Advances in Accounting 38 (2017) 114

Contents lists available at ScienceDirect

Advances in Accounting
journal homepage: www.elsevier.com/locate/adiac

The predictive ability of investment property fair value adjustments under MARK
IFRS and the role of accounting conservatism
Sati P. Bandyopadhyaya, Changling Chena, Mindy Wolfeb,
a
University of Waterloo, Canada
b
Arizona State University, United States

A B S T R A C T

This paper examines the predictive ability (relevance) of fair value adjustments of Canadian investment prop-
erty, for future cash ow outcomes. We hypothesize and nd that the fair value adjustments of more con-
servative rms are more predictive of future cash ows. We also nd that the market prices fair value adjust-
ments of more conservative rms at a premium as compared to those of less conservative rms. Our empirical
tests control for possible self-selection of sample rms into low and high accounting conservatism groups.

1. Introduction
In this study we examine the relevance (predictive ability) of invest-
ment property's fair value asset revaluations and, in particular, how ac-
counting conservatism aects this relationship under International
Accounting Standard (IAS) 40, Investment Property. We dene earnings
relevance as the ability of earnings in the current period to forecast
future operating cash ow outcomes, which is consistent with the deni-
tion of relevance in the International Financial Reporting Standard's
(IFRS) conceptual framework (QC6, QC7, and QC8).1 Our denition is also
consistent with Kim and Kross's (2005) measurement of earnings relevance
as the strength of the association between current earnings and future
operating cash ows.
On January 1, 2011 the accounting treatment of investment properties
in Canada transitioned from historical cost accounting to fair value ac-
counting under IFRS. Under fair value accounting, managers have the
opportunity to undertake earnings management activities by manipulating
fair values for opportunistic purposes such as meeting or beating earnings
forecasts or maximizing bonuses (Ramanna & Watts, 2012). This is
particularly true when market values of assets are not readily available and
managers must make subjective judgments to derive asset market values.
The foregoing managerial opportunism incentives tend to adversely aect
the information content of reported accounting numbers, making them less
predictive of future cash ows (i.e., less relevant).
However, subjective judgements also allow managers the opportunity
to provide managerial private information about future expected outcomes
from their investment property assets to security markets through ecient
accounting choices arising from explicit and implicit contracts that rely on
accounting numbers (Holthausen, 1990; Christie & Zimmerman, 1991).
Under the ecient contracting perspective, managerial private information
embedded in fair value accounting numbers will likely enhance the pre-
dictability of current accounting numbers for future outcomes. If fair value
adjustments to investment properties (i.e., investment property revalua-
tions) reect private information and managers are motivated to adopt
ecient accounting choices over opportunistic ones, these adjustments will
be predictive of (relevant for) future operating cash ows because equity's
value is determined by discounted future cash ows.2 In contrast, if fair
value adjustments are based on managerial opportunism instead, they will

We would like to acknowledge the support of the University of Waterloo/SSHRC Seed Grant Program. We thank participants at the 2014 AAA Western Regional meeting and the
University of Waterloo Brown Bag Lunch Group.

Corresponding author.
E-mail addresses: bandy@uwaterloo.ca (S.P. Bandyopadhyay), clchen@uwaterloo.ca (C. Chen), mindy.wolfe@asu.edu (M. Wolfe).
1
The IFRS conceptual framework (IASB, 2010) denes information as relevant if it is capable of making a dierence in the decisions made by users (QC6). In addition, the IFRS
conceptual framework states that Financial information is capable of making a dierence in decisions if it has predictive value, conrmatory value, or both (QC7), and Financial
information has predictive value if it can be used as an input to processes employed by users to predict future outcomes (QC8). The IFRS denition corroborates the prediction of
outcomes denition by the Statement of Financial Concepts (SFAC) No. 2 (paragraph 57) of U.S. General Accepted Accounting Principles (GAAP).
2
Note that by denition, fair value adjustments of IAS 40 (paragraph 35) reect gains or losses arising from a change in the fair value of investment property, and the fair value reects,
among other things, cash inows from rental income from current leases and reasonable and supportable assumptions that represent what knowledgeable, willing parties would assume
about rental income from future leases in the light of current conditions. (IAS 40, paragraph 40). Therefore, we expect a link between fair value adjustments and future cash ows. If
expectations of future cash ows (from rental income for example) change, there is a change in (or adjustment to) the fair value of the property and this change is designated as a fair
value adjustment (FVADJ). In other words, FVADJ does not cause or induce changes in future cash ows; but changes in future expected cash ows are captured (or reected) in current
changes of fair values (or current amounts of FVADJ).

http://dx.doi.org/10.1016/j.adiac.2017.05.002
Received 25 May 2015; Received in revised form 21 April 2017; Accepted 17 May 2017
Available online 02 June 2017
0882-6110/ 2017 Elsevier Ltd. All rights reserved.
S.P. Bandyopadhyay et al.
likely not reect future cash ow outcomes.
Therefore, the relevance of reported fair value adjustments is an
empirical issue and depends on the outcome of the trade-o between
managerial opportunism and ecient contracting incentives. Using a
Canadian sample, we rst examine the relationship between fair value
adjustments and future outcomes and nd that fair value adjustments
are positively associated with both future cash ows and market prices.
More importantly, we hypothesize and nd that (i) the managerial
opportunism versus ecient contracting trade-o appears to be re-
ected in the realized levels of accounting conservatism, and (ii) high
levels of accounting conservatism, in the pre-IFRS regime, are asso-
ciated with greater relevance of fair value adjustments in the post-IFRS
period.
While the European Union adopted IFRS in 2005 and Canada
adopted IFRS in 2011, the issue of fair valuing investment properties
continues to be a contentious issue. Recently, the U.S. Financial
Accounting Standards Board (FASB) proposed fair value accounting for
investment properties in its Exposure Draft (ED) issued in 2011 with the
comment period ending February 15, 2012. The FASB received as many
as 80 comment letters on this Exposure Draft. Many of these comment
letters do not support the proposed fair value accounting for REIT
properties and instead recommend continuation of the historical cost
model consistent with the existing provisions of US GAAP.3 While the
FASB has since deferred deliberations of this Exposure Draft (ED), it
remains on its future agenda. This issue is important because although
US GAAP currently recommends historical cost accounting for US-based
REITs, the foregoing 2011 ED requires the use of fair value accounting
for US REITs. Consequently, the issue of relevance (as well as relia-
bility) of reported fair values of investment properties is an on-going
debate and thus our results are likely to provide new insights into the
debate.
A number of European studies (e.g., Hung & Subramanyam, 2007;
Paananen & Lin, 2009; Bissessur, Goncharov, & Wirtz, 2012) have ex-
amined the eects of IFRS on the relevance of fair value adjustments
in the EU following the adoption of IFRS in 2005.4 Among others,
Israeli (2015) examines the relevance of REITs' fair value adjustments
after the EU's move to IFRS. Under IAS 40, rms have the option to
recognize investment property at fair value or at historical cost. Israeli
(2015) compares a rm's choice to recognize versus disclose fair va-
lues of investment properties under IAS 40. The author nds that the
recognition versus disclosure choice is related to contractual and
asset-pricing incentives and that the market valuation of disclosed
amounts is less than recognized amounts. In contrast to Israeli (2015),
we test the association between fair values and future cash ows
conditioning on the level of accounting conservatism, over shorter,
quarterly windows using a sample of Canadian REITs. Our unique
contribution to the extant literature is that our ndings highlight the
importance of pre-IFRS accounting conservatism on the relevance of
fair value adjustments under IAS 40. Prior studies have examined the
relation between fair value accounting and future cash ows but not
how the strength of this relationship varies with rms' prior ac-
counting practices.
We examine the changes in investment property's fair values in -
nancial statements issued by REITs after January 1, 2011, when Canada
adopted IFRS. We focus our study on investment properties of Canadian
REITs because in Canada, as in many other countries that transitioned
to IFRS, the impact of fair valuing investment property is particularly
important to the overall value of REITs, which allows for more powerful
3
http://www.fasb.org/jsp/FASB/CommentLetter_C/CommentLetterPage&cid=
1218220137090&project_id=2011-210
4
Extant literature on the usefulness of fair value asset revaluations of investment
properties has also often dealt with the notion of reliability (faithful representation).
Please see Section 2, Background and Literature Review for more details on this strand of
literature.
2
Advances in Accounting 38 (2017) 114
tests of the coecients in our models.5 Changes in the fair value of
investment properties ow through the company's statement of prot
and loss under IFRS. Our sample consists of Canadian REITs that chose
mark-to-market accounting for their investment properties. We use data
from the pre-IFRS period, 2008 to 2010, to estimate accounting con-
servatism. Our sample period spans the period from the rst quarter of
2011 when Canadian rms adopted IFRS and in particular IAS 40 to the
rst quarter of 2014 to test our hypotheses regarding the relevance and
usefulness of fair value adjustments and the role of accounting con-
servatism.
We contribute to the literature in a number of ways. First, we extend
previous research that examines the relevance (predictive ability of future
outcomes) of fair value adjustments (e.g., Israeli, 2015) by identifying pre-
IFRS accounting conservatism as a determinant of the degree of relevance
of these adjustments. We show that the pre-IFRS level of accounting
conservatism reects the trade-o between managerial opportunism and
ecient accounting choices and drives the strength of the relevance of fair
value adjustments in the post-IFRS period. These results are new to the
literature, and imply that factors that motivate managers to use more
conservative accounting practices in the pre-IFRS regime continue to im-
part greater relevance to accounting numbers under IFRS. We also nd
that the association between stock prices and fair value adjustments are
stronger when the pre-IFRS conservatism of sample rms is higher.
In terms of methodology, we undertake empirical tests that control
for the endogenous choice of conservative practices by sample rms. We
contend that conservative accounting practices are not random choices
for rms and reect the consequences of extant lending contracts and the
eects of corporate governance. We control for this endogeneity with a
two-stage Heckman (1979) approach to arrive at our results.
Our results are subject to some caveats. First, the power of our tests
may be weak because of data restrictions arising from a short post-IFRS
adoption period (January 1, 2011), and because the sample of Canadian
REITs is small (17 rms in our sample). Second, we do not control for
the potential self-selection bias of Canadian REITs that voluntarily
choose fair value accounting rather than the historical cost model
(which is also permitted under IAS 40) because of data constraints.6
Third, we base our measure of accounting conservatism on pre-IFRS
data, which could contain measurement error if the mandatory adop-
tion of IFRS abruptly changes Canadian managers' incentives in un-
known ways. Finally, the relation between investment property re-
valuations and future cash ows not only reect the trade-o between
managerial opportunism and ecient contracting incentives, the rela-
tion is also subject to the eect of other factors. One factor is a four-
quarter ahead window for testing future cash ows. Four-quarters
ahead may not be long enough to capture changes in future cash ows
from long-term rental commitments and hence changes in fair values
may not necessarily translate into immediate changes in operating cash
ows. We run regressions using cumulative cash ows through the
future fth, sixth and seventh quarters ahead and our main results
continue to hold. Moreover, if there are ineciencies in the market, for
instance if there is a real estate market bubble, then managers'
5
REITs are a comparatively cleaner choice for testing alternative hypotheses about the
eects of the transition from historical cost to fair value accounting because this industry
tends to predominantly use fair value accounting for its operating assets. In contrast,
nancial institutions use both historical cost accounting (for loans and leases) and fair
value accounting for their assets. Manufacturing rms, on the other hand, use mostly
historical cost accounting for its operating assets despite the fact that the fair value option
is available to these rms under IFRS. The importance of REITS to the economy and their
investments on real estate assets measured at fair market values provides a cleaner en-
vironment to examine our hypothesis. Also, the use of one specic industry reduces the
noise in the interpretation of the analyses. In terms of economic signicance our selected
sample includes 17 REITs exceeding $20 billion in market capitalization.
6
While the majority of REITs choose the fair value option, of the 31 Canadian REITs in
our initial sample, seven rms opt to continue reporting under the cost model. However,
we nd no disclosure on investment property's fair values in the notes of their nancial
statements. Because we are not able to collect the fair value data of these seven rms we
exclude them from our selected sample.
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

