Fair value or cost model?

Drivers of choice for IAS 40 in the real estate industry

ABSTRACT

We analyse the reasons which might impact the choice, within the real estate industry, of adopting either the fair value or the cost approach, as well

as investigating countries where the fair value model was not allowed for investment properties by pre-IFRS domestic GAAP. Using a sample of

European real estate companies from Finland, France, Germany, Greece, Italy, Spain, and Sweden, we show that information asymmetry usually

explains the choice while efficiency reasons have no bearing. Particularly, we find that the more the core business is based on renting out investment

properties, the more the future prospects of the property need to be disclosed, which in turn induces the firm to choose the fair value method in order

to reduce information asymmetry. Additionally, we find that the probability of choosing fair value decreases if the firm adopts the option of “fair

value as deemed cost” allowed by IFRS 1, demonstrating that accounting choices are not independent from each other.

This evidence consolidates progress in the accounting choice theory because it reveals, in such a context, the irrelevance of the usual relations

between accounting choice and firm variables like leverage and size to explain the choice. Our findings are also useful for standard setters. It

demonstrates that the choice of the fair value method, when optional, depends on firm specific factors, with an ensuing evaluation of the fair value

approach in a more relative way.

I. INTRODUCTION

Electronic copy available at: http://ssrn.com/abstract=1262205

The mandatory adoption of IAS 40 (Investment properties) for European listed companies offers a unique chance to verify managers’ behaviour.

IAS 40 gives two alternative methods for appraisal of investment property assets: the cost method or the fair value method with recognition of the

fair value changes in income statements.

Studying managers’ choices in this unique occasion could help to verify the current validity of the traditional accounting choice theory (Watts and

Zimmerman, 1990) using a multiple motivations approach (Fields et al. 2001). Additionally, the analysis of the reasons for choosing fair value are

of some interest for the current standard setting process.

In our study we try to understand the main drivers of this accounting choice. We focus on the real estate industry due to its relevance within the

property investment field and we investigate countries where the fair value model was not allowed for investment properties by pre-IFRS domestic

GAAP. Looking specifically at traditional cost-model countries enables us to study in more depth the possible reasons behind managers’ choices,

starting from the fact that each country adopts the same accounting treatment before the change we are focusing on. Our objective is to understand if

the fair value approach is chosen to reduce information asymmetries, as standard setters claim, or the choice is driven by efficiency reasons too.

According to previous literature on accounting choices (Fields et al., 2001), we suppose that company behaviour should be driven by efficiency

reasons and information asymmetry.

The former group considers the benefits for company value due to the reduction of contracting costs. In this sense fair value could be expected to

change some agency costs in a different way. On one hand, fair value increases the volatility of the reported profit thus enhancing political costs; on

the other, it conveys more updated information to company creditors concerning debt covenants, thus reducing contracting costs.

Electronic copy available at: http://ssrn.com/abstract=1262205

The second group regards fair value accounting as an instrument to reduce investors’ information asymmetry. In other words, the fair value method

may offer more relevant and updated information to investors than the cost model. In this perspective, a large information asymmetry could produce

pressure to move from the cost model to the fair value method.

Another reason that could influence the aforementioned IAS 40 accounting choice is the use of the IFRS 1 option in that it allows a revaluation of

fixed assets at the transition date (using the fair value as deemed cost). We expect that this option reduces the incentive towards fair value because

the accounting effects of IFRS 1 in the balance sheet can be seen as a partial alternative to the choice of the fair value method. In this sense we try to

evaluate the influence of an accounting choice on another option, both concerning fair value adoption.

Using a LOGIT regression, we test these hypotheses using 76 observations from real estate companies located in European countries (Finland,

France, Germany, Greece, Italy, Spain, and Sweden) adopting the cost method in the pre-IAS/IFRS mandatory period.

Our findings suggest that information asymmetry drives the choice. Specifically, we find that the more the core business is based on renting out

investment properties, the more there is a need to disclose its future prospects, which induces the companies to opt for the fair value method to

reduce information asymmetry. Additionally, we find that the probability of choosing the fair value approach increases if firms adopt fair value as

deemed cost when it adopts IAS/IFRS for the first time (FTA). By contrast, we do not find that efficiencies motives significantly influence the

choice of the fair value method.

This paper offers two contributions to the literature. First, it adds to the literature that investigates the reasons behind the accounting choice a

research designed to analyse different motivations (efficiencies and information asymmetries). Second, we contribute to the current debate on fair

value showing which firm characteristics drive the choice of this method.

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The paper proceeds as follows. Section II concerns the literature related to our analysis. Section III goes on to describe the main features of IAS 40

and the pre-IFRS domestic GAAP of the countries sampled. Section IV illustrates the development of our hypotheses while section V provides

details on the empirical model design, sample selection, and data. Finally, section VI describes descriptive statistics and the main findings.

II. THEORY AND RELATION TO EXISTING RESEARCH

This research is related to three streams of literature. First, it is related to studies concerning the comparison between cost and fair value. Second,

our subject is strictly linked to the accounting choice theory. Last, the studies dedicated to real estate companies accounting choices are taken into

consideration.

The choice between fair value and cost is a central topic in the current debate on accounting. After the move of the main standard setters towards

fair value (FASB with SFASs 157 and 159 e IASB with its project on Fair Value Measurement), the recent financial shock strengthens critics to

assess fair value, mainly from the political point of view (European banks, European Commission). Fair value is generally preferred due to the fact

that financial statements reveals a higher level of information (Barlev and Haddad, 2003; Ball 2006; Danboldt and Rees, 2008; see CFA 2008), even

if its adoption requires specific conditions: liquid markets, large data base of available prices, (Barth and Landsman, 1995; Ball, 2006), and new

competencies in developing measurement models in absence of liquid markets, in order to enhance reliability of its estimates (Schipper, 2005). On

the other hand, the reliability of fair value estimates is the most critical point (Watts, 2006; Martin, 2006; Whittington, 2008), with the potential

damage brought to the stewardship function of financial statements. However, some scholars cast doubts on the fair value information content.

Watts (Watts, 2006) states that fair value estimated by managers could never reach the information level of the whole financial market, due to the

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enormous number of market operators and consequent information contributing to determine the prices. In this perspective, financial accounting can

only produce “hard verifiable numbers” (based on the cost model) giving market operators the basis for their personal interpretation.

Other studies compare the pros and cons of fair value (Penman, 2007) and try to develop a more comprehensive accounting model (Ronen, 2008) or,

focusing on financial institutions, compare the consequences of the two accounting regimes (fair value and cost) using analytical models (Reis–

Stocken, 2007; Plantin et al., 2008) and evaluate the difference in value relevance (Khurana and Kim, 2003). These studies provide empirical

evidence supporting a stronger value relevance of fair value model versus cost model when fair values are obtained from liquid markets.

More generally, the demand for fair value has to be evaluated in its specific country context. The demand for fair value and the related preference

for a higher level of information versus reliability of financial statements in Common law Countries is quite different from the same demand in

Code law Countries (see Ball et al., 2000).

Recent studies, however, seem to ignore the importance that the analysis of IFRS evaluation alternatives could have in providing some more

explanations for managers’ accounting choices and, consequently, in the progress of accounting theory. Therefore, the choice between cost or fair

value is a central topic in this sense.

