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Fair Value or Cost Model? Drivers of Choice for IAS 40 in the Real Estate
Industry
A. Quaglia; F. Avalloneb
a
Department of Accounting and Business Studies (DITEA), University of Genova, Genova, Italy b
Department of Computer and Management Science (DISA), University of Trento, Trento, Italy
First published on: 08 September 2010
To cite this Article Quagli, A. and Avallone, F.(2010) 'Fair Value or Cost Model? Drivers of Choice for IAS 40 in the Real
Estate Industry', European Accounting Review, 19: 3, 461 493, First published on: 08 September 2010 (iFirst)
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European Accounting Review
Vol. 19, No. 3, 461 493, 2010
Fair Value or Cost Model? Drivers

of Choice for IAS 40 in the Real
Estate Industry
Downloaded By: [Faculdade De Economua Administracao E Contabilidade USP] At: 21:24 12 March 2011
A. QUAGLI and F. AVALLONE

Department of Accounting and Business Studies (DITEA), University of Genova, Genova, Italy
and Department of Computer and Management Science (DISA), University of Trento,
Trento, Italy
(Received September 2008; accepted February 2010)
ABSTRACT The IFRS mandatory adoption in European countries is an excellent context

from which to assess the validity of accounting choice theory, which postulates that
information asymmetry, contractual efficiency (agency costs) and managerial
opportunism reasons could drive the choice. With this aim, we test the impact of these
factors to explain the adoption of fair value for investment properties (IAS 40) in the
real estate industry, taking into account the revaluation option offered by IFRS1 and
using historical cost without revaluations as a baseline category for comparison
purposes. We select a sample of European real estate companies from Finland, France,
Germany, Greece, Italy, Spain and Sweden, all first-time adopters of the IFRS. Using a
multinomial logistic model, we show that information asymmetry, contractual efficiency
and managerial opportunism could account for the fair value choice. Particularly, the
most significant findings are that size as a proxy of political costs reduces the likelihood
of using fair value while market-to-book ratio is negatively associated with the fair
value choice. On the other hand, leverage, another typical proxy of contracting costs,
seems not to influence the choice. This evidence confirms the current validity of
traditional accounting choice theory even if it reveals, in such a context, the irrelevance
of the usual relations between accounting choice and leverage.
1. Introduction
We analyse if the choice between cost or fair value for investment property
under IAS 40 aims at (i) reducing agency costs (contractual efficiency
Correspondence Address: A. Quagli, Department of Accounting and Business Studies (DITEA),

University of Genova, Via Vivaldi 2, 16126 Genova (GE), Italy. E-mail: quaglia@economia.unige.it
0963-8180 Print/1468-4497 Online/10/03046133 # 2010 European Accounting Association

DOI: 10.1080/09638180.2010.496547
Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA.
462 A. Quagli and F. Avallone
reasons), (ii) mitigating information asymmetries, as standard setters claim, or

(iii) allowing managerial opportunism, typical motives defined by accounting
choice theory (Holthausen, 1990; Fields et al., 2001).
Using a multinomial logistic regression, we test these hypotheses using 73
observations from real estate companies located in European countries
(Finland, France, Germany, Greece, Italy, Spain and Sweden) which do not
allow the fair value method in the pre-IFRS mandatory period in order to elim-
inate the influence of pre-existing fair value adoption. All these firms are first-
time IFRS adopters, enabling us to compare the same accounting choice in a
similar situation (first-time adoption).

The mandatory adoption of IAS 40 (Investment properties) by European listed
companies offers a unique opportunity to verify managers behaviour in a com-
posite context of accounting choice. In fact, IAS 40 allows two alternative
methods for appraisal of investment property assets: the cost method or the fair
value method with recognition of fair value changes through profit and loss.
Additionally, taking into account the IFRS1 fair value as deemed cost option,
the cost choice could be split into two alternatives: (i) historical cost without
revaluation, (ii) historical cost with the IFRS1 option to revaluate investment
property. This second option could represent a partial substitute for the fair
value method, showing its effects only in equity without influencing profit and
loss.1
Thus, our model assumes the choice of applying historical cost without reval-
uating it as the referent outcome category to compare (Y 0), and forms logits
comparing the choice of using historical cost with IFRS1 revaluations of invest-
ment property (Y 1) and fair value choice (Y 2) to it.
Our findings suggest that all the rationales described by accounting choice
theory (information asymmetry, contractual efficiency and managerial opportu-
nism) drive the decision to adopt fair value. Indeed, regarding contractual effi-
ciency reasons in particular, we find that the larger the size (proxy of political
costs), the less likely fair value is to be chosen, while leverage and consequent
lenders protection seems to be insignificant for the choice.
Furthermore, our results show that market-to-book ratio (MTBV) (proxy of
information asymmetry) is negatively related to the fair value choice. This
finding, that conflicts with existing literature, could be accounted for in the real
estate industry due to the fact that high levels of MTBV in this context reveal
growth opportunities associated with a fair estimation of investment properties
and therefore with a low information asymmetry. Managerial opportunism be-
haviour, measured by a dummy variable for earnings smoothing, seems to
have an influence on fair value choice.
While all these variables seem to have an influence on the fair value choice, the
same variables do not explain the choice of historical cost with the IFRS1 reva-
luation option in preference to the cost maintenance approach.
This paper offers various contributions to current literature. Firstly, to the best
of our knowledge, it is one of the first papers specifically focused on the choice
Fair Value or Cost Model? 463
between cost and fair value in the IFRS context. We perform the analysis using a
sample of first-time IFRS adopters from several European countries adopting
only the cost method in the pre-IFRS phase in order to both not limit the research
to the traditional comparison between German and UK firms and eliminate the
risk of influence from past experience.
Secondly, this paper introduces to the accounting choice literature a research
designed to analyse the influence of multiple motivations (contractual efficiency,
information asymmetry and managerial opportunism) for a multiple-choice
environment (cost, cost with IFRS1 revaluation or fair value through profit and
loss), testing through a multinomial logistic regression all the possible causes.
Previous research, on the contrary, usually overlooks a comparison of multiple
motivations (Fields et al., 2001, pp. 290 291). In other words, compared to exist-
ing studies we conduct an analysis using an innovative multiple motivations
multiple choices approach that better captures the complexity of accounting
choices in management decisions.
Finally, we contribute to the current debate on fair value showing which firm
characteristics drive the choice of this method. While information asymmetries
are the most discussed motives for fair value, we demonstrate the influence of
contractual efficiency motivation as well as managerial opportunism, and the
actual choices by firms demonstrate only a partial enthusiasm towards fair
value, even in a sector where liquid markets exist.
The paper proceeds as follows. Section 2 concerns the literature related to our
analysis. Section 3 goes on to describe the main features of IAS 40 and the pre-
IFRS domestic GAAP of the countries sampled. Section 4 illustrates the develop-
ment of our hypotheses, while Section 5 provides details on the empirical model
design, variable definition, sample selection and data. Finally, Section 6 describes
descriptive statistics, the main findings and the robustness of the results.
2. Theory and Relation to Existing Research

The choice between fair value and cost is a central topic in the current debate on
accounting. Fair value is generally preferred due to the fact that financial state-
ments reveal a higher level of information (CFA Institute Centre, 2008),2 even
if its adoption requires specific conditions: liquid markets, large database of
available prices (Barth and Landsman, 1995; Ball, 2006), as well as new compe-
tencies in developing measurement models in the absence of liquid markets,
making it possible to enhance estimate reliability (Schipper, 2005). On the
other hand, the reliability of fair value estimates is the most critical point
(Martin et al., 2006; Watts, 2006; Whittington, 2008), with the potential
damage brought to the stewardship function of financial statements. More gener-
ally, 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 infor-
mation vs. reliability of financial statements in Common law countries is quite
different from the same demand in Code law countries (see Ball et al., 2000).
Alternatively, a cost model seems more efficient in a contractual perspective

because it reduces agency costs generated by creditors protection, political visi-
bility, taxation and litigation (Watts, 2003; Qiang, 2007).
Recent studies, however, seem to ignore the importance that the analysis of the
adoption of IFRS evaluation alternatives could have in providing some more
explanations for managers accounting choices and, consequently, for the pro-
gress of accounting choice theory. Therefore, the choice between cost and fair
value is a central topic in this sense.
Following the framework of Francis et al. (2004), fair value and cost affect the
properties of accounting numbers in a very different way. Fair value is more