estimated future cash ows from rental contracts may deviate from (2000) examine the reliability of fair value estimates in the pre-IFRS
their fundamental values determined by future cash ows under the period and nd that they are less biased and more accurate than his-
inuence of market optimism.7 torical costs for U.K. real estate rms.
The rest of the paper is organized as follows: Section 2 provides the In the post-IFRS period, following EU's adoption of IFRS in 2005, a
background and literature review, Section 3 develops the hypotheses number of European studies have investigated the eects of IFRS on the
that we empirically test in this paper, Section 4 describes the research reliability of earnings and fair value adjustments of REITs. The evidence
design and sample selection, and Section 5 describes the results of the from this literature is mixed. Some researchers nd that fair value es-
empirical tests. We conclude in Section 6. timates of investment properties are subject to managerial opportunism
and are not reliable. For example, Fortin, Tsang, and Dionne (2008)
provide evidence that reported income of their European sample rms
2. Background and literature review
was positively aected by the fair value adjustment of their real estate
assets, which is consistent with managerial opportunism. Also using a
Prior to the adoption of IFRS by the Accounting Standards Board of
sample of European real estate rms, Muller, Riedl, and Selhorn (2008)
Canada, Canadian GAAP (Section 3855 of the CICA Handbook) was
report evidence of opportunism consistent with rms that adopt the fair
similar to US GAAP which requires fair value accounting for debt and
value model reporting larger fair value gains as compared to as if
equity securities (SFAS 115) and derivatives (SFAS 113). For xed as-
gures for rms using the cost model. Dietrich et al. (2000), on the
sets, including investment properties, pre-IFRS Canadian GAAP re-
other hand, compare a sample of UK real estate companies' book values
quired historical cost accounting for long-lived assets, subject to peri-
and selling prices of investment properties and conclude that reliability
odic impairment tests. However, the adoption of IFRS allows Canadian
of fair value estimates are less biased and more accurate than historical
companies to use fair value or historical cost reporting for property
cost estimates.
plant & equipment (PP & E) and intangible assets such as goodwill
Our paper is also related to the extant research that examines the
under IAS 36, and for investment properties under IAS 40. Very few
impact of IFRS on the relevance of earnings and fair value adjustments
Canadian rms adopted the fair value option for PP & E assets.
of investment properties. For instance, Bissessur et al. (2012) examine
Christensen and Nikolaev (2013) nd similar results for U.K. and
the value relevance of net income under IFRS versus US GAAP and
German rms. In contrast, we nd that a signicant proportion of Ca-
provide evidence that income becomes more useful in explaining share
nadian REITs have chosen to use the fair value option for investment
prices and market returns under IFRS. They measure relevance as the
properties under IFRS, again, consistent with the ndings of
adjusted R-squared obtained by regressing prices and stock returns on
Christensen and Nikolaev (2013), Cairns, Massoudi, Taplin, and Tarca
net income. Other research takes a broad perspective of IFRS adoption.
(2011), and Muller, Riedl, and Sellhorn (2011) for European rms.
Hung and Subramanyam (2007) nd that IFRS adoption has no eect
An extensive body of fair value accounting research examines the
on the correlation of reported book values (and earnings) with market
relevance of fair value numbers, which, with the exception of European
values for German rms. Barth, Landsman, and Lang (2008) examine
studies, has mostly been based on the valuation of nancial assets. In
rms applying IAS from 21 countries and nd their accounting numbers
general, results from this line of research are mixed. For instance, Barth
are more closely related to market values and exhibit a lower level of
(1994), Barth, Beaver, and Landsman (1996), and Eccher, Ramesh, and
earnings management than companies applying non-U.S. domestic
Thiagarajan (1996) nd that the reported fair values of investment
standards. Paananen and Lin (2009) nd that earnings management is
securities, loans, and long-term debt are associated with stock market
higher in the post-IFRS period and rms recognize losses later than in
values. Nelson (1996), however, argues that the models used in these
the pre-IFRS period for German rms.
studies are mis-specied because of correlated and omitted variables
However, none of these foregoing papers examine the association
such as future growth opportunities. More recent research by Evans,
between the fair values of REITs and future cash ows, as we do in our
Hodder, and Hopkins (2014) nds that commercial banks' fair value
paper. Israeli (2015) compares the association of future annual cash
adjustments for investment securities are associated with future -
ows with recognized versus disclosed fair values, nding that their
nancial performance. As far as the use of fair value models for xed
associations with future cash ows are statistically equivalent. We rst
assets are concerned, researchers have expressed the view that potential
extend Israeli (2015) by examining the association between recognized
estimation errors in valuing non-quoted assets could impart measure-
fair value adjustments and future rm outcomes (cash ows and market
ment error in reported accounting numbers, and adversely aect their
prices) using a Canadian sample over quarterly windows. More im-
quality (Holthausen & Watts, 2001; Watts 2003a and 2003b; Kothari,
portantly, we contribute to the literature by exploring the role that
Ramanna, & Skinner, 2010).
accounting conservatism has on this association.
Another stream of research investigates the valuation of investment
properties of REITs under alternative accounting regimes such as U.S.
3. Hypotheses development
GAAP and pre-IFRS U.K. GAAP. The historical cost based U.S. GAAP
model can be viewed as a one-sided fair value model with no upward
The application of IAS 40 on investment properties provides a un-
value adjustment allowed for investment properties but requiring write-
ique opportunity to test the eects of the managerial opportunism
downs to recognize impairments. Using U.S. data, Fields, Lys, and
versus ecient contracting trade-o under fair value accounting. On
Vincent (2001) examine a sample of real estate rms and nd that
the one hand, Ramanna and Watts (2012) argue that when fair values
impairment charges reported by real estate rms are incrementally
are unveriable, it provides managers a mechanism for earnings man-
related to share prices. In contrast, pre-IFRS U.K. GAAP did require fair
agement. This implies that the relevance of accounting numbers using
value accounting for investment properties; however, the fair value
reported fair market values could be adversely aected if managers
adjustments were not recorded in net income but in a fair value reserves
have incentives to bias reported numbers. For example, managers might
account, a component of owners' equity. Dietrich, Harris, and Muller
have incentives to upwardly bias reported investment property asset
values and thus REIT earnings, in order to maximize net income based
7
There is concern that the real estate market for larger cities in Canada (e.g., bonuses under IAS 40, which requires recognition of changes in fair
Vancouver and Toronto) showed signs of a market bubble during our sample period. values of investment properties through the income statement. In this
However, all of our sample rms have diversied holdings in that while some property
case, because fair values are adjusted upwards regardless of whether
holdings are in large cities such as Toronto, Vancouver, or Montreal, the majority of
REITS' property holdings are in moderately sized towns. Also, these market ineciencies
future cash ows from investment property are expected to increase or
bias against nding results. We thank our anonymous reviewer for providing insights into decrease, there would be zero correlation between fair value adjust-
confounding factors. ments and future cash ows.