In the context of accounting choice theory, Watts and Zimmerman (1978) proposed and empirically demonstrated the relevance of two groups of

factors that could explain management’s accounting choices. The first group concerns the efforts to reduce the contractual costs due to agency

relationships (i.e. debt covenants, political costs) in order to boost the company value. The second group is related to managerial opportunism aimed

at capturing a part of this value for their personal wealth via the bonus plans (Christie and Zimmermann, 1994).

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Additionally, some studies also examined the impact of information asymmetry on accounting choice (Bartov and Bodnar, 1996). Managers could

provide private information through their accounting choice in order to influence the beliefs of rational investors or to meet the analysts’ earnings

forecast in order to avoid a negative stock price reaction. Information asymmetries and efficient contracting are thus reputed as being the main

drivers of the accounting choice (Fields et al., 2001).

Looking at asymmetries for market participants, fair value could be preferred to cost method because of its higher level of information (see above),

but concerning the impact of fair value on contracting costs, expectations derived from this theory could be controversial. The greater income

fluctuations induced by fair value could enhance the perceived risk by investors (ECB, 2004) and consequently the cost of capital, as the high level

of reported profits could increase political costs due to higher company visibility (Hagerman and Zmijewski, 1979). On the other hand, fair value

represents the current value of assets and it could be more efficient in negotiating for debt covenant.

Our objective is to test empirically how these multiple, and in part controversial, motivations (both agency costs and information asymmetries)

account for the choice of either fair value or the cost model due to the recent mandatory adoption of IFRS. In the typical discussion about IFRS, in

fact, the power of fair value is recognized especially regarding its potential to reduce information asymmetries (see Whittington, 2008).

Additionally, we are interested in the “fair value as deemed cost” option (IFRS 1), which allows a reappraisal of fixed assets at the first time

adoption date, to assess if it could have an influence on the choice of accounting method under IAS 40. The accounting effects of this IFRS 1 option,

at least on a balance sheet level, could be seen as an alternative to the choice of fair value in the initial decision about the evaluation method.

In our analysis of multiple stimuli in accounting choice (Francis, 2001), we posit a model based on the following group of variables: i) efficiency

reasons, such as advantages that managers could achieve through accounting numbers (decrease in the cost of capital, political costs etc.), ii)

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information asymmetry reasons, proxy for managers’ intentions to show clearly to the financial market the “true” value of the firm’s assets, iii) a

concurrent accounting choice with partially similar effects, the IFRS 1 option.

With reference to the fair value adoption in real estate industry, our research finds correlations with four studies. Firstly, Owusu-Ansah and Yeoh,

(2006) demonstrate the indifference in terms of value relevance of recognising property fair value changes in profit and loss accounts or directly in

equity under New Zealand GAAP. This study supports the inclusion of IFRS 1 option (fair value as deemed cost) as an “alternative” to fair value

method.

Muller et al. (2008) analyse the impact of IAS 40 on the cost capital (in terms of bid-ask spread) in a sample of 77 European real estate companies

and find that the IFRS mandatory adoption does not change the impact. Considering the pre-IFRS mandatory phase, however, they show that the

voluntary adoption of fair value is associated with a significant lower bid-ask spread.

Christensen and Nikolaev’s paper (2008), based on a sample of French and German companies, has a broader scope, examining the choice of

accounting alternatives allowed by IFRS for all fixed assets (IAS 16, IAS 38, IAS 40) and with reference to a multi – industry sample. In broad

terms, they find that the fair value method is preferred by companies with a high leverage and account for this through information asymmetry: the

current value of fixed assets gives more thorough information about the firm’s solvency capability. Furthermore, they observe that German real

estate companies, moving from the national cost method rule, are more likely to opt for the fair value approach. In our regression we include

leverage as a variable, with an expected positive correlation with the fair value choice.

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Finally, Danbolt and Rees (2003), studying the value relevance of accounting figures in real estate and in the investment industry, find a significant

revaluation of investment assets shifting from cost to market. Danboldt and Rees’ recent paper (2008) confirms this result, although the fair value

relevance depends on the reliability of the estimates, more so for investment trusts than for real estate companies.

III. MAIN FEATURES OF IAS 40 AND DIFFERENCES WITH THE DOMESTIC GAAP OF COUNTRIES SAMPLED

IAS 40 is concerned with investment property that is property (land or a building) held to earn rentals or for capital appreciation or both, rather than

for use as a site in which to run a manufacturing business or as a good to sell in the ordinary course of business.

The most relevant feature for our interests in the IAS 40 is the evaluation method. IAS 40 permits evaluation of investment properties choosing

alternatively:

- fair value model, by which an investment property is measured, after an initial measurement, at fair value with changes in fair value

recognised in income statement and with no depreciation;

- cost model, with the same rule as in IAS 16 (the property is to be measured after initial recognition at depreciated cost less any accumulated

impairment losses).

This feature makes IAS 40 unique within the IFRS because it represents the only case where the two main evaluation criteria, fair value and cost,

are alternatively admitted in their “pure” form; the IAS 40 fair value reflects its changes from one period to another in the income statement and not

directly in an equity reserve as established by IAS 16 or IAS 38. As a consequence, managers are conscious that the choice between these

accounting methods implies substantial variations in accounting results.

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As reported in the Basis for Conclusions, in the 2003 IAS 40 revision (par. BC 12), the IASB discussed whether to eliminate the choice between fair

value model and cost model, thus implicitly enforcing the former as the only evaluation method allowed. However, it was decided to leave the

choice between the two approaches for two main reasons: “the first was to give preparers and users time to acquire experience before using a fair

value model. Obviously, with regard to the practice of fair value assessment the second was to allow time for countries with less-developed property

markets and valuation professions to mature”. The IASB planned to reconsider the option of using the cost model at a later date, in the light of “fair

value supremacy” pervading the International Accounting Standards.

Nonetheless, the fair value primacy is notable for its disclose clause, requesting the fair value of the investment property for the entities that choose

the cost model, this means that an entity is obliged to assess fair value in all cases, a logical premise to permitting an easier transition to the fair

value method at a later date.

Additionally, the entity has to declare in notes whether it applies the fair value model or the cost model and the methods and significant assumptions

applied in determining the fair value, including a statement whether the determination of fair value was supported by market evidence or was more

heavily based on other factors (which the entity should disclose) relating to the nature of the property and the lack of comparable market data.

The fair value method benchmarked by IAS 40 is a novelty for several European countries. Our sample looks at domestic accounting rules; it is

made up of companies from countries which allow only the cost method for investment property: Germany (Deloitte & Touche, 2001), Finland

(KPMG, 2003), France (KPMG, 2003), Greece (Tsalavoutas and Evans, 2007), Italy (PWC, 2005), Spain, (Perramon – Amat, 2007), Sweden

(KPMG, 2005). More specifically, in Spain and Italy an asset revaluation credited to equity is permitted only if a special law allows it. In France a

revaluation to equity is permitted only if it embraces all fixed assets and the long-term financial assets. In Greece, it is possible to revaluate fixed

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assets to equity every four years following a revaluation index established by the Government. In Germany no revaluations are allowed. The Finland

and Sweden GAAP permit a revaluation of properties credited to equity if their fair value exceeds cost in a permanent, significant, and reliable way.

