Does fair value accounting for non-financial assets

pass the market test?

Hans B. Christensen and Valeri V. Nikolaev

The University of Chicago

Booth School of Business
5807 South Woodlawn Avenue
Chicago, IL 60637

Abstract: We study managers revealed preferences for fair value or historical cost accounting
for non-financial assets when market forces, rather than regulators, determine the choice. We
document that almost all managers pre-commit to historical cost accounting for plant, equipment,
and intangible assets, suggesting that fair value for illiquid non-financial assets is associated with
net firm-specific costs. However, for the more liquid assets groups, property and investment
property, the observed choices suggest that fair value is often associated with net benefits.
Indeed, the majority of real estate companies choose fair value over historical cost for investment
property. We also find that fair value use is positively associated with reliance on debt financing.
However, unlike prior studies, we conclude that this result is likely attributable to lower
incremental costs of fair value reporting rather than an attempt to avoid covenant violations. Our
findings contribute to the policy debate over fair value accounting for non-financial assets by
documenting that the firm-specific cost of establishing reliable fair value estimates represents a
barrier for fair value to become the primary valuation method on a voluntary basis.

Keywords: Fair value, IFRS, non-financial assets, illiquid assets.

JEL Classification: M4, M41

This paper previously circulated under the title: "Who uses fair-value accounting for non-financial assets after
IFRS adoption?". This research was funded in part by the Initiative on Global Markets at the University of Chicago
Booth School of Business. We benefited from helpful comments from Ray Ball, Philip Berger, Alexander Bleck,
Christof Beuselinck, Johan van Helleman, S.P. Kothari, Laurence van Lent, Christian Leuz, Paul Madsen, Karl
Muller, Edward Riedl, Douglas Skinner, Abbie Smith, Ross Watts, Li Zhang, and workshop participants at the EAA
2009 Annual Meeting, University of Chicago, University of North Carolinas GIA Conference, Harvard
Universitys IMO Conference, ISCTE, and Tilburg University. Michelle Grise, SaeHanSol Kim, Shannon Kirwin,
Ilona Ori, Russell Ruch, and Onur Surgit provided excellent research assistance.

1. Introduction
Academics, standard setters, and practitioners actively debate the use of fair value
accounting for illiquid assets (e.g., Schipper 2005a, 2005b; Ball 2006; Watts 2006; Herrmann et
al. 2006; Kothari et al. 2009; Hail et al. 2009; Laux and Leuz 2009). The debate dates back to the
1930s (e.g., Paton 1932, pp. 739-743) and has recently been fuelled by the financial crisis and
the potential adoption of International Financial Reporting Standards (IFRS) in the United States.
We contribute evidence to this debate by studying managers preferences, revealed by their
choice between fair value and historical cost accounting for non-financial assets when market
forces, rather than regulators, determine the outcome. Examining managers actual choices is
useful in light of the policy debate as it reveals whether the firm-specific benefits of fair value
accounting exceed the firm-specific costs. However, we do not evaluate the net social costs or
benefits of fair value accounting due to potential externalities, which may be relevant to
regulators decisions. While we are not the first study that examines the choice between fair
value vs. historical cost (Brown et al. 1992; Whittred and Chan 1992; Cotter and Zimmer 1995),
our setting is likely to be more revealing about the costs and benefits of fair value accounting
than prior settings because of the requirement to pre-commit to one valuation practice, as
discussed next.
We exploit the recent IFRS adoption in the European Union (EU) and focus on major and
arguably the most controversial non-financial asset groups: (i) property, plant, and equipment
(PPE), (ii) investment property, and (iii) intangible assets. 1 IFRS requires that companies state
their valuation method in the accounting policy section of their annual reports and apply the
1

In this paper, we use the term asset group to describe the three types of assets we examine. Intangible assets,
investment property, and property, plant, and equipment each constitute one asset group. We use the term asset class
to describe a subsection of an asset group. For instance, property constitutes an asset class under the asset group
property, plant, and equipment. Our definition of an asset class is consistent with IAS 16.37.

chosen method consistently over time. This implies that companies need to pre-commit ex ante
to one valuation practice, which differs from prior studies where managers had discretion to
revalue selectively (from time to time). Pre-commitment is likely to reduce incentives for
opportunistic use of fair value and, in turn, allows us to focus on more fundamental economic
trade-offs. Out of the 28 EU countries adopting IFRS in 2005, we select the United Kingdom
(UK) and Germany because they have the largest financial markets in the EU and, historically,
are at the opposite ends of the spectrum in terms of using fair value accounting under local
GAAP. Specifically, for non-financial assets, German GAAP allows only historical cost
accounting, whereas UK GAAP either allows (for PPE) or mandates (for investment property)
fair value accounting. IFRS expands the available valuation practices in both the UK and
Germany. Indeed, under IFRS both fair value and historical cost are allowed for each of the three
asset groups, which enables managers to reveal their preferences. 2
Throughout this paper, we assume that managers ex ante choices of valuation practices
primarily reflect capital markets reporting demands. From a capital markets viewpoint, the
choice between historical cost and fair value involves a cost-benefit tradeoff. On the benefit side,
fair value represents more relevant information used by investors in their capital allocation
decisions (e.g., Barth and Clinch 1998; Schipper 2005a; Herrmann et al. 2006). On the cost side,
construction of reliable fair value estimates is expensive due to their inherent lack of verifiability
(Watts 2006). Subjectivity in non-verifiable fair value estimates can be exploited
opportunistically to manipulate reported performance, and, therefore, translates into agency costs
borne by shareholders (Jensen and Meckling 1976). To alleviate these agency costs managers
need to pre-commit to accounting methods that reduce accounting discretion (Watts and

We use the term historical cost to describe accounting treatment under which assets are recognized at historical
cost less subsequent depreciation (amortization) and/or impairments.

Zimmerman 1979, 1986). For example, choosing historical cost serves as a commitment against
discretionary upward asset revaluations. This tradeoff between relevance and reliability lies at
the center of the controversy over fair value accounting (e.g., Sloan 1999; Wahlen et al. 2000;
Dietrich et al. 2001; Schipper 2005a; Herrmann et al. 2006; Laux and Leuz 2009) and hence we
argue that this tradeoff should largely determine the choice between the two accounting
principles that we study.
We make three empirical predictions. First, the recent move towards fair value in
accounting standards (e.g., Johnson 2005) suggests that standard setters believe the efficient
solution to asset measurement has shifted towards the relevance side of the tradeoff (Watts and
Zimmerman 1986). In other words, the relevance benefits of fair value are on average expected
to outweigh the cost of lower reliability. Hence, we predict that IFRS adoption is associated with
a significant shift towards fair value accounting for non-financial assets among firms that were
constrained to historical cost accounting under local GAAP. Costs of constructing reliable fair
value estimates, however, are expected to be an important cross-sectional determinant behind the
choice to adopt fair value. Given this, our second prediction is that fair value accounting is more
likely for assets that exhibit relatively more liquid markets (which serves as a source of
verification and hence reduces the cost of establishing reliable fair value estimates). Property is
more likely than other non-financial asset classes to be re-deployable by other firms and
therefore has relatively liquid markets (Shleifer and Vishny 1992). Hence we expect a more
frequent use of fair value for property. Our third prediction is that fair value accounting is
positively associated with reliance on debt financing. Companies that frequently and more
heavily rely on debt are commonly required by creditors to invest in construction of reliable fair
value estimates for the purposes of debt contracting and reporting to creditors. Given this, the

marginal cost of recognizing these estimates in financial statements is low (Holthausen and
Watts 2001).
Another distinctive feature of our study is that we avoid drawing conclusions based on a
particular industry or asset group. While prior studies mainly focus on a selected sample (e.g.,
investment property), preferences towards fair value use are likely to vary considerably across
assets and industries, and understanding this variation can be useful from the policy perspective.
We examine this variation to establish for which assets and in which industries fair value is
associated with net firm-specific benefits. Our hand-collected sample consists of 1,539
companies, which approximates the population of publicly traded companies in Germany and the
UK. We read the accounting policy sections in annual reports to identify the valuation practices.
We find that only 3% of the sample firms use fair value accounting for at least one asset
class under the PPE asset group following IFRS adoption. With very few exceptions, these
companies use fair value accounting for the property asset class only; members of the plant and
equipment asset classes are valued at historical cost in almost all cases. 3 An even more striking
observation emerges when we examine the post-IFRS choices of companies that recognized at
least one PPE asset class at fair value under local GAAP (i.e., under UK GAAP). We find that
44% of these companies in fact switch to historical cost accounting upon IFRS adoption. In
contrast, among companies that recognized all PPE asset classes at historical cost under local
GAAP, only 1% switch to fair value for at least one asset class.

Total assets and shareholders equity are, respectively, 31% and 88% higher on average for companies that apply
fair value than for a matched sample of companies that use only historical cost accounting. This suggests that the
choice between the valuation methods is not random and is economically important. This result cannot be
interpreted as causal, however, because incentives to use fair value depend on how using fair value accounting
versus historical cost accounting affects the outcome. See appendix C for the results.

We find that companies are equally likely to use historical cost and fair value accounting
for investment property (i.e., property held for the purpose of earning rental income or for capital
appreciation). The strongest determinant of fair value use for this asset group is whether real
estate is one of the company's primary business activities. Namely, German companies, all of
which were constrained to historical cost before IFRS adoption, are significantly more likely to
switch to fair value accounting for investment property when real estate is among their primary
activities. In contrast, in the UK, where all companies were constrained to fair value for
investment property prior to IFRS, we observe more frequent switches to historical cost
accounting when real estate is not among their primary activities. The results are consistent with
managers revealing their preferences and switching accounting treatments once their choice is
not constrained by accounting regulation. The preferences of real estate companies managers in
the UK and Germany indicate that fair value accounting for investment property in this industry
is generally associated with net firm-specific benefits, consistent with Muller et al. (2008). Since
the real estate industry exhibits relatively liquid markets, the costs of constructing reliable fair
value estimates are lower. In addition, changes in the value of investment property are directly
linked to the performance of real estate business. This implies that benefits of fair value are more
likely to outweigh its costs for real estate companies. Finally, we find that no companies in our
sample use fair value accounting for intangible assets.
Logistic regression analysis of the decisions to use fair value reveals for both investment
property and PPE that reliance on debt financing is positively associated with the use of fair
value. This finding holds both when measuring reliance on debt by leverage and the frequency of
accessing debt markets. Further analysis reveals that short-term debt is more important than
long-term debt in explaining the fair value use. Given that we study pre-commitments to fair

