Review of Quantitative Finance and Accounting, 25: 413427, 2005

c 2005 Springer Science + Business Media, Inc. Manufactured in The Netherlands.

The Value-Relevance of Derivative Disclosures

by Commercial Banks: A Comprehensive Study
of Information Content Under SFAS Nos. 119 and 133
LI WANG
Department of Accounting, Kent State University, College of Business Administration, Kent, Ohio 44242
E-mail: lwang@kent.edu
PERVAIZ ALAM
Department of Accounting, Kent State University, College of Business Administration, Kent, Ohio 44242,
Tel.: 330-672-1121, Fax: 330-672-2548
E-mail: palam@kent.edu
STEPHEN MAKAR
Department of Accounting, University of Wisconsin Oshkosh, College of Business Administration, Oshkosh,
WI 54901-8677
E-mail: makar@uwosh.edu

Abstract. This study examines the value-relevance of banks derivative disclosures under Statements of Financial
Accounting Standards (SFAS) Nos. 119 and 133. Using the complete time-series of SFAS No. 119 disaggregated
notional value disclosures and the most recently available SFAS No. 133 fair value data, this study investigates
whether such expanded disclosures provide incremental information content beyond earnings and book value.
Our results indicate that banks notional principal amount disclosures are value-relevant, and that this evidence
of incremental information content is robust to the inclusion of recently available fair value data and alternative
model specifications.
Key words: derivatives, banks, information content
JEL Classification: M41, G21

1.

Introduction

The ongoing dramatic growth in the use of derivatives, together with the accompanying
derivative debacles, has motivated accounting regulators to develop and expand disclosure
requirements. In the U.S., for example, accounting regulators (Financial Accounting Standards Board, FASB) began their derivatives project in 1986. The FASB subsequently sought
to improve the usefulness of publicly available derivatives information with significant revisions to disclosure requirements in 1994 and 1998. This study investigates whether such
expanded derivative disclosures provide incremental information content beyond earnings
and book value.
Corresponding

author.

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WANG, ALAM AND MAKAR

Corresponding to the FASBs derivatives project, the notional amount of derivatives

increased more than twelve-fold, from $1.5 trillion in 1986 to $20.2 trillion in 1994 (Bank
for International Settlements, 2004). Derivative debacles in 1994-1995 alone included the
bankruptcy of Orange County in California, and substantial financial losses at major U.S.
corporations such as Procter and Gamble, and Gibson Greetings. By the end of 2003, the
notional amount of derivatives reached $234 trillion, and was accompanied by U.S. business
scandals at Enron and Fannie Mae that centered on their improper derivatives reporting. The
increasing use of derivatives suggests that risk management practices have changed over
the years. In fact, previous research suggests that derivatives are an endogenous component
of the firms risk management strategy (Nance, Smith and Smithson, 1993; Geczy, Minton
and Schrand, 1997; Henstschel and Kothari, 2001).
Before the U.S. disclosure requirements on derivatives were written, firms selectively
reported their derivative transactions, including any associated gains or losses. The lack of
consistent disclosure became a major issue when the substantial losses became apparent.
In an attempt to address this lack of useful publicly available information, the FASB issued
Statements of Financial Accounting Standards (SFAS) No. 119 in 1994 and SFAS No. 133 in
1998. However, prior research on the information content of derivative disclosures has been
inconclusive (e.g., Khurana and Kim, 2003). Some previous studies were performed before
the accounting standards were fully implemented (e.g., Riffe, 1997), while others use only
two years of post-implementation data (e.g., Barth, Beaver and Landsman, 1996; Nelson,
1996; Venkatachalam, 1996). Seow and Tam (2002) contribute to this literature using large
banks disclosure data for 19901996 in a returns regression framework, but do not find
any evidence that the notional principal amounts of derivatives are value-relevant. These
authors call for more research on the information content of derivative notional amounts in
particular, as well as on the usefulness of subsequently available derivative disclosures.
This study investigates the value-relevance1 of banks derivative disclosures for the entire
SFAS No. 119 reporting period (i.e., 19942000) as well as for the most recent SFAS No.
133 reporting period (i.e., 20012002). Using data from the Chicago Federal Reserve Banks
Call and Income Reports, we examine the disaggregated notional values of derivatives by
risk category (i.e., interest rate and foreign exchange) and by intended use (i.e., trading and
non-trading). Our investigation focuses on the banking industry because of the uniqueness of
the industry and the size of derivative losses some banks have reported (see Springett, 1995;
Kaplan, 1997). Recent data show that the five largest banks have entered into derivative
contracts of nearly $78 trillion (Office of the Comptroller, 2004). In the banking industry,
there is also a severe moral hazard problem due to both the heavy federal and state regulation,
in general, and the federal insurance protection of bank deposits, in particular.
The research design used in this study follows the work of Ohlson (1995), which is noted
for its rigorous specification of the association between accounting information and stock
prices (Richardson and Tinaikar, 2004). Our results indicate that the notional principal
amounts of derivatives are economically significant and provide incremental information
content beyond earnings and book value. Moreover, such results are robust to the inclusion
of SFAS No. 133 fair value data as well as to alternative model specifications.
The remainder of this paper is organized as follows. Section 2 describes the FASBs
derivatives project and the accompanying disclosure requirements. In addition, hypotheses

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THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

pertaining to such reporting requirements are developed in relation to prior research. Section
3 details the empirical models, Section 4 discusses sample selection and data description,
and Section 5 presents the empirical results. Finally, Section 6 provides a summary and
suggestions for future research.

