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Fair value and audit fees
(2012)
This paper investigates the effect of fair value reporting and its attributes on audit fees. We use as our primary sample the European real estate industry around mandatory IFRS adoption (under which reporting of property fair values becomes compulsory), due to its unique operating and reporting characteristics. We document lower audit fees for firms reporting property assets at fair value relative to those employing depreciated cost―a difference that appears driven (in part) by impairment tests that occur only under depreciated cost. We further find that audit fees are decreasing in firm’s exposure to fair value, and increasing both in the complexity of the fair value estimation and for recognition (versus only disclosure) of fair values. We corroborate our findings in two alternative settings: contrasting UK and US real estate firms; and using UK investment trusts. Overall, the results suggest that fair values can lead to lower monitoring costs; however, any reductions in audit fees will vary with salient characteristics of the fair value reporting, including the difficulty to measure and the treatment within the financial statements.
A growing body of literature investigates the interaction of changes in accounting standards with institutions such as investor protection laws and corporate governance mechanisms. We examine the unintended consequences of fair value accounting in determining mandated preferred dividends. We study the case of Russian energy conglomerate UES, which had a good corporate governance track record and a consistent dividend history. Following its adoption of fair value accounting, UES reported the highest quarterly profit in world corporate history, but it subsequently omitted dividends for all its shareholders. The case analysis suggests that the transitory nature of fair value adjustments and the interaction with the investment policy were important considerations in justifying the dividend omission. The reduction in preferred dividends was not offset by any capital gains, and led to a wealth transfer from preferred to ordinary shareholders. Thus, requiring the use of fair value accounting when determining the dividend distribution base can lead to unintended consequences, and increase agency costs for minority shareholders.
This paper examines pricing differences across recognized and disclosed fair values. We build on prior literature by examining two theoretical causes of such differences: lower reliability of the disclosed information, and/or investors’ higher related information processing costs. We examine European real estate firms reporting under International Financial Reporting Standards (IFRS), which require that fair values for investment properties, our sample firms’ key operating asset, either be recognized on the balance sheet or disclosed in the footnotes. Consistent with prior research, we predict and find a lower association between equity prices and disclosed relative to recognized investment property fair values, reflecting a discount assigned to disclosed fair values. We then predict and find that this discount is mitigated by lower information processing costs (proxied via high analyst following), and some support that it is also mitigated by higher reliability (proxied via use of external appraisals). These latter results are documented using subsample analyses to test one attribute (either information processing costs or reliability) while holding the other constant. Overall, these findings are consistent with fair value reliability and information processing costs providing complementary explanations for observed pricing discounts assessed on disclosed accounting amounts.