value relevant,3 and provides more predictable and timely earnings figures
because it is more oriented towards future cash flows (derivable by the current
value of some assets); on the contrary, the cost method approach supports conser-
vatism, smoothness and the accrual quality, due to the recognition of value
changes only if realized. While it is difficult to suppose the impact on earnings
persistence, depending on the size of fair value changes, the aforementioned
aspects will give rise to different accounting behaviours. The information
about future cash flows derived by fair value will be more appreciated in financial
markets (analysts and equity investors), because it will contribute to mitigate
information asymmetries. On the other hand, the cost method is less costly and
has more utility for income smoothing and contractual efficiency for which con-
servatism is a precious support. In other words, each of these methods has, at a
theoretical level, pros and cons and the actual choice will likely depend on
firm-specific circumstances. The different impact of these two methods strongly
implies the need of the accounting choice theory to investigate the topic.
A powerful starting point for accounting choice investigation is offered by
Holthausen (1990; see also Watts and Zimmerman, 1978; Fields et al., 2001)
who classified in: (i) contractual efficiency (agency costs), (ii) information asym-
metry and (iii) managerial opportunism, the reasons for accounting choices.
(i) Expectations derived from the accounting choice theory concerning the
impact of fair value on contractual efficiency could lead to a supposed nega-
tive relationship: the choice of fair value could increase agency costs for
several reasons. The greater income fluctuations induced by fair value com-
pared to the cost model could enhance the perceived risk by investors (Euro-
pean Central Bank, 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). Additionally, the doubtful ver-
ifiability of fair value compared to cost measures, in some contexts (illiquid
markets) could increase litigation and its related costs (Watts, 2003), as well
as the fact that fair value through profit and loss could anticipate taxation
costs. Furthermore, we can infer from the contractual efficiency reasons
regarding lenders protection contrasting hypotheses on fair value prefer-
ence. On the one hand (Watts, 2003; Qiang, 2007), lenders prefer
conservatism (thus the cost method) because it reduces the risk of distribut-
ing firm value through dividends. On the other hand, fair value represents
the current value of assets and it could be more efficient in negotiating
for debt covenants. In this sense Christensen and Nikolaev (2008), basing
their research on a sample of French and German multi-industry companies,
find that the fair value method is preferred by companies with high leverage
and they account for this through information asymmetry: the current value
of fixed assets gives more thorough information about the firms solvency
capability. In this sense, IFRS1 revaluation option could be a partial sub-
stitute of IAS 40 fair value, that is, firms could use the conservative cost
approach to guarantee lenders protection but they could opportunistically
revaluate investment assets through IFRS1 to beat covenants or to give a
signal about their solvency capability. In other words, while IAS 40 fair
value is a long-term strategy whose effects are uncertain (fair value
could give rise to future revaluations or impairments), the IFRS1 option
could be seen as a short-term strategy, the accounting consequences of
which could be made available before its adoption (the revaluations ex
IFRS1 option must exist at the transition date, that is, one year before the
first exercise IFRS compliant). In this sense, this option would encourage
opportunistic (and aggressive) accounting behaviour. All these propositions,
however, could fail to be applied if we take into account that covenants use,
on average, to exclude revaluation reserves in financial ratios.
(ii) Looking at asymmetries for market participants, measured by market-to-
book ratio (MTBV), fair value could be preferred to cost method because
of its higher and updated level of information divulgated to financial state-
ment users. This is the main argument supporting the fair value primacy
from a current standard setters viewpoint (Barlev and Haddad, 2003;
Ball, 2006; Danbolt and Rees, 2008; Whittington, 2008). For this hypoth-
esis, IFRS1 option could be a partial substitute for IAS 40 fair value,
because of its influence on equity and, consequently, on MTBV.
(iii) When a firm is choosing between cost and fair value, the managerial oppor-
tunistic accounting behaviour, previously demonstrated by income smooth-
ing practices (Barth et al., 1999; Heflin et al., 2002; Graham et al., 2005) is
less likely with fair value through profit and loss, which obliges large earn-
ings impact due to the volatility of market prices. However, the choice of the
IFRS1 option in this sense should be irrelevant (thus not competing with fair
value through profit and loss method), because this accounting option influ-
ences only equity and has no impact on profit and loss.
Our objective is to test empirically how these multiple, and in part controversial,
reasons (managerial opportunism, contractual efficiency and information asym-
metries) 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 specifically regarding its potential to
reduce information asymmetries (Whittington, 2008).
Our analysis is based on the assumption that recognition is more value relevant
than simple disclosure. Since IAS 40 requires footnote disclosure of fair value
investment properties for firms adopting cost (see Section 3), it could be
assumed that the choice between cost and fair value is not relevant, because
the information about fair value is available for financial statement users what-
ever the accounting policy chosen for investment properties. Nonetheless, our
paper poses disclosure not equivalent to recognition according to the prevailing
literature4 (for a review see Schipper, 2007). In all probability, the reasons can be
found in a different reliability of data included in the footnotes relating to the
balance sheet measures (Schipper, 2007). As affirmed by Cotter and Zimmer
(2003), specifically for revaluations of fixed assets, the value relevance of recog-
nized revaluations is not due to recognition per se, but rather to the fact that the
assets being revalued are more reliably measured (p. 1).
3. 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 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 recognized in the 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.
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 the 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 disclosure clause, request-
ing 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, which
is 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 prop-
erty and the lack of comparable market data.
The fair value method benchmarked by IAS 40 is a novelty for several Euro-
pean countries. Our sample looks at domestic accounting rules; it is made up of
companies from countries which allow only the cost method for investment prop-
erty: Germany (Deloitte & Touche, 2001), Finland (KPMG, 2003a), France
(KPMG, 2003b), Greece (Tsalavoutas and Evans, 2009), Italy (PWC, 2005),
Spain (Perramon and 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 poss-
ible to revaluate fixed assets to equity every four years following a revaluation
index established by the Government. In Germany no revaluations are allowed.
Finnish and Swedish 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.
4. Hypothesis Development
Following Section 2, we develop our hypotheses concerning: (i) efficiency
reasons, in terms of both the reduction of political costs and the lenders protec-
tion, (ii) information asymmetry and (iii) managerial opportunism.
(1) Contractual Efficiency

Following the hypothesis that conservatism accounting should reduce agency
costs through a greater lenders protection (Watts, 2003; Qiang, 2007), we
suppose a negative correlation between leverage and fair value method. We do
not conjecture the opposite assumption (Holthausen and Leftwich, 1983) that
in order to beat covenants, higher leverage could induce earnings increasing pol-
icies (like, in our specific context, the choice of fair value through profit and loss)
because covenants usually do not take into account fair value revaluations
(Citron, 1992; Christensen and Nikolaev, 2008). Thus,
H1: The probability of choosing fair value decreases if company has a high
leverage ratio level before IFRS adoption.
We do not posit any assumption on the relationship between leverage and the
choice of historical cost with the IFRS1 option for the aforementioned exclusion
of revaluation reserves in financial ratios used by covenants.
As already described in the part of Section 2 that looks at political costs, we can
suppose from the literature that conservative accounting reduces political costs
because the high level of reported profits could affect them due to higher
company visibility (Hagerman and Zmijewski, 1979; Watts, 2003). In order to
verify the impact of political cost on fair value choice, we adopt the firm size
as an independent variable. The size per se has been mentioned specifically as
a criterion for actions against corporations since several studies document that
the magnitude of political costs is highly dependent on the size of corporation
(Watts and Zimmerman, 1978). Thus, we conjecture that the political costs
increase according to the company size; the larger it is the higher are the political
costs and the lower is the probability that is advantageous to choose a fair value
approach. Accordingly, our research proposition is:
H2: The probability of choosing fair value decreases with the size of the
firm.
Even in this case, we do not suppose any relationship between political costs and
the choice of historical cost with the IFRS1 option, because this option has no
impact on profit and loss.
(2) Information Asymmetry