2.

Derivative disclosures and prior research

Table 1 shows that derivatives held by commercial banks and trust companies at the end
of September 2004 totaled $82 trillion, of which $78 trillion were held by the 5 largest
banks. Table 1 also shows that most of the derivatives held by all banks and trust companies
($79.69 trillion) were held for trading purposes.
As introduced in the previous section, the U.S. accounting regulators (FASB) began
their study of derivatives in 1986. Because of the intricacies of derivative instruments, the
FASB elected to address this problem in a series of Statements of Financial Accounting
Standards: SFAS Nos. 105, 107, 119, and 133. Among the required disclosures of SFAS
No. 105 (FASB, 1990), firms reported the face, contract or notional principal amount of
financial instruments with off-balance-sheet risk. SFAS No. 107 (FASB, 1991) expanded
such derivatives reporting to include the fair value amounts of all financial instruments
(assets and liabilities) in notes to the financial statements, suggesting that FASB believed
that the information was relevant to financial statement users. Barth (1994) demonstrates
that the fair value amounts of banks financial investment securities are value-relevant, and
that such information content exceeds that of historical costs. In an attempt to substantively
improve the derivative disclosures required under both of these standards, the FASB issued
SFAS No. 119 in 1994 (effective in December 1994). Among the expanded reporting
mandated in this standard is the requirement that firms provide disaggregated notional
value disclosures (e.g., asset versus liability positions).
The fourth and most recent accounting standard, SFAS No. 133 (FASB, 1998), was effective for fiscal years beginning after June 2000. Subsequent to its issuance, the FASBs

Table 1. Notional amounts of derivatives contracts held by commercial banks and trusts, September 30, 2004
(millions of dollars)

Rank

Bank name

Total assets

1
JPMorgan Chase Bank
$661,772
2
Bank of America NA
740,695
3
Citibank NA
651,346
4
Wachovia Bank NA
380,236
5
HSBC Bank USA NA
118,454
Top 5 banks & trusts with derivatives
$2,552,503
Other 662 banks & trusts with derivatives 4,202,500
Total amounts for 667 banks & trusts
$6,755,003

Total
derivatives

Total held for

trading MTM

Total not
traded MTM

$42,128,402
16,165,883
15,154,814
2,947,107
1,655,178
$78,051,384
4,215,941
$82,267,325

$42,028,862
15,586,689
14,927,224
2,597,611
1,639,177
$76,779,563
2,909,841
$79,689,404

$99,540
579,194
227,590
349,496
16,002
$1,271,822
1,306,100
$2,477,922

Notes: Credit derivatives are excluded from the sum of total derivatives. Data source: Office of the Comptroller
of the Currency (2004). MTM = marked to market.

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WANG, ALAM AND MAKAR

Derivatives Implementation Group has issued more than 180 guidelines to help firms understand and apply this standards complex reporting requirements. SFAS No. 133 hedge
accounting, in particular, has been criticized as being so idiosyncratic and . . . esoteric
that auditing departments dont have the expertise to implement this without bringing in
specialist expertise (Hawser, 2004, p. 45). For example, derivatives designated as one of
three types of hedges (cash flow hedge, fair value hedge, net investment hedge) receive
special accounting treatment by deferring gains or losses until the underlying transaction
is complete. On the other hand, when derivatives are not designated as hedges, or if the
hedge is ineffective, derivatives are marked-to-market on the balance sheet, with the corresponding gain or loss reported either on the income statement or as a separate component
of equity. Indeed, SFAS No. 133 is notorious for being the most complex of any of the
FASBs pronouncements (Kawaller, 2004, p. 24), and thus the information content of the
most recently available derivative disclosures are an open question.
This study investigates the usefulness of notional and fair value derivative disclosures by
commercial banks under SFAS Nos. 119 and 133. Sample firms are drawn from the banking
industry in light of their large-scale use of derivatives and their comprehensive derivatives
reporting. Given the existing gap in such prior research, we are interested primarily in the
information content of derivative notional principal amounts. In contrast to prior research,
we focus our analysis on the entire reporting period of SFAS No. 119, and take advantage of
recently available SFAS No. 133 data to examine the sensitivity of notional value disclosures
to fair value data.
As stated above, SFAS No. 119 is noteworthy in that it requires firms to provide disaggregated notional value disclosures by asset versus liability position, by category of derivative
(e.g., interest rate and foreign exchange), and by purpose for which the derivative is held
(e.g., trading and non-trading). By incorporating such expanded disclosures, we are able to
construct more powerful tests of incremental information content than was possible prior
to SFAS No. 119. While both notional and fair value disclosures have limitations (e.g.,
Hentschel and Kothari, 2001), recent research has cautioned that banks fair value disclosures, in particular, may not be reliable (Nissim, 2003; Khurana and Kim, 2003). Indeed,
Fannie Mae recently has been charged by the SEC with manipulating SFAS No. 133 fair
value adjustments to smooth earnings fluctuations (Hagerty, 2004).
As introduced in Section 1, prior research on the value-relevance of derivative disclosures
is inconclusive. Riffe (1997) reports that notional value disclosures by banks for 19861989
are positively related to their market values. In contrast, Venkatachalam (1996) provides
evidence that suggests notional derivative disclosures for 19931994 have negative valuation
implications. Moreover, Venkatachalam reports that the value-relevance of banks notional
value disclosures is incremental to fair value, and vice versa. Similarly, Eccher, Ramesh and
Thiagarajan (1996) and Nelson (1996) control for notional principal amounts, but provide
limited results pertaining to the information content of fair value disclosures for 19921993.
Taking advantage of a longer time-series of derivatives data, Seow and Tam (2002) find
that all derivative disclosures for 19901996, except notional principal amounts, are valuerelevant. As noted in Section 1, we respond to these authors call for additional research on
the information content of notional derivative value disclosures.

THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

417

This study contributes to the literature on the information content of derivatives reporting by using the complete time-series of disaggregated derivative disclosures under SFAS
No. 119 and the rigorous specification of the Ohlson (1995) firm valuation framework. In
particular, we examine the following hypotheses (in alternative form).
Hypothesis 1. The notional amounts of trading derivatives are value-relevant, and provide
additional explanatory power beyond earnings and book value.
Hypothesis 2. The notional amounts of non-trading derivatives are value-relevant, and
provide additional explanatory power beyond earnings and book value.
These two formal hypotheses, which distinguish a banks intent of holding derivatives,
are investigated for each of the two major risk categories faced by our sample firms: interest
rates and foreign exchange. Beyond these four tests pertaining to our primary analyses,
we examine the robustness of such results to the inclusion of SFAS No. 133 fair value
disclosures (i.e., fair value gains/losses for trading derivatives or fair value asset/liability
positions for non-trading derivatives). We also examine the sensitivity of our primary results
to alternative model specifications.

3.

Empirical models

Bank managers are likely to hedge when there is uncertainty about the variability of their cash
flows and the consequent effect on firm value. For example, Geczy, Minton and Schrand
(1997) and Graham and Rogers (2002) report that firms use derivatives to reduce cash
flow variability, which allows them to raise additional funds and invest in new growth
opportunities. Increased investment, in turn, may bring increased firm value. Following
Dechow, Hutton and Sloan (1999) and Barth et al. (1998), we use Ohlsons (1995) valuation
framework to develop our empirical models for assessing the impact of derivatives use on
firm value. Ohlsons (1995) valuation framework can be expressed as follows:
Pit = 0 + 1 E it + 2 BVit + 3 Vit
Stock price (Pit ) proxies for firm valuation, and is calculated for each firm i three months
after fiscal year-end period t. Earnings (E it ) are income before extraordinary items for firm
i in period t, while book value (BVit ) is calculated as of the end of period t. Vit captures the
information about future abnormal earnings based on non-financial statement variables.
In our primary analyses, we examine hypothesis 1 pertaining to the value-relevance of
trading derivatives in total (TDER), as well as trading interest rate derivatives (TINT) and
trading foreign exchange derivatives (TFX), using the following OLS regression models.
Pit = 0 + 1 E it + 2 BVit + 3 SALEGROWit + 4 TDERit + it
Pit = 0 + 1 E it + 2 BVit + 3 SALEGROWit + 4 TINTit + 5 TFXit + it

(1)
(2)

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WANG, ALAM AND MAKAR

As noted above, these models are based on the well-known Ohlson (1995) firm valuation framework, which indicates that summary accounting measures such as earnings and
book value are useful in explaining variations in firm value.2 The sales growth variable
(SALEGROWit ) is used in prior research to control for omitted variables (e.g., Skinner,
1996). Specifically, SALEGROW operationalizes other information specified in the
Ohlson (1995) framework, to proxy for future growth potential. This variable is calculated for each firm i over the three years ending in period t.3 With regard to the primary
variables of interest, TDER, TINT and TFX are the notional amounts of trading derivatives
disclosed under SFAS No. 119. In contrast to the control variables in our models, such
notional amounts are not recognized in the financial statements, but may reveal important
information regarding the magnitude and the purpose of a banks derivatives holdings. Thus,
we predict that TDER, TINT and TFX will provide additional explanatory power beyond
book value and earnings (i.e., the coefficients of TDER, TINT and TFX will be significant
after controlling for book value, earnings, and sales growth).
As summarized in Section 2, Riffe (1997) finds that the notional amounts of derivatives are
positively related to bank equity, while Venkatachalam (1996) documents that the notional
amounts are negatively related to bank equity value. If notional amounts serve as a proxy for
the expected future net benefits, then the coefficient is expected to be positive. However, prior
studies (e.g., Venkatachalam, 1996; McAnally 1996; Riffe, 1997) suggest that if the stock
market perceives the notional amounts as a proxy for risk in off-balance sheet instruments,
then the coefficient is expected to be negative. Accordingly, we do not predict the signs of
the TDER, TINT and TFX estimated coefficients . To test the sensitivity of hypothesis 1 to
the inclusion of SFAS No. 133 fair value gains (GAINS) or fair value losses (LOSSES), we
estimate the following two OLS models.
Pit = 0 + 1 E it + 2 BV2it + 3 SALEGROWit + 4 TINTit + 5 TFXit
+ 6 GAINSit + it
Pit = 0 + 1 E it + 2 BV2it + 3 SALEGROWit + 4 TINTit + 5 TFXit
+6 LOSSESit + it