value, and that accounting-based covenants are less common for short-term debt, the results are
inconsistent with the conclusion that companies use fair value opportunistically to avoid
covenant violations (opportunism is one proposed explanation for the results in prior literature,
see Cotter and Zimmer 1999 for discussion).
Overall, our results do not support our first prediction that a significant fraction of firms
shift towards fair value accounting upon IFRS adoption. Rather, the evidence indicates that
almost all firms pre-commit against upward asset revaluations for the majority of illiquid (nonfinancial) asset groups and therefore stands in contrast to the standard setters' enthusiasm for fair
value accounting. The cross-sectional tests of our second and third predictions suggest that fair
value is used when the costs of obtaining reliable estimates are relatively low. Hence, the
resistance to fair value does not appear to be due to managers disagreement with standard setters
on the conceptual merits of fair values in decision making, but rather due to the costs of
establishing reliable fair value estimates.
Our paper makes three contributions to the literature. First, it documents that, in a setting
where companies must adhere to their choice in the future, fair value accounting for nonfinancial assets is crowded out by historical cost accounting, arguably with the exception of
property. This finding implies that despite the conceptual appeal of fair value, the costs of
establishing reliable estimates prevent fair value from becoming the primary valuation method
for non-financial assets. In light of the policy debate over whether to expand mandatory fair
value accounting for non-financial assets, our evidence on managers actual choices cautions that
the firm-specific benefits are unlikely to exceed the firm-specific costs. However, mandatory fair
value accounting for illiquid non-financial assets may still be socially optimal if fair value

accounting is associated with positive externalities. More research is needed to understand

potential externalities.
Second, this is the first study to exploit revealed preferences for pre-commitment to fair
value accounting. Our results contrast sharply to the prior evidence on ex post revaluations. For
example, Brown et al. (1992) report that about two-thirds of Australian companies revalued
assets upwards (at least once) over three- and four-year periods. Similarly, studies on intangibles
such as brand names (e.g., Barth and Clinch 1998; Muller 1999) report relatively frequent ex
post revaluations. We, however, find that few companies pre-commit to the use of fair value for
PPE and no sample firms make such a pre-commitment for intangibles. These differences
suggest that the requirement to pre-commit affects managers choices and also highlights the
difference between our setting and the settings studied in prior literature.
Third, our study contributes to the policy-related debate on the consequences of adopting
IFRS in the US (e.g., Hail et al. 2009). Under US GAAP, fair value accounting is not allowed for
non-financial assets, and this difference between US GAAP and IFRS amounts to an important
point of disagreement among the standard setters. It is often argued that a consequence of
mandatory IFRS adoption is a significant increase in the use of fair value (see Cairns 2006 for
examples). Our evidence generally does not support this conjecture for non-financial assets. One
potential scenario is that fair value accounting becomes a popular and widely used vehicle for
misrepresentation of financial reports. For example, recent evidence in Ramanna and Watts
(2009) suggests that mandatory application of fair value to assess goodwill impairments is
consistent with opportunistic representation of financial reports. In our voluntary setting,
however, most companies choose to pre-commit against the use of fair value for non-financial
assets. This suggests that most managers are unwilling to subject shareholders to the agency

costs associated with fair value measurement for non-financial assets. Interestingly, our finding
echoes accounting practice in the United States before the Securities and Exchange Commission
(SEC) banned upward revaluations in 1940: downward revaluations were much more common
than upward revaluations and the latter were almost never performed on intangible assets
(Fabricant 1936; Paton 1932). The consistency of accounting practice across time and different
institutional settings speaks to the existence of an economic mechanism that governs companies
choice to use fair value.
Section 2 describes the accounting traditions in the UK and Germany, as well as the
valuation methods available to companies under German GAAP, UK-GAAP, and IFRS; Section
3 develops testable hypotheses; Section 4 describes the sample selection procedure and presents
our results; and Section 5 concludes.
2. Accounting in the UK and Germany
Despite EU accounting harmonization that began decades prior to IFRS, the UK and
Germany arguably had the two most distinct asset valuation traditions in Europe at the time of
IFRS adoption. The differences in their accounting traditions are due to institutional differences
in legal systems and ownership structures. Germany has traditionally been characterized by the
existence of private companies who raise capital from banks and communicate via private
information channels (Leuz and Wstemann 2004). Accounting was mainly used to establish
taxable income; hence, accounting regulation was codified and focused mainly on legal entity
statements. As revaluations are often in conflict with the objectives of tax authorities, German
GAAP only allowed historical cost accounting. Today in Germany, there is no formal link
between legal entity reports, which are still used primarily for tax purposes, and consolidated
statements. Thus, companies financial reporting choices in the consolidated statements,

including their valuations of non-financial assets, have no tax consequences. In contrast, UK

accounting has historically developed separately from tax accounting and in the private sector
rather than in company law. UK ownership is dispersed and even middle-sized companies are
commonly listed on the London Stock Exchange. Such ownership structure requires that
financial reporting reduce information asymmetry, and in this context revaluations may serve the
purpose of conveying information about assets' current values.
Next, we discuss the accounting treatment of long-term non-financial assetsinvestment
property, PPE, and intangible assetsunder UK-GAAP, German GAAP, and IFRS.
2.1 Accounting for investment property
IAS 40 defines investment property as land or buildings not currently occupied by the
owner that are held to generate rental income or capital appreciation. Under German GAAP,
companies must value investment property at historical cost, while under UK-GAAP, companies
are required to use fair value. Net income is unaffected by upward revaluations of this asset
group under UK-GAAP, as they are credited to the revaluation reserve. IFRS offers companies
the choice between recognizing investment property at historical cost or fair value. Thus a
significant shift towards fair value is expected among German companies while not for UK
firms. Under IFRS, if a company chooses to recognize investment property at historical cost, it
must systematically depreciate the acquisition costs and disclose the investment property's fair
value in the notes accompanying the financial statements. In contrast, if a company chooses to
apply fair value, changes in the investment property's value become part of operating income and
the assets are not subject to depreciation. We assume that investors are rational and cannot be
misled by whether fair value changes affect net income or directly go to shareholders equity.
Thus we rule out this consideration as a determinant of the fair value choice.

2.2 Accounting for property, plant, and equipment (PPE)

The only valuation method for PPE permitted under German GAAP is historical cost.
Under both IFRS and UK-GAAP, PPE is initially recognized at cost but at each subsequent
balance sheet date is valued at either historical cost or fair value. In either case, these assets are
subject to depreciation. When fair value is applied, positive changes in an asset's value are
credited to the revaluation reserve, which constitutes part of shareholders equity. Revaluations,
therefore, only affect net income through future depreciation charges (unlike for investment
property). Finally, under IFRS, the choice of valuation method must be consistent for all assets in
the same asset class (IAS16.29).
2.3 Accounting for intangible assets
Under German GAAP, historical cost is the only valuation method permitted for
intangible assets. Under both UK-GAAP and IFRS, however, intangible assets are to be carried
at either historical cost or fair value less any amortization and impairment charges. Under fair
value, the accounting treatment is similar to that of PPE; that said, a company may only apply
fair value to an intangible asset if an active market exists for that asset (IAS38.75). The
definition of an active market is very narrow, and for many intangible assets, such as brands,
patents, and trademarks, it is nonexistent, due to their uniqueness and the specificity of their
application (IAS38.78).
2.4 Fair value under IFRS vs. settings in prior literature
The IFRS setting is different from the Australian and UK settings used in prior research
in that companies must ex ante state their choice between historical cost and fair value in their
accounting policy. 4,5 If a company decides to apply fair value under IFRS, it must revalue assets

Note that both the UK and Australia adopted accounting standards in 1999 and 2000 that are similar to IAS 16,
however, the prior literature we refer to rely on data before this change.

10

every time the book value is materially different from the market value (IAS 16 and IAS 40). If
the same company instead decides to use historical cost, it cannot perform upward revaluations
in the future. A switch between historical cost and fair value is considered a voluntary change in
accounting principles and needs to be justified to auditors, lenders, equity investors, and
potentially to regulators. Therefore, the choice between fair value and historical cost in our
setting represents an ex ante commitment and hence is unlikely to be driven by instantaneous
earnings management considerations. Indeed, the early studies argued that discretionary
revaluations are related to contracting motives consistent with this view leveraged companies
in danger of violating covenants are more likely to revalue assets (Whittred and Chan 1992;
Brown et al. 1992; Cotter and Zimmer 1995). 6
The problem with discretionary revaluations is that managers decide whether to revalue
assets ex post after they know the effect of the fair value estimate on the financial statements. For
instance, managers may only revalue assets when they need to manipulate reported performance.
Alternatively, managers may revalue assets when reliable fair value estimates are available. Our
setting isolates this issue as we examine ex ante choices to use fair value with limited ex post
discretion to change valuation methods. Thus, examining ex ante choices is more likely to be
informative about the economic trade-off between fair value and historical cost than examining
ex post revaluations. Furthermore, the ex ante requirement in IFRS aids firms in committing to
non-opportunistic use of fair value accounting, which may imply that fair value accounting under
IFRS is associated with greater benefits than ex post revaluations. Consistent with this view,
5

Analogous to, e.g., inventory valuation methods.

Whittred and Chan argue that asset revaluations reduce underinvestment problems that arise from contractual
restrictions, while Cotter and Zimmer argue that upward revaluations increase borrowing capacity. While debt
contracting is the main explanation for asset revaluations, Brown et al. also find that bonus contracts, as well as
signaling and political cost explanations, play an important role.

11

Muller et al. (2008) find lower bid-ask spreads for fair value companies and Cairns et al. (2008)
find that fair value accounting increases international comparability in the IFRS setting.
3. Background and hypotheses
Relevance and reliability are the most basic and important attributes of accounting
information. The tradeoff between relevance and reliability is recognized in the conceptual
frameworks of both the Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB). 7 Thus, when standard setters choose between fair value
and historical cost, the relevance-reliability tradeoff is at play. In recent years, both FASB and
IASB have placed more emphasis on relevance, not reliability. 8 This change in focus is reflected,
for example, in the conclusion of a discussion of relevance and reliability by L. Todd Johnson, a
senior project manager at FASB:
The Board has required greater use of fair value measurements in financial statements
because it perceives that information as more relevant to investors and creditors than
historical cost information. Such measures better reflect the present financial state of
reporting entities and better facilitate assessing their past performance and future
prospects. In that regard, the Board does not accept the view that reliability should
outweigh relevance for financial statement measures. (Johnson 2005).
FASB's and IASB's shift towards fair value accounting suggests that they believe the
efficient solution to asset measurement has shifted closer to the relevance side of the tradeoff
(Watts and Zimmerman 1986). The standard setters position is justified on the grounds that fair
value measurement aids financial statement users' decision making. Fair value is also argued to
improve transparency, comparability, the timeliness of accounting information, and relative
performance measurement (e.g., Schipper 2005a). In line with benefits of fair value, a large
stream of value relevance studies on asset revaluations indeed finds that fair value possesses
7

See IASB's Framework paragraph 45 and FASB's Conceptual Statement 2 paragraph 15.

