Fair value accounting and earnings quality (EQ) in banking sector: Evidence from Europe

This research investigates the influence of fair value accounting (FVA) on earnings quality (EQ) in European banking sector over the 2007 to 2016 period. As financial reporting system of banks is particularly exposed to FVA, we assume that FVA may produce significant effects on EQ for European banks. It can be expected that financial instruments’ prices are not available in illiquid markets, so Fair Values are estimated by applying valuation models. The application of valuation models (that is, market to model) in estimating Fair Value gives managers the opportunity to manipulate values, and thus could bring through lower quality of earnings. This study develops a multidimensional concept of EQ, and measures it using a set of attributes as persistence, predictability, variability, and earnings smoothing. The findings suggest that European banks with large Fair Value reporting in financial statements have higher rank of aggregate EQ.