The choice of Countries using only the cost model in the pre-IFRS mandatory phase allows us to eliminate the influence of any pre-existing

influence of fair value adoption.

IV. HYPOTHESIS DEVELOPMENT

In order to develop our model we firstly look at the main regularities that the literature showed in accounting choices. Thus, we conceive the

accounting choice as a result of efficiency reasons, such as the reduction of political costs. We focus on information asymmetry as well. Previous

studies conjecture that managers could provide private information through their accounting choice in order to influence the beliefs of rational

investors. Particularly, in the specific context investigated we posit that managers could choose a fair value method in order to clearly show to the

market the true value of the firm and to implicitly disclose that they trust in the future business trend.

Hence, in our study we assume that the choice between the fair value model and the cost model for investment properties under IAS 40 is driven

both by efficiency and information asymmetry reasons.

Finally, the adoption of an accounting alternative could be influenced by other simultaneous accounting choices with a (at least partially) similar

impact. In this sense we take into account the influence of the above-mentioned IFRS 1 option.

Hereafter the variables we use to summarize the above-mentioned macro-classes are presented.

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1) Efficiency reasons

In accounting literature it is clear that there is a correlation between firms’ accounting choices and other variables, such as leverage and size, and

signs of these correlations are mostly consistent throughout the research.

The former hypothesis predicts that the higher the firm’s leverage, the more likely managers use accounting methods that increase equity. This is

expected behaviour if we think that the higher the leverage, the closer the firm is to the constraints in the debt covenants (Kalay, 1982). This

hypothesis is also verified by Christensen and Nikolaev (2008) in an IFRS adopters sample.

In the specific context we investigate, this means establishing a positive correlation between leverage and the fair value method. We think, however,

that the hypothesis needs to add the assumption that companies perform fair value gains. Since this information in usually not available in financial

statements for companies adopting the cost method under IAS 40, we found data concerning the index of real estate prices for the period and

verified if the change had a positive sign. Data from The European Central Bank and The International Bank of Settlement confirm this

assumption.1

Thus we test the hypothesis in our model to verify its power in the specific context we investigate. The leverage ratio (total debt to total asset ratio)

is estimated as an average value over a two-year period before the IFRS mandatory adoption. Hence:

H1: The probability of choosing fair value increases if company achieves high a leverage ratio level before IFRS adoption;

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Another variable we use to verify the existence of efficiency reasons is the pre-IFRS level of earnings management practices. A proxy of earnings

smoothing practices could also be a proxy of a managers’ goal to reduce political costs, enhanced instead by variable reported profit (Watts –

Zimmermann, 1978; Hagerman – Zmijewski, 1979). In other words, the managers could manage accrual accounting to smooth current earnings in

order to reduce political costs. If so, managers should find it to their advantage to adopt the cost model under the IAS 40. Actually, the recognition

of fair value changes for investment properties in income statements determine, ceteris paribus, a higher variability of earnings.

Another link between earnings smoothing behaviour and preference of cost model is represented by the cost of capital, another source of efficiency.

Accounting scholars (Ball, 2006) and practitioners (see the survey of Jermakowicz - Gornik-Tomaszewski, 2006) show in their research that volatile

earnings are a consequence of fair value adoption, especially induced by economic factors outside the companies’ control, such as a change in asset

market prices (Ronen, 2008; Whittington, 2008). This volatility is one of the main arguments against the fair value method (European Central Bank,

2004), because volatility is a strong capital cost driver, as described in finance literature (Fama, 1977). Recent studies present controversial findings

about the influence of earning persistence on the cost of capital: while Francis et al. (2004) find a negative correlation between earnings smoothing

and the cost of capital, McInnis (2008) and Core et al. (2007) find no significant association.

The relationship between cost of capital (measured in terms of share bid-ask spread) and the adoption of fair value is investigated by Muller et al.

(2008) as well, but they start from the hypothesis that fair value lowers information asymmetries, a topic considered in our research in the second

group of possible drivers. Furthermore, Muller et al. find a negative correlation between fair value adoption and cost of capital in the pre-IFRS

mandatory phase, while no significant results are found after that period.

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So, if a manager needs to reduce the firm cost of capital, according to the IAS 40 he has good reasons to choose the cost method instead of the fair

value method as cost models should be used to smooth earnings and price volatility and hence reduce both the market (non-diversifiable) risk of

securities and therefore the cost of capital. So, a negative association between fair value choice and pre-IFRS earnings smoothing activities is

expected. Hence:

H2: The probability of choosing fair value decreases if managers reduce the variability of reported earnings using accruals.

Following Leuz et al., (2003) and Burgstahler et al. (2006) our proxy to capture earnings smoothing activities in the pre-IFRS period is computed as

the ratio of the standard deviation of operating income divided by the standard deviation of cash flow from the operation, both measures being

computed over the four years before IFRS mandatory adoption. The ratio is then multiplied by -1 so that higher values are associated with higher

earnings smoothing activities.

Moreover, in order to capture the real significant of the smoothing ratio (just values around zero denote strong earnings smoothing activities but the

more the values decrease the more the smoothing significance disappears), in our analysis for each firm we only measure the ratio distance from the

average value of the same ratio for the country of origin as measured in Burgstahler et al. (2006). So, the resulting dummy variable is equal to 1 if

the firm has an earning smoothing index lower then the average index estimated for the country of origin, and 0 otherwise. This procedure enables

us to capture the peculiarity of each country due to the different local GAAP adopted before IFRS (Leuz et al. 2003; Burgstahler et al. 2006).

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B) Information asymmetry

The rise of fair value is based on the reduction of asymmetries between companies and market (CFA, 1997; Ball, 2006). Then we assume that if

information asymmetry exists in the specific context investigated, managers could choose a fair value method in order to clearly illustrate to the

market the true value of the firm and to highlight their trust in the future business trend. So, if we recognize information asymmetry by means of

specific proxy, it is probable that a fair value method would be preferable to managers to be able to clearly reveal useful information about

investment property value on balance sheet and to give signals to the market. Thus, a positive association between the accounting choice of fair

value method and high levels of information asymmetry should be assumed.

As a signal of an existing information asymmetry we use the market-to-book ratio. We use a mean of that ratio over a period when the market was

still not influenced by information disclosed under IFRS (two years before IFRS mandatory adoption). Therefore, we assume:

H3: The probability of choosing fair value increases, the more marked the difference between market value and book value of equity is.

Additionally, information asymmetry could also depend on the time lag that accumulates before the fair value of the investment property is

recognised with in the financial statement. If an investment property asset is accounted at cost but will be sold in the immediate future, financial

statements will contain the market value in a relatively short-term. On the other hand, if an investment property asset accounted at cost will be sold

in the long term, financial statements do not contain the fair value until the actual sale of the asset and this could generate more information

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asymmetry for investors. So, we assume there could be an incentive to use the fair value method for companies with lower investment property

turnover.

Real estate companies usually operate in the following business sectors: renting out investment properties, services, trading and development. So,

the core business of a company influences the structure of operating revenues.