See for example IASB Discussion Paper July 2006, paragraph BC2.62.

12

superior relevance. These studies find that upward revaluations are positively associated with
equity returns in the month of the revaluation (Sharpe and Walker 1975; Standish and Ung 1982)
and that they are associated with longer period stock returns, future cash flows, and the market
value of equity (e.g., Easton et al. 1993; Barth and Clinch 1998; Aboody et al. 1999; Danbolt and
Rees 2008).
Barth et al. (2001) argue that the value relevance tests are joint tests of relevance and
reliability, because a certain degree of reliability is also established by rejecting the null of no
association. This conclusion increases confidence in fair value and (combined with the argument
that the reliability of fair values is similar to that of other accounting estimates, e.g., allowance
for uncollectible accounts) potentially influences the regulators views. A caveat that is in order
is that the previously documented associations between revaluations and equity values are
largely conditional on a companys discretionary choice to revalue assets. These choices are
non-random as, for example, managers may revalue assets because they anticipate a markets
response to the reported numbers or know how reliable the revaluations are. Alternatively, as the
association is measured over a relatively long window, it could be that managers choose to
revalue when the firm does well, hence has higher returns. Thus, the association could capture
the underlying change in firm performance and hence does not establish that the markets trust the
re-valued numbers. These possibilities potentially limit the generalizability of value relevance
tests for companies that do not use fair value and underscore the need to study the choice
between fair value and historical cost.
IFRS offers an opportunity to test whether the move toward fair value in accounting
standards is supported by the accounting practice choices that managers are making. Managers
have incentives to make ex ante valuation choices that reflect the interests of firms stakeholders

13

(otherwise stakeholders will price protect or impose costs on management), and hence are costjustified for a particular company. The observed choices can be used to infer whether managers
agree with IASB (and FASB) that the efficient solution to the relevance-reliability trade-off has
indeed shifted towards relevance. If the firm-specific benefits of fair value exceed its costs we
hypothesize:
H1: IFRS adoption is associated with a shift towards fair value accounting for non-financial
assets.
The effort and resources a company needs to expend in order to obtain reliable fair value
estimates are likely important in determining a managers choice of valuation practice. We next
consider how the costs of obtaining reliable estimates affect the choice between fair value and
historical cost. The ability to obtain reliable fair value estimates is closely related to the existence
of liquid markets for assets, which provide an independent source of verification (Watts 2006).
Property is the only non-financial asset class for which a relatively liquid market with official
statistics exists. Therefore, our second hypothesis proposes:
H2: Fair value accounting is more likely for asset classes for which liquid markets exist, i.e., for
property as opposed to plant, equipment, and intangibles.
Similarly, the existence of reliable fair value estimates for purposes other than financial
reporting affects the marginal cost of recognizing fair values in financial statements. Companies
that access debt markets are commonly required under their credit arrangements to provide
valuations of collateral. The fact that lenders are willing to lend against these valuations implies
that a company invests in measuring them reliably (e.g., independent valuation and
certification). 9 Given this, recognizing the fair values of these assets in financial statements is

Muller and Riedl (2002) document that fair value estimates produced by independent valuators are viewed by
capital markets as being more reliable than fair value estimates produced by managers.

14

associated with low incremental costs (Holthausen and Watts 2001). Therefore, our third
hypothesis is:
H3: Fair value accounting is positively associated with reliance on debt financing.
Earlier studies have documented a positive correlation between ex post revaluations and
leverage (Brown et al. 1992; Whittred and Chan 1992; Cotter and Zimmer 1995). However, this
positive correlation is often attributed to opportunistic behaviour where managers perform
upward revaluation to avoid covenant violations when they move closer to technical default (see
discussion in Cotter and Zimmer 1999). If this hypothesis is indeed true, then we do not expect
to find a significant association between leverage and the use of fair value since avoiding default
on covenants is unlikely to drive managerial choice (i.e., pre-commitments) in our setting.
Furthermore, if opportunism was to explain the association between leverage and the use of fair
value, we would expect to find the association stronger in case of long-term debt, where
accounting-based covenants are more common compared to short-term debt. We test this
implication empirically.
4. Results
4.1 Sample selection and descriptive statistics
We manually verify the accounting standards that a given company follows by looking at
either the accounting policy section or the auditors opinion section of its annual report(s). To
identify the asset valuation practice a company follows, we read the accounting policy section of
its annual report(s). We begin with all UK and German companies (active and inactive) in
Worldscope and further restrict to those complying with IFRS in either 2005 or 2006. For
inclusion in the German and UK cross-sectional samples, we further require that a company has
an annual report under IFRS in Thomson One Banker. We construct a cross-sectional sample to

15

examine valuation practices after mandatory IFRS adoption and a switch sample (UK only) to
examine whether companies use mandatory IFRS adoption to switch their accounting practices.
For inclusion in the UK switch sample, we also require that a company has an annual report
(prepared according to UK-GAAP) before IFRS adoption. 10
Table 1, Panels A and B present the distribution by industry of companies in Worldscope
as well as in the German sample, the UK cross-sectional sample, and the UK switch sample. The
industry distribution in each sub-sample approximates that of Worldscope.
4.2 Valuation practices
In this section, we provide evidence on hypothesis H1. A company is classified as
applying fair value accounting if it recognizes at least one asset class (within an asset group) at
fair value. 11 Similarly, a company is classified as applying historical cost if it recognizes at least
one asset class (within an asset group) at historical cost. Appendix A presents examples of fair
value accounting and historical cost accounting for PPE. 12
4.2.1 Valuation practices in the UK
Table 2 documents the valuation practices in the UK cross-sectional sample. We identify
no use of fair value accounting for intangible assets; instead, all companies in our sample rely on
historical cost for this asset group. For PPE, 5% of companies use fair value accounting while all

10

For companies both in Germany and the UK, we obtain their first annual report under mandatory IFRS, which is
typically for fiscal year 2005. In addition, for companies in the UK, we look for their last UK-GAAP annual report,
which is typically for fiscal year 2004. In the rare cases where we cannot find these annual reports, we take the next
annual report available in Thomson One Banker (e.g., for fiscal year 2006).
11

Note that this is a conservative way of defining the use of fair value because the fraction of assets recognized at
fair value can be relatively small. Yet, even this definition generates pronounced economic differences across the
two groups of companies.
12

Panel A of Appendix A provides an example of a company that switched from fair value to historical cost, Panel
B provides an example of a company that used fair value under both UK-GAAP and IFRS, and Panel C provides an
example of a German company that uses fair value.

16

companies use historical cost for at least one asset class within this asset group. We observe that
fair value use differs across industries, with higher concentration in the financial sector.
Table 3 presents the results from the UK switch sample. For PPE, we find that 6% of
companies use fair value under UK-GAAP and 5% use fair value under IFRS. A large number of
switches occur for this asset group. Specifically, 44% of companies that use fair value for at least
one asset class in PPE under UK-GAAP switch to historical cost (for all asset classes) upon IFRS
adoption. In contrast, only 1% of companies using historical cost for all asset classes under UKGAAP switch to fair value for at least one asset class upon IFRS adoption. The joint evidence in
both tables does not support H1 and implies that only a small number of companies find fair
value to be cost-justified.
What made a high portion of UK companies switch to historical cost on IFRS adoption?
IFRS and UK-GAAP are very similar when it comes to the valuation of PPE (see Section 2.2).
Thus, the switches observed upon IFRS adoption are voluntary in the sense that IFRS did not
force these companies to switch to historical cost. If historical cost maximizes net benefits, why
did these firms not switch to historical cost under UK GAAP? 13 One explanation is that
switching accounting principles is uncommon in practice because it is costly. 14 The costs of
switching accounting principles include renegotiating contracts that require consistency in
GAAP, convincing auditors that the new practice better reflects the underlying economics of the
company, and communicating the change to financial statement users. Most of these costs are
13

We contacted those non-financial companies that switched to historical cost and received several replies
indicating that IFRS was a convenient opportunity for them to make the switch.
14

Consistency in accounting policies across time is highly regarded by the accounting profession. Comparability is a
qualitative characteristic expressed in IASBs Framework (paragraph 39): . . . the measurement and display of the
financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and
over time for that entity. In U.S. literature, consistency is expressed in several places, including the Accounting
Research Study No. 1 of the American Institute of Certified Public Accountants (postulate C-3). See Ball (1972) for
an extensive discussion of the accounting professions reliance on consistency.

17

fixed (i.e., they are independent of the number of changes) so the incremental cost of voluntary
changes is substantially lower when combined with a mandatory change such as IFRS adoption.
Even if these companies did want to switch to historical cost before IFRS adoption, the
associated costs could have made switching unattractive. However, the observation that a switch
is more likely from fair value to historical cost than from historical cost to fair value implies that
firms revealed preferences do not echo with the standard setters' enthusiasm over fair value
accounting, in contrast to hypothesis H1.
After IFRS adoption, fair value is more common for investment property, for which UK
companies had to use fair value under local GAAP, than it is for PPE. Nevertheless, 23% of
companies reveal preferences for historical cost by switching from fair value to historical cost
once they are no longer constrained to the use of fair value by accounting regulation. Significant
industry variation is present: whereas only 2% of financial companies switch to historical cost,
45% of non-financial companies switch.
4.2.2 Valuation practices in Germany
Table 4 documents the valuation practices in the German sample. We find no use of fair
value accounting for intangible assets in Germany, similar to the UK. For PPE, 1% of companies
switch to fair value for at least one asset class upon IFRS adoption (note that under German
GAAP fair value was not allowed). Only one company applies fair value to all asset classes in
PPE, while all other companies use historical cost for at least one asset class. These findings
approximate those we observed in the UK and indicate that most managers reveal preferences for
historical cost.
For investment property, we find that 23% of German companies reveal preferences for
fair value by switching from historical cost to fair value once they are no longer constrained to

18

historical cost by accounting regulation. However, we also observe substantial industry variation.
Among financial companies, 49% switch to fair value, while only 6% of non-financial
companies switch.
In summary, we find that a small number of companies use fair value accounting for at
least one asset class under PPE after IFRS adoption. The absence of fair value accounting for
intangibles and its limited use for PPE in both the UK and Germany suggests that only a small
subset of companies perceive net firm-specific benefits of fair value accounting. Counter to
hypothesis H1, there is no general shift towards fair value accounting for non-financial assets.
The exception is investment property among German financial institutions where approximately
one half of them shift to fair value. The evidence that shifts towards fair value occur for
investment property rather than PPE and intangibles is consistent with H2. Next, we provide
further evidence on H2 by exploiting the differences in asset liquidity within the PPE group.
4.2.3 Assets recognized at fair value
In this section, we examine which asset classes in PPE are recognized at fair value. Table
5 presents the distribution of fair value use across the three asset classes within the asset group.
Sixty-nine companies in the sample use fair value accounting either before mandatory IFRS
adoption, after mandatory IFRS adoption, or both. Of these companies, 93% use fair value
accounting for property. Only 3% use fair value for plant, and only 4% use fair value for several
asset classes in PPE. The distributions of fair value use in the UK and Germany are similar.
Hence, the application of fair value accounting is, in practice, not only limited in terms of the
number of companies using it, but also in terms of the assets to which it is applied, namely
property. While this evidence is at odds with hypothesis H1, it supports H2 as property is the
only non-financial asset class for which a relatively liquid market is often present.

