVA has been used for earnings management practices in Sri Lanka. However, external disclosures from the regulator provide value information to banks to reduce the cost of debt and improve performance. This is a novel area of evidence-holding value generation hypothesis in the Sri Lankan context as an emerging economy with respect to external disclosures from the regulator. The cost of debt was significant for all performance measures in banks. Other explanatory variables show mixed results, with different performance measures of banks and capital showing a significant negative relationship with efficiency, suggesting regulators adopt a mechanism to decide the optimum level of capital structure considering the value of a bank. Practical implications The findings imply that the regulatory authorities should encourage banks to disclose value information and control earnings management practices through proper regulations. Importantly, banks’ capital levels need to be decided based on the optimum level of capital structure at which a bank’s value is maximized instead of the prevailing regulatory levels of capital. The entry level of capital needs to be decided based on the proportionality concept. Originality/value This study contributes to developing a risk-based approach to measuring bank performance. It conceptualizes value information in terms of different accounting principles and external disclosures of the regulator as novel concepts and provides substantial evidence.