(3)
(4)

While the variables of interest (TINTit and TFXit ), as well as the earnings (Eit ) and SALEGROW variables, are the same as in equations (1) and (2), book value (BV2it ) is calculated
before SFAS No. 133 revaluation gains or losses of trading derivatives for firm i in period
t. Equations (3) and (4) isolate the effect of SFAS No. 133 fair value disclosures of trading
derivatives on stock price, after controlling for the notional amount disclosures as well as
earnings, book value, and sales growth. To the extent that SFAS No. 133 fair value disclosures provide incremental information beyond notional amounts and the three control
variables, we expect that the coefficient of GAINS (LOSSES) will be positive (negative)
and significant.
Moving to hypothesis 2, primary tests pertaining to the value-relevance of non-trading
derivatives in total (NTDER), as well as non-trading interest rate derivatives (NTINT) and
non-trading foreign exchange derivatives (NTFX), employ the following OLS regression
models. The sensitivity of hypothesis 2 to SFAS No. 133 disclosures is considered by incorporating fair value data for assets (NTA) and liabilities (NTL) when non-trading derivative

THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

419

values are positive or negative, respectively.

Pit = 0 + 1 E it + 2 BVit + 3 SALEGROWit + 4 NTDERit + it
(5)
Pit = 0 + 1 E it + 2 BVit + 3 SALEGROWit + 4 NTINTit + 5 NTFXit + it
(6)
Pit = 0 + 1 E it + 2 BV3it + 3 SALEGROWit + 4 NTINTit
+ 5 NTFXit + 6 NTAit + 7 NTLit + it

(7)

These three OLS models parallel the hypothesis 1 tests, except that the variables of interest in hypothesis 2 are non-trading derivatives in total (NTDER), non-trading interest
rate derivatives (NTINT) and foreign exchange derivatives (NTFX). Similar to robustness
checks of hypothesis 1, the equation (7) book value (BV3it ) has been adjusted for nontrading derivative assets (NTA) or non-trading derivative liabilities (NTL). To the extent
that SFAS No. 119 notional value disclosures of non-traded derivatives provide information
regarding the magnitude and purpose of banks derivative holding, we expect the estimated
coefficients on NTDER, NTINT and NTFX to be significant. Similar to our hypothesis 1
tests, the signs of such coefficients are indeterminate (e.g., Venkatachalam, 1996; Riffe,
1997). While our formal hypotheses pertain to notional value disclosures, we take advantage of recently available fair value disclosures under SFAS No. 133. If such fair value
data provide additional explanatory power, the estimated coefficients on NTA (NTL) will
be positive (negative) and significant.
As a final test of robustness, the dependent variable in the above seven equations (stock
price, Pit ) is replaced with firm value deflated by book value. In this way, we respond to
prior studies that caution that tests of fair value information content may be sensitive to
model specification (e.g., Simko, 1999; Mozes, 2002). Given the use of book value as a
deflator, the independent variables in the models below are deflated accordingly. Thus, for
example, equation (1) becomes:
MVit /BVit = 0 1/BVit + 1 Eit /BVit + 2 + 3 SALEGROWit /BVit
+ 4 TDERit /BVit + it

(8)

In this deflated model, market value (MVit ) is defined as stock price times the number
of shares outstanding for firm i at the end of period t. The deflator (BVit ) is the book
value of equity for firm i at the end of period t, where the estimated intercept ( 2 ) can be
interpreted as the estimated coefficient on book value (Core, Guay and Buskirk, 2003). All
other variables are defined as before.
4.

Sample selection and data description

Data related to derivatives in this study come from the Consolidated Reports of Condition
and Income for Banks with Domestic and Foreign Offices (FFIEC 031), filed with the
Federal Financial Institutions Examination Council by state and national banks. These
reports are available from the website of the Chicago Federal Reserve Bank. Other financial

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WANG, ALAM AND MAKAR

Table 2. Descriptive statistics (millions of dollars)

Variable
All tests
TA
MV
BV
E
SALEGROW
Hypothesis 1 variables
TINT
TFX
TCOM
GAINS
LOSSES
Hypothesis 2 variables
NTINT
NTFX
NTCOM
NTA
NTL

Mean

Std. dev.

