Abstract
Value relevance studies assess how well accounting amounts reflect the market information that investors use for their economic decisions. Analysing a sample of 90 banks listed in 24 European stock markets, this study uses a price model (Ohlson, 1995) and provides evidence that a risk-sensitive metric like regulatory capital is more useful for investors’ decisions than book value of equity and that investors price the parts of regulatory capital that are devoted ideally to absorb losses differently due to the different risks taken. In particular, the part devoted to absorb losses due to credit risk is priced higher than the parts devoted to absorb other risks (e.g. market risks, operational risk). According to our evidence, this is due to the business model of the entities analysed, which are mostly retail and wholesale banks with significant credit exposure to clients and other banks. The paper adds to the literature and has implications for regulators and standard setters showing that the assessment and disclosure of regulatory capital not only strengthens the soundness and the stability of the international banking system (Basle Committee on banking supervision, 1988), but provides to investors useful information for their future investment strategies.
Highlights
The objective of this paper is to compare and contrast the value relevance of own funds, which is a measure of capital calculated according to the requirements of the third international accords of Basel, with that of book value of equity calculated according to the international accounting standards of the International Accounting Standards Board (IASB)
This paper has shown that investors price higher a measure of capital that is risk-sensitive with respect to an alternative measure of capital that does not take into account the risk profile of the entity
Analysing a sample of 90 banks listed in the market of 24 European countries, we provided evidence that regulatory capital is more value relevant than book value of equity and that its parts devoted to absorb losses due to the risks assumed are priced differently by investors
Summary
The objective of this paper is to compare and contrast the value relevance of own funds (i.e. regulatory capital), which is a measure of capital calculated according to the requirements of the third international accords of Basel, with that of book value of equity calculated according to the international accounting standards of the International Accounting Standards Board (IASB). The paper aims at assessing and comparing the value relevance of the different parts of regulatory capital that are devoted ideally to absorb losses due to the different risks taken. Financial entities must calculate this in compliance with the Basel Committee standards, issued to strengthen the soundness and the stability of the international banking system and to diminish an existing source of competitive inequality among international banks (Basle Committee on banking supervision, 1988)
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