19

4.3 Analysis of the decision to use fair value

In this section, we examine the revealed preferences for valuation practices following
IFRS adoption in a cross-section of firms using logistic regression analysis. Our analysis draws
on two different subsamples and controls for common company-specific characteristics. First, we
analyse the sample of all companies that hold investment property. Second, we restrict our
analysis to the sample of companies that use fair value for PPE matched with a historical cost
control group. The summary statistics for variables used in this analysis are reported in Table 6.
All variables are defined in Appendix B. Because the number of observations and the set of
explanatory variables vary across the two subsamples, we report two separate sets of summary
statistics in Panels A and B.
4.3.1 Investment property
While IFRS provides UK companies with the first opportunity to switch to historical cost
for investment property, in Germany the opposite is the case. Thus, IFRS gives both German and
UK company managers an option to move to the asset valuation method not previously available
under local GAAP in these countries. Such a setting is particularly convenient to study revealed
preferences because significant switching from historical cost to fair value in Germany and, in
contrast, from fair value to historical cost in the UK is difficult to attribute to factors other than
the presence of considerable firm-specific benefits associated with the alternative accounting
treatment. We begin by exploring whether firm-specific cost and firms-specific benefits of fair
value accounting differ across industries. Note that in this regard the real estate industry is
unique, as its main assets (investment property) exhibit relatively liquid markets. Consequently,
under H2, we predict that German real estate firms are more likely to switch to fair value than

20

German firms in other industries, while UK real estate firms are less likely to switch to historical
cost than UK firms in other industries.
Our sample comprises the 275 companies (124 UK companies; 151 German companies)
that hold investment property. Depending on the specification, additional data requirements limit
the sample further. We begin with a basic regression that examines whether accounting methods
vary based on country of domicile and industry type,

FairIFRS = 1UK + 2UK * Sic65 + 3Germany + 4Germany * Sic65 + ,

(1)

where UK (Germany) is an indicator variable that takes the value of one for UK (German)
companies and zero otherwise, and Sic65 is an indicator that takes the value of one when a
company has SIC code 65 (real estate) among its first five SIC codes and zero otherwise.
Equation 1 examines how consistency of valuation practices varies, conditional on whether real
estate is among a company's primary business activities. As discussed in Section 2, the UK and
Germany have very different institutional features. If institutions, as opposed to accounting
standards per se, determine the accounting practice, then we expect to find the country variables
to be significant. Specifically, the coefficients 1 and 3 capture the consistency of reporting
methods in the UK and Germany in general, while 2 and 4 measure increments in consistency
when real estate is among a company's primary business activities.
Table 7 Column 1 presents the regression estimates of Equation 1. The pseudo R-squared
suggests that Equation 1 explains a substantial portion (i.e., 34%) of the variance in the decision
to use fair value. The estimates indicate that companies domiciled in Germany are significantly
more likely to use historical cost after IFRS adoption (3). This effect, however, is significantly
smaller for companies whose primary industries include real estate (3 + 4). Companies
domiciled in the UK are generally more likely to use fair value under IFRS, although the effect is

21

small. This effect, however, is much stronger (and more significant) for companies in the real
estate business (1 + 2). The evidence is in line with H2. The switches from historical cost to
fair value among German real-estate-companies and from fair value to historical cost among UK
non-real-estate-companies, when companies are no longer constrained by accounting regulation,
is strong evidence that the real estate industry has net firm-specific benefits of fair value
accounting for investment property. This finding is consistent with the capital market benefits of
fair value accounting for real estate firms documented in Muller et al. (2008). Real estate
businesses' greater propensity to switch to fair value (or continue its use) is consistent with fair
value being a superior measure of economic performance in the real estate industry. However,
the evidence also indicates that the valuation practices remain somewhat persistent across IFRS
adoption (historical cost in Germany and fair value in the UK). This finding is policy-relevant
because it implies that the application of GAAP need not be uniform under one set of standards,
and is specific to institutional setting, in line with arguments in Ball (2006).
In Table 7, Columns 2 through 6, we augment Equation 1 with log of market
capitalization and an IFRS early adoption dummy (Muller et al. 2008) and test whether fair value
is positively associated with reliance on debt as predicted by hypothesis H3.
The key finding in Column 2 is that companies that rely more heavily on debt financing
are more likely to use fair value accounting for investment property. This is consistent with the
incremental costs of obtaining reliable fair value for financial reporting purposes being low when
they are already produced for financing purposes (Holthausen and Watts 2001). An alternative
explanation is that companies may choose fair value accounting because it allows them to avoid
covenant breaches (Cotter and Zimmer 1999).

22

To shed more light on this issue, in Model 3 we decompose leverage into its long- and
short-term components, as well as proxy for reliance on convertible debt. We find that short-term
leverage is more important than long-term debt in explaining fair value use. The coefficient on
convertible debt is also significantly positive. As accounting-based covenants are less important
and less common from short-term and convertible-debt perspectives, the results are inconsistent
with the conclusion that companies use fair value opportunistically to avoid covenant violations.
Rather this finding suggests that firms accessing debt markets frequently are more likely to use
fair value. This is intuitive as these companies need to produce reliable estimates for financing
purposes more frequently and therefore have a low incremental cost of committing to fair value.
Models 4 through 6 of Table 7 replace leverage with other leverage proxies frequently
used in contracts. 15 We find that the ratio of total debt to operating income is positively related to
the use of fair value, while the coverage of interest and the current ratios are negatively related to
fair value use. These results are consistent with hypothesis H3 and confirm the effect of leverage
by showing that companies that rely more on debt are more likely to use fair value.
To provide further evidence on H3, we examine whether fair value companies access
debt markets more frequently than historical cost companies following IFRS adoption in 2005. If
indeed the availability of reliable fair value estimates relates to debt financing activities, fair
value choices should predict more frequent debt market access. Based on Worldscope data for
2006 and 2007, we construct several proxies for access to debt and equity financing.
Specifically, we proxy for future debt financing with the following variables: DebtIss1
(DebtIss2) indicates whether by 2007 total debt (long-term debt) had increased by more than
10% of the current market value of assets; FtrLev1 (FtrLev2) proxies for the level of future total

15

We exclude leverage because these variables are highly correlated with leverage and therefore capture aspects of
the same construct.

23

debt (long-term debt) in 2007 while controlling for the level of current debt in the regression; and
DbtGrow1 (DbtGrow2) indicates growth in total debt (long-term debt). To ensure that our debt
financing variables are not capturing financing activity in general we measured equity market
access as a benchmark. Proxies for equity issuance over 2006 and 2007 are as follows: EqIss1
indicates whether combined net proceeds of equity issuance less proceeds from stock options
exceed 10% of market value of current assets; and EqIss2 is the ratio of net proceeds to current
market value of assets. We regress these proxies on both the fair value indicator variable and
controls for company characteristics that include country, size, leverage, and an SIC code 65
indicator.
We present our findings in Table 8. Columns (1) through (6) present regressions with the
six proxies for debt issuance used as the dependent variables, while columns (7) and (8) are
based on the two equity issuance variables. All proxies for debt issuance are statistically
significant and indicate a relation between fair value use and future debt financing. Proxies for
equity financing are insignificant at the conventional levels. While we have no strong prior for
why equity market access should relate to fair value use, the relation between fair value use and
future debt issuance supports the explanation that the costs of recognizing reliable fair value
estimates are lower when firms regularly enter debt markets, as predicted by H3.
4.3.2 Property, plant, and equipment (PPE)
We conduct a similar analysis of a company's decision, post-IFRS, to apply fair value to
PPE. A few distinctions, however, bear mentioning. First, we hand-collect the fair value
revaluation reserve data from companies annual reports. This enables us to compute book values
of equity, PPE, and total assets as if companies used historical cost. Thus we can include bookto-market and book leverage as additional explanatory variables. In addition, we include the ratio

24

of PPE to total assets to examine weather PPE-heavy companies are more likely to use fair value.
Second, the percentage of fair value companies in the population is low for this asset group;
therefore, to improve our ability to draw inferences, we match each fair value company to a
historical cost company. 16 We perform this match according to country of domicile, two-digit
industry code, and the log of market value of equity and use the closest match. This procedure,
which requires non-missing market value of equity, yields 90 observations. Data availability
restrictions further reduce the sample to 87 (86 in Table 8 column 7) observations.
Table 9 presents the results from our logistic regression analysis. Because we match
according to country, industry, and size, we omit these as explanatory variables. In line with the
evidence for investment property and hypothesis H3, we find a positive and significant
association between market leverage (book leverage) and the use of fair value accounting.
Further analysis in column (3) reveals that, once again, short-term debt is at least as important as
long-term debt in this association. The portion of convertible debt is now significantly negatively
related to the use of fair value, a finding for which we currently have no explanation.
The effect of book-to-market is somewhat stronger in some specifications and indicates
that after IFRS adoption, high growth companies are less likely to use fair value. One
interpretation of this result is that companies with fewer growth opportunities use fair value
accounting as a means of avoiding overinvestment in fixed assets. In particular, common
accounting metricsfor example, return on assets or return on investmentare less likely to
reflect actual performance under historical cost accounting because the depreciated cost is
usually lower than market value, that is, the value in alternative use (see Appendix C). A
commitment to fair value accounting dilutes the return on assets, makes it more costly for
16

We do not include all historical cost companies in the logit regressions because this would result in an unbalanced
sample. While our matched sample is sufficient to perform statistical tests, we acknowledge that a larger sample
would be preferable for making robust inferences.

