12 Fontes2018

THE ACCOUNTING REVIEW American Accounting Association
Vol. 93, No. 6 DOI: 10.2308/accr-52070

November 2018
pp. 127–147
The Impact of Fair Value Measurement for Bank Assets on

Information Asymmetry and the Moderating Effect of Own
Credit Risk Gains and Losses
Downloaded from aaajournals.org by Kings College London-FWIC Journals on 01/27/19. For personal use only.
Joana C. Fontes
UCP–Catolica Lisbon School of Business and Economics
Argyro Panaretou
Kenneth V. Peasnell
Lancaster University
ABSTRACT: We examine whether the use of fair value measurement (FVM) for bank assets reduces information
asymmetry among equity investors (bid-ask spread) and how this is affected by the recognition of own credit risk
The Accounting Review 2018.93:127-147.
gains and losses (OCR). Our findings show that FVM of assets is associated with noticeably lower information
asymmetry, and that this reduction is more than twice as large when banks also recognize OCR. In addition, we find
that the bid-ask spread is incrementally lower for banks that provide more detailed narrative disclosures on OCR.
The findings also indicate that the effects of asset FVM and OCR recognition on the bid-ask spread do not simply
capture the differences in the characteristics of the banks and the quality of their information environments.
Data Availability: All data are available from public sources.
Keywords: mixed-attribute model; own credit risk; fair value option; ﬁnancial instruments; IAS 39; banks.
I. INTRODUCTION
F
or the last two decades, the Financial Accounting Standards Board (FASB) and the International Accounting Standards
Board (IASB) have been discussing whether fair value measurement (FVM) should be extended to a more complete set
of financial instruments. Under the current mixed-attribute model, firms recognize some instruments at fair value and
some at historical cost. This has led to criticisms of the use of different measurement attributes to account for economically
related assets and liabilities as obscuring the economics involved (Ryan 2007).
The extension of FVM to financial liabilities is one of the most controversial issues that standard setters face in their fair
value projects. This is mainly because of the effect of the recognition of ‘‘own credit risk’’ gains and losses on the usefulness
and informativeness of accounting numbers (FASB 2008; IASB 2009). Own credit risk refers to the possibility that a firm will
not be able to pay its debts in full and on time, and is reflected in the credit spread component of the interest payable on the
debt. If an entity adopts the fair value option for financial liabilities (FVOL), then the component of any change in the fair value
of liabilities that arises from changes in own credit risk must be separately recognized and disclosed. (For brevity, hereafter, we
refer to such gains and losses arising due to changes in own credit risk as OCR.) OCR recognition is viewed by some
commentators as misleading and difficult to explain to investors (Lipe 2002; Chasteen and Ransom 2007; Reilly 2007; Lucas
2011). Liabilities appear to diminish as the firm’s underlying financial condition deteriorates, and the results have been argued
to be counterintuitive: gains are recognized when bad economic events occur, and losses when the firm is doing well.
Proponents of OCR recognition argue that it is consistent with the economic wealth transfer between debt holders and equity
We thank the participants in the 2014 European Accounting Association Annual Meeting in Tallinn, and the 2014 British Accounting and Finance
Association Annual Meeting in London. We are also grateful to the participants at seminars at University of Exeter, Lancaster University, and UCP–
Catolica Lisbon. We are particularly grateful to Leslie D. Hodder (editor), John O’Hanlon, Catherine Shakespeare, and the two anonymous referees for
suggestions that have greatly helped to improve this paper. Joana C. Fontes gratefully acknowledges research funding from the Foundation for Science and
Technology in Portugal (grant PTDC/IIMGES/2686/2014).
Editor’s note: Accepted by Leslie D. Hodder, under the Senior Editorship of Mark L. DeFond.
Submitted: February 2014
Accepted: February 2018
Published Online: February 2018
127
128 Fontes, Panaretou, and Peasnell
holders that occurs when the firm’s creditworthiness changes (Merton 1974). Barth, Hodder, and Stubben (2008) empirically
show that the presence of debt attenuates the effect of OCR on equity returns, and argue that such gains and losses should be
candidates for inclusion in accounting income if the objective is the faithful representation of the firm’s liabilities and economic
performance.
The dramatic fall in the prices of financial assets and the resultant crisis faced by the banking sector led to the spotlight
falling on FVM generally, and on the recognition of OCR in particular, because of the critical role that accounting measures
play in the regulation of such institutions and the importance of financial instruments to banks. Financial instruments comprise
a larger proportion of banks’ assets than they do for nonfinancial companies, and banks are much more highly leveraged. The
effects of OCR recognition are, therefore, likely to be more pronounced for banks.
In this study, we examine the effects of the current mixed-attribute model on investors’ uncertainty, and how OCR
recognition affects this relation for a sample of European banks that report under international financial reporting standards
(IFRS). For this purpose, we refer to the extent to which banks measure assets on a fair value basis and include the resultant
gains and losses in net income as the degree of asset completeness.1 First, we predict that banks with higher asset completeness
have lower information asymmetry. The greater the degree of asset completeness, the more the financial statements provide
investors with a key part of the relevant information needed for equity valuation purposes, which includes the evaluation of the
ability to repay debt holders. Also, recognizing assets at fair value requires the provision of measurement disclosures that can
result in estimates that are more verifiable and understandable to more investors (Koonce, Nelson, and Shakespeare 2011).
We then examine whether OCR recognition moderates the effect of asset completeness on information asymmetry.
Suppose data about the firm’s asset values are provided in the financial statements. What weight should equity investors place
on the reported asset gains and losses if they cannot easily determine what part of these gains and losses will be borne by debt
holders? Reporting OCR provides investors with important information on how gains and losses are shared. Indeed, accounting
standard setters introduced the FVOL because they saw clear benefits to having fair value information on financial liabilities
recognized and disclosed in annual reports, and believed that those benefits exceeded the costs of implementing such a change.2
Accordingly, we predict that OCR recognition has an incremental effect on the role of asset completeness in reducing
information asymmetry.
Using the bid-ask spread as a proxy for information asymmetry, we find that asset completeness is associated with lower
information asymmetry. This result supports the argument that the measurement of bank assets at fair value through net income
increases transparency. Furthermore, the reduction in information asymmetry is more than two times greater when banks
recognize OCR, a finding consistent with OCR recognition reducing uncertainty about the equity valuation implications of
asset fair value gains and losses. When we control for the endogeneity in a bank’s decision to use the FVOL, our findings show
that the reduction in bid-ask spread is not simply the result of self-selection.
An important complication in our study is that differences in bank characteristics are likely to have different informational
effects, and this poses an identification problem. OCR recognizers in our sample are different from non-recognizers in a number
of key respects related to the quality of the information environment: more analysts follow them, a bigger percentage of their
shares is owned by institutional investors, their country of origin is more likely to be one that has a high-quality regulatory
environment, and a larger percentage of their assets is fair valued. When we control for information environment quality, we
find that being an OCR recognizer incrementally increases the impact of asset completeness on information asymmetry, even
after interacting this effect with environment controls. In addition, we examine the effects of narrative disclosures regarding
OCR on the bid-ask spread. We find that the bid-ask spread is incrementally lower for banks that provide more detailed OCR
narrative disclosures. Given that the OCR narrative disclosures are only available for OCR recognizers, we cannot rule out that
the results are confounded with unobserved characteristics of the OCR recognizers that are correlated with FVOL adoption.
Nevertheless, the fact that the results are consistent across the alternative controls suggests that our findings are driven, at least
partly, by an informational effect of OCR recognition and asset completeness, rather than these other factors.
We caution that our measure of asset completeness does not provide investors with all the information required for equity
valuation purposes. Changes in the risk profile of the assets and the asset-liability hedging relation are not directly reflected in
the measure. Also, OCR recognition is necessarily a result of the change in the creditworthiness of a bank, which can itself
affect information asymmetry. Controlling for changes in creditworthiness substantially reduces the size of our sample. We,
therefore, cannot rule out the possibility that a change in own credit risk itself drives our findings, rather than the recognition of
1
Such assets might initially have been recognized at cost and then subsequently remeasured at fair value. In the case of many derivatives, the initial
recognition will also have been at fair value.
2
The exposure draft Fair Value Option for Financial Liabilities (IASB 2010, ED/2010/4) points out that many users of financial reports find the
information about the changes in fair value of liabilities due to OCR useful: ‘‘They use it for purposes such as determining the overall riskiness of the
entity, identifying when the entity is in distress, indicating when an entity’s assets may be impaired, estimating the entity’s future financing costs and
comparing the entity with others in the same industry’’ (IASB 2010, BC 27, 25).
The Accounting Review

Volume 93, Number 6, 2018
Impact of Fair Value Measurement on Information Asymmetry and Moderating Effect of Own Credit Risk 129
that change in the financial statements. What we can reasonably conclude is that information asymmetry is lower for banks with
higher asset completeness, and this effect is even greater when OCR is recognized. We present arguments as to why OCR
recognition might be the explanation, but we acknowledge that there could be other factors involved, as well.
The remainder of the paper proceeds as follows. Section II presents a review of related academic research and the
hypothesis development. Section III outlines the research design, and Section IV describes the sample and provides descriptive
statistics. Section V presents empirical results, and Section VI summarizes the findings and contains concluding remarks.
II. RELATED LITERATURE AND HYPOTHESIS DEVELOPMENT

