Agency Problems, Accounting Slack and Banks’ Response to Proposed Reporting of Loan Fair Values

62 Pages Posted: 22 Mar 2012 Last revised: 3 Jun 2014

Leslie D. Hodder

Indiana University - Kelley School of Business - Department of Accounting

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting

Date Written: September 10, 2012

Abstract

We investigate the determinants of banks’ responses to the United States Financial Accounting Standard Board’s 2010 Exposure Draft that proposes fair value measurement for most financial instruments. Over 85 percent of the 2,971 comment letters were received from banks, with most bank-affiliated letters addressing—and rejecting — one issue: fair value measurement of loans. Interestingly, banks’ resistance to fair value measurement occurred despite the fact that the Exposure Draft explicitly proposed continued reporting of amortized cost information on the face of the financial statements. By proposing that companies report both fair value and amortized cost measures for loans, the Exposure Draft should result in increased levels of loan-related information and improve financial reporting transparency. We propose that agency problems are an important motivating factor for responding banks because banks reaping more private benefits have less incentive to increase financial reporting transparency. Consistent with weak monitoring and risk-shifting on the part of responding banks, we find that our non-accounting-based proxies for contemporaneous agency problems are associated with a higher propensity for banks to submit comment letters. In addition, consistent with banks valuing slack available in current generally accepted accounting principles, we find that banks historically and opportunistically using loan-related accounting discretion are more likely to submit negative comment letters. The narrow scope of banks’ comments and our empirical findings suggest that banks’ responses to the Exposure Draft may be more driven by concerns over reduced availability of accounting slack and accompanying de facto regulatory forbearance than by the conceptual arguments they offered. Our results have implications for standard setters, who must navigate special interests as they attempt to promulgate high quality accounting standards, and for users of financial statements who must consider how political forces shape generally accepted accounting principles.

Keywords: FASB, Fair Value, Financial Instruments, Banks, Lobbying, Agency

JEL Classification: G21, G28, M40, M41

Suggested Citation

Hodder, Leslie D. and Hopkins, Patrick E., Agency Problems, Accounting Slack and Banks’ Response to Proposed Reporting of Loan Fair Values (September 10, 2012). Available at SSRN: https://ssrn.com/abstract=2026588 or http://dx.doi.org/10.2139/ssrn.2026588

Leslie D. Davis Hodder (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting ( email )

Kelley School of Business
1309 E. 10th Street
Bloomington, IN 47405
United States
812-855 2617 (Phone)
812-855 8679 (Fax)

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