FIGURE 1 (INSERT HERE)

Specifically, there is a significant difference in the amount of realised changes in value of investment properties between companies that consider

trade as their core business and companies whose main business is renting and leasing properties. Thus, we use the ratio between total rents and

total operating income as a proxy of investment property turnover. In particular, both rents and total operating income are hand-collected from

financial statements for the fiscal year preceding the IFRS mandatory adoption and the latter has been computed as the sum of rents, services,

realised gains/losses on investment property sales and other operating revenues. So, a high ratio value suggests that a renting activity may be

considered the core business of the company and, on the other hand, that the company has a low investment property turnover. Thus, we suppose

that the probability of choosing the fair value method increases with a higher ratio value or, in other words, with a lower investment property

turnover. Hence:

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H4: The probability of choosing fair value increases with a higher value of rental income to total revenue ratio (lower investment property

turnover).

C) The adoption of a concurrent accounting choice

The “fair value as deemed cost” option under IFRS 1 gives the companies the opportunity to revaluate fixed assets at the fair value existing at the

transition date and to use this value both to recognize them in the balance sheet and as a basis of the depreciation process.

The accounting effects of this IFRS 1 option, at least at a balance sheet level, could be seen as an alternative to the choice of fair value method.

So, we predict that a firm adopting this option should have less incentive to choose the fair value method because investment property assets are

already recognized at the fair value existing at the transition date. Companies should take advantage of revaluation of assets without suffering

volatility in future earnings. On the other hand, if a company admits earnings volatility due to the fair value method there is no reason to choose the

IFRS 1 option at the transition date.

The use of this option could reflect both an attempt to reduce information asymmetries (companies choose to show the fair value at the transition

date) and efficiency reasons, because of the generally positive impact on leverage caused by the specific equity reserve at the transition date. But the

analysis of linkages with the other variables through a univariate analysis shows a relatively weak correlation only with an efficiency proxy (RENT).

The sign, however, shows that the higher the information asymmetry proxy (RENT) the less IFRS_1 option is used. No other significant

relationship with leverage or the other information asymmetries proxies exists.

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We use a dummy variable coded 0 if company adopts fair value as deemed cost under IFRS 1 and 1 otherwise. We hand-collect the information

concerning the IFRS 1 option for sampled companies from the financial statements published over the first fiscal year of the IFRS mandatory

adoption. Thus, we assume the following hypothesis:

H5: The probability of choosing fair value decreases if firms adopt the fair value as deemed cost option under IFRS 1

Control variables

The hypothesized relation between fair value choice and explanatory variables are based on the assumption that other variable are held constant. In

practice, however, other factors could be related to both the fair value choice and explanatory variables. For example, firm size is positively related

to political costs (Watts and Zimmermann, 1978), showing both a possible negative relationship with fair value choice and a positive relationship

with earnings smoothing. If we do not control for size, a significant negative relation between earning smoothing and fair value choice could be

observed even if the size were the true explanatory variable. The size is measured as the log of the average total asset over the two years before first

time adoption and, as mentioned, there could be e negative relation with fair value choice.

Additionally, we use a second variable to control the country effect. We do not use the distinction between Code Law Countries and Common Law

Countries (Ball et al., 2000), because our sample is made up of Code Law Countries only. Since accounting practices usually adhere to financing

systems (systems based on banks are generally more conservative that systems based on markets), we decided to capture the country effect with the

level of financial market development. So, following Nobes (1998), we theoretically classify countries included in our sample in two groups:

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countries where the role of financial markets is more developed (capital market-based systems) and countries where the markets are less developed

(credit-based systems). Thus, we can assume that the adoption of the fair value method should be easier in capital market based systems, where the

indirect cost of information production should be lower and the more developed market could better appreciate the informative content of fair value

estimates.

In order to summarize financial markets development, we use the same variable and values as in La Porta et al. (1997). Specifically, we adopt a

proxy computed as the ratio of stock market capitalization held by minorities to gross national product. So, the higher ratio value is associated with

highly diffused equity and, as a consequence, with more financially developed markets.

The stock market capitalization held by minorities is computed as the product of the aggregate stock market capitalization and the average

percentage of common shares not owned by the top three shareholders in the ten largest non-financial, privately owned domestic firms in a given

country. The lack of availability of certain data forced us to use the same values estimated by La Porta. Thus, a positive sign of this variable could

be expected.

Table 1 summarized the proxies used for independent variables and the predicted sign of each relation with fair value choice for investment

properties under IAS 40.

TABLE 1 (INSERT HERE)

V. RESEARCH DESIGN

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Sample and Data

Our study focuses on a sample of real estate firms from countries where a systematic use of fair value model was not allowed for investment

property assets by pre-IAS/IFRS domestic GAAP. A sample of 76 companies was selected from a population of 216 European real estate companies

listed in their own country of origin in December, 2007 in the following stock markets: Finland, France, Germany, Greece, Italy, Spain and Sweden.

The Datastream database revealed 216 real estate firms from the countries which were analyzed in December 2007 (235 items, of which 19 were

paid rights, preferred share etc.).

This sample was then screened against a set of conditions: (i) the availability of the full version of the first financial statement complying with

IAS/IFRS, obtained from the corporate web site or via a specific inquiry to Investor Relators, (ii) the actual presence of investment properties assets

(as defined by IAS 40) not equal to zero, and (iii) the full data availability in the Datastream database. Of the original 216 firms, 40 had neither web

site nor IR contact, 26 had financial statements not complying with IAS/IFRS in the period of analysis (2005-2007), 7 had no investment properties,

27 failed to respond, and 40 firms did have complete availability of data in financial statements or in the Datastream database. Thus, only 76 firms

had sufficient information for the above-mentioned explanatory variables to be included in the sample. Table 2 shows the sample selection

procedure.

TABLE 2 (INSERT HERE)

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The described procedure clearly illustrates that our sample consists of the maximum number of companies for which it is possible to obtain

sufficient information for the analysis, starting from the initial number of companies identified (N=216). However, our analysis could have

introduced a selection bias if an association between firms’ disclosure policies (e.g. assuring the availability of the full financial statement on the

corporate web site or replying to a specific request) and the accounting choice had existed. In order to remove any doubts we test whether there is a

difference of drivers of choice used in our analysis between firms that provide an annual report or disclose it after request (the sample) and those

that do not. Table 3 presents the Mann-Whitney non-parametric U tests of differences between the two groups. Of course, we could only test the

difference between the variables we collected from the Datastream database because we do not have access to the financial statement of non-

disclosing firms. Of the original 67 non-disclosing firms, 34 firms could not give complete data availability on the Datastream database. Thus, only

33 firms had sufficient information to be included in the test. For non-disclosing firms, we collected data using the same rules as applied in the

sample and considering 2005 as a reference date unless companies were not listed yet. In that case the reference date is the listing year.

TABLE 3 (INSERT HERE)

The results show that disclosing firms (the sample) are not statistically different from the non-disclosing firms in terms of the explanatory variables

we selected, that is, looking at the market-to-book value (MTBV), leverage (LEV) and the earning smoothing index (SM). Thus, the results validate

our sample and suggest that the sample selection did not introduce a bias into the analysis even if one of the control variables (the size, LA) appears

statistically different between sampled firms and non-disclosing firms. This result is consistent with literature since disclosure levels are usually

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positively correlated with firm size because disclosure costs decrease with size (Lang and Lundholm, 1993). However, we keep the variable in the

analysis since, as already suggested, if we do not control for size, a significant negative relation between earning smoothing and fair value choice

could be observed even if the size were the true explanatory variable.