The theoretical literature concerning the effects of increased disclosure on information asymmetry yields conflicting
predictions. Diamond and Verrecchia (1991) contend that increased levels of corporate disclosure can have welfare benefits
even when no new information is generated. Disclosure that converts private information into public information will reduce
the information advantage of informed investors over uninformed investors, and thereby increase the liquidity of the firm’s
securities.3 However, information asymmetry could also increase, if public disclosure provides incentives for increased private
information production (McNichols and Trueman 1994; Demski and Feltham 1994). Moreover, recognition can have different
effects on information asymmetry than disclosure. Recognition can affect management compensation, regulatory outcomes,
and other contracting effects and, therefore, provide incentives for earnings management, all of which can be difficult for
uninformed investors to discern (Ball, Jayaraman, and Shivakumar 2012). Thus, the direction of the net effect of FVM on
information asymmetry is unclear.
Two streams of empirical work are relevant to our study. The first stream looks at the effects of FVM on information
asymmetry. The results are conflicting. Muller, Riedl, and Sellhorn (2011) investigate whether the requirement that European
real estate firms disclose the fair values of their investment property assets under International Accounting Standard (IAS) 40
had an effect on information asymmetry. They find that mandatory adopters that did not previously disclose fair values (either
recognized in the financial statements or reported in footnotes) show a larger reduction in the bid-ask spread than early
voluntary adopters. This finding supports the idea that the release of private information on fair values reduces information
asymmetry. In contrast, Ball et al. (2012) provide evidence that U.S. banks’ use of FVM for trading securities is associated with
greater information asymmetry, but they find that there is no increase in spreads for banks that previously used FVM on a
voluntary basis. They also find similar results for non-trading securities for which banks exercised the fair value option
introduced in 2007. They attribute these results to recognition effects and the consequent association with contracting roles of
financial reporting rather than disclosure. The information environment of European banks is generally less rich than that of
their U.S. counterparts. Therefore, it is unclear whether the improved disclosure effect of greater accounting completeness on
information asymmetry relative to the contracting effects will be the same for European banks.
The second stream of literature considers the informational effects and value implications of OCR recognition. The IASB’s
intention when introducing the FVOL was to reduce earnings volatility associated with measurement mismatches. Although the
empirical evidence shows that banks typically use FVOL to better reflect the economic hedging between selected financial
assets and liabilities (Chang, Liu, and Ryan 2011; Fiechter 2011), regulators and practitioners raised concerns regarding the
inclusion of OCR in the FVM of financial liabilities (Financial Executives International 2004; American Bankers Association
2006; The Clearing House 2009).
Based on an experimental study using Certified Public Accountants as participants, Gaynor, McDaniel, and Yohn (2011)
provide evidence that OCR disclosures mandated in Statement of Financial Accounting Standards (SFAS) No. 159 are not
sufficient to avoid misleading interpretations: the participants were unable to associate a gain (loss) arising from changes in the
fair value of liabilities with an increase (decrease) in credit risk. Using archival data, Schneider and Tran (2015) examine the
informational effects of FVOL adoption, as well as of OCR recognition. For a sample of European IFRS banks, they provide
evidence that OCR recognizers have lower bid-ask spreads compared to non-recognizers and non-adopters of FVOL. However,
these studies do not address the question of whether the recognition of OCR moderates the informativeness of asset
completeness. Value relevance studies on OCR recognition also provide mixed results. Cedergren, C. Chen, and K. Chen
(2015) find that OCR is not associated with stock returns, while Chung, Lobo, and Yong (2017) do. However, when Cedergren
et al. (2015) consider the amount of unrecognized intangible assets, they find that OCR is positively related to equity returns
when the level of these omitted assets is low.
Our first hypothesis examines whether asset completeness affects bid-ask spreads. We define asset completeness as the
proportion of assets that are recognized at fair value through net income (FVNI), as this reflects the extent to which changes in
cash flows and/or the risk of assets are fully reflected in the financial statements in a timely manner. The greater the proportion
3
Disclosure can be interpreted as a choice of an accounting technique or as the amount and quality of information disclosed (Diamond and Verrecchia
1991). The former one is the focus of our study as firms have discretion whether or not to choose the FVOL.

of assets recognized at FVNI, the more financial statements provide investors with a key part of the relevant information needed
for equity valuation purposes, which includes the evaluation of the ability to repay debt holders. The beneficial effects of the
more timely information provided by FVNI have to be weighed against any adverse effects on information asymmetry.
However, we conjecture that the beneficial effects of greater asset completeness on information asymmetry will be larger in an
international setting, where the information environment is generally less rich than that in the U.S. In practice, banks’ use of
FVNI is constrained by accounting standards, and some banks might choose not to use FVNI for all eligible assets. This
incomplete accounting can pose informational problems for investors.
Our second hypothesis investigates whether OCR recognition affects the extent to which asset completeness reduces
information asymmetry. OCR can arise even when the value of assets is unchanged, but the risk profile of the assets is altered,
for example, if the firm sells some of its low-risk assets and invests the proceeds in high-risk ones. Banks devote much time and
attention to managing their asset-liability risk exposures, and whether there is any OCR to be recognized ultimately depends on
the effectiveness of such strategies. Sources of risk include interest rate and foreign currency exposures, liquidity risk, and risks
stemming from their trading and lending activities. Liabilities can be used to hedge asset risks and vice versa. Moreover, the
more equity a bank has, the less significant OCR will be. From an investor’s perspective, having information about the asset
value provides only part of the information needed for equity valuation.4 The reporting of OCR amounts is likely to offer
investors a parsimonious (albeit incomplete and imperfect) source of information on how gains and losses are shared.
III. RESEARCH DESIGN
Definition and Measurement of Variables

Dependent Variable
We use the natural logarithm of the bid-ask spread (lnSpread) as a proxy for information asymmetry. We measure this
proxy over relatively short intervals (Glosten and Milgrom 1985; Daske, Hail, Leuz, and Verdi 2008; Muller et al. 2011).
Following the literature that tests for the informational effects of financial reporting (Leuz and Verrecchia 2000; Leuz 2003),
we use the mean quoted spread by starting in month 5 and ending in month þ7 relative to the bank’s fiscal year-end. To
mitigate the effect of outliers, we winsorize the dependent variable at the top 1 percent level.5
Independent Variables
Asset completeness captures the extent to which assets are at FVNI.6 Koonce et al. (2011) conduct three behavioral
experiments that suggest that investors’ fair value judgments are contingent on whether the item is an asset or a liability, and
that investors consider fair valued assets to be more relevant than fair valued liabilities. Based on this evidence, we measure
asset completeness as the proportion of assets that are fair valued. Consistent with prior research that finds that net income is
more informative than other comprehensive income (OCI), we exclude assets available-for-sale (AFS) (Ball et al. 2012; Dong,
Ryan, and Zhang 2014; Badertscher, Burks, and Easton 2014).
We use three alternative variables to capture asset completeness that are described in detail in Appendix A.
FVNItoEarnAssets is the ratio of FVNI assets to earnings assets;7 FVNItoDiscandRecFV is the ratio of FVNI assets to financial
assets recognized and disclosed at fair value; and FVNItoMVAssets is the ratio of FVNI assets to market value of assets. A low
FVNItoMVAssets ratio can stem from either the bank having a lower proportion of FVNI assets or because it has significant
omitted resources.8 We predict asset completeness to be negatively associated with bid-ask spread. For our regression analyses,
4
Finance theory characterizes risky debt as being equivalent to riskless debt minus a put option, held by the equity holders, with an exercise price equal
to the face value of the debt (Merton 1974). The value of the put is an increasing function of the volatility (risk) of the business and how leveraged it is,
and a decreasing function of the value of the assets.
5
Untabulated findings show similar results if we do not winsorize or delete the top 1 percent of observations.
6
IFRS requires all derivatives to be measured at fair value, including those held for hedging. As most derivatives in banks are classified as held for
trading, the resulting gains and losses are recognized in net income (Nissim and Penman 2007). Gains and losses of some derivatives that qualify for a
specific type of hedge accounting are recognized in OCI, but as this data item is not available in our databases, we include all derivatives in our asset
completeness measure.
7
Earnings assets come from Worldscope and include income-generating financial assets. As an alternative to earnings assets, we hand-collect recognized
financial assets and compute the ratio of FVNI assets to financial assets. Untabulated findings show that descriptive statistics and results using the ratio
of FVNI assets to financial assets are very similar to the ones using FVNItoEarnAssets.
8
Omitted resources are intangible resources that allow banks to generate fees and other sources of noninterest income from activities such as investment
banking, asset management, and securitizations. Omitted resources can be significant value drivers in banks (Nissim and Penman 2007). These are
implicitly included in the market value of assets, but as they do not meet the definition of an asset for financial reporting purposes, they do not appear in
the book value of total assets. Untabulated descriptive statistics show that in the case of our sample, the distribution of FVNItoMVAssets is very similar
to the ratio of FVNI assets to the book value of total assets.

