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COMPLIANCE WITH DISCLOSURE REQUIREMENTS FOR INVESTMENT
PROPERTIES: A COMPARATIVE STUDY BETWEEN SPAIN AND UK
Marta de Vicente Lama
ETEA, UNIVERSIDAD DE CÓRDOBA
Horacio Molina Sánchez
ETEA, UNIVERSIDAD DE CÓRDOBA
Jesús N. Ramírez Sobrino
ETEA, UNIVERSIDAD DE CÓRDOBA
Area temática: A) Información Financiera y Normalización Contable
Keywords: Mandatory disclosure, Investment properties, accounting choice,
recognition vs. disclosure
126a
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COMPLIANCE WITH DISCLOSURE REQUIREMENTS FOR INVESTMENT
PROPERTIES: A COMPARATIVE STUDY BETWEEN SPAIN AND UK
Abstract
The primary aim of this study is to analyse the extent to which listed companies in
Spain and the United Kingdom (UK) comply with the disclosure requirements under
International Accounting Standard 40 (IAS 40) for investment properties and to what
extent corporate characteristics are associated with compliance with this standard.
Our results suggest that disclosure regulation acts as a benchmark more than as a
minimum level of information, and companies react to the information’s overload with a
relaxation on fulfilment.
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INTRODUCTION
The primary aim of this study is to analyse the extent to which listed companies in
Spain and the United Kingdom (UK) comply with the disclosure requirements under
International Accounting Standard 40 (IAS 40) for investment properties and to what
extent corporate characteristics are associated with compliance with this standard. We
focused on the case of Spain and UK because they were the most dynamic real estate
markets in Europe at the time of the mandatory adoption of International Financial
Reporting Standards (IFRS) and where the boom of housing prices could have had a
greater impact on financial statements. We analysed 2005 and 2008 annual reports in
order to compare the determinants of the extent compliance with disclosure
requirements for investment properties on a pre and post-crisis period and to determine
if there has been an improvement in the quality of disclosure between these two
periods. For our knowledge disclosure on investment properties has never been
studied in this way before, particularly in Spain and UK.
IAS 40 allows two alternative treatments to measure investment property after initial
recognition: either a cost model, disclosing the fair value of the investment property in
the notes, or a fair value model recognizing the changes in the fair value of investment
property in the income statement. The choice afforded under IAS 40 represents
primarily an accounting choice (between cost and fair value). Secondly, it is a choice
between recognition and/or disclosure of the financial information and, finally, an
election between two characteristics of the financial information such as relevance and
reliability. Disclosure requirements under IAS 40 could be sorted by three types: (1)
disclosures applicable to all investment properties, (2) disclosures applicable to
investment properties carried according to the fair value model and (3) disclosures
applicable to investment properties valued according to the cost model. Within the first
category, firms are required to disclose information about their business model (such
as rental income and direct costs) and, on the other hand, firms are required to
disclose information regarding the reliability of the fair value amounts (such as to what
extent the fair value of investment property is based on valuations of independent
appraisers or not, the latter having also to be declared, the methods used and
important assumptions applied in determining the fair value of investment properties).
Disclosure requirements under the second and third categories are similar to those of
other fixed assets investigated in some manner by previous researchers. In our study,
we focused on the disclosure requirements for all investment properties since IAS 40
provides us with a unique setting to investigate disclosure compliance. Chavent et al
(2006: 191) argue that, although studies on mandatory disclosure could appear
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illogical, researchers have found some flexibility in the way firms report their financial
information.
As argued by Schipper (2007), one of the purposes of disclosure that present an
alternative measurement attribute is to mitigate the effects of accounting choice on the
comparability of financial reporting providing users sufficient information for a
comparative analysis. In this sense, IAS 40 results in an asymmetric treatment of
disclosure requirements because the cost model requires the disclosure of the fair
value of the investment property whereas the use of the fair value model does not
require firms disclosure on historical cost amounts. Firms using the cost model are
obliged to disclose fair value amounts to enable users to carry out a comparative
analysis. However, in our view comparability can not be achieved since users can not
obtain the annual impact on the income statement because the difference between the
fair value and the depreciated cost reflects solely the cumulative effect of the years
during which the asset is under control and not just the last year gain or loss.
Obviously, this lack of information is more striking when the rationale for choosing the
fair value is that the management of these assets can not be understood without
considering the gain from holding the asset (Barlev y Haddad 2003). On the other
hand, firms valuing their investment property under the fair value model are not
required to disclose information on the historical cost amounts or the cumulative
depreciation that these assets would have generated. The latter shows the implicit
preference of the standard setter upon the fair value model1. Schipper (2007: 308) also
argues that “the clearest conceptual message – that disclosures should present
relevant but less reliably measured items – does not seem to capture the purpose of
some existing disclosure requirements”. This is the case under IAS 40 for at least two
reasons: firstly, although the fair value model seems to be the standard setter’s
preferred presentation for investment property as stated above2, alternative treatments
are a free choice; and secondly, disclosure requirements applicable to all investment
properties, regardless of the accounting choice, intend to mitigate reliability concerns.
IAS 40 disclosure requirements applicable to all investment properties concern: the
value measurement of the investment property (historical cost versus fair value),
1 The Exposure Draft 64 (IASC 1999) published in 1999 by the International Accounting
Standards Committee (from 2001 IASB) proposed the fair value model as the unique accounting treatment available for investment properties. However, on the basis of the comment letters received by respondents, the IASC decided to introduce, additionally to the fair value model proposed, an alternative: the cost model but requiring disclosure on fair value amounts of investment properties.
