Fair Values, Comprehensive Income Reporting, and Bank Analysts' Risk and Valuation Judgments

Abstract

We investigate whether the measurement and reporting of comprehensive income in financial statements systematically affects commercial bank equity analysts' investment risk assessments and valuation judgments. In an experiment in which 80 buy side analysts specializing in banking and financial institutions participated, we vary whether a bank is exposed to or hedged against interest rate risk across three different comprehensive income accounting regimes - piecemeal fair value accounting with comprehensive income reported in the statement of changes in equity, piecemeal fair value accounting with comprehensive income reported in a separate statement of performance, and full fair value accounting with comprehensive income reported in a separate statement of performance. When fair value changes are measured and reported on a piecemeal basis, we find no investment risk or valuation judgment differences across CI reporting regimes. Although we find that the analysts' investment risk judgments are influenced by the banks' risk management strategies, their valuation judgments are not. Only when fair value changes are measured completely and reported transparently (i.e., full fair value accounting) do analysts' valuation judgments distinguish between banks with different levels of risk. The study contributes to three avenues of literature concerned with financial-reporting transparency, risk, and fair value accounting. First, our ex ante evidence informs accounting standard setters as they evaluate whether to move to full fair value accounting for all financial instruments, and assess the degree to which differences in comprehensive income measurement and reporting affect the information analysts obtain from financial statements. Second, the study adds to the experimental accounting literature that examines comprehensive income reporting format effects and valuation judgments. Third, we add to archival accounting research on the information in comprehensive income by testing market participants' judgments under different comprehensive income reporting regimes, which cannot be directly investigated with archival data.

Keywords: Fair value, Comprehensive income, Financial analysts, Behavioral finance

JEL Classification: M41, G12, G14, G21