Managerial learning and the informational role of fair values

• Published date: 01 April 2022
• Author: Mohamed A. Elbannan
• Date: 01 April 2022
• DOI: http://doi.org/10.1002/jcaf.22535

Received: 22 October 2021Revised: 24 December 2021Accepted: 20 December 2021

DOI: 10.1002/jcaf.22535

RESEARCH ARTICLE

Managerial learning and the informational role

of fair values

Mohamed A. Elbannan

College of Business, Analytics, and

Communication, Minnesota State

University Moorhead, Moorhead, MN,

USA

Correspondence

MohamedA. Elbannan, College of Busi-

ness,Analytics, and Communication,

MinnesotaState University Moorhead,

11047th Avenue South, Moorhead,

Minnesota56563, USA.

Email:mohamed.elbannan@mnstate.edu

Abstract

This paper examines whether fair values provide useful information for man-

agement decision making. This study uses a sample of 9733 bank-quarters, cov-

ering 2009–2016 to examine the relation. Empirical evidence suggests that fair

values, particularly of liability items, affect for stock price informativeness for

managers. The effects, however, depend on the account type (asset or liability)

and the investment area. Information contained within level 3 items, in general,

benefits management learning. Evidence also suggests that accounting discre-

tion and macroeconomic uncertainty largely disrupt management learning from

reported fair values and that the fair value effects on management learning per-

sists over the long-run.

KEYWORDS

fair value reporting, investment sensitivity to stock price, accounting discretion

JEL CLASSIFICATION

G11, G12, G21

1 INTRODUCTION

The purpose of this study is to examine the implications

of SFAS 157 fair value reporting on the informativeness

of stock prices for management learning.1Issued in 2006,

Statement of Financial Accounting Standards 157 (SFAS

157), Fair Value Measurements, creates a coherent frame-

1While this study examines economic consequences of U.S. GAAP fair

value rules, the author believes that the underlying economic question of

whether fair value reporting affects managerial learning applies equally

well in countries adopting IFRS 13, “Fair Value Measurement”. Despite

differences emanating from unique country characteristics,the economic

and legal institutional environmentsin many IFRS Asia-Pacific countries

are similar to those in the United States in respects that are relevant to

the underlying question. For more comprehensive literature reviews on

Asia-Pacific region studies, please refer to Benson, Clarkson, Smith, and

Tutticci (2015),Benson, Faff, and Smith (2014), Linnenluecke, Birt, Chen,

Ling, and Smith (2017), Linnenluecke,Chen, Ling, Smith, and Zhu (2017)

and de Villiers and Hsiao (2018).

work for the recognition and reporting rules of assets’ and

liabilities fair values, defined as the exit price that would

be received upon sale of an asset or paid upon transfer of a

liability in an orderly transaction at the measurement date

(FASB,2006). Prior studies are mixed on the pros and cons

of fair value accounting and the issue of whether fair val-

ues are more or less informative than historical cost is far

from being resolved.

Generally, the literature on information economics

suggests that more informative stock prices enhance

investment decision making. They increase marginal

Tobin’s q(Durnev et al., 2004), facilitate timely with-

drawal of seasoned equity offerings (Giammarino et al.,

2004), and help managers complete mergers with posi-

tive impact on announcement date stock returns (Luo,

2005). Conversely, irrational prices (e.g., evidenced by

higher analysts’ forecast dispersion) decrease real invest-

ment (Gilchrist et al., 2005). Prior studies also examined

specific settings that impact the informational role of stock

J Corp Account Finance. 2022;33:49–67. © 2022Wiley Periodicals LLC49wileyonlinelibrary.com/journal/jcaf

50 ELBANNAN

prices, for example, cross-listing (Foucault and Fresard,

2012).

The investigation in this paper is grounded in the price

informativeness theory, which postulates that investment

will be more sensitive to stock price when the price offers

new information to managers. “Old” information will not

affect management investment decision making and thus

will decrease the investment sensitivity to stock price

(henceforth, investment sensitivity; Chen et al., 2007).