2 The recent publication of IFRS for SME (IASB 2009) also reveals this preference for the fair value model. The new standard eliminates the alternative treatment and requires investment property being carried according to the fair value model.
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measurement uncertainty (source and methods in determining fair value amounts),
management of investment property (rental income and direct costs) and the economic
risks derived from its management (capital commitments). Disclosure regulation
represents a benchmark on the level of disclosure but not the minimum information to
be disclosed, perhaps trying to avoid an overload in the amount of financial reporting
information (Schipper 2007). Why firms do not fully comply with disclosure
requirements? Regulated financial disclosures are informative to investors and, in our
study, we argue that different levels of compliance are the result of: (1) economic
reasons or a firm’s proactive attitude towards its own specific characteristics and (2) a
reactive response of the firm to the cultural environment. Under the framework of the
signalling theory, the present study identifies size, profitability, leverage and the
cumulative impact of the fair value of investment properties over total assets as the
economic determinants of the level of compliance. It also provides further evidence on
the influence of cultural variables such as industry and the country of origin showing
that firms tend to follow the best disclosure practices in the real estate industry and that
prior local accounting standards have an impact on the level of compliance with
mandatory disclosures by firms from different countries.
The remaining of the paper is organized as follows. Section 2 shows the institutional
background in Spain and UK focusing on the topics of accounting and disclosure
requirements for investment properties. Section 3 reviews prior studies addressing the
determinants of disclosure compliance and the value relevance of recognition versus
disclosure. In Section 4 we present our hypotheses concerning compliance with the
disclosure requirements of IAS 40. Section 5 describes the methodology of our
investigation and the sample used. Empirical results are presented in Section 6 being
analysed and discussed in Section 7.
1. INSTITUTIONAL BACKGROUND
Prior to implementation of IAS 40, accounting for investment properties was governed
by the General Accounting Plan (PGC 1990) and SSAP No. 19 (ICAEW 1981) in Spain
and UK respectively.
The accounting treatment for investment properties in Spain under PGC 1990 was the
cost model and they were presented within the rest of tangible assets on the balance
sheet. In addition neither disclosure of fair value amounts nor lessor’s disclosure for
operating leases were required. In 2007, Law 1514/2007 of 16 November established
the new General Accounting Plan (PGC 2007) under which investment properties are
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recorded under a separate hedging of non-current assets and continued being valued
at historical cost without requiring disclosure of fair value amounts.
According to UK regulation, SSAP No. 19 required that investment property assets had
to be accounted for under the revaluation model. Changes in fair value3 were recorded
through equity, as a revaluation reserve, rather than directly to the income statement.
As IAS 40, the standard did not require the valuation being made by qualified or
independent appraisers but it explicitly stated that if investment properties represented
a significant proportion of the total assets of a major enterprise, valuation would
normally be carried out annually by appraisers who held a recognised professional
qualification and had recent experience in the location and category of the investment
property being valued. The statement, apart from the information about the appraiser,
also required disclosing the valuation method and assumptions in determining the fair
value.
To summarize, domestic accounting standards prior to the adoption of IFRS and, in the
case of Spain, also after the implementation of IFRS varied considerably across the
two countries being studied.
2. RELATED PRIOR STUDIES
Empirical disclosure literature is very extensive (see Healy and Palepu 2001 for a
review). Most researches focus on voluntary items and examine the relationship
between a number of firm-specific characteristics and a general disclosure level under
the framework of the agency, signalling and proprietary costs theories. However,
according to the objective of our study, we concentrate on several studies addressing
mandatory disclosure or IAS adoption (Cooke 1989a, 1992; Wallace et al 1994; Giner
1997; Chen and Jaggi 2000; Jaggi and Low 2000; Glaum and Street 2003; Ali et al
2004). These researchers found that the level of disclosure is influenced by cultural
factors (Jaggi and Low 2000) and some firm-specific characteristics such as size,
industry, listing status, profitability, auditor and, as Chen and Jaggi (2000) found, the
number of independent non-executive directors. Regarding to leverage, previous
researchers could not obtain significant evidence to support its relationship with the
level of compliance.
With respect to the methodology, the majority of disclosure studies use a self-
constructed disclosure index (weighted or unweighted) as a proxy of disclosure quality
3 SSAP No. 19 used the “open market value” as the valuation criteria for investment property.
Its definition was similar to “fair value” under IFRS.
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and then apply regression techniques (mainly linear and OLS regression) with
unranked and/or ranked data. Chavent et al (2006) after summarizing the objective,
research design and main results of 49 disclosure studies (both voluntary and
mandatory), introduce a “divisive clustering method” complementary to the disclosure
index commonly used in such studies and with the aim of analysing disclosure patterns
as well as disclosure levels.
As mentioned before, IAS 40 also represents a choice between recognition and
disclosure of financial information. In fact, a good part of the literature analyzes the
relationship between recognition and/or disclosure and the reliability of the financial
information. The research on this field focuses on a specific context (primarily United
States) and in particular accounting standards. Indeed, some authors take the
opportunity of comparing the perception in the market about the reliability of financial
reporting immediately before and after a new standard, which requires recognition
whereas it only required disclosure before, was adopted. Davis-Friday et al (2004), in
relation to the accounting change that occurs in the US with the adoption of Statement
of Financial Standards No 106 (SFAS 106) which relates to the accounting treatment of
liabilities for retiree benefits other than pensions (other benefits such as health or life
insurance) find that market considers disclosed liabilities (prior to the adoption of SFAS
106) as less reliable than recognized liabilities (subsequently to adoption of SFAS 106).
