Probability thresholds and equity values

Some accounting standards specify probability thresholds to determine recognition and measurement of assets and liabilities (e.g., SFAS No. 5). This requirement is meant to communicate information to investors on the uncertainty of future benefits and obligations. I identify a unique setting to test whether investors make use of these probability thresholds for equity valuation.;This study is relevant to regulators and investors. The FASB and the IASB are currently discussing the role of probability thresholds in their joint Conceptual Framework project. My findings offer support for the use and disclosure of probability thresholds in asset measurement to inform investors. The incremental value relevance of the new oil and gas reserves classification is also informative for the IASB in their ongoing development of a new standard for the extractive industries.;A recent regulatory change in Canada requires oil and gas firms to break down their estimates of natural reserves into proved and probable, dependent on the probability of eventual production (i.e., P[proved]>90%, P[proved+probable]>50%). I find that investors attach a higher market value to proved reserves consistently with a simple expected value model. Lower measurement error in past reserves estimates and the presence of a reserves committee strengthen these results. The market value weight of proved reserves tends to be larger for small size firms with a lower ratio of proved to probable reserves. The market value weight of probable reserves tends to be larger for large size firms with a higher ratio of proved to probable reserves.