If information asymmetry exists in the specific context investigated, managers
could choose fair value in order to clearly inform the market about the true
value of the firm. So, under the assumption that disclosure is not equivalent to
recognition (Schipper, 2007), a positive association between the choice of the
fair value method and information asymmetry is assumed.
Many studies (Smith and Watts, 1992; Amir and Lev, 1996) use market-to-
book ratio (MTBV) as a proxy for information asymmetry, starting from the
intuition that while market value captures the present value of growth opportu-
nities, the book value approximates the value of assets in place. As a result, we
posit that MTBV is positively related to information asymmetry and, conse-
quently, positively related to fair value choice. Therefore, we assume:
H3a: The probability of choosing fair value increases the more marked is
the difference between market value and the book value of equity.
We could also develop a concurrent hypothesis to H3a, on the basis that, in this
case, the choice of historical cost with IFRS1 option, influencing equity, could be
a partial substitute of fair value through profit and loss. Thus, we expect a posi-
tive association between the choice of historical cost with IFRS1 option and
information asymmetry, as measured by MTBV ratio.
H3b: The probability of choosing historical cost with IFRS1 option

increases the more marked is the difference between market value and
book value of equity.
(3) Managerial Opportunism

From the theory we derive that managerial opportunistic accounting behaviour is
demonstrated by income smoothing practices (Barth et al., 1999; Heflin et al.,
2002; Graham et al., 2005) and we thus suppose that fair value through profit
and loss with its volatile changes contrasts smoothing policies. So, a negative
association between fair value choice and pre-IFRS earnings smoothing is
expected. Hence:
H4: The probability of choosing fair value decreases if managers reduce

the variability of reported earnings using accruals.
We do not suppose any relationship between managerial opportunism estimated

by earnings smoothing and the choice of historical cost with IFRS1 revaluation,
because this option has no impact on profit and loss.
5. Research Design
Empirical Model and Variable Definitions
Two statistical procedures are used in our analysis: (i) the non-parametric Mann
Whitney two-sample rank-sum test is used to analyse the difference in explana-
tory variables between the group of firms that have adopted the fair value model
or cost model with the IFRS1 revaluation and the group that have chosen the cost
model (the cost group has been taken as a referent category). Additionally, (ii) we
use a multinomial logistic regression model (MNL) to test the relationship
between the firm accounting choice for investment properties and the hypoth-
esized explanatory variables. Under the multinomial logistic model with three
outcome categories (0, 1 and 2), p covariates and a constant term (b) denoted
by the vector x, two logit functions are described as follows (Hosmer and Leme-
show, 2000):
g1 (x) = ln[P(Y = 1| x)/P(Y = 0| x)]

= b10 + b11 X1 + b12 X2 + . . . + b1p Xp (1)
and
g2 (x) = ln[P(Y = 2| x)/P(Y = 0| x)]

= b20 + b21 X1 + b22 X2 + . . . + b2p Xp . (2)
It follows that the conditional probabilities of each outcome category given the
covariate vector are:
P(Y = 0| x) = 1/1 + eg1 (x) + eg2 (x)

P(Y = 1| x) = eg1 (x) /1 + eg1 (x) + eg2 (x) (3)
P(Y = 2| x) = eg2 (x) /1 + eg1 (x) + eg2 (x) .
Our model assumes the choice to use historical cost without revaluating as the
referent or baseline outcome category to compare (Y 0), and forms logits com-
paring the choice to use historical cost with the IFRS1 revaluation of investment
properties (Y 1) and fair value choice (Y 2) to it. Furthermore, the model
assumes the following relation between the proposed explanatory variables and
the fair value accounting choice:
ln[P(Y = FV| x)/P(Y = COST| x)] = b

0 + b 1 LEV+ b 2 SIZE+ b 3 MTBV
(4)
+b 4 SM+ b 5 CNT+ b 6 EPRA+ b 7 ACT+1
where

b bFV;
CHOICEi dependent variable equal to 2 if the firm i adopts fair value
model under IAS 40 in first-time adoption (FTA), 1 if firm i
adopts the historical cost and uses IFRS1 to revalue invest-
ment properties and 0 if the firm i adopts the historical cost
without revaluating;
LEVi the average debt to asset ratio for firm i, measured over two
years before FTA;
SIZEi log of the average total asset over the two years before FTA;
MTBVi market-to-book value of firm i calculated over the last
month of the FTA year since the market is influenced by
the IFRS immediately after the FTA year;
SMij dummy variable coded 1 if firm i has an earnings smoothing
index . the average index of earnings smoothing in country
j (firms country of domicile) and 0 otherwise;
CNTi dummy variable coded 1 if firm i has an external market

capitalization on GNP . the average external market capi-
talization on GNP for his legal country of origin (from La
Porta et al., 1997) and 0 otherwise;
EPRA dummy variable coded 1 if firm i is a member of the Euro-
pean Public Real Estate Association (EPRA) and 0
otherwise;
ACT ratio between total rents and total operating income esti-
mated over the fiscal year preceding the IFRS mandatory
adoption.
Following Leuz et al. (2003) and Burgstahler et al. (2006) our proxy to capture
earnings smoothing policies 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 21 so that
higher values are associated with higher earnings smoothing policies.
Moreover, in order to capture the real significance of the smoothing ratio (only
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 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 earnings smoothing
index higher than the average index estimated for the country of origin and 0 other-
wise. 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).
We control for three variables we conjecture to affect the fair value choice by
including them as independent variables in the model. Controlling for both the
country of origin and the EPRA (European Public Real Estate Association) mem-
bership allows us to include two exogenous factors that could affect the fair value
choice. The former factor is considered because the differences in the nature of
financial systems around Europe are innate factors for international divergences
in accounting (Nobes, 1998), thus influencing the fair value choice as well. The
latter factor is considered because the EPRAs Best Practices Committee encour-
aged the members to adopt fair value accounting to enhance uniformity, compar-
ability and transparency of financial reporting by real estate companies (EPRA,
2006). Additionally, it makes sense to control for the firm activity since the
business segments within the real estate industry could be considerably different
(long-term investments, trading activity, development or services).
With reference to the country (CNT), we do not use the distinction between
Code Law Countries and Common Law Countries (Ball et al., 2000), because
our sample is entirely made up of Code Law Countries. Since accounting prac-
tices usually adhere to financing systems (systems based on banks are generally
more conservative than 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: countries where the role of financial markets is more developed
(capital market-based systems) and countries where financial markets are less
developed (credit-based systems). 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 market development, we use the same variable and values as
in La Porta et al. (1997). Specifically, we firstly computed the ratio of stock
market capitalization held by minorities to gross national product. Hence, the
higher ratio value is associated with highly diffused equity and, as a consequence,
with more financially developed markets. Therefore, we adopt a dummy variable
coded 1 if the firm has an external market capitalization on GNP higher than the
average external market capitalization on GNP for its legal country of origin
(from La Porta et al., 1997) and 0 otherwise. The stock market capitalization
held by minorities is computed as the product of the aggregate stock market capi-
talization and the average percentage of common shares not owned by the top
three shareholders in the 10 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 et al.
With reference to the EPRA membership, we only use a dummy variable
(EPRA) that takes a value of 1 for firms that are EPRA members and 0 otherwise.
Lastly, we control for firm activity (ACT). Particularly, since real estate compa-
nies could operate in many businesses (renting out investment properties, ser-
vices, trading of investment properties and development), we use a variable to
discriminate the firms which generally rent out investment properties from
firms that operate in trading, services and development. Thus, we use the ratio
between total rents and total operating income as a proxy of firm activity. So,
the high values of the ratio suggest that the renting activity may be considered
the companys core business while low values of the ratio express the opposite.
Both rents and total operating income are hand-collected from financial state-
ments for the fiscal year preceding the IFRS mandatory adoption and the latter
has been computed as the sum of rents, services, realized gains/losses on invest-
ment property sales and other operating revenues.
In terms of empirical predictions, we conjecture a positive relationship
between the fair value choice (CHOICE) and both financial market development
(CNT) and EPRA membership (EPRA). The present work makes no prediction
with respect to the other control variable (ACT).
Table 1, Panel A presents the proxies used for independent variables and the
predicted sign of each relation between covariates and fair value choice for
investment properties under IAS 40. Moreover, Table 1, Panel B only shows
the relations between independent variables and the choice to use historical
cost with IFRS1 revaluation, if theoretically significant.
Sample and Data

