Are Level 3 fair value remeasurements useful? Evidence from ASC 820 rollforward disclosures

Abstract

Exploiting detailed disclosures mandated by Accounting Standard Codification (ASC) 820, we provide evidence for the return relevance of Level 3 fair value remeasurements for a comprehensive sample of U.S. listed banks. We find that Level 3 remeasurements recognized in earnings are more return relevant than those recognized in other comprehensive income (OCI). Our results suggest that Level 3 remeasurements in OCI partially reflect transitory illiquidity discounts that are less relevant when banks have the ability to hold the underlying assets. The regulatory capital treatment of OCI also affects the return relevance of Level 3 remeasurements in OCI. Importantly, we find no differences in the return relevance of realized versus unrealized Level 3 remeasurements in earnings, allaying concerns that investors perceive unrealized Level 3 remeasurements of lesser quality. Overall, our findings support the usefulness of the segregated disclosures of Level 3 fair value remeasurements.

Keywords: Fair value accounting, Level 3, return relevance, ASC 820, FAS 157, other comprehensive income (OCI), fair value disclosures

JEL Classification: M41, G21, G14