Knowledge that Transforms

Amir and Lev (1996) address two interesting issues: the value-relevance of reported financial information for fast-changing, science-based companies and the value-relevance of nonfinancial information incremental to financial information. Using a sample of cellular phone companies, they report that the financial accounting information is only value-relevant after the inclusion of the nonfinancial information and that the nonfinancial information they examine is value-relevant both by itself and incremental to the financial information. I first discuss details specific to the tests conducted by Amir and Lev before discussing some of the implications offered by Amir and Lev.

In the preceding papers, Beaver and Engel and Adiel investigate managerial discretion in the financial services industry. This comment evaluates the contribution and limitations of both papers and suggests avenues for further extensions.

The study examines the capital market pricing of discretionary and nondiscretionary components of a major accrual in the banking industry, the allowance for loan losses. The analysis employs a two-stage approach in which the allowance account is first decomposed into estimates of its nondiscretionary and discretionary components. The second stage evaluates the market's valuation of the estimates of the components. Evidence suggests that the capital market perceives the allowance to be comprised of two components, a nondiscretionary component which is negatively priced and a discretionary component whose incremental pricing coefficient is positive.

This paper examines the value relevance of fair value data disclosed under SFAS 107 by banks for 1992 and 1993. Collectively, the evidence suggests differences between fair and book values of financial instruments are associated with market-to-book ratios. However, fair value disclosures for financial instruments other than securities are value-relevant only in limited settings. In addition, only in 1992 are fair value variables associated with market-to-book ratios after incorporating existing historical cost information. Further analysis suggests the weaker 1993 results are not necessarily due to increased measurement error in fair value numbers.

We examine the value-relevance to investors of financial (accounting) and nonfinancial information of independent cellular companies and find that, on a stand-alone basis, financial information (earnings, book values, and cash flows) are largely irrelevant for security valuation. Nonfinancial indicators, such as POPS (a growth proxy) and Market Penetration (an operating performance measure), are highly value-relevant. However, combined with nonfinancial information, earnings do contribute to the explanation of prices. The complementarity between financial and nonfinancial data is highlighted in this study.

I develop a benchmark for evaluating whether fair values disclosed by banks differ from investors' estimates of the market value of financial assets and liabilities. Using this benchmark, I conclude that the hypothesis that disclosed fair values closely approximate investors' estimates should be rejected. I present evidence suggesting that the procedure used in establishing fair values results in an understatement of the value of financial assets an an overstatement of liabilities. I also conclude that the reaction of bank stocks to the adoption of SFAS 105, 107, and 115 is more consistent with regulatory concerns and not with potential adverse effects of those statements for contracting.

The papers by Venkatachalam (1996) and Aboody (1996) provide some interesting evidence on issues that are important to accounting regulators as well as accounting academics. However, for econometric as well as economic reasons, there are limits to what we can learn from this type of research (cross-sectional ‘levels’ studies). Careful attention to methodological issues in this type of research design can reduce, but likely will not eliminate, these interpretational difficulties.

Financial reporting, Moral Hazard, Contracting, Accrual accounting

Jennifer Francis, J. Douglas Hanna, Linda Vincent, Causes and Effects of Discretionary Asset Write-Offs, Journal of Accounting Research, Vol. 34, Studies on Recognition, Measurement, and Disclosure Issues in Accounting (1996), pp. 117-134

Financial ratios, Price-Earnings Ratio, Market-to-Book ratios, Earnings Growth