Fair Value Accounting Information

Rev Account Stud (2015) 20:559–591
DOI 10.1007/s11142-014-9306-7
Fair value accounting: information or confusion

for financial markets?
Michel Magnan • Andrea Menini • Antonio Parbonetti
Published online: 9 September 2014

Springer Science+Business Media New York 2014
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 pro-
portion of assets at fair value. Furthermore, level 2 measurement relates to enhanced
forecast accuracy, while level 3 measurement relates to increased forecast disper-
sion. These contrasting results reflect analysts’ underlying information environment,
with level 2 measurement translating into higher quality private and public infor-
mation 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.
Keywords Fair value accounting Valuation of assets disclosure Analysts’

earnings forecasts Mandatory disclosure
M. Magnan
John Molson School of Business, Concordia University, Montreal, QC, Canada
e-mail: michel.magnan@concordia.ca
M. Magnan
CIRANO, Montreal, QC, Canada
A. Menini (&) A. Parbonetti

Department of Economics and Management, University of Padova, Via del Santo 33, 35123 Padua,
Italy
e-mail: andrea.menini@unipd.it
A. Parbonetti
e-mail: antonio.parbonetti@unipd.it
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560 M. Magnan et al.
JEL Classification M41 G21 G12
1 Introduction
The recent financial crisis led to a critical evaluation of fair value accounting’s (FVA)
role in undermining the stability of financial markets. Accounting standard-setters
reacted to the crisis by providing additional guidance on the application of FVA.
Underlying such measures is a vigorous debate between proponents of FVA, such as
the CFA Institute, which represents financial analysts and argues that fair value
provides useful information, and skeptics such as many bank regulators and bank
executives who argue that fair value provides noisy information as it raises earnings’
volatility. To illuminate the issue, we focus on the relation between FVA and the
accuracy and dispersion of financial analysts’ earnings forecasts. Therefore we
address the following question: how does the extent of a firm’s use of FVA relate to
financial analysts’ ability to forecast its earnings in terms of accuracy and dispersion?
Our study contributes to the debate surrounding the use of FVA as a foundation for
financial reporting. This debate, which involves professionals as well as academics,
mostly revolves around FVA’s implications for the relevance and reliability of
financial statements. From a professional perspective, standard-setters such as the
Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) have been gradually raising the prominence of FVA in
financial reporting, a case in point being the FASB’s proposal to require banks to value
their loan portfolios at FV (FASB 2010). While some of these changes are welcome by
the investment community, their usefulness is unclear. For example, a survey of
professional investors and analysts reveals that they prefer (1) a mixed measurement
model with only short term instruments valued at fair value; (2) earnings that are free
from fair value fluctuations in long term assets; (3) fair value as an input to evaluate
liquidity, capital adequacy, and enterprise value but rarely as an indicator of future
cash flows; and (4) more detailed but not excessive disclosure (PricewaterhouseCo-
opers 2010). Respondents’ views about FVA’s lack of usefulness in estimating future
cash flows contrasts with the objective of financial reporting, as stated in the latest
exposure draft jointly made by IASB and FASB (FASB-IASB 2010).
From an academic perspective, Barth (2007) argues that there is basically no
alternative to a fair value-based model. Her position is consistent with most prior research
on FVA, which documents its value relevance; that is, fair value-based information in the
financial statements relates to a firm’s stock market value. Generally, most evidence
shows that FVA-based information has a greater association with a firm’s stock market
valuation than historical cost information (e.g., Barth et al. 2001a). Moreover, there are
indications that disclosure about the measurement of fair value assets and liabilities is
value relevant, with investors’ discounting the measurement uncertainty that accompa-
nies movement from level 1 to levels 2 and 3 (e.g., Song et al. 2010).
However, while useful in assessing the market impact of accounting standards,
value-relevance research has limitations and cannot serve as a sole basis for
standard development and regulatory interventions (Holthausen and Watts 2001).
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Fair value accounting 561
For instance, Watts (2003) argues that FVA severely undermines the reliability of
financial reporting and does not provide investors with a useful input to make their
own projections. Specifically, FVA provides managers with much accounting
discretion, especially for assets and liabilities that are measured according to level 2
and 3 inputs. Such discretion translates into biased and less reliable financial
reporting (e.g., Ramanna and Watts 2009; Dechow et al. 2010).
Research results and comments following the 2007–2009 financial crisis offer a
mixed picture as to FVA’s role in its propagation. For example, in a report, the
Financial Stability Forum (2009) recommends, ‘‘Accounting standard setters and
prudential supervisors should examine possible changes to relevant standards to
dampen adverse dynamics potentially associated with fair value accounting’’
(recommendation 3.5, page 6). In contrast, Koonce (2009) argues that associating
FVA with the crisis is ‘‘simply a case of blaming the messenger’’ for poor
underlying economic conditions. Laux and Leuz (2009) and Pozen (2009) take a
more nuanced approach and, instead of focusing on FVA per se, highlight potential
concerns regarding its implementation.
In developing our empirical predictions, we build on the conceptual template
developed by Kothari et al. (2010). They formalize a positive theory of Generally
Accepted Accounting Principles (GAAP) highlighting financial reporting’s primary
focus as being performance measurement and stewardship. In that context,
verifiability and conservatism in financial statements become key features for
market participants, with FVA providing both advantages and disadvantages
depending upon market circumstances.
We rely on a sample of publicly traded US bank holding companies during the
1996–2009 period. Throughout that period, FVA was used for financial instruments.
Moreover, just before the financial crisis, the enactment of SFAS 157 (FASB 2006a)
expanded the disclosure of FVA information, mostly by requiring the measurement
basis of FV assets and liabilities to be revealed, that is, level 1 (mark-to-market), level 2
(market inputs), and level 3 (mark-to-model). We focus initially on how FVA relates
with financial analysts’ ability to forecast a bank’s earnings, in terms of both accuracy
and dispersion. Our choice rests on the premise that financial analysts represent one of
financial markets’ key stakeholder groups and a critical means by which financial
information gets disseminated to market participants. We then explore the factors that
may influence FVA’s impact on analyst forecasts such as (1) the advent of SFAS 157,
(2) the measurement basis for FVA assets and liabilities (i.e., levels 1, 2, and 3), (3) the
quality of the information environment faced by analysts, as proxied by the precision of
public and private information (Barron et al. 1998), (4) the underlying riskiness of a
bank’s assets, and (5) the impact of macroeconomic shocks (liquidity crisis, volatility).
Our results reveal that FVA has a nuanced relation with analysts’ earnings
forecasts. On one hand, the greater the extent of a bank’s assets and liabilities
reported at fair value, the more dispersed are analysts’ earnings forecasts. On the
other, there are indications that, under some conditions, FVA translates into greater
earnings accuracy. Specifically, it appears that the advent of SFAS 157 in 2007
allows analysts to make more accurate and less dispersed forecasts. In addition, the
higher the proportion of assets and liabilities measured at FVA level 2, the more
accurate are analyst forecasts: an improvement in the quality of the information
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environment faced by analysts seems to underlie that outcome. In contrast, the

