Pros And Cons Of FVA On Capital Market Volatility And Performance
First and foremost, FVA provides more relevant and timely information to the FS users, thus increasing the transparency of FS disclosure. FVA uses market selling price which are determined in competitive markets to measure the firm’s financial performance rather than based on historical cost. This allows shareholders to have a direct insight on the current value of the firm. Indeed, it provides relevant and latest financial information which reflect value and true economic substance to the FS users and functions like an early warning mechanism, allowing investors to exercise market discipline the earliest possible. When the FS’s transparency increases, market is said to be efficient, achieving semi strong form of EMH whereby company’s share price not only reflect historical information, but also all published information. This enhances capital market performance by enabling investors to buy or sell financial asset based on the information readily …show more content…
In conjunction with this, FVA recognized unrealized holding gains and loss. If the FV measurement is based on level 2 and 3 input which are less reliable, the instantly recognition of these profit and loss would increase FS volatility. Worse still, if the company is to distribute dividend based on this unrealized gain, the company financial structure would be impaired. Also, excessive write down of financial assets value is likely to occur during financial crisis. This would leads to distress sales and forced liquidation which may affect company’s reported earnings and shareholder’s equity. Consequently, company might default in existing debt repayment and face difficulties in issuing new debt. Poor credit record of the company would directly increase the company’s cost of capital. From the effect of market condition on company reported earnings, equity financing and debt financing, capital market is volatile under FVA practice. It’s trading activities and volume can be affected easily.
In conclusion, FVA provides timely and relevant information to the FS users. Yet, the information reliability is subjected to the level of input being used in measuring the FV. Also, FVA is vulnerable to the economic change in the market, leading to the volatility of company’s financial performance which directly affects the company’s cost of capital and capital market trading activities and performance.