Does fair value accounting for non-financial assets pass the market test?

The choice between fair value and historical cost accounting is the subject of long-standing controversy among accounting academics and regulators. Nevertheless, the market-based evidence on this subject is limited. We study the choice of fair value versus historical cost accounting for non-financial assets in a setting where market forces rather than regulators determine the outcome. In general, we find a very limited use of fair value accounting. However, the observed variation is consistent with market forces determining the choice. Fair value accounting is used when reliable fair value estimates are available at a lower cost and when they convey information about operating performance. For example, with very few exceptions, firms’ managers commit to historical cost accounting for plant and equipment. Our findings contribute to the policy debate by documenting the market solution to one of the central questions in the accounting literature. Our findings indicate that, despite its conceptual merits, fair value is unlikely to become the primary valuation method for illiquid non-financial assets on a voluntary basis.     

Voluntary fair value disclosures beyond SFAS 157’s three-level estimates

Some firms voluntarily make disclosures about the controls and processes in place to ensure the reliability of fair value estimates. Consistent with these disclosures being driven by investors’ concerns about the reliability of their SFAS 157 estimates, we find that firms with more opaque estimates are more likely to provide such disclosures. We then examine whether these disclosures improve investors’ perception about the reliability of fair value estimates. We find that they are associated with higher market pricing and lower information risk for Level 3 estimates. Further analyses of the disclosures reveal that the following types of information are particularly important to investors: discussion of the external and independent pricing of fair value estimates and their proper classification according to the SFAS 157 hierarchy. Overall, our results suggest that the voluntary reliability disclosures that firms provide beyond SFAS 157’s three-level estimates help reduce investors’ uncertainty toward the more opaque fair value estimates.     

‘Deprival value’ vs. ‘fair value’ measurement for contract liabilities: how to resolve the ‘revenue recognition’ conundrum?

Revenue recognition and measurement principles can conflict with liability recognition and measurement principles. We explore here under different market conditions when the two measurement approaches coincide and when they conflict. We show that where entities expect to earn ‘super profits’ (residual income) the conceptual conflict is exacerbated by the adoption of ‘fair value’ (FV) as the measurement basis for assets and liabilities rather than the more theoretically grounded approach of ‘deprival value/relief value’ (DV/RV) which better reflects the impact of, and rational management response to, varying market conditions. However, while the problems of balance sheet liability and revenue recognition, and the related problems of income statement presentation, can be resolved by the application of DV/RV reasoning, this is not sufficient fully to resolve issues of the appropriate timing of profit recognition. Performance measurement issues still need to be addressed directly. The standard setters' current projects on ‘revenue recognition’, ‘insurance contracts’ and ‘measurement’ therefore need broadening to consider the pervasive issue of accounting for internally generated intangibles.     

Does fair value accounting contribute to market price volatility? An experimental approach

This paper contributes to the debate on the impact of accounting measurement rules for financial assets. We examine the association between fair value accounting for financial assets and market price volatility for nonfinancial firms in an experimental setting. One group of participants was provided with financial statements where held‐for‐trading securities were reported at fair market value (FVA). Another group received financial statements with investments reported at historical cost (HCA). Controlling for accounting data, we find no systematic difference between FVA and HCA for three different measures of market price volatility, despite higher earnings volatility and marginally heavier trading under FVA.     

New development: The conundrum of fair value measurement—evidence from the UK FRAB

This article is based on documentation from the UK Financial Reporting Advisory Board (FRAB) relating to the adoption of IFRS 13 Fair Value Measurement. It shows that the development of financial reporting in government involves continuous adaption to new and updated international standards and changing circumstances. Outcomes are influenced by path dependencies and the taking of particular conceptual positions.     

Multidimensional principal–agent value for money in healthcare project financing

Value for money (VfM) is a key parameter for the public sector in the choice between a public–private partnership (PPP) and traditional procurement, especially for healthcare infrastructure. This paper investigates the differences in what VfM means to the public and private sectors.     

