Fair Value Measurements of Control Premiums

Abstract

Abstract:As the overview of the current state of research within this paper shows, the debate around fair value measurements is far from over. This paper analyses fair value measurement requirements in a controversial scenario, namely when a control premium exists. The analyses of the paper show that, while measurement rules around control premiums could have a material impact on fair value measurements and the financial statements as a whole, significant fair value measurement issues remain unresolved.The conclusion is that fair value measurements should include or exclude control premiums consistently. It is argued that including control premiums for all fair value measurements is the most faithful representation of the underlying economic phenomenon. This paper contributes to the fair value measurement debate by comparing the merits of alternative fair value measurements for control premiums and highlights an area where researchers, investors and other users should exercise caution when evaluating financial statements.

Fair value measurements of exchange-traded funds

“…However, as Badenhorst (2014) notes, only limited prior research has considered the merits of rival fair value measurements. Notable exceptions include So and Smith (2009) who find that fair value changes recognised in profit or loss are more value-relevant than those recognised in equity.…”

“…Other papers in this area include Song et al (2010) who determine that higher-ranked fair value measurements have greater value-relevance, as well as Cullinan and Zheng (2013) who find that the premium or discount to net asset value is affected by the fair value hierarchy of underlying investments for a sample of closed-end funds. More recently, Badenhorst (2014) evaluates the theoretical support for differing fair value measurement requirements for control premiums of listed and unlisted investments. However, alternative fair values for a single measurement scenario (within a single level of the fair value hierarchy) have not formed the explicit subject of prior research.…”

“…of exchangetraded funds closed-end funds. More recently, Badenhorst (2014) evaluates the theoretical support for differing fair value measurement requirements for control premiums of listed and unlisted investments. However, alternative fair values for a single measurement scenario (within a single level of the fair value hierarchy) have not formed the explicit subject of prior research.…”

Fair value intensity and analyst forecasts

“…As earnings and book values are interrelated, fair value accounting could also complicate book value forecasts. Furthermore, the rules under accounting standards limit the degree to which fair values can be recognised (Badenhorst 2014;Palea & Maino 2013) and fair value forecasts are about more than predicting future accounting data, as they must incorporate potential future changes in valuation multiples. The forecasts and equity valuations of all market participants cannot be investigated as they are not generally observable, but analysts provide book value and earnings forecasts for many firms.…”