we use the natural logarithm of the continuous variables for asset completeness.9 OCRRecognizer takes the value of 1 if a bank
recognizes OCR in the financial year, and 0 otherwise.10 Previous studies provide mixed evidence regarding the informational
effects of OCR recognition and, therefore, we have no clear prediction for the sign of the coefficient on OCRRecognizer.11
AssetCompleteness OCRRecognizer is the interaction between asset completeness and OCR recognition. We expect the
coefficient on the interaction variable to be negative.
Based on the extensive empirical literature on the factors determining the bid-ask spread (Welker 1995; Leuz and
Verrecchia 2000; Muller and Riedl 2002; Leuz 2003), we expect it to be negatively associated with share turnover (lnTO), price
(lnPrc), free float (lnFF), Tier 1 capital (lnTier1), market value of assets (Size), and large bank indicator (LBI); and to be
positively associated with stock return volatility (lnRetVol) and country bid-ask spread (lnSpreadCount).12 Appendix A
provides a detailed description of the control variables.
Models
Model 1 examines the effect of asset completeness on information asymmetry, and Model 2 examines the extent to which
OCR recognition moderates the impact of asset completeness on information asymmetry:
lnSpreadit ¼ a0 þ a1 AssetCompletenessit þ Controls þ eit ð1Þ
lnSpreadit ¼ a0 þ a1 AssetCompletenessit þ a2 OCRRecognizerit þ a3 AssetCompleteness 3 OCRRecognizerit þ Controls

þ eit
ð2Þ
We use ordinary least squares (OLS) to estimate the models. Consistent with extant microstructure analytical models that
identify multiplicative relations between the bid-ask spread and its determinants (e.g., Glosten and Milgrom 1985; Stoll 2000),
and similar to other studies looking at the informational effects of financial reporting (Leuz and Verrecchia 2000; Leuz 2003),
we use a log-linear specification. We include year fixed effects to control for the decreasing trend in bid-ask spreads over time
(Chordia, Roll, and Subrahmanyam 2008; Ball et al. 2012). To account for the correlations within banks, we present robust
standard errors clustered by bank (Wooldridge 2003).13
IV. SAMPLE AND DATA

We conduct our tests on a sample of European banks, all of which use IFRS. These banks provide a unique framework for
this analysis for two reasons. First, banks have been at the forefront of the debate over the FVM of financial liabilities and the
recognition of the associated OCR. Second, the choice of a European setting instead of a single country (e.g., the United States)
is based on sample size concerns. Using only one country would result in a very small number of OCR recognizers that would
limit both the representativeness and the statistical power of the results. Also, information asymmetry in the banking sector is
likely to be higher in Europe than in the United States because banking supervision rules and disclosure practices are not yet
fully harmonized across Europe (KPMG 2009; European Banking Authority 2012). The institutional environment that
ultimately determines the accounting quality of the numbers provided to investors is mostly dictated by each host country’s
supervisory authority (Nobes 2006).
We draw our sample from the Thomson ONE Banker database. We identify all active banks that (1) are classified as
Financials (industry code 8000), Banks (subsector code 8355), and Depository and Nondepository institutions (primary SIC
code 60 or 61 or 67); (2) are located in a European country; (3) are listed as of December 31, 2008; and (4) prepare their
financial statements under IFRS. The sample period spans the years from 2005 to 2014. The choice of this period reflects the
date after which the fair value option for assets and liabilities became effective, and hence the earliest date OCR could be
9
We use the logarithmic form as this makes the variables less skewed. Our inferences are unchanged if we use the non-logarithmic form.
10
Although IFRS 9 requires changes in the fair value of financial liabilities attributable to changes in OCR to be recognized in OCI for financial years
beginning on or after January 1, 2015, with early adoption permitted starting in 2009, all banks in our sample recognize OCR changes in net income
during the sample period.
11
An added complication is that OCR recognizers might be more inclined to engage in earnings management. The incentive to manage earnings is high
when the firm is doing badly, and these are the times when the market value of its debt could be low. In this case, we expect to see a positive relation
between the bid-ask spread and OCR recognition.
12
Some studies use analysts following as a control for size (e.g., Brennan and Subrahmanyam 1995). To ensure that our results are not driven by the
omission of analyst following, we reestimate our models by adding the natural logarithm of 1 plus the number of analysts as a control. The inferences
remain unchanged.
13
Our inferences are unchanged if we cluster standard errors by both bank and year and if we bootstrap standard errors.

TABLE 1
The Sample
Unique Firm-Year
Banks Observations
All entities that are classified as Financials (8000), Banks (8355) and Depository and Non-Depository Entities 1,649
(SIC Codes 60 or 61 or 67)
Less entities that:
—are not European (i.e., Thomson One Banker Region is different from Europe) 1,392
—do not apply IFRS as of December 31, 2008 (Accounting Standard different from 23) 59
—are not listed as of December 31, 2008 23
—have no annual reports available 3
—have annual reports in languages other than English, French, German, Greek, Spanish, and Portuguese 14
Listed entities with annual reports available for the years 2005–2014 158 1,360
Less observations with:

—missing data on OCR recognition and accounting completeness 25 378
—missing data on control and explanatory variables 29 370
Final sample 104 612
The table presents data on sample selection. In the sample, we include European banks that report under IFRS for the period 2005–2014 that have available
data. This process leads to 612 firm-year observations.
recognized in net income. We also require our banks to have the necessary data to compute all of the variables in our study.
These requirements yield a sample of 612 firm-year observations that represent 104 unique banks. The sample selection process
is summarized in Table 1.
The data on the use of the fair value option for assets and liabilities and on the recognition of OCR are hand-collected from
annual reports downloaded from the Perfect Information database or from the banks’ websites. We also hand-collect
information on the amount of trading assets, derivatives, AFS, and disclosed fair values of loans and assets held-to-maturity
(HTM) because although some of these items are available from Bankscope, many observations are missing in that database.
Accounting data on the control variables come from Worldscope, the market data are extracted from Datastream, and the
analyst information from CRSP.
Table 2 provides detailed information on the number of banks that adopted the FVOL and recognized OCR, broken down
by country and year. Of the 612 firm-year observations, we identify FVOL adoption in 236 (39 percent) cases. Of the adopters,
74 percent are also OCR recognizers (174 out of 236). The OCR recognizers represent 28 percent of the whole sample. These
numbers are consistent with the evidence provided by Fiechter (2011), who finds that 31 percent of his sample of international
banks adopted FVOL. Banks from Italy, Great Britain, France, and Germany together comprise 65 percent of the OCR
recognizers (59 percent of the FVOL adopters). The number of OCR recognizers has grown considerably since the FVOL was
introduced in 2005.14
Table 3 presents the descriptive statistics for the main variables. Panel A reports the descriptive statistics for all banks.
Panels B and C provide the descriptive statistics for the subgroups of OCR recognizers and non-recognizers, respectively. The
OCR recognizers have higher levels of asset completeness, stock return volatility, share turnover, size, and free float than do the
non-recognizers.
Table 4 provides the bivariate correlations for the main variables used in the regression analysis. All of the measures of
asset completeness are negatively correlated with bid-ask spread (lnSpread). OCRRecognizer is also negatively associated with
lnSpread. We use three alternative measures of asset completeness in order to capture incompleteness arising from both
measurement and omitted assets. These measures are highly correlated. We, therefore, use them separately in different
regressions in order to ascertain whether our results are sensitive to how asset completeness is captured. The interaction variable
AssetCompleteness OCRRecognizer is highly correlated with OCRRecognizer for all three asset completeness measures. In
14
The drop in the number of banks (and OCR recognizers) in the sample for 2013 and 2014 is driven by missing data for some explanatory variables,
such as adverse selection controls, as well as by the fact that some banks were merged or acquired by other banks.

TABLE 2
FVOL Adopters and OCR Recognizers
Panel A: FVOL and OCR Recognizers by Country

All FVOL OCR
Austria 29 (4.74%) 8 (3.39%) 6 (3.45%)
Belgium 17 (2.78%) 17 (7.20%) 11 (6.32%)
Denmark 32 (5.23%) 0 (0.00%) 0 (0.00%)
Finland 17 (2.78%) 9 (3.81%) 7 (4.02%)

France 71 (11.60%) 32 (13.56%) 26 (14.94%)
Germany 40 (6.54%) 22 (9.32%) 21 (12.07%)
Great Britain 37 (6.05%) 36 (15.25%) 30 (17.24%)
Greece 9 (1.47%) 4 (1.69%) 3 (1.72%)
Hungary 5 (0.82%) 0 (0.00%) 0 (0.00%)
Ireland 16 (2.61%) 8 (3.39%) 7 (4.02%)
Italy 78 (12.75%) 50 (21.19%) 36 (20.69%)
Liechtenstein 12 (1.96%) 0 (0.00%) 0 (0.00%)
Lithuania 10 (1.63%) 2 (0.85%) 1 (0.57%)
Luxembourg 3 (0.49%) 0 (0.00%) 0 (0.00%)
Norway 39 (6.37%) 7 (2.97%) 3 (1.72%)
Poland 35 (5.72%) 0 (0.00%) 0 (0.00%)
Portugal 28 (4.58%) 8 (3.39%) 8 (4.60%)

