Model-based fair values for financial instruments: relevance or reliability?

Conjoint measurement-based evidence

Stephanie Jana, Martin Schmidt*

*
ESCP Europe Berlin, Department of Financial Reporting & Audit

This version: September 2017

Acknowledgements:
The authors thank Philip Gisdakis, CFA, and Alexander Plenk, CFA (UniCredit Bank,
Munich), for their support in designing the research instrument, and Michael Ende, CFA
(BHF Bank, Frankfurt/Main), Ralph Kärcher (Landesbank Baden-Württemberg,
Stuttgart), Nico Popp, CFA (Mizuho Corporate Bank, Frankfurt/Main), Rüdiger
Schmidt, CFA (Accounting Standards Committee of Germany, Berlin), and Olaf
Witthöft (Bayerische Landesbank, Munich) for their participation in pre-testing and
reviewing the research instrument. We also thank the participants of the 2017 Eufin
workshop for their helpful comments.
 Model-based fair values for financial instruments: relevance or reliability?
Conjoint measurement-based evidence

Accounting standard setters have defined the provision of decision useful information as
the primary objective of financial reporting. According to the FASB’s and IASB’s
conceptual frameworks, decision usefulness is based on two fundamental qualitative
characteristics, relevance and reliability (now replaced by ‘‘representational
faithfulness’’). This paper reports on a conjoint analysis which examines preferences for
these two qualitative characteristics, and the extent to which these characteristics
contribute to decision usefulness. 202 master students enrolled in financial and
managerial accounting courses completed a case that asked them to rank by decision
usefulness five different techniques to calculate the risk premium in the context of
determining a model-based fair value for a corporate bond. Different combinations of
relevance and reliability are inherent in the five techniques in such a way that an
increase in one characteristic is associated with a decrease in the other characteristic.
The results show that relevance is preferred to reliability. Neither the individuals’
degree of uncertainty avoidance nor their familiarity with fair values impacts these
preferences. Additional experimentation with auditors confirms the preference for
relevance. These results have important implications for researchers, practitioners, and
especially for standard setters.

Keywords: fair value, financial instrument, relevance, reliability, valuation

model
Subject classification codes: M40, M41
1 Introduction

Accounting standard setters have defined the provision of decision useful information as
the primary objective of financial reporting. According to the Financial Accounting
Standard Board’s (FASB) and International Accounting Standard Board’s (IASB)
conceptual frameworks, meeting this objective hinges on two fundamental
characteristics of information, relevance and reliability.1 For decades, standard setters
have been debating measurement concepts such as fair value2 or historical costs and the
information provided by these concepts in order to identify and select the measurement
concept that provides a maximum of decision useful information.
One key difference between these measurement concepts is that different levels
and “mixing ratios” of relevance and reliability are inherent in the information provided.
Similar to the long-standing debate within standard setting, there is extensive research
on the informational properties of the measurement concepts (e.g., Maines and Wahlen
2006, Landsman 2007, Marra 2016). Especially standard setters’ increasing tendency to
shift towards fair value measurement in financial reporting raises questions as to the
decision usefulness of the information (Maines and Wahlen 2006).
On the one hand, fair values reflect present market conditions with a predictive
value and provide transparent and timely information (Barth 2007). Empirical research
provides evidence for the value relevance of fair values (see e.g. Barth, Beaver and
Landsman 2001, Hodder, Hopkins and Schipper 2013). On the other hand, there is
common concern that fair values are less reliable if no active markets exist and fair
value is determined based on a valuation technique (mark-to-model). Specifically, so-
called level 3 fair values are based on unobservable inputs. These fair values tend to be
biased by managerial discretion and are subject to greater estimation error (Landsman
2007, Kolev 2008, Ramanna and Watts 2012). Hence, level 3 fair values may suffer
from diminished reliability and consequently might be less decision useful for users of
financial statements. Prior research examined the value relevance of level 3 inputs and
found lower value relevance for level 3 fair values (Song, Thomas and Yi 2010).

1
In 2010, the FASB and IASB in their revised conceptual frameworks replaced the term
“reliability” with “representational faithfulness”. We discuss this change and its implications
in section 2. We note, however, that this change has no impact on our analysis.
2
Fair value is defined as “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date”
defined similarly under IFRS and US-GAAP (IFRS 13, par. 9, ASC 820-10-05-1B).