3
S.P. Bandyopadhyay et al.
On the other hand, Dietrich et al. (2000) investigate managerial
discretion over fair value reporting, revealing that managers sometimes
select among permissible accounting methods to smooth reported
earnings changes, to reduce the riskiness of their future net income
based expected bonus stream. In order to smooth earnings over time,
managers might have incentives to opportunistically lower the varia-
bility in changes of reported investment property asset values. This
implies that they might understate reported values of investment
property when future cash ows are expected to be high and conse-
quently reported increases in current earnings will be too small; when
future cash ows are expected to be low, managers overstate invest-
ment property and raise current reported earnings levels. In this case,
the time series of reported earnings will be smoother through man-
agerial earnings manipulation over time, and the fair value adjustments
are likely to be negatively correlated with future cash ows assuming
that expectations of future cash ows are on average, fullled. This is
another example of managerial opportunism.
However, fair value accounting also provides a mechanism for
managers to convey credible private information about the future
earnings potential (future expected cash ows) of the rms' assets
(Holthausen, 1990; Christie & Zimmerman, 1991). Hendershott and
Kane (1995), (Eq. (1)) model the fundamental value of a property as a
function of future expected gross rental income from the property be-
sides other factors such as future expected tax rates, the ratio of oper-
ating expenses to replacement costs, and expected vacancy rates. Fol-
lowing prior research, we posit that increases (decreases) in Real Estate
Investment Trusts' (REITs) asset fair values reect managers' private
information about potential increases (decreases) in future after-tax
rental incomes from REIT properties. In this case, we hypothesize a
positive relation between the changes in the fair value of REIT assets
(fair value adjustments) and future cash ows.
Prior literature (Dechow, 1994; Dichev & Skinner, 2002) discusses
the tension between reporting accounting numbers to serve managerial
opportunism versus revealing managers' value-relevant private in-
formation to enable ecient contracting. Under the ecient con-
tracting reporting incentives, fair value adjustments to investment
properties are hypothesized to be value-relevant, whereas managerial
opportunism incentives will result in biased and/or noisy fair value
adjustments that are not driven by value changes in investment prop-
erties. An empirical examination of the relation between property fair
value adjustments and future cash ows is important because it is a
fundamental tenet of real estate property valuation.
In summary, depending on managers' incentives, there may be a
positive, a negative, or even a zero correlation between reported
amounts of fair value adjustments and future cash ows. Consequently,
we have no directional predictions. The observed sign of the correlation
between current amounts of fair value adjustments is the result of a
trade-o between managerial opportunism and ecient contracting.
While prior research (e.g., Israeli, 2015) provides some evidence of
the value relevance of fair value adjustments using European samples,
our paper studies a Canadian sample. Because the observed sign of the
correlation between current amounts of fair value adjustments and
future benets is the result of a trade-o between managerial oppor-
tunism and ecient contracting, the trade-o may be sample specic
because the level of managerial opportunism and the eectiveness of
ecient contracting both vary across countries (e.g., Bruce,
Buck, & Main, 2005). Therefore, we run preliminary analysis to in-
vestigate the relation between fair value adjustments and future out-
comes before we posit accounting conservatism's role.
Our rst hypothesis (H1), which is non-directional, is as follows:
H1. Investment property revaluations are not related to future cash
ows under IAS40.
Our next hypothesis, H2, addresses the relation between stock prices
and fair value accounting adjustments. Note that H1 examines the re-
levance of fair value accounting adjustments where relevant
4
Advances in Accounting 38 (2017) 114
adjustments reect future outcomes (cash ows). However, even re-
levant accounting adjustments may not be useful to investors for setting
prices if these adjustments are not reliable (faithfully representative). In
other words, the usefulness of accounting adjustments are the result of
joint eects of relevance and reliability, as noted in the IFRS conceptual
framework (QC4) and SFAC No. 2. Prior research investigates the re-
lation between asset fair values and stock prices (e.g., Barth, 1994 and
Barth et al., 1996). The research also argues that current stock prices
reect the overall usefulness of reported accounting numbers to users of
nancial statements and are driven by not only their relevance but also
reliability. Research ndings of Collins, Maydew, and Weiss (1997),
Richardson, Sloan, Soliman, and Tuna (2005), and Bandyopadhyay,
Chen, Huang, and Jha (2010), document consistent evidence that the
usefulness of accounting earnings is aected by both earnings' re-
levance and reliability, where usefulness is dened as the extent to
which accounting numbers are associated with stock prices.
In H2, we do not make a directional prediction about the usefulness
of fair value adjustments because it is the outcome of joint eects of
both relevance and reliability, which is an empirical issue. Note that, as
mentioned earlier, a number of European studies nd that the eects of
IFRS on the reliability of earnings and fair value adjustments are un-
certain. Also, under managerial opportunism incentives, biased or in-
accurate (noisy) fair value adjustment numbers are not valued by the
market, implying a zero correlation between prices and fair value ad-
justments, under market eciency assumptions. Along this line of lit-
erature, we posit the second hypothesis (which is also non-directional)
as follows:
H2. Investment property revaluations are not related to stock price
under IAS40.
Hypothesis H1 explores the relevance of fair value adjustments,
which reects the net outcome of the eects of managerial opportunism
and ecient contracting incentives of managers. However, these in-
centives are not directly measurable. In order to better capture the
trade-o of managerial opportunism versus ecient contracting in-
centives facing managers, we identify the level of accounting con-
servatism as the conditioning variable in our empirical tests of the
predictive ability of fair value accounting numbers.
We contend that managers' use of conservative accounting during
the pre-IFRS period reects reporting incentives to undertake ecient
contracting rather than to exercise managerial opportunism because the
use of conservative accounting normally leads to a lower cost of debt
(Ahmed, Billings, Morton, & Stanford-Harris, 2002; Zhang, 2008) and
more useful earnings (Bandyopadhyay et al., 2010). Specically, con-
servative accounting is associated with low reported values of assets
that tend to bring covenant ratios (such as debt to equity) closer to
covenant limits. This occurs because, as compared to less conservative
rms, more conservative rms record losses in earnings earlier when
losses are expected, but recognize gains later only when gains are
realized. This makes covenant violation more likely if there is any de-
cline in rm performance. Therefore, conservative accounting provides
an early warning signal of default risk to lenders such that lenders tend
to demand conservative accounting practices by borrowers (Ahmed
et al., 2002, Zhang, 2008). This is particularly important for rms who
hold investment property, as they tend to be highly leveraged. For ex-
ample, Ooi, Ong, and Li (2010) report that interest charges constitute
30 to 70% of the total expenses of their U.S. REITs sample. The benets
of the early warning tend to be passed on to borrowers in the form of
lower interest rates for loans, which helps achieve ecient contracting
because borrowers tend to enjoy a lower cost of debt. Accounting
conservatism tends to mitigate bondholder-shareholder conicts and
reduce interest costs borne by the borrowing rm (Ahmed et al., 2002).
On the other hand, if managers' accounting choices are opportunistic,
for example, reecting incentives to maximize bonuses or to meet or
beat earnings forecasts, accounting conservatism will be low, by po-
tentially delaying loss recognition and hastening recognition of gains.
S.P. Bandyopadhyay et al.
In other words, the realized level of accounting conservatism likely
captures the net eect of the trade-o between managerial opportunism
and ecient contracting incentives facing a rm. We test this con-
jecture by estimating a probit model (see Section 4) where the depen-
dent variable is a measure of accounting conservatism and the in-
dependent variables are proxies for managerial opportunism and
ecient contracting.
A high level of accounting conservatism is the likely result of the
dominance of ecient contracting choices over managerial opportu-
nism incentives and vice versa. Bandyopadhyay et al. (2010) provide
evidence that the increasing conservatism of U.S. publicly listed com-
panies over the 19732005 period is related to the increasing ability of
earnings to predict future cash ows. Therefore, we posit that the fair
value asset revaluations of investment properties for rms with high-
accounting conservatism in the pre-IFRS period will be more informative
of future cash ows in the post-IFRS period.8 Our third hypothesis is as
follows:
H3. The association between investment property revaluations under
IAS 40 and future cash ow is more (less) positive for REITs with high
(low) levels of accounting conservatism.
In our third hypothesis, accounting conservatism has a positive role
on the relevance of investment property revaluations. According to
discounted future cash ow models for equity valuation, current stock
price is determined by future cash ows. Therefore, if fair value ad-
justments are more related to future cash ows for more conservative
REITs, we expect that the association between fair value adjustments
and current stock price is also more pronounced for more conservative
REITs. Our fourth hypothesis is stated as follows:
H4. The association between investment property revaluations under
IAS 40 and stock price in the post-IFRS period is more (less) positive for
REITs with high (low) levels of accounting conservatism.
4. Research Methods
4.1. Conservatism measure
Our measure of accounting conservatism, following Givoly and
Hayn (2000), is cumulative non-operating accruals (total accruals
minus operating accruals), where total accruals are measured as con-
tinuing income less operating cash ow, consistent with prior REITs
research such as Anglin, Edelstein, Gao, and Tsang (2013). Non-oper-
ating accruals consist primarily of loss and bad debt provisions (or their
reversal), restructuring charges, the eect of changes in estimates, gains
or losses on the sale of assets, asset write-downs, the accrual and ca-
pitalization of expenses, and the deferral of revenues and their sub-
sequent recognition. These elements mostly capture pre-recognition of
accounting losses but not gains and therefore, more conservative rms
are more likely to recognize bad news and have more negative non-
operating accruals (Givoly & Hayn, 2000). Therefore, the extent that
accumulated non-operating accruals over a designated period deviate
negatively from zero, indicates the degree of accounting conservatism
during the period because rms in a steady state tend to have ac-
counting accruals that are mean-reverting over time (Givoly & Hayn,
2000).
Our sample rms own and operate income-producing real estate,
8
We also compute sample rms' accounting conservatism measure (Givoly & Hayn,
2000) using data from year 2010 only to avoid the confounding eect of the 2008 -
nancial crisis and our results again remain largely unchanged. The ratio of the cumulative
negative fair value adjustments to cumulative positive fair value adjustments is also a
possible measure of accounting conservatism for REITs during the post-IFRS regime. But,
we cannot use this as a conservatism measure in our empirical tests because there are too
few observations available for each rm to calculate this ratio during a holdout period
and then use this ratio in empirical tests.
5
Advances in Accounting 38 (2017) 114
ranging from oce and apartment buildings to warehouses, hospitals,
shopping centers, and hotels, among others.9 While real estate rms
have unique industry characteristics, we do not expect REITs to be
dierent in their accrual compositions relative to rms in other in-
dustries such as retail and manufacturing. For example, the net change
in operating working capital of REITs consists mainly of the net change
in accounts (and/or rent) receivable, the net change in inventory (and
other operating current assets such as tenants' security deposits), and
the net change in accounts payable, which are components used in
deriving operating accruals in extant research. As for non-operating
accruals, some REITs also engage in the nancing of real estate which
results in losses and bad debt provisions. Similar to rms in other in-
dustries, REITs also likely recognize restructuring charges, the eect of
changes in accounting estimates, gains or losses on the sale of assets,
and asset write-downs (also write-ups of investment properties after
IAS 40) in net income. We nd that the components of non-operating
accruals in our sample rms are consistent with the forgoing descrip-
tion.
Our estimate of accounting conservatism is based on information
obtained from the pre-IFRS historical cost accounting regime. We do not
use a post-IFRS fair value accounting based measure because we do not
have a long enough time series in the post period to estimate conven-
tional measures of conservatism (e.g., Basu, 1997; Givoly & Hayn,
2000).10 We argue that under historical accounting, reporting incentives
aect a rm's level of accounting conservatism. For example, Watts
(2003a) points out that ecient contracting is a major incentive that
drives accounting conservatism; ecient contracting implies that
conservatism has a productive role in nancial reports providing in-
formation to capital market investors (Watts, 2003a, page 210). Man-
agerial incentives likely remain intact after the accounting rule change
because underlying economic rationales are unlikely to change im-
mediately.11 Assuming that the pre-IFRS managerial incentives do not
change immediately after Canadian public rms' transition from Cana-
dian GAAP to IFRS, we use the level of pre-IFRS period accounting
conservatism as a proxy of managerial reporting incentives during the
post-IFRS period.12
In summary, we measure accounting conservatism as the cumula-
tive non-operating accruals (Givoly & Hayn, 2000) in the pre-IFRS
9
There are two types of REITS, Mortgage REITS and Equity REITS. Mortgage REITs
typically loan money to real estate investors or purchase mortgage backed securities and
thus derive income through interest. Equity REITs derive income from purchasing,
building, renovating, managing, and selling real estate. Our sample consists solely or
Equity REITS.
10
As we indicate earlier, IFRS became mandatory for Canadian rms in 2011.
Following Givoly and Hayn (2000), we use 12-quarters of accrual data to measure ac-
counting conservatism. If we use the post-IFRS period from 2011, 2012, and 2013 to
measure accounting conservatism, it would leave us with only four quarters in 2014 and
one quarter in 2015 to analyze the eect of conservatism on the association between
future cash ows and fair value adjustments. Consequently, this would greatly reduce the
number of observations available for estimating our models. Due to the small size of our
sample, we do not use the Basu (1997) conservatism measure which requires the esti-
mation of a piecewise linear regression model.
11
For example, prior research (Ahmed & Duellman, 2007; Garcia Lara, Garcia
Osma, & Penalva, 2009) indicates that accounting conservatism is related to board of
director characteristics. If the characteristics of the board of directors are relatively stable
over time, arguably, rms' choice of accounting conservatism will reect this stability.
12
We nd support of this assumption. As a sensitivity test, we examine the ratio of the
dollar amount of accumulated negative fair value adjustments divided by the dollar
amount of positive fair value adjustments during the post-IFRS (fair value) regime. We
expect more conservative rms to have a higher ratio than less conservative rms. We
nd that the average absolute value of negative fair value adjustments divided by positive
fair value adjustments, as dened above, for more conservative rms is 0.712 while the
ratio for less conservative rms is much lower at 0.198. Likewise, the average ratio of the
number of negative fair value adjustments to the number of positive fair value adjust-
ments is 0.251 for conservative rms and 0.751 for less conservative rms. These ndings
(untabulated) imply that rms exhibiting higher conservatism in the pre-IFRS period