Romania 4 (0.65%) 0 (0.00%) 0 (0.00%)
Russia 36 (5.88%) 0 (0.00%) 0 (0.00%)
Spain 46 (7.52%) 12 (5.08%) 0 (0.00%)
Sweden 24 (3.92%) 20 (8.47%) 15 (8.62%)
Switzerland 5 (0.82%) 1 (0.42%) 0 (0.00%)
Turkey 19 (3.10%) 0 (0.00%) 0 (0.00%)
Total 612 236 174
Panel B: FVOL and OCR Recognizers by Year

All FVOL OCR
2005 44 (7.19%) 12 (5.08%) 5 (2.87%)
2006 52 (8.50%) 15 (6.36%) 6 (3.45%)
2007 62 (10.13%) 26 (11.02%) 20 (11.49%)
2008 67 (10.95%) 26 (11.02%) 23 (13.22%)
2009 67 (10.95%) 28 (11.86%) 23 (13.22%)
2010 76 (12.42%) 29 (12.29%) 20 (11.49%)
2011 79 (12.91%) 29 (12.29%) 23 (13.22%)
2012 76 (12.42%) 31 (13.14%) 26 (14.94%)
2013 47 (7.68%) 20 (8.47%) 13 (7.47%)
2014 42 (6.86%) 20 (8.47%) 15 (8.62%)
Total 612 236 174
The table reports the number and percentage of banks that adopt FVOL and, within the adopters of FVOL, the ones that recognize OCR, by country (Panel
A) and year (Panel B). The sample includes all European banks using IFRS that have data to calculate dependent and control variables (n ¼ 612) for the
period 2005–2014.
order to investigate this further, we calculate the variance inflation factors and tolerance for all of our regression models.
Untabulated results indicate that there is no multicollinearity problem between our variables.
V. RESULTS
Table 5 presents the regression results on the effect of asset completeness (Model 1, first three columns) and the
incremental effect of OCR (Model 2, last three columns) on the bid-ask spread. The adjusted R2 for the different models varies

TABLE 3
Descriptive Statistics
Panel A: All Sample

n Mean Median Std P10 P90
lnSpread 612 5.29 5.25 1.42 7.10 3.28
OCRRecognizer 612 0.28 0.00 0.45 0.00 1.00
lnFVNItoEarnAssets 612 2.11 2.02 1.06 3.72 0.75
lnFVNItoDiscandRecFV 612 2.05 1.95 1.12 3.70 0.66

lnFVNItoMVAssets 612 2.21 2.13 1.03 3.75 0.87
lnTO 612 7.36 6.74 2.22 10.77 5.10
lnRetVol 612 2.47 2.50 0.67 3.20 1.73
lnPrc 612 1.95 2.08 1.81 0.33 3.99
lnSpreadCount 612 4.47 4.49 1.21 6.07 3.06
lnFF 612 3.82 4.16 0.96 2.45 4.60
lnTier1 612 2.89 2.86 0.64 3.47 2.25
Size 612 10.81 10.78 2.00 8.13 13.85
LBI 612 0.10 0.00 0.30 0.00 0.00
Panel B: OCR Recognizers


lnSpread 174 5.85 6.08 1.43 7.63 3.59
lnTO 174 6.80 6.14 1.95 10.25 5.02
lnRetVol 174 2.32 2.42 0.63 3.06 1.53
lnPrc 174 1.77 2.07 1.69 0.70 3.71
lnSpreadCount 174 4.61 4.43 1.07 6.11 3.53
lnFF 174 3.94 4.34 0.91 2.75 4.60
lnTier1 174 3.16 3.12 0.37 3.70 2.70
Size 174 12.25 12.35 1.79 9.42 14.41
LBI 174 0.24 0.00 0.43 0.00 1.00
Panel C: Non-Recognizers
lnSpread 438 5.06 5.04 1.35 6.90 3.27
lnTO 438 7.58 7.08 2.28 11.28 5.17
lnRetVol 438 2.53 2.54 0.67 3.23 1.78
lnPrc 438 2.02 2.10 1.85 0.16 4.11
lnSpreadCount 438 4.42 4.50 1.25 6.04 2.95
lnFF 438 3.77 4.09 0.98 2.41 4.58
lnTier1 438 2.78 2.71 0.69 3.36 2.17
Size 438 10.24 10.23 1.79 7.84 12.55
LBI 438 0.04 0.00 0.20 0.00 0.00
The table provides descriptive statistics of the variables used in the main analysis. Panel A reports descriptive statistics for all the sample. Panels B and C
provide descriptive statistics for the subgroups of OCR recognizers and non-recognizers, respectively.
All variables are defined in Appendix A.

TABLE 4
Correlations
Panel A: Correlation Variables

1 2 3 4 5 6 7 8
1. lnSpread
2. OCRRecognizer 0.251
3. lnFVNItoEarnAssets 0.398 0.316
4. lnFVNItoDiscandRecFV 0.311 0.240 0.907

5. lnFVNItoMVAssets 0.396 0.335 0.996 0.901
6. lnFVNItoEarnAssets OCRRecognizer 0.006 0.829 0.009 0.035 0.022
7. lnFVCItoDiscandRecFV OCRRecognizer 0.021 0.841 0.024 0.027 0.037 0.996
8. lnFVNItoMVAssets OCRRecognizer 0.023 0.846 0.026 0.020 0.039 0.999 0.997
9. lnTO 0.641 0.157 0.254 0.230 0.252 0.059 0.064 0.067
10. lnRetVol 0.096 0.141 0.109 0.096 0.113 0.120 0.112 0.118
11. lnPrc 0.078 0.063 0.082 0.054 0.077 0.120 0.113 0.117
12. lnSpreadCount 0.492 0.072 0.069 0.118 0.061 0.031 0.038 0.036
13. lnFF 0.347 0.081 0.096 0.116 0.105 0.005 0.013 0.011
14. lnTier1 0.164 0.264 0.222 0.245 0.237 0.113 0.115 0.122
15. Size 0.706 0.453 0.458 0.360 0.466 0.167 0.178 0.184
16. LBI 0.439 0.298 0.424 0.371 0.437 0.005 0.013 0.019
Panel B: Correlation Variables (continued)

9 10 11 12 13 14 15
9. lnTO
10. lnRetVol 0.205
11. lnPrc 0.143 0.315
12. lnSpreadCount 0.428 0.122 0.116
13. lnFF 0.586 0.046 0.096 0.197
14. lnTier1 0.003 0.027 0.083 0.090 0.047
15. Size 0.455 0.113 0.038 0.269 0.156 0.466
16. LBI 0.204 0.031 0.102 0.008 0.164 0.325 0.572
The table reports Pearson correlation coefficients.
from 73 to 74 percent, which indicates a good fit. Consistent with our predictions, Model 1 shows that asset completeness is
associated with a lower bid-ask spread. The coefficients on all three alternative asset completeness variables are negative and
statistically significant. Also in line with our predictions, Model 2 shows that the coefficients both on asset completeness and on
the interaction of asset completeness with OCR recognition are negative and statistically significant. This result is consistent
with OCR recognition adding to the effect of asset completeness in reducing information asymmetry. The impact is
economically significant for each of the three asset completeness measures. For example, our results show that an increase of 10
percent in asset completeness is associated with an additional 2 percent decrease in the bid-ask spread for OCR recognizers
compared to non-recognizers.15 Moreover, the decrease in the spread associated with asset completeness is between 2.4 and 3.4
times larger for OCR recognizers than for non-recognizers, depending on the asset completeness measure. For example, with
lnFVNItoDiscandRecFV, it is (0.226 0.093)/0.093 ¼ 3.43.
As expected, the coefficients on the control variables lnTO, lnTier1, Size, and LBI are negative and significant in Table 5,
which means that the bid-ask spread is lower for firms with higher share turnover, greater capital strength, and larger size. In
line with the literature, lnRetVol and lnSpreadCount significantly increase the bid-ask spread. The coefficients on lnFF and
lnPrc are negative, but statistically insignificant.
15
As both the dependent variable and each of our asset completeness measures are subject to logarithmic transformation, the latter’s coefficients can be
interpreted as elasticities.