1
 However, studies that compare measurement bases, such as fair value and
historical costs, do not directly analyze the trade-off between relevance and reliability.
Rather, prior research analyzes the decision usefulness of the information provided in
accordance with a specific measurement concept, and inherent in that measurement
concept is a specific “mixing ratio” of relevance and reliability. Hence, the analyses are
“joint tests” of both relevance and reliability. Also, comparisons of measurement
concepts are confounded by other informational properties of the concepts, such as how
changes of the carrying amounts on the face of the balance sheet are treated in the
statement of comprehensive income. Overall, these research designs do not allow
disentangling to which extent the two fundamental characteristics contribute to decision
usefulness.
To the best of our knowledge, there is no prior study that specifically analyzes the
extent to which the two fundamental characteristics contribute to decision usefulness
and the related preferences of financial statement users for financial instruments if no
active markets exist. Our study aims to provide a better understanding of the trade-off
between relevance and reliability for fair value measurements from a user perspective.
To test user preferences for relevance and reliability in the context of decision
usefulness of mark-to-model fair values, we conducted a conjoint analysis, which is a
widespread method in marketing research. Conjoint analysis enables us to examine
users’ preferences for one of the two fundamental characteristics if these characteristics
come with a trade-off, and the extent to which the two fundamental characteristics
contribute to decision usefulness. We use a case where five different techniques are
offered to determine a risk premium in the context of determining a model-based fair
value for a corporate bond. The five techniques vary in different combinations of
relevance and reliability in a way so that an increase in one characteristic is associated
with a decrease in the other characteristic. The participants, 202 master students
enrolled in financial and managerial accounting courses, had to rank these five
techniques by decision usefulness.
We find that participants assign higher decision usefulness to techniques with a
higher level of relevance and, correspondingly, a lower level of reliability. Additional
analyses reveal that neither participants’ degree of uncertainty avoidance nor their
familiarity with fair values has a significant impact on the rankings and thus on the
preferences for relevance and reliability. However, there is weak evidence that

2
participants with low uncertainty avoidance tend to assign higher decision usefulness to
techniques with higher levels of relevance compared to participants with a higher
degree of uncertainty avoidance. The overall ranking of the techniques is not changed
by these differences and hence by the preference for relevance.
Additional experimentation with auditors confirms our results. Compared to the
main sample, the extent to which relevance contributes to decision usefulness is even
higher from the perspective of auditors. Also, the ranking of the techniques is increasing
monotonically in relevance, and has a lower standard deviation compared to our student
sample. This corroboration suggests that different levels of practical experience and
knowledge do not have a significant impact on the results. Rather, higher levels of
practical experience and knowledge even increase the preference for relevance over
reliability.
Our findings are of interest to academics, researchers, practitioners, and especially
standard setters as we demonstrate that users of financial statement prefer relevance
over reliability in the context of fair value measurements if no active market exists.
Also, prior research methods do not allow disentangling the extent to which relevance
and reliability contribute to decision usefulness. Implementing the conjoint analysis as a
quantitative method in accounting research enables new insights and future research for
examining users’ preferences in financial reporting.
The remainder of this paper is organized as follows. Section two reviews relevant
prior research concerning the conceptual framework and the fair value concept and
briefly motivates our research question. Section three outlines our research design, the
applied methodology and documents the response to our survey. Section four presents
our research results and the additional test. Section five states the limitations of our
study and concludes.

2 Background
Relevance and reliability in the conceptual frameworks
Identifying and selecting the measurement concept or concepts that provide a maximum
of decision useful information to users of financial statements is a key challenge for
preparers, standard setters and academics alike. There has been a long-standing debate
in standard setting and accounting research regarding different measurement concepts
and the implicit tension between relevance and reliability as fundamental characteristics

3
of decision useful information (e.g., Laux and Leuz 2009, Erb and Pelger 2015, Marra
2016). Various studies have investigated the fundamental relationship as a trade-off
between relevance and reliability (e.g., Stanga 1980, Schipper 2003, Dye and Sridhar
2004, Kadous, Koonce and Thayer 2012).
In 2010, the FASB and IASB replaced the term “reliability” with
“representational faithfulness” in their revised conceptual frameworks. According to the
revised conceptual frameworks, information is useful when it is relevant and faithfully
represents what it purports to represent (IASB 2010 & FASB 2010, par. QC4).
Financial information is relevant when it is capable of making a difference in the
decisions made by users especially about the prediction of future outcomes (IASB 2010
& FASB 2010, par. QC6). A measure “faithfully represents” an economic construct if
the measure is complete, neutral, and free from error (IASB 2010 & FASB 2010, par.
QC12). The boards decided to replace the term “reliability” because they observed that
“reliability” can cause misunderstanding and misapplication. Different meanings were
applied to “reliability”, as evidenced in the comment letters received on the related
discussion paper (IASB 2006).
Indeed, many constituents have taken the view that “precision” or “limited room
for discretion” is (and continues to be) an important – or even key – component of
“reliability” (IASB 2006, par. BC26). This notion of “precision” as a key component of
reliability is no longer present in “representational faithfulness”. “Verifiability”, a
notion related to “precision”, is only mentioned as an enhancing qualitative
characteristic, rather than a fundamental characteristic (IASB 2010 & FASB 2010, par.
QC26). Consequently, 73 % of the comment letters expressed disagreement with the
replacement of “reliability” by “representational faithfulness”. 23 % stated that “faithful
representation” does not equate with reliability (IASB 2007, par. 56). The European
Financial Reporting Advisory Group (EFRAG) argued that “faithful representation is a
narrower notion than reliability” and that it “is just one sub-characteristic of reliability”
(IASB 2007, par. 56). Some authors even viewed this change as a logical step towards
the direction of fair value accounting (e.g., Power 2010, Walton 2006, O’Brien 2009).
According to Erb and Pelger (2015), after the revision the IASB no longer sees a
trade-off between relevance and representational faithfulness as fundamental
characteristics. The IASB’s view is plausible, as the trade-off existed between relevance
and the “precision” notion inherent in reliability. Since the “precision” notion has been