higher the proportion of assets and liabilities measured at FVA level 3, the more
dispersed are analyst forecasts: a decline in the quality of the information
environment faced by analysts seems to underlie that outcome. Moreover,
controlling for the underlying riskiness of assets and liabilities measured at fair
value does not affect the relation between FVA and analysts’ forecasts accuracy and
dispersion. Finally, it appears that proxies for market uncertainty (i.e., option
volatility measured by VIX and market illiquidity) do not modify our primary
evidence.
We contribute to the debate surrounding FVA in the following ways. First,
starting with Bernard et al. (1995), prior research generally finds that FVA-based
financial information is value relevant for stock market investors. (See Barth et al.
2001a for an early review of the evidence.) However, most of the evidence relies on
valuation models that find an association between FVA-based assets and a firm’s
stock price. This type of statistical relation does not reveal much about the
underlying process by which FVA-derived information is disseminated and is used
by financial market participants to set prices. In that regard, analyzing whether and
how fair value-based information maps into analysts’ forecasting ability should be a
critical issue for regulators, standard-setters, investors, directors, and managers.
Therefore we examine analysts to capture whether first-hand users of accounting
information rely on fair value to assess companies’ future performance. Overall, the
results indicate that FVA is related to analysts’ forecast dispersion irrespective of
the underlying riskiness of assets measured at fair value, thus showing that, by itself,
FVA has a distinct impact on financial markets over and above the nature of assets
and liabilities that are measured.
Second, our evidence that a bank’s extent of FVA level 2 assets and liabilities is
associated with more accurate forecasts relative to FVA level 1 assets illuminates
why the value relevance coefficients of level 1 and level 2 assets and liabilities are
so close (Song et al. 2010). The result that the quality of the information
environment faced by analysts improves with the extent of level 2 measurement is
consistent with bank managers’ using their private information to provide better
estimates of bonds’ level 2 fair values, as discussed by Landsman (2007) and
initially conjectured by Barth et al. (1998a). In contrast, as argued by Kothari et al.
(2010), the opaqueness surrounding level 3 measurement seems to be conducive to
managerial opportunism and translates into a deterioration in the quality of analysts’
information environment and, ultimately, into more dispersed earnings forecasts,
thus explaining the value relevance discount found by Song et al. (2010).
Third, while the advent of SFAS 157 provides market participants with more
detailed disclosure regarding the measurement basis for FVA assets and liabilities
(i.e., levels 1, 2, and 3), there is a debate as to whether FVA is indeed enhancing
transparency (Laux and Leuz 2009). The fact that actual measurement methodol-
ogies and valuation inputs are not explicitly provided does contribute to uncertainty
within the marketplace regarding reported values and opens the door to the
opportunistic use of such opaqueness. Moreover, finer-grained disclosure about the
measurement basis for reported assets and liabilities either help investors at large or,
alternatively, only those investors and analysts with sufficient tools and background
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information to make sense of the disclosure (Beyer et al. 2010). While FVA has
existed for many years, the ability to assess the nature of its reach within financial
statements (mark to market vs. mark to model) has expanded significantly in the
past few years with the advent and application of SFAS 157. Since the
implementation of FVA affects reported earnings, it is an open question as to
whether financial markets’ participants could apprehend the new information being
conveyed and integrate into their decision-making. In that regard, by being
associated with an increase in the precision of public information, additional
disclosure following the adoption of SFAS 157 does seem to enhance the quality of
information available to all market participants, thus contributing to the financial
disclosure/information asymmetry literature (e.g., Healy and Palepu 2001; Leuz and
Verrecchia 2000).
2 Background and conceptual framework
2.1 An overview of fair value accounting
Fair value is ‘‘… the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date…’’ (SFAS 157.5, FASB 2006a). The parties to the transaction are assumed to
be willing and knowledgeable. In essence, all financial instruments held by an entity
must be measured and reported at fair value on its balance sheet, with some caveats
(SFAS 115, FASB 1993; SFAS 133, FASB 1998). First, SFAS 115 allows debt
securities, such as unsecuritized loans, for which an enterprise has the positive intent
and ability to hold to maturity to be classified as held-to-maturity securities and
reported at amortized cost. However, if these securities suffer a decline in fair value
below the amortized cost basis that is other than temporary, their accounting cost
must be written down to that value and the write-down included in net earnings as a
realized loss. Once written down, held-to-maturity securities cannot be written up.1
Second, firms have also an option to expand the scope of assets and liabilities that
are accounted for using fair value (SFAS 159, FASB 2006b). The option must be
applied on an instrument-by-instrument basis and constitutes an irrevocable choice.2
Under a single label, FVA comprises three measurement bases that reflect the
level of judgment (subjectivity) associated with the inputs to determine fair value.
With the advent of SFAS 157 (FASB 2006a), such measurement bases must be
formally disclosed. Assets and liabilities designated as Level 1 are measured and
reported on a firm’s financial statements at their market value, which typically
1
For specialized firms (pension funds, investment banks, etc.), fair market value applies to all assets,
liabilities, or both. Moreover, while SFAS 115 does not apply to unsecuritized loans, it does apply after
their securitization.
2
The rationale for such an option is well described in Citicorp’s financial statements: ‘‘The fair value
option provides an opportunity to mitigate volatility in reported earnings that resulted prior to its adoption
from being required to apply fair value accounting to certain economic hedges while having to measure
the assets and liabilities being economically hedged using an accounting method other than fair value.’’
(Citicorp’s 2009 annual report, p. 138).
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reflects the quoted prices for identical assets or liabilities in active markets. In the
absence of an active market, fair value has to be inferred by relying on observable
valuation inputs that reflect (a) quoted prices for similar financial instruments in
active markets, (b) quoted prices for identical or similar financial instruments in
markets that are not active, (c) inputs other than quoted prices but that are
observable (e.g., yield curve) or (d) correlated prices. Such a measurement basis is
deemed to be Level 2. Finally, certain financial instruments that are customized or
have no market are typically valued by relying on models that reflect management’s
assumptions about economic, market, and firm-specific conditions (e.g., private
placement investments, unique derivative products, etc.). This type of valuation is
deemed to be derived from Level 3 inputs and is commonly referred as ‘‘mark-to-
model’’ (FASB 2006a). In other words, the objective in level 3 measurement is to
infer what the price of the asset would be, if the market existed. Models underlying
level 3 FVA are typically not disclosed.
The mapping of FVA into the income statement is conditional upon
management’s initial classification and hence somewhat more difficult to decipher
(SFAS 115, FASB 1993). On one hand, debt and equity securities that are bought
and held principally for the purpose of selling them in the near term are classified
as trading securities, with unrealized gains and losses flowing directly into
reported earnings. On the other hand, debt and equity securities that are
considered to be neither held-to-maturity (long term) or trading (short term)
securities are classified as available-for-sale securities and are reported on the
balance sheet at fair value. But unrealized gains and losses on these securities are
excluded from earnings and reported in a separate component of shareholders’
equity (other comprehensive income). In terms of regulatory impact, unrealized
gains (or losses) on available-for-sale securities are excluded in the estimation of
Tier 1 equity capital.
2.2 The debate about fair value accounting and financial markets’ information
quality
Extending the reach of FVA moves financial reporting into uncharted territory on
three dimensions (Plantin et al. 2008; Magnan and Markarian 2011). First, there is a
widespread consensus and solid evidence that financial analysts’ and investors’
decisions are based upon their ability to predict a firm’s performance. In that regard,
there is evidence that accrual earnings are a useful basis to predict future cash flows,
thus indicating the critical role of the income statement in financial markets (Barth
et al. 2001b).
In contrast, the recent trend in standard setting, exemplified by FVA, is to
deemphasize the relative importance of the income statement, with net earnings
becoming a byproduct of the variation between two end-of-period balance sheets:
‘‘In measuring performance, an entity first identifies and measures its economic
resources and the claims to them… then calculates the net change in economic
resources and claims other than changes resulting from transactions with owners as
owners’’ (excerpt from the joint IASB/FASB proposed conceptual framework,
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FASB 2008). In this vein, Penman (2007) argues that, under ideal conditions, FVA
is better than historical cost accounting since it conveys the value directly from the
balance sheet. Indeed, by using FVA-based information provided by the firm,
analysts and investors do not need to estimate future earnings and expected returns
and then to convert the flow of future earnings into equity value, because the
balance sheet provides directly the value of equity. However, under no-ideal
conditions, fair value impairs the ability to forecast earnings when assets and
liabilities reflect different measurement bases. When the fair value of an asset is not
matched with the fair value of the associated asset or liability whose prices are
negatively correlated with those of the asset, then the income statement recognizes
gains without the associated losses (or vice versa). Thus this fair value mismatch
produces artificial volatility that impairs the usefulness of income to forecast future
earnings. For example, an increase in the probability of default of a firm translates
into a reduction in the fair value of its outstanding liabilities and ultimately
increases earnings as the financial gain is recognized into the income statement.
However, we can assume that, if the probability of default has increased, it is
because the value of some assets has declined. Nevertheless, if these assets are not
measured at fair value or are not recognized on the balance sheet, then the income
figure is artificially volatile, thus becoming a poor input to forecast earnings.
Moreover, given that the balance sheet is not fully at the fair value, it cannot directly
report the equity value.
Second, historically, financial reporting has reflected an ongoing tension between
relevance and reliability (e.g., Bushman and Smith 2001; Scott 2008; Laux and
Leuz 2009). According to many professionals, the advent of FVA undermines the
reliability of financial reporting (e.g., Mintz 2008). Ramanna and Watts (2009)
argue that the use of FVA provides executives with more opportunities to manage
asset values and reported earnings: in contrast to historical cost, FVA relies on
several assumptions about the future, many of which are not be verifiable. In
financial institutions, there are serious concerns about the verifiability of level 2 and
3 FV assets and liabilities, which heavily rely on managerial assumptions. Some
observers even label level 3 fair value assets and liabilities as being ‘‘marked-to-
myth’’ (Kolev 2008). Moreover the ability of firms to shift assets into the level 3
category (marked-to-model) has also been criticized (Saft 2008). A recent study
highlights similar concerns about the reliability of FVA information. Using a global
sample of 322 banks that apply IFRS between 2006 and 2008, Fiechter and
Novotny-Farkas (2011) find that, while FVA information is value relevant, its
pricing differs across firm-specific and institutional factors and exhibits a substantial
discount during the financial crisis. They conclude that their findings raise concerns
about the general reliability of fair value.
Finally, FVA, measured as exit price, increases volatility in reported earnings
incorporating bubble prices into earnings, thus potentially providing a misleading
image of underlying performance (Benston 2008). For instance, evidence suggests
that FVA-based information about corporate retirement plans does not dominate the
current smoothing model for pension accounting and that there are no obvious
informational advantages in moving toward a fair-value pension accounting model
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(Hann et al. 2007).3 FVA-induced volatility translates into a more difficult

forecasting environment for financial markets’ participants as they attempt to
disentangle transitory and permanent earnings shifts. Moreover, there is evidence
that financial institutions with a larger proportion of FVA assets and liabilities face a
higher failure contagion risk (Khan 2010).
In contrast, the case for FVA rests essentially on its ability to reduce the
information risk for investors, by providing relevant information to financial
markets and enhancing financial transparency. Blankespoor et al. (2013) suggest
that recognizing loans and deposits at fair value provides a balance sheet that
reflects the average bank’s credit risk better than a more historical-cost-oriented
balance sheet. In the same vein, Schneider and Tran (2012) show a lower level of
information asymmetries for banks adopting the fair value option. Moreover,
several studies show that FVA-based information dominates historical cost-based
information in terms of value relevance; that is, a firm’s stock market value is more
closely associated with FVA-based information than with historical cost informa-
tion. Many of these studies have been conducted within the financial services or
commercial banking industries (e.g., Ahmed et al. 2006; Barth 1994; Barth et al.
1996; Eccher et al. 1996; Nelson 1996). Consistent with such evidence, Linsmeier
(2011) argues that it would be preferable to mandate the reporting of fair values for
all financial instruments in addition to some historical cost information since fair
value information alerts investors and regulators of changes in current market
expectations when asset prices are declining and risk levels for financial institutions
are increasing. Historical cost accounting with impairment estimates provides
insufficient warning of these changes. Moreover, the advent of FVA allows
investors to pierce through various earnings management schemes by financial
institutions’ executives: FVA essentially precludes the strategic timing of asset sales
to recognize gains or losses (Barth and Taylor 2010).
With respect to transparency, the disclosure of which measurement methodol-
ogies underlie the valuation of different assets and liabilities (i.e., disclosure of FVA
levels 1, 2, and 3) allows investors to differentially value them (e.g., Song et al.
2010). Overall, Barth (2007, p. 12) argues that ‘‘Although opponents of more
comprehensive use of fair value have some legitimate concerns, standard setters are
unaware of a plausible alternative.’’ Moreover, arguments to the effect that the use
of FVA (1) reduces the ability to predict future earnings, (2) overemphasizes
relevance to the detriment of reliability, and (3) induces excess volatility can be
countered in the following ways. First, FVA figures reflect market prices or
approximations of market prices. If markets are efficient, such prices or price
estimates reflect unbiased expectations about underlying assets future cash flows
(Milburn 2008). Hence, with appropriate disclosure, analysts can deconstruct the
reported values and predict future earnings. Second, FVA figures (especially level 1)
3
The latter point is difficult to ascertain. For instance, Fiechter (2010) finds evidence that banks applying
the Fair Value Option (FVO) with the intention of reducing accounting mismatches as well as banks that
apply the FVO to financial liabilities report lower levels of earnings volatility than non-appliers.
However, such reduced volatility either reflects calm and steady underlying economic conditions or,
alternatively, increased ability by executives to smooth reported earnings through strategic use of the
various FVA measurement levels.
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can be deemed reliable as they reflect market prices that are readily observable.
Third, volatility in FVA figures reflects the fundamentals of a business and needs to
be reported, not smoothed away.
2.3 Conceptual template and hypotheses
2.3.1 Conceptual template
Kothari et al. (2010) review recent developments in financial reporting standard-

