The Effect of Managers Discretion in Fair Value Measurement on Investment Selling Decisions

Document Type : Research Paper

Authors

1 Department of Accounting, Shahrekord Branch, Islamic Azad University, Shahrekord, Iran.

2 Department of Accounting, Isfahan (Khorasgan) Branch, Islamic Azad University, Isfahan, Iran

3 Department of Accounting, University of Isfahan, Isfahan, Iran

Abstract

  Fair value accounting for valuation of assets and liabilities has given managers the discretion.The purpose of this study is to investigate the effect of manager’s discretion allowed in fair value measurement on investment selling decisions. In order to test the research hypotheses, a questionnaire based on the scenario was used. This questionnaire is based on Green et al. (2015). The statistical population consists of all active financial analysts in investment companies and stock exchange brokers and the statistical sample of the study was determined using the sample size tables of Cohen et al. (2000) of 268 people. Multivariate analysis of variance (MANOVA) and univariate analysis of variance (ANOVA) were used to analyze the data and test hypotheses. The results of this study showed that conservatism and its interaction with the fair value volatility have a significant effect on the investment selling decisions based on fair value, but the fair value volatility has no significant effect on these decisions. Overall, the results of the research showed that the directors' discretions in fair value accounting affects investment selling decisions.
  1- Introduction
Accounting academics and practitioners have been debating the reliability and relevance of fair value accounting. According to Financial Accounting Standards, fair value accounting, often referred to as mark-to-market occurs when a firm revalues assets and liabilities based on an exit price. Advocates contend that fair value provides valuable and timely information to financial statement users by increasing transparency that aid in assessing firm value. In contrast, opponents argue that fair value is transitory because once the asset or liability is traded, the related accounting entries are reversed (Green, 2015). Thus, fair value may provide misleading and unreliable information. In particular, Level 3 fair value assets have no observable inputs and are valued by managers’ assumptions, thus the fair value is subjective (Zyla, 2013).
Level 3 fair values are unique in that subjective assumptions that are necessary to arrive at the fair value are based on unobservable inputs. According to the IASB codification glossary, unobservable inputs are defined as “market data that are not available and that are developed using the best information available about the assumptions that market participants would use 2 when pricing the asset or liability”. Depending on the valuation method selected, discretion can include the expected life of the asset or liability, the cash discount rate, and risk return rates (Zyla, 2013). This discretion can affect financial statements.
Prior reserch has established that factors such as earnings management (Dechow and Shakespear, 2009, Dechow et al, 2010), optimism (Kedia and Philippon, 2009), national culture (Ball et al., 2000), fear of litigation (Lobo and Zhou, 2006), and auditor compliance (Milbradt 2012) influence the recognized fair value. However, limited research has examined how managerial behavioral effects prior to recognizing fair value (Chen et al., 2013, Green, 2015).
Motivated reasoning theory contends that individuals will perceive information in a manner that will benefit their desired outcome (Kunda 1990). Thus, managers are likely to view a fair value that results in gains as a valid representation of the true underlying value. Because of the resulting unrealized gains, managers will be motivated to base Level 3 fair value selling decisions at the fair valuation amount (Green, 2015).
When examining manager’s likelihood to sell a Level 3 fair value asset or liability, prospect theory (Kahneman and Tversky, 1979) suggests that only unrealized gain from the increase of the recognized fair value will motivate managers to be risk averse. In order to preserve the unrealized gain, managers will not sell the asset or liability if the market offers a price less than the most recent recognized fair value (Green, 2015).
  2- Research hypotheses         
Based on theoretical foundations and research background, the research hypotheses can be expressed as follows:
H1: The conservative level used in the assessment of fair value affects the decision to sell investment at the 3 level of fair value.
H2: The level of historical volatility of fair value affects the decision to sell investment at the 3 level of fair value.
H3: The interaction of the level of conservatism and the level of historical volatility of fair value, affects the decisio to sell investment at the 3 level of fair value.
  3- Methods
This research in terms of purpose is a fundamental research, in terms of method is quasi-empirical and in the point of data collection is survey. In this research, to test the research hypotheses, a questionnaire based on the scenario was used. This questionnaire is based on Green (2015). The statistical population consists of all active financial analysts in investment companies and stock exchange brokers and the statistical sample of the study was determined using the sample size tables of Cohen et al. (2000) of 268 people. Multivariate analysis of variance (MANOVA) and univariate analysis of variance (ANOVA) were used to analyze the data and test hypotheses.
  4- Results
The results of this study showed that conservatism and its interaction with the fair value volatility have a significant effect on the investment selling decisions based on fair value. However, the fair value volatility has no significant effect on these decisions. The other results showed that financial analysts' demographic characteristics do not have a significant effect on investment decision-making. Overall, the results of the research showed that the directors' discretions in fair value accounting affects investment selling decisions.
  5- Discussion and conclusion
Findings of the research indicate that with the increase in the level of conservatism used in the assessment of fair value, managers' willingness to sell investments increases. This result is consistent with the motivated reasoning and the prospect theory. The results of this study are consistent with the results of Green (2015). In addition, the results of the research showed that the historical volatility of fair value does not affect the decision of investment sales. This result is not consistent with agency theory and prospect theory, but is consistent with the results of Green (2015). The sensitivity analysis of this result suggests that, the increase in the fair value volatility, the asking sales price and the probability of sales below the current fair value has not increased and did not reduce the lowest acceptable price.
  Keywords: Manager Discretion, Conservatism, Fair Value Volatility, Investment Selling Decisions.
   