4
dropped in the replacement of the term, the trade-off disappears. Similarly, Power
(2010) argued that the boards have collapsed reliability into relevance. Kadous, Koonce
and Thayer (2012), using an experimental research design, found that users view
relevance and faithful representation as dependent constructs with a unidirectional
relation.
Although the replacement of “reliability” by “representational faithfulness” may
have effectively eliminated the trade-off between relevance and representational
faithfulness, the old trade-off between relevance and reliability still exists (Erb and
Pelger 2015). Regardless of how the characteristic is termed and whether the conceptual
framework defines the characteristic as a fundamental or enhancing characteristic, the
level of precision (and lack of discretion) will influence the decision usefulness of
information from users’ perspective. Information may be relevant, but users may not
use this information in their decision making if it is not reliable, because users cannot
differentiate between underlying economics and management that opportunistically
exercises discretion.

Value relevance of fair values for financial instruments

Both fair value as a measurement concept in financial reporting and the measurement of
financial instruments have been extensively researched in the past, using many different
research designs.
In general, the literature suggest that fair values are value-relevant. Fair values
have incremental value-relevance if disclosed in the notes (e.g., Ahmed and Takeda
1995, McAnally 1996, Eccher, Ramesh, and Thiagarajanet 1996, Barth, Beaver and
Landsman 1996, Venkatachalam 1996), as well as recognized in the balance sheet.
These findings are consistent over different reporting standards and different types of
instruments (Bernhard, Merton, and Palepu 1995, Petroni and Whalen 1995, Barth and
Clinch 1998, Park, Park, and Ro 1999). Overall, the evidence strongly suggests fair
value as a measurement concept for financial instruments to be decision useful.
A new set of disclosure requirements related to the fair value hierarchy was
introduced by SFAS 157 (similar disclosures are required by International Financial
Reporting Standards (IFRS) 7). The rationale underlying the so-called fair value
hierarchy with three levels is that the room for management discretion and judgment
increases from level 1 to 3 (and correspondingly, the degree of reliability decreases),

5
impairing comparability (e.g., Ramanna and Watts 2012).3 Overall, these disclosures
aim to compensate a lack of “reliability” by making the associated room for
management discretion and judgment more transparent, especially for level 3 fair
values, because the inputs cannot be measured objectively (Landsman 2007).
Indeed, prior research has shown that the value relevance of fair value varies with
the reliability of the inputs (e.g., Petroni and Wahlen 1995). Similarly, Song, Thomas
and Yi (2010) and Kolev (2008) found that level 1 and level 2 fair value measurements
are more value-relevant than level 3 fair value measurements. Strong corporate
governance can mitigate the lower level of reliability of level 3 fair values by
effectively limiting management discretion and increases their value relevance (Song,
Thomas and Yi 2010). The SFAS 157 disclosures were also analyzed by Riedl and
Serafeim (2011) with an alternative research design using the association between an
entity’s systematic risk and its disclosures. They found that entities with a higher
exposure to level 3 instruments also evidence higher systematic risk. This effect is
stronger in lower information quality environments. Their findings suggest that
measurement uncertainties (lower reliability) associated with level 3 fair value
measurements are reflected in capital market participants’ decisions. Conversely,
Altamuro and Zang (2013) found that level 3 fair values are at least as relevant as level
2 fair values. However, Hendricks and Shakespeare (2013) raised questions about their
research design. Similarly, Lawrence, Siriviriyakul and Sloan (2016) found that level 3
fair values are similarly value-relevant to level 1 and level 2 fair values and found no
evidence that the predictive ability significantly varies across the three levels of the fair
value hierarchy.
In their study on behalf of the Accounting Standards Committee of Germany
(ASCG), Gassen and Schwedler (2010) examined the preferences of professional
investors and their advisors for different measurement concepts. Their 242 survey
respondents prefer fair values to historical cost measure if, and only if, fair value is
determined by observation in an active market. A likely explanation is that fair values
provide more relevant information compared to historical cost. If reliability is
comparable across the two measurement concepts, as is likely the case if fair value is

3
Level 1 fair values are based on market prices observed in active markets (mark-to-market).
Level 2 fair values are determined by the way of valuation technique (mark-to-model), but
the inputs used are only observable market data. Level 3 fair values are based on
unobservable assumptions.

