| Using disclosure mandated by Statement of Financial Accounting Standards (FAS) 157 "Fair Value Measurements," I evaluate the concern that fair value estimates for assets and liabilities not traded in active markets, aka mark-to-model, are too unreliable to be used in financial reporting. For the first and second quarters of 2008, I document a significant positive association between stock prices and fair values measured using unadjusted market prices (Level 1), other observable inputs (Level 2), and significant unobservable inputs (Level 3). While the coefficients on the mark-to-model estimates (Levels 2 and 3) are lower than these on the mark-to-market fair values (Level 1), the difference is significant only for Level 3 net assets. Even at its maximum, however, the difference remains below 40% of the coefficient on Level 1 net assets.;I also document a significant positive association between Level 3 gains and both quarterly returns and returns for the three-day period surrounding the filing of Form 10-Q. The returns tests further suggest that investors attach different weights to the components of the changes in Level 3 net assets, suggesting that the FAS 157 changes disclosure is informative. The findings are robust to alternative specifications and controls for company-specific risk factors. Collectively, the results are consistent with the conjecture that although investors discount to some extent the management-provided, mark-to-model, fair value estimates, they find them sufficiently reliable to incorporate in determining firm value. |