TABLE 5
Impact of Asset Completeness and OCR Recognition on Bid-Ask Spread
Model 1 Model 2
lnFVNIto lnFVNIto
lnFVNIto Discand lnFVNIto lnFVNIto Discand lnFVNIto
Variable Pred. EarnAssets RecFV MVAssets EarnAssets RecFV MVAssets
Intercept 2.819*** 2.577*** 2.859*** 2.814*** 2.635*** 2.841***
(4.15) (3.83) (4.17) (4.35) (4.05) (4.35)

AssetCompleteness () 0.168*** 0.122*** 0.163*** 0.142*** 0.093** 0.138***
(4.04) (3.31) (3.84) (3.29) (2.41) (3.09)
OCRRecognizer (?) 0.216 0.296 0.229
(1.08) (1.53) (1.09)
AssetCompleteness OCRRecognizer () 0.200** 0.226*** 0.200**
(2.28) (2.70) (2.27)
lnTO () 0.207*** 0.207*** 0.209*** 0.209*** 0.210*** 0.210***
(4.92) (4.77) (4.92) (5.09) (4.93) (5.08)
lnRetVol (þ) 0.323*** 0.329*** 0.323*** 0.317*** 0.325*** 0.318***
(4.05) (4.11) (4.05) (3.98) (4.05) (3.99)
lnPrc () 0.033 0.029 0.032 0.026 0.022 0.025
(0.70) (0.60) (0.68) (0.55) (0.47) (0.54)
lnSpreadCount (þ) 0.238*** 0.237*** 0.234*** 0.234*** 0.231*** 0.231***

(3.96) (3.96) (3.90) (3.98) (3.94) (3.93)
lnFF () 0.012 0.008 0.008 0.010 0.006 0.007
(0.20) (0.14) (0.14) (0.18) (0.10) (0.13)
lnTier1 () 0.264*** 0.283*** 0.267*** 0.258*** 0.274*** 0.260***
(3.54) (4.00) (3.53) (3.74) (4.04) (3.73)
Size () 0.323*** 0.341*** 0.325*** 0.327*** 0.339*** 0.329***
(8.36) (9.00) (8.35) (8.20) (8.40) (8.14)
LBI () 0.450*** 0.486*** 0.451*** 0.379** 0.402** 0.380**
(2.84) (3.07) (2.83) (2.29) (2.46) (2.29)
Year Dummies Yes Yes Yes Yes Yes Yes
Adj. R2 74.34% 73.89% 74.20% 74.75% 74.33% 74.62%
Observations 612 612 612 612 612 612
**, *** Indicate statistical significance at the 5 percent and 1 percent levels (two-tailed), respectively.
The table presents the regression results of the impact of asset completeness and OCR recognition on the bid-ask spread. The coefficient estimates and t-
statistics are based on robust standard errors that are clustered by bank.
Controlling for Endogeneity

Although FVOL adoption is subject to eligibility criteria, the ultimate decision is left to the firm. To control for possible
selection bias, we use the two-stage Heckman (1979) correction procedure.16 Following the studies of Fiechter (2011), Muller
et al. (2011), and Daske, Hail, Leuz, and Verdi (2013) on the determinants of FVOL adoption and commitment to transparent
reporting, our probit model comprises the following explanatory variables, which are defined in Appendix A: RegQuality, Big4,
Size, EligibleInstruments, Leverage, BooktoMarket, OwnershipConcentration, and LBI.
The results from estimating the probit model are presented in Panel A of Table 6.17 Due to additional data requirements,
the number of observations drops to 606. The Pearson test does not indicate that the observed frequency distribution differs
from the theoretical distribution, while the likelihood ratio test indicates that the null model is rejected. The pseudo R2 is 33
percent, which is close to the one reported in Fiechter (2011). In line with our expectations, the coefficients on Size, Leverage,
16
Alternatively, we could use bank fixed effects to control for the firm’s time-invariant unobservable characteristics that affect information asymmetry
were it not for the fact that OCRRecognizer varies little for any given bank.
17
Our tabulated results estimate the probit model for the whole sample period. Untabulated findings yield unchanged inferences if we estimate the probit
model at the time of the FVOL first adoption.

TABLE 6
Controlling for Endogeneity
Panel A: Probit Estimates for FVO Election

Variable Pred. Probit Chi-square
Intercept 26.893*** (57.94)
RegQuality (þ) 0.222 (2.06)
Big4 (þ) 0.524 (1.62)

EligibleInstruments (þ) 2.260*** (7.77)
Size (þ) 0.302*** (45.96)
Leverage (þ) 16.493*** (28.91)
BooktoMarket (þ) 8.854*** (30.72)
OwnershipConcentration () 0.631*** (8.69)
LBI (þ) 0.467* (2.84)
Pseudo R2 33.19%
LR Chi-square 268.9247***
Pearson 565.086
Observations 606
Panel B: Including Self-Selection Parameter

Model 2
lnFVNIto lnFVNIto lnFVNIto
Variable Pred. EarnAssets DiscandRecFV MVAssets
Intercept 2.755*** 2.564*** 2.780***
(4.25) (3.96) (4.24)
AssetCompleteness () 0.146*** 0.094** 0.141***
(3.32) (2.45) (3.10)
OCRRecognizer (?) 0.166 0.246 0.182
(0.82) (1.27) (0.86)
AssetCompleteness OCRRecognizer () 0.209** 0.239*** 0.210**
(2.24) (2.66) (2.23)
k (?) 0.056 0.064 0.056
(0.77) (0.86) (0.76)
Control Variables Yes Yes Yes
Year Dummies Yes Yes Yes
Adj. R2 74.93% 74.47% 74.77%
Observations 606 606 606
(continued on next page)
and BooktoMarket are positive and statistically significant, while the coefficient on OwnershipConcentration is negative and
statistically significant.
In the second stage, reported in Panel B of Table 6, we add the self-selection parameter (k) calculated from the probit
regression to Equation (2). The coefficient on the self-selection parameter is statistically insignificant. Moreover, the
coefficients on the interaction of asset completeness with OCR recognition are always negative and statistically significant, and
of very similar magnitudes to those reported in Table 5. These findings indicate that the incremental informativeness of OCR
recognition to asset completeness is not a result of self-selection.
We also use propensity score matching as an alternative way to address possible self-selection (Rosenbaum and Rubin
1983). Following Kim and Shi (2012), we construct a matched sample of FVOL adopters and non-adopters by using the
predicted likelihood (propensity score) of FVOL adoption that we calculate from the probit model in Panel A of Table 6. Our
matching procedure is with no replacement and relies on a nearest-neighbor match, resulting in 472 observations. The results
are presented in Panel C of Table 6. The coefficients on asset completeness and the interaction with OCR recognition are

TABLE 6 (continued)
Panel C: Using Propensity Score Matching
Model 2
Variable Pred. EarnAssets DiscandRecFV MVAssets
Intercept 3.151*** 2.995*** 3.143***
(3.74) (3.55) (3.69)
AssetCompleteness () 0.164*** 0.105** 0.155***
(3.21) (2.12) (3.00)

OCRRecognizer (?) 0.139 0.225 0.157
(0.71) (1.15) (0.78)
AssetCompleteness OCRRecognizer () 0.154* 0.182** 0.156*
(1.80) (2.15) (1.81)
Control Variables Yes Yes Yes
Adj. R2 78.64% 78.64% 78.64%
*, **, *** Indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels (two-tailed), respectively.
The table presents the regression results after controlling for endogeneity. Panel A reports the first-stage probit results of the FVO election. The inverse
Mills ratio (k) is computed from the first-stage regression and included in the second-stage equation (Model 2). Panel B reports the second-stage regression
results of the impact of asset completeness and OCR recognition on the bid-ask spread, including the self-selection parameter (k). Panel C reports the
results using a sample matched on the predicted likelihood (propensity score) of the FVOL adoption. The coefficient estimates and t-statistics are based on
robust standard errors that are clustered by bank.
always negative and statistically significant, suggesting that the differences between FVOL adopters and non-adopters do not
drive our results. The economic significance of OCR recognition on the effect of asset completeness on bid-ask spreads is also
considerable.
Informativeness of Narrative Disclosures

Next, we investigate whether the narrative disclosures related to OCR recognition have a moderating effect on information
asymmetry, using hand-collected information from annual reports. In our sample, if banks do not recognize OCR, then we find
that they also do not provide narrative disclosures in this area. To ascertain the extent of the narrative disclosures, we examine
whether banks provide information on the following: (1) why FVOL was adopted; (2) what economic factors determined the
OCR amounts; (3) how OCR amounts were related to asset changes; (4) how own credit risk was measured; and (5) what
valuation techniques were used to estimate OCR amounts. This grouping approach to summarizing the narrative disclosures
represents the best practical method we have been able to devise to deal with the heterogeneity in the OCR-related disclosures.
We extend Equation (2) with two alternative narrative disclosure variables: NarrativeScore indicates the percentage of the
above areas covered in the narrative disclosures; NarrativeDummy equals 1 if the bank provides narrative disclosures in three or
more of the above areas, and 0 otherwise. Because only OCR recognizers provide narrative disclosures, we drop the variable
OCRRecognizer. The results are presented in Table 7. The coefficients on the interaction of asset completeness with
NarrativeScore or NarrativeDummy are negative and statistically significant, a finding consistent with better OCR narrative
disclosures having an incremental effect on the reduction in information asymmetry associated with asset completeness. While
the AssetCompleteness NarrativeScore coefficients are too small to be economically significant, this is not so with the
AssetCompleteness NarrativeDummy ones. The coefficients indicate that the decrease in the spread associated with asset
completeness is approximately three to four times larger for the banks that provide good OCR disclosures.
Information Environment and Business Model

A confounding factor is the quality of a bank’s information environment. The OCR recognizers in our sample are likely to
operate in a better information environment than non-recognizers. We find, for example, that OCR recognizers tend to have a
higher number of professional information intermediaries, better corporate governance, better regulatory environment (both in
terms of the quality of the regulations in place and their enforcement), and their loans comprise a lower percentage of their