Minimum

Maximum

3,873
1,002
375
60
754

10,651
3,503
1,054
189
19,064

93
1
5
(326)
(65)

115,149
40,835
9,101
1,766
521,800

1,801
735
0
6
6

18,616
8,409
1
118
113

0
0
0
0
0

345,464
137,193
20
2,647
2,673

3,112
301
1
8
1

0
0
0
0
0

58,724
6,264
20
237
45

417
35
0
0
0

TAit is the total assets of firm i at the end of year t; MVit is stock price multiplied by the number of common
stock shares outstanding for firm i at end of year t; BVit is the book value of firm i at the end of year t; Eit
is the income before extraordinary items of firm i for year t; SALEGROWit is sales growth for firm i over
three years ending in year t; TINTit is the notional amount of trading interest derivatives of firm i for year
t; TFXit is the notional amount of trading foreign exchange derivatives of firm i for year t; TCOMit is the
notional amount of trading commodity derivatives of firm i for year t; Gains and losses are revaluation gains
and losses of trading derivatives of firm i in year t; NTINTit is the notional amount of non-trading interest
derivatives of firm i in year t; NTFXit is the notional amount of non-trading foreign exchange derivatives of
firm i in year t; NTCOMit is the notional amount of non-trading commodity derivatives of firm i in year t;
NTAit is the positive fair values of non-trading derivatives for firm i in year t (reported as assets); and NTLit
is the negative fair values of non-trading derivatives for i in year t (reported as liabilities).

data (stock price, number of shares outstanding, book value, earnings, sales growth and
total assets) are obtained from Standard & Poors Research Insight. The 19942002 sample
period includes the entire SFAS No. 119 reporting period (i.e., 1994 through May 2000)
and the most recent SFAS No. 133 reporting period (i.e., June 2000 through year-end 2002).
The final sample consists of 161 banks and 992 firm-year observations.
Table 2 presents the descriptive statistics of the sample data. The sample data include
both state and national banks, of varying size. For example, total assets range from $93
million to $115 billion, with an average of $3.9 billion. The average notional amount for
trading interest derivatives (TINT) is about $1.8 billion, which is more than twice the
average ($0.7 billion) for foreign exchange derivatives (TFX). In contrast, very few banks
use commodity derivatives (TCOM), indicated by the zero mean amount of this type of
derivatives. Therefore, these derivatives are excluded from our subsequent analyses. The
average revaluation gains (GAINS) and losses (LOSSES) are about the same, both around
$6 million. The revaluation gains and losses are only a small fraction of the notional amount
of the trading derivatives. Such modest levels of fair value gains or losses are consistent

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THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

with prior research findings that derivatives use has a relatively small effect on the total risk
profile of banks (e.g., Hentschel and Kothari, 2001). Banks also recognize gains or losses
as a result of interest rate changes. However, some banks are better able to hedge interest
rate risk by matching maturities of assets and liabilities and/or by matching re-pricing
dates.
The notional amounts for non-trading derivatives are considerably smaller than for trading
derivatives. The average non-trading interest derivatives (NTINT) is $417 million, which
is only about one-fourth of the trading interest derivatives (TINT). The average notional
amount for non-trading foreign exchange derivatives (NTFX) is $35 million, only a fraction
of the trading foreign exchange derivatives (TFX) and much smaller than the non-trading
interest derivatives. Also, very few banks have non-trading commodity derivatives (NTCOM). Similarly, the fair values of the non-trading derivatives are very small, indicated by
the statistics of NTA and NTL. The averages for NTA and NTL are zero, and the maximums are only $237 million and $45 million, respectively. These numbers are only small
fractions of the notional amounts for the non-trading derivative notional amounts, let alone
of total assets and market value. The considerable difference between the fair values of the
non-trading derivatives and their notional amounts, as well as total assets and market value,
is consistent with Guay and Kothari (2003), who report that the effect of derivative use is
modest relative to firm-level measures.
Table 3 reports the Pearson and Spearman correlations for the variables specified in the
models. All variables are deflated by number of shares. The correlation between revaluation
gains and losses (GAINS and LOSSES) is very high. The Pearson and Spearman correlations
are 1.00 and 0.89, respectively. As detailed in Table 1, the top 5 banks hold about 95% of the
derivatives market (in terms of notional values). Moreover, as these banks trade positions
largely with each other, it is not surprising that derivative gains and losses are perfectly
correlated by one measure and highly correlated by another measure.4 Accordingly, we

Table 3. Correlations
PRICE BV
PRICE
BV
0.59
E
0.78
TINT
0.34
TFX
0.25
GAINS
0.13
LOSSES
0.14
NTINT
0.30
NTFX
0.23
NTA
0.10
NTL
0.01
SALEGROW (0.10)

0.62

E
0.64
0.56

0.66
0.05 0.28
(0.01) 0.17
0.08 0.13
0.10 0.14
0.13 0.27
0.06 0.17
0.09 0.10
0.02 0.03
(0.28) (0.23)