Our study focuses on a sample of real estate firms from countries where a sys-
tematic use of fair value model was not allowed for investment property assets
by pre-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.
In December 2007, the Datastream International database revealed 216 real
estate firms from the countries that were analysed (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 IFRS, obtained
from the corporate website or via a specific request to Investor Relators, (ii)
investment property assets on the balance sheet (as defined by IAS 40) not
equal to zero, and (iii) the full data availability in the Datastream International
database. Of the original 216 firms, 40 had neither website nor IR contact, 26
had financial statements not complying with IFRS in the period of analysis
(2005 2007), 7 had no investment properties, 27 failed to respond and 40
firms did not 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,
Panel A shows the sample selection procedure.
The described procedure clearly illustrates that our sample consists of the
maximum number of companies for which it is possible to obtain sufficient infor-
mation for the analysis, starting from the initial number of companies identified in
the database (N 216). Nevertheless, our analysis could have introduced a selec-
tion bias if an association between firms disclosure policies (e.g. assuring the
availability of the full financial statement on the corporate website 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 in drivers of choice
used in our analysis between firms that provide an annual report or disclose it
Table 1. Proxies and predicted signs for explanatory variables. The variables are grouped
according to the main hypotheses for fair value choice and for the choice to use historical
cost with IFRS1 revaluation
Predicted Explanatory
Hypotheses sign Proxies variables
Panel A: explanatory variables and fair value choice
(1) Contractual efficiency
The probability of choosing (H1) 2 Debt/asset LEV
fair value model decreases (leverage)
with higher leverage

The probability of choosing (H2) 2 Log of total asset SIZE
fair value model decreases
with the size
(2) Information asymmetry
The probability of choosing (H3a) + Market-to-book MTBV
the fair value model value
increases the higher is
information asymmetry
(3) Managerial opportunism
The probability of choosing (H4) 2 Earning SM
the fair value model Smoothing
decreases with the extent to Index (dummy
which corporate insiders variable)
reduce the variability of
reported earnings (earnings
smoothing)
(4) Control variables
Firms country of origin + External cap/ CNT
(financial markets GNP (dummy
development) variable)
EPRA members (European + Yes/no (dummy EPRA
Public Real Estate variable)
Association)
Firm activity ? Total rents/total ACT
operating
income
Panel B: explanatory variables and historical cost with the IFRS1 option
(2) Information asymmetry
The probability of choosing (H3b) + Market-to-book MTBV
the historical cost with value
IFRS1 option increases the
higher is the information
asymmetry
after request (the sample) and those that do not. 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 statements of non-disclosing
firm. Thus, we do not control if a difference exists in firm activity (ACT)
between sampled and non-sampled firms.
Table 2 . Sample selection procedure and breakdown by country

Panel A: sample selection procedure Number Per cent
European Real Estate Firms listed in their own country 216 100%
of origin in December 2007 in the following stock
markets (source: Datastream): Finland, France,
Germany, Greece, Italy, Spain and Sweden (countries
where systematic revaluation of investment
properties was not allowed before the IFRS adoption)
Excluding the firms:
not reporting under IAS/IFRS in the period of 226 12%

analysis (2005 2007)
with no investment property assets (or with 27 3%
investment properties equal to zero)
with neither website nor IR contact 240 18.5%
failing to respond 227 13%
with insufficient data to estimate equation (3) (in 240 18.5%
financial statements or in Datastream database)
Final sample 76 35%
Panel B: breakdown of sampled firms by country and the number (percentage) of
companies selecting fair value, cost with the IFRS1 revaluation or cost method
Country No. of sampled Weight Fair value Cost with the Cost (%)
companies (%) (%) IFRS1 (%)
Finland 4 5 4 (100) 0 (0) 0 (0)
France 26 34 11 (42) 4 (16) 11 (42)
Germany 22 29 12 (55) 4 (18) 6 (27)
Greece 4 5 3 (75) 1 (25) 0 (0)
Italy 8 11 2 (25) 1 (12) 5 (63)
Spain 4 5 0 (0) 3 (75) 1 (25)
Sweden 8 11 8 (100) 0 (0) 0 (0)
Total 76 100
Panel B shows the breakdown by country of the sample and the proportion of companies that select
fair value, cost with IFRS1 revaluation or cost method without revaluating 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).
Of the original 67 non-disclosing firms (which have neither website nor IR

contact or failed to respond), 34 firms did not have 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 still not listed. In that case the reference date has been
considered as the listing year.
The results show that disclosing firms (the sample) are not statistically differ-
ent from the non-disclosing firms in terms of the explanatory variables we
selected except for the size (p-value of 0.000).
This result is consistent with the literature that shows disclosure levels are
usually positively correlated with firm size because of the decrease in the cost
of disclosure (Lang and Lundholm, 1993). However, we keep the variable in
the analysis for two reasons. Firstly, the firm size (our proxy for political
costs) could have both a possible negative relationship with fair value choice
and a positive relationship with earnings smoothing (Watts and Zimmerman,
1978). If we do not include the firm size in the analysis, a significant negative
relation between earnings smoothing and fair value choice could be observed
even if the size were the true explanatory variable. Secondly, even if a difference
between sampled firms and non-disclosing firms exists in terms of size, summary
statistics show a deviation in size within the sample that does not affect the results
of the analysis.
With reference to the control variables, among the non-sampled firms only one
company is an EPRA member. This is an expected result because the EPRAs
objective is to establish best practices in reporting and to provide high-quality
information to investors. The result, however, does not introduce a selection
bias in the analysis because the sample is made of both EPRAs members (34
firms, around 45% of the sample) and companies that are not (42 companies,
55% of the sample).
For these reasons, the results validate our sample and suggest that the sample
selection did not introduce a bias into the analysis.
We relied on two sources for obtaining data for tests: (i) the first financial state-
ment compliant with 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 IFRS1 and
to hand-collect from notes the portion of revenue that is a result of rental activi-
ties. The latter source provides all the accounting and non-accounting data we
need to define the other explanatory and control variables. Non-accounting
data includes market-to-book ratio while the accounting data consists of leverage
(debt to asset ratio), total asset, operating income and cash flow from the oper-
ation (the last two accounting numbers have been used to estimate the earnings
smoothing ratio) and the revenues that come from rents.
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 which is not influenced by the
choice. In order to make sense of this key assumption, we referred to different
periods for market records and information collected from financial statements
when collecting data. Market data refers to the end of the FTA year because
the market is influenced by IFRS immediately after the FTA year. In other
words, immediately after the FTA financial data under IFRS is actually disclosed
in financial statements (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 is considered to be more representa-
tive of a firms general characteristics and, in particular, able to reduce the effects
that might occur from any unusual or abnormal data from a single year. Only the
earnings smoothing ratio required a longer period of time; we used a four-year
time period before the FTA for both operating income and cash flow from oper-
ation in order to estimate the related standard deviations. These two values were
then compared to detect any earnings smoothing propensity.
Financial information about the Swedish firms is converted into euros on the
date of download from Datastream. Market data was automatically converted
by the Datastream database.
6. Analysis of Results
Summary Statistics
Table 2, Panel B shows the sample by country breakdown and displays both the
number and the proportion of companies that select fair value, fair value with
IFRS1 or cost model, respectively, in each country. At first glance, Table 2,
Panel B seems to reveal some national patterns in explaining the selection
between fair value, historical cost with IFRS1 and cost model without revaluating
investment properties.
Despite the relatively small number of companies selected in some countries, it

has still been possible to observe that companies from Finland, Greece and
Sweden are extremely prone to adopting the fair value method. Conversely,
Italian companies seem to prefer historical cost without revaluating, Spanish
companies have a preference for historical cost with the IFRS1 choice to
revalue investment properties, 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. Thus, the results justify our choice to control for a
country variable through the multivariate analysis.
Table 3 presents summary statistics for the full sample of 76 firms. It should be
noted that the two variables, market-to-book value (MTBV) and leverage (LEV),
give rise to outlying observations implied by the values in the minimum and
maximum columns of the table.
One firm in particular had problematic values of both MTBV (value below
zero) and LEV (value above one), due to a negative book value and this obser-
vation was removed from the analysis. Additionally, we isolate the outlying
observations by means of the three sigma (standard deviation) rule (Barnett
and Lewis, 1994), thus separating companies which have

x m(x) 3s(x) (5)
where s(x) is the standard deviation of the variable (x).