appear to be less aggressive in recognizing positive fair value adjustments in the post-IFRS
period, in that they book smaller and fewer positive fair value adjustments as compared to
those of less conservative rms.
S.P. Bandyopadhyay et al.
regime, using quarterly data from the 20082010 period.13 We dene
high (low) conservatism rms as those whose cumulative non-operating
accruals in the pre IAS 40 period is below (above) the industry median.
Note that more conservative rms are more likely to recognize bad
news and have more negative cumulative non-operating accruals.
4.2. Research models
We follow Doyle, Lundholm, and Soliman (2003) and use the fol-
lowing equation to test our rst hypothesis about the unconditional
association between fair value adjustments of investment properties
and future cash ows:
F CFOi,t+k = 0 + 1 FVADJi,t + 2 MBi,t + 3 CFOi,t
+ 4 Accrualsi, t + 5 DiscRt + 6 LnMarketValuei, t + i, t
(1)
The dependent variable is cumulative cash ow from the subsequent
one to k successive quarters (F_CFOt + 1 to F_CFOt + k). Subscripts i and t
are rm and period subscripts respectively, and k equals 1, 2, 3, and 4
respectively, reecting the rst, second, third and the fourth leading
quarters. FVADJ is the fair value adjustment gain or loss for investment
property reported in quarter t's net income. A positive estimate of 1 is
consistent with the predictive ability of the rms' IAS 40 fair value
adjustment for future cumulative cash ow, resulting from the dom-
inance of ecient contracting in its trade-o with managerial oppor-
tunism. A negative or zero estimate of 1 suggests the opposite con-
sequence of the trade-o, namely that fair value adjustments reect the
dominance of managerial opportunism rather than that of ecient
contracting. However, as stated earlier, a zero or a negative coecient
might also indicate market ineciencies such as a market bubble.
The control variable MB is the rm's market to book ratio, a proxy
for future growth opportunities (Nelson, 1996). Doyle et al. (2003) note
that growing rms have predictably lower cash ow due to increases in
working capital. CFO is the current level of cash ows, which controls
for the permanent portion of recurring cash ows. Accruals controls for
the portion of future cash ow that results from the reversals of current
period accruals.14 To control for market uctuations from year to year
and for dierences between geographic regions, we include the rms'
yearly discount rate (DiscR) to value the rm's investment property. We
deate F_CFO, FVADJ, CFO, and Accruals by lagged market value. We
also include LnMarketValue or the natural log of market value at time t
to control for rm size. Appendix 1 provides denitions of variables
included in Eq. (1) and of all other variable descriptions of later
equations.
As we discuss earlier, we base H2 on the notion that usefulness of
reported accounting adjustments is captured by the strength of its as-
sociation with current stock prices. Prior research (Collins et al., 1997;
Francis & Schipper, 1999) shows that both balance sheet information
13
For the years 2008 and 2009, many countries experienced a severe recession.
However, Canada was not aected as heavily as other countries by the nancial crisis.
Dupuis, Durocher, and St-Maurice (2008), page 1) state that First o, let's be reassuring:
on the whole, the nancial position of the main Canadian nancial institutions is rela-
tively sound. A recent study by the World Economic Forum ranks Canada rst in the
world for the soundness of its banking system. Risks of defaulting or declaring bankruptcy
are extremely low in Canada. While Canada may not have been aected by the nancial
crisis, it is still possible that the 2008 2009 period we use to estimate conservatism is
not characteristic of the regular activities of rms because rms might change their ac-
counting procedures during a nancial crisis (e.g., by taking big baths). To address this
concern, we derive a conservatism measure after removing 2008 and 2009 data and nd
the results (untabulated) are qualitatively similar.
14
Prior research examines the eects of conservatism on the time-series properties of
earnings and nds that conservatism increases earnings volatility and decreases earnings
persistence (Dichev & Tang, 2008). Also, Bandyopadhyay et al. (2010) nd that con-
servatism enhances relevance of current earnings but reduces current earnings reliability
because estimates of future expected losses might contain bias or error. The research
suggests that conservatism may capture a general form of nancial reporting quality. The
Accruals variable also addresses this concern.
Advances in Accounting 38 (2017) 114
(book value) and income statement information (earnings) play a role
in determining equity value. Following Collins et al. (1997), we use the
Ohlson (1995) model and specify stock price (PRC) as a function of
book value (BV), earnings (E), and dividends (DIV):
PRCi, t = a0 + a1 BVi, t + a2 Ei, t + a3 DIVi, t + i, t
We then decompose earnings into current period's fair value ad-
justments (FVADJ) and earnings before fair value adjustments
(E_FVADJ). Because REITs pay most of their earnings out in dividends,
we remove the earnings variable (E_FVADJ) due to the possible colli-
nearity between earnings and dividends.15 We rewrite Ohlson's model
as:
PRCi, t = 0 + 1 BVi, t + 2 FVADJi, t + 3 DIVi, t + i, t (2)
Consistent with tests of H1 for Eq. (1), a positive and signicant
coecient estimate of 2 in Eq. (2) implies that fair value adjustments
are useful to users of nancial statements.
When estimating the eects of the sample rms' pre-IFRS ac-
counting conservatism on the predictive ability of fair value asset re-
valuations for future cash ows, we control for the possible self-selec-
tion of sample rms into high versus low conservative accounting
groups (Watts 2003a, 2003b). We hypothesize that conservative ac-
counting practices reect the consequences of extant lending contracts
and the eects of corporate governance, rather than being random
choices for rms. We attempt to control for this endogeneity with a
two-stage Heckman (1979) approach by adding the Inverse Mills Ratio
estimated from the equation below into the main tests of hypotheses H3
and H4:
iCSVi, pre IAS 40 = 0 + 1 BoardSizei, t
+ 2 Levi, t + 3 LROAi, t + 4 LnMarketValuei, t +i, t (3)
where iCSVi, pre-IAS40 is an indicator variable with a value of zero or one,
respectively, for REITs whose accounting conservatism in the pre IAS
40 period is low or high (i.e., less than or more than the industry
median level).
Eq. (3) relates four rm characteristics to accounting conservatism.
The variable BoardSize measures the size of the entire board of direc-
tors.16 Prior research shows that conservatism is positively related to
corporate governance mechanisms (Ahmed & Duellman, 2007). We in-
clude a broad size measure to capture strength of board governance. A
relatively large board may allow more diversity and specialization
(Klein, 2002) or alternatively may be less ecient due to the diculties
in coordinating and engaging a large group (Jensen, 1993). The vari-
able Lev measures the debt to asset leverage ratio. If accounting prac-
tices reect managerial opportunism, managers have incentives to
overstate earnings and assets in order to avoid a breach of debt cove-
nants (Watts & Zimmerman, 1979), which leads to less conservative
accounting choices. This is particularly true when leverage is high and
15
We thank our anonymous reviewers for their comments on REITs' dividend re-
quirements. In Canada, REITs are required to distribute a considerable proportion
(7595%) of their taxable earnings as dividends to avoid taxes. The Spearman correlation
between earnings and dividends is 0.265 (p-value = 0.044) at the yearly level but in-
signicant at the quarterly level. This may be due to quarterly earnings being more vo-
latile than yearly earnings. In addition, when managers do comment on dividend policy,
all state that cash ow from operations is the most inuential factor in determining the
amount of the dividend. Our (untabulated) results continue to hold when we include both
earnings and dividends in our regression as independent variables.
16
The presence of these incentives may have an impact on the choice of rms' ac-
counting policies. We examined the proxy statements of each of our sample rms and nd
that few rms explicitly state that bonuses or a portion of bonuses are aected by meeting
earnings benchmarks. In general bonuses are based on short term goals, but those goals
are not explicitly explained in the rm's proxy statements. REITs often note that short
term bonuses are at the discretion of the board. In terms of analyst following few rms
are followed consistently by analysts. Ten of our sample rms have at least one quarter for
which an analyst makes a forecast. However, of these ten sample rms, only a total of 24
rm-quarter observations have an analyst forecast, i.e., on average, analyst forecast data
is available for < 3 quarters per rm.
6
S.P. Bandyopadhyay et al.
implies a positive coecient on Lev.
If managerial opportunism motivates managers to smooth income,
large (small) past earnings will be associated with greater (less) con-
servatism and reduced earnings volatility (Leuz, Nanda & Wysocki,
2003). This argument leads us to predict a positive sign for the L_ROA
variable in Eq. (3). However, there is no hypothesized association be-
tween L_ROA and conservatism under ecient contracting. We include
the natural logarithm of Market Value (LnMarketValue) to proxy for
rm size. In summary, the realized levels of accounting conservatism
likely capture the trade-o of ecient contracting and managerial
opportunism. The estimated value and sign of coecients in Eq. (3)
reect the net eect of potentially conicting managerial opportunism
and ecient contracting incentives facing sample rms.
We estimate the following model to test H3, namely, the impact of
historical (pre-IFRS) accounting conservatism on the relevance of fair
value adjustments of investment properties under IAS 40.17
FCFOi,t+k = 0 + 1 iCSVi,pre IAS 40 + 2 FVADJi,t
+ 3 iCSVi, pre IAS 40FVADJi, t + 4 MBi, t + 5 CFOi, t
+ 6 Accrualsi, t + 7 DiscRi, t
+ 8 LnMarketValuei,t + 9 IMRi, t + i, t (4)
where the conservatism (binary) variable iCSV is the same as dened in
Eq. (3), and FVADJ is the fair value adjustment gain or loss for in-
vestment property reported in quarter t's net income. Control variables
MB, CFO, Accruals, and DiscR, and LnMarketValue have the same de-
nitions as in Eq. (1). The IMR variable is the Inverse Mills Ratio we
estimate using Eq. (3).
The interaction term, iCSV FVADJ, is our variable of interest and is
the interaction between a rm's history of accounting conservatism and
the net fair value adjustment of investment property. If rms that in the
past reported conservatively, exhibit more value-relevant estimates of
fair value under IAS 40, we expect 3 to be positive and signicant in
Eq. (4). That is, a positive and signicant estimate of 3 is consistent
with a pre-IFRS record of accounting conservatism enhancing the pre-
dictive ability of rms' IAS 40 fair value adjustments for cumulative
future cash ow in the post-IFRS period.
We extend Eq. (2) by interacting the variable of interest FVADJ with
iCSV in order to test H4, i.e., conservative accounting practices result in
more useful fair value adjustments of investment properties.
PRCi, t = 0 + 1 iCSVi, pre IAS 40 +2 BVi, t + 3 FVADJi, t
+ 4 iCSVi, pre IAS 40FVADJi, t + 5 DIVi, t + i, t (5)
where variables are dened the same way as in earlier equations. We
expect the coecient of iCSV FVADJ, 4, to be positive, implying that
fair value adjustments of investment property are more useful in ex-
plaining stock price for rms with more conservative accounting.
17
If iCSV is not a random choice variable and is determined by a number of rm-
specic factors, and further, if any determinant of iCSV has independent eects on the
dependent variable then the coecient of iCSV in the future cash ow regression will not
reect the eects of conservatism alone on the dependent variable. See for example,
Chapter 24.5 in Green (2008). This problem is resolved by adding to the right hand side of
our regressions (as in Eq. (4) above), the Inverse Mills Ratio (IMR) obtained from a rst
stage model of the determinants of high versus low levels of conservation. In our case the
rst stage model is Eq. (3) where iCSV is the dependent variable and rm-specic factors
like Board Size, etc., are the independent variables, the hypothesized determinants of
rm-level accounting conservatism. Green (2008) shows the coecient on the treatment
variable (i.e., iCSV in our case) will no longer be biased when IMR from the rst stage
determinant model is added to the second stage. This is consistent with our second stage
Eq. (4), which adds the IMR variable as an independent variable. However, the two-stage
regression method might not fully control for endogeneity because there might not be a
theoretically correct way to build the rst-stage model and thus the omitted variable
problem may be an issue with the rst-stage regression. Thus, the two-stage model of
controlling for endogeneity is not capable of measuring how much of the ndings are
attributable to conservatism and how much are due to the underlying rst-stage omitted
factors that contribute to conservatism.
Advances in Accounting 38 (2017) 114
4.3. Sample description
To test our hypotheses, we gather nancial statements from all
Canadian REITs with SIC code 6798 available in the Compustat
Industrial quarterly database. Of the 31 REITs found in Compustat,
seven rms opt to continue reporting under the cost model (permitted
under IAS 40) and one rm reports fair values of its investment prop-
erty annually (not quarterly). Additionally, we exclude four rms that
report a discontinued operation between 2011 and 2014 and do not
report cash ows for the discontinued operations, and two more rms
that were acquired in 2011. This leaves 17 rms in our sample with
quarterly nancial statement data including fair value adjustments.
We hand collect fair value data from nancial statements available
on www.SEDAR.com, and general nancial statement data from
Compustat. Firms began fair valuing investment property under IAS 40
beginning January 1, 2011.18 We hand-collect fair value data on in-
vestment properties from rm quarterly nancial statements starting in
the rst quarter of 2011 through the rst quarter of 2014. Our model
requires a minimum of one-quarter-ahead cash ow data which implies
a sample of 17 rms with 13 quarters (4 quarters in each of 2011, 2012,
and 2013 and one quarter in 2014) of data for 221 (17 rms times 13
quarters) rm-quarter observations. We lose 22 rm-quarter observa-
tions because rms were acquired and 13 observations were missing
required nancial statement data. Our nal quarterly sample consists of
186 rm-quarter observations for analyses using one-quarter ahead
future cash ow as the dependent variable. In addition to examining the
inuence fair value adjustments have on one-quarter-ahead cash ow
we also examine the sum of the subsequent two, three, and four leading
quarter cash ows. The analysis that requires four leading quarters of
cash ows further reduces the sample to 173 rm-quarter observations.
5. Empirical tests
5.1. Univariate analyses
Panel A of Table 1 provides descriptive statistics for our sample of
186 rm-quarter observations between Q1, 2011 and Q1, 2014. The
variable F_CFOt + 1 or cumulative one-quarter-ahead cash ow is
0.024 and 0.020 at the mean and median respectively, indicating little
skewness in the dependent variable. The corresponding gures for cu-
mulative four-quarter-ahead cash ow, F_CFOt + 4, are 0.103 and
0.089 for a reduced sample of 173 rm-quarter observations. The mean
(median) fair value adjustment, FVADJ, is 2.1% (1.4%) of market value,
indicating these adjustments are non-trivial and speaks to the sig-
nicant impact of fair value accounting on REITs' book values. In terms
of the selection model variables, BoardSize averages 7.038 members
with a median of 7 members; Leverage ratio (Lev) is 0.428 and 0.413 at
the mean and median respectively, and the previous quarters' ROA
(L_ROA) is 0.016 and 0.027 at the mean and median respectively.
Panel B of Table 1 provides descriptive statistics broken out between
rms with lower and higher than the industry median non-operating
accruals (iCSV = 1, more conservative versus iCSV = 0, less con-
servative). We also provide p-values for the dierences in the mean and
median for each variable. Note that our accounting conservatism
measure (CSV) is time-invariant, being a single conservatism score,
based on pre-IFRS data, for each of the 17 sample rms. This is based on
the notion that managers' conservative accounting choices reect a
long-term decision horizon rather than a year-by-year or a quarter-by-
quarter decision. We observe considerable cross-sectional variation in
the distribution of the conservatism measure. In Table 1 Panel A, CSV
has a mean (median) of 0.175 ( 0.040) and a standard deviation of
0.247. Note that more conservative rms have lower cumulative non-
operating accruals due to their tendency to recognize bad news on a
18
There are no early IFRS adopters in our Canadian REIT sample.
7
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

