Investment property: Fair value or cost model? Recent evidence from the application of IAS 40 in Europe

The purpose of this study is to shed light on the management choice between fair value and cost for investment property under IAS 40 in Europe. Using a multi-motivation approach, we explore what drives this choice across countries and across industries after ten years have passed from the first adoption of IAS 40. Following the theoretical framework developed by the accounting choice theory, we hypothesize that there are several classes of reasons possibly leading managers to commit to fair value: contractual efficiency motives, asset pricing incentives tied to information asymmetries, country institutional factors, and industry factors. In order to test these hypotheses, we select a sample of publicly-traded firms operating in the real estate, manufacturing and banking industries, and located in nine European countries where national pre-IFRS standards mandated either fair value or historical cost for investment property. We test our hypotheses running our model both on the full sample (real estate, manufacturing, and banking) and on a subsample that excludes real estate firms.

We find that all the proposed rationales included in our model play a role in explaining the choice between fair value and cost. Particularly, with regard to asset pricing incentives, the ratio of market to book value, as a proxy for information asymmetries, has a negative association with fair value. As for contractual motives, firm size, as a proxy for political costs is negatively related with the choice of fair value, although the firm's reliance on debt (measured by leverage) seems not to affect the choice. Firms with a higher ratio of investment property over total assets are much more likely to opt for fair value than firms for which IAS 40 assets are less significant. Finally, the comparison of choices made by firms in our sample at the first adoption of IFRS in 2005 with those made after ten years provides evidence of a learning process. The fair value choice however appears to be strongly related to country institutional factors, particularly the development of capital markets and legal origin, with firms operating in countries where markets are more developed being more likely to choose fair value.