Accounting Choices and Risk Management: SFAS No. 115 and U.S. Bank Holding Companies*

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.