Fair Valuations of Non-Traded Financial Assets: Evidence from the Mutual Fund Industry

Abstract

We exploit a growing trend of mutual funds investing in private companies to examine the practice of fair value accounting. This particular setting provides a unique opportunity to examine fair value accounting because multiple mutual funds are required to simultaneously report valuations of identical assets that are not publicly traded. We find that funds’ valuations of private companies are much sticker than that of publicly traded companies. In more than a third of the quarterly observations of private companies, valuations are unchanged from the prior quarter – compared to only 0.1% for publicly traded companies. In fact, for 16% of the observations of private companies, valuations are unchanged for at least a year after a fund’s initial investment. We empirically examine potential explanations for this stickiness. First, we provide some evidence that changes in the valuation of private companies are timed to improve funds’ performance rankings, but no evidence that the valuations associated with changes are biased to improve rankings. Second, consistent with funds managing reporting costs and risks associated with fair value accounting by recording changes only when there is a compelling case for doing so, we provide evidence that changes often follow large macroeconomic and firm specific events, and that change behavior is highly correlated across funds and fund families. Finally, we find that changes are more likely around large negative market fluctuations than large positive market fluctuations suggesting that funds perceive that reporting risks associated with fair value accounting are asymmetric in nature.