Accounting for transferring financial assets: Is the financial-components approach valued by the capital market?

Purpose – This study examines the stock market valuation of securitization gains reported by using the financial-components approach under FAS125 (Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities). Design/methodology/approach – Based on a sample of US securitizing firms for the period from 1993 to 2000, I conduct two analyses to examine the extent to which the securitization gains reported under FAS125 are reflected in the stock market valuation. Findings – The paper finds that the reported gains are positively associated with the stock returns, suggesting that the reported gains are perceived to be value relevant, and that investors appear to use gains in the same manner as they use other earnings information. In addition, it is found that the association between returns and securitization earnings is stronger in the post-FAS125 period than in the pre-FAS125 period, suggesting that the financial-components approach improves the capacity of reported financial statement information to explain stock returns when compared with pre-FAS125 regulations. Research limitations/implications – The results of this study should be helpful to standard setters who continue to apply the financial-components approach for securitizations and for other transactions involving financial instruments.