In addition they conclude that reported amounts of recognized liabilities are more
accurate than disclosed liabilities. This finding suggests that recognition increases the
reliability of financial reporting. Ahmed et al (2006) argue that the investigation of these
authors suffers from a weakness, which is that the nature of the information and the
different valuation criteria used before and after the adoption of the new standard. To
mitigate this problem, the authors consider an ideal setting to analyze how investors
value financial derivatives depending on whether they are being revealed or recognized
and focus their investigation on the accounting regulatory change that occurs in the
treatment of derivatives with the adoption of Statement of Financial Standards No 113
(SFAS 113). Their results are consistent with those of Davis-Friday et al (2004)
suggesting that market does not perceive recognition and disclosure as substitutes. In
respect of investment properties, Muller et al (2008) show that investors do not
consider as substitutes disclosure and recognition of fair value amounts of investment
properties4.
4 Additionally, So and Smith (2009) find that, in Hong Kong, presenting changes in fair value
of investment properties is more value-relevance compared to reporting changes through equity (as a revaluation reserve).
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In this study, we also analyse if there is an improvement in the quality of disclosure
between 2005 and 2008. Leuz and Verrecchia (2000) argue that prior empirical studies
which try to analyse the economic benefits of increase disclosure are varied and
suggest that one of the reasons could be that the majority of these studies are focused
in the United States, country where local GAAP already required to disclose extensive
financial information. For this reason, the authors investigate the economic benefits of
increasing disclosure from the adoption of international standards (US GAAP or IFRS)
on a sample of German companies for which local GAAP established fewer disclosure
requirements. The authors use the bid-ask spread and trading volume as a proxy for
measuring information asymmetries and conclude that increases in disclosure reduce
information asymmetries and consequently, according to the economic theory, the cost
of capital.
Finally and regarding the auditor behaviour with respect to the reliability of disclosed
items, Libby et al (2006) conclude that, in relation to the disclosure requirements and
accounting treatment of stock compensation and leases in the United States, auditors
are more likely to allow more misstatements in disclosed than in recognized items and
they do so intentionally because they consider as lower the materiality level of the
recognized amounts. Therefore, the authors suggest that the decision of the standard
setters to relegate some items into the notes to the accounts could reduce the
perceived reliability of these items while, on the other hand, recognition implies that
auditors would exercise a greater pressure on their clients to avoid or correct the
misstatements increasing the reliability of the financial information.
3. HYPOTHESES DEVELOPMENT
In order to investigate the determinants of the level of compliance with IAS 40
disclosure requirements, we developed our hypotheses according to the prior literature
addressing disclosure compliance while introducing specialties in the topic of
investment properties. We used the theoretical framework of the signalling theory and
argue that the flexibility with which firms comply with mandatory disclosures rely on a
two-faced behaviour. First of all, firms will have a proactive attitude towards its own
performance and specific characteristics (size, leverage, profitability, accounting choice
and the impact of fair value accounting) and they will intend to signal the market their
reporting quality. Secondly, companies will also be influenced by cultural factors
(country of origin, prior domestic accounting standards, industry and auditor) and will
have a reactive behaviour trying to comply with the best practices.
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3.1. ECONOMIC DETERMINANTS OF COMPLIANCE: A PROACTIVE BEHAVIOUR
Size
The previous empirical research suggests that large companies disclose more
information than small companies (Cooke 1989a, 1992; Wallace et al 1994; Giner
1997; Ali et al 2004). According to the signalling theory, there is a major demand on the
part of large firms to provide extensive disclosure for stakeholders and, as argued by
Watson et al (2002: 297), “larger corporations may have greater benefits to be gained
by better disclosure in terms of easier marketability of securities as a result of reduced
uncertainty”. However, regarding to the proprietary cost theory, Healy and Palepu
(2001) relate that several researchers conclude in their studies that firms tend to not
disclose information if such disclosure can damage their competitive position. It is also
likely that larger firms will have the ability to disclose more information since
compliance with disclosure requirements for investment properties implies to incur in
significant costs for small companies or requires sufficient experience and resources
(such as the case of the external appraisal’s fees or the internal estimation of fair value
amounts). We test the following hypothesis:
H1: The extent of compliance with IAS 40 disclosure requirements is higher for
larger firms.
The independent variable considered as measure of size is total assets
(TOTAL_ASSETS).
Profitability
Profitability has been identified as a determinant of disclosure compliance in Spain
(Giner 1997). However, the results were opposite to those predicted and show a
negative relationship between the level of compliance and profitability. The author
argue that the results are consistent with the hypothesis that firms will disclose more
information when they report a low profitability ratio and use disclosure to explain the
bad news.
According to the signalling theory, we argue that companies with higher profitability are
more likely to provide more information signalling the market and providing assurance
to investors. We test the following hypothesis:
H2: The level of compliance with IAS 40 disclosure requirements is higher for
more profitable companies.
The variable ROA is measured as of the ratio net income to total assets.
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Leverage
The relationship between capital structure (leverage) and the level of disclosure is
unclear as none of the studies, which hypothesized a positive relationship between
these two variables, report empirically consistent results. However, in our study, we
cannot ignore that property assets are the main guarantee for lending operations,
especially in the real estate sector in which companies depend greatly on debt
financing. A good part of disclosure items regarding investment properties are required
with the aim of increasing the reliability of the fair value estimations. This fact suggests
that there may be a positive relationship between leverage of firms and disclosure
compliance.
