Risk Measurement and Disclosure, Measurement Issues in Accounting, Options and other Financial Instruments, Organizational Form, Financial Institutions
Academic Degrees
PhD, Graduate School of Business, University of Texas, 2001
MBA/M.Acc., University of New Mexico, 1988
BBA, University of New Mexico, 1984
Professional Experience
Indiana University (2003-present), Associate Professor, Tenured 2008
Stanford University (2001-2003), Assistant Professor
Selected Publications
Cheng, M., Hodder, L. D. and Watkins, J. C. (2021). Usefulness of Interest Income Sensitivity Disclosures. The Accounting Review, 96(1), 117–146.
Abstract
We document multiple dimensions of usefulness of banks' interest income sensitivity disclosures. First, we find management-generated sensitivity measures are predictive of future realized changes in net interest income. Second, we find financial analysts' forecasts of net interest income reflect information provided by interest income sensitivity disclosures. Third, we find equity market responses to interest rate shocks as well as firms' interest rate betas are larger for banks with greater disclosed sensitivity of net interest income to interest rate changes. Across all of these tests, the informativeness of income sensitivity measures is incremental to that of regulatory data. These results suggest that interest income sensitivity disclosures are informative measures of interest rate risk. Our results contradict assertions that these disclosures are useless due to lack of relevance of income sensitivity, poor modeling techniques, and/or redundancy relative to regulatory data.
Anderson, S., Brown, J. L., Hodder, L., and Hopkins, P. E. (2015). The Effect of Alternative Accounting Measurement Bases on Financial Statement Users’ Resource Allocation Decisions and Assessments of Managers’ Stewardship. Accounting, Organizations and Society, 46(1), 100-114.
Hodder, L. D., and Hopkins, P. E. (2014). Agency Problems, Accounting Slack and Banks’ Response to Proposed Reporting of Loan Fair Values. Accounting, Organizations and Society, 39(1), 117–133.
Abstract
We investigate the determinants of bank representatives’ responses to the United States Financial Accounting Standard Board’s 2010 Exposure Draft that proposes fair value measurement for most financial instruments. Over 85 percent of the 2,971 comment letters were received from bank representatives, with most bank-affiliated letters addressing—and opposing—one issue: fair value measurement of loans. The Exposure Draft proposes that companies report both fair value and amortized cost measures for loans; thus, the proposal should result in increased levels of loan-related information and improved financial reporting transparency. We investigate three reasons for bank representatives’ resistance. First, fair value measurement should result in less accounting slack than the current incurred-loss model for loan impairments; therefore, we propose that representatives from banks that historically utilized that slack will resist fair value measurement for loans. Second, we propose that agency problems are an important motivating factor because bank representatives reaping more private benefits from their franchises have less incentive to support increases in financial reporting transparency. Third, we test whether the most common reasons for opposition included in the comment letters are associated with negative letter writing. Our analyses support the first two determinants of bank representatives’ resistance to the Exposure Draft. Specifically, accounting slack and lower demand for accounting transparency are strongly associated with resistance to the standard. However, we find that stated reasons for resistance are not associated with letter writing. Specifically, representatives at firms with difficult to value loans and firms that mostly hold loans to maturity are no more likely to resist the standard than others. The narrow scope of bank representatives’ comments and our empirical findings suggest that bankers’ responses to the Exposure Draft may be more driven by concerns over reduced availability of accounting slack and accompanying de facto regulatory forbearance than by the conceptual arguments they offer. Our results have implications for standard setters, who must navigate special interests as they attempt to promulgate high quality accounting standards, and for users of financial statements who must consider how political forces shape generally accepted accounting principles.
Hodder, L., Hopkins, P. E., and Schipper, K. (2014). Fair Value Measurement in Financial Reporting. Foundations and Trends in Accounting, 8(3-4), 143-270.
Evans, M., Hodder, L., and Hopkins, P. E. (2014). The Predictive Ability of Fair Values for Future Financial Performance of Commercial Banks and the Relation of Predictive Ability to Banks’ Share Prices. Contemporary Accounting Research,31(1), 13-44.
