Value Relevance of FAS No. 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms

Abstract

Statement of Financial Accounting Standards No. 157 (FAS No. 157), Fair Value Measurements, prioritizes the source of information used in fair value measurements into three levels: (1) Level 1 (observable inputs from quoted prices in active markets), (2) Level 2 (indirectly observable inputs from quoted prices of comparable items in active markets, identical items in inactive markets, or other market-related information), and (3) Level 3 (unobservable, firm-generated inputs). Using quarterly reports of banking firms in 2008, we find that the value relevance of Level 1 and Level 2 fair values is greater than the value relevance of Level 3 fair values. In addition, we find evidence that the value relevance of fair values (especially Level 3 fair values) is greater for firms with strong corporate governance. Overall, our results support the relevance of fair value measurements under FAS No. 157, but weaker corporate governance mechanisms may reduce the relevance of these measures.

Cross-Country Differences in Disclosure Quality: A Study of Fair Value Disclosures by European Real Estate Companies.

“…Fair values of properties are normally Level 3 fair values according to the IFRS 13 classification. Level 3 fair values have been criticized for being vulnerable for manipulation and for being less value relevant than Level 1 and 2 fair values (e.g., Bernston 2006; Song et al 2010). However, high quality disclosures about methods used and assumptions applied arguably reduce information asymmetry problems between the firm and its stakeholders.…”

Value Relevance of Investment Properties’ Fair Value and Board Characteristics in Malaysian Real Estate Investment Trusts

“…However, the most common method used (Level 3 inputs 1 ) is too subjective as the fair value is determine based on the firms estimate of discounted future cash flows (MFRS 140, para 46C). However, this approach is less reliable as the value is not observable from the market (Danbolt & Rees 2008;Landsman 2007;Laux & Leuz 2009;Lefebvre et al 2009;Penman 2007;Song, Thomas & Yi 2010). Level 3 inputs require firms to make assumptions about the future cash flows associated with the asset and discount it using an appropriate discount rate.…”

The Politics of Fair Value Reporting and the Governance of the Standards-Setting Process: Critical Issues and Pitfalls from a European Perspective

“…assets with lower liquidity and greater information risk, than for mark-to-market assets. Likewise, Song et al (2010) provide evidence that Level 3 fair value measurements are valued less than Level 1 and Level 2 assets. Finally, Fiechter and Novotny-Farkas (2011) show that the value relevance of fair value assets decreased as the financial crisis worsened, which suggests increased uncertainty about the reliability of financial data.…”