Do Voluntary Disclosures that Disavow the Reliability of Mandated Fair Value Information Reflect Legitimate Concerns About Reliability?

Abstract:     
U.S. and international accounting standards have mandated recognition and/or disclosure of fair value information for an increasing number of items. One consequence of this shift has been the emergence of voluntary disclosures in audited financial statements that explicitly question the reliability of the mandated fair value information. We investigate whether these voluntary disclosures reflect legitimate concerns by examining whether the mandated fair value information is less reliable for firms that include such disclosures in the footnotes of their financial statements. We examine this issue in the context of the fair value estimate of employee stock options mandated by SFAS 123. After controlling for other motivations to disavow, we find that a firm is more likely to make a disavowal disclosure when inputs into its stock-option valuation model are less reliable. In contrast, we find little evidence that stock option disavowals are motivated by managers' desires to hide abnormally high compensation or downplay the detrimental impact of stock option expense on performance metrics. These findings are consistent with the FASB's view in SFAS 157 that supplemental disclosures related to fair value information are necessary for users to understand the information and limitations of fair value estimates. Surprisingly, we also find that disavowals are most common when Ernst and Young audited the financial statements. This result is interesting as it suggests that firms' disclosure policies are impacted by both firm-specific costs and benefits of disclosure and the opinions of third parties (which presumably increase the perceived benefits of the disclosure).

Number of Pages in PDF File: 52

Keywords: fair value, disclosure, reliability, stock options

working papers series