To remove the possible effects of the outliers on the results, we present both the
nonparametric analysis and the multinomial logistic regression excluding these
values (N 73).
Downloaded By: [Faculdade De Economua Administracao E Contabilidade USP] At: 2
478
A. Quagli and F. Avallone
Table 3. Summary statistics of explanatory variables for sampled firms (n 76)
Variable Mean Std. dev. Minimum Q1 Median Q3 Maximum
Explanatory variables:
LEV 0.5881 0.2802 0 0.4829 0.6015 0.7235 2.07
SIZE 12.7876 1.6774 8.2765 11.9451 12.9058 13.9800 16.6882
MTBV 1.4739 1.1350 20.17 0.965 1.3 1.615 8.94
SM 0.3684 0.4855 0 0 0 1 1
Control variables:
CNT 0.4736 0.5026 0 0 0 1 1
EPRA 0.4473 0.5005 0 0 0 1 1
ACT 0.4999 0.3492 0 0.1834 0.4551 0.7778 1
LEV leverage; SIZE log of total asset; MTBV market-to-book value; SM earnings smoothing (dummy); CNT financial market development (dummy);
EPRA EPRA member (dummy); ACT firm activity.
Nonparametric Mann Whitney Test

To begin by analysing the characteristics of the firms that adopt the fair value
method or the historical cost with the IFRS1 revaluation in comparison to those
that adopt the historical cost without revaluation, we use a MannWhitney two-
sample rank-sum test. In view of the small size of the three groups, a nonparametric
alternative to a conventional t-test is justified because of the less challenging
assumptions it requires, although this test has some limitations of its own, including
being somewhat less powerful than the t-test. Table 4 shows evident differences
across our independent variables, some of which appear statistically significant.
Consistent with the information asymmetry hypothesis (H3a), the output

shows that there is a statistically significant difference in MTBV between real
estate firms that choose the fair value method and real estate firms that adopt his-
torical cost without revaluation (difference significant at 0.000 level). The analy-
sis of both means and median for fair value and cost groups makes the direction of
the difference clear (for the fair value group, a mean of 1.203 and a median of
1.11 against 1.775 and 1.49 for the cost group). The output exhibits a negative
relation between the MTBV and the fair value choice, contrary to the prediction
derived by the traditional meaning of MTBV as proxy for information asymme-
try. In fact, the usual interpretation of high MTBV ratios as a signal of infor-
mation asymmetry is based on the existence of growth options well known by
managers, not revealed by accounting rules and, consequently, not identified
by investors. In theory, more growth options for high-tech firms in particular,
are supposed as a consequence of a large bulk of intangibles whose recognition
in financial statements is not allowed, even though investors can estimate their
importance (Smith and Watts, 1992; Amir and Lev, 1996). However, in the
real estate industry the relevance of intangibles seems less important than in
high-tech firms. The main assets are investment properties, whose fair value
could be easily estimated by financial analysts. In this context, the meaning of
high MTBV ratios might be in direct conflict with the original intuition. In the
cost accounting systems before IFRS adoption, higher values of MTBV ratios
revealed growth opportunities associated with a fair estimation of investment
properties and therefore with a lower information asymmetry. Conversely,
lower MTBV ratios for real estate firms adopting the cost method could feasibly
be the effect of information asymmetries on investment properties value and
managers could prefer to use fair value method to reduce these asymmetries.
In more precise terms, under the assumption that disclosure is not equivalent to
recognition (Schipper, 2007), lower MTBV ratios estimated before the IFRS adop-
tion for real estate firms adopting historical cost should be the result of information
asymmetries on investment properties value. Thus, lower MTBV ratios could justify
the managers preference to the fair value method in order to reduce the asymmetries.
This reasoning makes it possible to demonstrate the validity of the hypothesis
(H3a), even if the sign of the variable is opposite to the traditional interpretation
of the relationship between MTBV and information asymmetry.
Table 4. Mann Whitney two-sample rank-sum test. Fair Value Group vs. Cost Group
(NFV 38; NCOST 16) and Cost with IFRS1 revaluation vs. Cost Group (NIFRS1
19; NCOST 16)
Group Z-Statistics Pr . |Z|

Explanatory variables:
LEV FV vs. COST 20.114 0.909
IFRS_1 vs. COST 1.192 0.233
SIZE FV vs. COST 0.682 0.495
IFRS_1 vs. COST 0.762 0.446
0.000
MTBV FV vs. COST 3.543

IFRS_1 vs. COST 1.258 0.208
SM FV vs. COST 0.814 0.415
IFRS_1 vs. COST 21.185 0.235
Control variables:
CNT FV vs. COST 22.018 0.043
IFRS_1 vs. COST 21.931 0.053
EPRA FV vs. COST 21.007 0.314
IFRS_1 vs. COST 0.040 0.968
ACT FV vs. COST 23.523 0.000
IFRS_1 vs. COST 20.364 0.715
This table presents the MannWhitney two-sample rank-sum test for both explanatory and control
variables. , and indicate statistical significance at less than 10%, 5% and 1% level, respectively.
The sample (excluding the outliers) comprises 73 companies from seven countries, split into three
groups: firms that adopt the fair value model (NFV 38), firms that choose the historical cost and use
the IFRS1 option to revalue investment properties (NIFRS1 19) and firms that adopt the cost model
without revaluating (NCOST 16) for investment properties under IAS 40.
LEV leverage; SIZE log of total asset; MTBV market-to-book value; SM earnings
smoothing (dummy); CNT financial market development (dummy); EPRA EPRA member
(dummy); ACT firm activity.
Furthermore, both the financial market development (CNT) and the firm
activity (ACT) appear statistically significant as well, with a difference signifi-
cant at 0.043 and 0.000 levels, respectively. The analysis of the means and
median for CNT (mean of 0.5526 and median of 1 for the fair value group
against a mean of 0.25 and median of 0 for the cost group) also shows a direction
for the difference consistent with our assumption. Particularly, more developed
financial markets (estimated as in La Porta et al., 1997) with the ratio of stock
market capitalization held by minorities to GNP) seem to facilitate the adoption
of fair value. Hence, the companies from countries where the role of financial
markets is more developed (capital market based systems) appear to view the
fair value method more favourably than companies from countries where the
markets are less developed (credit-based systems).
With respect to the firm activity (ACT), we made no prediction of the sign.
Both the output and the analysis of the mean and the median (mean of 0.6558
and median of 0.7507 for the fair value group against a mean of 0.3005 and
median of 0.2756 for the cost group) show a positive direction of the difference.
The result suggests that the predominant activity of the firms that choose the fair
value model seems to be investment properties rental instead of other activities

such as development and trading. Renting out properties implies a longer time
period than other activities like development or trading, where assets would typi-
cally be sold in a shorter time. Thus, we could interpret the relation with fair value
choice as the firms need to show the market value of their properties on the
balance sheet when their realization will be in a longer time (rental activity).
This would reduce the information asymmetry otherwise existing if properties
were evaluated at cost. Conversely, when the business is more concentrated on
development and trading, the need for fair value recognition is less strong, due
to a shorter time horizon for the realization of these assets.

