Does Recognition versus Disclosure Matter? Evidence from Value-Relevance of Banks' Recognized and Disclosed Derivative Financial Instruments

Abstract

We provide evidence on how investor valuation of derivative financial instruments differs depending upon whether the fair value of these instruments is recognized or disclosed. Expanded disclosures and accounting practices prior to SFAS No. 133 and mandatory recognition of derivative fair values after SFAS No. 133 provide a natural setting for comparing the valuation implications of recognized and disclosed derivative fair value information. This unique setting mitigates many of the research design problems with recognition versus disclosure studies. Using a sample of banks that simultaneously hold recognized and disclosed derivatives prior to SFAS No. 133, we find that the valuation coefficients on recognized derivatives are significant, whereas the valuation coefficients on disclosed derivatives are not significant. Further, using a sample of banks that have only disclosed derivatives prior to SFAS No. 133, which are recognized after SFAS No.133, we find that while the valuation coefficients on disclosed derivatives are not significant, the valuation coefficients on recognized derivatives are significant. These results are consistent with the view that recognition and disclosure are not substitutes. Our findings suggest that SFAS No. 133 has increased the transparency of derivative financial instruments.

Fair value accounting: information or confusion for financial markets?

“…Several studies show that FVA-based information dominates historical cost-based information in terms of value relevance, i.e., a firm's stock market value is more closely associated with FVA-based information than with historical cost information. 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.…”

“…Using a global sample of 322 banks that apply IFRS between 2006, 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.…”

An Event Study Analysis of Statement of Financial Accounting Standards No. 158

“…In the oil and gas industry, Aboody (1996) finds that the recognized write downs of full cost firms were given greater weight by the market than the footnote disclosures of successful effort firms. Ahmed, Kilic, & Lobo (2006) find that post-SFAS No. 133 recognized derivatives are valued by the market whereas pre-SFAS No.…”

Critical accounting policy and estimate disclosures: Company response to the evolving SEC guidance

“…Content analysis is frequently used in studies that investigate how companies re-spond to changes in disclosure requirements brought about by new financial accounting standards and releases (Herrmann & Thomas, 2000;Marquardt & Wiedman, 2007;Roulstone, 1999;Street et al, 2000). Most of the company response studies analyzed disclosures for the year directly before and the year directly following the change in disclosure requirements (see also Ahmed, Kilic, & Lobo, 2006;To fully capture the extent of company compliance with the SEC's guidance for both narrative and quantitative disclosures, we separately identified narrative and quantitative disclosures within the coding scheme and subsequent analysis. In addition, data were collected and analyzed using both the number of companies that made a disclosure and the number of sentences included in the disclosure.…”