Skip to main content

The Effect of Fair Value Method Adoption: Evidence from Real Estate Firms in the EU

Abstract

The adoption of the International Accounting Standard 40 (IAS 40) in 2005 by public companies in the European Union required firms to disclose the fair value of their investment properties. We study whether this increase in the transparency in financial reporting reduces information asymmetry and leads to higher pricing efficiency and improved liquidity. We investigate this question in the context of the real estate industry, which due to its unique structure stands to be affected the most by the adoption of the fair value method. We observe that post regulation the coefficients of variation of trading volume and daily turnover decreased significantly, while turnover ratio increased significantly. In addition, these effects are stronger for larger firms. We further note that although post-IAS 40 asymmetric information decreases and liquidity increases, the disclosure of fair value does not lead to lower NAV deviation. Furthermore, our results suggest that fair value disclosure exacerbates NAV deviation and illiquidity during the crisis period.

This is a preview of subscription content, access via your institution.

Fig. 1

Notes

  1. Morri and Baccarin (2016) suggest that a priori differences between the two valuations should be expected due to differences in liquidity, price formation, financial structuring, search costs, management and control, taxation, and transaction costs between real estate assets and publicly-traded real estate.

  2. By contrast, Quagli and Avallone (2010) find that the likelihood of choosing fair value method is negatively related to the market-to-book ratio (a proxy of information asymmetry), which is in conflict with the extant evidence.

  3. Private firms with publicly traded debt are not subject to this regulation. Firms having non-December fiscal year-ends adopted IFRS in fiscal year 2006.

  4. IAS 40 was issued on December 18th, 2003 and became effective for annual periods beginning on or after January 1st, 2005. For more information see: https://www.iasplus.com/en/standards/ias/ias40

  5. Other reasons for deviation of market prices from NAV are managerial ownership, tax timing, and market segmentation. However, despite extensive research, there is lack of consensus on the impact of individual factors explored in the literature on the deviation.

  6. In a cross-country study, Cumming and Walz (2010) report that PE funds systematically overstate valuations to attract investors to future fund-raising, and the extent of manipulation is greater in countries where legal systems and disclosure requirements are less stringent.

  7. We drop Cyprus (2 observations) from the sample as we don’t have NAV data for this country.

  8. Conducting the VCV and turnover models using the smaller sample of 1378 observations does not change the results.

  9. In unreported results we also test whether the effect post regulation for voluntary disclosing firms is different than for mandatory disclosing firms, but we find no evidence. The voluntary disclosure effect does not change post regulation. This is consistent with Muller III et al.’s (2011) findings.

  10. We also test, if larger firms are more likely to choose to disclose voluntary, but we do not find any evidence for potential endogeneity.

References

  • Armstrong, C. S., Barth, M. E., Jagolinzer, A. D., & Riedl, E. J. (2010). Market reaction to the adoption of IFRS in Europe. The Accounting Review, 85(1), 31–61.

    Article  Google Scholar 

  • Ball, R. (1995). Making accounting more international: Why, how, and how far will it go? Journal of Applied Corporate Finance, 8(3), 19–29.

    Article  Google Scholar 

  • Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for investors, Accounting and Business Research., 36(1), 5–27.

  • Ball, R., Robin, A., & Wu, J. S. (2003). Incentives versus standards: Properties of accounting income in four east Asian countries. Journal of Accounting and Economics, 36(1–3), 235–270.

    Article  Google Scholar 

  • Barkham, R., & Ward, C. (1999). Investor sentiment and noise traders: Discount to net asset value in listed property companies in the UK. Journal of Real Estate Research, 18(2), 291–312.

    Google Scholar 

  • Barlev, B., & Haddad, J. R. (2003). Fair value accounting and the management of the firm. Critical Perspectives on Accounting, 14(4), 383–415.

    Article  Google Scholar 

  • Barth, M. E. (1994). Fair value accounting: Evidence from investment securities and the market valuation of banks. The Accounting Review, 69(1), 1–25.

    Google Scholar 

  • Barth, M. E., Landsman, W. R., & Wahlen, J. M. (1995). Fair value accounting: Effects on banks' earnings volatility, regulatory capital, and value of contractual cash flows. Journal of Banking & Finance, 19(3–4), 577–605.

    Article  Google Scholar 

  • Barth, M. E., Beaver, W. H., & Landsman, W. R. (1996). Value-Relevance of Banks' Fair Value Disclosures under SFAS No. 107. The Accounting Review, 71(4), 513–537.

