Change in the Accounting Criterion for Financial Investments: an event study on the sovereign debt of Greece

This study was instigated by the change made in 2008 by the International Accounting Standards Board (IASB), following upon a request filed by the European Union, to the classification of financial instruments in order to reduce bank losses from the subprime crisis and from sovereign bonds of EU member states. This alteration gave rise to the modification of the evaluation criterion for the reclassified instruments from fair value to amortized cost, although some banks did not adhere to the reclassification and maintained use of the original directive that determined the valuation at fair value. Although the change contributed to the postponement by banks of reporting these losses in the accounting result, it did not affect future cash flows. Using event study methodology, this study tested the Efficient Market Hypothesis (EMH), analyzing 33 banks holding Greek sovereign bonds. Results reveal that the market treated those institutions with an even hand, penalizing them based on their degree of exposure to Greek bonds, regardless of the criterion used, and supporting the EMH: the value of an asset is the present value of future cash flows and not the profits. The contribution of this research is in once again testing the EMH with respect to the adoption or not of accounting procedures that alter the accounting result without changing future cash flows. An important consequence of this was that governments, in the third revision of the Basel Capital Accord, adopted measures to more strictly regulate financial institutions in order that these institutions, in the future, might better withstand the effects of a financial crisis.