TABLE 7
Impact of Narrative Disclosures of OCR Recognition on Bid-Ask Spread
NarrativeScore NarrativeDummy
lnFVNIto lnFVNIto
Variable Pred. EarnAssets RecFV MVAssets EarnAssets RecFV MVAssets
Intercept 2.991*** 2.804*** 3.016*** 2.874*** 2.635*** 2.902***
(4.50) (4.21) (4.50) (4.27) (3.94) (4.27)

AssetCompleteness () 0.140*** 0.093** 0.135*** 0.158*** 0.113*** 0.153***
(3.27) (2.41) (3.07) (3.85) (3.07) (3.66)
NarrativeDisclosures (?) 0.006 0.008* 0.007 0.572*** 0.598*** 0.602***
(1.59) (1.92) (1.62) (2.82) (2.89) (2.88)
AssetCompleteness NarrativeDisclosures () 0.004** 0.005*** 0.004** 0.335*** 0.337*** 0.335**
(2.52) (2.81) (2.50) (2.65) (2.67) (2.60)
Control Variables Yes Yes Yes Yes Yes Yes
Year Dummies Yes Yes Yes Yes Yes Yes
Adj. R2 74.63% 74.23% 74.50% 74.55% 74.10% 74.40%
Observations 612 612 612 612 612 612
* ,**, *** Indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels (two-tailed), respectively.
The table reports the regression results of the impact of the narrative disclosures regarding OCR recognition on the bid-ask spread. NarrativeScore
indicates the percentage of the relevant areas covered in the narrative disclosures, whereas the NarrativeDummy equals 1 if the bank provides narrative
disclosures in three or more of the relevant areas, and 0 otherwise. The coefficient estimates and t-statistics are based on robust standard errors that are
clustered by bank.
All other variables are defined in Appendix A.
assets. Furthermore, a bank’s choice of business model is likely to affect the extent of its asset completeness and OCR
recognition. A bank whose primary focus is its banking book activities will have assets mostly consisting of loans that are
measured at historical cost. But a bank that has substantial trading activities will have many trading instruments that are
measured at fair value. This may make the latter more inclined to adopt the FVOL.
To address the concern that our results might be driven more by the quality of a bank’s information environment than by
the OCR recognition, we extend Equation (2) by adding information environment control variables. Following Fiechter and
Novotny-Farkas (2017) and Song, Thomas, and Yi (2010), we interact these control variables with our primary variable of
interest, AssetCompleteness OCRRecognizer, in order to mitigate multicollinearity issues. Numest_High (InstOwn_High)
equals 1 if a bank has above the median sample number of analysts following (institutional ownership), and 0 otherwise.
RegQ_High equals 1 if Kaufmann, Kraay, and Mastruzzi’s (2009) country-specific score is above the median for our sample,
and 0 otherwise. The score is intended to capture disclosure incentives arising from a bank’s regulatory environment and,
specifically, the quality of supervisory scrutiny. Enfor_High equals 1 if the bank operates in a high-enforcement country
(France, Portugal, Turkey, and the United Kingdom), and 0 otherwise. LoanstoTA_Low controls for the bank’s choice of
business model (Bischof, Daske, and Gebhardt 2011) and is 1 if a bank has below the median sample percentage of loans to
total assets, and 0 otherwise.
Results for the lnFVNItoEarnAssets measure of asset completeness are shown in Table 8 (results are very similar with
either of the other two measures). The coefficient on the interaction variable of asset completeness and OCR recognition is
negative and statistically significant across all environment controls. The effect of OCR recognition remains economically
significant: the decrease in the spread associated with asset completeness is more than three times as large for OCR
recognizers than for non-recognizers. For example, the final column of Table 8 shows that when allowing for the size of a
bank’s loan portfolio, lnFVNItoEarnAssets, it is (0.200 0.151)/0.151 ¼ 3.33. In contrast, the coefficient on the three-
way interaction of OCRRecognizer, AssetCompleteness, and EnvironmentControl is statistically insignificant for each of the
information environment controls. This latter result suggests that a better information environment is not incrementally
helpful in explaining the impact of asset completeness on information asymmetry for OCR recognizers. Untabulated findings
reveal that our results also hold if we use samples of FVOL adopters and non-adopters matched with each of the information
environment controls.

TABLE 8
Impact of Information Environment
Numest InstOwn RegQ Enfor LoansTA
Variable _High _High _High _High _Low
Intercept 2.800*** 2.722*** 2.726*** 2.784*** 2.836***
(4.44) (4.28) (4.08) (4.29) (4.46)
lnFVNItoEarnAssets 0.147*** 0.152*** 0.149*** 0.158*** 0.151***
(3.32) (3.40) (3.42) (3.42) (3.48)

OCRRecognizer 0.131 0.233 0.195 0.143 0.189
(0.62) (1.07) (1.01) (0.74) (0.94)
EnvironmentControl 0.010 0.126 0.119 0.073 0.046
(0.05) (1.14) (1.18) (0.77) (0.42)
lnFVNItoEarnAssets OCRRecognizer 0.211** 0.288** 0.217** 0.193** 0.200**
(2.31) (2.52) (2.40) (2.15) (2.27)
lnFVNItoEarnAssets OCRRecognizer EnvironmentControl 0.111 0.131 0.069 0.147 0.030
(1.20) (1.19) (0.75) (1.31) (0.34)
Control Variables Yes Yes Yes Yes Yes
Year Dummies Yes Yes Yes Yes Yes
Adj. R2 74.77% 74.07% 74.79% 74.92% 74.69%
Observations 612 506 612 612 612

**, *** Indicate statistical significance at the 5 percent and 1 percent levels (two-tailed), respectively.
The table reports the regression results of the impact of asset completeness and OCR recognition on the bid-ask spread, after controlling for information
environment. The coefficient estimates and t-statistics are based on robust standard errors that are clustered by bank.
Controlling for Size and Different Levels of Asset Completeness

Given that larger banks are more likely to have higher asset completeness, we include a control for size in all the
regressions in Tables 5–8. To further investigate whether size, rather than asset completeness, is driving our results, we add the
interaction between LBI and OCRRecognizer to Equation (2).18 Table 9 presents the results. To avoid multicollinearity
problems, we include all controls except Size. The coefficient on the interaction between OCR recognition and asset
completeness is negative and statistically significant, while the coefficient on the interaction between asset completeness and
LBI is insignificant. The results are robust across all asset completeness measures. Untabulated findings indicated that all our
results also hold if we use a sample of FVOL adopters and non-adopters matched on Size.
In Panel B of Table 9, we replace the continuous measures of asset completeness with variables that indicate different
levels of asset completeness. AssetCompD1 (AssetCompD2) is an indicator variable that equals 1 if asset completeness is in the
second (third) quartile of the sample, and 0 otherwise. AssetCompD3 comprises banks whose asset completeness is in the top
quartile of the sample. The first three columns of Panel B indicate that asset completeness decreases information asymmetry,
and that this effect increases with the level of asset completeness. When we add the interaction between asset completeness and
OCR recognition (columns 4–6), we find that the coefficients are consistently statistically significant only for the interaction
with AssetCompD3. In these banks, the effect is also economically significant: the decrease in the spread associated with asset
completeness is twice as large for OCR recognizers as for non-recognizers. For example, the fourth column of Table 9,
lnFVNItoEarnAssets shows that the decrease is (0.444 0.402)/0.402 ¼ 2.1. Taken together, these results show that the
OCR recognition moderates the effect of asset completeness on information asymmetry if there is a sufficient degree of asset
completeness.
Further Sensitivity Analyses

To investigate the robustness of our findings, we conduct several additional analyses. Our research design focuses on the
questions of whether the measurement of bank assets at FVNI reduces information asymmetry and whether the reduction is
18
We are precluded from using the interaction of OCRRecognizer with bank size due to multicollinearity, and so we use a large bank indicator variable
that presents no such econometric problems.

TABLE 9
Controlling for Size and Different Levels of Asset Completeness
Panel A: Impact of Size

Model 2
Variable EarnAssets DiscandRecFV MVAssets
Intercept 6.788*** 6.742*** 6.854***