H3: The level of compliance with IAS 40 disclosure requirements is higher for
firms with a high rate of leverage.
In this study we use the total debt to total equity as the measure of leverage (LEV).
Accounting choice
We assume accounting choice for investment properties as a determinant of the
disclosure policy. Companies choosing the fair value model under IAS 40 show their
preference for relevant and timely financial information and increasing or complying
with disclosure requirements improve the reliability of accounting information and, as
argued by Barlev y Haddad (2003), the transparency which fair value provides in itself
to financial information. Moreover, the fair value measurement of investment property
introduces greater volatility in the income statement and affects the risk perceived by
actual and prospective investors. Following this reasoning, managers’ incentives to
comply with disclosure requirements will be greater if the company recognizes its
investment properties under the fair value model and, even more, when the cumulative
impact of fair value is very significant. We propose the following two hypotheses:
H4a: The extent of compliance with IAS 40 disclosure requirements is higher for
companies that choose fair value model than for those choosing the cost
model.
To test H4a we have used the variable CHOICE as a dummy variable (1 = Fair Value
Model, 2 = Cost Model).
H4b: The extent of compliance with IAS 40 disclosure requirements is higher as
greater it is the cumulative impact of fair value accounting.
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The independent variable employed is the ratio: Cumulative impact of Fair Value to
Total assets (FV_CI_TOTALASSETS).
3.2. CULTURAL DETERMINANTS OF COMPLIANCE: A REACTIVE RESPONSE
Country of origin
We argue that the level of disclosure is associated to the country of origin. As shown by
Jaggi and Low (2000) over a sample of 401 companies from six countries, common law
countries as UK are associated to higher level of disclosure rather than code law
countries such as Spain. Also, as discussed previously in section 2, domestic
accounting standards in Spain and UK prior to the IAS implementation varied and, in
particular, disclosure requirements were more stringent and similar to IAS 40’s in UK
than in Spain. Following these reasoning, we test the following hypothesis:
H5: The extent of compliance with IAS 40 disclosure requirements is higher for
UK companies than for Spanish companies.
The variable COUNTRY is coded as a dichotomous variable (1 = Spanish firms, 2 = UK
firms).
Industry
Several previous empirical researches on mandatory disclosure suggest that
companies in the same industry tend to disclose similar information to users (Cooke
1992; Wallace et al 1994; Giner 1997). However, results were not always satisfactory
and while Cooke (1992) and Giner (1997) showed a relationship between the type of
industry and the level of disclosure, Wallace et al (1994) found no association between
these variables.
Investment properties of companies in real estate industry represent a substantial part
of business activities and these amounts are subject to the scrutiny of analysts and
investors. We argue that the greater the importance of investment properties over total
assets, which usually occur in real estate companies, greater will be the managers’
incentives to fully comply with the disclosure requirements providing to the financial
information with relevance and/or reliability depending on the accounting choice
afforded. Furthermore, real estate companies have greater experience in dealing with
fair value estimations and, as argued by Landsman (2007), valuations performed by
independent appraisers represent an institutional factor for these types of companies.
Under the framework of the signalling theory, companies will wish to comply and will
follow the best practices in their industry (Wallace et al 2002). So it is reasonable to
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think that the level of compliance with IAS 40 disclosure requirements will be higher for
companies in real estate industry than in other industries. We test the following
hypothesis:
H6: The extent of compliance with IAS 40 disclosure requirements is higher for
companies in real estate industry than in other industries.
Regarding to industry, variable (IND) is coded as a dummy variable with an assigned
value of 1 if the company belongs to real estate industry and 2 otherwise.
Audit firm
The quality of accounting information is linked to the quality and reputation of its
auditor. Previous researchers have examined the relationship between size of audit
firm and the level of compliance with mandatory disclosure (Wallace et al 1994; Giner
1997; Dumontier and Raffournier 1998; Glaum and Street 2003; Ali et al 2004). All the
studies, except for Ali et al (2004), categorise audit firms depending on whether an
auditor belongs to a Big Five (Big Six or Big Four depending on the country and year)
international audit firm or not. Ali et al (2004) use audit fees and audit market
concentration as a measure of the audit firm size.
Giner (1997) in Spain, Glaum and Street (2003) in Germany and Dumontier and
Raffournier (1998) in Switzerland found a positive association between the size of the
audit firm and the level of disclosure. In contrast, Wallace et al (1994) and Ali et al
(2004) found no significant relationship between these two variables. We propose the
following hypothesis:
H7: The level of compliance with IAS 40 disclosure requirements is higher for
companies audited by Big Four auditing firms than for other firms.
The variable AUD is coded as a dichotomous variable (1 = Big Four, 2 = Others).
4. RESEARCH DESIGN
4.1. SAMPLE
The sample for our research concerning the disclosure of required information for
investment property was selected among non-financial and non-insurance5 listed
companies on the Spanish continuous market and the London Stock Exchange in 2005
and 2008 (896 and 709 respectively in total). Companies in the sample were drawn in a
5 We did not include financial either assurance firms because of their singular characteristics
which make the financial information non comparable with non-financial and non-insurance firms.