Further explanatory variables, such as leverage (LEV), dimension (SIZE) and
earnings smoothing (SM), appear not to be significant in the univariate analysis.
However, even if not significant it seems interesting to highlight that for both the
size (SIZE) and the earnings smoothing (SM) the analysis of the mean and
median reveals differences coherent with our research proposition, hence
larger size and earnings smoothing for firms adopting historical cost (for size,
mean of 12.781 and median of 12.905 for the fair value group against mean of
13.167 and median of 12.932 for the cost group; for earnings smoothing, mean
of 0.263 and median of 0 for the fair value group against mean of 0.375 and
median of 0 for the cost group).
Except for the financial market development (CNT), neither explanatory nor
control variables seem to explain the managers choice to adopt the historical
cost with the IFRS1 option to revalue investment properties rather than opting
for historical cost without revaluation. As for fair value choice, the analysis of
the means and median for CNT (mean of 0.578 and median of 1 for the IFRS1
group against a mean of 0.25 and median of 0 for the cost group) shows a direc-
tion for the difference consistent with the idea that in countries where the role of
financial markets is more developed (capital market based systems), companies
seem to view the revaluation of investment properties allowed by IFRS1 more
favourably than in countries where the markets are less developed (credit-
based systems).
Multivariate Analysis
Before presenting the results of the multinomial logistic regression, we report the
Spearman (rank) correlation coefficients for the variables (Table 5).
Considering the following multinomial logistic regression analysis, the depen-
dent variable has been split into three variables: (i) CHOICE, equal to 0 if com-
panies adopt the historical cost, 1 if companies adopt the historical cost with the
IFRS1 revaluation and 2 if firms embrace the fair value; (ii) FV vs. COST that
only regards as fair value choice (Y 1) and historical cost (Y 0) and (iii)
IFRS1 vs. COST that only takes into account the choice to adopt historical
cost with the IFRS1 revaluation (Y 1) and the historical cost (Y 0). With
reference to the dependent variable, Table 5 confirms the previous univariate
482
Table 5. Spearman (rank) correlation matrix
Variables CHOICE FV vs. COST IFRS1 vs. COST LEV SIZE MTBV SM CNT EPRA ACT
CHOICE
FV vs. COST
IFRS1 vs. COST
LEV 0.0552 0.0122 20.2045
SIZE 20.0620 20.0978 20.1306 0.1780
MTBV 2 0.4343 2 0.4745 20.2131 0.1657 0.0915
SM 20.1728 20.0983 0.2033 20.1818 0.0781 0.0633
CNT 0.1890 0.2499 0.3311 20.0312 0.2874 20.0826 0.2091
EPRA 0.1462 0.1356 20.0068 0.0895 0.3638 0.1176 0.2734 0.0400
ACT 0.4707 0.472 0.0625 20.1136 0.0239 2 0.2627 20.0525 0.4447 0.1659
This table provides Spearman (rank) correlation matrix for both explanatory and dependent variables. Considering the following multinomial logistic regression
analysis, dependent variable has been split into three variables: CHOICE, equal to 0 if companies adopt historical cost, 1 if companies adopt historical cost with the
IFRS1 revaluation and 2 if firms adopt the fair value; FV vs. COST that only regards the fair value choice (1) and the historical cost (0) and IFRS1 vs. COST that only
takes into account the choice to adopt the historical cost with IFRS1 revaluation (1) and the historical cost (0). Values indicated in bold show statistically significant
relationship between variables. , and indicate statistical significance at less than 10%, 5% and 1% levels, respectively (two-tailed). Pearson correlation shows
similar results.
Table 6. Multinomial logistic regression results

Panel A: model summary goodness of fit
Number of obs. 73
LR chi2 (14) 41.81
Log-likelihood 253.766523 Prob . chi2 0.0001
Pseudo-R2 0.2799
Panel B: estimated coefficients
LOGIT Variable Hypothesis Predicted sign Coeff. Std. err. z P . |z| 95% conf. interval
1 LEV 20.6117228 1.681102 20.36 0.716 23.906621 2.683176
SIZE 20.4409383 0.2748586 21.60 0.109 20.9796511 0.0977746
MTBV (H3b) + 20.6115429 0.5957133 21.03 0.305 21.779119 0.5560336
SM 0.2741504 0.8804852 0.31 0.756 21.451569 1.99987
0.043
Fair Value or Cost Model?

CNT 1.900273 0.9408805 2.02 0.0561811 3.744365
EPRA 0.8488012 1.124734 0.75 0.450 21.355637 3.053239
ACT 20.9708886 1.421061 20.68 0.494 23.756117 1.81434
Constant 6.279216 3.866769 1.62 0.104 21.299512 13.85794
2 LEV (H1) 2 1.734055 1.715306 1.01 0.312 21.627883 5.095992
SIZE (H2) 2 20.6789767 0.289514 22.35 0.019 21.246414 20.1115397
MTBV (H3a) + 21.662586 0.6609104 22.52 0.012 22.957947 20.3672257
SM (H4) 2 21.692808 0.9636362 21.76 0.079 23.5815 0.1958842
CNT + 1.510263 0.949826 1.59 0.112 20.3513614 3.371888
EPRA + 2.449269 1.124299 2.18 0.029 0.2456834 4.652855
ACT ? 2.263975 1.353768 1.67 0.094 20.3893613 4.91731
Constant 8.836272 3.969725 2.23 0.026 1.055755 16.61679
483
(Continued)
484
Table 6. Continued
Panel C: estimated odds ratios
LOGIT Variable Odds ratio Std. err. z P . |z| 95% conf. interval
1 LEV 0.5424156 0.9118557 20.36 0.716 0.0201083 14.63149
SIZE 0.6434324 0.1768529 21.60 0.109 0.3754421 1.102714
MTBV 0.5425132 0.3231823 21.03 0.305 0.1687867 1.743742
SM 1.315413 1.158201 0.31 0.756 0.2342026 7.388093
CNT 6.68772 6.292345 2.02 0.043 1.057789 42.28214
EPRA 2.336844 2.628327 0.75 0.450 0.2577831 21.18385
ACT 0.3787464 0.5382217 20.68 0.494 0.0233743 6.137025
2 LEV 5.663571 9.714756 1.01 0.312 0.1963449 163.3658
SIZE 0.5071357 0.1468229 22.35 0.019 0.2875341 0.8944559
MTBV 0.1896479 0.1253403 22.52 0.012 0.0519254 0.6926533
SM 0.1840021 0.1773111 21.76 0.079 0.0278339 1.216386
CNT 4.527923 4.300739 1.59 0.112 0.7037294 29.13348
EPRA 11.57988 13.01925 2.18 0.029 1.278495 104.884
ACT 9.621254 13.02494 1.67 0.094 0.6774894 136.6346
Choice 0 (historical cost) is the base outcome.
This table presents coefficients/odds ratios from multinomial logistic regression (MLN). Our model assumes the choice to use the historical cost without revaluating
as the baseline outcome category to compare (Y 0), and forms logits comparing the choice to use the historical cost with the IFRS1 revaluation of investment
properties (Y 1) and their fair value choice (Y 2) to it. We present Wald statistics, log-likelihood and McFadden pseudo-R2. , and indicate significance at
less than 10%, 5% and 1% level, respectively.
analysis results. Our proxy for information asymmetry, the market-to book ratio
(MTBV), has a strong negative association with fair value choice, thus discrimi-
nating the fair value model group from the cost model group. The result confirms
the above-mentioned interpretation of this sign. Furthermore, both the financial
market development (CNT) and the firm main business (ACT) condition the
choice as well. Conversely, the choice to adopt the historical cost with IFRS1
revaluation is not accounted for by the explanatory variables except for the finan-
cial market development (CNT).
With reference to independent variables, Table 5 shows that some statistically
significant correlations exist. Firstly, the firms size (SIZE) is positively associ-
ated with both the financial market development (CNT) and EPRA membership
(EPRA) (statistically significant at less than 0.05 and 0.001, respectively). These
results show the larger firms attitude towards EPRA membership and their wider
presence in more developed financial markets (capital market based systems).
Moreover, financial market development (CNT) is also positively associated
with firms activity (ACT) at less than 0.01, demonstrating a better feeling
about renting activities in countries where financial markets are more developed.
Additionally, companies from countries where financial markets are more
developed (CNT) or that are EPRA members (EPRA) seem to be more inclined
towards earnings smoothing (SM), with a statistically significant correlation at
less than 0.10 and 0.05, respectively.
Finally, it is interesting to highlight that the correlation matrix exhibits a nega-
tive association between MTBV and firm activity (ACT) and between MTBV and
FV vs. COST variable. Taken together, the relations suggest that investors ident-
ify less growth options in companies whose main business is renting out invest-
ment properties and, under the assumption that disclosure is not equivalent to
recognition, that managers who operate in rental business would find more
useful to choose the fair value method to reduce the information asymmetry.
However, the relative weakness in the correlation coefficients for independent
variables suggests that multicollinearity is not likely to be a significant issue in
the multivariate analysis. The Pearson correlation (untabulated) shows similar
results, validating the robustness of the above-mentioned core results.
Table 6 presents the results of the multinomial logistic regression. Firstly,
Table 6, Panel A indicates feasibility of the model in explaining the accounting
choice, with a likelihood-ratio chi-squared significance at less than 0.000 and a
McFadden pseudo-R2 of 0.2799. Interpreting the pseudo-R2, it should not be con-
fused with R2 for OLS regression and it is necessary to consider that it is often a
small value.
As already shown in the univariate analyses, the regression coefficients for
logit 1 (logit function for historical cost with the IFRS1 revaluation vs. historical
cost without revaluation) shows that variables do not account for the managers
choice to adopt the historical cost without revaluating investment properties,
except for CNT (financial market development) that is statistically significant
at less than 5% (Table 6, Panel B). The variable has a positive coefficient,
meaning that the more the market is developed, the higher is the logit for the
choice of historical cost with the IFRS1 revaluation.
The coefficients for logit 2 (logit function for fair value vs. historical cost
without revaluation), by contrast, reveal that both the size (SIZE) and the infor-
mation asymmetry (MTBV) are statistically significant at less then 0.05 while
the earnings smoothing (SM) is significant with a p-value of less than 0.10. All
the peer variables have negative coefficients, supporting our propositions that
the larger the company size and the earnings smoothing activity, the higher is
the probability of choosing the fair value method instead of the historical cost.
As already illustrated in the nonparametric analysis, the negative coefficient of