Abstract
The conceptual frameworks of International Accounting Standards Board (2010, QC7-QC8) and Financial Accounting Standards Board (2010b, QC7-QC8) both include predictive value as a fundamental qualitative characteristic of useful financial information. Because changes in fair value are unpredictable—that is, one period’s fair value gains (losses) cannot predict future periods’ fair value gains (losses)—fair value is criticized as diminishing the predictive ability (and, therefore, the usefulness) of financial information. We propose that the time-series relationship of fair value gains (losses) is an overly restrictive way to define predictive ability, and completely ignores the forward looking information that is impounded in fair value measures. Specifically, the fair values of interest-bearing financial instruments capture the opportunity costs and benefits of holding below- and above-market instruments. Thus, we propose that the relative levels of unrealized holding gains (losses) should predict relative levels of future realized gains (losses) and interest income across firms (hereafter, “cross-sectional predictive ability of fair values for future reported income”). Because of the significance of financial instruments to commercial banks’ balance sheets and the availability of detailed fair value information for these instruments in banks’ regulatory reports, we test our predictions for a sample of commercial banks during 1994-2008. Consistent with our predictions, we find that accumulated fair value adjustments for interest-bearing securities are positively cross-sectionally associated with future interest income, future total realized investment holding returns, and future investment-security-related cash flows. Additional analyses reveal that the cross-sectional predictive ability of fair values for future reported income is positively related to the measurement precision of reported fair value measurements. Finally, we show that cross-sectional predictive ability of fair values for future reported income is positively associated with the value relevance of reported fair value measurements. Overall, our results suggest that fair values have predictive ability despite the low persistence of fair value changes. Cross-sectional predictive ability of fair values for future reported income is an important dimension of financial-information usefulness that standard setters and researchers may wish to consider in evaluating fair value as a measurement basis.
Barth, M., Hodder, L., and Stubben, S. (2013), Financial reporting for employee stock options: Liabilities or equity? Review of Accounting Studies, 18(3), 642-682.
Hodder, L., Hopkins, P. E., and Wood, D. (2008). The Effects of Financial Statement and Informational Complexity on Analysts' Cash Flow Forecasts. The Accounting Review, 83(4), 915-956.
Abstract
We characterize the operating-activities section of the indirect-approach statement of cash flows as backwards because it presents reconciling adjustments in a way that is opposite from the intuitively appealing, future-oriented, Conceptual Framework definitions of assets, liabilities and the accruals process. We propose that the reversed-accruals orientation required in the currently mandated indirect-approach statement of cash flows is unnecessarily complex, causing information-processing problems that result in increased cash-flow forecast error and dispersion. We also predict that the mixed pattern (i.e., +/–, –/+) of operating cash flows and operating accruals reported by most companies impedes investors’ ability to learn the time-series properties of cash flows and accruals. We conduct a carefully controlled experiment and find that (1) cash-flow forecasts have lower forecast error and dispersion when the indirect-approach statement of cash flows starts with operating cash flows and adds changes in accruals to arrive at net income and (2) cash-flow forecasts have lower forecast error and dispersion when the cash flows and accruals are of the same sign (i.e., +/+,–/–); with the sign-based difference attenuated in the forward-oriented statement of cash flows. We also conduct a quasi-experiment to test our mixed-sign versus same-sign hypotheses using archival samples of publicly available I/B/E/S and Value Line cash-flow forecasts. We find that the passively observed samples of cash-flow forecasts exhibit a similar pattern of mixed-sign versus same-sign forecast error as documented in our experiment.
Beneish, M. D., Billings, M. B., and Hodder, L. (2008). Internal Control Weaknesses and Information Uncertainty. The Accounting Review, 83(3), 665-703.