setting and assess their implications for, as they say, ‘‘… the form and substance of
financial reporting, with attendant economic consequences’’ (p. 247). These
developments include, most notably, the expanded use of fair values in financial
statements and movement away from historical cost as a measurement basis. While
there is widespread consensus that the objective of GAAP is to facilitate efficient
capital allocation within the economy, Kothari et al. (2010) do point out that there
are divergent views regarding the means to achieve such an objective. On one hand,
accounting rules are perceived to lead to financial statements that allow for a direct
firm valuation. On the other hand, the authors also argue that the use of financial
statements as a tool for performance evaluation and stewardship arises from the
economic tensions that collide in GAAP in an effort to facilitate efficient capital
allocation. In summary, Kothari et al. (2010) argue that GAAP-driven financial
statements respond to two market-driven demands that specify their primary role:
(1) the income statement provides information useful for managerial performance
evaluation, and (2) the balance sheet provides information on the values of the
entity’s separable assets and liabilities, for both debt contracting and managerial
monitoring (p. 260).
By emphasizing the duality between income (performance evaluation) and the
balance sheet (stewardship), the template developed by Kothari et al. (2010)
provides a useful framework to develop predictions regarding the mapping between
FVA and the information environment of financial analysts.
In a frictionless world, a full FVA model provides a balance sheet that can jointly
fulfill both roles. However, if a balance sheet contains both historical cost- and fair
value-measured items, then a firm’s income statement will reflect volatility that is
induced by accounting measurement mismatches, thus potentially undermining
current earnings’ usefulness as a basis for forecasting future earnings (Penman
2007). As a consequence, De Weerts (2011) points out that information derived
from the balance sheet becomes a direct input to the earnings forecasting process. In
other words, the balance sheet reflects the quality of stewardship through attributes
such as asset mix (securities vs. loans), leverage, or the extent of assets at fair value,
all of which are critical in forecasting earnings. As a consequence, we analyze
whether assets and liabilities measured at the fair value improve analysts’ ability to
predict earnings.
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2.3.2 Fair value accounting and analyst forecasts
Our research question relates to how the extent of a firm’s use of FVA in measuring
its assets and liabilities enhances or undermines the ability of financial analysts to
forecast the firm’s future financial performance. In that regard, Kothari et al. (2010)
argue that, if measurement is sufficiently reliable, then reporting assets or liabilities
at fair value is likely to be superior to an historical cost basis in terms of providing
information about performance and stewardship, assuming assets and liabilities are
separable. A caveat to their assessment is that such assets and liabilities must trade
in liquid secondary markets, providing firm investors with relevant, reliable
information about underlying values. For example, for marketable investment
securities (e.g., US Treasury bonds), which trade in deeply liquid markets, fair value
provides a solid footing for financial reporting. However, there are four reasons why
fair value might reduce the predictability of earnings.
First, as Penman (2007) points out, the use of FVA with other measurement bases
in the balance sheet induces artificial volatility in reported earnings, making them
more difficult to predict.
Second, for assets traded in imperfectly liquid markets, there is the possibility to
trade strategically to influence the year-end fair value and the related earnings. The
evidence on year-end price manipulations is widespread (Gallagher et al. 2009;
Comerton-Forde and Putninš 2011). Gorton et al. (2010) show that the informa-
tiveness of prices is undermined by a coordinated manipulation. As a consequence,
incorporating the manipulated prices into the balance sheet and income statement,
through the use of fair value, severely undermines the usefulness of current income
in forecasting earnings.
Third, for assets such as customized or exotic derivatives, which do not always
trade in liquid secondary markets, if they trade at all, the superiority of fair value
over historical cost is questionable. For these assets, fair values are not
independently observable and are subject to managerial discretion, thus severely
undermining the reliability of reported values (in addition to the potential for
measurement errors arising from faulty models). Hence, while there are both
advantages and disadvantages to using FVA in financial statements, the main
concern is the nonverifiability of fair value estimates, especially given managers’
asymmetric incentives to overstate income and net assets.
Fourth, there is evidence that fair value-based earnings are more volatile than
historical cost-based figures (Barth 1994; Landsman 2007), most likely as a result of
measurement error or assets-liabilities mismatch or as a reflection of underlying
economic volatility. However, in the latter case, changes in fair value reflect either a
permanent change (an external event or shock that will affect earnings in a
persistent manner) or a temporary change (fluctuations in market risk that will affect
short term earnings but will most likely reverse in the long run). In that regard, a
survey of CFOs reveals that they believe FVA should be used mostly for disclosure
rather than ‘‘running fair-value changes through earnings’’ (Dichev et al. 2013,
p. 21). One CFO actually said: ‘‘fair value accounting creates a level of volatility
and change, even though nothing in the business seems to have changed. That is the
new frontier of confusion.’’ These comments are consistent with Givoly and Hayn’s
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(2000) view that FVA induces the recognition of more transitory items into reported
earnings, thus increasing their volatility but also, presumably, reducing their
predictability. Hence it is possible that the use of FVA reduces analysts’ ability to
forecast earnings, even when it perfectly reflects the underlying economic volatility,
thus rendering reported earnings a timely representation of underlying economic
performance. Indeed, it forces analysts to distinguish between permanent and
temporary changes in value to correctly predict future earnings. Obviously, earnings
volatility induced by measurement errors and the assets-liabilities mismatch makes
the forecast of earnings even more difficult.
In light of the above arguments, we put forward the following hypotheses:
H1a: There is a negative relation between the extent of a bank holding company’s
assets and liabilities measured and reported at fair value and the accuracy of
analysts’ earnings forecasts.
H1b: There is a positive relation between the extent of a bank holding company’s
assets and liabilities measured and reported at fair value and the dispersion of
analysts’ earnings forecasts.
2.3.3 Impact of SFAS 157 disclosure on the information environment
Prior research on analyst behavior shows that an increase in firms’ disclosure

positively affects analysts’ ability to forecasts earnings (e.g., Lang and Lundholm
1996). Following the enactment of SFAS 157 (FASB 2006a), banks have to disclose
the measurement basis for assets and liabilities reported at fair value, that is, level 1
(valuation based upon market prices), level 2 (valuation based upon market inputs),
and level 3 (valuation based upon model estimates). Prior to SFAS 157, such
information was not available. Hence there was significant uncertainty associated
with the future cash flows to be expected from balance sheet assets and liabilities.
Kothari et al. (2010) assert that, within an efficient contracting perspective,
standards regarding asset recognition must be consistent with evaluating manage-
ment’s stewardship of the firm’s net assets. To achieve that aim, the following
criteria are deemed appropriate: (1) there is a reasonable expectation that the
balance sheet item will generate future economic benefits (cash flows), (2) the
balance sheet item has economic value on a standalone basis (separate and salable),
and (3) the benefits to be derived from the balance sheet item can be reliably verified
by parties other than management.
With the advent of SFAS 157, it can be argued that analysts can better assess the
appropriateness of all three criteria when examining assets recorded at fair value on
a bank’s balance sheet and apply discounts when needed. The disclosure is expected
to be beneficial because knowing the underlying fair value measurement basis for
fair value assets and liabilities does provide information to analysts that helps them
assess the quality of earnings as a basis for forecasts. For instance, being solely
determined by market conditions, level 1 estimates are not subject to managerial
discretion but, as a result, do reflect market factors that may be temporary and not
representative of long-term trends (e.g., poor liquidity). In contrast, level 3 estimates
are not market based and are derived from underlying models that are not
123
transparent, thus providing management with much discretion. In between, level 2

estimates are based upon market inputs but allow management to supplement such
values with private information. Landsman (2007) discusses this issue when
reviewing findings reported in Barth et al. (1998a) about the valuation of bond
holdings. Hence we propose the following hypotheses:
H2: Disclosure resulting from the advent of SFAS 157 enhances the information
environment faced by financial analysts.
H3: There is a positive relation between the reliability of the measurement basis
of a bank holding company’s assets and liabilities reported at fair value and
analysts’ forecasting ability, as reflected in the accuracy and dispersion of their
earnings forecasts.
3 Methodology
3.1 Sample
The initial sample consists of 1,161 US bank holding companies (labeled simply as
banks in the remainder of the text) for which data is available in the form FR Y-9C4
from the Federal Reserve Bank of Chicago from 1996 to 2009. We require that each
bank be followed by three active financial analysts who provide earnings forecasts.5
We also require the availability of financial and stock market data on Datastream
and analysts’ forecasts on I/B/E/S. As a result, the final number of banks included in
our sample is 309, and the total number of bank-quarter observations is 5,963.
3.2 Empirical model
We proxy for analysts’ information environment (IE) using analyst forecast