6
marked-to-market, then users deem fair values as more decision useful. Presumably, if
no active markets exist, the diminished reliability has a pervasive detrimental effect on
the decision usefulness. Gassen and Schwedler (2010) also find that, for financial assets,
fair value is always preferred to historical cost, even if the asset is marked-to-model and
the fair value is based on unobservable inputs (a level 3 fair value). A possible
explanation is that, for financial instruments, historical cost information is not relevant
at all, and thus, a diminished reliability of level 3 fair values is not a pervasive concern
for users.
Overall, the literature suggests that fair value is a measurement concept that
provides more decision useful information compared to historical cost measures.
Nevertheless, the decision usefulness of information disclosed in accordance with
different measurement concepts continues to be a controversial issue for standard
setters, preparers and users of financial statements alike.
More importantly, prior empirical studies that compare measurement concepts
provide only limited evidence on the relation between relevance and reliability and the
extent to which relevance and reliability contribute to decision usefulness. A preference
for one specific measurement concept does not necessarily mean that a specific
characteristic, such as relevance, is generally preferred to the other characteristic, in this
case reliability. It might be possible that, within a specific scenario, fair values might be
(slightly) less reliable, but (much more) relevant compared to historical costs. If the
decrease in reliability was more pronounced, and/or the increase in relevance was
smaller when switching from historical costs to fair value, users might deem historical
costs as more decision useful. Similarly, arguments against fair values such as less
reliable information cannot automatically be translated into arguments in favour of
historical cost measures (Power 2010). Barth, Beaver, and Landsman (2001, p. 81)
argue:
“Value relevance tests generally are joint tests of relevance and reliability.
Although finding value relevance indicates the accounting amount is
relevant and reliable, at least to some degree, it is difficult to attribute the
cause of lack of value relevance to one or the other attribute. Neither
relevance nor reliability is a dichotomous attribute, and SFAC No. 5 does
not specify “how much” relevance or reliability is sufficient to meet the

7
 FASB’s criteria. In addition, it is difficult to test separately relevance and
reliability of an accounting amount”.
Another limitation of studies that compare different measurement concepts is that
the preferences for relevance and reliability implicit in the concepts are confounded by
other informational properties: A measure that approximates the present value of future
economic benefits, such as fair value, on the face of the balance sheet might provide
decision useful information, but including changes in fair value in income or
comprehensive income might not enhance the decision usefulness of the information
provided on the firm’s performance. However, both informational properties (fair value
in the balance sheet, and changes in fair value in income) are inextricably related,
making it difficult to draw conclusions on users’ preferences for relevance and
reliability. Also, it is easier for users to assess different levels of reliability in fair value
measurements than to assess different levels of relevance (Kadous, Koonce and Thayer
2012).
Our paper aims to address this gap in the literature. Specifically, we analyze
users’ preference for relevance over reliability (or vice versa), and the extent to which
the two fundamental characteristics contribute to decision usefulness. Decision useful
information is a matter of the “mixing ratio” of relevance and reliability, rather than an
either-or decision (FASB 1980).

3 Research design
Conjoint Analysis
Our aim is to analyze user preferences for relevance and reliability, and how each of
these characteristics contributes to decision usefulness. However, users are unlikely to
be able to assess and express a preference for one of the two characteristics if these
characteristics are negatively associated with one another (i.e. a trade-off, where an
increase in one characteristic is associated with a decrease in the other characteristic).
These scenarios are typical in marketing research when a product or service is to
be designed in such a way that its customer-perceived value can be measured and
optimized in a scenario where one characteristic can only be increased at the expense of
another. Conjoint analysis is a widely used quantitative method in marketing research to
understand consumer preferences for the product characteristics and the associated
value trade-off. Rather than having to express a preference for each characteristic,

8
participants choose from or rank a set of product alternatives (so-called “stimuli”). The
rankings then provide information about the value of (preference for) each of the
characteristics.
We use a case where five different techniques are offered to determine a risk
premium in the context of determining a model-based fair value as stimuli. The five
techniques (stimuli) vary in terms of differing combinations of relevance and reliability.
In our case, the two characteristics are perfectly negatively correlated. An increase in
relevance comes with a decrease in reliability and vice versa. Thus, if the stimuli are
ranked according to relevance so that relevance is monotonically increasing
(decreasing), then reliability is monotonically decreasing (increasing). Figure 1
illustrates the differing combinations of relevance and reliability that are inherent in the
five techniques (stimuli).
[insert Figure 1 here]
We use the rank-ordered logit model4 (Beggs, Cardell, and Hausman 1981) to analyze
the value that participants assign to the two characteristics relevance and reliability.
A crucial condition for this type of analysis is that the characteristics are at least
ordinally scaled and the stimuli can be unanimously rank-ordered according to every
characteristic. In our case, there must be agreement that one specific technique yields
more relevant, but less reliable outcomes, so that the order indeed is monotonically
increasing (decreasing) if the stimuli are ranked by relevance (reliability).
When developing the five techniques, we were supported by two financial
analysts working as analysts for fixed income (debt) securities at a German bank. Then,
the resulting five techniques were reviewed and pre-tested by five different financial
analysts working at other banks and organizations. There was unanimous agreement
among the analysts about the monotonically increasing (decreasing) properties of the
five techniques in terms of relevance and reliability, and hence, their order.

Case Materials
The case materials started with a letter that described the study followed by a consent
form. Part I elicited demographic information (such as age, gender, country of birth,
education and accounting work experience questions, instrument items 1.1–1.6), and

4
This type of analysis is also referred to as the exploded logit model (Punj and Staelin 1978) and the
choice-based conjoint analysis model (Hair et al. 2010) in the literature.

