Does Fair Value Accounting Affect How Banks Convey Information About Future Performance? Evidence from SFAS 115

• In Event: Research in Financial Accounting

Abstract

We investigate whether fair value accounting for investment securities, required under SFAS 115, affected how banks convey private information about future performance. Specifically, we test whether banks shifted away from using realized gains and losses on investment securities (RGL) to provide information after SFAS 115’s fair value requirement reduced the prominence of RGL. We find a significant reduction in the informativeness of RGL after SFAS 115, suggesting that fair value accounting reduced the use of RGL to inform investors. Next, we consider whether the shift away from RGL after SFAS 115 was associated with informative accruals earnings management through the loan loss provision (LLP). We find that banks increased their use of the LLP to indicate future performance after SFAS 115, suggesting that accruals manipulation served as a substitute for RGL. Finally, we confirm these results by showing that analyst forecasts reflect the shift from informative RGL to informative LLP management after SFAS 115. Our results extend and update prior studies on banks’ use of earnings management to indicate future performance and present evidence consistent with a shift toward accrual management and away from asset sales after SFAS 115.

Authors

• Jonathan Black, Purdue University

• R. Thomas Godwin, Purdue University

• David G Harris, Syracuse University