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During our 2007 to 2015 sample period, firms recorded unrealized gains and losses on fair-valued liabilities attributable to changes in the firms’ own credit risk, referred to as the debt valuation adjustment (DVA), in earnings. Various parties criticized the inclusion of DVA in earnings as counterintuitive and manipulable. Using a small but comprehensive sample of European banks reporting nonzero DVA during this period, we decompose banks’ DVA into a normal portion explained by economic factors (e.g., changes in bond yield spreads) and an abnormal portion (the residual). Controlling for abnormal loan loss provisions (LLP) and realized securities gains and losses (RGL), we find that banks’ abnormal DVA is negatively associated with their premanaged earnings, consistent with banks exercising discretion over DVA to smooth earnings. We further find that banks that record larger LLP or RGL or that have histories of using LLP or RGL to smooth earnings are less likely to exercise discretion over DVA. These findings obtain in the financial crisis but not afterward. Collectively, our findings suggest that banks exercised discretion over DVA substitutably with discretion over LLP and RGL during the crisis. With the caveat that our analysis is limited by a small sample and the inherent difficulties of DVA decomposition, our findings have implications for how bank regulators and investors should interpret banks’ reported DVA, particularly in stress periods such as the crisis, and they provide support for the International Accounting Standards Board and Financial Accounting Standards Board’s (FASB) decisions to require firms to record DVA in other comprehensive income starting in 2018.

Basu's [“The Conservatism Principle and the Asymmetric Timeliness of Earnings.” Journal of Accounting and Economics 24 (1997): 3–37] measurement of conditional conservatism as the asymmetric timeliness of earnings underlies hundreds of studies. However, many subsequent studies cast doubt on the extent to which Basu's measure captures conditional conservatism versus statistical biases or alternative constructs (collectively, “biases”), thereby questioning the validity of the inferences that empirical researchers draw from analyses using the measure. We modify Basu's measure in four simple ways to remove these biases. Our key modification is the inclusion of interactive controls for return variance, a volatility proxy that captures Patatoukas and Thomas’ [“More Evidence of Bias in Differential Timeliness Estimates of Conditional Conservatism.” The Accounting Review 86 (2011): 1765–1794] return variance effect and various sources of economic optionality and adjustment costs. This inclusion captures volatility-related effects on both the level of earnings and the sensitivity of earnings to returns, and it allows the magnitudes of these effects to vary with the sign of returns. We conduct validation analyses using placebo-dependent variables, synthetic returns, and nonconditionally conservative earnings components that show our modified Basu measure is largely free of known biases. We further show that our measure is associated with contracting and other economic variables as predicted by theory. Our findings suggest that researchers can rely on our modified Basu measure to identify the determinants and effects of conditional conservatism.

Banks’ financial reporting requirements and discretionary choices may affect financial stability by altering one or more of the likelihood that banks violate regulatory capital requirements, banks’ internal discipline over risk management and financial reporting, and external market and regulatory discipline over banks. In this article, I discuss five recent empirical papers that examine these channels linking banks’ financial reporting to financial stability. I explain how these papers identify economic contexts and associated financial reporting constructs that enable powerful examinations of these channels, and how they employ research designs that meaningfully address the issues regarding valid causal inference raised by Acharya & Ryan (2016) . I conclude that, while each study examines a specific channel or two in a specific setting, collectively the literature is making steady progress in enhancing our understanding of the causal forces at play in the channels linking banks’ financial reporting and financial stability, the goal set forth by Acharya & Ryan (2016) . I also identify open questions that these papers suggest for future research on the effects of banks’ financial reporting on financial stability.

We examine banks’ accounting policy choices during the financial crisis where they are strongly motivated to manage earnings or regulatory capital. We address the issue via the initial elections of the fair value option (FVO) under SFAS No. 159, which provides considerable latitude and in particular its transition guidance is amenable to exploitation. We investigate banks’ reasons to elect the FVO and provide evidence regarding whether and how these reasons differed for banks adopting the standard in the first quarter of 2007 (early adopters) versus first quarter of 2008 (regular adopters). We predict and find that early adopters with histories of managing accounting numbers were more likely to make opportunistic FVO elections, and we show that early adopters with low capital tended to exploit the FVO in the opposite direction as those with high capital. With intense regulatory scrutiny since April 2007, we predict and find that regular adopters’ FVO elections complied with SFAS No. 159’s intent. We further analyze the particular reasons why early and regular adopters most commonly elected the FVO for specific types of financial instruments. We find that early adopters’ elections for available-for-sale (AFS) securities and debt reflected opportunism, and regular adopters’ elections for loans held for sale reflected compliance with the standard’s intent to remedy accounting mismatches for economic hedges.