Discussion of “The financial reporting of fair value based on managerial inputs versus market inputs: evidence from mortgage servicing rights”

Contrary to the guidance provided by regulators and industry associations suggesting that mortgage servicing rights (MSRs) be recorded as Level 3 assets, Altamuro and Zhang identify that 25 % of banks classify them as Level 2 assets. This variation in the asset classification of a single asset type provides a unique setting to examine the role of inputs in the fair value measurement process. Altamuro and Zhang find that the fair value of MSRs based on managerial inputs (Level 3) better reflects the economics of the underlying assets than the fair value of MSRs based on market inputs (Level 2). This discussion examines the institutional features of the MSR market, particularly the market concentration and the illiquidity of the market, that are important when considering this result. The discussion also raises a number of questions about the inputs used in the fair value process and calls for further research on this topic.     

Predicting premiums for the market, size, value, and momentum factors

This paper investigates the out-of-sample predictability of monthly market as well as size, value, and momentum premiums. We use a sample from each of the US and the Swiss stock markets between 1989 and 2007. Using the Swiss sample provides an important new perspective as the repeated evaluation of the same (US) data set leads to data mining problems. To avoid data mining in our predictability study, we test both statistical significance and robustness in the two samples. Our key results are as follows. We find no robust indication that the market premium is predictable, which is also true for the momentum and value premiums. It cannot be excluded that the results from the US may be caused by data mining in light of the results from the Swiss sample. However, the size premium seems to be somewhat predictable, due to the credit spread. We theorize that there are three possible reasons for this rare evidence for predictability. First, predictability may have disappeared over the last decade, as academic research made the respective information public. Second, predictability seems, as we demonstrate, not to be robust to the choice of methodology. Third, robustness tests in the Swiss sample reveal that many of the supposedly statistically significant interrelations from the US sample may be attributed to randomness, which, in that case, would be data mining. Therefore, we think that future discussions of predictability should address the issue of data mining by applying robustness tests.

Usefulness of fair values for predicting banks’ future earnings: evidence from other comprehensive income and its components

This paper examines whether fair value adjustments included in other comprehensive income (OCI) predict future bank performance. It also examines whether the reliability of these estimates affects their predictive value. Using a sample of bank holding companies, we find that fair value adjustments included in OCI can predict earnings both 1 and 2 years ahead. However, not all fair value-related unrealized gains and losses included in OCI have similar implications. While net unrealized gains and losses on available-for-sale securities are positively associated with future earnings, net unrealized gains and losses on derivative contracts classified as cash flow hedges are negatively associated with future earnings. We also find that reliable measurement of fair values enhances predictive value. Finally, we show that fair value adjustments recorded in OCI during the 2007–2009 financial crisis predicted future profitability, contradicting criticism that fair value accounting forced banks to record excessive downward adjustments.     

Do investors value smooth performance?

This paper presents empirical evidence that cash-flow volatility is negatively valued by investors. The magnitude of the effect is substantial with a 1% increase in cash-flow volatility, resulting in approximately a 0.15% decrease in firm value. We show that this increase, however, is not associated with earnings smoothing resulting from managers’ accrual estimates. Our results are consistent with a preference by the market for less volatile cash flows and suggest that managers’ efforts to produce smooth financial statements add value, but only via the cash component of earnings.     

Is value creation consistent with currency hedging?

This paper analyzes value creation through currency hedging in the Spanish market. The results show that the hedging with derivatives generated an average premium of 1.53% and that foreign currency debt generated 7.52%, with respect to company value approximated by Tobin's Q, while operational hedging does not affect company value. Moreover, in half of the observations corresponding to companies that hedged with derivatives, the value premium was between 0.08% and 0.99%. In the case of foreign currency debt, the range was between 1.79% and 10.37%. It demonstrates that the contribution of currency hedging to company value fluctuates considerable according to the volume of financial hedging. Thus, an empirical study of this aspect which only analyses the decision to hedge through dummy variables to define financial hedging, as empirical previous studies, can lead to biased results in terms of estimated premium amounts, because it assumes a homogenous treatment of companies regardless of hedging volumes.     

Do Chinese government subsidies affect firm value?

Consistent with the prevailing socio-political ideology of China, the Chinese government offers financial assistance to firms, including many listed companies. Government subsidies are provided for several reasons including support for investment, support to enable firms to pursue social objectives, and support to prop up ailing firms in order to protect jobs.     

