Abstract
AbstractUsing a balance sheet valuation model, this study examines if information on the fair value hierarchy of on-balance sheet financial assets and financial liabilities are incorporated in the market’s valuation of companies’ equities in Singapore. The results of the study show significant associations between as-reported Level 1 and Level 2 fair value measures of financial assets and market values. However, the results are not significant for Level 3 fair value measures of financial assets and each of the three levels of fair value measures of financial liabilities. The results also show that returns are more positively associated with as-reported gains and losses from Level 1 and Level 2 fair value measures than those from Level 3 fair value measures. Overall, the evidence suggests that information on the fair value hierarchy of IFRS 7 Financial Instruments: Disclosures are used by market participants in their pricing decisions. The market however appears to place greater weights on fair value changes taken to the income statement than those taken to OCI, notwithstanding the level of the fair value measure. While the fixation with income statement measures remains a puzzle, the results are consistent with prior studies that show that investors largely ignore OCI in their pricing of shares.
Highlights
One of the primary concerns of fair value accounting is the real risk of measurement errors and earnings management
Research proposition 3: All things being equal, gains and losses on fair value measures taken to net income are likely to be more significantly associated with returns on market value of equity than gains and losses on fair value measures taken to OCI
Jt (3) Where j and t denote firms and years; MVE is market value of common equity determined three months after the financial year end; FVFA is the fair value of financial assets and FVFL is the fair value of financial liabilities; BVOA 3 is the carrying amount of other assets (i.e. Total assets – FVFA); BVOL is the carrying amount of other liabilities (i.e. Total liabilities – FVFL); The variables are deflated by end of year number of issued ordinary shares to control for size differences across firms
Summary
One of the primary concerns of fair value accounting is the real risk of measurement errors and earnings management. In assessing the value relevance of fair value information on financial instruments, the study examines both balance sheet (levels) and income items (changes) relating to fair value measures. The study uses a returns model to evaluate the significance of the relationship between returns and reported fair value gains and losses from financial instruments reported in net income and OCI. In his survey of capital market research, Landsman (2007) indicates that evidence from research shows that disclosed and recognized fair values are informative but he cautions that the level of informativeness is affected by the extent of measurement error and reliability of estimates. A moderating factor to the value relevance of Level 3 fair value information is the state of corporate governance of the reporting entity
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