We examine the real effects of FAS 166 and FAS 167 on banks’ loan‐level mortgage approval and sale decisions. Effective in 2010, these standards tightened the accounting for securitizations and consolidation of securitization entities, respectively, causing banks to recognize an estimated $811 billion of securitized assets on balance sheet. We find that banks that recognize more securitized assets exhibit larger decreases in mortgage approval rates and larger increases in mortgage sale rates. These effects significantly exceed those of banks’ off–balance sheet securitized assets, consistent with our results being driven by the consolidation of securitization entities rather than by securitization per se. We conduct tests that help rule out the financial crisis as an alternative explanation for our results. Further analyses suggest that mechanisms underlying the results include consolidating banks’ reduced regulatory capital adequacy, increased market discipline, and consequent desire not to recognize high‐risk mortgages on balance sheet.

Exploiting differential interstate-branching deregulation across contiguous counties of adjacent states, we investigate the effect of entry threat on incumbent banks’ loan-loss provisions. Incumbents exposed to entry threat have offsetting incentives; lower provisions make their loan-underwriting quality appear better, deterring entry, but make local economic conditions appear better, encouraging entry. We find that the incentive to increase apparent loan-underwriting quality dominates on average. We further find that this incentive is stronger in counties with a higher proportion of heterogeneous loans, while the other incentive dominates in counties with both low heterogeneous loans and highly volatile economic conditions.

During the 2007–2009 financial crisis, many parties criticized aspects of accounting requirements for banks as undermining financial stability. These criticisms generally reflect the view that these requirements primarily affect stability through their effects on banks’ regulatory capital adequacy. I criti-cally evaluate whether this idea can be sustained on logical and evidential grounds. I explain how accounting requirements typically have quite small effects on banks’ regulatory capital adequacy. I discuss the plausibility of the alternative view that accounting requirements primarily affect stability by improving banks’ understanding of their risks and their transparency to markets and regulators. Because securitization is the setting in which banks’ regulatory capital adequacy is most likely to be significantly affected by accounting requirements, I describe empirical research on significant changes in securitization accounting effective in 2010. I explain how even in this setting regulatory capital adequacy incompletely explains how accounting requirements for banks affect stability.

We identify covenants in commercial loan contracts that require public borrowers to periodically disclose two types of accounting-related private information to lenders: projected financial statements for future periods and monthly historical financial statements. We hypothesize and provide evidence that: (1) loan contracts include these covenants in settings where they enhance lenders’ loan contract monitoring; (2) the covenants are positively associated with the frequency of loan contract amendments; and (3) lenders trade on the borrower private information they receive in secondary loan markets. We further show that the two types of covenants have predictably different determinants and effects.

We investigate how overlapping activities of bank regulators and supervisors and bank auditors influence banks’ internal control quality, auditor-client contracting (audit fees and audit effort), and financial statement reliability. Using material weaknesses in internal controls as a proxy for internal control quality, we find that banks exhibit fewer internal control problems than do nonbanks. Using audit fees, earnings announcement lags and audit report lags as alternative proxies for audit effort, we find that auditors expend less effort in audits of banks than in audits of nonbanks. Despite the lower audit effort, we find that banks report fewer and less severe restatements of prior period financial statements than do nonbanks, suggesting that the aggregate efforts of bank regulators/supervisors and bank auditors generate more reliable financial reporting by banks. A notable implication of our study is that bank regulation and supervision alter the auditor-client contracting equilibrium, with a notable benefit being an increase in banks’ financial reporting quality.

Accounting principles state that the net presentation of offsetting assets and liabilities on the balance sheet is improper unless the right of setoff exists. Derivatives dealers and their frequent counterparties engage in master netting agreements (MNAs) that provide a limited right of setoff that is insufficient (sufficient) for net presentation under IFRS (US GAAP). To remedy this presentation difference, as of 2013, IFRS and US GAAP require dealers to disclose the gross, reported, and net amounts of derivatives assets and liabilities that they present net or present gross but cover under enforceable MNAs. We first study real effects of these mandatory disclosures on dealers’ financial leverage. We posit that dealers prefer market participants to view their leverage as lower. Because the 2013 requirements provide new information for IFRS dealers but not for US GAAP dealers, we hypothesize and provide evidence that the requirements induce IFRS dealers to reduce their derivatives leverage by eliminating unnecessary offsetting derivatives and using MNAs more effectively. We then study the usefulness of the disclosures to market participants. Because the right of setoff provided by MNAs does not eliminate all significant risks of the covered derivatives, we hypothesize and provide evidence that dealers’ net derivatives leverage and disclosure quality under the 2013 requirements inform market participants about dealers’ credit risk uncertainty.