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two-step procedure. First, a sample was drawn from listed companies holding
investment properties at the year-end started in 2005 (106 in total). In a second step,
using the sample already selected for 2005, sample was drawn from companies
beginning the accounting period on 2008. This procedure reduced the size of our
sample as some of the companies de-listed from de Madrid Stock Exchange or London
Stock Exchange in 2008. In the case of merger after 2005, we included in our sample
the acquiring company in 2005 and the merged company in 2008. The final matched
sample is composed of 87 Spanish and UK listed companies (174 observations) as of
31 December 2005 and 2008 (see Appendix A).
With regards to corporate reporting dates, the whole sample from Spain had 31
December reporting year-ends, whereas the majority of the companies from UK
reported their consolidated accounts at March, June, September and December year-
ends. All the information was collected manually.
4.2. DISCLOSURE INDEX
We started our analysis by reading IAS 40 and IAS 17 Leases6 disclosure requirements
for investment properties7. However, as stated by IAS 40 and as we have commented
before, a number of items are required regardless of the chosen accounting model (12
items), being the rest applicable on the basis of the accounting model chosen (12 items
in case of fair value model and 15 items if the entity has applied the cost model).
Furthermore, IAS 17 requires a total of 12 additional items to be disclosed. The
purposes of disclosure requirements under IAS 40 for all investment properties could
be classified into two categories: (1) mitigate concerns about the reliability of fair value
estimates and (2) provide users with information about the entity business model. The
major criticism of the use of fair value as a measurement attribute for investment
properties comes from the difficulty for obtaining reliable estimations and, in order to
enhance the reliability of the fair values reported, disclosure regarding whether the
valuation has been determine on the basis of a valuation by an independent appraiser
or not, the methods used and main assumptions applied in determining the fair value
are required to be disclosed within disclosure requirements for all investment properties
regardless of the accounting model used. Dietrich et al (2001) and Muller and Riedl
(2002) concluded that fair value estimations determined on the basis of an independent
appraiser, increase the reliability of the fair values reported. However, Barth and Clinch
6 In accordance with IAS 17, entities which hold investment properties under financial or
operating lease should provide lessee’s disclosure for financial leases and lessor’s disclosure for operating leases.
7 We also analysed the disclosure requirements on the basis of the International GAAP Disclosure Checklist (Ernst & Young 2009) published by the BIG4 international audit firm.
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(1998) found little evidence to support a significant difference between assessments
made by external or internal appraisers8. Due to the importance of the information
required to all investment properties, in our study we focus on these items rather than
on the disclosure requirements applicable for investment properties carried out
according to one of the two alternative treatments allowed by IAS 40 and which are
similar to those of other fixed assets already investigated in some manner by previous
researchers.
In the present study, we have developed a checklist comprising the 12 items9 in total to
be disclosed for all investment properties. Instead of selecting a list of items, we
considered all the items applicable in order to reduce subjectivity. The disclosure index
developed is an unweighted index and then it scores each item equally. Since not all of
the 12 items are applicable to all companies because a part of them depends on the
business model of the firms10, in a first step we assigned a value of one if the item was
applicable and zero if it did not apply to the specific company and so the firms were no
penalised for non-disclosure. As Beretta and Bozzolan (2008) relate there is no
conclusive evidence to support whether an unweighted or a weighted index better
represents the quality of disclosure. However many researchers are in favour of
unweighted indexes because they reduce additional subjectivity (Chavent et al 2006).
In a second step, we also used a dichotomous procedure to develop our disclosure
index in which an item scored a value of one if it was disclosed and zero otherwise
(Cooke 1989a, 1989b). The determination of the index was obtained as follows:
8 Landsman (2007) justified the different results obtained arguing that the investigation of
Muller and Riedl (2002) is “more powerful”, though Landsman (2007: 24) notes that “ this conclusion must be made with caution because the Muller and Riedl (2002) sample of firms is limited to a specialised industry, investment property firms, where external appraisals are an institutional feature”
9 The number of items is limited due to the scope of our study. Previous research was also carried out on a small number of items (Prencipe 2004; Chavent et al 2006).
10 Investment properties, as defined by IAS 40, are land and/or buildings held for rentals or for capital appreciation. Three of the items considered in the development of our index regard to information about rental income and direct cost of this activity. In the case of a firm holding its investment properties for capital appreciations these items would no be applicable.
nj
1nj
i =1
CIndexj = Σ di
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where Ij is the unweighted disclosure index for the company j, nj is the total number of
items expected to be disclosed by company j and di is the number of information items
disclosed by the company j (Beretta y Bozzolan 2008).
5. RESULTS
5.1. DESCRIPTIVE STATITISCS
Table 1 contains descriptive statistics for the independent variables (except for
industry11). The findings show that Spanish companies which hold investment
properties are larger in size (measured by total assets amount) than UK firms, with an
average of Spanish 7.23 and 12.46 million euros and UK firm’s average size of 3.76
and 3.37 million euros in 2005 and 2008 respectively. Profitability figures show that, in
2005, UK companies are on average 1.78 times more profitable than Spanish firms.
However, descriptive statistics for this variable in 2008 show that, on average, UK firms
are almost seven times less profitable than Spanish firms. This fact is not surprising
considering the downturn in the housing market from 2005 to 2008 and taking into
account that the accounting treatment for investment properties (see descriptive
statistics for CHOICE variable) for the 70.4% of UK companies in both years was the
fair value model (in contrast, 12.1% in 2005 and 24.2% in 2008 of the Spanish firms
used the fair value model).