accuracy and forecast dispersion, where higher accuracy and smaller dispersion
reveal a richer information environment. To show the mechanisms through which
fair value information translate into earnings forecasts, we perform additional
analyses in which we use the precision of public (h) and private (s) analysts’
information as in Barron et al. (1998).6 We use h and s to analyze the underlying
mechanisms that drive the effect of FVA disclosure and measurement on analysts’
forecasts accuracy and dispersion. Indeed, accuracy and dispersion reflect the
commonality of information among analysts as well as the precision in individual
analyst forecast. We fit panel data models by using generalized least square (GLS)
4
The FR Y-9C report form is to be filed at least by bank holding companies with total consolidated
assets of $500 million or more. Prior to 2006, the report had to be filed by bank holding companies with
total consolidated assets of $150 million. Due to the requirement of at least three analysts following, we
do not observe a drop in the number of banks around 2006.
5
We consider active all those analysts who forecast annual earnings at least twice in a year in two but not
in the same quarter.
6
Please, refer to Sect. 3.6 for the details on how to calculate the precision of public (h) and private
(s) analysts’ information.
123
estimation allowing for AR1 autocorrelation structure to analyze the impact of fair
value on analysts’ information environment features. (All standard errors are
adjusted for heteroskedasticity).7 We use the following multivariate model to test
our hypotheses.
IEt ¼ a þ bFVt1 þ Rj cj Controlj þ e ð1Þ
where IE information environment: accuracy (Acc), dispersion (Disp), or precision

of analysts’ public (h) and private (s) information as in Barron et al. (1998), FV total
value of assets and liabilities measured at fair value on recurring basis divided by
the total value of assets.8
We pay attention to the fair value reported on the balance sheet to avoid other
possible confounding sources of uncertainty from analysts’ perspective. For
example, a decline in fair value below the amortized costs is recognized in the
income statement according to the specific rule governing the impairment test.
Given that the impairment test captures only losses and differs between held to
maturity and loans, using a total fair value that encompasses the fair value in the
notes potentially represents an additional source of uncertainty other than the fair
value itself. The uncertainty consists in estimating when a loss (a drop in fair value)
is ‘‘other than temporary,’’ implying a distinction between the losses attributable to
loans and the losses attributable to held to maturity financial instruments. Therefore
we cannot understand whether the uncertainty is due to the specific impairment test
rules or to the fair value itself.9
To test our first hypotheses (H1a and H1b), we use the entire sample from 1996
to 2009. We test our second hypothesis on disclosure (H2) interacting the total fair
(FV) value with a dummy variable taking the value of 1 (DISlevels) since the first
quarter 2007.10 For this analysis, we use a subsample of observations from 2004 to
2009 to have an equal number of years around the enactment of SFAS 157.11 To test
hypothesis 3 (H3), we break down the total fair value (FV) considering the different
measurement levels, thus modeling the relationship among the proportion of level 2
(L2) and level 3 (L3) and analyst’s information environment. In this case, we hand-
collect fair value data from quarterly reports for a subsample of 150 banks from
2007 to 2009.12
7
Untabulated results using panel fixed and random effects linear model specifications show that total fair
value is statistically positively associated with accuracy and dispersion.
8
FV is equal to the sum of available-for-sale securities, loan and leases held for sale, trading assets, other
financial assets and servicing assets at fair value, trading liabilities, all other financial liabilities and
servicing liabilities at fair value, and loan commitments not accounted for as derivatives at fair value.
9
The approach chosen in this paper is consistent with the approach used by Ball et al. (2012).
10
Starting the first quarter of 2007, banks have to disclose fair value levels to the Federal Reserve Bank
of Chicago.
11
Results are unchanged if we use the entire sample period.
12
We hand-collect data on fair value levels and disclosure from annual and quarterly reports, because the
Federal Reserve Bank of Chicago required the disclosure of Level 1 assets and liabilities only in 2008.
We exclude 19 banks due to unclear disclosure or missing values.
123
3.3 Dependent variables
We analyze the effect of fair value and fair value disclosure on the accuracy (Acc)
and dispersion (Disp) of analysts’ earnings forecasts. Accuracy is minus the
absolute value of the median13 Earnings per share (EPS) estimated by analysts less
the reported EPS standardized over the stock market price at the end of the year.
Dispersion is the standard deviation of EPS analysts’ forecast estimates over the
stock market price at the end of the year. In our analyses, we use quarterly ranked
measures of accuracy (Acc) and dispersion (Disp).
3.4 Fair value variables
Our main fair value variable is the proportion of the sum of assets and liabilities
measured at fair value on total assets (FV).14 To test H2, we use DISlevels an
indicator (dummy) variable taking the value of 1 after 2006. Starting from the first
quarter of 2007, banks should report to the Federal Reserve Bank of Chicago the
breakdown of assets and liabilities classified as level 2 and 3. Note that SFAS 157
required the disclosure of the level of fair value starting in 2008, but some firms
provided such information in notes to their financial statements as early as 2007.
Therefore we include DISlevels and the interaction between FV and DISlevels in Eq. 1
(p. 17), thus allowing us to understand whether the availability of the disclosure
levels has, per se, an effect on analysts’ information environment.15
3.5 Control variables
Equation 1 (p. 17) includes several control variables. In line with Song et al.
(2010),16 to capture the underlying banking business model, we add loans valued at
amortized cost (Loanamortized) as a control variable in our models. To capture
riskiness of banks’ portfolio, we also include the ratio between risk-weighted assets
and total book value of assets (RWA; Das and Sy 2012). We include three
macroeconomic variables to control for economy-wide conditions. First, we
consider a measure of market illiquidity (Illiquidity).17 Second, we include in the
analyses the change of quarterly GDP (DGDPq). Third, we add to the regressions the
13
Using the mean earnings per share estimated by analysts does not affect the results.
14
Standardizing the FV over total book value of equity does not affect the results.
15
We are aware that, as in most studies that analyze the effect of a regulatory change, it is not possible to
eliminate the influence of other changes. In our case, for example, the forms FR Y-9C were 39, 40, 43,
and 51 pages long in 2006, 2007, 2008, and 2009, respectively, with additions that include some FV level
information in 2007, details on the nature of loans measured at fair value (real estate, commercial, or
industrial, individuals) in 2008, and details on the nature of assets and liabilities in 2009 (from three
categories for the assets at FV in 2008 to 7 in 2009). Even with this caveat, we are using SFAS 157 as the
most prominent change related with fair value accounting around 2007.
16
In their analysis, Song et al. (2010) include the amount of nonfair value assets. To capture the effect of
banks’ investment decision, we include the loans at the amortized cost in our tabulated results. However
including the nonfair value assets instead of loans does not change the results.
17
We adjust Amihud’s (2002) measure of single stock illiquidity to the entire US market: the quarterly
average ratio of the daily absolute return to the (dollar) trading volume on that day.
123
quarterly unemployment rate (Unemployment). We include in our model specifi-

cations the change in GDP (DGDPq) and the unemployment rate (Unemployment)
because, as Guenther and Young (2000) point out, they are capturing two different
economy-wide trends: short period and long period effects, respectively.18 To
control for the level of information asymmetries, we include in the analysis analyst
following (Follow) and banks’ stock price volatility (Volatility). We also control for
a bank’s size (Size) using the natural logarithm of total assets. To capture the effect
of bank’s financial strength, we include the amount of Tier 1 capital (Tier 1). We
also control for bank’s performance using the return on equity ratio (ROE) and
include DEarnings as a proxy for earnings surprises, measured as the earnings at
time t minus earning at time t - 1 over earning at time t - 1. Barth et al. (1998b)
suggest that the effort and probably the quality of analysts’ forecasts vary according
to the amount of tangible assets. In the same vein, Barron et al. (2002b) find that
analyst consensus is negatively affected by the amount of intangible assets. Hence
we include market to book value (MB) as a variable to control for banks’ growth
opportunities. Finally, to control for bank type, we use a dummy variable that is
equal to 1 if the bank is a financial holding company and 0 if it is a bank holding
company (Financial). In all our analysis, we also include a separate dummy for each
quarter as well as for each year. Quarter fixed-effects variables control for within-
year patterns in financial reporting as there is a well-documented quarter effect in
financial reporting across all firms, with the fourth quarter typically exhibiting a
different pattern than other quarters as managers and auditors close the books for the
year (Beaver et al. 2008). Year-fixed effects variables control for year-specific
trends or events that are common to all banks.
3.6 Additional dependent variables
To understand the mechanisms that underlie the effect of FVA disclosure and
measurement on analysts’ forecasts accuracy and dispersion, we adopt the more
focused approach developed in Barron et al. (1998). As discussed by Barron et al.
(2002a), changes in dispersion and accuracy can reflect both the commonality of
information among analysts and the precision in the individual analyst forecast. For
example, if releasing information (e.g., earnings announcement) results in a
decrease in the dispersion of analysts’ forecasts, this implies that the new
information reduces uncertainty and increases the commonality of information
among analysts. Barron et al. (1998) show that forecasts dispersion reflects not only
the commonality of information among analysts but also the precision in individual
analyst forecasts. As new information is released, the precision of forecasts
increases over time irrespective of whether that information is common or
idiosyncratic.
18
Results are robust if we perform our analyses with the same models but using only one of these two
variables. To mitigate the effect of short period change in GDP, we also perform the very same models
using quarterly change in GDP with respect to the same quarter one year before (DGDPy). Although
results using both unemployment and DGDPq or DGDPy are the same, this last variable is highly
negatively correlated with unemployment (-0.764).
123
According to the Barron et al. (1998) model, each analyst observes two signals
about future earnings: a common signal that reflects knowledge shared by all
analysts and a private signal available only to an individual analyst. Thus analysts
forecast future earning based on both common and idiosyncratic knowledge.
Although the precision of common and idiosyncratic information (labeled as h and s
respectively) cannot be calculated for an individual forecast, Barron et al. (1998)
show that, with multiple forecasts, h and s can be measured by using the information
in the aggregated forecast properties: accuracy and dispersion. Relying on the
assumption that s is identical across analysts, Barron et al. demonstrate that:
SE D
N
h¼ 2
1
1 N D þ SE
D
s¼ 2
1
1 D þ SE
N
where D is the dispersion of analyst forecasts for a firm; SE is the squared error in
the mean forecasts; and N is the number of analyst. We standardize both dispersion
and SE on earnings before extraordinary items per share but using stock market
price at the year-end as deflector does not change the results. Following Gu (2005),
we use the square root transformation of the analysts’ forecast properties and h and
s as dependent variables.
Table 1 provides a complete list of all variables.
4 Empirical results
4.1 Descriptive statistics
Table 2 provides descriptive information about our variables. From Table 2, we

infer that assets and liabilities valued at fair value (FV), on average, represent 22 %
of all assets. Untabulated results show that liabilities valued at fair value represent
2 % of total fair value.19 In addition, Table 2 shows that the majority of fair value
assets and liabilities are evaluated on the basis of market inputs (level 2) (87 %),
with direct market valuations (level 1) at 8 % and mark-to-model (level 3)
valuations at 4 %. Untabulated statistics reveal that level 2 assets and liabilities are
on average $35.60 per share, while level 1 are ten times less, and level 3 assets and
liabilities only $1.97 per share. Untabulated results also suggest that level 2 assets
and liabilities exceed 19 % of all assets, while level 1 assets and liabilities are 1.9 %
of all assets. Moreover, the average amount of level 3 assets and liabilities
represents around 0.9 % of all assets. Almost 40 % of banks do not have level 3
assets or liabilities.
19
For additional details on the application of fair value accounting in bank holding companies in the
United States, see Nissim and Penman (2007).
123
Table 1 Select variable definitions

