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Fair Value Hierarchy And Earnings Volatility

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  • Slavko Sodan

    (University of Split)

Abstract

International Financial Reporting Standard 13 establishes a fair value hierarchy that categorizes sources of information used to measure fair value into three levels. The aim of this paper is to investigate the relation between the use of Level 2 and Level 3 fair value inputs (i.e. mark-to-model) and earnings volatility. The main assumption is that Level 2 and Level 3 inputs are more subjective, contain more measurement errors and allow managers to use their earnings management practices more often in comparison to Level 1 inputs. This estimation error in the measurement of assets and liabilities can be a source of additional financial statement volatility. Accordingly, when assets and liabilities are volatile, so are earnings. Most prior studies were mainly focused on the impact of the fair value hierarchy on the earnings value relevance. However, there is a lack of reliable empirical evidence on fair value hierarchy effects on earnings volatility and this study tries to fill that void.

Suggested Citation

  • Slavko Sodan, 2019. "Fair Value Hierarchy And Earnings Volatility," Economic Thought and Practice, Department of Economics and Business, University of Dubrovnik, vol. 28(2), pages 567-577, december.
    • Handle: RePEc:avo:emipdu:v:28:y:2019:i:2:p:567-577
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    References listed on IDEAS

    as
    1. Michel Magnan, 2009. "Fair Value Accounting and the Financial Crisis: Messenger or Contributor?," CIRANO Working Papers 2009s-27, CIRANO.
    2. Bernard, Vl & Merton, Rc & Palepu, Kg, 1995. "Mark-To-Market Accounting For Banks And Thrifts - Lessons From The Danish Experience," Journal of Accounting Research, Wiley Blackwell, vol. 33(1), pages 1-32.
    3. Bosch, Patrick, 2012. "Value Relevance of the Fair Value Hierarchy of IFRS 7 in Europe - How reliable are mark-to-model Fair Values ?," FSES Working Papers 439, Faculty of Economics and Social Sciences, University of Freiburg/Fribourg Switzerland.
    4. Dichev, Ilia D. & Tang, Vicki Wei, 2009. "Earnings volatility and earnings predictability," Journal of Accounting and Economics, Elsevier, vol. 47(1-2), pages 160-181, March.
    5. Duh, Rong-Ruey & Hsu, Audrey Wen-hsin & Alves, Paulo Alexandre Pimenta, 2012. "The impact of IAS 39 on the risk-relevance of earnings volatility: Evidence from foreign banks cross-listed in the USA," Journal of Contemporary Accounting and Economics, Elsevier, vol. 8(1), pages 23-38.
    6. Barth, Mary E. & Landsman, Wayne R. & Wahlen, James M., 1995. "Fair value accounting: Effects on banks' earnings volatility, regulatory capital, and value of contractual cash flows," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 577-605, June.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Fair value; Earnings volatility; Fair value hierarchy; Level 3 inputs;
    All these keywords.

    JEL classification:

    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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