Regarding to leverage, descriptive statistics in table 1 show that the rate of financial
leverage is greater on average for Spanish companies than for UK companies and,
considering the whole sample, the ratio increases significantly from 2005 to 2008. This
is consistent with the majority of UK firm’s fair value accounting for investment
properties. During the property bubble, as in 2005, the valuation at fair value of
investment properties increased the net income and equity reported by firms, thus
reducing their leverage. However, the decline of real estate market and housing prices
experienced in 2008, results on higher leverage in the companies that account their
investment property under the fair value model. In respect to the auditor, 75 and 77
companies in total are audited by BIG 4 firms and 12 and 10 are audited by other firms.
According to the accounting choice, table 1 shows that almost half of the companies
chose the firm value model and the other half the cost model. However, if we analyse
cross-country descriptive statistics for this variable, the findings show that the majority
of the firms that account their investment property under the fair value model are
11 Our total sample is composed of 37 real estate firms (9 and 28 Spanish and UK,
respectively) and 50 companies which belong to other industries.
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domiciled in UK. In Spain, the firm’s accounting choice has been mainly for the cost
model.
Table 1: Descriptive statistics for independent variables
Variable Mean St. Dev. Mean St. Dev. Mean St. Dev.TOTAL_ASSETS (000) 7,231.33 12,987.20 3,756.79 7,030.56 5,086.10 9,805.46ROA 4.53 5.92 8.05 6.45 6.71 6.45LEV 1.80 3.27 0.33 5.66 0.89 4.93FV_CI_TOTALASSETS 5.27 9.33 13.03 14.32 10.23 13.23IP_TOTALASSETS 12.22 22.85 42.40 39.79 31.17 37.32
Dichotomous (Dummy) variable n =1 n = 2 n =1 n = 2 n =1 n = 2AUD 30 3 45 9 75 12CHOICE 4 29 38 16 42 45
Variable Mean St. Dev. Mean St. Dev. Mean St. Dev.TOTAL_ASSETS (000) 12,456.64 20,886.41 3,369.70 7,684.37 6,815.33 14,777.25ROA -2,34 12.79 -14.12 26.09 -9.65 22.66LEV 5.37 11.89 2.89 11.51 3.83 11.65FV_CI_TOTALASSETS 3.17 7.19 5.93 13.81 4.58 11.05IP_TOTALASSETS 8.72 16.84 40.76 38.60 28.61 35.62
Dichotomous (Dummy) variable n =1 n = 2 n =1 n = 2 n =1 n = 2AUD 31 2 46 8 77 10CHOICE 8 25 38 16 46 41
Spain (n = 33)
UK (n = 54)
Total (n = 87)
Panel A: Descriptive statistics of explanatory variables in 2005 (by country and total sample)
Panel B: Descriptive statistics of explanatory variables in 2008 (by country and total sample)
Spain (n = 33)
UK (n = 54)
Total (n = 87)
5.2. EMPIRICAL RESULTS
5.2.1. Descriptive results
One of the objectives of our study is to analyse if there has been an improvement in the
level of compliance with disclosure requirements for investment properties between the
two periods considered (2005 and 2008).
In Table 2 we report overall average, minimum and maximum values as well as
standard deviation of the compliance index (Cindex, dependent variable). We also
show the same statistics for Spanish and UK firms considered solely as well as for real
estate companies or firms belonging to other industries.
The average compliance level is 61.9% and 69.8% for the whole sample in 2005 and
2008 respectively. This finding shows an improvement in the level of compliance from
2005 to 2008, the difference is significant at p< 0.000 (t = -4.303 and df = 86). Four
17
companies provided all the required disclosures in 2005 (Cindex = 1) and ten in 2008
which also shows an increase in the number of companies that fully comply with
requirements. In both years, the degree of compliance of 34 companies was under the
overall average.
Table 2: Descriptive statistics for the dependent variable
Table 2 also shows that Spanish firms display a lower level of compliance than UK
companies (0.509 and 0.581 versus 0.686 and 0.769 in 2005 and 2008 respectively).
However, the level of compliance in both countries increases from 2005 and 2008 and
the differences are significant at p < 0.000 (t = -3.915 and df = 53) in the case of UK
and at p < 0.050 (t = -2.116 and df = 32) in Spain. These results are consistent with
cultural influences, such as the domestic accounting standards prior to the adoption of
IFRS, in firm’s reporting decisions. Moreover, the majority of UK firms have chosen the
fair value model in accounting for investment properties and a greater fulfilment of
disclosure requirements (and particularly the items included in the disclosure index
developed for this study) introduces reliability to fair value estimates. In the same
manner, results on the average level of compliance of real estate firms (78% in 2005
and 86% en 2008) which is significantly higher than firms belonging to other industries
(50% and 58% in 2005 and 2008, respectively) could also be attributable to cultural
factors and to the fair value model as the preferred presentation for investment
properties within the European real estate industry.
5.2.2. Determinants of compliance with IAS 40 disclosure requirements
Firstly, we run a multivariate linear regression model [1] in order to test the relationship
between the disclosure level and the different metric variables according to our
Variable n Mean St. Dev. Minimum MaximumCindex all firms 87 0.619 0.224 0.167 1.000Cindex - Spanish firms 33 0.509 0.238 0.167 1.000Cindex - UK firms 54 0.686 0.187 0.167 1.000Cindex - Real Estate firms 37 0.780 0.160 0.222 1.000Cindex - Non Real Estate firms 50 0.500 0.187 0.167 0.889
Variable n Mean St. Dev. Minimum MaximumCindex all firms 87 0.698 0,221 0.167 1.000Cindex - Spanish firms 33 0.581 0.250 0.167 1.000Cindex - UK firms 54 0.769 0.168 0.333 1.000Cindex - Real Estate firms 37 0.860 0.115 0.625 1.000Cindex - Non Real Estate firms 50 0.578 0.205 0.167 1.000
Panel A: Descriptive statistics of the dependent variable in 2005 (by country and industry)
Panel B: Descriptive statistics of the dependent variable in 2008 (by country and industry)
18
hypotheses concerning the economic determinants of compliance (H1, H2, H3 and
H4b). Secondly, we use the Exhaustive Chi Squared Automatic Interaction Detector
(Exhaustive CHAID) in order in order to analyse which independent variables better
predict or are associated with the level of compliance.