Table 1
Descriptive statistics.

Panel A

Firm-quarter observations

Obs. Mean Median Std.

dev.

Main analysis variables

F_CFOt + 1 186 0.024 0.020 0.020
F_CFOt + 4 173 0.103 0.089 0.067
iCSV 186 0.489 0.000 0.501
CSV 186 -0.175 0.040 0.247
FVADJ 186 0.021 0.014 0.043
MB 186 1.221 1.177 0.372
CFO 186 0.022 0.019 0.018
Accruals 186 0.002 0.004 0.043
DiscR 186 0.072 0.073 0.010
LnMarketValue 186 6.598 6.943 1.334
PRC 186 1.087 1.041 0.217

Selection model variables

BoardSize 186 7.038 7 1.609
Lev 186 0.428 0.413 0.094
L_ROA 186 0.016 0.027 0.075
LnMarketValue See Main Analysis Variables above.
The above descriptive statistics include rms with valid data for Cash Flows one quarter ahead ( F_CFOt + 1) except that the variable F_CFO t + 4 is for rms with valid data for
four-quarter-ahead cumulative cash ows. Data are taken from Compustat Industrial Quarterly database, or hand collected from company quarterly lings. Variables are
dened in Appendix 1.

Panel B

iCSV = 1 rms iCSV = 0 rms Dierence

Mean Median

Obs Mean Median Min Max Obs Mean Median Min Max p-Value p-Value

Main analysis variables

F_CFOt + 1 91 0.025 0.020 0.047 0.152 95 0.022 0.021 0.009 0.071 (0.24) (1.00)
F_CFOt + 4 89 0.115 0.096 0.011 0.467 84 0.091 0.087 0.053 0.151 (0.02) (0.49)
CSV 91 0.342 0.202 0.872 0.065 95 0.015 0.014 0.040 0.000 (0.00) (0.00)
FVADJ 91 0.021 0.007 0.091 0.295 95 0.021 0.019 0.111 0.129 (0.95) (0.24)
MB 91 1.141 1.138 0.517 1.922 95 1.297 1.244 0.575 2.998 (0.00) (0.08)
CFO 91 0.022 0.019 0.047 0.117 95 0.021 0.020 0.009 0.065 (0.76) (1.00)
Accruals 91 0.005 0.002 0.124 0.173 95 0.001 0.005 0.099 0.331 (0.33) (0.24)
DiscR 91 0.077 0.078 0.054 0.100 95 0.068 0.069 0.055 0.083 (0.00) (0.00)
LnMarketValue 91 6.061 5.694 3.977 8.249 95 7.113 7.533 3.715 8.749 (0.00) (0.00)
PRC 91 1.115 1.040 0.766 2.523 95 1.061 1.042 0.830 1.464 (0.09) (1.00)

Selection model variables

BoardSize 91 7.143 7 5 10 95 6.937 7 3 9 (0.38) (0.04)
Lev 91 0.449 0.446 0.243 0.755 95 0.408 0.397 0.267 0.586 (0.00) (0.02)
L_ROA 91 0.011 0.026 0.171 0.111 95 0.021 0.029 0.166 0.352 (0.36) (0.24)
LnMarketValue See Main analysis variables above.

Variables are as dened in Appendix 1.

timelier manner than their recognition of good news. The range of CSV
for high conservatism rms is 0.807 (the maximum value of 0.065
minus the minimum value of 0.872), which is about 4 times the
median value 0.202. Similarly, the range of CSV for the low con-
servatism rm group is 0.040 (maximum 0.000 minus minimum value
0.040), which is about 4 times of the median value 0.014.
More highly conservative rms do not have signicantly dierent
fair value adjustments (FVADJ) than less conservative rms but are
signicantly smaller in size (log of Market Value, or LnMarketValue) for
both the mean (6.061 versus 7.113) and median (5.694 versus 7.533)
measures. The mean discount rate, DiscR, is signicantly larger for more
conservative rms at both the mean (0.077 versus 0.068) and the
median (0.078 versus 0.069) values, consistent with more conservative
reporting. Market to Book (MB) is signicantly lower at both the mean
and median for conservative rms suggesting fewer growth opportu-
nities for these rms. However, of the remaining control variables, CFO
and Accruals are not signicantly dierent between the two groups. Of
the selection model variables, more conservative rms are more le-
veraged (Lev) than less conservative rms at both the mean (0.449
versus 0.408) and median (0.446 versus 0.397). This is consistent with
the notion that leveraged rms report more conservatively. Even
though the median board size (BoardSize) is the same (7) for both high
and low conservatism rms, low conservatism rms have a higher
distribution of rms with more than the median number of board
members.
Panel A of Table 2 provides Pearson and Spearman correlation
coecients for variables in our future cash ow and stock price tests.
Note that the continuous variable CSV and the indicator variable iCSV

8
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

Table 2
Panel A correlation matrix-main analysis variables.

Spearman coecients(lower matrix) / pearson coecients(upper matrix), p-values reported in parentheses, 186 observations

F_CFOt + 1 iCSV CSV FVADJ MB CFO Accruals LnMktVal DiscR PRC

F_CFOt + 1 0.086 0.314 0.164 0.104 0.120 0.241 0.182 0.012 0.336
(0.24) (0.00) (0.03) (0.16) (0.10) (0.00) (0.01) (0.87) (0.00)
iCSV 0.001 0.664 0.004 0.210 0.023 0.072 0.395 0.436 0.124
(0.99) (0.00) (0.95) (0.00) (0.76) (0.33) (0.00) (0.00) (0.09)
CSV -0.075 0.868 0.190 0.135 0.204 0.135 0.516 0.049 0.209
(0.31) (0.00) (0.01) (0.07) (0.01) (0.07) (0.00) (0.50) (0.00)
FVADJ 0.014 0.122 0.090 0.230 0.230 0.213 0.035 0.277 0.310
(0.85) (0.10) (0.22) (0.00) (0.00) (0.00) (0.64) (0.00) (0.00)
MB 0.119 0.151 0.078 0.319 0.109 0.104 0.564 0.465 0.016
(0.11) (0.04) (0.29) (0.00) (0.14) (0.16) (0.00) (0.00) (0.83)
CFO 0.170 0.045 0.038 0.066 0.098 0.251 0.099 0.021 0.186
(0.02) (0.54) (0.61) (0.37) (0.18) (0.00) (0.18) (0.78) (0.01)
Accruals 0.207 0.044 0.103 0.273 0.172 0.473 0.026 0.029 0.160
(0.00) (0.55) (0.16) (0.00) (0.02) (0.00) (0.72) (0.70) (0.03)
LnMktVal 0.126 0.402 0.377 0.130 0.624 0.074 0.032 0.324 0.246
(0.09) (0.00) (0.00) (0.08) (0.00) (0.32) (0.66) (0.00) (0.00)
DiscR 0.042 0.469 0.273 0.259 0.455 0.068 0.162 0.366 0.063
(0.57) (0.00) (0.00) (0.00) (0.00) (0.36) (0.03) (0.00) (0.39)
PRC 0.201 0.027 0.051 0.364 0.120 0.122 0.264 0.087 0.158
(0.01) (0.72) (0.49) (0.00) (0.10) (0.10) (0.00) (0.24) (0.03)