9
asked for how many years the participant had been familiar with the concept of fair
value (instrument item 1.7) and had practical experience with fair value measurements
(instrument item 1.8). Specifically, to measure a fair value familiarity score the
participants received four specific questions (DCF concept, risk premium, overall
familiarity, self-assessed perceived competence in applying fair value measurements,
instrument items 1.9–1.12). Part II of the research instrument asked the three question
items that were used in the GLOBE study (House et al. 2004) for the cultural dimension
uncertainty avoidance (values)5 in random order (instrument items 1.13–1.15). Part III
of the research instrument included the main case about determining fair value for a
corporate ‘plain vanilla’ coupon bond. The instrument informed participants that “the
contractual cash flows (settlement, interest) are fixed and need to be determined.
However, there is default risk (credit risk, risk of non-payment). To compensate for the
default risk, the cash flows are discounted by a discount rate which includes a risk
premium.” Next, the instrument provided participants with the definition of decision
usefulness taken from the IFRS Framework.
The instrument further explained that, on the next page, there would be “five
alternative techniques to determine a risk premium”, and that the task would be to rank
these five techniques according to the decision usefulness by numbering the techniques
with 1 (“most decision useful”) to 5 (“least decision useful”). Without introducing the
terms “relevance”, “reliability”, or “representational faithfulness”, the instrument
clarified that “there is no correct or incorrect order of precedence for the five
techniques. All techniques have different properties that come with advantages and
disadvantages. For example, one technique might yield a risk premium that better
reflects the specifics of the issuer and the instrument, but may also require more
judgement, whereas another technique requires less judgement, but reflects only
specifics of the issuer, and only to a lesser extent.”6 We rotated the five stimuli
randomly to create five different versions of the research instrument to avoid an order
effect. The participants were randomly assigned to one of the five versions.

Participants & procedure

For our main experiment, the research instrument was administered personally by one

5
Items 3-1, 3-16, 3-19 from the Phase 2 Beta Questionnaire (House et al. 2004).
6
The research instrument used British English.

10
of the researchers to master students enrolled in financial and managerial accounting
courses at different campuses of a business school. After having obtained informed
consent, the participants were (again) informed that when determining the ranking for
the model-based fair value there would be no “correct” or “incorrect” answers in order
to minimize potential response bias that could arise if participants assume that particular
stimuli are more or less in accordance with IFRS. 208 students participated in the main
experiment. Four participants were deleted because they failed to rank all stimuli. Two
participants were deleted because they did not assign every rank (from 1 to 5) just once
to one of the stimuli (e.g., two stimuli were ranked “3”, but none of the stimuli was
ranked “4”). This results in a final sample of 202. Table 1 presents the demographic
data on the final sample of participants.
[insert Table 1 here]
On average our participants have been familiar with fair values for 2 years, and have 1
year of practical experience. The average age is 23 years. The sample is fairly balanced
between the two genders.7

Independent and dependent variables

We use decision usefulness as the dependent variable in all our analyses. We reverse the
scale used for the ranks assigned by the participants (from “1” denoting “most decision
useful” to “5” denoting “least decision useful”), so that higher levels indicate higher
decision usefulness. Hence, an original rank of “1” gets assigned a decision usefulness
of “5”, rank “2” is assigned a level of decision usefulness of “4”, etc.). As the
independent variable, we can only use one of the two characteristics (in this case
relevance), because reliability and relevance are perfectly negatively correlated. This
rank-ordered logit analysis serves as our baseline analysis. However, this baseline
analysis assumes that all respondents have the same preferences (e.g., assign the same
value to) relevance and reliability. Therefore, in the baseline analysis, all beta
coefficients are constant between the respondents.
In our additional analyses, we relax this assumption and test whether other factors
influence the ranking of the stimuli (and thus, implicitly, the values assigned to
relevance and reliability) across participants. We test two moderating factors,

7
None of these four variables (age, gender, familiarity with fair value in years, experience
with fair value in years) has significant impact on the rankings assigned by the participants.

11
uncertainty avoidance and familiarity with fair values. For uncertainty avoidance, we
compute a score by adding the responses to the three GLOBE question items
(instrument items 1.13–1.15). To compute a fair value familiarity score, we add the
responses to instrument items 1.9–1.12. Table 2 provides an overview of all variables.
[insert Table 2 here]