The use of accounting measures and disclosures in banks’ contracts and regulation suggests that the quality of banks’ financial reporting is central to the efficacy of market discipline and nonmarket mechanisms in limiting banks’ development of debt and risk overhangs in economic good times and in mitigating the adverse consequences of those overhangs for the stability of the financial system in downturns. This essay examines how research on banks’ financial reporting, informed by the financial economics literature on banking, can generate insights about how to enhance the stability of the financial system. We begin with a foundational discussion of how aspects of banks’ accounting and disclosures may affect stability. We then evaluate representative papers in the empirical literature on banks’ financial reporting and stability, pointing out the research design issues that empirical accounting researchers need to confront to develop well-specified tests able to generate reliably interpretable findings. To this end, we provide examples of settings amenable to addressing these issues. We conclude with considerations for accounting standard setters and financial system policy makers.

I discuss Desai, Rajgopal, and Yu (2015) with the goal of helping readers think carefully about which implications of the study are likely to generalize to future economic downturns and which are likely to be specific to the facts and circumstances of the recent financial crisis, given that the crisis was driven by the expectation and then the realization of a single market variable, national house price depreciation.

This is an Online Appendix to "Economic Consequences of the AOCI Filter Removal for Advanced Approaches Banks", available at: https://ssrn.com/abstract=3071942.

We obtain industry output volume changes from the Census Bureau for 338 six-digit NAICS code manufacturing industries and from the Centers for Medicare & Medicaid Services for skilled nursing facilities as an example of a service industry. Industry output volume changes have distinct and largely desirable features as a news proxy to measure the asymmetric timeliness of (the accrual components of) earnings to good and bad news documented by Basu (1997) and the ensuing literature. Industry output volume changes (1) are exogenous to individual firms’ economic and accounting choices, as well as minimally correlated with firm characteristics that prior research shows are associated with statistical biases in measures of asymmetric timeliness; (2) reflect both the public and the private firms in the industry; and (3) have relatively short-run implications for firm performance, so that accounting rules typically require firms to recognize these implications in operating accruals. We exploit these features to reassess the previously identified drivers of asymmetric timeliness. We find that the use of industry output volume changes as the news proxy (1) enables researchers to demonstrate conditional conservatism through the asymmetric timeliness of operating accruals but not of write-downs of long-lived assets; (2) helps distinguish the effects of curtailment and cost stickiness on asymmetric timeliness; and (3) largely eliminates statistical biases in estimates of asymmetric timeliness.

We examine whether and how measures of market and credit risk modeling identified from banks’ financial reports enhance the returns-relevance of their estimated annual unrealized fair value gains and losses for financial instruments. To capture differences in market liquidity and fair valuation difficulties across types of financial instruments, we distinguish unrealized gains and losses that are recorded in net income versus recorded in other comprehensive income versus calculable using financial statement note disclosures. We predict and generally find that banks’ market (credit) risk modeling enhances the returns-relevance of their unrealized fair value gains and losses, more so for less liquid instruments subject to greater market-risk-related (credit-risk-related) valuation difficulties and during periods for which market (credit) risk is higher. We obtain these findings both for banks’ unadjusted risk modeling measures and for the portions of these measures that we model as attributable to banks’ risk modeling activities, but not for the portions we model as attributable to banks’ disclosure of these activities.

We examine trade-offs that Prosper, a large online peer-to-peer lending platform, has made over time in its lending processes. Since its 2006 inception, Prosper has (1) changed the way it sets the interest rates on loans from auctions among peer lenders to pre-set pricing based on a proprietary credit-rating model in December 2010; (2) enabled institutional investors to fund whole rather than just fractional loans in April 2013; and (3) reduced the extent of soft information available to peer lenders in September 2013. In each of these changes, Prosper has traded off the aggregation of soft information by peer lenders for transaction processing efficiency, a trade-off similar to that made by large traditional banks. We provide the following evidence regarding the costs and benefits of this trade-off. On the cost side, after the December 2010 change the distribution of loan interest rates shrinks and the ability of interest rates to predict loan default deteriorates, particularly for loans to low credit quality borrowers for whom soft information is more important for credit screening. After the April 2013 change interest rates for low credit quality loans in the fractional loan market are more predictive of default than are interest rates in the whole loan market. On the benefit side, loan volume and funding speed rise sharply after each of these changes. Moreover, the costs appear manageable, as peer lenders’ ability to diversify increases and the weighted-average interest rate of a modest-size portfolio of Prosper loans remain just as predictive of default. Placebo and difference-in-differences tests using a peer-to-peer lender that did not change its lending processes during our sample period (Lending Club) indicates that these effects are attributable to the changes in Prosper’s processes.