Dependent variables
Acc Accuracy of analyst forecasts (ranked)
Disp Dispersion of analyst forecasts (ranked)
h Precision of common information calculated as in Barron et al. (1998)
s Precision of idiosyncratic information calculated as in Barron et al. (1998)
Fair value variables
FV Total value of assets and liabilities measured at fair value on recurring basis divided
by the total value of assets
DISlevels Dummy variable taking the value of 1 if after 2006, zero otherwise
L1 Proportion of level 1 assets and liabilities on recurring basis
Loan_Dneg Yearly difference between the fair value and the amortized cost of loans measured at
amortized cost if negative and 0 otherwise
Loan_Dpos Yearly difference between the fair value and the amortized cost of loans measured at
amortized cost if positive and 0 otherwise
Risk50–100 % Proportion of fair value assets that require 50 % or 100 % of regulatory capital
Risk100 % Proportion of fair value assets that require 100 % of regulatory capital
Control variables
Loanamortized Loans at amortized cost scaled by total book value of assets
RWA Risk weighted assets over total book value of assets
Illiquidity Quarterly average ratio of the daily absolute return to the (dollar) trading volume on
that day of the US stock market (multiplied by 106)
DGDPq Variation of quarterly US gross domestic product
Unemployment Quarterly US unemployment rate calculated as (100—quarterly US employment rate)
Follow Number of active analysts following the company
Volatility Yearly stock price volatility
Size Natural logarithm of total assets
Tier1 Tier 1 capital ratio
ROE Return on equity index
DEarnings Earnings at time t minus earning at time t - 1 over earning at time t - 1
MB Market value of equity over book value of equity
Financial Dummy variable taking the value of 1 if the bank is a financial holding bank and 0
otherwise
VIX Average daily Chicago Board Options Exchange Market Volatility Index between the
earnings announcement of quarter t - 1 and t
Years Dummy variables identifying each year
Quarters Three different dummy variables identifying the 2nd, 3rd and 4th quarter in the year
4.2 Univariate analysis
Table 3 presents the results of Spearman cross-correlations among selected

variables. Accuracy (Acc) is positively correlated with dispersion (Disp) (0.11),
the precision of common (h) (0.51) and idiosyncratic (s) (0.58) information. On the
contrary, dispersion (Disp) is negatively correlated with h (-0.24) and s (-0.05).
123
Table 2 Descriptive statistics for select variables
576
Count Mean sd p5 p25 p50 p75 p95
123
Acc 5,963 -0.67 1.67 -2.66 -0.60 -0.15 -0.04 -0.01
Disp 5,963 0.02 0.11 1.89e-05 1.81e-04 7.68e-04 3.99e-03 8.41e-02
h 5,963 6.39 8.95 0.00 0.94 2.69 8.16 25.50
s 5,963 5.36 11.70 0.00 0.06 0.66 4.44 28.80
FV 5,963 0.22 0.11 0.08 0.15 0.21 0.28 0.43
L1 649 0.08 0.21 0.00 0.00 0.01 0.05 0.60
L2 649 0.87 0.23 0.12 0.87 0.96 0.99 1.00
L3 649 0.04 0.09 0.00 0.00 0.01 0.04 0.18
Loanamortized 5,963 0.64 0.12 0.40 0.59 0.66 0.72 0.81
RWA 5,963 0.76 0.12 0.56 0.69 0.76 0.83 0.94
Illiquidity 5,963 8.23e-04 5.88e-04 3.24e-04 4.32e-04 6.82e-04 9.43e-04 1.91e-03
DGDP 5,963 5.28e-03 7.51e-03 -9.29e-03 3.29e-03 6.55e-03 9.00e-03 1.73e-02
Unemployment 5,963 28.23 1.65 26.00 27.20 28.30 28.80 32.10
Follow 5,963 7.27 4.91 3.00 4.00 5.00 9.00 18.00
Volatility 5,963 3.37 11.30 0.35 0.76 1.26 2.28 10.80
Size 5,963 6.94 1.63 4.65 5.76 6.74 7.87 9.97
Tier1 5,963 0.11 0.03 0.08 0.09 0.11 0.12 0.16
ROE 5,963 0.07 0.08 -0.00 0.04 0.07 0.11 0.16
DEarnings 5,963 0.29 12.00 -0.81 -0.61 0.40 0.77 1.20
Financial 5,963 0.38 0.49 0.00 0.00 0.00 1.00 1.00
MB 5,963 1.95 0.87 0.72 1.41 1.87 2.35 3.40
LoanamortizedDneg 1,644 -4.78e-03 1.53e-02 -1.72e-02 -3.60e-03 0.00 0.00 0.00
e-03 e-03
LoanamortizedDpos 1,644 4.81 8.35 0.00 0.00 2.25e-04 6.23e-03 2.18e-02
Risk50-100 % 4,579 0.16 0.16 0.01 0.05 0.11 0.22 0.51
Risk100 % 4,579 0.07 0.10 0.00 0.01 0.04 0.09 0.29
VIX 5,963 21.78 8.60 12.09 15.18 20.94 25.74 36.22
The descriptive statistics of accuracy (Acc) and dispersion (Disp) represent actual numbers, not ranks. See Table 1 for the variables definitions
M. Magnan et al.
Table 3 Correlation matrix for select variables
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
Fair value accounting
(1) Acc 1.00

(2) Disp 0.11*** 1.00
(3) h 0.51*** -0.24*** 1.00
(4) s 0.58*** -0.05*** 0.43*** 1.00
(5) FV 0.03** 0.13*** -0.01 -0.01 1.00
(6) L1 -0.10** 0.04 0.01 -0.05 0.00 1.00
(7) L2 0.12*** -0.13*** 0.03 0.09** -0.01 -0.91*** 1.00
(8) L3 -0.07* 0.22*** -0.11*** -0.09** 0.02 -0.05 -0.37*** 1.00
(9) Loanamortized 0.06*** -0.07*** 0.06*** 0.04*** -0.77*** -0.01 0.02 -0.03 1.00
(10) LoanamortizedDneg -0.03 -0.10*** 0.06** 0.04 0.04* 0.05 -0.01 -0.07 -0.02 1.00
(11) LoanamortizedDpos 0.07*** -0.07*** -0.05** -0.04 0.11*** -0.02 0.01 0.04 -0.10*** 0.18*** 1.00
(12) Risk50-100 % -0.05*** 0.07*** -0.06*** -0.07*** 0.00 -0.03 -0.05 0.19*** -0.02 0.01 0.01 1.00
(13) Risk100 % -0.03* 0.08*** -0.06*** -0.06*** 0.04*** -0.05 -0.08** 0.30*** -0.09*** 0.00 -0.03 0.64*** 1.00
(14) Illiquidity -0.09*** -0.09*** -0.15*** -0.11*** -0.06*** -0.19*** 0.13*** 0.11*** 0.03*** -0.04* 0.10*** 0.03* 0.04** 1.00
(15) VIX -0.09*** -0.09*** -0.18*** -0.13*** -0.09*** -0.19*** 0.13*** 0.10** 0.06*** -0.04* 0.11*** 0.05*** 0.06*** 0.92***
See Table 1 for variables definitions

