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    Agency problems, accounting slack, and banks’ response to p...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements 
    Agency problems, accounting slack, and banks’ response to proposed reporting of loan fair value.
    Practical Implications:

    The results should be considered in the context of due process for setting accounting standards and for legislating financial regulation. The study suggests that bank representatives writing negative comment letters have motives to resist accounting standards that result in reduced accounting slack and increased transparency. As one would expect, these motives and patterns of financial-reporting behavior are not mentioned in the comment letters. Instead, the negative letters submitted by responding bank representatives cite conceptual reasons for resisting proposals intended to increase financial reporting transparency. The results suggest that the processing of comment-letters should explicitly include consideration of letter-writer motivations, and weigh carefully the stated reasons for support or opposition against letter-writer incentives and potentially divergent facts.


    Hodder, L. D., & Hopkins, P. E. 2014. Agency problems, accounting slack, and banks’ response to proposed reporting of loan fair values. Accounting, Organizations & Society, 39 (2): 117-133.

    fair value accounting, bank loans, financial statements, FASB
    Purpose of the Study:

    In May 2010, the United States (US) Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED) that proposes greatly expanding fair value recognition for most financial instruments, including long-term receivables, such as bank loans. Responses received by the FASB during the ED’s comment period were overwhelmingly negative and particularly concentrated within the banking industry; specifically, the FASB received 2971 comment letters in response to the ED, with over 85% from bank representatives and banking trade organizations. Through the end of 2011, this is one of the highest comment-letter volumes in response to any single FASB-issued public-comment discussion document. Because of the large volume of negative letters received from bank representatives, the FASB withdrew the proposal in January 2011. This study seeks to understand the factors systematically associated with bank representatives’ decisions to submit comment letters.

    Despite the many changes proposed in the ED, the vast majority of letters submitted by commercial-bank representatives addressed only one issue: opposition to the proposed reporting of loans at fair value. Given the large, uniform, and narrowly focused response that was concentrated in the banking industry, this suggests that responding bank representatives perceived an economic threat from the FASB’s ED and its proposal to change current accounting for loans.

    Design/Method/ Approach:

    The authors use logistic regression analysis to test the determinants of differential bank comment-letter writing. The primary sample consists of all private and public commercial banks with necessary financial data in the periods covered by the tests. The authors collect financial statement data from publicly available regulatory filings. The authors include quarterly data spanning 2001Q1 through 2011Q4. The sample includes 5,289 unique banks. From the FASB’s web site, the authors collect all 2,971 comment letters submitted.


    The authors provide evidence suggesting that bank representatives’ objections to the ED are motivated less by stated conceptual concerns and more by self-interest. The incurred loss model for accounting for loan losses makes available accounting slack that can be used to manage capital and earnings. The finding that banks historically using accounting slack are more likely to oppose the ED suggests that the FASB’s fair value proposal is perceived to decrease available accounting slack related to loans. In the analysis of transparency-related motives, banks submitting comment letters opposing the loan-reporting provisions of the ED are:

    1. More likely to elect to participate in the new optional, supplemental, fixed-price deposit insurance and debt guarantee programs offered by the FDIC,
    2. Less likely to have nonguaranteed outside creditors and
    3. Less likely to obtain financial statement audits of their non-regulatory GAAP financial statements.

    These results are consistent with bank managers and shareholders affiliated with lobbying banks benefitting from the lower agency costs that accompany government guarantees of indebtedness and the lower levels of external monitoring that otherwise would be provided by unguaranteed debt holders and by auditors.

    Standard Setting
    Impact of New Accounting Pronouncements