MTBV could be accounted for, in the cost accounting systems before IFRS adop-
tion, taking into account that higher MTBV could reveal growth opportunities
associated with a fair estimation of investment properties and, therefore, with a
lower information asymmetry.
Additionally, the output also shows that the fair value accounting has been con-
ditioned by both EPRA membership (EPRA) and the firms main business
(ACT), statistically significant at less than 0.05 and 0.10, respectively. The posi-
tive coefficient for the EPRA membership confirms our assumption, revealing
that the EPRA Best Practices Committees encouragement to adopt fair value
accounting to enhance uniformity, comparability and transparency of financial
reporting seems to have a significant influence on the fair value choice. Further-
more, the positive coefficient for the firm activity (ACT) shows a positive associ-
ation between rental activity and fair value choice. The latter relation could be
explained from an accounting point of view. Under the assumption that disclosure
is not equivalent to recognition, the fair value method for companies that broadly
operate in the renting business could help to illustrate the true value of the invest-
ment properties, despite the fact that they will be sold in the long term. Trading
activity rapidly reveals the fair value of the investment property asset sold on the
income statement. However, using historical cost for investment properties, the
income statement only shows the rents gained, requiring a more active disclosure
on the investment properties net asset value (NAV) that could be replaced by
their fair value recognition on the balance sheet.
With reference to the other variables, leverage (LEV) does not verify our prop-
osition that higher debt levels could induce managers to opt for the cost model
(H1) and the financial market development (CNT) is not statistically significant
as in the previous univariate analysis.
With reference to the prediction, the second output (Table 6, Panel C) shows
the transformation of the regression coefficients (odds ratios). These ratios help
us to interpret the possible effect of the dependent variables on the probability
of the choice of the fair value in the IFRS transition (logit 2), even if the units
of the variables could also make it problematic. In other words, when a logistic
regression model contains a continuous independent variable, interpretation of
the estimated odds ratio (and coefficients) depends on how it is entered into
the model and the particular units of the variable.
The variable SIZE (H2) has an odds ratio of 0.507 (statistically significant at
0.019). Thus, for each unit increase in the ln of total asset (asset expressed in
E/000) the odds of choosing fair value is reduced by 50%. In this case, interpret-
ing the odds ratio is extremely difficult, due to the variable which is expressed in
logarithm form. Nevertheless, we could show the specific effect of a unit increase
in SIZE considering the range of the variable in the study sample (see summary
statistics in Table 5). For instance, an increase in firm SIZE from 8 to 9 (expressed
in ln of total asset/000) means that an increase of (e9 2 e8) 1,000 5,122,000
euros reduces the odds of choosing fair value by 50%.
The interpretation of the odds ratio for market-to-book value (H3a) is also dif-
ficult. Actually, the variable is continuous and it ranges from 0 (removing the out-
liers) to 8 in the study sample. Since one unit variation in MTBV does not clearly
explain the impact on the fair value choice, we transform the odds ratio of
e21.662586 0.1896479 taking into consideration a change of 0.10 (10%) in
the variable instead of a unit change; thus, we use the odds ratio of e20.1662586
0.84682722 (e21.662586/10). This means that the odds of choosing fair value
for investment properties are multiplied by 0.85 for each additional 10% variation
in MTBV. In other words, the odds of choosing the fair value are reduced by (1 2
0.85) 100 15% for each 10% increase in MTBV.
With reference to the firms activity (ACT), the interpretation of the odds ratio
is quite difficult as it is a continuous independent variable ranging from zero (no
renting activity) to one (100% of the business comes from renting out investment
properties). In this case, a change of 1 is too large whilst a change of 0.10 is more
realistic. Thus, instead of considering the odds ratio equal to 9.621254 (ecoeffACT,
so e2.263975), we interpret the odds ratio of e0.2263975 1.2540734 (e2.263975/10).
Since the ratio is equal to 1.2540734, it means that for each increase of 10% in
renting out investment properties (% of rental income on total income), there
is a 25% increase in the odds of fair value choice (H7).
For binary predictor variables, odds ratios could be easily interpreted. For
example, since the earnings smoothing variable (SM) denotes the presence (1)
or absence (0) of earnings smoothing activity higher than the average smoothing
in the country of origin, an odds ratio equal to 0.18 estimates that the fair value
choice for investment properties is about one-fifth as likely to occur among firms
that used to smooth earnings before IFRS first-time adoption than among firms
that do not in the study population. This result denotes the predicted negative
association (H4). Similarly, the estimated odds ratio of 11.57 for EPRA
denotes that the fair value choice for investment property assets is more than
11 times as likely to occur among firms that are EPRA members than among
those that are not in the sample. Hence, this means that the EPRA Best Practices
Committees encouragement to adopt fair value accounting seems to have a sig-
nificant influence on partners choice (H6).
These results, taken together, support the following assumptions: (a) the firm
size (our proxy of political costs) appreciably reduces the likelihood of using
fair value, (b) the odds of choosing fair value are reduced by 15% for each
10% increase in MTBV, (c) fair value choice is about one-fifth as likely to occur
among firms that used to have smooth earnings before the IFRS first-time adop-
tion, (d) leverage does not influence the fair value choice and (f) the probability of
choosing fair value increases with both the increase in renting activity and with
the fact that the company is an EPRA member.
Robustness Checks
To assess the robustness of our findings, we run different tests. Firstly, in our
analysis we decided to present the main results removing the outliers. Results,
however, do not significantly differ from those obtained with outliers. Particu-
larly, with 76 observations (untabulated), we find a pseudo-R2 of 0.28, LR-chi2
equal to 43.48 with Prob . chi2 of 0.0001. In logit 1, only CNT has a coefficient
statistically significant at 0.037 (coefficient of 1.873634). With respect to logit 2,
all the variables as in the main analysis are statistically significant (MTBV, coef-
ficient of 21.296378 with p-value of 0.026; SIZE, coefficient of 20.5703505, p-
value of 0.033; EPRA, coefficient of 1.960713, p-value of 0.049; CNT, coeffi-
cient of 2.715747, p-value of 0.035), except for the coefficient of SM that is
not statistically significant (p-value of 0.128).
Additionally, to check the stability of our results we re-test our model adding
a variable that captures litigation risks as another possible accounting choice
driver (Watts, 2003) that we have not taken into account in the main model
since in European countries litigations between investors and companies are
less evident than in the USA. Using a conventional proxy for litigation risk
(Qiang, 2007), following prior research we consider Big Auditors clients
(dummy variable, equal to 1 if the firm is a Big Auditors client, 0 otherwise)
as they could be forced to conditional conservatism (Basu et al., 2001; Chung
et al., 2003). Our results (untabulated) do not substantially differ when we
add the dummy variable for Big Auditor. We find a pseudo-R2 of 0.30, LR-
chi2 equal to 45.65 with Prob . chi2 of 0.0001. In logit 1, only CNT is statisti-
cally significant at 0.045 with a coefficient of 1.902863. In logit 2, the same
variables as in the main analysis are statistically significant (MTBV, coefficient
of 21.709357 with p-value of 0.010; SIZE, coefficient of 20.6610026, p-value
of 0.023; SM, coefficient of 21.971219 with p-value of 0.056; EPRA, coeffi-
cient of 2.951666, p-value of 0.016; CNT, coefficient of 1.834959, p-value of
0.066) while the dummy variable for the Big Auditor has a statistically insignif-
icant coefficient (p 0.251).
Finally, we estimate the main model using the alternative interpretation of
leverage as an accounting choice driver, as discussed in Section 2. While we
supposed a negative relationship between leverage and fair value, a conjecture
theorized for lenders protection (Watts, 2003; Qiang, 2007), former studies
(see the review in Holthausen and Leftwich, 1983) observed a positive relation
between leverage and earnings increasing choices. Thus fair value could be
used to alleviate monitoring and other contracting costs for lenders. Hence,
following Christensen and Nikolaev (2008) we decompose leverage into its short-
term and long-term components in order to capture a possible higher relevance
for the latter components. Even in this case the results do not substantially
change. We find a pseudo-R2 of 0.29, LR-chi2 equal to 43.47 with Prob . chi2
of 0.0002. In logit 1, only CNT is statistically significant at 0.041 with a coeffi-
cient of 1.947969. In logit 2, the leverage (LEV) is not statistically significant
even when it is decomposed into its short-term and long-term components
(p-value of 0.635 for long term and of 0.139 for short term). The other variables
results statistically significant and do not differ from those reported in Table 6
(MTBV, coefficient of 21.65115 with p-value of 0.012; SIZE, coefficient of