* p \ 0.10, ** p \ 0.05, *** p \ 0.01
577
123
Hence less (more) accuracy relates with less (more) dispersion and less (more)
precision of information, either common or idiosyncratic. Assets and liabilities
measured at fair value (FV) are associated with more accurate yet more dispersed
forecasts. Nevertheless, the proportion of assets and liabilities measured at level 2
positively correlates with accuracy and negatively correlates with dispersion, while
the opposite is true for assets and liabilities measured at level 3.
4.3 Multivariate analyses
Our multivariate analyses consist of the following steps. First, we test the impact of
FVA on analysts’ forecasts accuracy and dispersion. Second, we analyze if the
disclosure requirements introduced by SFAS 157 regarding FVA measurement
relate with analyst forecasts. While we present initially the results on accuracy and
dispersion, we then delve more deeply to understand the underlying mechanism
through which information at fair value affect accuracy and dispersion by looking at
analysts’ precision of private and public information (Tables 4, 5). Third, to rule out
alternative explanations, we investigate (1) whether the effect of fair value assets is
fully determined by assets’ riskiness (Table 6) and whether (2) the effect of fair
value is different the macroeconomic context (Table 7).
4.3.1 FVA and analysts’ information environment (accuracy and dispersion)
Models 1 and 2 of Table 4 explore the effect of fair value on accuracy and
dispersion. The results indicate that overall FV is associated to greater dispersion
(Model 2) (15.40; p \ 0.05).20 Models 3–6 consider the effect of fair value
disclosure introduced by SFAS 157.
Models 3 and 4 consider as research variables the total fair value (FV), whether
the disclosure about the levels is available (DISLevels) and the interaction between
FV and DISLevels. The results suggest that, while the disclosure of FV measurement
levels (DISLevels) increases accuracy (29.40; p \ 0.01) and dispersion (32.70;
p \ 0.01), the total fair value (FV) continues to have a positive impact only on
dispersion (26; p \ 0.05), and the interaction term (DISLevels*FV) increases
accuracy (37.80; p \ 0.01) and decreases dispersion (-35.80; p \ 0.01).21 Hence
it appears that the advent of SFAS 157 was beneficial to analysts.22
20
In untabulated tests, we exclude each year of data one by one, and in all of the tests, the results are the
same.
21
The regression models use a subsample of observations centered around the application of SFAS 157.
Therefore we consider the years 2007, 2008, and 2009 as the post-adoption period and the years 2004,
2005, and 2006 as pre-adoption period. Considering the entire sample from 1996 does not modify the
results.
22
Note that SFAS 157 mandates the disclosure of fair value levels starting from the fiscal year beginning
after November 15, 2007. The adoption period overlaps quite extensively with the start of the financial
crisis, which may induce analysts to screen accurately securities typically evaluated at fair value. To
alleviate the concern that the results are driven by an increase in the level of attention paid by analysts, we
include in the post-adoption period the bank-quarter observations that voluntarily release fair value. By
including banks that voluntarily reported fair value levels in 2007, before the most severe crisis period,
we aim to reduce the concern that the results are simply driven by analysts’ attention. We are aware that
123
Models 5 and 6 provide results on the relation between fair value measurement
basis (i.e., levels 1, 2, or 3) and the information environment. To understand the
impact of the measurement basis along with the total fair value, the models include
the proportion of FV level 2 and level 3 assets over total FV (respectively L2 and
L3). Results indicate that the proportion of assets and liabilities assessed at level 2
(L2) relates to more accurate forecasts (Model 5; 14.08; p \ 0.01). In contrast, the
proportion of level 3 assets and liabilities (L3) relates to more dispersion (Model 6;
40.20; p \ 0.01), while total fair value is not associated with accuracy and
dispersion. Results in columns 5 and 6 help to interpret results reported in columns 3
and 4. They show that a marginal increase in FV level 2 is positively associated with
accuracy while a marginal increase in FV level 3 is positively associated with
dispersion. The result for level 3 is consistent with previous literature that identifies
level 3 as the most confusing fair value (Evans et al. 2014), while the results in
column 5 are puzzling. However, they are consistent with the explanation provided
by Landsman (2007) when discussing the argument and the empirical findings put
forward by Barth et al. (1998a). The underlying intuition is that FV level 2
information is based upon market inputs, so managerial discretion is constrained. In
contrast, Level 3 information is based upon opaque models (almost no disclosure),
which do not necessarily rely on market inputs. So, level 2 measurement contains
market inputs that keep management honest while allowing some discretion.
However, level 3 measurement imposes no such constraint.
Overall, Table 4 provides evidence consistent with H1b but not with H1a.
Particularly, total fair value is associated with more dispersion, suggesting that
analysts disagree more as the amount of assets and liabilities measured and reported
at fair value increases (H1b). The disclosure of the measurement basis (SFAS 157)
has per se a positive effect on accuracy and dispersion. Moreover, the greater the
extent of fair value assets and liabilities, jointly with the disclosure of levels, the
more analysts’ forecasts are accurate and less dispersed (H2).
With respect to the measurement basis, we hypothesize a monotonic decrease in the
quality of analysts’ information environment as the estimation basis for reported fair
values evolves from level 1 (mark-to-market) toward level 3 (mark-to-model) (H3).
Consistent with H3, there is a negative association between level 3 and dispersion
compared to the most reliable estimation basis (level 1). However, contrary to
expectations, results indicate a positive association between level 2 and accuracy.
A potential explanation for these unexpected results is the specific period over
which the analysis on fair value level is performed. SFAS 157 mandates the
disclosure of the levels starting from the first quarter 2007; therefore, the period of
analysis overlaps with the financial crisis. During the crisis, even forecasting the
overall market would have been a challenge, and several markets dried up, raising
Footnote 22 continued
banks that report on a voluntarily basis have incentives to be more transparent and their commitment
towards transparency may drive the results. In any case, using only 2008 and 2009 as the post-adoption
period does not affect the results. Finally, results in Table 7 (columns 1–4) show that, when the illiquidity
and the VIX are high, the accuracy of analysts’ forecasts does not increase, thus reducing the concern that
the increase in accuracy during the post-disclosure period is due to an increase in the level of attention
paid by analysts.
123
Table 4 GLS Models (using panel-specific AR1 autocorrelation structure) that analyze the association
between total fair value (Models 1 and 2), fair value disclosure (Models 3 and 4), and fair value levels
(Models 5 and 6) with accuracy and dispersion
FV Disclosure Levels
(1) (2) (3) (4) (5) (6)

Acc Disp Acc Disp Acc Disp
Research variables
FV 10.30 15.40** 1.79 26.00** -0.06 -3.24
(1.36) (2.38) (0.15) (2.01) (-0.02) (-1.30)
FV*DISLevels 37.80*** -35.80***
(2.92) (-3.12)
DISLevels 29.40*** 32.70***
(5.47) (5.29)
L2 14.80*** -1.89
(3.09) (-0.47)
L3 8.92 40.20***
(0.95) (5.16)
Control variables
Loanamortized 20.40** -24.10*** 31.80** -61.80*** -37.00*** -13.80
(2.49) (-3.57) (2.26) (-4.47) (-2.60) (-1.28)
RWA -4.73 16.40*** -17.70 66.00*** -14.70 57.60***
(-0.82) (3.26) (-1.52) (6.45) (-0.87) (6.63)
Illiquidity -4,671*** -4,761*** -4,223*** -358 -10,772* 1,613
(-7.00) (-5.66) (-3.04) (-0.22) (-1.91) (0.60)
DGDPq -227*** -275*** -353*** 59 184 1,378***
(-4.87) (-4.40) (-3.07) (0.40) (0.23) (3.51)
Unemployment -0.61 -4.15*** -6.83*** -11.30*** -1.43 14.7***
(-0.86) (-5.11) (-6.02) (-8.52) (-0.21) (4.01)
Follow -0.07 1.67*** -0.51*** 2.23*** -1.42*** 1.58***
(-0.75) (17.79) (-2.61) (12.78) (-5.42) (9.09)
Volatility -0.03 0.23*** 0.01 0.20*** 0.04 0.14**
(-0.66) (4.78) (0.23) (4.15) (0.68) (2.57)
Size 3.77*** 2.68*** 4.89*** 1.66** 8.23*** 5.05***
(7.76) (7.22) (5.70) (2.41) (6.67) (7.87)
Tier1 -28.90 -22.80* -27.60 4.74 193*** -113***
(-1.50) (-1.91) (-1.56) (0.20) (3.90) (-4.23)
ROE -4.16 -49.90*** -10.00 -61.40*** 18.20* -87.40***
(-0.68) (-6.73) (-1.38) (-7.16) (1.72) (-8.77)
Dearnings -0.06*** 0.05*** -0.06** 0.03 0.43*** -0.22*
(-3.80) (2.58) (-2.41) (0.90) (2.73) (-1.75)
MB 1.35** -6.54*** 5.67*** -5.88*** 7.90*** -5.28***
(2.32) (-11.04) (4.79) (-5.32) (4.93) (-3.65)
Financial 0.14 4.62*** -2.79 4.41*** -9.56*** 6.05***
(0.10) (4.18) (-1.43) (2.88) (-4.65) (3.86)
123
Table 4 continued
(1) (2) (3) (4) (5) (6)

Constant 12.30 136*** 213*** 355*** 55.40 -390***

(0.60) (5.80) (6.19) (8.78) (0.30) (-3.88)
Year Yes Yes Yes Yes Yes Yes
Quarters Yes Yes Yes Yes Yes Yes
v2 1,257.9 12,191.1 455.2 1,466.3 1,615.5 22,227.8
N. of cases 5,963 5,963 3,284 3,284 649 649
N. of banks 309 309 219 219 131 131
Average group size 19.3 19.3 15.0 15.0 4.95 4.95

