Economic Consequences of Bias in Fair Value Accounting: Evidence from the Korean Bond Markets

We study the effect of competition between bond pricing agencies (BPAs) on bias in fair value prices, and whether there is an effect on liquidity in the corporate bond markets. BPAs are agencies in Korea which provide fair value estimates of all OTC-traded products to financial institutions. We use the entry of a new BPA into the Korean market as a shock to the competition between BPAs and employ a difference-in-differences analysis to investigate changes in BPAs’ reporting behavior. We find that the increased competition between BPAs leads to an increased upward bias in bond prices, and we document that this effect is higher for securities that are not traded, less liquid, and have higher credit ratings. Moreover, our results provide new insights on the real effects of accounting by showing that this bias in fair value estimates decreases liquidity in the corporate bond market.