5.2.2.1. Linear regression
For the multivariate regression model, the equation is formulated as follows:
CIndexit = β1TOTAL_ASSETSit + β2ROAit + β3LEVit + β5FV_CI_TOTALASSETSit
[1]
We test multicollinearity among the independent variables via VIF (variance inflation
factor). Results do not show collinearity between the variables included in our model
(the highest VIF calculated was 1.604 for ROA in 2005 and 1.525 for LEV in 2008) and
all of them were included in the final model.
Table 3 presents the results from our model trying to determine which factors are
associated with the level of compliance with IAS 40 disclosure requirements in Spain
and UK in 2005 and 2008.
Table 3: Multivariate regression results
Variable Predicted sign Coeff. T-value Coeff. T-valueTOTAL_ASSETS + 0.211 3.219 *** 0.377 3.843 ***ROA + 0.418 5.370 *** -0.216 1.866 *LEV + -0.005 0.071 0.305 2.599 **FV_CI_TOTALASSETS + 0.435 5.823 *** 0.477 4.909 ***
Adjusted R2
Model's F-valueModel's significance level
0.68746.567
0.50214.8530.0000.000
2005 2008
The adjusted R2 is satisfactory, approximately 69% in 2005 and 50% in 2008. The F-
values of 46.567 and 14.853 in 2005 an 2008 respectively are significant at p < 0.000,
meaning that the entire model is well specified.
The results confirm the validity of the hypothesis related to size in 2005 and 2008 (both
significant at the 0.01 level) and they are consistent with those obtained by Wallace et
al (1994) and Giner (1997) in Spain, Cooke (1989a and 1992) in Switzerland and Ali et
al (2004) in India, Pakistan and Bangladesh.
Profitability proved to be positively related to disclosure compliance in 2005, with a
coefficient that is significant at the 0.01 level. The majority of previous researchers
could not confirm the hypothesis related to profitability except for Giner (1997) who
found a negative relationship between the level of disclosure and profitability in Spain.
19
Accordingly, we also obtained a negative association in 2008 (although significance is
low, at the 0.10 level). The different sign of the coefficient obtained in 2005 and 2008
could be explained by the economic situation. In 2005 real estate markets, particularly
in Spain and the UK, experienced an extraordinary growth with a constant increase of
housing prices. However, in 2008 the housing bubble generated from 2005 exploded
and this fact together with the international financial crisis led to a sharp slowdown in
the construction activities, the number of real estate transactions and, consequently, a
strong decrease of housing prices. According to the results, firms with higher
profitability in 2005 use disclosure compliance as a way of signalling the market.
However, results in 2008 show that the extent of compliance is higher for firms with
lower profitability probably to explain better to users the bad news12 (Giner 1997).
Leverage was found not to be significantly related to disclosure compliance in 2005. In
contrast, the results in 2008 confirm that the level of compliance is higher for firms with
higher leverage ratios (significant at the 0.05 level). The results are not surprising as in
2008 most of the real estate firms were in the process of negotiating refinancing of their
debt facilities due to the situation of the real estate market, practically inactive.
Also the cumulative impact of fair value was found to be significantly related to the level
of disclosure compliance, with a coefficient which is significant at the 0.01 level. The
relationship is positive as expected, confirming that Spanish and UK firms use
disclosure to provide users sufficient information to assess the reliability of property
estimates.
5.2.2.2. Exhaustive CHAID Analysis
We use the Exhaustive CHAID (a tree-based model) in order to analyse which
independent variables better predict or are associated with the level of compliance.
Firstly, we discretized the dependent continuous variable (Cindexit) into a categorical
variable (Cindexit_CAT) by the grouping low, medium and high level of compliance with
disclosure items. We have selected all the dependent variables (metric and categorical)
as hypothesized in section 4 in order to determine which of them more strongly predicts
the degree of compliance.
In a first step, CHAID analysis makes a first segmentation which is the selection of the
variable (predictor) that best predicts the level of compliance with disclosure items for
12 During the reading of the 2008 annual reports, we have observed that a significant number
of firms (the majority in the real estate industry) disclose in 2008 information about the historical cost amounts of their investment properties even though the accounting choice has been for the fair value model and IAS 40 does not require disclosure on historical cost amounts under such model.
20
investment properties (dependent variable). The selection of the best predictor is based
on the results of the Chi-Squared Test. In a second step, for each segment formed in
the previous step, the exogenous variable with the most powerful prediction ability for
the behaviour of the dependent variable is selected. Subsequently, successive
classifications occur in the same manner as the previous step for each subgroup
formed by the immediately preceding segmentation procedure.
As illustrated in Figure 1, CHAID found that the best explanatory variable of compliance
disclosure in 2005 was industry (significant at the 0.01 level). Figure 1 shows that, in
2005, real estate firms present a higher level of compliance (75,7% with a high degree
of compliance) with disclosure requirements for investment properties than firms
belonging to other industries (12% with a high level versus 50% with a low level of
compliance).