20.6635355, p-value of 0.023; SM, coefficient of 21.764597 with p-value of
0.071; EPRA, coefficient of 2.516479, p-value of 0.029; CNT, coefficient of
1.734141, p-value of 0.076 and ACT, coefficient of 2.693015, p-value of 0.062).
These results, contrasting with Christensen and Nikolaev (2008), reinforce our
findings that leverage, whatever interpretation is given to the sign of the relation-
ship, is irrelevant to the fair value choice explanation. In this sense, we can
suppose that for value monitoring of companies investment properties, lenders
use private information channels (such as professional assessment) instead of
financial statements data, thus contributing to the irrelevance of the accounting
method chosen for those assets.
7. Conclusion
This paper analyses the choice of evaluation criteria for investment properties
under IAS 40 in the real estate industry. 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 that permit only
the cost model in the pre-mandatory IFRS phase in order to eliminate the influ-
ence of a preceding use of fair value. All these firms are first-time IFRS adopters,
enabling us to compare the same accounting choice in a similar situation (first-
time adoption). We develop an explanatory model following the theoretical fra-
mework derived from the accounting choice theory where information asymme-
try, contractual efficiency (agency costs) and managerial opportunism reasons
could drive the choice. We run a multinomial logistic regression which takes
into account the revaluation option offered by IFRS1 and uses historical cost
without revaluations as a baseline outcome category of comparison. We
control for the country of origin (CNT), the specific business activities and the
membership to the industry association (EPRA), whose effects are generally rel-
evant except for CNT.
Our findings show that information asymmetry, contractual efficiency and
managerial opportunism explain the fair value choice. Particularly, the more
significant findings are that size as proxy of political costs reduces the likeli-
hood of using fair value while market-to-book ratio is negatively associated
with the fair value choice. Managerial opportunism, revealed by earnings

smoothing activities, is also negatively related to fair value choice. On the
other hand, leverage, another typical proxy of contracting costs, appears not
to influence the choice. An additional variable theorized by the literature, the
litigation costs, has no effect either.
We do not find any significant relations between explanatory variables and the
use of the IFRS1 option fair value as deemed cost (possible only at the IFRS
transition date) as a partial substitute of IAS 40 fair value through profit and
loss method, except for the financial market development. This result demon-
strates that the accounting choices, fair value vs. historical cost with the IFRS1
option, operate separately, with a different time horizon.
Our overall evidence confirms the current validity of traditional accounting
choice theory even if it reveals, in such a context, the irrelevance of the usual
relations between accounting choice and leverage. Future research could deal
with this issue more deeply using more detailed proxies for lenders protection
and taking into account specific covenants data.
We contribute to the accounting choice literature with a first study in the IFRS
context, with abundant alternative accounting options and considering a multiple
motivations approach, attempting to overcome current research limits (Fields
et al., 2001, pp. 290 291). The proposed method, a multinomial logistic
regression, could have interesting applications where many possible alternatives
exist.
In normative terms, our findings could be of some use for standard setters. The
demonstrated dependence of the fair value choice, when optional, on firms
specific factors should give rise to doubts about the general acceptance of fair
value method by firms.
This study is in its early stages and it is therefore subject to potential limit-
ations. Firstly, we might contemplate the fact that a larger sample size could
lead to enhanced results even if such a sample is about 35% of the entire popu-
lation examined and it would be difficult to extend it further because of the una-
vailability of extra data, 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.
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. Questions remain, however, that could be examined in future
research. Other explanations could illustrate the choice more clearly, such as
the individual managers cultural background, the corporate governance
context or the cost of information (Watts and Zimmerman, 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 gen-
eralize our findings.
Acknowledgements
The authors gratefully acknowledge the help of the two anonymous referees of
the European Accounting Review, as well as Katherine Schipper, Marco Trom-
betta and Beatriz Garca Osma. The paper has benefited from comments and sug-
gestions by seminar participants at the EAR research conference on Measurement
Issues in Financial Reporting (Segovia, 2009), and at the Wards Seminars,
Department of Accounting and Finance, Glasgow University (February, 2008).
The authors would also like to thank Professor Jo Danbolt for the precious com-
ments on the earlier version of the paper. The previous draft of this paper was
entitled: Why Do Real Estate Companies Adopt Fair Value? A Cross-Country

Analysis on Investment Properties. All views and errors are our own.
Notes
1
This second alternative is possible only at the IFRS transition date and implies a revaluation only
in equity, without any impact on profit and loss.
2
Some scholars cast doubts on the fair value information content. Watts (2006) states that fair
value estimated by managers could never reach the information level of the whole financial
market, due to the enormous number of market operators and consequent information contribut-
ing to determine the prices. In this perspective, financial accounting can only produce hard ver-
ifiable numbers (based on the cost model), giving market operators the basis for their personal
interpretation.
3
Through analytical models (Reis and Stocken, 2007; Plantin et al., 2008) and empirical evidence
(Khurana and Kim, 2003), a stronger value relevance of the fair value model is supported vs. the
cost model when fair values are obtained from liquid markets.
4
While there are few studies demonstrating that recognition has the same effect as disclosure (see
Gopalakrishnan, 1994; Davis-Friday et al., 1999, for pension accounting under US GAAP),
much more evidence is found where recognition has a stronger impact on financial markets
(Aboody, 1996; Espahbodi et al., 2002; Beattie et al., 2003; Ahmed et al., 2006; Viger et al.,
2008).
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Fair Value or Cost Model? Drivers

A. QUAGLI and F. AVALLONE

(Received September 2008; accepted February 2010)

ABSTRACT The IFRS mandatory adoption in European countries is an excellent context

Correspondence Address: A. Quagli, Department of Accounting and Business Studies (DITEA),

0963-8180 Print/1468-4497 Online/10/03046133 # 2010 European Accounting Association

reasons), (ii) mitigating information asymmetries, as standard setters claim, or

similar situation (first-time adoption).

2. Theory and Relation to Existing Research

Alternatively, a cost model seems more efficient in a contractual perspective

properties of accounting numbers in a very different way. Fair value is more

3. Main Features of IAS 40 and Differences with the Domestic GAAP of

. fair value model, by which an investment property is measured, after an initial

in the light of fair value supremacy pervading the International Accounting

(1) Contractual Efficiency

(2) Information Asymmetry

H3b: The probability of choosing historical cost with IFRS1 option

(3) Managerial Opportunism

H4: The probability of choosing fair value decreases if managers reduce

We do not suppose any relationship between managerial opportunism estimated

g1 (x) = ln[P(Y = 1| x)/P(Y = 0| x)]

= b10 + b11 X1 + b12 X2 + . . . + b1p Xp (1)

g2 (x) = ln[P(Y = 2| x)/P(Y = 0| x)]

P(Y = 0| x) = 1/1 + eg1 (x) + eg2 (x)

ln[P(Y = FV| x)/P(Y = COST| x)] = b

CNTi dummy variable coded 1 if firm i has an external market

Sample and Data

with higher leverage

Table 2 . Sample selection procedure and breakdown by country

not reporting under IAS/IFRS in the period of 226 12%

Of the original 67 non-disclosing firms (which have neither website nor IR

Despite the relatively small number of companies selected in some countries, it

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

Nonparametric Mann Whitney Test

Consistent with the information asymmetry hypothesis (H3a), the output

Group Z-Statistics Pr . |Z|

MTBV FV vs. COST 3.543

value model seems to be investment properties rental instead of other activities

to a shorter time horizon for the realization of these assets.

Table 6. Multinomial logistic regression results

Fair Value or Cost Model?

As already illustrated in the nonparametric analysis, the negative coefficient of

(MTBV, coefficient of 21.65115 with p-value of 0.012; SIZE, coefficient of

with the fair value choice. Managerial opportunism, revealed by earnings

entitled: Why Do Real Estate Companies Adopt Fair Value? A Cross-Country

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