TINT TFX
0.35
0.16
0.19
0.51
0.19
0.19
0.68
0.38
0.25
0.12
0.08

0.16
(0.04)
0.05
0.61

GAINS LOSSES NTINT NTFX NTA

0.14
0.09
0.10
0.62
0.29

0.17
0.17 0.89
0.37 0.25
0.65 0.13
0.03 (0.01)
(0.01) 0.09
0.13 (0.13)

0.14
0.08
0.09
0.64
0.30
1.00
0.26
0.13
0.06
0.09
(0.12)

0.32
0.21
0.20
0.40
0.02
0.11
0.11
0.32
0.37
0.20
(0.03)

0.33
0.17
0.18
0.32
0.16
0.33
0.32
0.31

0.08
0.11
0.09
0.04
(0.01)
(0.01)
(0.01)
0.08
(0.01)

NTL

SALEGROW

(0.01)
0.01
0.02
(0.00)
(0.01)
0.02
0.02
0.00
(0.01)
(0.01)

(0.04)
(0.04)
(0.04)
(0.01)
(0.00)
(0.00)
(0.00)
(0.01)
(0.00)
(0.00)
(0.00)

0.03
(0.02) 0.11
0.07
(0.08) (0.06)

Pearson correlations are reported above the diagonal, Spearman correlations are below the diagonal. All variables
are per-share.
PRICE is the closing price of firm i, three months after fiscal year-end period t. All remaining variables are as
defined in Table 2.

422

WANG, ALAM AND MAKAR

include only the GAINS variable in the Section 5 reported results to avoid multicollinearity
problems. The empirical results for the LOSSES variable are footnoted. The dependent and
independent variables in such analyses have been windsorized at both the top and bottom
1% to mitigate the effect of extreme values.
5.

Results

Table 4 presents the OLS regression results pertaining to our primary tests of hypothesis
1, where models 13 correspond to the first three models developed in Section 3.5 OLS
estimates of model 0 are provided for completeness, and are consistent with prior research
indicating that all three Ohlson model variables (BV, E, and SALEGROW) are useful
in estimating firm value. Similarly, the variables of interest (TDER, TINT, and TFX) are
positive and statistically significant (at a.01 level). Consistent with expectations, the notional
amounts of trading derivatives provide incremental information content beyond earnings,
book value, and sales growth. Moreover, these results are robust to the inclusion of SFAS
No. 133 fair value gains (GAINS).6 The magnitude of the estimated coefficients on foreign
exchange derivatives disclosures, in particular (TFX), is notable compared to the estimated
coefficients on either the total trading derivatives (TDER) or the interest rate derivatives
(TINT).
Moving to the non-trading derivatives results, Table 5 details the OLS regression estimates
pertaining to tests of hypothesis 2 in models 57. The estimated coefficients for the Ohlson
model variables (BV, E, and SALEGROW) are comparable to the Table 4 results, and
indicate that all three variables are useful in estimating firm value. Likewise, the variables
Table 4. OLS regressionprimary tests of hypothesis one (Trading Derivatives)
Priceit = a + b Independent Variableit + eit
Independent Variables

MODEL 0
MODEL 1
MODEL 2
MODEL 3

Estimate
P-value
Estimate
P-value
Estimate
P-value
Estimate
P-value

Intercept BV

SALEGROW

2.81984
0.00000
3.25320
0.00000
3.12079
0.00000
3.12304
0.00000

8.76632
0.00000
8.22527
0.00000
8.12397
0.00000
8.11421
0.00000

0.02238
0.00000
0.02173
0.00000
0.02079
0.00000
0.02061
0.00000

0.32210
0.00000
0.31181
0.00000
0.33761
0.00000
0.33847
0.00000

TDER

TINT

TFX

GAINS

ADJ RSQ
0.6394

0.06451
0.00000

0.6616
0.04227
0.00811
0.04618
0.00767

0.86258
0.6698
0.00786
0.87858 (0.68057) 0.6698
0.00707 0.46808

Number of observations = 992.

Tests of hypothesis one, that the notional amounts of trading derivatives are value-relevant, use pooled time-series
cross-sectional OLS estimates of models 03. Models 13 correspond to Section 3 equations (1)(3), while model
0 is provided for completeness. As noted in relation to Table 3, model 4 results are reported in a text footnote.
A statistically significant coefficient on any of the variables of interest (TDER, TINT, or TFX) is consistent with
notional derivative amounts providing incremental information content beyond Ohlson model control variables
(BV, E, and SALEGROW) and SFAS No. 133 fair value gains or losses (GAINS, LOSSES).
See Tables 2 and 3 for variable definitions.
All p-values are based on White (1980) heteroscedastcity corrected t-values and two-tailed tests.

