The Effects of SFAS 157 Disclosures on Investment Decisions

• In Event: Financial Accounting and Reporting III

Abstract

This paper examines whether public banks attempted to avoid disclosing level 3 asset holdings by changing both the composition and classification of their investment portfolios after the effective date of SFAS 157. Prior research suggests that assets valued using unobservable, level 3 inputs are associated with greater information risk than assets valued using observable inputs, which results in a higher cost of equity capital. Private banks provide a suitable control group in a difference-in-differences analysis as managerial incentives at these banks are unlikely to be affected by a change in information risk. We find that after the effective date of SFAS 157, public banks (1) reduced their exposure to assets typically measured with level 3 inputs in their available-for-sale portfolio, where SFAS 157 disclosures are required, (2) increased their exposure to these assets in their held-to-maturity portfolio, where the disclosures are not required, and (3) decreased the overall exposure to these assets. These findings contribute to the literature by documenting changes in investment behavior resulting from an accounting standard that primarily affects disclosure requirements and has no impact on regulatory capital ratios.

Authors

• Allison Nicoletti, Ohio State University

• Michael Iselin, Ohio State University