We relied on two sources for obtaining data for tests: (i) the first financial statement complying with IAS/IFRS and (ii) the Datastream database.

The former source enables us to verify the firms’fair value or cost method choice for investment properties (IAS 40), the choice of“fair value as

deemed cost”under IFRS 1, and to hand-collect from notes the portion of revenue that is a result of rental activities. The latter source provides all

the accounting and non-accounting data we need to define the others explanatory and control variables.

Non-accounting data include market-to-book value while the accounting data consist of leverage (debt to asset ratio), total asset, operating income

and cash flow from the operation (the last two accounting numbers have been used to estimate the earnings’ smoothing ratio).

Since the aim of this study is to find out why fair value might be preferred to cost under IAS 40, we have commonly used data not influenced by the

choice. To make sense of this key assumption, when collecting data we referred to different periods for market records and information collected

from financial statements. Market data refers to the end of the FTA year because the market is influenced by IFRS not before the beginning of the

fiscal year but immediately after the FTA (which explains why the market-to-book value is collected during the last month of the first time adoption

fiscal year).

Financial data was collected over the two fiscal years before the FTA. Two years of financial data rather than one year are considered to be more

representative of a firm’s general characteristics and, in particular, able to reduce the effects that might occur from any unusual or abnormal data

from a single year. Exclusively the earning smoothing ratio required a longer period of time; we used a four-year time period before the FTA for

21
both operating income and cash flow from operation in order to estimate the related standard deviations. These two values were then compared to

detect any earning smoothing propensity.

Financial information for Swedish firms is converted into Euros on the date of download from Datastream. Market data were automatically

converted by Datastream database.

Empirical model

Two statistical procedures are used in our analysis: (i) the non-parametric Mann-Whitney U test is used to analyse the difference in

explanatory variables between the group of firms that have adopted fair value model and the group that have chosen the cost model. Additionally, (ii)

we use a Logit regression model (forward stepwise) to test the relationship between fair value choice and the hypothesized explanatory variables.

Under the Logit model, the odds of a firm fair value choice for IAS 40 is described as follows:

Log (pi / 1-pi) = β0 + β1 X1 + β2 X2 + . . . . . + βn Xn (1)

where pi is the probability of a fair value choice for firm i, β0 is a constant and with n independent variables. For each firm in the sample, the

probability is estimated as

pi = 1/(1+ e-Zi) (2)

where e is the base of the natural logarithm and Zi = d0 + d1X1 + d2X2 + . . . + dnXn

Our model assumes the following relation between the proposed explanatory variables and the firms’ choice to adopt fair value rather than the cost

approach for investment properties under IAS 40:

22
 P(FV_COST)i = 1 / (1+e-Zi)
(3)
Zi = β0 + β SMij + β2 LEVi + β3 IFRS_1i + β4 MTBVi + β5RENTi + β6 LAi + β7 CNTi+εi

The empirical variables used in this model are defined as follows:

dependent variable equal to 1 if the firm i adopts fair value model

FV_COSTi = under IAS 40 in FTA, and 0 otherwise;

dummy variable coded 1 if firm i has an earning smoothing index > to

SMij = the average index of earning smoothing in country j (firm’s country of
6. ANALYSIS OF RESULTS
domicile), and 0 otherwise;

LEVi = the average debt to asset ratio for firm i, measured over two years Summary Statistics
before FTA;
Table 4 shows the breakdown of the sample by country and
IFRS_1i = dummy variable equal to 1 if firm i uses fair value as deemed cost
under IFRS 1 in FTA, 0 otherwise; displays both the number and the proportion of companies

MTBVi = Market-to-book value of firm i collected over the last month of the that select fair value or cost model, respectively, in each
FTA year;
country. At first glance, Table 4 seems to reveal some
RENTi = percentage of rents on total revenue measured the year before FTA;
national patterns in explaining the selection between fair
LAi = log of the average total asset over the two years before FTA;
value and cost model.
CNTi = external market capitalization on GNP (from La Porta et al., 1997);

εi = error term,
TABLE 4 (INSERT HERE)

23
Despite the relatively small number of companies selected in some countries, companies from Finland, Greece, Spain and Sweden are extremely

prone to adopting the fair value method. Conversely, Italian companies seem to prefer the cost model while companies from France and Germany,

the main countries in our study in terms of number of companies examined, do not show an a priori preference. However, since the above-

mentioned countries which are predominately oriented towards the fair value approach are all codified legal systems, but lacking similar features in

terms of external environment, culture or institutional structures, according to Nobes (1998) we decided to classify countries depending upon the

strength of the equity-outsider systems. Thus, the results justify our choice to control for a country variable through the multivariate analysis,

adopting a proxy computed as the ratio of stock market capitalization held by minorities to gross national product (La Porta et al., 1997). So, the

higher value of the ratio is associated with highly diffused equity and, as a consequence, with more financially developed markets.

Table 5 presents summary statistics about the characteristics of the sampled firms. It should be noted that two variables, market-to-book value

(MTBV) and leverage (LEV), have outlying observations as suggested by the values in the minimum and maximum columns of the table.

We isolate the outlying observations by means of the three sigma (standard deviation) rule (Barnet-Lewis, 1994), thus separating companies which

have:

 x - µ(x)  ≥ 3 σ(x) (4)

where σ(x) is the standard deviation of the variable (x).

To remove the effect of these outliers on the regression results, we also present a Logit regression without these values.

TABLE 5 (INSERT HERE)

24
Non-parametric Mann-Whitney Test

To analyze the characteristics of firms that adopt the fair value method in comparison to those that do not, we used a Mann-Whitney non-parametric

U test. Table 6 shows a number of differences across our independent variables, some of which appear statistically significant.

TABLE 6 (INSERT HERE)

Consistent with our hypotheses, real estate companies that choose the fair value method are statistically different from real estate firms that adopt

the cost method for their renting activity (RENT), “fair value as deemed cost” option (IFRS_1) as well as market-to-book value (MTBV).

Specifically, the predominant activity of firms that choose the fair value model seems to be the rental of investment properties instead of other

activities such as development, trading and real estate services. On average, the fair value group has higher rental revenue to total revenue ratio,

with a mean of about .65 against .32 for cost group, with a statistically significant difference at .000 level. The IFRS 1 variable appears statistically

significant as well, with a mean of .075 for the fair value model group and .5556 for the cost model group, respectively (statistically significant

at .000 level).

These values are consistent with our hypothesis that managers have less interest in the fair value method if the fair value of investment property

assets is already captured in balance sheet under the IFRS 1 option.

25
The MTBV variable does not seem to lead to predictable results. In other words, we use market-to-book value as a proxy for information asymmetry,

predicting a higher probability of choosing fair value if information asymmetry exists. However, Table 6 shows an average MTBV of 1.1785 for fair

value firms while the cost group has a MTBV of 1.8022 (significant at .000 level). This variable, however, also reflects financial market

expectations that can also be related to other factors. Thus, we can illustrate the Logit model results also using the bid-ask spread as a proxy of

information asymmetry instead of market-to-book value. The possible advantage of using the bid-ask spread comes at the cost of reducing the

sample size because of the insufficient Datastream data, with a reduction of more than 10% (from 76 to 68 firms).