25

management to hold unproductive assets, and when fair value estimates are reliable, improves
performance measurement. In other words, a commitment to fair value effectively forces
managers to incur rent on their investments' current values, regardless of the time of purchase
and their historical cost.
We further find a positive coefficient on PPE, but it does not attain statistical significance
in most specifications. The positive coefficient on FairInvPr in Table 9 Column 5 suggests that
companies that apply fair value to investment property are more likely to also apply fair value to
PPE. Controlling for this effect, however, does not alter our findings with respect to leverage or
book-to-market.
5. Summary
We investigate the choice between fair value and historical cost accounting for nonfinancial assets when markets, rather than regulators, determine the outcome. In light of the
significant debate over fair value, understanding this choice is useful for regulators as it informs
about relative firm-specific costs and benefits of fair value accounting. The IFRS setting is
different from the settings in prior studies as it allows companies to choose between historical
cost and fair value accounting for non-financial assets, but requires companies to pre-commit to
their choice over time. We examined the accounting policies for intangible assets, investment
property, and PPE of 1,539 companies. With very few exceptions, we find that fair value is used
exclusively for property. We find that 3% of companies use fair value for owner-occupied
property, compared with 47% for investment property. The lack of companies that use fair value
for all other non-financial assets is inconsistent with fair value accounting yielding net firmspecific benefits for those assets. The use of fair value for property alone is likely explained by
lower costs to reliably measure fair values in the presence of relatively liquid property markets.

26

The main cross-sectional determinant of fair value for both investment property and PPE
is reliance on debt financing. When fair value estimates are constructed for financing purposes,
they are likely to be relatively reliable, and the incremental costs of also recognizing them in
financial reports are low.
Overall, our evidence suggests that most managers do not perceive the net benefits of fair
value accounting to exceed those of historical cost accounting for non-financial assets. However,
the cross-sectional variation in the choice reveal that fair value is chosen over historical costs
when the cost of establishing reliable fair value estimates are low. This suggests that managers
resistance to fair value use is likely to be driven by the costs of establishing reliable fair value
estimates rather than a disagreement with standard setters on the conceptual merits of fair value
accounting. These results have policy implications, as they suggest that fair value accounting for
non-financial assets is costly for most firms. Thus, mandatory fair value accounting for illiquid
non-financial assets may only be socially optimal if fair value accounting is associated with
positive externalities that exceed the net costs imposed on those firms forced to use fair value
accounting. Our setting does not allow us to explore externalities associated with fair value
accounting. More research is needed to understand these issues.

27

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Appendix A: Examples of accounting practice

This appendix presents examples of fair value and historical cost accounting from the accounting policy
section of annual reports of companies in our samples. Panel A presents an example of a switch from fair
value under UK-GAAP to historical cost under IFRS. Panel B presents an example of fair value
accounting under both UK-GAAP and IFRS. Panel C presents an example of a German company that
uses fair value accounting under IFRS.
Panel A: Switch from fair value to historical cost
Annual report according to UK-GAAP for 2004
AMEC plc annual report and accounts 2004 (page 67)
12 Tangible assets (continued)
All significant freehold and long leasehold properties were externally valued as at 31 December 2004 by
CB Richard Ellis Limited in accordance with the Appraisal and Valuation Manual of the Royal Institute
of Chartered Surveyors.
For the United Kingdom, the basis of revaluation was the existing use value for properties occupied by
group companies and the market value for those properties without group occupancy. For properties
outside the United Kingdom, appropriate country valuation standards were adopted that generally reflect
market value.
No provision has been made for the tax liability that may arise in the event that certain properties are
disposed of at their revalued amounts.
The amount of land and buildings included at valuation, determined according to the historical cost
convention, was as follows:

Cost
Depreciation
Net book value

Group
2004
million
39.2
(10.61)
26.6

Group
2003
million
46.4
(13.9)
32.5

Company
2004
million
9.3
(2.5)
6.8

Company
2003
million
8.6
(1.7)
6.9

Annual report according to IFRS for 2005

AMEC plc annual report and accounts 2005 (page 102)
IAS 16 Property, plant and equipment
Under UK-GAAP, AMECs policy was to revalue freehold and long leasehold property on a regular
basis. Under IAS 16, AMEC has opted to carry property, plant, and equipment at cost less accumulated
depreciation and impairment losses. As permitted by IFRS 1, AMEC has frozen the UK-GAAP land and
buildings revaluations as at 1 January 2004 by ascribing the carrying value as deemed cost. The impact of
this change in policy is as follows:

the revaluation reserve is reclassified into retained earnings as at the date of transition;
the results of the external revaluation as at 31 December 2004 are reversed, reducing the value of
property, plant and equipment as at 31 December 2004 by 9.6 million; and
as part of the 2004 external revaluation, certain properties were revalued downwards. Under UKGAAP, these deficits were charged against previous revaluations held in the revaluation reserve.
Under IFRS, these downward revaluations have been taken as indicators that the value of the
relevant properties is impaired and as such, they have been charged to the income statement as

30

impairment charges in 2004. This reduces the profit for the year ended 31 December 2004 and the
value of property, plant and equipment as at 31 December 2004 by 1.8 million.
Panel B: Fair value under both UK-GAAP and IFRS
Annual report according to UK-GAAP for 2004
The Wolverhampton & Dudley Breweries, PLC Annual report 2005 (page 44).
(e) Tangible fixed assets

Freehold and leasehold properties are stated at valuation or at cost. Plant, furnishings, equipment,
and other similar items are stated at cost.
Freehold buildings are depreciated to their residual value on a straight line basis over 50 years.
Other tangible fixed assets are depreciated to their residual value on a straight line basis at rates
calculated to provide for the cost of the assets over their anticipated useful lives. Leasehold
properties are depreciated over the lower of the lease period and 50 years and other tangible
assets over periods ranging from three to 15 years.
Own labor directly attributable to capital projects is capitalized.

Valuation of properties: Trading properties are revalued professionally by independent valuers on a fiveyear rolling basis. When a valuation or expected proceeds are below current carrying value, the asset
concerned is reviewed for impairment. Impairment losses are charged directly to the revaluation reserve
until the carrying amount reaches historical cost. Deficits below historical cost are charged to the profit
and loss account except to the extent that the value in use exceeds the valuation, in which case this is
taken to the revaluation reserve. Surpluses on revaluation are recognized in the revaluation reserve, except
to the extent that they reverse previously charged impairment losses, in which case they are recorded in
the profit and loss account. Any negative valuations are accounted for as onerous leases and included
within provisions (see note 20).
Annual report according to IFRS for 2005
The Wolverhampton & Dudley Breweries, PLC Annual report 2006 (page 46).
Property, plant and equipment

Freehold and leasehold properties are stated at valuation or at cost. Plant, furnishings, equipment,
and other similar items are stated at cost.
Depreciation is charged to the income statement on a straight-line basis to provide for the cost of
the assets less residual value over their useful lives.
Freehold and long leasehold buildings are depreciated to residual value over 50 years.
Short leasehold properties are depreciated over the life of the lease.
Other plant and equipment is depreciated over periods ranging from 3 to 15 years.
Own labor directly attributable to capital projects is capitalized.
Land is not depreciated.

Valuation of properties - Properties are revalued by qualified valuers on a regular basis using open market
value so that the carrying value of an asset does not differ significantly from its fair value at the balance
sheet date. When a valuation is below current carrying value, the asset concerned is reviewed for
impairment. Impairment losses are charged to the revaluation reserve to the extent that a previous gain
has been recorded, and thereafter to the income statement. Surpluses on revaluation are recognized in the
revaluation reserve, except where they reverse previously charged impairment losses, in which case they
are recorded in the income statement.

31

Panel C: Fair value accounting by German company

Annual report according to IFRS for 2005
Hypo Real Estate Group, Annual report 2006 (page 96)
12 Property, plant, and equipment
Property, plant, and equipment is normally shown at cost of purchase or cost of production. As an
exception to this rule, land and buildings are shown with their fair value in accordance with IAS 16. The
carrying amounts if the assets are subject to wear and tear are diminished by depreciation in
accordance with the expected service life of the assets. In the case of fittings in rented buildings, the
contract duration taking account of extension options is used as the basis of this contract duration is
shorter than the economic life.
Appendix B: Variable definitions
Fair_IFRS = one if the company uses fair value after adoption of IFRS, and zero otherwise.
UK = one if a company is domiciled in the UK, and zero otherwise.
UkSic65 = one if a company has SIC 65 (real estate) among its first five SIC codes and is domiciled in the
UK, and zero otherwise.
Germany = one if a company is domiciled in Germany, and zero otherwise.
GermanySic65 = one if a company has SIC 65 (real estate) among its first five SIC codes and is domiciled
in Germany, and zero otherwise.
Early = one if the company adopted IFRS before 2005, and zero otherwise.
Size = log of market value of equity.
PPEA = property, plant, and equipment less revaluation reserve divided by total assets less revaluation
reserve.
MktLev = total liabilities divided by market value of assets (defined as book value of liabilities plus
market value of equity) as of December 2005.
MktLevLong = long-term debt divided by market value of assets (liabilities plus market value of equity)
as of December 2005.
MktLevShort = short-term liabilities defined as total liabilities less long-term debt divided by market
value of assets (liabilities plus market value of equity) as of December 2005.
LevBook = book leverage defined as total liabilities divided by total assets net of fair value revaluation
reserve.
LevBookLong = long-term debt divided by total assets net of fair value revaluation reserve.
LevBookShort = ratio of total liabilities minus long-term debt to total assets net of fair value revaluation
reserve.
Convertible = ratio of convertible debt to long-term debt.
DebtToOi = total liabilities divided by operating income.
Coverage = operating income divided by interest expense.
Current = current assets divided by current liabilities.
Dividend = one if company pays dividends, and zero otherwise.