4 Empirical results
Baseline analysis
Table 3, Panel A presents descriptive statistics for our baseline analysis. Panel B
presents the results from the rank-ordered logit analysis. Figure 2 illustrates the
descriptive statistics.
[insert Table 3 here]
[insert Figure 2 here]
As is apparent from Table 3, Panel A and Figure 2, participants generally favor
relevance over reliability. Participants assign a higher level of decision usefulness to the
techniques with a higher level of relevance (lower level of reliability). The highest mean
(3.48) of decision usefulness is assigned to the technique with a high level of relevance
(low reliability). The two techniques that follow have maximum and medium levels of
relevance (mean = 3.16). The two techniques with a low level of relevance (high level
of reliability) have means of 2.47 (minimum relevance/maximum reliability) and 2.73
(low relevance/high reliability). Table 3, Panel B shows that the level of relevance
significantly influences the ranking and thus the level of decision usefulness (p-value <
0.000). The coefficient of 0.14 implies that the decision usefulness of the technique
increases by 0.14 levels across all techniques, for every incremental level of relevance
(even though an increase in relevance is associated with a decrease in reliability).
Our findings are consistent with the results reported in the ASCG study (Gassen
and Schwedler 2010). This study has documented that users – in this case, professional
analysts – favor fair values over cost-based measurement concepts for financial
instrument fair values even if the fair value cannot be determined based on an active
market (i.e., is marked-to-model). If the fair value is not determined based on an active
market, then the fair value may suffer from low reliability (depending on the parameters
used in the valuation technique to determine fair value). Also, fair value is attributed to
lower reliability compared to a cost-based measurement concept.

12
Additional analyses
Uncertainty avoidance and familiarity with fair values
Based on our theoretical consideration and prior literature, we expect uncertainty
avoidance and familiarity with fair values and their determination to be the two factors
that are most likely to impact the preference for relevance and reliability, and the extent
to which these characteristics contribute to decision usefulness.
To analyze the potential impact of uncertainty avoidance and familiarity with fair
values, we include both variables in our rank-ordered logit model. Table 4 presents the
results. We measure uncertainty avoidance and familiarity with fair values as two-level
ordinal variables (low/high, using the mid-point of the original scales to distinguish
between low and high).
[insert Table 4 here]
Neither uncertainty avoidance nor familiarity with fair values has a significant impact
on the participants’ rankings and thus, on the implicit preferences for relevance and
reliability. This result suggests that users’ preferences for relevance and reliability, as
well as the preference for relevance over reliability are fairly stable across different
levels of uncertainty avoidance or familiarity with fair values.
Table 5 presents descriptive statistics for the rankings, distinguishing between low
uncertainty avoidance and high uncertainty avoidance (Table 5, Panels A and B). These
descriptive statistics provide some weak evidence for an impact of both factors on the
participants’ rankings and thus, preferences for relevance and reliability.
[insert Table 5 here]
On average participants with low uncertainty avoidance tend to assign higher
levels of decision usefulness to the techniques with higher levels of relevance and lower
levels of reliability (means for techniques 3–5 = 3.29, 3.60, 3.16) compared to
participants with high uncertainty avoidance (means for the same techniques = 3.10,
3.42, 3.16). These differences between the two groups of participants imply that the
preference for relevance is less pronounced (and the preference for reliability is more
pronounced) if participants are more uncertainty avoidant. This is plausible. We note,
however, that these differences are small, and they do not change the overall ranking of
the techniques. Hence, for both groups of participants, relevance is assigned a higher

13
value compared to reliability, but the difference is higher if the participants are less
uncertainty avoidant.
Using professional accountants as subjects
Accounting students should have a level of knowledge that is at least equal to (or even
higher than) the level of knowledge of an average user of financial statements. Prior
research suggests that students are an adequate substitute for practitioners, especially in
decision-making experiments (Ashton and Kramer 1980, Liyanarachchi 2007,
Liyanarachchi and Milne 2005, Elliott et al. 2007). Evidence also suggests that students
and practitioners share a similar cognitive structure within which fundamental
accounting concepts are held (Houghton and Hronsky 1993). Furthermore, our case
does not focus on specific traits of expertise of professional accountants. Rather, we
employ the perspective of users of financial statements.
Nevertheless, we also run the main experiment with a small sample of 21 auditors
of different audit firms. One participant was deleted because he did not assign every
rank. Table 6 depicts demographical data (Panel A), descriptive statistics (Panel B) and
results (Panel C) for the remaining 20 participants. The auditors have a mean audit
experience of 7.5 years and on average 5.8 years of professional experience with fair
values. Thus, the participating auditors are very experienced. Figure 3 illustrates the
descriptive statistics.
[insert Table 6]
[insert Figure 3]
We obtain similar results. Just as the student participants, professional accountants
favor relevance over reliability. The level of relevance inherent in the technique
significantly impacts the assigned level of decision usefulness (p-value < 0.000).
Compared to the student participants, the value assigned to relevance is even higher:
The coefficient of 1.08 implies that the incremental increase in decision usefulness is
1.08 levels for every additional level of relevance. As is apparent from Figure 3, another
interesting difference when comparing the results of the auditors with those of the
student participants is that the auditors’ ranking of the techniques is monotonically
increasing in relevance, i.e. a technique with a higher level of relevance is always
preferred over a technique with a lower level of relevance. Hence, the technique with a
maximum of relevance gets assigned the highest level of decision usefulness (mean =
4.5). Also, the standard deviation of ranks is lower than with the student participants,

14
indicating that the auditors’ preferences are more homogenous, despite being from
different audit firms.
Overall, the results obtained with the auditor sample provide us with assurance
that our findings obtained with the student sample are robust to different levels of
practical experience and knowledge, which are the primary differences between
students and auditors. Particularly, the preferences for relevance and reliability, the
preference of relevance over reliability, and the extent to which both characteristics
contribute to decision usefulness are not significantly affected by practical experience.
Rather, it appears that higher levels of practical experience and knowledge increase the
preference for (value of) relevance compared to reliability.