* p \ 0.10, ** p \ 0.05, *** p \ 0.01; z statistics in parentheses
the issue of the relevance and reliability of level 1 figures. In this context, it seems
that the discretion in the measurement of fair value level 2 assets and liabilities
permits managers to convey information about the fundamental value of assets, thus
offering a more appropriate measurement basis than level 1, which rests solely on
market values. Moreover, the need to rely on market inputs for level 2 estimation
does provide a safeguard constraining the extent of management’s discretion, which
is not present for level 3 estimations (Landsman 2007; Barth et al. 1998a).
4.3.2 FVA and the precision of public and private information
To understand the underlying mechanisms that influence the results on accuracy and
dispersion, we use the Barron et al. (1998) metrics of precision of public and private
information. Models 1 and 2 of Table 5 show that, overall, fair value does not affect
the precision of public (h) and private (s) information.
Models 3 and 4 of Table 5 analyze the effect of FV level disclosure on h and s. In
model 3, FV per se is negatively associated with the precision of public information
(-7.25; p \ 0.01), while the interaction term between fair value and disclosure
(FV*DISLevels) is positively associated with the precision of public information
(5.16; p \ 0.01), thus suggesting that disclosing the fair value levels is beneficial to
analysts. Following Barron et al. (1998), we interpret the improvement in the
precision of public information as the impetus for the increase in accuracy.
Models 5 and 6 of Table 5 report the relationship between fair value levels and
h and s. Only fair value level 2 maps into higher precision of both public (0.99;
p \ 0.05) and private information (1.81; p \ 0.01), which explains the positive
relation between level 2 (L2) and accuracy reported in Table 4. After controlling for
the proportion of level 2 and level 3 fair value assets and liabilities (L2, L3), total
fair value relates with a higher precision of private information (Model 6, 0.65;
p \ 0.01) but with a lower precision of public information (Model 5, -0.37;
p \ 0.10).
123
Finally, level 3 (L3) is associated with less precision of both public (Model 5,
-2.53; p \ 0.05) and private information (Model 6, -1.67; p \ 0.10), thus
supporting the results on accuracy and dispersion reported in Table 4.23
4.3.3 Disentangling FVA effects from underlying asset risk
Overall, the main results on total fair value seem driven by the small proportion of
assets (in average 4 % of all assets and liabilities at fair value) for which estimation
is based on proprietary models without a formal link with market prices or input
coming from an active market for identical or similar products. However, for assets
at level 3, a severe liquidity risk exists. Hence, as a consequence, it is unclear
whether the results on accuracy and dispersion are driven by the riskiness of
underlying assets or by concerns about fair value reliability. Therefore, to rule out
the alternative explanation that results on fair value reflect differences in the
underlying level of risk, we conduct two sets of test, the results of which are
reported in Tables 6 and 7.
First, we consider the yearly difference (negative or positive) between the
disclosed fair value and the amortized cost of loans measured at amortized cost
(LoanamortizedDneg and LoanamortizedDpos). Models 1 and 2 of Table 6 show that,
while a positive difference does not relate to analysts’ forecasts, a negative one (i.e.,
the loan portfolio’s fair value is lower than its amortized cost) implies a decrease in
forecast accuracy (Model 1, -171; p \ 0.05). Our results differ from Chee (2011),
who finds that disclosed FV provides little incremental information about future
loan defaults over historical cost and concludes that both measures suffer from
similar timeliness problems. The differences in the results can be due to the different
empirical strategy. In contrast to Chee (2011), we analyze separately positive and
negative differences between fair value and amortized cost. Our interpretation of the
results is that loan fair values that exceed historical cost are not useful to analysts, as
they most likely do not translate into higher earnings or cash flows if clients repay
their loans on schedule. However, when fair values are lower than amortized cost,
the difference reflects either (1) a deteriorating credit quality that translates into
lower future cash flows and earnings or, alternatively, (2) fluctuating debt market
conditions that do not imply any change in actual future cash flows from clients. As
a consequence, given that it is difficult to separate permanent from transient shocks
to fair value, its use leads to a deterioration in analysts’ information environment.
Hence, holding constant the investment and the related risk, increasing use of FV
appears to worsen the information environment for analysts. Positive differences
(fair value—amortized cost) do not affect the informational environment because,
23
Altamuro and Zhang (2013) find that Mortgage Servicing Rights (MSR) measured at level 3 are more
informative than MSR measured at level 2. However, most banks do not report any MSR, and these
represent a minute portion of banks’ assets (less than 1 %), thus making any generalization to other
classes of asset tentative (Hendricks and Shakespeare 2013). In contrast, consistent with our results,
Evans et al. (2014) show that the predictive ability of FVA-based information on interest-bearing
investment securities is positively related to its measurement precision, with level 3 exhibiting the least
precision (vs. levels 2 and 1). Our results provide also further support to Bratten et al. (2012), who find
that the impact of FVA on the predictability of future return on assets, cash flow from operations, and
earnings is conditional on several variables or mixed at best.
123
between total fair value (Models 1 and 2), fair value disclosure (Models 3 and 4), and fair value levels
(Models 5 and 6) with h and s
(1) (2) (3) (4) (5) (6)

h s h s h s
Research variables
FV -0.10 0.23 -7.25*** -2.64 -0.37* 0.65***
(-0.08) (0.18) (-3.12) (-0.89) (-1.68) (4.93)
FV*DISLevels 5.16*** 2.15
(2.80) (0.88)
DISLevels -3.09*** 0.10
(-3.41) (0.09)
L2 0.99** 1.81***
(2.12) (3.26)
L3 -2.53** -1.67*
(-2.53) (-1.70)
Control variables
Loanamortized 5.17*** 3.30** 1.58 1.04 -1.99* -2.53
(3.61) (2.30) (0.67) (0.32) (-1.81) (-1.40)
RWA -0.98 -1.47 -3.16* -2.05 -0.21 2.28
(-0.89) (-1.24) (-1.79) (-0.88) (-0.17) (1.54)
Illiquidity -152 -7.89 -168 -294 1,358* 413
(-1.07) (-0.06) (-0.63) (-1.01) (1.78) (0.39)
DGDPq -5.66 -15.80 -5.00 -40.30 162 217
(-0.50) (-1.64) (-0.21) (-1.55) (1.52) (1.53)
Unemployment 0.20 0.06 -0.59*** -0.47** 0.45 -1.71*
(1.46) (0.42) (-3.09) (-1.98) (0.61) (-1.72)
Follow -0.10*** -0.09*** -0.10*** -0.09** -0.09*** -0.04
(-4.70) (-4.48) (-3.23) (-2.46) (-4.04) (-1.19)
Volatility -0.01 -0.01 -0.01 -0.01 -0.01 -0.01*
(-1.14) (-0.94) (-1.49) (-1.32) (-1.40) (-1.88)
Size -0.03 0.22** -0.26** -0.22 -0.18* -0.36***
(-0.37) (2.36) (-2.10) (-1.36) (-1.80) (-2.67)
Tier1 -12.10*** -5.02** -13.30** 5.51 24.10*** 24.70***
(-6.12) (-2.30) (-2.46) (0.97) (5.70) (4.92)
ROE 2.77** 2.15* 2.52* 1.53 5.38*** 4.72***
(2.10) (1.85) (1.80) (1.11) (7.09) (4.40)
Dearnings -0.01*** -0.01 -0.01** -0.01 3.91e-04 0.03*
(-3.05) (-1.22) (-2.00) (-1.04) (0.03) (1.75)
MB 0.67*** 0.46*** 0.97*** 1.19*** -0.37** 0.20
(5.05) (3.41) (4.91) (4.80) (-2.16) (0.81)
Financial -0.16 0.41 -0.13 0.65 -0.23 -0.41*
(-0.64) (1.48) (-0.43) (1.59) (-1.33) (-1.66)
123
Table 5 continued
(1) (2) (3) (4) (5) (6)

h s h s h s
Constant -5.92 -3.22 28.40*** 18** -7.85 48*

(-1.47) (-0.78) (4.75) (2.34) (-0.38) (1.74)
Year Yes Yes Yes Yes Yes Yes
Quarters Yes Yes Yes Yes Yes Yes
v2 1,383.4 793.7 1,871.6 424.9 690.9 758.5
N. of cases 5,963 5,963 3,284 3,284 649 649
N. of banks 309 309 219 219 131 131

between total fair value and accuracy and dispersion considering the riskiness of assets at fair value,
proxied by the positive and negative difference between fair value and amortized costs (Models 1 and 2)
and by the level of risk as for capital requirement of assets measured at fair value (Models 3 and 4)
LoanamortizedDfv-hc Risky assets
(1) (2) (3) (4) (5) (6)

FV 39.60*** 19.70 7.26 18.20** 6.84 18.30**

(2.62) (1.26) (0.73) (2.11) (0.71) (2.15)
LoanamortizedDneg -171.00** 63.80
(-2.17) (1.06)
LoanamortizedDpos 92.30 -56.50
(0.71) (-0.50)
Risk50-100 % -0.41 9.15***
(-0.11) (2.84)
Risk100 % -1.67 2.32
(-0.28) (0.52)
Controls Yes Yes Yes Yes Yes Yes
v2 293.0 1,472.3 652.6 2,531.9 667.7 2,220.0
N. of cases 1,644 1,644 4,576 4,576 4,576 4,576
N. of banks 138 138 252 252 252 252
CONTROLS: Constant, Loanamortized, RWA, DGDPq, Unemployment, Follow, Volatility, Size, Tier1,
ROE, MB, Dearnings, Financial, Quarters, Years
123
between total fair value and accuracy and dispersion considering macroeconomics trends, proxied by the
level of illiquidity (Models 1 and 2) and by the VIX (Models 3 and 4)
Illiquidity VIX
(1) (2) (3) (4)

Acc Disp Acc Disp
FV 8.97 20.70*** 5.93 36***

(1.02) (2.58) (0.52) (3.33)
FV 9 illiquidity 1,709 -6,135
(0.33) (-1.08)
FV 9 VIX 0.22 -0.86**
(0.58) (-2.16)
Illiquidity -5,050*** -3,436**
(-3.84) (-2.36)
VIX -0.49*** -0.24**
(-5.06) (-2.26)
Controls Yes Yes Yes Yes
chi2 1,245.6 14,485.1 1,298.5 13,695.3
N. of cases 5,963 5,963 5,963 5,963
N. of banks 309 309 309 309
Average group size 19.3 19.3 19.3 19.3
CONTROLS: Constant, Loanamortized, RWA, DGDPq, Unemployment, Follow, Volatility, Size, Tier1,
ROE, MB, Dearnings, Financial, Quarters, Years
for held-to-maturity investments, they never translate into earnings. In contrast,