Beck and Narayanamoorthy (this issue) argue and provide evidence that SEC pressure culminating in the issuance of SAB 102 in July 2001: (1) caused banks to record allowances for loan losses that were more associated with historical loan charge-offs and less associated with current non-accrual loans; (2) primarily affected large and strong banks; and (3) caused allowances for loan losses to be more (less) informative of future loan charge-offs for strong (weak) banks. We argue and provide evidence that the results the authors ascribe to SAB 102 are primarily explained by consumer loan charge-offs dominating banks’ loan charge-offs and, thus, allowances for loan losses in the post-SAB 102/pre-financial crisis period. This period coincided with a real estate and general macroeconomic boom in which other loan types experienced very low charge-offs.

SFAS No. 115 requires firms to recognize available-for-sale (AFS) securities at fair value with accumulated unrealized gains and losses (AUGL) recorded in accumulated other comprehensive income. Firms reclassify AUGL to net income when they realize gains and losses. We refer to the amount reclassified each period by ''RECLASS.'' As of 1998, SFAS No. 130 requires firms to present RECLASS prominently in their financial statements. We investigate the incremental explanatory power of RECLASS for banks' market values and market-adjusted returns. In the market value analysis, we control for AUGL, other components of book value of equity, net income before extraordinary items and RECLASS (NIBEXother), and other components of comprehensive income. In the returns analysis, we control for DAUGL, DNIBEXother, and extraordinary items. We find high positive coefficients on RECLASS in both analyses, consistent with investors pricing RECLASS as a relatively permanent component of net income. Exploring possible explanations for these pricing implications, we find no evidence that they are attributable to RECLASS remedying unreliable fair value measurement of AUGL. We provide three distinct analyses indicating that RECLASS's pricing implications are explained in significant part by it helping investors predict banks' future performance. Our results illustrate that an important type of amortized cost accounting information, realized gains and losses, remains highly useful to investors despite the overall fair-value-accounting framework for AFS securities.

We document a significant increase in firms’ revenue growth rate as they approach $100 million annual revenue. We identify substantial capital markets and other visibility benefits to firms achieving this goal, including discontinuous increases in analyst and media coverage and in transient and growth-focused institutional investment. We find no evidence of decreased investment efficiency or overall profitability. We find that firm CEOs benefit through higher bonuses, pay-for-performance sensitivity, and stock and stock option awards in the year after reaching the goal. We find that firms make acquisitions, expand their labor forces, and increase leasing of assets to reach $100 million revenue. Collectively, our results suggest that achieving $100 million revenue is a critical event in the trajectory of firm growth that enhances firms’ capital market receptions and information environments and sharpens CEOs’ incentives. These results constitute rare systematic firm-level evidence of upward-striving, and they suggest conditions under which setting challenging goals enables firms to achieve positive performance effects.

We investigate the impact of recurring fair value versus amortized cost measurement for accounting recognition purposes on the timeliness of insurers' other-than-temporary (OTT) impairments of non-agency residential mortgage-backed securities (NAMBS) around the 2007–2009 financial crisis. Unlike largely predetermined amortized cost measurement, recurring fair value measurement requires firms to invest in information and control systems to assess relevant economic conditions and estimate fair values quarterly. We expect these systems discipline insurers' OTT impairments. Exploiting statutory requirements that PC (life) insurers measure securities with NAIC designations from 3 to 5 at fair value (amortized cost) and disclose security-level accounting information, we predict and find that PC insurers record timelier OTT impairments of the same NAMBS with NAIC designations of 3 to 5 than life insurers. We predict and find weaker evidence of spillover effects to the timeliness of OTT impairments of the same NAMBS with NAIC designations of 1 or 2. JEL Classifications: G22; M41. Data Availability: Data are available from public sources cited in the text.

