The Value relevance of the IFRS 7 fair value hierarchy: Evidence from the European banking sector

Abstract

PURPOSE OF THE STUDY

The purpose of the study is to analyze whether investors see fair values of mark-to-market financial instruments as more value relevant than fair values of mark-to-model financial instruments. Additional research questions set out to explore if certain company characteristics have an effect on the value relevance of fair values that are based on subjective valuation models. We expect the value relevance of mark-to-model financial instruments to be lower for companies with higher leverage ratios. Additionally, mark-to-model financial instruments are expected to be less value relevant for small companies.

DATA

A sample of 98 European publicly listed banks is used to conduct the empirical study. Data on the amount of fair value financial instruments held by the banks is collected from annual reports for fiscal year 2009. We utilize disclosures mandated by the IFRS 7 fair value hierarchy which requires companies to categorize fair value instruments into three levels based on the objectivity of the inputs used in the valuation models. Additional data needed for the regression models is collected from the Thomson Datastream and Thomson Worldscope databases.

RESULTS

Results of the empirical study support our main hypothesis, i.e. that fair values based on market data are perceived by financial markets as more value relevant than fair values based on valuation models that utilize subjective inputs. For our additional research questions on the effect of company characteristics (leverage and size) on the value relevance of fair values we find no conclusive evidence. However, our findings provide some preliminary evidence in support of the previously mentioned hypotheses.