Usefulness of Fair Values for Predicting Banks’ Future Earnings: Evidence from Other Comprehensive Income and Its Components

44 Pages Posted: 24 Oct 2012 Last revised: 19 Feb 2016

See all articles by Brian Bratten

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy

Monika Causholli

University of Kentucky - Von Allmen School of Accountancy

Urooj Khan

Columbia Business School - Accounting, Business Law & Taxation

Date Written: August 1, 2015

Abstract

This paper examines whether fair value adjustments included in other comprehensive income (OCI) can predict future performance in banks. We also examine whether the reliability of these fair value estimates affects their predictive value. Using a sample of bank holding companies, we find that fair value adjustments included in OCI can predict bank earnings both one and two years ahead. However, not all fair value related unrealized gains and losses included in OCI have similar implications for future performance. While unrealized gains and losses on available-for-sale securities are positively associated with future earnings, unrealized gains and losses on derivative contracts classified as cash flow hedges are negatively associated with future earnings. We also find that the predictive value of fair value estimates is enhanced when fair values are measured more reliably. Finally, we show that fair value adjustments recorded in OCI during the 2007-2009 financial crisis were predictive of future profitability, contradicting the criticism that fair value accounting forced banks to record excessive downward adjustments. Overall, our findings support the view of the Financial Accounting Standards Board and International Accounting Standards Board that use of fair value estimates in financial reporting meets their objective of providing decision-useful information about future firm performance.

Keywords: Earnings, Other Comprehensive Income, Fair value, Predictability

JEL Classification: G21, M41, M48

Suggested Citation

Bratten, Brian and Causholli, Monika and Khan, Urooj, Usefulness of Fair Values for Predicting Banks’ Future Earnings: Evidence from Other Comprehensive Income and Its Components (August 1, 2015). Review of Accounting Studies, Vol. 21, No. 1, pp. 280-315, 2016 . Available at SSRN: https://ssrn.com/abstract=2165996 or http://dx.doi.org/10.2139/ssrn.2165996

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States

Monika Causholli

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States

Urooj Khan (Contact Author)

Columbia Business School - Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

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