Variables are as dened in Appendix 1.

are negatively related. Low CSV, as measured by more negative non- Table 2
operating accruals, indicates a more conservative rm with an iCSV Panel B correlation matrix - selection model variables.
value of one; high CSV rms are the opposite with an iCSV value of
Spearman coecients(lower matrix) / Pearson coecients(upper matrix), p-values
zero. The Spearman ( 0.122) coecient indicates a negative asso-
reported in parentheses, 186 observations
ciation between FVADJ and conservatism (iCSV). FVADJ is positively
correlated with MB for both the Spearman and Pearson measures in- iCSV Lev BoardSize L_ROA LnMarketValue
dicating a rm's growth opportunities map into increases in fair values iCSV 0.220 0.064 0.068 0.395
(0.00) (0.38) (0.36) (0.00)
of investment properties. The correlation coecients indicate a nega-
Lev 0.183 0.293 0.265 0.471
tive association between MB and conservatism (iCSV), suggesting that (0.01) (0.00) (0.00) (0.00)
rms with more growth potential report more conservatively. The Board Size 0.005 0.186 0.047 0.626
coecients also indicate a negative relationship between DiscR and (0.94) (0.01) (0.53) (0.00)
FVADJ, which is not surprising because the higher the discount rates the L_ROA -0.028 0.336 0.078 0.231
(0.71) (0.00) (0.29) (0.00)
lower are fair value estimates when using a discounted future cash ow LnMarketValue 0.419 0.387 0.577 0.205
model. (0.00) (0.00) (0.00) (0.01)
Panel B of Table 2 reports correlation coecients for Eq. (3) the
conservatism determinants model. The Pearson and Spearman corre- Variables are as dened in Appendix 1.
lation coecients between iCSV and Lev are both positive (0.220 and
0.183 respectively), indicating more conservative accounting for high
leverage rms. The Pearson and Spearman correlation coecients be- FVADJ are also increasing, with values of 0.171, 0.348 and 0.580 for
tween BoardSize and Lev are negative (0.293 and 0.186), sug- the second, third, and fourth cumulative quarters of cash ows.
gesting that REITs with large boards tend to take on low levels of debt. This result is consistent with investment property revaluation pro-
Lagged ROA (L_ROA) is negatively related to leverage (Lev), suggesting viding relevant information for predicting future cash ows. In terms of
that REITs with low prots in the previous period have higher levels of economic signicance, a $1.00 increase in fair value adjustments maps
debt in the current period. into $0.17 of cumulative cash ows realized over the succeeding two
quarters and rises up to $0.58 of cumulative cash ows realized over
the subsequent four quarters. The adjusted R2 values increase pro-
5.2. Regression analyses gressively from 8% for one-quarter-ahead cash ows to 34% for the
cumulative four-quarter-ahead cash ows, indicating that for reported
Table 3 provides the results of Eq. (1) for the test of our rst hy- amounts of fair value adjustments, the model has better explanatory
pothesis which examines the unconditional relationship between fair power for longer term cash ows.
value adjustments and future cash ow. The table provides the coe- Note that the coecient on the independent variable CFO is not
cient estimates and t-statistics using Rogers standard errors, which are signicant in any of the measures of future cash ow, which is contrary
White's standard errors adjusted for possible correlation between clus- to prior research in cash ow persistence. We believe the insignicant
ters in our sample rms (Petersen, 2009). The rst column provides the coecient on CFO is due to our use of quarterly data. To test this
results for one-quarter-ahead cash ows as the dependent variable; the premise we replicate Sloan (1996) and use yearly data for both the
second column includes results for the cumulative two-quarters-ahead independent and the dependent cash ow variable. We nd similar
cash ow as the dependent variable, and so forth. While the coecient results to Sloan (1996) using our sample rms in that cash ow from
of FVADJ is not signicantly dierent from zero for the one-quarter- operations is highly persistence. In a regression of year t + 1 cash ows
ahead cash ow regression, it is positive and signicant for cumulative on year t cash ows during our sample period, we nd that the
two, three, and four quarters future cash ow tests. The coecients on

9
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

Table 3
Fair value adjustments' association with future cash ows.

F_CFOi , t + k = 0 + 1FVADJi , t + 2MBi , t + 3CFOi , t + 4Accrualsi , t + 5DiscRt + 6LnMarketValuei , t +i , t (1)

Variables F_CFOt + 1 F_CFOt + 2 F_CFOt + 3 F_CFOt + 4

Coef. t-Stat Coef. t-Stat Coef. t-Stat Coef. t-Stat

Intercept 0.052 (2.25) ** 0.130 (1.86) * 0.244 (1.86) * 0.341 (1.88) *

FVADJ 0.059 (1.14) 0.171 (1.84) * 0.348 (2.43) ** 0.580 (2.92) **
MB -0.006 (1.71) 0.016 (1.72) 0.027 (1.45) 0.037 (1.32)
CFO 0.015 (0.12) 0.084 (0.51) 0.142 (0.57) 0.101 (0.25)
Accruals 0.101 (1.66) 0.099 (1.57) 0.123 (1.46) 0.130 (1.42)
DiscR 0.126 (0.62) 0.411 (0.75) 0.795 (0.84) 1.056 (0.82)
LnMarketValue 0.002 (1.17) 0.006 (1.27) 0.010 (1.60) 0.019 (1.85) *
Adjusted R2 8% 15% 24% 34%
N 186 183 178 173

This table presents the coecients and t-statistics using Rogers standard errors clustered by gvkey. *, **, and *** indicate a 10%, 5%, and 1% two sided level of signicance. Variables are
as dened in Appendix 1.

coecient on CFOt is 0.586 and strongly signicant (p < 0.01, un- Table 4
tabulated results).19 Fair value adjustments' association with price.
Table 4 presents results for the hypothesized relationship (H2) be-
PRCi , t = 0 + 1BVi , t + 2FVADJi , t + 3DIVi , 5 + i , t (2)
tween FVADJ and market price PRC. The variable of interest, FVADJ, is
signicantly positive (1.522, p < 0.01) in the rst column regression Variables Coef. t-Stat Coef. t-Stat
of Eq. (2), which suggests that investors nd fair value adjustments
useful for investing purposes. The positive relation between FVADJ and Intercept 0.824 (14.35) *** 0.824 (14.02) ***
BV 0.109 (2.21) **
PRC reects the benecial eects of ecient contracting over any FVADJ 1.522 (3.14) *** 1.523 (3.24) ***
detrimental outcomes from managerial opportunism in estimates of fair BV_AccumFVADJ 0.110 (2.04) *
value adjustments. This result is consistent with evidence provided in AccumFVAdj 0.109 (1.33)
Table 3, suggesting that fair value adjustments are relevant in pre- DIV 7.239 (2.37) ** 5.915 (1.94) *
Adjusted R2 19% 20%
dicting future cash ows and useful in explaining current stock price. As
N 186 186
a robustness check, we further break down book value into accumu-
lated fair value adjustments (AccumFVADJ) and pre-fair value adjust- This table presents the coecients and t-statistics using Rogers standard errors clustered
ment book value (BV_AccumFVADJ) to control for the prior-period's by gvkey. *, **, and *** indicate a 10%, 5%, and 1% two sided level of signicance.
cumulative FVADJ. The coecient on current period FVADJ remains Variables are as dened in Appendix 1.
signicantly positive (1.523, p < 0.01).
In general, the expectation is that the coecient on book value should are an important driver of conservatism, note that univariate results pre-
be close to one. However, because REITs pay out most earnings as divi- sented in Table 2, Panel B show that both the Pearson and Spearman
dends, we expect the coecient to be positive but may not be as close to correlations between Lev and iCSV are positive. REIT size (LnMarketValue)
one as in other industries. Investors likely invest in REITs for the constant is negatively related to conservatism (iCSV) with a coecient of 0.986,
revenue stream rather than for capital appreciation. Accordingly, our re- consistent with the Spearman and Pearson correlation coecients in
sults suggest that more emphasis is put on cash dividends as an indication Table 2 Panel A. As we indicate earlier, we assume that the incentives
of future dividend pay-outs. The dividend variable (DIV) is positive and facing managers do not change abruptly when IAS 40 became applicable
signicant, as the Ohlson (1995) model predicts, with coecients of 7.239 under IFRS. The coecient on L_ROA is 3.393 (p < 0.10) indicating more
and 5.915 respectively for both the regressions in Table 4. protable rms adopt more conservative accounting practises which
We next estimate the conservatism prediction model, Eq. (3), to apply might reect income smoothing, consistent with managerial opportunism.
the two-stage Heckman (1979) and Lee (1979) procedure in tests of H3 For example, risk-averse managers might smooth earnings opportunisti-
and H4, which are conditional on conservatism. A rms' choice of con- cally to reduce the riskiness of their future bonus streams. Alternatively,
servative accounting practice is voluntary, and driven by rm character- smooth earnings would also reduce the probability of violating debt
istics, which could potentially bias parameter estimates in empirical tests covenants that put a cap on debt to equity ratios and thus minimizing
because these choices are endogenous. As shown in Table 5, we nd that potential re-negotiation costs with lenders that could reduce rm value.
BoardSize is positively (0.631, p < 0.01) associated with conservatism, Thus, the results of Table 5 show that the realized levels of conservatism
consistent with corporate governance impacting ecient contracting ac- likely reect both the eects of managerial opportunism and ecient
counting practices leading to greater accounting conservatism. However, contracting.
we nd that the coecient on leverage (Lev) is not signicantly dierent Table 6 provides the results for our third hypothesis, that more con-
from zero. While this is not consistent with the notion that debt contracts servative rms exhibit a higher association between the current rm-
quarter fair value adjustment (FVADJ) and future quarters' cumulative
cash ows as compared to less conservative rms. The coecient on
19
In Table 3 our dependent variable sums CFO over future quarters while the in-
FVADJ is negative and signicant for the rst quarter (0.071,
dependent variable is CFO for the current quarter. Note that quarterly cash ows are p < 0.05) and the cumulative one and two quarters ahead cash ows
likely more volatile than annual cash ows because cumulating quarterly cash ows will (0.140, p < 0.05), indicating that less conservative REITs' fair value
have a smoothing eect. If quarterly cash ows are highly volatile the volatility will adjustments are negatively associated with future cash ows. As we dis-
reduce the correlation coecient between adjacent quarterly cash ows. In order to test
cuss earlier, a negative coecient on FVADJ in Eq. (3) reects income
the hypothesis that quarterly cash ows are more volatile than annual cash ows, we
compare the relative standard deviation (standard deviation divided by the mean) of smoothing which implies managerial opportunism rather than ecient
quarterly cash ows versus annual cash ows over the 2011 to 2015 period. The relative contracting. If managers have incentives to smooth income, they under-
standard deviation of quarterly cash ows is 0.832 and the relative standard deviation of state (overstate) reported values of FVADJ (which are directly recognized
annual cash ows is much smaller at 0.471(untabulated results).