The country variable (CNT), as measured in La Porta et al. (1997) with the ratio of stock market capitalization held by minorities to GNP, is higher

for firms that choose fair value (.2385 vs. .1661) even if it is not significant at less than .05 (p-value .054). So, the companies of countries where the

role of financial markets is more developed (capital market based systems) seem to view the fair value method more favourably than companies of

countries where the markets are less developed (credit-based systems).

With reference to the other explanatory variables, earning smoothing (SM) and leverage (LEV), they appear to be not significant in the univariate

analysis.

Multivariate analysis

The previous analyses suggest that three variables can discriminate the fair value model group from the cost model group in an univariate analysis:

the percentage of total operating income that comes from rental activities (RENT), the option expressed under IFRS 1 (IFRS_1), and the market-to-

book value (MTBV).

26
Before presenting the results of the Logistic procedures, we report the Spearman (rank) correlation matrix for the independent variables (Table 7).

TABLE 7 (INSERT HERE)

Table 7 shows that statistically significant correlations do not exist at a level less than .05 or .01. The highest correlation (.482) is between rental

revenue to total revenue ratio (RENT) and country (CNT), suggesting that in countries with more developed capital markets (capital market based

systems) real estate companies are more involved in the long-term investment business than in other activities (trading, development and services).

The other correlations between explanatory variables are relatively low, ranging from .226 to .311, suggesting that multicollinearity is not likely to

be a significant issue in the multivariate analysis.

TABLE 8 (INSERT HERE)

Table 8 presents the results of the Logistic regression with a forward stepwise method. In Table 8 Panels B, R2 indicates that a great part of the

variation in the dependent variable is explained by variation in explanatory variables (.51 the Nagelkerke R2 and .385 the Cox and Snell R2). Panel

A indicates the significant explanatory variables’ results for the forward stepwise method. The panel shows both coefficients and the probability of

the Chi-squares for each variable. Two variables have a significant impact on the choice examined at less than .01: IFRS_1 and RENT. Both of

them have their parameters in the predicted direction. These results support the hypotheses previously set forth.

27
The most significant variable is IFRS_1, the option allowed in IAS/IFRS first time adoption, that it is able to explain more than 25% of fair value

choice (.341 the Nagelkerke R2 and .255 the Cox and Snell R2). This result shows the complexity of fair value choice. Specifically, it seems that the

IFRS 1 option is strictly related to the accounting choice requested by IAS 40, significantly influencing the fair value choice. In other words, the

probability of choosing fair value for investment property under IAS 40 drastically decreases in the real estate industry if a company, with more

prudential accounting policies, decides to revaluate its investment property assets only in the FTA under IFRS 1, than adopting a cost model from

FTA on.

The significance of the other variable (RENT) shows the role the information asymmetry has in the choice examined. We have posited that

information asymmetry could depend on the amount of time that elapses before the fair value of investment properties is recognised with in

financial statements. Strictly speaking, if an investment property asset is accounted at cost but will be sold in the immediate future, financial

statements should contain the market value in a relatively short time. On the other hand, if an investment property asset accounted for at cost is sold

after an extended time period, financial statements do not contain the fair value until the actual sale of the asset and that could generate an

information asymmetry for investors. So, our results show that companies with lower investment property turnover could have an incentive to

reduce information asymmetry using the fair value method under IAS 40. No other variables appear statistically significant in the multivariate

analyses.

Turning to the prediction, Table 8 shows the parameters of the model that we can use to express the probability of choosing the fair value approach

for investment properties under IAS 40 in the real estate industry (PFv). That is

28
 Pfv = 1/1+ e -(-0,741 – 2,860 IFRS_1 + 3,308 RENT) (5)

Since we have only two explanatory variables which are statistically significant at conventional levels, we show the probability to choose the fair

value approach in four significant cases (Table 9).

TABLE 9 (INSERT HERE)

The interesting findings is that there is a greater probability of choosing the fair value approach for companies adopting the IFRS 1 option and with

no revenues coming from renting out investment properties (.026 probability), compared to companies which do not choose the IFRS 1 option and

have the 100% of the revenues coming from renting out the investment properties (.93 probability). Specifically, the results suggests that it is highly

probable that a company will choose the fair value approach if it has an information asymmetry problem on its main business (renting out the

investment properties) and if it has decided to give up the IFRS 1 option opportunity.

Finally, the interpretation of the Logit coefficients is usually not intuitive. Focusing on the efficiency reason variable (RENT), however, we can

observe an interesting result. If we posit a relative probability equal to 2, we have:

2 = exp (βRENT * RENT) (6)

and

29
 RENT = Log2/βRENT = Log2/3,308 ≅ 0,20 (7)

The result in (7) indicates that a 20% increase in renting out activity would make the fair value choice twice as likely to occur.

These results, taken together, support the idea that testing the implications of a single accounting standard could interfere with the real knowledge of

accounting choice determinants (Fields et al., 2001). Our study, for example, shows that the fair value choice under IAS 40 should be analysed

considering the previous IFRS 1 option.

The results do not change even when the Logistic procedures are carried out without a forward stepwise method. In this case, the statistically

significant explanatory variables are IFRS_1 (significant at .001 level) and RENT (significant at .010 level) as well, but adding the other variables

the concordance of the model improve (.603 the Nagelkerke R2 and .452 the Cox and Snell R2).

Additionally, we also perform the Logit regression removing the outliers (two companies), with both the forward stepwise method and considering

all the explanatory variables together. In the former case, IFRS_1 and RENT are statistically significant at .000 and .001 levels, respectively, with a

concordance of the model not less than .37 (.496 the Nagelkerke R2 and .371 the Cox and Snell R2). The latter method confirms the good fit of the

model (.588 the Nagelkerke R2 and .440 the Cox and Snell R2), with the two explanatory variables, IFRS_1 and RENT, statistically significant

at .001 and .010, respectively.

Finally, we also perform the Logit regression using the bid-ask spread instead of MTBV as a proxy for information asymmetry. The total number of

sampled companies decreases to 68 but the results support those of previous regression. With a forward stepwise method the statistically significant

explanatory variables are IFRS_1 and RENT, significant at .000 and .001 levels, respectively. The coefficients have predicted signs and the

30
concordance of the model is as follow: .242 (Cox and Snell R2) or .324 (Nagelkerke R2) at first step with only IFRS_1 variable, and .413 (Cox and

Snell R2) or .552 (Nagelkerke R2) at second step. Even in this case, the exclusion of the outliers does not invalidate the results (with a stepwise

method, at a second step, IFRS_1 and RENT statistically significant at .000 and .001, respectively, with a Nagelkerke R2 of .545 and a Cox and

Snell R2 of .408).

CONCLUSION

This paper analyses the choice of evaluation criteria for investment properties under IAS 40 in the real estate industry. In other words, we try to

answer the following question: why have companies recently adopted the fair value model instead of the cost model to account for their investment

properties? We use a sample of real estate companies located in countries which permit only the cost model in the pre-mandatory IFRS phase in

order to eliminate the influence of preceding use of fair value.