423

THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

Table 5. OLS regressionprimary tests of hypothesis two (Non-trading Derivatives)
Priceit = a + b Independent Variableit + eit
Independent variables

MODEL 5 Estimate
P-value
MODEL 6 Estimate
P-value
MODEL 7 Estimate
P-value

Intercept BV

SALEGROW NTDER NTINT NTFX

3.1785
0.0000
3.4021
0.0000
3.5679
0.0000

8.4845
0.0000
8.2454
0.0000
8.2709
0.0000

0.0218
0.0000
0.0202
0.0000
0.0200
0.0000

0.3060
0.0000
0.3085
0.0000
0.2892
0.0000

0.0634
0.00004

NTA

NTL

ADJ RSQ
0.6466

0.03570
0.07035
0.03540
0.07535

3.36650
0.6573
0.00001
3.37350 2.37710 260.1000 0.6561
0.00001 0.62844
0.16602

Number of observations = 992.

Tests of hypothesis two, that the notional amounts of non-trading derivatives are value-relevant, use pooled timeseries cross-sectional OLS estimates of models 57 which correspond to Section 3 equations (5)(7). A statistically
significant coefficient on any of the variables of interest (NTDER, NTINT, or NTFX) is consistent with notional
derivative amounts providing incremental information content beyond Ohlson model control variables (BV, E,
and SALEGROW) and SFAS No. 133 fair value derivative assets (NTA) or fair value derivative liabilities (NTL).
See Tables 2 and 3 for variable definitions.
All p-values are based on White (1980) heteroscedastcity corrected t-values and two-tailed tests.

of interest (NTDER, NTINT, and NTFX) are positive and statistically significant (NTDER
and NTFX are significant at a.05 level, while NTINT is significant at a.10 level). The
results are consistent with hypothesis 2. The model 5 results, for example, indicate that the
notional value of total non-traded derivatives (NTDER) provides incremental information
content beyond book value, earnings, and sales growth. Similarly, the notional values of both
non-traded interest rate derivatives (NTINT) and non-traded foreign exchange derivatives
(NTFX) in model 6 are value-relevant. Finally, the model 7 estimation results indicate that
these results are robust to the inclusion of SFAS No. 133 fair value derivative assets (NTA)
or liabilities (NTL).
The absence of value-relevance evidence for the asset (NTA) and liability (NTL) variables
in model 7 may be due, in part, to their economic insignificance, as discussed in relation to
our Table 2 descriptive statistics. More generally, the statistical insignificance of the SFAS
No. 133 variables in both Tables 4 and 5 is consistent with recent research, which cautions
that such fair value data may not be reliable for banks (e.g., Nissim, 2003). Similarly,
recent studies of SFAS No. 133 disclosures note that compliance has been mixed (Jones
and Wei, 2004), and conclude that the standards desired level of financial transparency on
the use of derivative financial instruments is not being adequately achieved (Bhamornsiri
and Schroeder, 2004, p. 680).
In summary, our primary results indicate that the notional principal amounts of both
trading derivatives (hypothesis 1) and non-trading derivatives (hypothesis 2) are useful in
explaining variations in bank firm values. These primary tests take advantage of the complete
time-series of disaggregated data under SFAS No. 119 and the rigorous specification of the
Ohlson model framework, for a sample of 166 state and national banks of varying size.
Moreover, evidence is provided that such support for hypotheses 1 and 2 is not sensitive
to the inclusion of SFAS No. 133 fair value data. Our findings are consistent with prior
studies such as Riffe (1997) and Venkatachlam (1996), both of whom conclude that the

424

WANG, ALAM AND MAKAR

notional amounts of derivatives contain value-relevant information for their sample of 242
banks and 99 banks, respectively. In contrast, Seow and Tam (2002) do not find notional
amounts significant in the return models for their sample of 35 NYSE traded banks. We
conjecture that such inconsistency could be due to their relatively small sample of top banks,
the specification of the reporting variable (square root of notional amounts) or the model
specification.
As an additional robustness check, the dependent variable in the above primary analyses
(stock price) is replaced with market value deflated by book value. Tables 6 and 7 detail the

Table 6. OLS regressionadditional tests of hypothesis one (Trading Derivatives)

MVit = a + b Independent Variableit + eit
Independent variables

MODEL 1a Estimate
P-value
MODEL 2a Estimate
P-value
MODEL 3a Estimate
P-value

Intercept C

SALEGROW TDER

0.93414
0.00000
0.97213
0.00000
0.97513
0.00000

6.80836
0.00000
6.64460
0.00000
6.62578
0.00000

0.00245
0.00000
0.00232
0.00000
0.00228
0.00000

(3.04454)
0.00341
(3.38888)
0.00102
(3.40272)
0.00094

TINT

TFX

GAINS

0.12614
0.00000

ADJ RSQ
0.424

0.06310
0.02586
0.06812
0.01760

0.62588
0.4445
0.00002
0.66499 (1.86786) 0.4452
0.00002 0.23559

Number of observations = 992.