negative differences worsen the information environment since they increase the
uncertainty as to whether and when they will flow into earnings.24 Overall, it does
appear that as the reliance on fair value as a measurement basis increases, the
informational environment worsens.25
Second, using the information reported in form FR Y-9C, which maps assets at
fair value and the regulatory capital required, we calculate the proportion of assets at
fair value (available for sale securities, loans and leases, securities, and trading
assets), which are assigned risk weightings of 50 % or 100 % (Risk 50–100 %), and
the proportion of assets at fair value, which are assigned a risk weighting of 100 %
(Risk 100 %), for the purpose of computing regulatory capital (over available for
24
Our results can be interpreted as the effect of a low level of reliability of the disclosure of fair value of
loan portfolios. However, Nissim (2003) suggests that banks are prone to overstate reported fair value of
loans with the intended goal of masking risk and performance. Our results show that negative differences
(fair value lower than the amortized cost) worsens the information environment, which is contrary to what
Nissim (2003) would predict.
25
Focusing on loan portfolios, Cantrell et al. (2011) provide evidence that is consistent with our findings
as they show that historical cost information is better predicts future credit losses, both short and long
term, and bank failures than FVA.
123
sale securities, loans and leases, securities, and trading assets at fair value, which are
assigned risk weightings of 0, 20, 50, or 100 %).26 Hence, in Table 6 (Models 3–6),
the coefficients for Risk50-100 % and Risk100 % represent the association between
the dependent variables and the proportion of different risky assets after having
purged out the effect of the total fair value. Results show that FV is not associated
with more accuracy but is still associated with more dispersion (Model 4, 18.2;
p \ 0.05; Model 6, 18.3; p \ 0.05) even after controlling for the level of risk of the
assets at FV. In addition, Risk50–100 % is associated with more dispersion (Model
4, 9.15; p \ 0.01). Therefore we conclude that assets’ underlying level of risk is not
the sole driver of analyst forecast dispersion and that fair value measurement plays a
role in this regard.
4.3.4 FVA, macroeconomic trends and analysts’ information environment
Table 7 revisits the relation between fair value and accuracy and dispersion
considering the interaction between total fair value and proxies for macroeconomic
trends. Models 1–2 report results considering illiquidity as a proxy while Models 3
and 4 rely upon VIX as a proxy. (VIX is the Chicago Board Options Exchange
Market Volatility Index, which measures the implied volatility of S&P 500 index
options.) The idea is to test whether results on fair value simply mimic
macroeconomic trends and, consequently, are not due to the fair value itself.
Results from Models 1 and 2 show that total fair value (FV) is positively associated
with dispersion (Model 2, 20.70; p \ 0.01), while the interaction terms between fair
value and illiquidity are not statistically significant. Models 3 and 4 show that total
fair value increases dispersion (Model 4: 36; p \ 0.01), while the interaction
between fair value and VIX reduces dispersion (-0.86; p \ 0.10). Those results
show that the effect of fair value on dispersion is not purely driven by
macroeconomic conditions.27 Moreover, using VIX as a proxy for uncertainty, we
find that there is less dispersion associated with fair value when VIX is high. The
results are consistent with Zhang (2006), who suggests that analyst underreact to
new information, especially in a situation of uncertainty, with analysts revising their
forecast in the same direction. In this vein, our results indicate that in periods of
high uncertainty, analysts mimic each other (‘‘herd’’), thus reducing dispersion
(Ramnath et al. 2008).
Overall, results suggest that the implication of using fair value as a measurement
basis differs across multiple dimensions, including the types of financial instruments
and the levels of measurement basis. With respect to H1a and H1b, most of the
26
For the purpose of computing the required level of regulatory capital, all asset categories are assigned
a risk weighting that varies between 0 and 100 %. Assets with a risk weight of 0 % (typically US
government bonds) do not require a bank to hold any regulatory capital: in essence, a bank can hold as
much of this type of asset as it wants without putting up capital to support that investment. In contrast,
assets with a risk weight of 100 % must be backed up with the required level of regulatory capital. For
example, if the required capital ratio is 10 %, then $100 of assets with a 100 % risk weight require the
bank to hold $10 of capital (10 % 9 $100 9 100 %).
27
Untabulated analyses reveal that the results are qualitatively the same if Illiquidity and VIX are
dichotomized using the median.
123
evidence suggests that reliance on FVA, relative to historical cost, leads to a

deterioration in analysts’ information environment, that is, increased forecast
dispersion and less information precision. However, the impact of FVA on the
information environment is not unidirectional, with some evidence pointing toward
enhanced forecast accuracy under some conditions.
4.4 Additional sensitivity analyses
Prior research shows that auditors’ reputations provide credibility to the annual
reports they audit (Teoh and Wong 1993). For example, Behn et al. (2007) point out
that audit quality affects accuracy and dispersion of analyst forecasts. Therefore
Big4, a dummy variable taking the value of one if the auditor is one of the Big Four
auditing firms and 0 otherwise, is included in model (1). Since we use quarterly
data, we decided to exclude Big4 as one of our main control variable because it is
not clear when auditors change. Untabulated results show that including Big4 does
not materially change results either if we use only fourth quarter data or if we
assume that the auditor is the same for the entire year.
5 Discussion and conclusion
This paper explores how banks’ use of FVA relates to financial analysts’ ability to
forecast their earnings in terms of accuracy and dispersion. Focusing on US bank
holding companies during the period spanning 1996 to 2009, we put forward three
hypotheses. Our results indicate that the increasing use of fair value on a bank’s
balance sheet is associated with more dispersed earnings forecasts (consistent with
H1b) and is not significantly associated with accuracy (H1a). As expected under H2,
the disclosure of measurement basis levels (i.e., the advent of SFAS 157 requiring
the disclosure of levels 1, 2, and 3) has benefited analysts and is associated with
more accurate and less dispersed earnings forecasts. Finally, consistent with H3,
results show that reliance on level 3 FV (mark-to-model) is associated with more
dispersed analyst forecasts. In that regard, it does appear that the opacity in level 3
FV leads to confusion among analysts. Further analyses reveal that underlying the
results for level 3 FV are deteriorations in analysts’ information environment, as
reflected in the precision of public and private information. Sensitivity and
robustness checks suggest that results are not driven by the underlying risk of a
bank’s assets or macroeconomic trends. Moreover, with respect to loans measured
at amortized cost, FV disclosure is associated with less accurate earnings forecasts.
With respect to our initial hypotheses, the evidence provides a mixed signal. On
one hand, consistent with the view that FVA compromises the reliability of financial
reporting and induces artificial volatility, results show that the greater (smaller) the
extent of a bank’s exposure to FVA reporting, the greater (smaller) the dispersion in
analysts’ forecasts. On the other hand, consistent with the view that FVA provides
financial markets with relevant information that embeds expectations about a firm’s
future cash flow performance, the act of providing more information, as required by
SFAS 157, does enhance analysts’ information environment.
123
Our results are subject to limitations. First, financial analysts are one only class of
financial information users. However, there is extensive empirical research that
suggests that financial analysts play an important role in financial markets and that
their actions are relevant and potentially representative of market sentiment as a
whole. Second, one concern is that results are not generalizable since SFAS 157 and
159 were implemented in 2007 during the financial crisis. However, we view
2007–2009 as a stress test for evaluating FVA’s ability to provide early and timely
signals about banks’ performance. In this respect, it is worth mentioning that fair
value was introduced in the aftermath of the savings and loan crisis, in which
historical cost-based financial statements were blamed for not revealing adequately
the underlying risks and performance of failing institutions. Third, alongside the
implementation of SFAS 157, our sample period saw other concurring events (e.g.,
regulatory changes) that affected banks’ reporting and analysts’ information
environment. While it is difficult to disentangle such effects from standard-setting
changes, the critical nature of SFAS 157 as well as our sensitivity analyses provide
us with some confidence regarding the robustness of our results.
Finally, considering both analysts’ forecast properties (accuracy and dispersion)
and the information environment they face (Barron et al. 1998 measures) does
provide the reader with a set of multiple results for which interpretation is
multifaceted. However, we believe that a comprehensive approach allows for a
more nuanced understanding of FVA’s impact on financial markets and facilitates
reconciliation with prior evidence.
Future research could extend and compare the influence and consequences of fair
value measurement and disclosure among US banks with Europe banks, Asian
banks, or both, which invest in different markets with different liquidity levels. The
impact of regulatory oversight and of corporate governance on the informational
properties of fair value information could also be investigated further.
Acknowledgments We thank the editor Patricia Dechow, the anonymous referee and attendants at the
European Accounting Association annual meeting (2011) and the third workshop of Financial Reporting
(2012) and workshop participants at the University of Padova, the Université de Lausanne, Concordia
University, Université Paris-Dauphine, Université de Rennes 1 and Brigham Young University for their
comments and suggestions. We also acknowledge the financial support from the Lawrence Bloomberg
Chair of Accountancy (Concordia), the Social Sciences and Humanities Research Council of Canada and
the research grant from University of Padova CPDA112122/11.
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Rev Account Stud (2015) 20:559–591

Fair value accounting: information or confusion

Michel Magnan • Andrea Menini • Antonio Parbonetti

Published online: 9 September 2014

Keywords Fair value accounting Valuation of assets disclosure Analysts’

A. Menini (&) A. Parbonetti

JEL Classification M41 G21 G12

environment faced by analysts seems to underlie that outcome. In contrast, the

2 Background and conceptual framework

2.1 An overview of fair value accounting

(Hann et al. 2007).3 FVA-induced volatility translates into a more difficult

2.3 Conceptual template and hypotheses

2.3.1 Conceptual template

Kothari et al. (2010) review recent developments in financial reporting standard-

2.3.2 Fair value accounting and analyst forecasts

2.3.3 Impact of SFAS 157 disclosure on the information environment

Prior research on analyst behavior shows that an increase in firms’ disclosure

transparent, thus providing management with much discretion. In between, level 2

3.2 Empirical model

We proxy for analysts’ information environment (IE) using analyst forecast

where IE information environment: accuracy (Acc), dispersion (Disp), or precision

3.3 Dependent variables

3.4 Fair value variables

3.5 Control variables

quarterly unemployment rate (Unemployment). We include in our model specifi-

3.6 Additional dependent variables

4.1 Descriptive statistics

Table 2 provides descriptive information about our variables. From Table 2, we

Table 1 Select variable definitions

4.2 Univariate analysis

Table 3 presents the results of Spearman cross-correlations among selected

Count Mean sd p5 p25 p50 p75 p95

(1) Acc 1.00

See Table 1 for variables definitions

4.3 Multivariate analyses

4.3.1 FVA and analysts’ information environment (accuracy and dispersion)

(1) (2) (3) (4) (5) (6)

(1) (2) (3) (4) (5) (6)

Constant 12.30 136*** 213*** 355*** 55.40 -390***

See Table 1 for variables definitions

4.3.2 FVA and the precision of public and private information

4.3.3 Disentangling FVA effects from underlying asset risk

(1) (2) (3) (4) (5) (6)

(1) (2) (3) (4) (5) (6)

Constant -5.92 -3.22 28.40*** 18** -7.85 48*

See Table 1 for variables definitions

(1) (2) (3) (4) (5) (6)

FV 39.60*** 19.70 7.26 18.20** 6.84 18.30**

(1) (2) (3) (4)

FV 8.97 20.70*** 5.93 36***

for held-to-maturity investments, they never translate into earnings. In contrast,

4.3.4 FVA, macroeconomic trends and analysts’ information environment

evidence suggests that reliance on FVA, relative to historical cost, leads to a

4.4 Additional sensitivity analyses

5 Discussion and conclusion

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Constant 12.30 136* 213* 355* 55.40 -390*

Constant -5.92 -3.22 28.40* 18 -7.85 48*

FV 39.60* 19.70 7.26 18.20 6.84 18.30**

FV 8.97 20.70* 5.93 36*