32

RE = retained earnings scaled by the market value of equity plus total liabilities.
D(RE<0) = one if retained earnings are negative, and zero otherwise.
FairInvPr = one if company holds investment property recorded at fair value, and zero otherwise.
DbtIss1 = change in total liabilities that took place from 2005 to 2007 scaled by beginning-of-period
market value of assets (liabilities plus market value of equity).
DbtIss2 = change in long-term debt that took place from 2005 to 2007 scaled by beginning-of-period
market value of assets (liabilities plus market value of equity).
FtrLev1 = total liabilities as of 2007 scaled by beginning-of-period market value of assets (liabilities plus
market value of equity).
FtrLev2 = long-term debt as of 2007 scaled by beginning-of-period market value of assets (liabilities plus
market value of equity).
DbtGrow1 = logarithmic growth in total liabilities from 2005 to 2007.
DbtGrow2 = logarithmic growth in long-term debt from 2005 to 2007.
EqIss1 = dummy variable; one if total net proceeds from issuance of common and preferred stock less
proceeds from stock options over 2006 and 2007 exceeded 10% of 2005 market value of assets
(liabilities plus market value of equity), and zero otherwise.
EqIss2 = net proceeds from issuance of common and preferred stock less proceeds from stock options
combined over 2006 and 2007 and scaled by 2005 market value of assets (liabilities plus market
value of equity).
Note: Unless otherwise stated, variables are measured as of December 2005 using the Worldscope
database.
Appendix C: Fair value accounting and the book value of assets
Companies that follow historical cost accounting must periodically test their assets for
impairment. An asset is considered impaired under IFRS when its carrying amount is higher than (i) its
fair value less costs to sell and (ii) the present value of future cash flows it is expected to generate
(IAS36.18). Thus, under historical cost accounting, companies will in practice value assets close to fair
value if depreciated historical cost exceeds fair value. In contrast, under fair value accounting, companies
revalue assets either upward or downward depending on the change in the fair value estimate. This
implies that book values of assets (equity) are likely to be higher for companies that use fair value
accounting. To provide evidence on the differences in balance sheet amounts of fair value versus
historical cost companies, we carry out the following analysis. 17
Table 6 compares the book value of total assets (book value of equity) divided by the market
value of total assets (market value of equity) for companies that use fair value with that of companies that
use only historical cost. 18 Panel A of Table 1C presents the evidence for investment property, and Panel B
of Table 1C presents the evidence for property, plant, and equipment. Each company that recognizes
property, plant, and equipment at fair value is matched, on country, industry, and market capitalization,
with a company that recognizes all assets at historical cost. For investment property, we include all
companies that hold investment property because there is no pronounced imbalance between the fair
17

We emphasize that one should not interpret these results as causal because they are conditional on the companys
decision to use fair value.
18
We proxy the market value of total assets by the sum of the market value of equity and the book value of
liabilities.

33

value and historical cost subgroups. We find that, on average, the ratio of book value of total assets to
market value of total assets is 16% higher for companies that recognize investment property at fair value;
the ratio of book value of equity to market value of equity is 27% higher. Among companies that apply
fair value to property, plant, and equipment, we find that the ratio of book value of total assets to market
value of total assets and the ratio of book value of equity to market value of equity are, respectively, 31%
and 87% higher than those of matched companies that use only historical cost. The differences in the
book values of assets and equity in both the investment property and property, plant, and equipment
samples are all significant at the 1% level. We also examine how return on assets (ROA) differs between
fair value and historical cost companies. We find a lower ROA in the property, plant, and equipment
sample among companies that recognize assets at fair value. In the investment property sample, we also
find a lower ROA among companies that use fair value accounting; this difference, however, is
statistically insignificant.19
[Insert Table 1C here]
The evidence in Table 6 indicates that the decision to use the fair value method is associated with
economically significant differences in companies balance sheets, which makes companies that use fair
value accounting appear less conservative in terms of their book-to-market ratios.

19

It is not surprising that fair value accounting for property decreases ROA because while, on average, fair value
accounting increases the book value of assets, upward revaluations do not affect the net income. For investment
property this effect is smaller because upward revaluations increase both net income and total assets (see Section 2).

34

Table 1: Sample selection process

Table 1 presents the sample selection process and industry distribution. Panel A presents the selection process for
the UK samples. The cross-sectional sample consists of companies for which we can identify an annual report
according to IFRS. Our switch sample further requires that an annual report (according to UK-GAAP) be available
prior to mandatory IFRS adoption. Panel B presents the selection process for the German sample. To be included in
the German sample, companies must have available an annual report according to IFRS. Percentages are rounded
and thus may not exactly sum to 100%.
Panel A: UK samples
Active companies (FBRIT, March 2008)
Inactive companies (DEADUK, March 2008)
UK listed companies in Worldscope

2,312
+ 5,597
7,909

Companies that Worldscope does not classify as complying with

IFRS in 2005 or 2006 (mainly inactive companies)
IFRS companies

6,464
1,445

Companies not domiciled in the UK

UK companies subject to mandatory IFRS

270
1,175

Companies for which we cannot identify an IFRS annual report

or companies with more than one security listed on LSE
UK Cross-Sectional Sample

241
934

Companies for which we cannot identify a UK-GAAP annual report

UK Switch Sample

231
703

Industry distribution in the UK samples

N/A No industry classification

13 Aerospace
16 Apparel
19 Automotive
22 Beverages
25 Chemicals
28 Construction
31 Diversified
34 Drugs, Cosmetics, & Health care
37 Electrical
40 Electronics
43 Financial
46 Food
49 Machinery & equipment
52 Metal producers
55 Metal product manufacturers
58 Oil, gas, coal, & related services
61 Paper
64 Printing & publishing
67 Recreation
70 Retail
73 Textile
76 Tobacco
79 Transportation
82 Utilities
85 Other industries

UK
Worldscope
All All Excl. N/A
obs. %
%
3,139 40%
19
0%
0%
42
1%
1%
44
1%
1%
50
1%
1%
106 1%
2%
234 3%
5%
48
1%
1%
178 2%
4%
55
1%
1%
539 7%
11%
674 9%
14%
107 1%
2%
141 2%
3%
213 3%
4%
63
1%
1%
251 3%
5%
44
1%
1%
92
1%
2%
294 4%
6%
211 3%
4%
53
1%
1%
10
0%
0%
73
1%
2%
232 3%
5%
997 13%
21%

Total

7,909 100%

No. Industry name

100%

UK
IFRS

UK
Cross-sectional

UK
Switch

Obs.

Obs.

Obs.

11
7
6
11
24
65
8
52
13
136
187
27
22
59
15
64
9
25
51
56
10
6
19
62
230

1%
1%
1%
1%
2%
5%
1%
4%
1%
11%
16%
2%
2%
6%
1%
6%
1%
2%
4%
4%
1%
0%
2%
6%
18%

5
7
6
7
20
54
6
44
10
109
140
23
22
49
12
52
6
19
41
51
8
3
17
31
192

1%
1%
1%
1%
2%
6%
1%
5%
1%
12%
15%
2%
2%
5%
1%
6%
1%
2%
4%
5%
1%
0%
2%
3%
21%

5
6
5
5
18
49
6
31
6
90
105
21
16
23
11
29
5
16
32
43
6
3
14
23
135

1%
1%
1%
1%
3%
7%
1%
4%
1%
13%
16%
3%
2%
3%
2%
4%
1%
2%
5%
6%
1%
0%
2%
3%
19%

1,175

100%

934

100%

703

100%

(Table 1 continued)
Panel B: The German sample
Active companies (March 2008)
Inactive companies (March 2008)
German listed companies in Worldscope

1,437
+ 10,126
11,563

Companies that Worldscope does not classify as complying with

IFRS in 2005 or 2006 (mainly inactive companies)
IFRS companies

10,117
1,446

Companies not domiciled in Germany

German companies subject to mandatory IFRS

635
811

Companies for which we cannot identify an IFRS annual report

German sample

206
605

Industry distribution in the German sample

No.

Industry name

N/A
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
70
73
76
79
82
85

No industry classification
Aerospace
Apparel
Automotive
Beverages
Chemicals
Construction
Diversified
Drugs, Cosmetics, & Health care
Electrical
Electronics
Financial
Food
Machinery & equipment
Metal producers
Metal product manufacturers
Oil, gas, coal, & related services
Paper
Printing & publishing
Recreation
Retail
Textile
Tobacco
Transportation
Utilities
Other industries

Total

All
obs.
2,192
25
72
99
93
207
235
74
610
143
1,832
1,430
154
324
251
108
323
69
78
371
350
46
16
148
497
1,816
11,563

German
Worldscope
All
Excl. N/A
%
%
19%
N/A
0%
0%
1%
1%
1%
1%
1%
1%
2%
2%
2%
3%
1%
1%
5%
7%
1%
2%
16%
20%
12%
15%
1%
2%
3%
3%
2%
3%
1%
1%
3%
3%
1%
1%
1%
1%
3%
4%
3%
4%
0%
0%
0%
0%
1%
2%
4%
5%
16%
19%
100%

100%

German
IFRS

German
Sample

Obs.
N/A
2
19
18
11
34
34
12
36
21
95
131
11
69
1
10
9
9
6
30
23
8
0
10
25
187

%
N/A
0%
2%
2%
1%
4%
4%
1%
4%
3%
12%
16%
1%
9%
0%
1%
1%
1%
1%
4%
3%
1%
0%
1%
3%
23%

Obs.
N/A
1
11
10
9
16
22
8
25
13
78
96
8
54
1
6
5
6
6
25
17
5
0
7
20
156

%
N/A
0%
2%
2%
1%
3%
4%
1%
4%
2%
13%
16%
1%
9%
0%
1%
1%
1%
1%
4%
3%
1%
0%
1%
3%
26%

811

100%

605 100%

Table 2: UK companies' valuation practices after IFRS adoption

Table 2 presents valuation practices among companies in the UK cross-sectional sample (defined in Table 1). The
industry classification is based on Worldscope's major industry groups. The "With PPE" ("With intan.") column presents
for each industry how many companies have property, plant, and equipment (intangible assets). The historical cost (fair
value) columns present how many companies use historical cost (fair value) for at least one asset class within property,
plant, and equipment and intangible assets.
CrossNo. Industry name

Property, Plant, and Equipment

Intangible assets

sectional

With

Historical

Fair

With

Historical

Fair

sample

PPE

cost

value

intan.

cost

value

No.

No.

No.

No.

No.

No. %

13

Aerospace

100%

0%

100%

0%

16

Apparel

100%

14%

100%

0%

19

Automotive

100%

0%

100%

0%

22

Beverages

100%

14%

100%

0%

25

Chemicals

20

20

20

100%

5%

20

20

100%

0%

28

Construction

54

54

54

100%

7%

39

39

100%

0%

31

Diversified

100%

0%

100%

0%

34

Drugs, Cosmetics, & Health care

44

44

44

100%

0%

44

44

100%

0%

37

Electrical

10

10

10

100%

0%

10

10

100%

0%

40

Electronics

109

107

107 100%

1%

100

100 100%

0%

43

Financial

140

118

118 100%

16 14%

68

68

100%

0%

46

Food

23

23

23

100%

9%

23

23

100%

0%

49

Machinery & equipment

22

22

22

100%

5%

22

22

100%

0%

52

Metal producers

49

44

44

100%

2%

44

44

100%

0%

55

Metal product manufacturers

12

12

12

100%

8%

12

12

100%

0%

58

Oil, gas, coal, & related services

52

52

52

100%

2%

50

50

100%

0%

61

Paper

100%

0%

100%

0%

64

Printing & publishing

19

19

19

100%

0%

16

16

100%

0%

67

Recreation

41

41

41

100%

2%

36

36

100%

0%

70

Retail

51

50

50

100%

6%

40

40

100%

0%

73

Textile

100%

13%

100%

0%

76

Tobacco

100%

0%

100%

0%

79

Transportation

17

17

17

100%

6%

17

17

100%

0%

82

Utilities

31

31

31

100%

0%

31

31

100%

0%

85

Other industries

192

191

191 100%

3%

185

185 100%

0%

934

903

903 100%

42

5%

805

805 100%

0%

Total Sample

Table 3: UK companies valuation practices before and after IFRS adoption

Table 3 presents valuation practices among companies in the UK switch sample (defined in Table 1). The industry
classification is based on Worldscope's major industry groups. The "With PPE" ("With inv. prop.") column presents for
each industry how many companies have property, plant, and equipment (investment property). The historical cost (fair
value) columns present how many companies use historical cost (fair value) for at least one asset class within property,
plant, and equipment and intangible assets.
1

As a percentage of companies that use fair value accounting under UK-GAAP.

