The Effect of Fair Value versus Historical Cost on Stock Price Crash Risks: Evidence from Investment Property

Abstract

The accounting standard used in China for investment property, Chinese Accounting Standards 3 (CASs) is comparable to IAS 40 Investment Property while there are two crucial differences: (1) an entity is allowed to use the fair value method if and only if the local property market is active or if the fair value of an entity’s investment property can be estimated reliably through the values and other information of the same or similar category of properties. In other words, CAS 3 is more prudential and restricted on the use of fair value model; (2) CAS 3 does not require an entity which uses the cost method to recognize investment property to also disclose the fair values of property in the footnotes. Using a sample of publicly traded firms that hold investment property from 2007 through 2011 in China, we conduct purer tests to shield some light on the effect of fair value reporting for investment property on firm opacity and stock price dynamics in an emerging market. We find that firms that recognize investment property at fair value in China experience an increase in crash risks, consistent with the notion that fair value reporting for investment property in China does not convey managerial private information regarding firm value while could be the channel to conceal information, and hence exhibit higher stock price crash risks. We further find evidence that the association between the fair value reporting and increased crash risks is mitigated when managers operating in firms with strong corporate governance.