Abstract
We analyze a sample of 330 firms making unaudited disclosures required by Section 302 and 383 firms making audited disclosures required by Section 404 of the Sarbanes-Oxley Act. We find that Section 302 disclosures are associated with negative announcement abnormal returns of -1.8 percent, and that firms experience an abnormal increase in equity cost of capital of 68 basis points. We conclude that Section 302 disclosures are informative and point to lower credibility of disclosing firms' financial reporting. In contrast, we find that Section 404 disclosures have no noticeable impact on stock prices or firms' cost of capital. Further, we find that auditor quality attenuates the negative response to Section 302 disclosures and that accelerated filers - larger firms required to file under Section 404 - have significantly less negative returns (-1.10 percent) than non-accelerated filers (-4.22 percent). The findings have implications for the debate about whether to implement a scaled securities regulation system for smaller public companies: material weakness disclosures are more informative for smaller firms that likely have higher pre-disclosure information uncertainty.
Barth, M., Hodder, L. and Stubben, S. (2008). Fair Value Accounting for Liabilities and Own Credit Risk. The AccountingReview,83(3), 629-664.
Abstract
We find that equity returns associated with credit risk changes are attenuated by the debt value effect of the credit risk changes, as Merton (1974) predicts. We find that the relation between credit risk changes and equity returns is significantly less negative for firms with more debt-controlling for asset value changes, credit risk increases (decreases) are associated with equity value increases (decreases). This result obtains across credit risk levels. The relation is associated with changes in both expected cash flows and systematic risk, as reflected in analyst earnings forecasts and equity cost of capital. By inverting the Merton (1974) model, we provide descriptive evidence that if unrecognized debt value changes were recognized in income, but not unrecognized asset value changes, most credit upgrade (downgrade) firms would recognize lower (higher) income. These potentially counterintuitive income effects primarily are attributable to incomplete recognition of contemporaneous asset value changes. However, for a substantial majority of downgrade firms we find that recognized asset write-downs exceed unrecognized gains from debt value decreases. This mitigates concerns that income effects from recognizing changes in debt values would be anomalous for such firms.
Hodder, L., Hopkins, P. E., and Wahlen, J. (2006). Risk‐Relevance of Fair‐Value Income Measures for Commercial Banks. The Accounting Review, 81(2), 337-375.
Abstract
We investigate the risk relevance of the standard deviation of three performance measures: net income, comprehensive income, and a constructed measure of full-fair-value income for a sample of 202 U.S. commercial banks from 1996 to 2004. We find that, for the average sample bank, the volatility of full-fair-value income is more than three times that of comprehensive income and more than five times that of net income. We find that the incremental volatility in full-fair-value income (beyond the volatility of net income and comprehensive income) is positively related to market-model beta, the standard deviation in stock returns, and long-term interest rate beta. Further, we predict and find that the incremental volatility in full-fair-value income (1) negatively moderates the relation between abnormal earnings and banks' share prices and (2) positively affects the expected return implicit in bank share prices. Our findings suggest full-fair-value income volatility reflects elements of risk that are not captured by volatility in net income or comprehensive income, and relates more closely to capital-market pricing of that risk than either net-income volatility or comprehensive-income volatility.
Hodder, L., Mayew, W., McAnally, M. and Weaver, C. (2006). Employee stock option fair-value estimates: Do managerial discretion and incentives explain accuracy? Contemporary Accounting Research, 23(4), 933-975.
Abstract
We examine the determinants of managers' use of discretion over employee stock option (ESO) valuation-model inputs that determine ESO fair values. We also explore the consequences of such discretion. Firms exercise considerable discretion over all model inputs and this discretion results in material differences in ESO fair-value estimates. Contrary to conventional wisdom, we find that a large proportion of firms exercise value-increasing discretion. Importantly, we find that the use of discretion improves predictive accuracy for about half of our sample firms. Moreover, we find that both opportunistic and informational managerial incentives together explain the accuracy firms' ESO fair value estimates. Partitioning on direction of discretion improves our understanding of managerial incentives. Our analysis identifies that financial statement readers can use mandated contextual disclosures to construct powerful ex ante predictions of ex post accuracy.
Hodder, L., McAnally, M., and Weaver, C. (2003). The Influence of Tax and Nontax Factors on Banks’ Choice of organizational Form. The Accounting Review, 78(1), 297-325.