(8.02) (7.90) (8.07)
AssetCompleteness 0.189*** 0.084* 0.183***
(3.39) (1.70) (3.14)
OCRRecognizer 0.806*** 1.091*** 0.851***
(2.91) (4.17) (2.97)
AssetCompleteness OCRRecognizer 0.370*** 0.475*** 0.378***
(3.00) (4.02) (3.07)
LBI 1.000*** 1.157*** 1.003***
(4.08) (4.66) (4.09)
LBI OCRRecognizer 0.006 0.215 0.062
(0.20) (0.73) (0.21)
Controls Yes, except Size Yes, except Size Yes, except Size
Adj. R2 67.22% 66.17% 66.98%
(continued on next page)
greater when banks recognize OCR. However, it should be noted that OCR amounts can arise simply because of hedging
failures that have nothing directly to do with asset completeness. To address this issue, we compute the following hedging
metric: the absolute difference between (1) the proportion of a bank’s assets that are recognized at fair value on its balance
sheet, and (2) the proportion of its liabilities at fair value. We treat this metric as a (rough) proxy for the extent of asset-liability
management the bank uses.19 Untabulated results show no statistically significant effect of our asset-liability measurement
matching variable on information asymmetry. Additionally, untabulated results based on a regression that includes this
variable, asset completeness, OCR recognition, and the two-way interactions of the matching variable and asset completeness
with OCR recognition, indicate that while OCR recognition has an incremental effect on the role of asset completeness in
reducing information asymmetry, this is not the case the for the asset-liability measurement matching.
Another weakness of our approach is that it does not capture the extent to which gains and losses on assets and liabilities
are matched together in income, thereby enabling investors to get insights into how asset gains and losses are distributed
between debt holders and equity holders. We, therefore, also investigate whether income-matching affects information
asymmetry by using the correlation between the volatility of stock returns and the volatility of net income (Hodder, Hopkins,
and Wahlen 2006). The rationale for this variable is that if gains and losses on assets and liabilities are measured in a timely
manner, then the net income should have similar volatility to the economic income, and the two volatility measures should be
highly correlated. On the other hand, if net income reflects volatility due to inconsistencies caused by the application of the
mixed-attribute model, then these two measures should be, at best, only weakly correlated. We have rerun the regressions by
19
This is the best measure we have been able to devise, given data constraints. However, assets and liabilities might have the same values, but differ
markedly in their riskiness. For example, they might have different durations, and currency and volatility exposures mismatches can lead to them
having different exposures. Moreover, empirical evidence shows that investors consider the fair value of assets more relevant than the fair value of
liabilities (Koonce et al. 2011). Therefore, the effect of fair value of liabilities on information asymmetry might be different from those of assets.
Untabulated results based on a regression that includes both the proportion of financial assets and the proportion of financial liabilities that are fair
valued separately indicate that while assets at fair value reduce information asymmetry, this is not the case for liabilities, the coefficient on which is not
statistically significant. Finally, some studies provide evidence that the fair value hierarchy itself is value-relevant. For example, Song et al. (2010)
report that investors put less weight on fair value level 3 gains and losses, relative to level 1 and level 2 ones. Therefore, if a bank has, say,
proportionally more level 3 liabilities than level 3 assets, then information asymmetry might be higher even if our measure of balance sheet matching
shows that the bank is matched.

TABLE 9 (continued)
Panel B: Impact of Different Levels of Asset Completeness
Model 1 Model 2
lnFVNIto lnFVNIto
EarnAssets RecFV MVAssets EarnAssets RecFV MVAssets
Intercept 2.372*** 2.184*** 2.382*** 2.320*** 2.290*** 2.386***
(3.52) (3.24) (3.51) (3.58) (3.53) (3.67)
AssetCompD1 0.227** 0.281*** 0.216** 0.277** 0.328*** 0.247**

(2.31) (2.63) (2.21) (2.44) (2.76) (2.18)
AssetCompD2 0.326*** 0.280** 0.353*** 0.302** 0.241* 0.331***
(3.08) (2.48) (3.75) (2.43) (1.78) (2.95)
AssetCompD3 0.504*** 0.374*** 0.468*** 0.402** 0.245* 0.356***
(3.70) (3.00) (3.92) (2.61) (1.67) (2.67)
OCRRecognizer 0.317** 0.292** 0.386**
(2.03) (2.01) (2.36)
AssetCompD1 OCRRecognizer 0.079 0.111 0.042
(0.44) (0.71) (0.22)
AssetCompD2 OCRRecognizer 0.225 0.247 0.259
(0.89) (0.96) (1.02)
AssetCompD3 OCRRecognizer
0.444** 0.502** 0.525**

(2.07) (2.40) (2.38)
Controls Yes Yes Yes Yes Yes Yes
Year dummies Yes Yes Yes Yes Yes Yes
Adj. R2 74.42% 74.02% 74.38% 74.81% 74.26% 74.71%
Observations 612 612 612 612 612 612
* ,**, *** Indicate statistical significance at 10 percent, 5 percent, and 1 percent levels (two-tailed), respectively.
The table reports the regression results of the impact of asset completeness and OCR recognition on the bid-ask spread, after controlling for bank size and
different levels of asset completeness. Panel A reports the results including the interaction of LBI with OCR recognition. Panel B reports the results for the
different levels of asset completeness. AssetCompD1 (AssetCompD2) equals 1 if asset completeness is in the second (third) quartile of the sample, and 0
otherwise. AssetCompD3 equals 1 if asset completeness is in the top quartile of the sample, and 0 otherwise. The coefficient estimates and t-statistics are
based on robust standard errors that are clustered by bank.
All other variables are defined in Appendix A.
replacing our asset completeness variables with this income-matching variable. In contrast to the results using asset
completeness, untabulated results show that income-matching is not associated with information asymmetry in our sample. In
addition, we rerun the results by adding the income-matching variable and its interaction with OCR recognition. Untabulated
results show that the coefficients on the income-matching variable and on the interaction of this with OCR recognition are
insignificant, while the coefficients on asset completeness and the interaction between asset completeness and OCR recognition
are statistically significant.
The measurement period used in the bid-ask spread calculation aims to capture the impact of all information disclosed by
banks on the bid-ask spread. Because banks release reports that become available to public investors regularly, we use a 12-
month interval starting five months before the fiscal year-end in the main analysis. Additionally, we use (1) a 12-month interval
starting in month 2 and ending in month þ10 relative to the bank’s fiscal year-end, and (2) a seven-month interval over the
first seven months after the fiscal year-end (Muller and Riedl 2002). Untabulated findings yield the same inferences. We also
run our results using forecast error as an alternative measure of information asymmetry. The number of observations drops to
436 because analysts do not follow all the banks in our sample. Untabulated findings show that the coefficient on the interaction
between OCR recognition and asset completeness remains negative and significant.
In our main analysis, we classify a bank as an OCR recognizer during a financial year if the bank adopts FVOL and
recognizes a non-zero OCR amount in that particular year. A bank that has adopted the FVOL, but has zero or immaterial
changes in its creditworthiness, will not have any OCR amounts to report. In such cases, most banks provide little or no
information, but some banks state in their reports that there was no change in own credit risk or that it was immaterial.
Although this information is more difficult to identify in the annual reports, it can be argued that when a bank discloses
information about the adoption of the FVOL, the bank should be classified as an OCR recognizer. We, therefore, test the

robustness of our results by using FVOLadopter as an alternative way of classifying a bank as an OCR recognizer.
FVOLadopter equals 1 if the bank elects the FVOL in a particular year, and 0 otherwise. Our inferences are unchanged
(untabulated results).
The recognition of OCR amounts is a result of the change in the creditworthiness of a bank, which can itself affect
information asymmetry. This change poses an identification problem in our study. To investigate whether changes in
creditworthiness drive our results, we add estimated changes in the probability of default to Equation (2) (Merton 1974;
Hillegeist, Keating, Cram, and Lundstedt 2004).20 Our inferences remain unchanged: OCR recognition has an incremental
effect on the reduction in bid-ask spread associated with asset completeness.
The use of the control variables for the adverse selection component, other than Size and LBI, reduces our sample size
significantly (from 844 to 612 firm-year observations). Because the number of banks with available data on the main variables
of interest is already limited, this reduction could bias our results. We, therefore, reestimate our main model by using a
sensitivity sample that excludes these controls for the adverse selection components. Our inferences do not change. Finally, the
results are robust if we winsorize asset completeness at the top 1 percent level and exclude from our sample all countries in
which no banks adopted the FVOL.
VI. CONCLUSIONS
In this study, we investigate whether asset completeness reduces investors’ uncertainty and how OCR recognition affects
this relation. Using the bid-ask spread as a proxy for information asymmetry, we find that asset completeness is associated with
lower information asymmetry and that this reduction is greater for OCR recognizers. However, OCR recognizers are different
in our sample from non-recognizers in many key respects that are related to the quality of the information environment (analyst
following, institutional ownership, country of origin, extent of use of fair value). When we control for information environment
quality, we find that being an OCR recognizer still incrementally increases the impact of asset completeness on information
asymmetry. In addition, we examine the effects of the narrative disclosures regarding OCR on the bid-ask spread. We find that
the bid-ask spread is incrementally lower for banks that provide more detailed OCR narrative disclosures. Given that the OCR
narrative disclosures are only available for OCR recognizers, we cannot rule out the possibility that the results are confounded
with unobserved characteristics of the OCR recognizers that are correlated with FVOL adoption. Nevertheless, the fact that the
results are consistent across the alternative specifications suggests that our findings are driven, at least partly, by the
informational effects of OCR recognition and asset completeness, rather than by other factors.
We caution that our measure of asset completeness does not provide investors with all the information required for equity
valuation purposes. Changes in the risk profile of the assets and the asset-liability hedging relation are not directly reflected in
the measure. Also, the recognition of OCR is necessarily a result of the change in the creditworthiness of a bank, which can
itself affect information asymmetry. What we can reasonably conclude is that information asymmetry is lower for banks with
higher asset completeness, and this effect is even greater for banks that recognize OCR. We present arguments as to why OCR
recognition might be the explanation, but we cannot completely rule out the possibility that there could be other additional
reasons for our findings.
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observations). Using only this limited sample, the coefficients on the interaction terms of OCR recognition and asset completeness are negative, but
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APPENDIX A
Variable Definitions
Spread (lnSpread) is the natural logarithm of the mean quoted spread between the bid and ask prices measured at the end
of each trading day, scaled by the midpoint, and computed over a year that starts in month 5 and ending in month þ7
relative to the bank’s fiscal year-end. This variable is winsorized at the top 1 percent. A minimum of 100 observations in
each period is required. Source: Datastream.
lnFVNItoEarnAssets is the natural logarithm of the ratio financial assets at FVNI to earnings assets recognized in the
balance sheet, as of the fiscal year-end. FVNI assets include: (1) cash, repos, and other short-term balances; (2) financial
assets held for trading (i.e., trading assets and derivatives); and (3) financial assets for which the fair value option is
elected (source: bank annual reports). Earnings Assets are given by the variable WS.EarningAssetsPctAssets. Source:
Worldscope.
lnFVNItoDiscandRecFV is the natural logarithm of the ratio of FVNI assets to the financial assets recognized and
disclosed at fair value, as of the fiscal year-end. Source: bank annual reports.
lnFVNItoMVAssets is the natural logarithm of the ratio of FVNI assets to the market value of total assets as of the fiscal
year-end. The market value of assets is given by the sum of market value of equity (source: Datastream) plus the book
value of total liabilities. Source: Worldscope.