Our findings lead us to conclude that the need to reduce information asymmetry and the influence of the alternative accounting choice of IFRS 1

“fair value as deemed cost option” go a long way towards explaining how choices are made.

Concerning the reduction of information asymmetry, we find that if the core business of a company is to rent out properties, the need to disclose

future perspectives induces the managers to prefer the fair value method. Under the cost model, in fact, the property held for renting out does not

show its market value in any transactions, thus reducing the information available on the balance sheet.

The opposite influence of the IFRS 1 option on the fair value choice under IAS 40 could be explained with the rationale that managers are not so

attracted by the “label” of the evaluation method (fair value instead of cost), so they search for specific results (to recognize the assets’ fair value

31
and, probably, to increase equity). At the same time, this finding could suggest that accounting choices in the IAS/IFRS first time adoption be made

within a short time horizon, because the assets’ fair value recognized under IFRS 1 option could be significant only for some years, without the

possibility of continuous adjustment to new fair values. Another reason could be the risk aversion of the decision-makers. The fair value evaluation

method implies that both negative and positive changes in value will be recognized in the future, while a risk adverse manager could prefer for only

actual positive changes to be accounted for, through the IFRS 1 aforementioned option, with a more conservative approach.

However these hypotheses need more specific studies. By contrast, we do not find any significant relationships between the fair value choice and

efficient contracting reasons (using proxies like leverage, and income smoothing).

In this sense, considering the current debate on fair value, our analysis supports the concept that fair value is chosen more for its informative power

than for opportunistic motives. Our findings could suggest to standard setters that fair value is an assets’ evaluation method which particularly suits

firms whose assets will be indirectly realized only in the long term. Nonetheless, the IASB must also rethink the transition accounting options (IFRS

1). From our study the option “fair value as deemed cost” seems to have a great influence on subsequent accounting choices, and it cannot simply be

relegated to a category of wanting “accounting simplification”.

This study is in its early stages and it is subject to potential limitations. Firstly, we might contemplate that a larger sample size could lead to

enhanced results even if such a sample is about 35% of the entire population examined and it would be difficult to enlarge it because of the

unavailability of further data, since it were hand-collected from different sources (financial statements and Datastream database).

Secondly, we limit ourselves to isolating some variables that could explain the choice made but many other causes, not necessarily financial ones,

could be added to explain company behaviour in more depth.

32
Finally, the analysis and results reported here are based on observations of firms in one industry; hence the results may not be entirely generalized to

other industries. Nevertheless, our makes a contribution to accounting choice studies, showing various factors that a manager might consider when

choosing alternative evaluation methods. Questions remain, however, that could be examined in future research. Other explanations could illustrate

the choice more clearly, such as the managers’individual cultural background, the corporate governance context or the cost of information (Watts

and Zimmermann, 1978). Additionally, even if the real estate industry seems a good context in which to study this choice process, an additional

analysis carried out in other industries could help to generalize our findings.

NOTES
1
In the “Euro Area 15” (including all our countries sampled apart from Sweden), the index of property prices rose from 92,97 in the year 2004 to 100 in
2005, 106,48 in 2006, and 111,08 in 2007 (source: The European Central Bank, www.ebc.int, http://sdw.ecb.europa.eu/browse.do?node=2120781).
In the same period, in Sweden, using data from Bank for International Settlement (www.bis.org, source Annual Report, year 2006-2008), the percentage
change of property prices (mean between residential and commercial properties) from one year to another has been 4,15% (2005-2004), 8,05% (2006-2005),
10% (2007-2006).

33
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Figure 1 - Business segments matrix for the real estate industry

Long-term
investment Trading Development Services
(investment
properties)

Residential

Business

Land and building sites

39
Table 1 - Proxies and predicted signs for explanatory variables. The variables are grouped
according to the main hypotheses for fair value choice.

Predicted Explanatory
Hypotheses Proxies
signs Variables

(1) Efficiency reasons

The probability of choosing fair value

LEV
model increases with higher leverage (H1) + debt/assets
(Leverage)
The probability of choosing the fair
value model decreases with the extent Earning Smoothing
SM
to which corporate insiders reduce the (H2) - Index
(Smooth)
variability of reported earnings (dummy variable)
(earnings smoothing)
(2) Information asymmetry

The probability of choosing the fair Market-to-book

value model increases with more (H3) + value MTBV
information asymmetry.
The probability of choosing the fair
value model increases with higher Rental income /
values of rental income to total (H4) + total revenues RENT
revenues ratio (lower investment
property turnover)

The probability of choosing the fair

IFRS 1
value model decreases with IFRS 1 (H5) - IFRS_1
(dummy variable)
adoption (fair value as deemed cost)

(3) Control Variables

Log of the average LA
Size of firm - total asset over the (Log total
2 years before FTA asset)
Firm’s country of origin
CNT
(in terms of financial markets + External cap/GNP
(Country)
development)

Note that the dependent variable is equal to 1 if the firm adopts FV, otherwise it is equal to 0. In H2
the predicted sign is negative because the dummy variable is equal to 1 if the firm has an earnings
smoothing index higher than the average index for the country of origin, otherwise it is equal to 0.
So, if the firms’ smooth earnings indexes are equal to more then the average for the country
(dummy = 1) we posit a cost model choice (dummy = 0).

40
Table 2 - Sample selection procedure Number Percent

European Real Estate Firms listed in their own country of origin in

December, 2007 in the following stock markets (source Datastream): 216 100%
Finland, France, Germany, Greece, Italy, Spain and Sweden

Excluding the firms:

- not reporting under IAS/IFRS in the period of analysis (2005-2007) - 26 12%

- with no investment property assets (or with investment properties -7 3%
equal to zero)
- with neither web-site nor IR contact - 40 18,5%
- failing to respond - 27 13%
- with insufficient data to estimate equation (3) (in financial statements
or in Datastream database) - 40 18,5%

Final sample 76 35%

41
Table 3 - Mann-Whitney Non-Parametric U Test results of the comparison between Sampled
firms and Non-Sampled Firms.

Panel A: Ranks
Mean Mean
Variable ( Sampled Firms, N=76) (Non-Sampled Firms, N=33)
Mean Ranks Sum of Ranks Mean Ranks Sum of Ranks

MTBV 57.53 4372.00 49.18 1623.00

LEV 58.29 4430.00 47.42 1565.00
CNT 54.20 4119.00 56.85 1876.00
LA 63.01 4789.00 36.55 1206.00
SM 57.08 4338.00 50.21 1657.00

Panel B: Test Statistics

Mean Mean Pr > Z
Variable Z-Statistics
( Sampled Firms, N=76) (Non-Sampled Firms, N=33) (2-tailed)

MTBV 1.4739 1.2755 -1.266 .205

LEV .5881 .5361 -1.649 .099
CNT .2042 .2147 -.418 .676
LA 12.7877 11.4675 -4,017 .000**
SM .3684 .2424 -1.279 .201

* statistically significant at less then .05; ** statistically significant at less then .01
MTBV = Market-to-Book Value; LEV = Leverage; CNT = Country of Origin; LA = Log of Total Asset;
SM = Index of Earnings Smoothing.