  • Beatty, A., & Harris, D. G. (1999). The effect of taxes, agency costs and information asymmetry on earnings management: A comparison of public and private firms. Review of Accounting Studies, 4(3–4), 299–326.

    Article  Google Scholar 

  • Boone, A., & White, J. T. (2015). The effect of institutional ownership on firm transparency and information production. Journal of Financial Economics, 117, 508–533.

    Article  Google Scholar 

  • Brown, G. W., O. Gredil and S. N. Kaplan, 2019. Do private equity funds manipulate reported returns?. Journal of Financial Economics, 132, (2), 267–297.

  • Burgstahler, D. C., Hail, L., & Leuz, C. (2006). The importance of reporting incentives: Earnings management in European private and public firms. The Accounting Review, 81(5), 983–1016.

    Article  Google Scholar 

  • Chakraborty, I., & Ewens, M. (2018). Managing performance signals through delay: Evidence from venture capital. Management Science, 64(6), 2875–2900.

    Article  Google Scholar 

  • Chari, V. V., Jagannathan, R., & Ofer, A. R. (1988). Seasonalities in security returns: The case of earnings announcements. Journal of Financial Economics, 21(1), 101–121.

    Article  Google Scholar 

  • Chee, J. (2005). Trading volume, information asymmetry, and timing information. The Journal of Finance, 60(1), 413–442.

    Article  Google Scholar 

  • Clayton, J., & MacKinnon, G. (2000). Measuring and explaining changes in REIT liquidity: Moving beyond the bid–ask spread. Real Estate Economics, 28(1), 89–115.

    Article  Google Scholar 

  • Clayton, J., and G. MacKinnon. 2002. “Departures from NAV in REIT pricing: The private real estate cycle, the value of liquidity and investor sentiment.” Working paper.

  • Conaway, J., L. Liang, and E. Riedl, “Market perceptions of the informational and convergence effects of fair value reporting for tangible assets: US and Cross-Country evidence.” https://ssrn.com/abstract=2802192. Accessed 13 June 2018.

  • Cumming, D., & Walz, U. (2010). Private equity returns and disclosure around the world. Journal of International Business, 41, 727–754.

    Article  Google Scholar 

  • Danbolt, J., & Rees, W. (2008). An experiment in fair value accounting: UK investment vehicles. European Accounting Review, 17(2), 271–303.

    Article  Google Scholar 

  • Daske, H., Hail, L., Leuz, C., & Verdi, R. (2008). Mandatory IFRS reporting around the world: Early evidence on the economic consequences. Journal of Accounting Research, 46(5), 1085–1142.

    Google Scholar 

  • Daske, H., Hail, L., Leuz, C., & Verdi, R. (2013). Adopting a label: Heterogeneity in the economic consequences around IAS/IFRS adoptions. Journal of Accounting Research, 51(3), 495–547.

    Article  Google Scholar 

  • De Fond, M. L., Hung, M., Li, S., & Li, Y. (2014). Does mandatory IFRS adoption affect crash risk? The Accounting Review, 90(1), 265–299.

    Google Scholar 

  • De George, E. T., Li, X., & Shivakumar, L. (2016). A review of the IFRS adoption literature. Review of Accounting Studies, 21(3), 898–1004.

    Article  Google Scholar 

  • Dietrich, J. R., Harris, M. S., & Muller, K. A., III. (2000). The reliability of investment property fair value estimates. Journal of Accounting and Economics, 30(2), 125–158.

    Article  Google Scholar 

  • Jenkinson, T., M. Sousa, and R. Stucke. 2013. “How fair are the valuations of private equity funds?.” Working Paper.

  • Lahr, H., and C. Kaserer. 2010. “Net asset value discounts in private equity funds.” Working Paper.

  • Landsman, W. R. (2007). Is fair value accounting information relevant and reliable? Evidence from capital market research. Accounting and Business Research, 37, 19–30.

    Article  Google Scholar 

  • Laux, C., & Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, Organizations and Society, 34(6–7), 826–834.

    Article  Google Scholar 

  • Lee, N. J., Sing, T. F., & Tran, D. H. (2013). REIT share price and NAV deviations: Noise or sentiment? International Real Estate Review, 16(1), 28–47.

