Do fair value adjustments excluded from net income convey new information that is complementary to GAAP earnings?

Abstract

We exploit banks’ recently mandated quarterly fair value disclosures to perform the first short-window event study of fair value adjustments excluded from net income. We find these fair value adjustments are positively associated with short-window stock returns and accentuate investors’ response to GAAP earnings, suggesting that these adjustments are complementary to GAAP earnings. These results concentrate in the period surrounding the financial crisis and in banks’ loan portfolios, where fair values depend on credit quality information not fully available in the public domain. Our results suggest that (i) fair value adjustments that rely on unobservable inputs reflect new information at their disclosure date that investors incorporate into price, (ii) these adjustments help investors interpret GAAP earnings, and (iii) these effects are limited to periods where fair values diverge significantly from book value. Overall, our study suggests that investors benefit from having both GAAP earnings and fair value information.