 

Keywords

References

 
Afrangan, A. (2016). Investigating the relationship between revaluation with fair value accounting base for non-current assets and auditing fees in companies listed in Tehran Stock Exchange. Master thesis. Accounting group. Marvdasht Branch. Islamic Azad University. (in Persian)
Ball, R., Kothari, S. P., & Robin, A. (2000). The effect of international institutional factors on properties of accounting earnings. Journal of Accounting and Economics, 29(1), 1-51.
Barron, O. E., Chung, S. G., & Yong, K. O. (2016). The effect of statement of financial accounting standards No. 157 fair value measurements on analysts’ information environment. Journal of Accounting and Public Policy, 35(4), 395-416.
Baucells, M., Weber, M., & Welfens, F. (2011). Reference-point formation and updating. Management Science, 57(3), 506-519.
Barth, M. E., Landsman, W. R., & Wahlen, J. M. (1995). Fair value accounting: Effects on banks' earnings volatility, regulatory capital and value of contractual cash flows. Journal of Banking & Finance, 19(3-4), 577-605.
Brink, A. G., Hobson, J. L., & Stevens, D. E. (2016). The effect of high power financial incentives on excessive risk-taking behavior: An experimental examination. Journal of Management Accounting Research, 29(1), 13-29.
Bromiley, P. (2009). A prospect theory model of resource allocation. Decision Analysis, 6(3), 124-138.
Chen, W., Tan, H. T., & Wang, E. Y. (2013) Fair value accounting and managers' hedging decisions. Journal of Accounting Research, 51(1): 67-103.
Cohen, L., Manion, L. & Morrison, K. (2000). Research Methods in Education. 5th Edition, London: Routledge Falmer.
Dechow, P. M., & Shakespear, C. (2009). Do managers time securitization transactions to obtain accounting benefits? The Accounting Review, 84(1): 99-132.
Dechow, P. M., Myers, L. A., & Shakespeare, C. (2010). Fair value accounting and gains from asset securitizations: A convenient earnings management tool with compensation side-benefits. Journal of Accounting and Economics, 49(1-2), 2-25.
Fiechter, P., & Novotny-Farkas, Z. (2017). The impact of the institutional environment on the value relevance of fair values. Review of Accounting Studies, 22(1), 392-429.
Filip, A., Hammami, A., Huang, Z., Jeny, A., Magnan, M., & Moldovan, R. (2017). Literature review on the effect of implementation of IFRS 13 fair value measurement. Working paper.
Golmohammadi, M., & Rahmani, A. (2018). Technical challenges of implementing fair values in financial reporting of Iran: Emphasizing on IFRS13 requirements. Journal of Accounting and Auditing Review, 25(3), 387-414. (In Persian)
Green, K. Y. (2015). Can fair value accounting create a cognitive bias? The effects of recognized level 3 fair value on manager selling decisions. https://scholarscompass.vcu.edu/cgi/viewcontent.cgi?article=4717&context=etd
Hodder, L. D., Hopkins, P. E., & Wahlen, J. M. (2006). Risk-relevance for fair-value income measures for commercial banks. The Accounting Review, 81(2), 337-375.
Hirst, E., Hopkins, P. E., & Wahlen, J. M. (2004). Fair values, income measurement, and bank analysts' risk and valuation judgments. The Accounting Review, 79(2), 453-472.
IFRS 13. (2012). IFRS 13.1.
Kadous, K., Koonce, L., & Thayer, J. M. (2012). Do financial statement users judge relevance based on properties of reliability? The Accounting Review, 87(4), 1335-1356.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291.
Kedia, S., & Philippon, T. (2009). The economics of fraudulent accounting. The Review of Financial Studies, 22(6), 2169-2199.
Khajavi, S. & Ghadirian-Arani, M. H. (2018). Research Methodology in accounting. 2nd Edition. Tehran: University of Tehran Press. (in Persian)
Kolev, K. (2009). Do investors perceive mark-to-model as marking-to-myth? Early evidence from FAS No. 157 disclosure. Working paper, New York University.
Koonce, L., Nelson, K. K., & Shakespeare, C. M. (2011). Judging the relevance of fair value for financial instruments. The Accounting Review, 86(6), 2075-2098.
