Fair Value Accounting for Liabilities and Own Credit Risk

Document Type : Research Paper


1 Department of Accounting, Islamic Azad University, Qazvin branch, Qazvin,Iran

2 Department of Accounting,Tarbiat Modares University, Tehran, Iran


Changes in credit risk may arise when either the value or the risk of corporate assets changes. Changes in the equity value associated with the changes in the asset value and changes in asset risk can be characterized into potentially countervailing direct and indirect effects. The indirect effect of risk on equity value is a function of factors that affect the debt value of including leverage, asset value, and asset risk. This study examines whether the equity value reflects the profits and losses associated with the changes in the debt value consistent with the predictions of Merton [21]. The insurance companies listed in the Stock Exchange during 2010-2015 were selected to test the desired hypotheses. It has been found that the stock returns are negatively related to the increase in credit risk as reflected in the changes of estimated bond ratings. More importantly for the research question, it has been realized that the relationship between risk changes and equity returns is negative when the leverage is higher.


[1] American Bankers Association, Letter to SEC on Fair Value and Other Accounting Standards, Washington: September, 2008, 23.
[2] Barth Mary E. Including Estimates of the Future in Today’s Financial Statements, Accounting Horizons, September 2006,  20(3), P.57-85.
[3] Barth, M. E, Why it’s not fair to blame fair value, IESE Insight, 2010, 7, P.48–54.
[4] Barth, M. E, Global comparability in financial reporting: What, why, how, and when? China Journal of Accounting Studies, 2013, 1, P.2–12.
[5] Barth, M. E, Measurement in Financial Reporting: The Need for Concepts, Accounting Horizons, 2014,28(2), P. 331–352.
[6] Barth, M. E., and W. R. Landsman, Fundamental issues related to using fair value accounting for financial reporting, Accounting Horizons, 1995, 9, P.97–107.
[7] Barth, M. E., L. D. Hodder, and S. R. Stubben, Financial reporting for employee stock options: Liabilities or equity?, Review of Accounting Studies, 2013, 18, P.642–682
[8] Barth, M.E., Hodder, L.D., Stubben, S.R., Fair Value Accounting for Liabilities and Own Credit Risk, The Accounting Review, 2008, 83(3), P. 629-664.
[9] Bohn, J., A survey of contingent-claims approaches to risky debt valuation, Journal of Risk Finance , 2000, P.1-18.
[10] Dhaliwal, D.S. Heitzman, S.; Li, O. Z., Taxes, leverage, and the cost of equity capital, Working paper, University of Arizona.2005.
[11] Dhaliwal, D.S, Reynolds, S.S., The effect of the default risk of debt on the earnings response coefficient, The Accounting Review , 2004, 69, P. 412-420.
[12] Dhaliwal, D.S., Lee, K.J., Fargher, N.L., The Association Between Unexpected Earnings and Abnormal Security Returns in the Presence of Financial Leverage, Contemporary Accounting Research, 1991, P.20-41.
[13] Duffee, G. R., Estimating the price of default risk. Finance and Economic Discussion Series, Federal Reserve Board, 1996, P.96-129.
[14] Duffie, D., Singleton, K., Modeling term structures of default able bonds, Review of Financial Studies, 1999, 12(4), P.687-720.
[15] Hand, Hughes, P. J., Sefcik, S. E., In substance defeasances: Security price reactions and motivations, Journal of Accounting and Economics, 1990, 13, P. 47-89.
[16] Hand, J.R., Holthausen, R.W, Leftwich, R.W., The effect of bond rating agency announcements on bond and stock prices, Journal of Finance, 1992, 47, P.733-752.
[17] Holthausen, R., Leftwich, R., The effect of bond rating changes on common stock prices, Journal of Financial Economics, 1996, 17, P. 57-90.
[18] Huang, J. Z., Huang, M., How much of the corporate-treasury yield spread is due to risk?,Working paper. Penn State University and Stanford University. 2003.
[19] Khodaka, B, Leverage and the Cost of Capital: some Tests Using Nepalese Data, The journal of Nepalese business studies, 2006, 3(1), P. 85-91.
[20] Kliger, D., Sarig, O., The information value of bond ratings, The Journal of Finance, 2000, 55, P.2879-2902.
[21] Merton, R.C., On the pricing of corporate debt: The risk structure of interest rates, Journal of Finance, 1974, 29, P. 449-470.
[22] RBC Assets Management, Being a Great Investor in All Types of Markets; “Rules” you Can Use to Take Advantage of Market Volatility, Royal Bank of Canada. 2006.
[23] Riahi Belkaoui, A, Theories of Accounting , 1943
[24] Sterling Robert R., Relevant Financial Reporting in an Age of Price Changes”, Journal of Accountancy, 1975, P.42-51.
[25] Strong, J. S., Valuation effects of holding gains in long-term debt, Journal of Accounting and Economics, 1990, 13, P. 267-283.
[26] Vassalou, M. and Xing, Y.,  Default Risk in Equity Returns , Journal of Finance, 2004, 59, P.831–868.