Do US Commercial Banks Use FAS 157 to Manage Earnings?

International Journal of Accounting and Information Management

16 Pages Posted: 7 Jul 2020 Last revised: 9 Jul 2020

See all articles by H Gin Chong

H Gin Chong

Prairie View A&M University - College of Business

Henry He Huang

Yeshiva University - Sy Syms School of Business

Yi Zhang

Prairie View A&M University

Date Written: February 24, 2012

Abstract


Purpose: This paper aims to examine whether commercial banks manage earnings through their use of Level 3 valuation under The Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements. To achieve this goal, we investigate the association between banks’ performance and size with the percentage of Level 3 inputs for valuing assets and liabilities. The FAS 157 requires or permits US listed firms to adopt one of the three levels of inputs to measure and report fair values of their assets and liabilities. Level 1 input is based on quoted prices in the active markets; Level 2 is from the observable markets other than quoted prices; while Level 3 is based on unobservable and firm-generated inputs.

Design/methodology/approach: We extract information from all the 10Q-reports submitted by the US commercial banks (SEC Code 6021) for the first two quarters of 2008. Since Level 3 input is subject to the highest level of managerial discretion, we expect this is an avenue for earnings management. We apply multivariate regression to test whether the banks’ performance and size are associated with a higher level of Level 3 input.

Findings: Out of 329 quarterly bank observations, we find large banks and poor performing banks with lower returns on assets, lower cash flows, and higher amounts of provision for loan losses, use more Level 3 inputs on valuing their assets and liabilities.

Research limitations/implications: Our results suggest that US commercial banks use FAS157 as an avenue for earnings management. The results have implications to the accounting standard setters, banking sector and policy decision makers.

Originality/value: This is the first paper providing evidence that banks use fair value measurements to manipulate earnings.

Keywords: Finance, FAS 157, fair value measurements, commercial banks, performance, provision for loan losses, earnings management, USA

JEL Classification: M1, M4

Suggested Citation

Chong, H Gin and Huang, Henry and Zhang, Yi, Do US Commercial Banks Use FAS 157 to Manage Earnings? (February 24, 2012). International Journal of Accounting and Information Management, Available at SSRN: https://ssrn.com/abstract=3643614

H Gin Chong (Contact Author)

Prairie View A&M University - College of Business ( email )

Prairie View, TX
United States

Henry Huang

Yeshiva University - Sy Syms School of Business ( email )

New York, NY 10033
United States

Yi Zhang

Prairie View A&M University ( email )

PO Box 519
MS2310
Prairie View, TX 77446
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
17
Abstract Views
332
PlumX Metrics