Earnings Management In The Real Estate Sector And Perceptions Of Appraiser Independence

The aim of this project is to examine whether fund managers strategically run the net asset value of the real estate investment funds under their management and which factors may influence their decisions. The legal framework of the Portuguese real estate investment funds allows fund managers to show some discretion in valuing properties opening room for empirical study on earnings management for this sector. According to the Portuguese securities market regulation for real estate investment funds, properties have to be appraised every two years at least . In the meantime, in order to determine the value of the property for subscriptions or redemptions, fund managers may choose any value between the acquisition cost and the average of the appraisal values attributed by two independent appraisers . This means that they may choose to keep the asset valued at its historical cost, to keep it at the revaluation value, or at any value between both. One common procedure is to progressively recognise the revaluation increments of properties starting from the acquisition cost up to the revaluation value. Therefore, we hypothesise that fund managers have the opportunity to control (ìmanipulateî, or ìmanageî) the investorsí earnings throughout the timing of the recognition of the unrealized gains that arise from fund assets. In order to test this hypothesis, based on a property-held sample, we first analyze the cross-sectional distribution of a variable named RDIF - Return Rate Difference computed as the difference between the annual asset value increments fixed by fund managers and the annual appraisal changes recommended by appraisers . The observation of unusually high frequencies of negative values of this variable can evidence that fund managers are using their discretion to manipulate earnings. If as we hypothesise, there is evidence of earnings management, it will be relevant to examine in what conditions managers work out the earnings and what are the major factors that lead to such a behaviour. Then, based on a fund-held sample and following a research design similar to McNichols, Wilson, and DeAngelo (1988) and Petrovits (2006), we test different hypothesis to examine if fund characteristics as fund type, dimension or fund vacancy rates can stimulate earnings management actions. After modelling how annual revaluations increments of funds properties would be reported in the absence of earnings management, we estimate a discretionary accrual proxy as the difference between the reported revaluation increment and its expected value obtained by the model. Considering that fund managers may also manage the net asset value through the influence that they can have on appraisers, we also plan to focus on the perception of appraisersí independence. Therefore, in a second phase of our work, we attempt to identify the factors that potentially influence the perceived appraiser independence in the real estate investment funds industry. Considering that properties appraisal values are of the essence in investment decisions and performance measurement of private real estate, the reliability of these values are crucial to the market in general. As such reliability is related to the confidence and transparency of the appraisal process and appraiser actions, we believe that a better understanding of the factors that influence the perceived appraiserís independence is crucial to the proper functioning of the market. As this area of research is in an early stage, we believe that this study may contribute to the literature for different reasons. First, it will provide a basis for the development of a theoretical framework on the definition of appraiser independence. Secondly, it will provide information for regulators that will certainly help in the monitoring of client/appraiser relationship. Finally, with the move to international accounting standards, and subsequent introduction of fair value as a basis for accounting measurements, the topic of appraiserís independence is acquiring a significant relevance, playing a key role for reliability of financial information in general.