Abstract
This paper identifies tax and non-tax factors that influence commercial banks conversion from taxable C-corporation to nontaxable S-corporation from 1997 to 1999. A 1996 tax-law change allowed banks to elect S-corporation status for the first time. We find that banks are more likely to convert when conversion saves dividend taxes, avoids alternative minimum taxes, and minimizes state income taxes. As well, banks are less likely to convert when conversion restricts access to equity capital, nullifies corporate tax loss carryforwards, and creates potential penalty taxes on unrealized gains existing at the conversion date. Moreover banks that would be required to write-off large deferred tax assets are less likely to convert because conversion decreases regulatory capital and exposes the bank to costly regulatory intervention. We also investigate the strategic choices banks made in anticipation of an S-election. We conclude that converting banks made anticipatory changes to their capital structure, deliberately sold appreciated assets, and strategically cut dividends to augment the net benefits from a planned election.
Hodder, L., Kohlbeck, M., and McAnally, M. (2002). Accounting Choices and Risk Management: SFAS 115 and U.S. Bank Holding Companies. Contemporary Accounting Research, 19(2), 225-270.
Abstract
This paper provides evidence that regulatory contracts affect firms' accounting choices and risk management decisions. Specifically, we investigate whether an exogenous shock to regulatory risk induced by Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities," (SFAS 115) encouraged U.S. banks to deviate from portfolio and risk benchmarks when they adopted the standard. Because we cannot observe relevant benchmarks, we model portfolio and risk decisions as functions of macroeconomic and firm-specific factors using data from a period when regulatory capital was immune to SFAS 115 accounting. We examine a sample of 230 publicly-traded banks and find that 1) irrespective of adoption timing, banks classified too few securities as AFS relative to estimated benchmarks, 2) weaker banks that adopted the standard early classified far more securities as AFS relative to benchmarks, 3) banks altered the size of their securities portfolios along with the levels of interest risk and credit risk as regulatory capital decreased, and 4) the level of interest risk on banks' loan portfolios increased at the time of SFAS 115 adoption. We also explore the 1995 FASB amnesty when firms could "re-adopt" SFAS 115. We find that banks used the 1995 FASB amnesty to undo strategic initial SFAS 115 adoption decisions. Taken together, our findings suggest that SFAS 115 caused some of the accounting and economic consequences predicted by bankers, analysts, and academics.
Hodder, L., Koonce, L., and McAnally, M. (2001). SEC market risk disclosures: Implications for judgment and decision making. Accounting Horizons, 15(1), 49-70.
Abstract
In this paper, we draw on judgment and decision making research to examine the behavioral implications of the SEC's Financial Reporting Release No. 48 on market risk disclosures. While these disclosures have been examined using archival data, no research has investigated how these disclosures might affect individual users of financial statements. The purpose of our paper is to draw on research in the judgment and decision making arena to identify and analyze the behavioral implications of the new risk disclosures. We offer three conclusions. First, FRR48 users may have more complex evaluations of risk than perhaps anticipated by the SEC. Second, the flexibility accorded firms in FRR48 will adversely affect users' risk judgments. Third, because the Release does not require disclosure of certain quantitative information that is important to risk assessments, inappropriate risk assessments may result. We believe our insights can help others conduct research in this important area and can help the SEC when they revisit the disclosure requirements in Release No. 48.
Hodder, L., and McAnally, M. (2001). SEC market risk disclosures: Enhancing comparability. Financial Analysts Journal, 57(2), 62-78.
Abstract
In 1997, the U.S. SEC mandated through Financial Reporting Release 48 (FRR48) the disclosure of forward-looking market risk information. Because of the recency of the required risk disclosures, little has been written about them or about how analysts might use them. FRR48 allows three disclosure formats: sensitivity measures, value at risk, and a tabular format. The issue is that variations among the disclosure formats and the discretion allowed about assumptions underlying sensitivity and VAR measures may impair analysts' use of the disclosures. We demonstrate how sensitivity and VAR measures can be derived from the tabular format. Our methodology allows financial analysts to derive risk measures based on consistent assumptions among companies. Tabular data provide a common denominator by which companies may be compared and provide a means of overcoming the limitations of sensitivity and VAR measures.
