Fair value accounting and the predictive ability of earnings: Evidence from the banking industry
Coauthor(s): Brian Bratten, Monika Causholli.
The increasing use of fair value in financial reporting has sparked an ongoing debate about the merits of a fair value accounting based reporting system. Motivated by the objectives of financial reporting stated in the conceptual framework, we investigate whether the extent to which fair values are used in financial reports is related to the ability of earnings to predict future cash flows and future earnings. For a sample of bank holding companies, we find that the use of fair values in financial reporting enhances the ability of earnings to predict future cash flows. However, we find mixed evidence with respect to fair values improving the ability of earnings to predict future earnings. Further, the ability of earnings to predict future cash flows and future earnings is improved by the use of fair value estimates only during periods of low market-wide credit risk. Overall, our findings support the view of FASB and IASB that fair value accounting helps in predicting returns on economic resources (earnings) and assessment of the amounts, timing and uncertainty of future cash flows.
Source: Working Paper
Bratten, Brian, Monika Causholli, and Urooj Khan. "Fair value accounting and the predictive ability of earnings: Evidence from the banking industry." Working Paper, Columbia Business School, 2012.