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Fair Values , Performance Reporting , and Bank Analysts ’ Risk and Valuation Judgments

In this paper, we provide evidence on how different ways of reporting performance affect industryspecialist professional analysts’ perceptions of the risk and value of a firm. In particular, we investigate whether the measurement and reporting of unrealized gains and losses on financial instruments systematically affects commercial bank equity analysts’ investment risk assessments and valuation judgments. In an experiment with 80 buy side analysts that specialize in banking and financial institutions, we vary whether a bank is exposed to or hedged against interest rate risk across three different performance reporting regimes—full fair value accounting with all fair value changes reported in a separate statement of performance, piecemeal fair value accounting with some fair value changes reported in a separate statement of performance, and piecemeal fair value accounting with some fair value changes reported in the statement of changes in equity. When fair value changes are measured and reported on a piecemeal basis, we find no investment risk or valuation judgment differences across performance 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 tied to performance (i.e., full fair value accounting) do analysts’ valuation judgments distinguish between banks with different levels of interest rate exposure. 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. The study also contributes to the archival research literature and the experimental research literature concerned with financial performance, risk, and fair value accounting.