As a percentage of companies that use only historical cost under UK-GAAP.
3
Given that UK-GAAP requires that investment property be recognized at fair value, the application of historical cost always
constitutes a switch. Therefore, in Table 3, we use the UK cross-sectional sample for investment property.
2

No. Industry name

13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
70
73
76
79
82
85

Property, plant, and equipment

Investment property
Switch With
Fair value
Switch to Switch to Cross- With Keep
Move to
sample PPE UK
IFRS historical cost fair value sectional inv. fair value historical cost
No. % No. % No. % 1 No. % 2 sample 3 prop. No. % No.
%

Aerospace
5
Apparel
6
Automotive
5
Beverages
5
Chemicals
18
Construction
49
Diversified
6
Drugs, Cosmetics, & Health care 31
Electrical
6
Electronics
90
Financial
105
Food
21
Machinery & equipment
16
Metal producers
23
Metal product manufacturers
11
Oil, gas, coal, & related services 29
Paper
5
Printing & publishing
16
Recreation
32
Retail
43
Textile
6
Tobacco
3
Transportation
14
Utilities
23
Other industries
135

Total Sample

703

5
6
5
5
18
49
6
31
6
89
90
21
16
22
11
29
5
16
32
42
6
3
14
23
135

0
1
1
1
1
6
0
1
0
1
13
2
0
0
0
1
0
0
2
4
1
0
0
1
8

0%
17%
20%
20%
6%
12%
0%
3%
0%
1%
14%
10%
0%
0%
0%
3%
0%
0%
6%
10%
17%
0%
0%
4%
6%

0
1
0
1
1
4
0
0
0
1
10
1
1
0
1
1
0
0
1
2
1
0
1
0
4

0%
17%
0%
20%
6%
8%
0%
0%
0%
1%
11%
5%
6%
0%
9%
3%
0%
0%
3%
5%
17%
0%
7%
0%
3%

0
0
1
0
0
3
0
1
0
0
6
1
0
0
0
0
0
0
1
2
0
0
0
1
4

N/A
0%
100%
0%
0%
50%
N/A
100%
N/A
0%
46%
50%
N/A
N/A
N/A
0%
N/A
N/A
50%
50%
0%
N/A
N/A
100%
50%

0
0
0
0
0
1
0
0
0
0
3
0
1
0
1
0
0
0
0
0
0
0
1
0
0

0%
0%
0%
0%
0%
2%
0%
0%
0%
0%
4%
0%
6%
0%
9%
0%
0%
0%
0%
0%
0%
0%
7%
0%
0%

5
7
6
7
20
54
6
44
10
109
140
23
22
49
12
52
6
19
41
51
8
3
17
31
192

2
0
1
1
0
10
1
0
1
3
66
2
1
1
0
3
1
0
1
9
2
0
2
3
14

1
0
1
0
0
7
1
0
1
1
65
1
0
0
0
3
0
0
0
1
1
0
2
1
10

50%
N/A
100%
0%
N/A
70%
100%
N/A
100%
33%
98%
50%
0%
0%
N/A
100%
0%
N/A
0%
11%
50%
N/A
100%
33%
71%

1
0
0
1
0
3
0
0
0
2
1
1
1
1
0
0
1
0
1
8
1
0
0
2
4

50%
N/A
0%
100%
N/A
30%
0%
N/A
0%
67%
2%
50%
100%
100%
N/A
0%
100%
N/A
100%
89%
50%
N/A
0%
67%
29%

685 44 6% 31 5% 20

44%

1%

934

124 96 77% 28

23%

38

Table 4: German companies valuation practices after IFRS adoption

Table 4 presents valuation practices among companies in the German sample (defined in Table 1). The industry
classification is based on Worldscope's major industry groups. The "With PPE" ("With inv. prop.") ["With intan."] column
presents for each industry how many companies have property, plant, and equipment (investment property) [intangible
assets]. The historical cost (fair value) columns present how many companies use historical cost (fair value) for at least one
asset class within property, plant, and equipment and intangible assets.
Property, plant and equipment
No. Industry name

Investment property

Sample With

Fair

Historical

With

Fair

Historical

PPE

value

cost

inv.

value

cost

No. % No.

prop. No. % No.

Intangibles
With

Fair

Historical

intan. value

cost

No. % No.

13 Aerospace

0%

1 100%

0 N/A

N/A

0 0% 1 100%

16 Apparel

11

11

0% 11 100%

0 N/A

N/A

11

0 0% 11 100%

19 Automotive

10

10

0% 10 100%

4 100%

22 Beverages

0%

9 100%

1 33% 2

25 Chemicals

16

16

0% 16 100%

28 Construction

22

22

0% 22 100%

1 13% 7

31 Diversified

0%

8 100%

34 Drugs, Cosmetics, & Health care

25

25

0% 25 100%

37 Electrical

13

13

0% 13 100%

40 Electronics

78

78

0% 78 100%

1 17% 5

43 Financial

96

96

3% 96 100%

57

0%
0%

10

0 0% 10 100%

67%

0 0% 9 100%

2 100%

16

0 0% 16 100%

88%

22

0 0% 22 100%

0%

7 100%

0 0% 8 100%

0%

4 100%

25

0 0% 25 100%

0%

3 100%

13

0 0% 13 100%

83%

77

0 0% 77 100%

28 49% 29 51%

87

0 0% 87 100%

46 Food

0%

8 100%

0 0% 8 100%

49 Machinery & equipment

54

54

2% 54 100%

11

2 18% 9

82%

54

0 0% 54 100%

52 Metal producers

0%

1 100%

0 N/A

N/A

0 0% 1 100%

55 Metal product manufacturers

1 17% 6 100%

0%

1 100%

0 0% 6 100%

58 Oil, gas, coal, & related services

0%

5 100%

0%

1 100%

0 0% 4 100%

61 Paper

0%

6 100%

0%

1 100%

0 0% 6 100%

64 Printing & publishing

0%

6 100%

0%

3 100%

0 0% 6 100%

67 Recreation

25

25

0% 25 100%

0 N/A

25

0 0% 25 100%

70 Retail

17

17

6% 17 100%

0%

8 100%

17

0 0% 17 100%

73 Textile

0%

5 100%

0%

3 100%

0 0% 5 100%

76 Tobacco

0 N/A

0 N/A

0 N/A 0

79 Transportation

0%

7 100%

0%

3 100%

0 0% 7 100%

N/A

0%

1 100%

N/A

N/A

N/A

82 Utilities

20

20

0% 20 100%

0%

6 100%

20

0 0% 20 100%

85 Other industries

156

156 1

1% 155 99%

19

5% 18 95%

154

0 0% 154 100%

Total Sample

605

605 7

1% 604 100%

151 34 23% 117 77%

592

0 0% 592 100%

39

Table 5: Asset classes and the application of fair value accounting

Table 5 presents evidence regarding which asset classes under property, plant, and equipment are recognized at fair value.
The No. columns present the number of companies that recognize assets at fair value within the respective asset classes.
The % columns present the values in the No. columns as a percentage of those companies in the UK, Germany, and the full
sample that use fair value for any class of assets under property, plant, and equipment.
1

Includes companies that use fair value under UK-GAAP or IFRS, or both.

United Kingdom
No.

Germany

Full sample

No.

No.

62

100%

100%

69

100%

Property

58

94%

86%

64

93%

Plant

3%

0%

3%

Equipment
PPE in general

0
2

0%
3%

0
1

0%
14%

0
3

0%
4%

Companies that use fair value for PPE

Divided according to asset classes:

40

Table 6: Summary statistics for logistic regression analysis

Table 6 presents summary statistics for three subsamples used in the logistic regression analysis presented in Tables 7
through 9. All variables are defined in Appendix B. Information regarding the use of fair value is hand-collected from
companies annual reports in Thompson One Banker. The data is taken from the Worldscope database as of December
2005. Panel A presents a sample of 275 companies (124 companies in the UK and 151 companies in Germany) that hold
investment property. Panel B presents a matched sample of companies that began using fair value after IFRS adoption.
We match each fair value company with historical cost companies on country, two-digit industry group, and the log of
market value of equity and take the closest match. This procedure, which requires non-missing market value of equity,
yields 90 observations. In Panel C, we match companies that use fair value for property, plant, and equipment during at
least one of the periods (i.e., either before IFRS adoption, after IFRS adoption, or both) with an equal sample of
companies that use historical cost both before and after IFRS adoption. Matches based on industry and log of market
valuation yield 102 observations. Note that requiring non-missing values for a particular variable often further limits the
sample.
Variable

Mean

Std. Dev.

Q25

Median

Q75

Obs.