We examine economic consequences of U.S. bank regulators' phased removal of the prudential filter for accumulated other comprehensive income for advanced approaches banks beginning on January 1, 2014. The primary effect of the AOCI filter is to exclude unrealized gains and losses on available-for-sale securities from banks' regulatory capital. We predict and find that, to mitigate regulatory capital volatility resulting from the filter removal, advanced approaches banks increased the proportion of investment securities classified as held-to-maturity, thereby limiting their financing and interest rate risk management options, and they decreased securities risk, thereby reducing their interest rate spread. We further predict and find that these banks borrow more under securities repurchase agreements potentially collateralized by held-to-maturity securities and reduce loan supply owing to their reduced financing options, and that they increase loan risk to mitigate the decrease in their interest rate spread. JEL Classifications: G21; G28; M41; M48. Data Availability: Data are available from the public sources cited in the text.

SYNOPSIS A concurrent session at the 2011 American Accounting Association Annual Meeting featured the panel discussion “Financial Market Regulation and Opportunities for Accounting Research.” Structuring their comments around their unique interests and expertise, the panelists covered diverse topics on the regulation of financial markets and financial institutions, including current activities of the primary financial market regulators responsible for accounting and auditing oversight, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the financial regulation of financial institutions from an economist's perspective. This paper summarizes the panelists' prepared remarks, which were followed by questions and comments from the audience.

We examine the real effects of FAS 166 and FAS 167 on banks’ lending and loan sale decisions. Effective as of 2010, the two accounting standards tightened the accounting for securitizations and the consolidation of securitization entities, respectively, causing banks to consolidate $765 billion of assets and thereby increasing capital requirements for consolidating banks. We find that banks consolidating more assets more strongly reduce loan supply, as proxied by loan-level mortgage approval decisions, and more strongly increase loan sales, as proxied by loan-level mortgage sale decisions. These effects of consolidated securitization entities are significantly larger than those of the assets held by banks’ unconsolidated securitization entities, consistent with it being the consolidation of securitization entities rather than securitization per se that reduces banks’ loan supply and increases their loan sales. The evidence suggests that FAS 166/167 leads regulated banks to reduce their loan risk, in part by transferring that risk to the less regulated shadow banking system.

The Australian Murray cod supports a growing national industry. However, with regard to the process of weaning fry, there is a lack of information and optimal procedures need to be developed. The aim of the present investigation was to test the biological and economic efficacy of different weaning strategies for Murray cod. Three weaning strategies were tested on triplicate groups of fish: (1) only Artemia for 5 d, 7 d on Artemia plus starter diet, and 14 d on dry diet only; (2) 12 d on Artemia plus starter diet and 14 d on dry diet only; and (3) directly to dry diet for the entire experimental period. No significant differences were recorded in the growth and feed efficiency, while significantly higher mortality (38.4 ± 0.35%) was recorded in fish weaned directly onto dry diet. Fish subjected to the first 5 d on Artemia only showed a growth reduction during this period, which was compensated by a phase of enhanced growth during the dry-diet phase. No significant differences were noted in the proximate composition of fish under the different treatments. The economic evaluation suggested that the treatment with the simultaneous supply of Artemia and starter diet is preferable.

Research on the usefulness of financial information generally focuses on the innovation in the information examined, such as an earnings surprise or cash flow growth. Consequently, prior research sheds little light on the role of the rich historical record of financial information in users' decision-making. Using a sample of published restatements of earnings, we show that the revision of the historical pattern of earnings, distinct from the magnitude of the restatement and its impact on current earnings, significantly affects investors' decisions and predicts class action lawsuits. Specifically, we find that restatements that eliminate or shorten histories of earnings growth or positive earnings have significantly more adverse effects for investor valuations and the likelihood of lawsuits than other restatements. This evidence about the value-relevance of refreshing the historical record of earnings is pertinent to the FASB's recent cautious expansion of the scope of circumstances that require a restatement of financial information in FAS 154.

This paper provides guidance for empiricists interested in measuring conditional conservatism and in interpreting associations of those measures with variables of interest. I begin by discussing the nature and importance of conditional conservatism and surveying the literature identifying conditional conservatism. I then describe and comment on the various limitations of asymmetric timeliness identified in the literature. Despite these limitations, I argue that asymmetric timeliness is the most direct implication of conditional conservatism, and that alternative measures that have been proposed need not capture any type of conservatism. Finally, I provide four specific suggestions for estimating asymmetric timeliness and for interpreting it as a measure of conditional conservatism.