OCRRecognizer is an indicator variable that equals 1 if a bank recognizes a non-zero OCR amount in the financial year,
and 0 otherwise. Source: bank annual reports.
NarrativeScore indicates the percentage of the five areas covered in the narrative disclosures. The five areas are: (1) why
FVOL was adopted; (2) what economic factors determined the OCR amounts; (3) how OCR amounts were related to
asset changes; (4) how own credit risk was measured; and (5) what valuation techniques were used to estimate OCR
amounts. Source: bank annual reports.
NarrativeDummy equals 1 if the bank provides narrative disclosures in three or more of the relevant areas, and 0
otherwise.
Control Variables
ShareTurnover (lnTO) is a proxy for stock liquidity and, as such, is a measure for the opportunity cost of holding
securities. Share turnover is measured as the natural logarithm of the median daily Euro value of trading volume divided
by the daily market value of outstanding equity. We compute lnTO over the same intervals as lnSpread. Source:
Datastream.
Stock Return Volatility (lnRetVol) is a proxy for the market maker’s price risk of holding inventory. Stock return
volatility is measured as the natural logarithm of the standard deviation of monthly dividend-adjusted stock returns. We
compute lnRetVol over the same intervals as lnSpread. Source: Datastream.
Price (lnPrc) is a proxy for fixed order processing costs. LnPrc is the natural logarithm of the share price on the last
trading day of the fiscal year. Source: Datastream.
Country Bid-Ask Spread (lnSpreadCount) is used to control for differences in microstructures and competition among
market makers. lnSpreadCount is the natural logarithm of the mean daily percentage spread for the country where the
firm is domiciled that is calculated by firm and by year and then averaged across all firms within a country in a given
year. We compute lnSpreadCount over the same intervals as lnSpread. Source: Datastream.
FreeFloat (lnFF) is an inverse proxy for the presence of insiders and is used to control for the information costs
associated with adverse selection. lnFF is the natural logarithm of 1 less percentage of closely held shares as of the fiscal
year-end. Source: Worldscope.
Tier 1 Capital (lnTier1) is a proxy for capital strength, which uninformed investors arguably have an information
disadvantage in assessing. lnTier1 is defined as the natural logarithm of Tier 1 capital to total assets as of the fiscal year-
end (Ball et al. 2012). Source: Worldscope.
Market Value of Assets (Size) is the natural logarithm of the market value of assets as of the fiscal year-end. Market value
of assets is given by the sum of market value of equity (source: Datastream) plus the book value of total liabilities.
Source: Worldscope.
Large Bank Indicator (LBI) is an indicator variable that takes the value of 1 if the market value of assets is above the
sample 90th percentile, and 0 otherwise.
Variables used in the First Stage of Heckman’s Model
RegQuality is a regulatory quality index provided by Kaufmann et al. (2009) for the year 2008 (last year available in
Kaufmann et al. [2009]). The index ranges from 2.5 to 2.5, with a higher value indicating a more regulated
environment. Banks domiciled in countries with a more regulated environment are expected to be more willing to adopt
the fair value option.
Big4 is an indicator variable that equals 1 if the bank is audited by a Big 4 audit company, and 0 otherwise. Source: bank
annual reports.
Size is measured as the natural logarithm of the market value of assets as of the fiscal year-end.
EligibleInstruments is defined as the ratio of the sum of earnings assets plus total debt relative to total assets plus total
liabilities. Source: Worldscope.
Leverage is measured as the ratio of total liabilities to total assets. Banks with higher leverage have greater motivation
for transparent reporting and are more likely to adopt FVOL.
BooktoMarket is the ratio of book value of assets to market value of assets used to capture growth opportunities.
OwnershipConcentration is the ratio of closely held shares to total shares.

Variables used to Control for Information Environment
Numest_High equals 1 if a bank has above the median sample number of analysts following, and 0 otherwise (source:
CRSP). If a bank is not covered by CRSP, then the number of analysts is assumed to be zero.
InstOwn_High equals 1 if a bank has above the median sample percentage of equity owned by institutional investors,
and 0 otherwise. Large institutional ownership indicates more oversight and hence better corporate governance that is
likely to lead to higher accounting quality. Sources: Worldscope and SNL.
RegQ_High equals 1 if the country-specific score from Kaufmann et al. (2009) is above the median sample, and 0
otherwise. The score indicates the disclosure incentives arising from a bank’s regulatory environment and, particularly,
the quality of supervisory scrutiny.

Enfor_High equals 1 if the bank operates in a high enforcement country (France, Portugal, Turkey, and the United
Kingdom), and 0 otherwise. The country categorization is based on the public enforcement index from Leuz (2010), who
captures market supervision through a country’s regulator, its investigative powers, and the sanctions available.
LoanstoTA_Low equals 1 if a bank has below the median sample percentage of loans to total assets, and 0 otherwise.
Variables used to Control for Different Levels of Asset Completeness
AssetCompD1 equals 1 if asset completeness is in the second quartile of the sample, and 0 otherwise.
AssetCompD2 equals 1 if asset completeness is in the third quartile of the sample, and 0 otherwise.
AssetCompD3 equals 1 if asset completeness is in the top quartile of the sample, and 0 otherwise.


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THE ACCOUNTING REVIEW American Accounting Association

Vol. 93, No. 6 DOI: 10.2308/accr-52070

The Impact of Fair Value Measurement for Bank Assets on

The Accounting Review

II. RELATED LITERATURE AND HYPOTHESIS DEVELOPMENT

The Accounting Review

III. RESEARCH DESIGN

Definition and Measurement of Variables

The Accounting Review

provides a detailed description of the control variables.

lnSpreadit ¼ a0 þ a1 AssetCompletenessit þ a2 OCRRecognizerit þ a3 AssetCompleteness 3 OCRRecognizerit þ Controls

IV. SAMPLE AND DATA

The Accounting Review

Less observations with:

data. This process leads to 612 firm-year observations.

The Accounting Review

Panel A: FVOL and OCR Recognizers by Country

Finland 17 (2.78%) 9 (3.81%) 7 (4.02%)

Portugal 28 (4.58%) 8 (3.39%) 8 (4.60%)

Panel B: FVOL and OCR Recognizers by Year

The Accounting Review

Panel A: All Sample

lnFVNItoDiscandRecFV 612 2.05 1.95 1.12 3.70 0.66

Panel B: OCR Recognizers

n Mean Median Std P10 P90

The Accounting Review

Panel A: Correlation Variables

4. lnFVNItoDiscandRecFV 0.311 0.240 0.907

Panel B: Correlation Variables (continued)

The Accounting Review

(4.15) (3.83) (4.17) (4.35) (4.05) (4.35)

lnSpreadCount (þ) 0.238*** 0.237*** 0.234*** 0.234*** 0.231*** 0.231***

Controlling for Endogeneity

The Accounting Review

Panel A: Probit Estimates for FVO Election

Big4 (þ) 0.524 (1.62)

Panel B: Including Self-Selection Parameter

The Accounting Review

(3.21) (2.12) (3.00)

Informativeness of Narrative Disclosures

Information Environment and Business Model

The Accounting Review

(4.50) (4.21) (4.50) (4.27) (3.94) (4.27)

The Accounting Review

(3.32) (3.40) (3.42) (3.42) (3.48)

Observations 612 506 612 612 612

Controlling for Size and Different Levels of Asset Completeness

Further Sensitivity Analyses

The Accounting Review

Panel A: Impact of Size

Intercept 6.788*** 6.742*** 6.854***

The Accounting Review

AssetCompD1 0.227** 0.281*** 0.216** 0.277** 0.328*** 0.247**

0.444** 0.502** 0.525**

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

Variables used in the First Stage of Heckman’s Model

The Accounting Review

Variables used to Control for Information Environment

the quality of supervisory scrutiny.

lnSpreadCount (þ) 0.238* 0.237* 0.234* 0.234* 0.231* 0.231*

Intercept 6.788* 6.742* 6.854***

AssetCompD1 0.227 0.281* 0.216 0.277 0.328* 0.247

0.444 0.502 0.525**