10
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

Table 5
Selection model.

iCSVi , pre IAS40 = 0 + 1BoardSizei , t + 2Levi , t 1 + 3L_ROAi , t + 4LnMarketValue + i , t (3)

Variables Coef. z-stat

Intercept 1.227 (1.18)
BoardSize 0.631 (6.00) ***
Lev 1.653 (1.18)
L_ROA 3.393 (1.90) *
LnMarketValue 0.986 (6.83) ***
Pseudo R2 30%
N 186
Wald X2 0.04

This table presents the coecients and z-statistics using Rogers standard errors clustered by gvkey. *, **, and *** indicate a 10%, 5%, and 1% two sided level of signicance. Variables are
as dened in Appendix 1.

Table 6
Fair value adjustments' association with future cash owsconditioning on conservatism.

FCFOi, t + k = 0 + 1 iCSVi, pre IAS 40 + 2 FVADJi, t + 3 iCSVi, pre IAS 40FVADJi, t + 4 MBi, t (4)
+ 5 CFOi, t + 6 Accrualsi, t + 7 DiscRt + 8 LnMarketValuet + 9 IMRi, t + i, t

Variables F_CFOt + 1 F_CFOt + 2 F_CFOt + 3 F_CFOt + 4

Coef. t-Stat Coef. t-Stat Coef. t-Stat Coef. t-Stat

Intercept 0.050 (2.21) ** 0.128 (1.91) * 0.241 (1.97) * 0.334 (1.96) *

iCSV 0.004 (1.38) 0.009 (1.06) 0.012 (0.86) 0.018 (0.79)
FVAdj 0.071 (2.76) ** 0.140 (2.51) ** 0.077 (1.25) 0.106 (0.87)
iCSV FVAdj 0.199 (3.74) *** 0.472 (6.68) *** 0.649 (6.05) *** 0.711 (3.96) ***
MB 0.006 (1.53) 0.017 (1.60) 0.031 (1.44) 0.044 (1.39)
CFO 0.029 (0.24) 0.024 (0.16) 0.299 (1.06) 0.282 (0.63)
Accruals 0.106 (1.87) * 0.111 (2.03) * 0.136 (1.94) * 0.140 (1.82) *
DiscR 0.103 (0.43) 0.403 (0.61) 0.849 (0.79) 1.123 (0.78)
LnMarketValue 0.001 (0.69) 0.003 (0.75) 0.007 (1.02) 0.011 (1.31)
IMR 0.003 (0.49) 0.006 (0.97) 0.013 (1.37) 0.022 (1.64)
F-Test 2 +3 = 0 0.128 (8.24) ** 0.332 (32.68) *** 0.572 (25.81) *** 0.817 (21.03) ***
Adjusted R2 15% 23% 32% 40%
N 186 183 178 173

This table presents the coecients and t-statistics using Rogers standard errors clustered by gvkey. *, **, and *** indicate a 10%, 5%, and 1% two sided level of signicance. Variables are
as dened in Appendix 1.

in net income) when they expect increases (decreases) in future cash ows
resulting in a smooth stream of reported net income.
The iCSV FVADJ interaction term is the incremental eect fair
value adjustments have on future cash ows for more conservative
rms. This coecient is positive and signicant for all measures of
future quarterly cash ows; the rst quarter (0.199, p < 0.01), the
subsequent two quarters (0.472, p < 0.01), the subsequent three
quarters (0.649, p < 0.01) and the subsequent four quarters (0.711,
p < 0.01). These results are indicative of fair value adjustments of
more conservative rms having a signicantly higher association with
future cash ows. The foregoing evidence supports the hypothesis that
more conservative rms' fair value adjustments are more relevant
compared to those of less conservative rms. Moreover, the coecient
of iCSV*FVADJ increases in regressions F_CFOt + 1 through
F_CFOt + 4, suggesting that the relevance of fair value adjustments
increases as cash ows accumulate over longer future time periods.
In addition, the sum of the coecients for FVADJ and iCSV FVADJ
(i.e., 2 + 3) is signicantly dierent from zero with a positive sign for
all four dependent variable measures. This indicates that fair value
adjustments are positively associated with future cash ows for more
conservative rms. The average eect of a $1.00 fair value adjustment
is associated with an increase of $0.13 (2 + 3 = 0.128, F = 8.24) in
one-quarter-ahead cash ows for more conservative rms. The corre-
sponding coecients for the subsequent two, three, and four cumula-
tive quarters cash ows are $0.33 (2 + 3 = 0.332, F = 32.68), $0.57
(2 + 3 = 0.572, F = 25.81), and $0.82 (2 + 3 = 0.817, F = 21.03),
respectively. Note that the total eect of fair value adjustments for
conservative rms increases monotonically as each additional quarter's
cash ows are cumulated. This is not surprising because fair value
adjustments represent expected revisions in cash ows in multiple fu-
ture periods. Among the control variables, Accruals is consistently ne-
gatively correlated with future cumulative cash ows which likely re-
ect potential reversal of accruals over time.
We provide results of our stock price test (H4) in Table 7. Similar to
Eq. (2) in Table 4 we use the Ohlson (1995) model to examine the
association between the fair value adjustment of investment property
and market price for more and less conservative rms. We interact
FVADJ with an indicator variable (iCSV) for rms we categorize as
conservative. A positive coecient (4) on the interaction term
iCSV FVADJ is consistent with the market pricing more conservative
rms' fair value adjustments at a higher value as compared to those of
less conservative rms.
Consistent with the above predictions, the results in Table 7 suggest
that the market puts greater weight on the fair value adjustments of more
conservative rms (4 = 1.420, t-stat = 2.29). The total eect the fair
value adjustment has on market price for conservative rms is also posi-
tive and signicant (3 + 4 = 1.984, F = 12.56). The results hold in the
augmented regression which decomposes accumulated fair value adjust-
ments from book value. Similar to the results of unconditional stock price
regression of Table 4, the dividend variable (DIV) is signicantly positive.
In sum, we nd that conservatism can act as an eective partition between
rms whose fair value adjustments are more indicative or less indicative of
future cash ow and that the market appears to recognize this relation.

11
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

Table 7
Fair value adjustments' association with priceconditioning on conservatism.

PRCi, t = 0 + 1 iCSVi, pre IAS 40 +2 BVi, t + 3 FVADJi, t + 4 iCSVi, pre IAS 40FVADJi, t (5)

+ 5 DIVi, t +i, t

Coef. t-Stat Coef. t-Stat

Intercept 0.851 (14.21) *** 0.852 (14.26) ***

iCSV 0.007 (0.25) 0.005 (0.19)
BV 0.095 (2.05) *
BV_AccumFVADJ 0.098 (1.99) *
AccumFVAdj 0.083 (1.23)
FVADJ 0.564 (1.10) 0.561 (1.09)
iCSV FVADJ 1.420 (2.29) ** 1.443 (2.31) **
DIV 6.649 (1.90) * 6.603 (1.90) *
F-Test (3 + 4) 1.984 (12.56) *** 2.004 (15.69) ***
Adjusted R2 19% 19%
N 186 186

This table presents the coecients and t-statistics using Rogers standard errors clustered by gvkey. *, **, and *** indicate a 10%, 5%, and 1% two sided level of signicance. Variables are
as dened in Appendix 1.

6. Conclusion
IAS 40 allows rms to recognize their investment properties at fair
value. In this paper we examine the relevance of Canadian REITs' fair
value adjustments insofar as they are predictive of future outcomes (future
cash ows). Canadian REITs were required to recognize all xed assets
including investment property at historical cost with periodic impairment
tests under Canadian GAAP in the pre-IFRS period, i.e., prior to January 1,
2011. The adoption of IFRS in Canada provides us with the opportunity to
address the continuing controversy of whether fair value accounting
provides managers more exibility to apply accounting standards oppor-
tunistically through arbitrary fair value measurements. Arbitrary fair value
measurements will likely lead to current accounting numbers such as asset
revaluations, being less predictive of future cash ows. The other point of
view is that fair value accounting allows managers to provide inside in-
formation to security markets credibly by recognizing current values in
nancial statements. This reects ecient contracting between dierent
parties such as lenders and borrowers. These incentives, which are not
opportunistic, will likely lead to fair value adjustments of investment
property being more predictive of future outcomes.
We rst examine the unconditional relevance of the investment
property revaluations of Canadian REITs and nd that fair value ad-
justments on investment properties are, on average, positively asso-
ciated with future cumulative cash ows and concurrent stock price.
We also test a conditional hypothesis that managers who practice high
levels of accounting conservatism in the pre-IFRS period for ecient
contracting reasons are less likely to manipulate fair value adjustment
numbers opportunistically in the post-IFRS period, resulting in fair
value adjustments being more predictive of future cash ows and more
highly correlated with concurrent stock price. We nd supporting evi-
dence of this after controlling for potential self-selection bias arising
from rms' voluntary choice of the level of accounting conservatism.
Our results suggest that accounting conservatism is able to capture
ecient contracting versus opportunistic incentives facing managers. We
nd that rms that practice high levels of accounting conservatism in the
pre-IFRS period, exhibit higher levels of relevance on the investment
property revaluations in the post-IFRS regime. We also nd that the
market assigns higher values to fair value adjustments of more con-
servative REITs rms. These results reect the importance of identifying
measures (such as level of accounting conservatism) that capture the in-
centives of managers to undertake opportunistic versus ecient con-
tracting accounting choices.

Appendix 1
Variable denitions.

Eq. (1) Variables

F_CFOt + k Cumulative operating cash ow (Xpressfeed OANCFY) from quarter t to quarter t + k, where k = 1, 2, 3 and 4, deated by
k = 1, 2, 3, 4 ending market value (Xpressfeed MKTVALTQ) in quarter t-1.
FVADJ Fair value revaluations (hand collected quarterly), deated by ending market value (Xpressfeed MKTVALTQ) in quarter t-1.
MB Market value at time t divided by book value (Xpressfeed CEQQ) at time t less the accumulated fair value adjustment hand
collected from rm nancial statements.
CFO Quarterly operating cash ows (change in Xpressfeed OANCFY) deated by ending market value (Xpressfeed MKTVALTQ) in
quarter t-1.
Accruals Quarterly net income (NIQ) less quarterly operating cash ow (change in Xpressfeed OANCFY) less the rm's quarterly fair
value adjustment deated by ending market value (Xpressfeed MKTVALTQ) in quarter t-1.
DiscR The discount rate used to fair value investment property and collected from company nancial statements.
LnMarketValue Natural logarithm of market value (Xpressfeed MKTVALTQ) at quarter end.
Eq. (2) Variables
PRC Market value (Xpressfeed PRCCD* Xpressfeed CSHOC) on report date of quarterly earnings (Xpressfeed RDQ) deated by
ending market value (Xpressfeed MKTVALTQ) in quarter t-1.
BV Prior quarterly period ending common equity (Xpressfeed CEQQ) deated by ending market value (Xpressfeed MKTVALTQ) in
quarter t-1.
BV_AccumFVADJ Prior quarterly period ending common equity (Xpressfeed CEQQ) less accumulated FVADJ (2011 Q1 to period t) hand
collected from company nancial statements, deated by ending market value (Xpressfeed MKTVALTQ) in quarter t-1.
AccumFVADJ Accumulated FVADJ hand collected from company nancial statements from 2011 Q1 to period t.

12
S.P. Bandyopadhyay et al. Advances in Accounting 38 (2017) 114

FVADJ See above under Eq. (1) variables denitions.

