Relative and incremental value relevance of fair value and historical cost measurements: evidence from European financial institutions

The ongoing debate, which has intensified during the recent financial crisis, regarding merits of fair value (FV) and historical cost (HC) accounting arises from concerns about what is the most appropriate measurement for assets and liabilities. This thesis investigates the relative and incremental value relevance of financial assets and liabilities measured at FV and HC for a sample of financial institutions from 25 European countries over the period 2006–2010. Relative value relevance considers whether FV alone provides greater information content than HC alone (and vice-versa), and incremental value relevance considers whether FV and HC together provide more information content than either FV or HC alone. Also examined is whether the relative and incremental value relevance of FV and HC are different during the financial crisis period (2008–2009) compared to the non-crisis period (2006, 2007, and 2010) and whether they vary across different European countries. Using market value of equity as a dependent variable and adopting the balance sheet model utilised in prior value relevance literature, I find that, for the whole sample period, FV measures are not relatively more value relevant than HC measures, and vice-versa. However, the multivariate regression results show that FV and HC together provide incremental information content over either FV or HC alone. Also, the empirical analysis shows that FV measures are relatively more value relevant to investors than HC measures in the financial crisis period but not in the non-crisis period. On the other hand, FV and HC measures together are found to be incrementally value relevant in both the crisis and non-crisis periods. Lastly, I divide the sample into country groups based on legal system and enforcement, transparency, size of the banking sector, and type of accounting model. Findings indicate that FV and HC have incremental, but not relative, information content in countries with a common law system, weak legal enforcement, high level of transparency, larger banking sector, and British-American or mixed economy accounting models