5 Conclusion
We use conjoint analysis to examine the preferences of users of financial statements for
the two fundamental characteristics “relevance” and “reliability” and the extent to
which both characteristics contribute to decision usefulness. Participants rank a set of
five different techniques to determine a risk premium for the discount rate of cash flows
in the context of fair value measurement of a corporate bond. Our results show that
participants generally prefer relevance over reliability. Participants assess higher
decision usefulness to the techniques that come with a high level of relevance (and
correspondingly a low level of reliability). Additional experimentation with auditors
confirms this preference.
Our study contributes to the existing literature in several ways. First, and
foremost, we shed light on users’ preferences to relevance and reliability and the extent
to which each of these two fundamental characteristics contribute to decision
usefulness. Prior research is characterized by “joint tests” of relevance and reliability,
but does not allow to analyse the extent to which both characteristics contribute to
decision usefulness and the related preferences of users of financial statements. Our
study fills this gap. Second, we introduce conjoint analysis into accounting research
which might suggest avenues for future research. Third, we provide input to the debate
on the decision usefulness of fair value accounting, especially if no active market for the
asset to be measured exists. Given the paucity of empirical accounting research
regarding users’ preferences our results may be of particular interest to standard setters
when deciding which measurement concept should be used in order to provide decision

15
useful information. This study has important implications for standard setters,
academics, practitioners and regulators. Our findings suggest that standard setters
should place more emphasis on relevance, even if measurement is less reliable.
Our study is subject to several limitations. First, we use an experimental research
design to analyze preferences of users. This design enables us to gather data on users’
preferences by manipulating relevance and reliability in such a way that an increase in
one characteristic is offset by a decrease in the other characteristic. Nevertheless, the
usual limitations of experimental design apply: Our case is a specific hypothetical
scenario. The findings may not generalize to other settings. External validity may be
limited, and real decisions might differ. Second, we use accounting students as
participants. Students are suitable substitutes for non-professional financial statement
users. Additional experimentation with auditors confirms our findings. Nevertheless,
professional users, such as analysts, may have different preferences, although prior
research (e.g., Gassen and Schwedler 2010) is consistent with our findings.
Future research could examine users’ preferences in other settings using conjoint
analysis. The question of whether relevance is as much preferred to reliability in other
settings might be another interesting research question. Further extending research can
help to capture the tension between relevance and reliability from different perspectives
to explore a general benchmark for the underlying factors of both. Hence, an experiment
which examines the preferences of other accounting groups such as preparers or
professional analysts can confirm our presented results.

16
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 Figure 1
Overview of the interaction between relevance and reliability in the techniques
maximum
used in the case

Technique 1
high

Technique 2
Reliability
medium

Technique 3
low

Technique 4
in minimum

Technique 5

um
gh
w

m
um

lo

iu

hi
im

im
ed

ax
m
m

m
Relevance

20
 Figure 2
Decision usefulness by level of relevance
5
4
(n = 202)
Usefulness
3 2
1
um

gh

um
w
lo

iu

hi
m

m
ed
i

i
in

ax
m
m

m
Relevance

The figure depicts the decision usefulness based on the rank of each of the five techniques and the level of
relevance inherent in the technique. The whiskers denote the 25%, 50%, and 75% percentile. The dot denotes
the mean.

21
 Figure 3
Decision usefulness by level of relevance
for data sample auditors
(n = 20)
5
4
Usefulness
3
2
1
um

gh

um
w
lo

iu

hi
m

m
ed
i

i
in

ax
m
m

Relevance m

The figure depicts the decision usefulness based on the rank of each of the five techniques and the level of relevance
inherent in the technique. The whiskers denote the 25%, 50%, and 75% percentile. The dot denotes the mean. For the
three techniques with minimum, low, and medium relevance, the 25%, 50%, and 75% percentiles are identical. For
the technique with high relevance, the 25% and 50% percentiles are identical. For the technique with maximum
relevance, the 50% and 75% percentiles are identical (see Table 6, Panel B).

22
 Table 1
Descriptive Data
n = 202 p25 median p75 mean standard
deviation
VARIABLES
Familiarity with fair values (years) 1 1 2 1.77 1.32
Experience with fair values (years) 0 0 1 0.73 0.87
Fair value familiarity score (n = 201)* 12 15 18 14.78 4.29
Uncertainty avoidance score 10 12 14 11.70 2.80
Age 21 23 25 23.21 2.30

Gender (n = 200)**
female 80
male 120

* One participant did not provide information on familiarity with fair value concept in financial reporting
** Two participants did not provide information on their gender

