Fair value accounting: information or confusion for financial markets?

Abstract

This paper examines whether and how fair value measurement and disclosure by US bank holding companies influences financial analysts’ ability to forecast earnings. Fair value measurement relates to more dispersed forecasts. Measurement basis disclosure (levels 1, 2 and 3) enacted by SFAS 157 translates into more accurate forecasts but has neutral effects for banks with a sizable proportion of assets at fair value. Furthermore, level 2 measurement relates to enhanced forecast accuracy, while level 3 measurement relates to increased forecast dispersion. These contrasting results reflect analysts’ underlying information environment, with level 2 measurement translating into higher quality private and public information and level 3 into reductions in the quality of private and public information. Results do not change after controlling for assets’ underlying riskiness. Overall, it appears that analysts perceive that managers convey useful information through level 2 figures but act opportunistically in measuring level 3 fair value figures

Does Managerial Opportunism Explain the Differential Pricing of Level 3 Fair Value Estimates?

“…Riedl and Serafeim () find higher costs of capital for firms with larger amounts of Level 3 instruments, suggesting Level 3 instruments are associated with more information asymmetry. Similarly, Magnan, Menini, and Parbonetti () find that Level 3 measurements increase forecast dispersion among analysts. They suggest that this finding is consistent with analysts perceiving management opportunism in the Level 3 measurement process.…”

“…Song, Thomas, and Yi () and Goh et al () document lower valuation multiples for Level 3 assets relative to Level 1 and Level 2, and suggest that this finding is due to the inherent measurement error present in Level 3 valuations. Findings from Magnan, Menini, and Parbonetti () suggest that analysts perceive that managers act opportunistically in measuring Level 3 fair values, so it is reasonable to suspect that capital markets would differentially price Level 3 assets lower if they suspect that Level 3 fair values have been opportunistically managed. Consistent with this argument, Song, Thomas, and Yi observe less Level 3 discounting for firms with stronger corporate governance, where management opportunism may be more constrained.…”

The Effect of the 2007/2008 Financial Crisis on Enterprise Risk Management Disclosure of Top US Banks

“…These years have been chosen in order to cover the closest period surrounding the financial crisis that occurred in 2008 (Schroeder & Schauer, 2010) and include the period around the adoption of Statement of Financial Accounting Standards (SFAS) 157 and 159, Basel 2, and International Financial Reporting Standards (IFRS) 7 all of which came into effect in 2007. Some studies have covered such period to investigate the effect of the crisis on disclosure practices such as Magnan, Menini, and Parbonetti (2015). Annual reports have been downloaded from the websites of banks and the EDGAR database on the website of the American Stock Exchange (SEC).…”

The Financial Accounting Standards Board’s Fair Value Mandate: Are Level 3 Assets and Liabilities Being Measured Accurately?

“…The suggestion is that earnings management using level 3 assets and liabilities is less obvious than other earnings management opportunities. Mannan, Menini & Parbonetti (2015) examined analysts' forecasts with respect to fair value assets and liabilities. They concluded that, ".…”