Kunda, Z. (1990). The case for motivated reasoning. Psychological Bulletin, 108(3), 480-498.
Lobo, G. J., & Zhou, J. (2006). Did conservatism in financial reporting increase after the Sarbanes-Oxley Act? Initial evidence. Accounting Horizons, 20(1), 57-73.
Lachmann, M., Wöhrmann, A., & Wömpener, A. (2011). Acquisition and integration of fair value information on liabilities into investors' judgments. Review of Accounting and Finance, 10(4), 385-410.
Marks, R. W. (1951). The effect of probability, desirability and "privilege" on the stated expectations of children. Journal of Personality, 19(3), 332-351.
Mishra, H., Mishra, A., Rixom, J., & Chatterjee, P. (2013). Influence of motivated reasoning on saving and spending decisions. Organizational Behavior and Human Decision Processes, 121(1), 13-23.
Milbradt, K. (2011). Level 3 assets: Booking profits and concealing losses. The Review of Financial Studies, 25(1), 55-95.
Mirza, A. A., Holt, G. & Knorr, L. (2017). Wiley IFRS: Practical Implementation Guide and Workbook. John Wiley & Sons, Inc.
Mirzaei, S. (2016). Impact of uncertainty and disclosure on auditors' decisions about fair value. Master thesis. Accounting Department. East Tehran Branch. Islamic Azad University. (in Persian)
Mihamy, S. (2015). Investigating different views on the impact of adopting the fair value accounting standard on accounting profit. Master thesis. Accounting Department. University of Al-Zahra. (in Persian)
Nadi, M. A. & Sajjadian, I. (2010). Fundamentals of Applied Research Methods in Humanities. First Edition. Isfahan: Khorasgan Branch of Islamic Azad University. (in Persian)
Pallant, J. (2015). A Step-by-step guide to data analysis using the SPSS program, translated by Akbar Rezaie, 2nd Edition, Tabriz: Forouzesh Publication. (In Persian)
Penman, S. H. (2007). Financial reporting quality: is fair value a plus or a minus? Accounting and Business Research, 37(sup1), 33-44.
Plantin, G., Sapra, H., & Shin, H. S. (2008). Marking‐to‐market: Panacea or Pandora's box? Journal of Accounting Research, 46(2), 435-460.
Rego, S. O., & Wilson, R. (2012). Equity risk incentives and corporate tax aggressiveness. Journal of Accounting Research, 50(3), 775-810.
Sapkauskiene, A. & Orlovskij, S. (2017). The usefulness of fair value estimates for financial decision-making, a literature review. Zeszyty Teoretyczne Rachunkowości, 93 (149), 163-173.
Safarzadeh, M. H. (2016). A practical guide to international financial reporting standards (IFRS) No. 13: Fair value measurement. Tehran: Audit Organization Publication. (in Persian)
Setayesh, M. H. & Jamalianpour, M. (2011). Investigating the conservatism in financial reporting of companies listed in Tehran Stock Exchange. Journal of Accounting Advances, 2 (1), 85-191. (in Persian)
Securities and Exchange Organization. (2016). Implementing international financial reporting standards (IFRS). Securities and Exchange Organization website. Deputy Governor of Stock Exchanges and Publishers, https://ifrs.seo.ir/News/Index/Ng==/13950326 (In Persian)
Song, C. J., Thomas, W. B., & Yi, H. (2010). Value relevance of FAS No. 157 fair value hierarchy information and the impact of corporate governance. The Accounting Review, 85(4): 1375-1410.
Toloui Ashlaghi, A., Safakish, M. S. & Pourebrahimi, A. (2011). Multivariate Statistical Analysis. First Edition. Tehran: Islamic Azad University Publication. (In Persian)
Wang, K. J. (2010). Negotiating a fair value under accounting uncertainty: A laboratory experiment. Behavioral Research in Accounting, 22(1), 109-134.
Zamora-Ramírez, C., & Morales-Díaz, J. (2018). The use of fair value measurement in financial reporting: A literature review. Estudios de Economía Aplicada, 36(2), 489-514.
Zyla, L. M. (2013). Fair value measurement: Practical Guidance and Implementation. Hoboken, New Jersey: John Wiley & Sons, Inc.
 
Journal of Accounting Advances
Volume 11, Issue 2 - Serial Number 79
December 2019
Pages 253-284

Files

History

  • Receive Date: 18 February 2019
  • Revise Date: 12 September 2019
  • Accept Date: 14 September 2019

Share

How to cite

Statistics