Additional tests of hypothesis one use pooled time-series cross-sectional OLS estimates of models 1a3a, which
parallel models 13 in Table 4. The dependent variable in Table 4 primary analysis is replaced with firm value
deflated by book value in Table 6.
Market value (MV) is price multiplied by the number of shares outstanding for firm i at end of year t, and is
deflated by book value of equity of firm i at the end of year t (BV); and the intercept (C) is 1/BV. All other
variables are as defined in Table 2 except that they are deflated by BV in this table.
All p-values are based on White (1980) heteroscedastcity corrected t-values and two-tailed tests.
Table 7. OLS regressionadditional tests of hypothesis two (Non-trading derivatives)
MVit = a + b Independent Variableit + eit
Independent Variables

MODEL 5a Estimate
P-value
MODEL 6a Estimate
P-value
MODEL 7a Estimate
P-value

Intercept C

SALEGROW NTDER NTINT NTFX NTA

0.9492
0.0000
0.9948
0.0000
1.0008
0.0000

7.0451
0.0000
6.6113
0.0000
6.6107
0.0000

0.0025
0.0000
0.0022
0.0000
0.0022
0.0000

(3.6728)
0.0005
(3.6224)
0.0004
(3.6841)
0.0003

0.1207
0.0014

NTL

ADJ RSQ
0.3957

0.0474
0.2418
0.0515
0.2107

5.0751
0.4338
0.0000
5.0358 (8.8354) (345.5000) 0.4335
0.0000 0.2486
0.0417

Number of observations = 992.

Additional tests of hypothesis two use pooled time-series cross-sectional OLS estimates of models 5a7a, which
parallel models 57 in Table 5. The dependent variable in Table 5 primary analysis is replaced with firm value
deflated by book value in Table 7.
Market value (MV) is price multiplied by the number of shares outstanding for firm i at end of year t, and is
deflated by book value of equity of firm i at the end of year t (BV); and intercept (C) is 1/BV. All other variables
are as defined in Table 2, except that they are deflated by BV in this table.
All p-values are based on White (1980) heteroscedastcity corrected t-values and two-tailed tests.

THE VALUE-RELEVANCE OF DERIVATIVE DISCLOSURES

425

OLS regression results pertaining to these additional tests of hypotheses 1 and 2, respectively. The results are similar to the primary evidence presented in Tables 4 and 5. Thus, we
conclude that the primary results are robust to alternative model specifications.
6.

Summary and suggestions for future research

This study investigates the value-relevance of banks expanded derivative disclosures under
SFAS Nos. 119 and 133. In light of the existing literature gap on the information content
of derivatives reporting (Seow and Tam, 2002), we focus our analysis on notional principal
amounts. By incorporating a complete time-series of disaggregated SFAS No. 119 notional
value data, we are able to construct more powerful tests than were possible prior to this standard. Using the rigorous specification of the Ohlson (1995) firm valuation framework, our
results suggest that notional principal amounts of derivatives are economically significant
and provide incremental information content beyond earnings and book value. Moreover,
such results are robust to the inclusion of recently available SFAS No. 133 fair value data
as well as to alternative model specifications.
There are a number of limitations to this study. First, only two years of SFAS No. 133
fair value data were available, which might have reduced the power of the tests. Second,
the study is limited to commercial banks. While our primary objective is to contribute
to the empirical evidence of notional value information content for banks, the statistically
insignificant results for our samples SFAS No. 133 fair value data are consistent with recent
concerns regarding the complexity of this recent standard (e.g., Bhamornsiri and Schroeder,
2004) and, in particular, the reliability of banks fair value disclosures (e.g., Nissim, 2003).
Future research can expand the scope of this study beyond banks, and take advantage of
additional SFAS No. 133 data as it becomes available. Finally, the primary tests rely on the
assumptions that underlie the modified Ohlson (1995) model. Future research can subject
such assumptions to theoretical examination.
Notes
1. Value-relevance, measured in terms of stock prices, refers to increases in firm value resulting from added
disclosure by firms.
2. Dechow, Hutton and Sloan (1999) find that short-term forecasts of earnings contain value-relevant information,
in empirical tests of Ohlsons (1995) valuation model. However, because forecasts of earnings are a potentially
biased measure (see, e.g., Abarbanell and Bernard, 1992; McNichols and OBrien, 1997; Das, Levine and
Sivaramakrishnan, 1998), we do not include earnings forecasts in our valuation models.
3. SALEGROW is calculated as ((SALE/SALE[3])1) 100. Per Research Insights definition of item A12 for
banks, SALE . . . . . . 11. . . includes total current operating revenue and net pretax profit or loss on securities
sold or redeemed.
4. We thank an anonymous reviewer for drawing our attention to this trading behavior and its implications for
analyses of SFAS No. 133 fair value gains and losses.
5. As noted in relation to the Table 3 descriptive statistics, model 4 results for the LOSSES variable are footnoted.
With regard to model assessment issues, diagnostics used to assess OLS error-term assumptions include the
Durbin-Watson test for autocorrelation, the White (1980) test for heteroscadasticity, and variance inflation
factors to determine the linear independence among the explanatory variables. In total, the model diagnostics
suggest that the OLS assumptions have been met.

426

WANG, ALAM AND MAKAR

6. The OLS estimated coefficients for the variables of interest (TINT and TFX) remain positive and statistically
significant (at a.01 level), while the LOSSES variable is not significant ( p-value of 0.2333), after the White
(1980) adjustment for heteroscadasticity.

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