Panel A: Investment Property subsample

Fair_IFRS

0.473

0.500

275

UkSic65

0.225

0.419

275

Germany

0.549

0.498

275

GermanySic65

0.189

0.392

275

Early

0.229

0.421

275

Size

12.550

2.257

10.908

12.502

14.119

245

MktLev

0.524

0.250

0.330

0.521

0.708

244

MktLevShort

0.356

0.245

0.164

0.301

0.514

244

MktLevLong

0.168

0.168

0.028

0.120

0.268

244

Convertible

0.055

0.387

180

DebtToOI

1.119

2.147

0.074

1.349

2.512

199

Coverage

1.330

1.725

0.259

1.200

2.183

210

Current

0.307

0.574

0.029

0.254

0.604

152

DivDum

0.761

0.427

276

RE

0.056

0.634

0.015

0.079

0.195

243

D(RE<0)

0.156

0.363

276

DbtIss1

0.562

0.497

276

DbtIss2

0.380

0.486

276

FtrLev1

0.924

1.639

0.376

0.613

0.928

230

FtrLev2

0.494

1.143

0.062

0.240

0.557

229

DbtGrow1

0.413

1.119

0.031

0.195

0.582

253

DbtGrow2

0.257

1.229

0.205

0.155

0.705

215

EqIss1

0.093

0.292

182

EqIss2

0.052

0.255

0.000

0.008

182

Panel B: Property Plant and Equipment subsample

FAIR_IFRS

0.517

0.503

87

12.037

2.114

10.2709

11.992

13.668

87

PPEA

0.316

0.314

0.027

0.217

0.479

87

Btm

0.576

0.351

0.3541

0.474

0.859

87

MktLev

0.498

0.235

0.3319

0.474

0.626

87

MktLevShort

0.365

0.239

0.1550

0.322

0.504

87

MktLevLong

0.132

0.165

0.011

0.067

0.170

87

BookLev

0.633

0.227

0.436

0.656

0.807

87

Size

41

BookLevShort

0.469

0.254

0.267

0.463

0.649

87

BookLevLong

0.164

0.194

0.015

0.092

0.237

87

Convertible

0.019

0.108

87

FairInvPr

0.253

0.437

0.000

0.000

1.000

87

DiviDum

0.828

0.380

1.000

1.000

1.000

87

RE
D(RE<0)

0.082
0.149

0.394
0.359

0.023
0

0.095
0

0.215
0

86
87

42

Table 7: Choice of fair value for investment property group

Table 7 presents estimates from the logistic regression of the IFRS fair value indicator on a set of company-specific
variables. All variables are defined in Appendix B. Information on the use of fair value is hand-collected from companies
annual reports in Thompson One Banker. The data is taken from Worldscope database as of December 2005. The sample
consists of 275 companies (124 UK companies; 151 German companies) that hold investment property. Requiring nonmissing values for explanatory variables further limits the sample in some specifications. ***, **, * indicate statistical
significance at less than 1%, 5%, and 10%, respectively.
Variables
UK (constant)

UkSic65

Germany

GermanySic65

(1)

(2)

(3)

(4)

(5)

(6)

0.460*
[1.759]
[0.079]
2.215***
[3.818]
[0.000]
2.539***
[6.142]
[0.000]
1.848***
[4.344]
[0.000]

1.24
[0.949]
[0.343]
2.115***
[3.436]
[0.001]
3.822***
[6.133]
[0.000]
1.893***
[3.586]
[0.000]
1.320**
[2.551]
[0.011]
0.158*
[1.680]
[0.093]
2.681***
[3.400]
[0.001]

1.37
[0.857]
[0.391]
2.792***
[3.231]
[0.001]
4.735***
[4.808]
[0.000]
1.776**
[2.284]
[0.022]
1.866**
[2.174]
[0.030]
0.214*
[1.789]
[0.074]

3.084**
[2.011]
[0.044]
1.873**
[2.140]
[0.032]
4.242***
[5.374]
[0.000]
1.672***
[2.714]
[0.007]
1.543***
[2.625]
[0.009]
0.202*
[1.914]
[0.056]

4.153***
[2.595]
[0.009]
1.425**
[1.996]
[0.046]
4.437***
[5.707]
[0.000]
1.632***
[2.675]
[0.007]
1.462**
[2.486]
[0.013]
0.204**
[1.991]
[0.046]

4.456**
[2.120]
[0.034]
2.090**
[2.432]
[0.015]
3.471***
[3.743]
[0.000]
0.298
[0.302]
[0.763]
1.151
[1.154]
[0.249]
0.370**
[2.210]
[0.027]

Early

Size

MktLev

MktLevShort

3.381***
[3.020]
[0.003]
4.090**
[1.966]
[0.049]
3.841**
[2.366]
[0.018]

MktLevLong

Convertible

DebtToOi

0.337**
[2.197]
[0.028]

Coverage

0.380***
[2.585]
[0.010]

Current

Observations
Pseudo R-squared

0.820*
[1.789]
[0.074]
275
0.335

244
0.409

172
0.508

182
0.437

192
0.426

140
0.434

43

Table 8: Future financing and the use of fair value accounting

Table 8 presents estimates from OLS regression of future financing choices on the IFRS fair value indicator and a set of
company-specific controls. All variables are defined in Appendix B. Information on the use of fair value is hand-collected
from companies annual reports in Thompson One Banker. All other data is taken from the Worldscope database between
December 2005 and 2007. The sample consists of 275 companies (124 UK companies; 151 German companies) that hold
investment property. Requiring non-missing values for explanatory variables further limits the sample in some
specifications. ***, **, * indicate statistical significance at less than 1%, 5%, and 10%, respectively.
(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

Variable

DbdIss1

DbtIss2

FtrLev1

FtrLev2

DbtGrow1

DbtGrow2

EqIss1

EqIss2

Fair

0.181**

0.130*

0.665*

0.357*

0.444***

0.445**

0.0512

0.0356

[2.084]

[1.706]

[1.729]

[1.898]

[2.724]

[1.973]

[1.014]

[0.919]

[0.038]

[0.089]

[0.085]

[0.059]

[0.007]

[0.050]

[0.312]

[0.359]

-0.0592

-0.105

-0.593

-0.245

-0.362**

-0.322

-0.0319

-0.0172

[-0.714]

[-1.437]

[-1.552]

[-1.358]

[-2.256]

[-1.450]

[-0.728]

[-0.751]

[0.476]

[0.152]

[0.122]

[0.176]

[0.025]

[0.149]

[0.467]

[0.454]

0.0399***

-0.00716

-0.0801

-0.0418

0.016

0.0222

-0.0216**

-0.0157

[2.798]

[-0.609]

[-1.451]

[-1.098]

[0.677]

[0.476]

[-1.978]

[-1.591]

[0.006]

[0.543]

[0.148]

[0.273]

[0.499]

[0.635]

[0.050]

[0.113]

-0.133

-0.111

-0.155

0.0984

-0.985***

-1.179**

-0.0642

-0.101

[-1.032]

[-0.976]

[-0.226]

[0.220]

[-3.586]

[-2.424]

[-0.780]

[-0.961]

[0.303]

[0.330]

[0.821]

[0.826]

[0.000]

[0.016]

[0.436]

[0.338]

0.0905

0.209***

0.115

0.351***

0.03

0.155

0.00779

0.0366

[1.258]

[3.159]

[0.746]

[3.234]

[0.304]

[0.758]

[0.136]

[1.225]

[0.210]

[0.002]

[0.457]

[0.001]

[0.761]

[0.449]

[0.892]

[0.222]

-0.0199

0.350**

1.936*

0.778

0.56

0.48

0.391**

0.282

[-0.104]

[2.233]

[1.817]

[1.161]

[1.360]

[0.815]

[2.573]

[1.638]

[0.434]

[0.111]

[0.115]

[0.126]

[0.024]

[0.122]

[0.462]

[0.373]

244
0.06

244
0.091

230
0.055

229
0.067

230
0.116

197
0.07

182
0.042

182
0.052

UK

Size

MktLev

Sic65

Constant

Observations
R-squared

44

Table 9: Use of fair value for property, plant, and equipment

Table 9 presents estimates from the logistic regression of the IFRS fair value indicator on a set of company specific
variables. All variables are defined in Appendix B. Information on the use of fair value is hand-collected from companies
annual reports in Thompson One Banker. The data is taken from the Worldscope database as of December 2005. The
results are based on a matched sample of companies that began using fair value after IFRS adoption. We match each fair
value company to historical cost companies on country, two-digit industry group, and the log of market value of equity and
take the closest match. This procedure, which requires non-missing market value of equity, yields 90 observations.
Requiring non-missing values for other explanatory variables further limits the sample. ***, **, * indicate statistical
significance at less than 1%, 5%, and 10%, respectively.
Variable
PPEA

Btm

MktLev

(1)

(2)

(3)

(4)

(5)

1.066
[1.391]

1.527*
[1.691]

1.048
[1.356]

1.302
[1.408]

0.923
[1.179]

[0.164]

[0.091]

[0.175]

[0.159]

[0.239]

1.075

1.136

1.892**

2.147**

0.642

[1.519]

[1.529]

[2.395]

[2.527]

[0.853]

[0.129]

[0.126]

[0.017]

[0.011]

[0.394]

2.276**

1.899*

[2.349]

[1.919]

[0.019]

[0.055]

MktLevShort

3.292***
[2.722]
[0.006]

MktLevLong

1.132
[0.759]
[0.448]

Convertible

-5.988**

-5.703**

[-2.439]

[-2.411]

[0.015]

[0.016]

LevBook

2.530**
[2.338]
[0.019]

LevBookShort

3.310***
[2.678]
[0.007]

LevBookLong

2.075
[1.465]
[0.143]

FairInvPr

0.96
[1.547]
[0.122]

Constant

Observations
Pseudo R-squared

-2.014***

-2.331***

-2.946***

-3.384***

-1.751**

[-2.787]

[-3.080]

[-2.785]

[-3.008]

[-2.391]

[0.005]

[0.002]

[0.005]

[0.003]

[0.017]

87
0.0734

87
0.106

87
0.0737

87
0.106

87
0.0982

45

Table 1C: The effect of fair value accounting on asset values

Table 1C illustrates the differences in the book value of assets for fair value vs. historical cost companies. Information
regarding the use of fair value is hand-collected from companies annual reports in Thompson One Banker. The data is
taken from the Worldscope database as of December 2005. Panel A presents a sample of 275 companies (124 UK
companies; 151 German companies) that hold investment property. Panel B is based on a matched sample of companies
that began using fair value after IFRS adoption. We match each fair value company with historical cost companies on
country, two-digit industry group, and the log of market value of equity, and take the closest match. This procedure,
which requires non-missing market value of equity, yields 90 observations. BTM is book value of equity divided by the
market value of equity, TA is total value of assets, MKT(TA) is market value of assets plus book value of liabilities,
ROA is return on assets, and PPE/MKT(EQUITY) is book value of property, plant, and equipment divided by the market
value of equity.
Statistics

BTM

TA/MKT(TA)

ROA

Historical cost mean

0.68

0.80

5.75

Fair value mean

0.87

0.93

4.98

PPE/MKT(EQUITY)

Panel A: Investment property

Mean:

Difference

0.18

0.13

0.77

26.78

16.11

13.46

t-stat

3.24

4.20

0.56

p-value

0.001

0.000

0.574

0.64

0.83

4.81

Median:
Historical cost median
Fair value median

0.88

0.97

3.79

Difference

0.25

0.14

1.02

38.55

16.45

21.12

z-stat

3.74

4.56

1.12

p-value

0.00

0.00

0.26

0.50

0.71

7.47

Panel B: Property, plant, and equipment

Mean:
Historical cost mean

0.40

Fair value mean

0.94

0.93

4.33

0.94

Difference

0.43

0.22

3.14

0.55

86.60

31.20

42.00

136.86

t-stat

4.40

4.06

2.24

2.81

p-value

0.00

0.00

0.14

0.01

Historical cost median

0.44

0.73

5.97

0.11

Fair value median

0.83

0.93

3.33

0.46

Median:

Difference

0.40

0.20

2.64

0.35

90.89

26.65

44.22

309.86

z-stat
p-value

3.91
0.00

3.60
0.00

1.83
0.07

3.12
0.00