Accounting Rules and Firm Performance: Impairment and Disclosure Practices Related to the AFS Equity Investments in Italian Listed Banks

Abstract

In banking industry, equity investments classified as available for sale (AFS) are a relevant portion of financial assets. According to IAS 39, they must be measured (“at” and “after” recognition) at fair value. Increases or decreases in this value have to be recognized in the other comprehensive income, except when there is objective evidence of impairment. In this case, impairment losses are recognized in the net income. IAS 39 lists some events that can give rise to an impairment loss, among which a “significant or prolonged” decline in fair value (par. 61). In the absence of detailed guidance, preparers have a great discretion in interpreting the meaning of the terms “significant” and “prolonged”. The paper shows the results of an empirical study about AFS equity investments in the annual report of Italian listed banks for the fiscal years 2007-2010. It investigates the events from which they deducted the impairment losses and the disclosure provided about them. The paper also looks at how the banks implemented the concept of “significant or prolonged decline in fair value”. The evidence is of a heterogeneous behavior among different banks in the same year and between different years for the same bank. The disclosure provided to the market was poor until the Authority imposed a mandatory information. The authors formulate hypothesis about the reasons of these evidences, especially as regards earnings management policies because of the financial crisis and its impact on financial performance.