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Table 4 - Breakdown of sampled firms by country and proportion of companies selecting FV
or Cost method

N. of sampled
Country Weight % Fair Value (%) Cost (%)
companies
Finland 4 .05 4 (1) 0 (0)
France 26 .34 11 (.42) 15 (.58)
Germany 22 .29 12 (.55) 10 (.45)
Greece 4 .05 3 (.75) 1 (.25)
Italy 8 .11 2 (.33) 6 (.67)
Spain 4 .05 4 (1) 0 (0)
Sweden 8 .11 8 (1) 0 (0)
Total 76 1

This table shows the breakdown by country of the sample and the proportion of companies
that select fair value or cost method in each country. We considered companies listed in:
Helsinki (Finland), Paris (France), Frankfurt and Munich (Germany), Athens (Greece),
Milan (Italy), Madrid (Spain) and Stockholm (Sweden).

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Table 5 - Summary Statistics of Explanatory Variables for Sampled Firms (N = 76).

Variable Mean Std. deviation Minimum Maximum

Explanatory variables:
MTBV 1.4739 1.13502 -.17 8.94
LEV .5881 .28026 .00 2.07
SM .3684 .48558 .00 1.00
RENT .5000 .34922 .00 1.00
IFRS_1 .3000 .46200 .00 1.00
Control variables:
CNT .2042 .12083 .07 .51
LA 12.7877 1.67746 8.28 16.69

MTBV = Market-to-Book Value; LEV = Leverage; SM = Index of Earnings Smoothing (dummy); RENT =
Rental income to total revenue ratio; IFRS_1 = Fair value as deemed cost option (dummy); CNT = Country
of Origin; LA = Log of Total Asset;

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 Table 6 – Mann-Whitney U Test. Fair Value group versus Cost Group (NFv=40; NCost=36)

Pr > Z
Group Mean Std. dev. Min. Max. Z - Statistics
(2-tailed)
Explanatory variables:

MTBV FV 1.1785 .76126 - .17 3.99 -3.605 .000**

COST 1.8022 1.37994 .43 8.94
LEV FV .6240 .31758 0 2.07 - .947 .344
COST .5482 .22983 .05 .95
SM FV .2750 .45220 .00 1 - 1.768 .077
COST .4722 .50631 .00 1
RENT FV .6545 .32833 .02 1 -4.135 .000**
COST .3283 .28915 .00 1
IFRS_1 FV .075 .26675 .00 1 -4.523 .000**
COST .5556 .50395 .00 1
Control variables:

LA FV 12.7041 1.73106 8.28 15.81 - .333 .739

COST 12.8805 1.63519 9.07 16.69
CNT FV .2385 .14916 .07 .51 -1.928 .054
COST .1661 .06049 .07 .23

This table presents the Mann-Whitney U Test for both explanatory and control variables. *,** indicate statistical significance for difference of mean
at less than 5 percent and 1 percent level, respectively. The sample comprises 76 companies from 7 countries, split into two groups: firms that adopt
the fair value model (NFV = 40) and firms that adopt the cost model (NC = 36) for investment properties under IAS 40.
MTBV = Market-to-Book Value; LEV = Leverage; SM = Index of Earnings Smoothing (dummy); RENT = Rental income to total revenue ratio;
IFRS_1 = Fair value as deemed cost option (dummy); CNT = Country of Origin; LA = Log of Total Asset.

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Table 7 – Spearman (Rank) correlation matrix between independent variables

Variables IFRS_1 MTBV RENT SM LEV LA CNT

IFRS_1 1,000
MTBV .182
1,000
(.115)
RENT - .226* - .311**
1,000
(.05) (.006)
SM .209 .007 - .001
1,000
(.069) (.953) (.991)
LEV - .104 .190 - .085 - .154
1,000
(.372) (.101) (.466) (.184)
LA - .022 .124 - .022 .039 .104
1,000
(.853) (.285) (.849) (.741) (.371)
CNT .009 - .054 .482** .077 .134 .203
1,000
(.935) (.646) (.000) (.507) (.249) (.079)

This table provides Spearman (Rank) correlations for explanatory variables (N=76). Values indicated in bold
show statistically significant relationship between variables while p-value is shown in brackets. *,** indicate
statistical significance at less than 5 percent and 1 percent level, respectively (two-tailed). Pearson correlation
shows similar results.
MTBV = Market-to-Book Value; LEV = Leverage; SM = Index of Earnings Smoothing (dummy); RENT =
Rental income to total revenue ratio; IFRS_1 = Fair value as deemed cost option (dummy); CNT = Country of
Origin; LA = Log of Total Asset.

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Table 8 – Logistic results. Forward Stepwise method (Likelihood Ratio)
Panel A – Variables in the equation (step 2)
Hypothesis Predicted sign Value Wald Chi-square statistics
Coefficient Significance
INTERCEPT - .741 1.994 (.158)
IFRS 1 (a) H5 - -2.860 13.625 (.000)**
RENT (b) H4 + 3.308 11.537 (.001)**

Panel B – Variables not in the equation (step 2)

Hypothesis Significance

MTBV H3 .100
SM H2 .258
LEV H1 .259
LA (control variable) .560
CNT (control variable) .253

(a) Variable entered on step 1: IFRS_1

(b) Variable entered on step 2: RENT
Panel C – Model Summary - Goodness of fit

Step -2 Log likelihood R2 (Cox and Snell) R2 (Nagelkerke)

1 82,732 (a) .255 .341
2 68,243 (a) .385 .513

(a) Estimation terminated at iteration number 5 because parameter estimates changed by less than .001

This table presents results from logistic regression with a forward stepwise method (likelihood ratio). We present Wald Chi-square coefficients,
Log Likelihood, Cox-Snell and Nagelkerke R2. *,** indicate statistical significance for mean difference at less than 3 percent and 5 percent
level, respectively. MTBV = Market-to-Book Value; LEV = Leverage; SM = Index of Earnings Smoothing (dummy); RENT = Rental income
to total revenue ratio; IFRS_1 = Fair value as deemed cost option (dummy); CNT = Country of Origin; LA = Log of Total Asset.

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Table 9 – Probabilities to choose the fair value approach

Situation Model Probability

IFRS_1 = 0
Pfv = 1/ 1+e –(-0,741) Pfv = 0,32
RENT = 0

IFRS_1 = 0 Pfv = 1/ 1+e –(-0,741+3,308) Pfv = 0,93

RENT = 1

IFRS_1 = 1
Pfv = 1/ 1+e –(-0,741-2,860) Pfv = 0,026
RENT = 0

IFRS_1 = 1 Pfv = 1/ 1+e –(-0,741-

2,860+3,308) Pfv = 0,42
RENT = 1

Pfv = probability of choosing the fair value approach for investment properties under IAS 40
RENT = Rental income to total revenue ratio; IFRS_1 = Fair value as deemed cost option
(dummy).
RENT = 0 (the company’s revenues do not come from renting out investment properties)
RENT = 1 (the 100% of company revenues comes from renting out investment properties)
IFRS_1 = 0 (company do not use the “fair value as deemed cost” option)
IFRS_1 = 1 (company opts for the “fair value as deemed cost” option)

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