23

Dependent Variables
Decision usefulness
Independent Variables
Relevance
Reliability
Control variables
Experience with fair values
Familiarity with fair values
Fair value familiarity score
Fair value familiarity dummy
Uncertainty avoidance score
Uncertainty avoidance dummy Dummy variable taking the value “1” if uncertainty avoidance
score is ≤ 10 (the mid-point of the scale), and zero otherwise.
Table 2
Variable Definitions
Measured on an ordinal scale with 5 levels, based on the ranking
of the technique assigned by participants.
Measured on an ordinal scale with 5 levels, implicit in the five
techniques offered to determine the risk premium. Relevance and
reliability are inversely related, so that an increase of one level
in one characteristic is associated with a decrease in one level in
the other characteristic.
number of years of using fair value measurement in practice
number of years of being familiar with the concept of fair value
measurement
grade of familiarity with fair value measurement, the sum of:
- familiarity with the concept of discounted cash flows’
analyses including risk-adjusted discount rates, as assessed
by participants, measured on a 6-point Likert scale
- self-assessment of familiarity with the determination of a
risk premium in the context of discounted cash flows in
practice, as assessed by participants, measured on a 6-point
Likert scale
- overall familiarity with fair value concept in financial
reporting, as assessed by participants, measured on a 6-point
Likert scale
- competence in using fair value valuation approach, as
assessed by participants, measured on a 6-point Likert scale
Consequently, fair value familiarity score can take values from
“4” to “24”.
Dummy variable taking the value of “1” if fair value familiarity
score is ≤ 13 (the mid-point of the scale), and zero otherwise.
The sum of the three question items for the cultural dimension
uncertainty avoidance (Phase 2 Beta Questionnaire, items 3-1, 3-
16, 3-19) adapted from the GLOBE study (House et al. 2004),
each measured on a 6-point Likert scale. Consequently,
uncertainty avoidance score can take values from “3” to “18”.
24
 Table 3
Decision usefulness by level of relevance

Panel A: Descriptive Statistics for decision usefulness by level of relevance

Relevance p25 median p75 mean standard

deviation

Minimum 1 2 3 2.47 1.36

Low 2 3 4 2.73 1.25
Medium 2 3 4 3.16 1.31
High 2 4 5 3.48 1.42
Maximum 2 3 5 3.16 1.52

Total 2 3 4 3.00 1.42

Panel B: Rank-ordered logit analysis for level of relevance (dependent variable = decision usefulness)

Usefulness Coef. Std.error z-value P>|z|

Relevance 0.14 0.03 5.07 0.000

LR χ2 26
Prob > χ2 (p-value): 0.0000
Observations 1010
Number of participants 202

25
 Table 4
Rank-ordered logit analysis for level of relevance and uncertainty avoidance and fair value familiarity
(dependent variable = decision usefulness)
Usefulness Coef. Std. error z-value P>|z|

Relevance 0.12 0.04 3.22 0.001

Uncertainty avoidance dummy 0.07 0.06 1.11 0.267
FV familiarity dummy -0.02 0.06 -0.32 0.751
LR χ2 26.13
Prob > χ2 (p-value): 0.0000
Observations 1005
Number of participants* 201

*One participant did not provide information on familiarity with fair value concept in financial reporting

26
 Table 5
Decision usefulness by level of relevance
and avoidance uncertainty score

Panel A: Descriptive Statistics for low uncertainty avoidance score

Relevance p25 median p75 mean standard

deviation

Minimum 1 2 4 2.60 1.51

Low 1 2 3 2.36 1.10
Medium 2 3.5 4 3.29 1.34
High 3 4 5 3.60 1.34
Maximum 2 3 5 3.16 1.43

Total 2 3 4 3.00 1.42

Panel B: Descriptive Statistics for high uncertainty avoidance score

Relevance p25 median p75 mean standard

deviation

Minimum 1 2 3 2.42 1.29

Low 2 3 4 2.91 1.27
Medium 2 3 4 3.10 1.30
High 2 4 5 3.42 1.45
Maximum 2 3 5 3.16 1.56

Total 2 3 4 3.00 1.42

27
 Table 6
Auditor data sample
(n = 20)
Panel A: Descriptive Data
n = 20 p25 Median p75 mean standard
deviation
VARIABLES
Audit Experience (years) 2 6.5 11 7.50 6.07
Audit Experience with fair values 1 2 10 5.77 6.11
(years)

Position
Assistant, (Senior) Associate 10
Manager 3
Senior Manager, director 5
partner 2

Age* 17 31 35 37 35.59 6.18

* Three participants did not provide information on their age

Panel B: Descriptive Statistics for decision usefulness by level of relevance

Relevance p25 median p75 mean standard

deviation

Minimum 1 1 1 1.25 0.64

Low 2 2 2 2.25 0.85
Medium 3 3 3 3.10 0.55
High 4 4 5 3.90 1.17
Maximum 4 5 5 4.50 0.83

28
Panel C: Rank-ordered logit analysis for level of relevance (dependent variable = decision usefulness)

Usefulness Coef. Std. error z-value P>|z|

Relevance 1.08 0.16 6.70 0.000

LR χ2 74.25
Prob > χ2 (p-value): 0.0000
Observations 100
Number of participants 20

29