This post comes to us from Chang Song, Assistant Professor of Accounting at Sungkyunkwan University, Wayne Thomas, Professor of Accounting at the University of Oklahoma, and Han Yi, Assistant Professor of Accounting at the University of Oklahoma.
In our paper, Value Relevance of FAS 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms, forthcoming in The Accounting Review, we use banking firm data from the first three quarters of 2008 to examine two important research questions related to fair value information provided by banks under FAS 157. First, we compare the value relevance of Level 1 and Level 2 fair values to the value relevance of Level 3 fair values. Second, we consider whether the impact of corporate governance on the value relevance of fair values is greater for Level 3 assets compared to Level 1 and Level 2 assets. Under FAS 157, firms are required to disclose fair values of asset and liability types by levels, where levels are based on inputs used to generate fair values: (1) Level 1 (observable inputs from quoted prices in active markets), (2) Level 2 (indirectly observable inputs from quoted prices of comparable items in active markets, identical items in inactive markets, or other market-related information), and (3) Level 3 (unobservable, firm-generated inputs). Thus, fair values are disclosed from most reliable (Level 1) to least reliable (Level 3), with a classification that potentially falls somewhere in the middle (Level 2).