Figure 1: Exhaustive CHAID results in 2005
21
As hypothesized, firms within the same industry tend to disclose similar information to
users and as the fair value model is the preferred presentation for investment
properties for the firms in the European real estate industry (Muller et al 2008) the level
of compliance results higher for real estate firms than for other industries.
At a second level of partitioning, Exhaustive CHAID did not find a statistically significant
predictor for real estate firms. However, it was found that the firm’s country of origin
was the most explanatory variable (at the level of 1%) of firms in other industries (non-
real estate firms). Figure 1 also shows that, as hypothesized, Spanish non-real estate
firms show a lower degree of compliance with investment property disclosure
requirements than UK companies. These results confirm the ones obtained by Jaggi
and Low (2000) and also reveal the influence of the previous domestic accounting
standards on disclosure compliance as we argued in section 4. At the third level of
splitting no statistically significant predictor was found.
In relation to the accuracy of the model in 2005, we obtained that CHAID would
correctly classify a 72.4% of the firms according to their disclosure index (dependent
variable).
We also used CHAID to analyse our sample in 2008, those results are illustrated in
Figure 2. In 2008, CHAID founds, consistently with the results in 2005, that industry is
the independent variable that more strongly predicts the level of disclosure companies
(at a level of 1%).
22
Figure 2: Exhaustive CHAID results in 2008
23
In addition, comparing information in node1 and node2 between 2005 and 2008, an
improvement in the level of compliance disclosure is observed in real estate firms as
well as in other industries.
At a second level and regarding to non-real estate firms, results are also similar to
those obtained in the model for 2005 and show a significant association (at a level of
1%) between non-real estate companies and the country of origin. A comparative
analysis between 2005 and 2008 reveals that although UK companies continued
presenting a higher level of compliance than Spanish firms, confirming our hypothesis,
there has been an improvement of disclosure compliance in non-real estate companies
in both countries.
Regarding to real estate firms, results at a second level show a significant association
(at a level of 5%) with the cumulative impact of fair value accounting. As disclosure
practices within the same industry tend to be similar, an economic variable results to be
the best predictor for the level of compliance. These results are very interesting
because they show that once cultural factors influence is controlled, firms use
mandatory disclosure to signal the market. The latter confirms that disclosure
regulation represents a benchmark on the level of disclosure but not the minimum
amount of information to be disclosed. This variable was also found to be significantly
associated to the level of compliance in our results from the multivariate regression run.
CHAID confirms those results for real estate companies.
The global accuracy of the model is acceptable and CHAID classify correctly a 65.5%
of the firms.
6. CONCLUSION
In this study we found that Spanish companies display a lower level of compliance with
mandatory disclosure of investment properties than UK firms although there has been
an improvement in the degree of compliance in both countries from 2005 to 2008.
Mandatory disclosures are informative to investors for decision making but the amount
of required information is very extensive and has been increasing over the years
(Schipper 2007). Firms show some flexibility in the level of compliance with disclosure
requirements (Chavent et al 2006) and a highest level of disclosure is firstly associated
with cultural pressures to reveal (proactive attitude) and later with communicative
purposes (reactive response). These results suggest that disclosure regulation acts as
a benchmark more than as a minimum level of information, and companies react to the
information’s overload with a relaxation on fulfilment.
24
We found in IAS 40 an ideal setting to analyse the determinants of the extent of
compliance with disclosure requirements. This study is carried out with reference to
Spain and UK and we issued a comparative analysis between 2005 and 2008 in order
to investigate two of the European countries where the boom of housing prices in 2005
and their sharp decline in 2008 have had a greater impact on investment property
amounts.
This study has a different approach for determining whether the level of compliance is
associated with some firm-specific characteristics and/or depends on cultural reasons.
We hypothesized that different levels of compliance may be influenced by a
conjunction of firm-specific economic characteristics as well as by cultural variables.
According to the signalling theory, we argue that firms will show a proactive attitude to
their own specific characteristics and a reactive response to the cultural environment.
As we control for many variables that may affect the extent of compliance to a
particular standard, our study will help to a better understanding of the purposes of
complying with mandatory disclosures from an internal firm’s perspective than previous
research which addressed a global extent of compliance level.
Size, profitability and the impact of fair value accounting over total assets proved to be
significant determinants of the extent of compliance with mandatory disclosure for
investment properties in 2005 and 2008. Leverage was not found to be significant in
2005 but we found a significant and positive relationship with the level of compliance in
2008, probably because firms used disclosure as a signalling in a period during which
most of real estate companies were in a process of refinancing their debt facilities.
These results confirm that companies tend to signal the market as a proactive attitude
towards their performance and economic characteristics. Further, this study shows that
firms in the same industry may adopt similar disclosure practices and, particularly, that
firms will have a reactive response trying to follow the best practices in their industry. In
addition, previous local accounting standards were also found to be a good predictor
for the level of compliance. Results also show that once cultural factors are controlled,
economic reasons appeared to be the best predictors for the extent of compliance with
mandatory disclosure.
The results from this study highlight the importance of controlling for several variables
and, as we focus on a particular standard, the importance of isolating economic from
cultural factors. However, we acknowledge some limitations of our study such us the
use of an unweigthed index and the subjective discrimination between applicable and
non-applicable items. Moreover, we also could not control for the learning effects of
new accounting standards in order to justify if the improvement in the level of
25
disclosure proved to be significant between 2005 and 2008, responds to such learning
effect or is a reactive response to the different economic situations.
APPENDIX
Appendix A: List of Companies included in the sample.
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26
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