The Role of Accounting Quality during Mutual Fund Fire Sales

Facundo Mercado; Silvina Rubio; Mariano Scapin

doi:10.1080/09638180.2023.2241884

The Role of Accounting Quality during Mutual Fund Fire Sales

Facundo Mercado^*, Silvina Rubio, Mariano Scapin

^*Corresponding author for this work

School of Accounting and Finance - Business School

Research output: Contribution to journal › Article (Academic Journal) › peer-review

Abstract

We study the ex ante role of accounting quality in mitigating the undervaluation generated by mutual fund fire sales. Asymmetric information between distressed mutual funds and the potential buyers of the securities being fire sold leads to an adverse selection problem resulting in an equilibrium in which buyers trade only at prices below the intrinsic value. Sellers accept these lower prices only because they have severe liquidity needs. To the extent that accounting quality helps market participants better estimate the intrinsic value of the securities being fire sold, we expect the adverse selection problem to be less severe for firms with better accounting quality. Consistently, we find that high accounting quality is associated with smaller fire-sale discounts. This result is explained by two complementary mechanisms. Analysts are more likely to provide price-correcting recommendations, and arbitrageurs trade more heavily on high-accounting-quality firms during mutual fund fire sales. Overall, our results show that accounting quality mitigates stock undervaluation caused by nonfundamental factors.

Original language	English
Journal	European Accounting Review
Volume	34
Issue number	1
DOIs	https://doi.org/10.1080/09638180.2023.2241884
Publication status	Published - 7 Aug 2023

Bibliographical note

Funding Information:
We acknowledge helpful comments and suggestions from Helena Isidro (the editor), two anonymous Reviewers, Jeffrey Ng (conference discussant) and participants at the 2023 EAR Annual Conference. We are also grateful for comments on prior drafts to Ted Christensen, Mark Clatworthy, Christina Dargenidou, Miguel Duro, Juan Manuel García Lara, Beatriz García-Osma, Jo Horton, Akram Khalilov, April Klein, David Martinez-Miera, Gaizka Ormazábal, Joaquín Pirez Pirez, Dan Segal, Cathy Shakespeare, Ian Tonks, Ann Vanstraelen, Pablo Ruiz Verdú, Lorien Stice-Lawrence, Steven Young and seminar participants at University of Exeter, Lancaster University, Universidad de San Andrés, Warwick Business School, XIII Workshop on Empirical Research in Financial Accounting, and the 2019 AAA Annual Meeting. Mariano Scapin appreciates funding from the Bristol Benjamin Meaker Distinguished Visiting Professor scheme, University of Bristol.

Publisher Copyright:
© 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.

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Benjamin Meaker Distinguished Visiting Professorship 2019
Shakespeare, C. (Principal Investigator) & Scapin, M. (Principal Investigator)
31/03/19 → 7/04/19
Project: Research

Cite this

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title = "The Role of Accounting Quality during Mutual Fund Fire Sales",

abstract = "We study the ex ante role of accounting quality in mitigating the undervaluation generated by mutual fund fire sales. Asymmetric information between distressed mutual funds and the potential buyers of the securities being fire sold leads to an adverse selection problem resulting in an equilibrium in which buyers trade only at prices below the intrinsic value. Sellers accept these lower prices only because they have severe liquidity needs. To the extent that accounting quality helps market participants better estimate the intrinsic value of the securities being fire sold, we expect the adverse selection problem to be less severe for firms with better accounting quality. Consistently, we find that high accounting quality is associated with smaller fire-sale discounts. This result is explained by two complementary mechanisms. Analysts are more likely to provide price-correcting recommendations, and arbitrageurs trade more heavily on high-accounting-quality firms during mutual fund fire sales. Overall, our results show that accounting quality mitigates stock undervaluation caused by nonfundamental factors.",

author = "Facundo Mercado and Silvina Rubio and Mariano Scapin",

note = "Funding Information: We acknowledge helpful comments and suggestions from Helena Isidro (the editor), two anonymous Reviewers, Jeffrey Ng (conference discussant) and participants at the 2023 EAR Annual Conference. We are also grateful for comments on prior drafts to Ted Christensen, Mark Clatworthy, Christina Dargenidou, Miguel Duro, Juan Manuel Garc{\'i}a Lara, Beatriz Garc{\'i}a-Osma, Jo Horton, Akram Khalilov, April Klein, David Martinez-Miera, Gaizka Ormaz{\'a}bal, Joaqu{\'i}n Pirez Pirez, Dan Segal, Cathy Shakespeare, Ian Tonks, Ann Vanstraelen, Pablo Ruiz Verd{\'u}, Lorien Stice-Lawrence, Steven Young and seminar participants at University of Exeter, Lancaster University, Universidad de San Andr{\'e}s, Warwick Business School, XIII Workshop on Empirical Research in Financial Accounting, and the 2019 AAA Annual Meeting. Mariano Scapin appreciates funding from the Bristol Benjamin Meaker Distinguished Visiting Professor scheme, University of Bristol. Publisher Copyright: {\textcopyright} 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.",

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N2 - We study the ex ante role of accounting quality in mitigating the undervaluation generated by mutual fund fire sales. Asymmetric information between distressed mutual funds and the potential buyers of the securities being fire sold leads to an adverse selection problem resulting in an equilibrium in which buyers trade only at prices below the intrinsic value. Sellers accept these lower prices only because they have severe liquidity needs. To the extent that accounting quality helps market participants better estimate the intrinsic value of the securities being fire sold, we expect the adverse selection problem to be less severe for firms with better accounting quality. Consistently, we find that high accounting quality is associated with smaller fire-sale discounts. This result is explained by two complementary mechanisms. Analysts are more likely to provide price-correcting recommendations, and arbitrageurs trade more heavily on high-accounting-quality firms during mutual fund fire sales. Overall, our results show that accounting quality mitigates stock undervaluation caused by nonfundamental factors.

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The Role of Accounting Quality during Mutual Fund Fire Sales

Abstract

Bibliographical note

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Benjamin Meaker Distinguished Visiting Professorship 2019

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