Demand for fair value accounting: The case of the asset revaluation boom in Korea during the global financial crisis

• Author: Tae Hee Choi,Jinhan Pae,Choong‐Yuel Yoo
• Published date: 01 January 2018
• Date: 01 January 2018
• DOI: http://doi.org/10.1111/jbfa.12266

DOI: 10.1111/jbfa.12266

Demand for fair value accounting: The case of the

asset revaluation boom in Korea during the global

financial crisis

Choong-Yuel Yoo1Tae Hee Choi2Jinhan Pae3

1KoreaAdvanced Institute of Science and

Technology(KAIST) College of Business

2KDISchool of Public Policy and Management

3KoreaUniversity Business School

Correspondence

JinhanPae, Professor of Accounting, Korea

UniversityBusiness School, 145 Anam-Ro,

Seongbuk-Gu,Seoul, Korea.

Email:jinhanpae@korea.ac.kr

Fundinginformation

KoreaUniversity Business School Grant

2014KAIST Internal Research Grant

Abstract

When the fair value accounting (FVA)option for property, plant, and

equipment was introduced in the midst of the global financial crisis,

a significant proportion of Korean firms elected FVA. We attribute

this unusual boom in asset revaluations to the nation’s culture of

government intervention and civilian compliance, which was partic-

ularly espoused during this period of financial turmoil, and a foresee-

able option to switch back to historical cost accounting. We find that

among those firms whose debt-to-equity ratios are low, public firms

opt for the FVA option more often than private firms, suggesting

that the need to communicate fair value information with diversified

equity holders is more important than the need to do so with credi-

tors. In contrast, among those firms whose debt-to-equity ratios are

high enough to warrant such unfavorable dispositions as new debt

freezes and monitoring by regulators, we find no difference in the

FVA choice between private and public firms. These findings imply

that during the global financial crisis, private firms that rely heavily

on debt financing have a strong incentive to utilize FVA to comply

with government guidelines for the debt-to-equity ratio and to ease

a potential hold-up problem by influential creditors.

KEYWORDS

asset revaluation, early adoption, IFRS, policy, private firms

1INTRODUCTION

Asset revaluation is a formal procedure by which firms update the carrying amount of an asset to the fair value. Fair

value accounting (FVA) has been widely accepted for financial instruments in recent years, but generally accepted

accounting principles (GAAP) in the United States and international financial reporting standards (IFRS) differ in their

positions on the adoption of FVA for non-financial assets. Whereas both US GAAP and IFRS mandate the recognition

of the decline in value through the impairment test requirement for fixed assets, only IFRS, not US GAAP, allows for

the appreciation in value through asset revaluation. In a setting in which the need to increase book values of assets and

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2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/jbfa JBus Fin Acc. 2018;45:92–114.

YOO ET AL.93

equities is substantial due to the global financial crisis, we investigate whether privately held and publiclytraded firms

react differently to the FVAoption for property, plant, and equipment (PP&E).

Prior studies suggest that firms revalue PP&E to improvetheir financial position and to signal their future prospects

and financial healthiness (Brown, Izan, & Loh, 1992; Whittred & Chan, 1992; Easton, Eddey,& Harris, 1993; Cotter &

Zimmer,1995; Gaeremynck & Veugelers, 1999; Lin & Peasnell, 2000; Barlev,Fried, Haddad, & Livnat, 2007). Except for

Gaeremynck and Veugelers(1999), who examined private Belgian firms, the extant literature on asset revaluation has

mostly focused on public firms. Accordingly,no existing study before ours has examined the differences in asset reval-

uation between private and public firms. We argue that private firms differ from public firms in their propensity and

incentives to revalue PP&E, partly because of their differing demands for fair value information regarding contracting

and investment decision-making. Prior studies show that private firms differ from public firms in many aspects, one

of which is on financial reporting incentives (e.g., Burgstahler, Hail, & Leuz, 2006; Hope, Thomas, & Vyas,2013). For

instance, Penno and Simon (1986) and Cloyd, Pratt, and Stock (1996) find that whereas public firms are more con-

cerned about increasing reported earnings, private firms’ primary concern is to reduce taxes. It has also been alleged

that in private firms, financial statements play a relatively less important role than they do in public firms because the

financial statements of private firms are not widely distributed to the public (Ball & Shivakumar,2005; Peek, Cuijpers,

& Buijink, 2010; Szczesny & Valentincic,2013).

We conduct our comparative analysis of asset revaluation between public and private firms in a Korean setting

because of the following advantages. First, in Korea, the financial reporting data necessary to investigate asset reval-

uation are widely available for both public and private firms. Furthermore, both private and public Korean firms

are subject to the same corporate tax rates and financial reporting regulations, including the external audit require-

ment (Kim & Yi, 2006; Choi, Pae, Park, & Song, 2013). Thus, a sample of Korean firms makes it possible to focus on

the differences in the ways private and public firms use general-purpose financial statements in explicit and implicit

contacts.

Second, Korea provides a good venue for a comparative study due to its unique circumstances resulting in a rela-

tively high number of apparent asset revaluation cases (17.9% of public firms and 14.6% of private firms in Panel A,

Table1). The asset revaluation boom among Korean firms contrasts with the scarcity of the FVAchoice following IFRS

adoptionin Europe: only 2–5% of German and UK listed firms c hoose the FVAoption for PP&E (Christensen & Nikolaev,

2013).

Finally,Korea provides an opportunity to investigate how firms react to the introduction of the FVA option for fixed

assets prior to the full adoption of IFRS. In 2008, as an attempt to facilitate a smooth transition to the 2011 mandatory

adoption of IFRS, the Korean Accounting Standard Board (KASB) selectively revised local accounting standards for

PP&E in accordance with International Accounting Standard 16: Property,Plant and Equipment (IAS 16). This early, partial

adoption (IAS 16, paras 39 and 40) of IFRS creates a quasi-experiment that enables us to pinpoint the exact yearthat

firms revalued their PP&E and, furthermore, to focus on the impact of the single item of IFRS on managers’ choices in

order to revalue PP&E while isolating the effects of other items of IFRS.

In our comparative analysis of asset revaluation between public and private firms, we note the difference in their

sources of financing. Unlike private firms, which usually get financed through bank debt or relationship loans, pub-

lic firms rely more on public debt or equity because they have easier access to the capital markets and need greater

amounts of capital. Whereas public financing creditors (e.g., bond issuers) are more likely to rely on information from

public sources, prospective creditors of a private firm are often in a position to directly ask the firm to provide infor-

mation relevant to their lending decisions (Ball & Shivakumar, 2005; Peek et al., 2010). Consequently, for the cur-

rent and prospective creditors of private firms, published financial statements are less likely to be the main source of

information.

Given the above difference in information channels between private and public firms, we argue that for pub-

lic firms, asset revaluation is an efficient way to convey reliable information through publicly disclosed general-

purpose financial statements – because private provision of fair value information would be inefficient or impossible.

However, in the case of private firms, a relatively smaller number of creditors makes it easier to convey fair value

information privately. Hence, our initial prediction is that private firms are less likely to revalue PP&E than public