Prior studies examining consequences of fair value disclo-

sures posit that fair values improve the earnings attributes

of the reporting entity,because, despite being more volatile

compared to cost values, fair values are considered more

timely and more relevant to the investors’ assessment of

future earnings (Goh et al., 2015; Song et al., 2010). Build-

ing on this view,the market reactions to reported fair value

and earnings information should be more robust as a result

of the improved attributes. Managers of reporting entities

benefit from the “new” information in the form of acceler-

ated management learning and more rational investment

decision making. However, other studies claim that fair

values are inherently less reliable because they are subject

to distortions due to market inefficiencies, investor irra-

tionality or liquidity problems which reduce their predic-

tive value (Barth et al., 1995). Given the mixedevidence, the

study examines whether fair values affect the investment

sensitivity of reporting entities. Higher (lower) investment

sensitivity implies gains (losses) in the knowledge of man-

agers that is gleaned from, and later applied to, investment

decision making.

To investigate the effect of fair values on the invest-

ment sensitivity, this study uses four investment proxies

covering multiple investment areas that comprise on aver-

age almost 80 percent of bank assets: loan, security, non-

consolidated affiliate, and fixed asset investments. The

study tests the hypotheses using a sample of 9733 bank-

quarters related to 502 unique US banks reporting SFAS

157 fair values during the period 2009–2016. In general,

results are in line with expectations of managerial learn-

ing effects for reported fair value information. Empirical

evidence was found of learning gains in some of the invest-

ment areas tested and losses in a few others. The gain or

loss is dependent on account type (asset or liability) and

the investment area. More specifically, asset (liability) fair

values and investment sensitivity are positively associated

in the area(s) of security (security,affiliate, and f ixedasset)

investments and negatively associated in the areas of loan

and fixed asset investments. Results also suggest that level

3 asset (liability) fair values and investment sensitivity are

positively (negatively) associated in the areas of loan and

affiliate investments.

This study makes the following contributions to the rel-

evant literatures. First, this study fills a gap in the dis-

closure literature (Beatty & Liao, 2014; Healy & Palepu,

2001) that relates to how the information contained within

current fair values impact future firm investment decision

making. In a sense, the evidence presented points towards

the existence of a perpetuation mechanism in which cur-

rent investment decision making builds the basis of future

decision making through managerial learning. Second, the

study contributes to stock price informativeness literature

by examining the informational role of prices in manage-

rial decision making (e.g., Goldstein & Guembel, 2008).

Third, this study contributes to the literature on the equity-

market implications of fair value estimates, where a grow-

ing area within this literature analyzes the value relevance

of fair values to market participants (Altamuro & Zhang,

2013;Lawrenceetal.,2016; Riedl & Serafeim, 2011; Song

et al., 2010). Finally, the paper extends the accounting

choice literature (e.g., Maines & Wahlen,2006) by suggest-

ing that accounting discretion affects managerial learning

through market reactions to reported fair value informa-

tion.

2RELATED LITERATURE AND

HYPOTHESES DEVELOPMENT

The majority of bank assets and liabilities represent finan-

cial instruments, including loans, equity and debt securi-

ties, and derivatives. US GAAP requires banks to report

most of these instruments at historical cost on the balance

sheet, net of an appropriate reserve (if applicable). Sev-

eral FASB pronouncements prescribethe use offair value,

along with historical cost, in a mixed-attribute model of

financial statement presentation.2

Despite the numerous studies on the usefulness of fair

values, prior research leaves the effect on management

learning largely unexamined. This study fills this gap by

examining whether fair value reporting increases price

informativeness from a managerial perspective. The learn-

ing hypothesis contends that the interaction between pri-

vate management information signals and the market

participants’ reactions to these signals provides valuable

learning opportunities for managers (Goldstein & Guem-

bel, 2008). In essence, market reactions to firm announce-

ments represent equity market perceptions of the impact

of management decisions (e.g., closure or relocation of an

operating facility) on firm growth prospects. In this view,a

stock price, the product of arbitrage among informed mar-

ket participants, may contain relevant information that

is incremental to managers’ private information on fac-

tors such as the bank’s competition, industry prospects,

2Please refer to Beatty and Liao (2014) for a recent literature review on

financial reporting in the banking industry.