Can Fair Values Be Used for Assessing Management's Stewardship?

Abstract

Providing stewardship information represents the traditional objective of financial reporting while the movement to fair value accounting (FVA) represents a key trend over recent years. Many believe that stewardship requires historical cost accounting due to potential bias and error in fair value (FV) estimates (e.g., Ijiri 1983; ASB 1999; AAA FASC 2007). Further, since FVs dominate historical costs (HCs) for valuation purposes, theory predicts that FVs cannot be used for stewardship (Paul 1992). Using pre-IFRS FV gains and losses for UK real estate firms from 1994-2005, my evidence demonstrates that: (1) FVs can be used for stewardship purposes; (2) HC gains and losses continue their stewardship relevance even when FVs are available, contrary to findings in the valuation literature; (3) factors improving estimate reliability increase the usefulness of FVs for stewardship, as theorized by Ijiri (1983); and (4) factors demonstrating the presence of management effort increase the usefulness of FVs for stewardship, supporting agency predictions (Lambert and Larcker 1987; Banker and Datar 1989). Overall, contrary to widespread belief, I demonstrate that FVs can be used for stewardship purposes.

Keywords: fair value accounting, stewardship, compensation contracting, valuation

JEL Classification: M41, M12, G32, G34