Recognition versus Disclosure of Fair Values

• In Event: Concurrent Session 3.4: Disclosure and Consequences

Abstract

This paper examines the relative earnings informativeness of recognized versus disclosed fair values. While prior literature documents valuation differences across recognized versus disclosed financial information, it is silent on attributing such differences across two theoretical causes: lower reliability of the disclosed information, and/or its incomplete processing by investors. To address this issue, we use the unique setting of European real estate firms reporting under International Financial Reporting Standards, which require that the fair values of investment properties either be recognized on the balance sheet (“recognition firms”) or disclosed in the footnotes (“disclosure firms”). Using this latter disclosure, we obtain comparable earnings constructs that include unrealized fair value changes for both sets of firms. We find that fair value-based earnings is less informative for disclosure firms, consistent with greater noise in disclosed versus recognized fair values. Further evidence supports lower reliability of disclosed fair values―reflected in improved earnings informativeness for those disclosure firms using external appraisers to derive fair value estimates―but fails to support incomplete processing of disclosed information by
investors. Overall, these findings are consistent with lower reliability of disclosed fair values
explaining its lower earnings informativeness relative to recognized fair values.

Authors

• Maximilian A Mueller, WHU

• Edward Riedl, Boston University

• Thorsten Sellhorn, WHU