Earnings management, firm location, and financial reporting choice: An analysis of fair value reporting for investment properties in an emerging market

In this study, we examine firms' decision to adopt fair value accounting for investment properties, and how firm and property locations can affect this financial reporting choice. Unlike financial assets reported at fair value, investment properties are unique and cannot be traded on an exchange. Hence, fair value estimation on investment properties is less verifiable and can be subject to more managerial discretion. As investment properties are location-specific, firms also have more opportunities to misstate fair values where the real estate markets are illiquid and investors' monitoring is low. Utilizing the emerging market setting of China, we find evidence that the fair value option for investment properties is more likely to be chosen by firms that had significant prior earnings management activities. We also find that earnings management firms are more likely to adopt the fair value model when the firms' headquarters and investment properties are located in less developed regions. Confirming that firm chooses the fair value model to manage earnings, we show that firms choosing the fair value model use unrealized gains and losses associated with investment properties to smooth earnings or to beat earnings benchmarks. Overall, our findings indicate fair value reporting decision for investment properties in the emerging Chinese market is primarily driven by managerial opportunism.