    Google Scholar 

  • Li, K., & Zhao, X. (2008). Asymmetric information and dividend policy. Financial Management, 37(4), 673–694.

    Article  Google Scholar 

  • Liang, L., & Riedl, E. J. (2013). The effect of fair value versus historical cost reporting model on analyst forecast accuracy. The Accounting Review, 89(3), 1151–1177.

    Article  Google Scholar 

  • Ling, D. C., Naranjo, A., & Scheick, B. (2014). Limits to arbitrage, investor sentiment, and private market returns. Real Estate Economics, 42(3), 531–577.

    Article  Google Scholar 

  • Lof, M., and J. van Bommel, 2017. “Asymmetric information and the distribution of trading volume.” Working Paper.

  • Meuller, M. G., & Pfnuer, A. (2013). A review of the noise trader model concerning the NAV spread in REIT pricing: Evidence from the Pan EU REIT market. Journal of Real Estate Portfolio Management, 19(3), 189–206.

    Google Scholar 

  • Mirza, A. A., Holt, G. J., & Knorr, L. (2011). Practical implementation guide and workbook for IFRS (3rd ed.). Hoboken: Wiley.

    Google Scholar 

  • Morri, G., & Baccarin, A. (2016). European REITs NAV discount: Do investors believe in property appraisal? Journal of Property Investment and Finance, 34(4), 347–374.

    Article  Google Scholar 

  • Muller, K. A., III, Riedl, E. J., & Sellhorn, T. (2011). Mandatory fair value accounting and information asymmetry: Evidence from the European real estate industry. Management Science, 57(6), 1138–1153.

    Article  Google Scholar 

  • Muller, M. A., Riedl, E. J., & Sellhorn, T. (2015). Recognition versus disclosure of fair values. The Accounting Review, 90(6), 2411–2447.

    Article  Google Scholar 

  • Nellessen, T., & Zuelch, H. (2011). The reliability of investment property fair values under IFRS. Journal of Property Investment & Finance, 29(1), 59–73.

    Article  Google Scholar 

  • Nissim, D. 2003. “Reliability of banks' fair value disclosure for loans.” Review of Quantitative Finance and Accounting 20(4) (2003): 355–384.

  • Petroni, K. R., & Wahlen, J. M. (1995). Fair values of equity and debt securities and share prices of property-liability insurers. Journal of Risk and Insurance, 62, 719–737.

    Article  Google Scholar 

  • Phallippou, L., & Gottschalg, O. (2009). The performance of private equity funds. Review of Financial Studies, 22(4), 1747–1776.

    Article  Google Scholar 

  • Quagli, A., & Avallone, F. (2010). Fair value or cost model? Drivers of choice for IAS 40 in the real estate industry. European Accounting Review, 19(3), 461–493.

    Article  Google Scholar 

  • Securities and Exchange Commission (SEC). 2008. “Procyclicality and accounting standards Fair value accounting and standard-setting process.” November 2008 Comment Letter on File 4–573.

  • Shaffer, S.. 2012. “Evaluating the impact of fair value accounting on financial institutions: implications for accounting standards setting and bank supervision.” Federal Reserve Bank of Boston Working Paper No. QAU 12–01.

  • Venkatachalam, M. (1996). Value-relevance of banks' derivatives disclosures. Journal of Accounting and Economics, 22(1–3), 327–355.

    Article  Google Scholar 

  • Wallison, P. J. (2016). “Fair-value accounting scales up the crisis” in Hidden in plain sight: what really caused the world’s worst financial crisis and why it could happen again. Encounter Books, New York.

Download references

Acknowledgements

We gratefully acknowledge Brad Case, Michael LaCour-Little, and an anonymous referee for valuable comments and suggestions. We also thank the participants of the FannieMae Appraisal Symposium, 2018, Washington, DC for helpful discussion.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Milena T Petrova.

Additional information

Publisher’s Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix: Variable Definitions

Appendix: Variable Definitions

Table 14 This table provides definitions of all variables used in our analysis

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Ghosh, C., Liang, M. & Petrova, M. The Effect of Fair Value Method Adoption: Evidence from Real Estate Firms in the EU. J Real Estate Finan Econ 60, 205–237 (2020). https://doi.org/10.1007/s11146-019-09721-z

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11146-019-09721-z

Keywords

  • Information asymmetry
  • Pricing efficiency
  • Fair value
  • Net asset value
  • IFRS