Portfolio diversification and value at risk under thick-tailedness†

This paper focuses on the study of portfolio diversification and value at risk analysis under heavy-tailedness. We use a notion of diversification based on majorization theory that will be explained in the text. The paper shows that the stylized fact that portfolio diversification is preferable is reversed for extremely heavy-tailed risks or returns. However, the stylized facts on diversification are robust to heavy-tailedness of risks or returns as long as their distributions are moderately heavy-tailed. Extensions of the results to the case of dependence, including convolutions of α-symmetric distributions and models with common shocks are provided.     

The real value of China’s stock market

What capital allocation role can China’s stock market play? Counter to perception, stock prices in China have become as informative about future profits as they are in the US. This rise in stock price informativeness has coincided with an increase in investment efficiency among privately owned firms, suggesting the market is aggregating information and providing useful signals to managers. However, price informativeness and investment efficiency for state-owned enterprises fell below that of privately owned firms after the postcrisis stimulus, perhaps reflecting unpredictable subsidies and state-directed investment policy. Finally, evidence from realized returns suggests Chinese firms face a higher cost of equity capital than US firms.     

Do spin-offs really create value? The European case

We study wealth effects for a sample of 156 spin-offs from 15 different European countries that were announced between January 1987 and September 2000. The cumulative average abnormal return over the 3-day event window is 2.62%. This number increases to 2.66% for the subsequently completed spin-offs. The cumulative average abnormal return is 3.57% for completed spin-offs by companies that increase their industrial focus and only 0.76% for non-focus increasing companies. The difference between these two sub-samples is significantly different from zero. These results are in line with previous studies for the US. The long-run returns in excess of matching firms are mostly insignificant for parents, subsidiaries and pro-forma combined firms. This result suggests that, unlike US spin-offs, European spin-offs are not associated with long-run superior performance.     

Does corporate diversification reduce value in high technology firms?

We find that firm value is reduced via industrial diversification and this reduction in value depends upon a firm’s technology intensity. We consider that asymmetric information problems are more severe in technology intensive industries and find that high tech industry firms present distinctly larger value reduction when compared to low tech industry firms. The negative valuation effect is greater for firms that have a relatively larger amount of intangible assets and greater R&D capital. We determine that our findings are robust to different estimation methods and alternative excess value measures.     

Distracted directors: Does board busyness hurt shareholder value?

We use the deaths of directors and chief executive officers as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The loss of such key co-employees is an attention shock because it increases the board committee workload only for some interlocked directors—the ‘treatment group’. There is a negative stock market reaction to attention shocks only for treated director-interlocked firms. Interlocking directors? busyness, the importance of their board roles, and their degree of independence magnify the treatment effect. Overall, directors? busyness is detrimental to board monitoring quality and shareholder value.     

Net value created: measuring a non-life insurer’s performance

The measure Net Value Created (NVC) captures periodic deviations of planned for and realized net present values at a specific reporting date. Therefore, NVC provides control-related signals about the company’s performance additional to economic value added/residual income measures. In this paper we adopt the NVC to the Flow to Equity approach, commonly used in non-life insurance company valuation. In a multi-period context the NVC allows for an update of information over time regarding planned for and realized values and, it further allows for a separation of value contributions of the main insurer’s business units and value contributions due to a change in cost of capital. Thus, NVC is useful for value-based performance measurement in the retrospect and for strategic (investment-) decision support in the prospect for non-life insurance companies.     

Towards a fair degrowth-society: Justice and the right to a ‘good life’ beyond growth

A critical scrutiny is presented of the ethical assumptions of growth and degrowth theories with respect to distributive justice and the normative conditions for a ‘good human life’. An argument is made in favor of Sen's and Nussbaum's ‘capabilities approach’ as the most suitable theoretical framework for addressing these questions. Since industrialization economic growth has played a key-role as an attraction pole, around which issues of social justice, political stability, and welfare protection seemed to gravitate. Accordingly, it is considered as a necessary condition for both intragenerational and intragenerational justice. These assumptions have been subjected to substantial critique by degrowth-thinkers, according to which economic growth is rather a threat than a condition for intragenerational and intergenerational justice. However, a theoretical underpinning of these assumptions is missing so far. In the paper I analyze the ethical and moral assumptions in both approaches by focusing on the theories of justice that are implicitly laid down as a background for their arguments (welfarism, resourcism, and the capabilities-approach). In a detailed analysis of the main critical points formulated by degrowth advocates I take the capabilities approach perspective and show why it can offer a more adequate normative underpinning for the conceptualization of a degrowth society.