DIV Current quarter's cash dividends (Xpressfeed DVY-lagged Xpressfeed DVY) deated by ending market value (Xpressfeed
MKTVALTQ) in quarter t-1.
Eq. (3) Variables
CSV Cumulative non-operating accruals deated by lagged market value (Xpressfeed MKTVALTQ). Note a lower CSV value (more
negative cumulative non-operating accruals) indicates a more conservative rm. Non-operating accruals are total accruals
[income before extraordinary items (Xpressfeed IBQ) + depreciation (Xpressfeed DPQ) cash ow from operations
(Xpressfeed OANCFY lagged Xpressfeed OANCFY)] less operating accruals [(change in accounts receivable (Xpressfeed
RECTQ) + change in inventory (Xpressfeed INVTQ) change in accounts payable (Xpressfeed APQ) change in taxes payable
(Xpressfeed TXPQ)-change in deferred tax liability (Xpressfeed TDBQ)] (see Givoly & Hayn, 2000).
iCSV Indicator variable = 1 if the sum of a rm's cumulative non-operating accruals over 12 quarters (in 2008, 2009, and 2010) are
lower than the industry median, and 0 otherwise. Non-operating accruals are dened above.
BoardSize Total number of director's on a rm's board of directors. Hand collected from proxy statements.
Lev Total long term debt (Xpressfeed DLTTQ) divided by assets (Xpressfeed ATQ).
L_ROA The prior scal year's return on assets or income before extraordinary items (Xpressfeed IBY) in divided by total assets
(Xpressfeed ATY).
LnMarketValue See above under Eq. (1) variable denitions.
Eq. (4) Variables
All variables are as dened in Eq. (1) and Eq. (3) with the exception of IMR.
IMR Inverse mills ratio determined from Eq. (3). IMR is estimated as (z)/(z), where z is the tted value of the probit regression
of Eq. (3); is the density function for the standard normal distribution, and is the cumulative density function for the
standard normal distribution.
Eq. (5) Variables
All variables are as dened in Eqs. (2) and (3).

References
Ahmed, A. S., Billings, B. K., Morton, R. M., & Stanford-Harris, M. (2002). The role of
accounting conservatism in mitigating bondholder-shareholder conicts over divi-
dend policy and in reducing debt costs. The Accounting Review, 77(4), 867890.
Ahmed, A. S., & Duellman, S. (2007). Accounting conservatism and board of director
characteristics: An empirical analysis. Journal of Accounting and Economics, 43(23),
411437.
Anglin, P., Edelstein, R., Gao, Y., & Tsang, D. (2013). What is the relationship between
REIT governance and earnings management? The Journal of Real Estate Finance and
Economics, 47(3), 538563.
Bandyopadhyay, S. P., Chen, C., Huang, A., & Jha, R. (2010). Accounting conservatism
and the temporal trends in current earnings' ability to predict future cash ows versus
future earnings: Evidence on the trade-o between relevance and reliability.
Contemporary Accounting Research, 27(2), 413460.
Barth, M. E. (1994). Fair value accounting: Evidence from investment securities and the
market valuation of banks. The Accounting Review, 69(1), 125.
Barth, M. E., Beaver, W., & Landsman, W. (1996). Value-relevance of banks' fair value
disclosures under SFAS no. 107. The Accounting Review, 71(4), 513537.
Barth, M. E., Landsman, W., & Lang, M. (2008). International accounting standards and
accounting quality. Journal of Accounting Research, 46(3), 467498.
Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings.
Journal of Accounting and Economics, 24, 337.
Bissessur, S., Goncharov, I., & Wirtz, D. (2012). Comparing the usefulness of historical-cost
income and fair-value based income. Working paper. Retrieved from http://arw-
suisse.ch/wp-content/uploads/2013/05/bissesur-goncharov-wirtz.pdf.
Bruce, A. C., Buck, T., & Main, B. G. M. (2005). Top executive remuneration: A view from
Europe. Journal of Management Studies, 42(7), 14931506.
Cairns, D., Massoudi, D., Taplin, R., & Tarca, A. (2011). IFRS fair value measurement and
accounting policy choice in the United Kingdom and Australia. The British Accounting
Review, 43(1), 121.
Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-nancial
assets pass the market test? Review of Accounting Studies, 18(3), 734775.
Christie, A., & Zimmerman, J. (1991). Ecient versus opportunistic choice of accounting
procedures: Non-synergistic takeovers. (IDEAS Working Paper Series from REPEc).
Collins, D., Maydew, E., & Weiss, I. (1997). Changes in the value-relevance of earnings and
book values over the past forty years. Journal of Accounting and Economics, 24(1),
3967.
Dechow, P. (1994). Accounting earnings and cash ows as measures of rm performance:
The role of accounting accruals. Journal of Accounting and Economics, 18(1), 342.
Dichev, I., & Skinner, D. (2002). Large-sample evidence on the debt covenant hypothesis.
Journal of Accounting Research, 40(4), 10911123.
Dichev, I., & Tang, V. (2008). Matching and the changing properties of accounting
earnings over the last 40 years. The Accounting Review, 83(6), 14251460.
Dietrich, J. R., Harris, M., & Muller, K., III (2000). The reliability of investment property
fair value estimates. Journal of Accounting and Economics, 30(2), 125158.
Doyle, J. T., Lundholm, R. J., & Soliman, M. T. (2003). The predictive value of expenses
excluded from pro forma earnings. Review of Accounting Studies, 8(23), 145174.
Dupuis, F., Durocher, B. P., & St-Maurice, Y. (2008). The impact of the nancial crisis in
Canada. Desjardins Economic Studies: Economic Viewpoint.
Eccher, A., Ramesh, K., & Thiagarajan, S. R. (1996). Fair value disclosures by bank holding
companies. Journal of Accounting and Economics, 22(13), 79117.
Evans, M., Hodder, L., & Hopkins, P. (2014). The predictive ability of fair values for future
nancial performance of commercial banks and the relation of predictive ability to
banks' share prices. Contemporary Accounting Research. http://dx.doi.org/10.1111/
1911-3846.12028 (Forthcoming).
FASB SFAC No. 2 (1980). Statement of nancial accounting concepts no. 2: Qualitative
characteristics of accounting information. Nowalk, CT: Financial Accounting Standards
Board.
Fields, T. D., Lys, T. Z., & Vincent, L. (2001). Empirical research on accounting choice.
Journal of Accounting and Economics, 31(1), 255307.
Fortin, S., Tsang, D., & Dionne, F. P. (2008). Performance measurement and recognition of
real estate assets: An international exploration of reporting practices adopted in the real
estate industry. McGill University working paper.
Francis, J., & Schipper, K. (1999). Have nancial statements lost their relevance? Journal
of Accounting Research, 37(2), 319352.
Garcia Lara, J., Garcia Osma, B., & Penalva, F. (2009). Accounting conservatism and
corporate governance. Review of Accounting Studies, 14(1), 161201.
Givoly, D., & Hayn, C. (2000). The changing time-series properties of earnings, cash ows
and accruals: Has nancial reporting become more conservative? Journal of
Accounting and Economics, 29(3), 287320.
Green, W. H. (2008). Econometric analysis 6th edition. Prentice Hall.
Heckman, J. (1979). Sample selection bias as a specication error. Econometrica, 47,
153161.
Hendershott, P. H., & Kane, E. J. (1995). U.S. oce market values during the past decade:
How distorted have appraisals been? Real Estate Economics, 23(2), 101116.
Holthausen, R. (1990). Accounting method choice: Opportunistic behaviour, ecient
contracting, and information perspectives. Journal of Accounting and Economics,
12(13), 207218.
Holthausen, R., & Watts, R. L. (2001). The relevance of value-relevance literature for -
nancial accounting standard-setting. Journal of Accounting and Economics, 31(1), 375.
Hung, M., & Subramanyam, K. R. (2007). Financial statement eects of adopting inter-
national accounting standards: The case of Germany. Review of Accounting Studies,
12(4), 623657.
International Accounting Standards Board (IASB) (2010). The conceptual framework for
nancial reporting. London: UK.
Israeli, D. (2015). Recognition versus disclosure: Evidence from fair value of investment
property. Review of Accounting Studies, 20(4), 14571503.
Jensen, M. C. (1993). The modern industrial revolution, exit and failure of internal control
systems. Journal of Finance, 48, 831880.
Kim, M., & Kross, W. (2005). The ability of earnings to predict future operating cash ows
has been increasingNot decreasing. Journal of Accounting Research, 43, 753780.
Klein, A. (2002). Economic determinants of audit committee independence. The
Accounting Review, 77, 435452.
Kothari, S., Ramanna, K., & Skinner, D. (2010). Implications for GAAP from an analysis of

13
S.P. Bandyopadhyay et al.
positive research in accounting. Journal of Accounting and Economics, 50(23),
246286.
Lee, L. (1979). On the estimation of multiple equations error components regression
models. American Statistical Association Proceedings of Economic and Business Section,
310313.
Leuz, C., Nanda, D., & Wysocki, P. (2003). Earnings management and investor protection:
An international comparison. Journal of Financial Economics, 69, 505527.
Muller, K., Riedl, E., & Selhorn, T. (2008). Consequences of voluntary and mandatory fair
value accounting: Evidence surrounding IFRS adoption in the EU real estate industry.
(Working paper).
Muller, K., Riedl, E., & Sellhorn, T. (2011). Mandatory fair value accounting and in-
formation asymmetry: Evidence from the European real estate industry. Management
Science, 57(6), 11381153.
Nelson, K. (1996). Fair value accounting for commercial banks: An empirical analysis of
SFAS no. 107. The Accounting Review, 71(2), 161182.
Ohlson, J. A. (1995). Earnings, book values, and dividends in equity valuation.
Contemporary Accounting Research, 11(2), 661687.
Ooi, J., Ong, S., & Li, L. (2010). An analysis of nancial decisions of REITs: The role of
market timing and target leverage. Journal of Real Estate Financial Economics, 40(2),
130160.
14
Advances in Accounting 38 (2017) 114
Paananen, M., & Lin, H. (2009). The development of accounting quality of IAS and IFRS
over time: The case of Germany. Journal of International Accounting Research, 8(1),
3155.
Petersen, M. (2009). Estimating standard errors in nance panel data sets: Comparing
approaches. Review of Financial Studies, 22(1), 435480.
Ramanna, K., & Watts, R. L. (2012). Evidence on the use of unveriable estimates in
required goodwill impairment. Review of Accounting Studies, 17(4), 749780.
Richardson, S., Sloan, R., Soliman, M., & Tuna, I. (2005). Accrual reliability, earnings
persistence and stock prices. Journal of Accounting and Economics, 39(3), 437485.
Sloan, R. G. (1996). Do stock prices fully reect information in accruals and cash ows
about future earnings? The Account Review, 7(3), 289315.
Watts, R. (2003a). Conservatism in accounting part I: Explanations and implications.
Accounting Horizons, 17(3), 207221.
Watts, R. (2003b). Conservatism in accounting part II: Evidence and research opportu-
nities. Accounting Horizons, 17(4), 287301.
Watts, R., & Zimmerman, J. (1979). The demand for and supply of accounting theories:
The market for excuses. The Accounting Review, 54(2), 273305.
Zhang, J. (2008). The contracting benets of accounting conservatism to lenders and
borrowers. Journal of Accounting and Economics, 45(1), 2754.