The impact of legal efficacy on value relevance of the three-level fair value measurement hierarchy

We examine whether the three-level fair value measurement hierarchy in IFRS 13 is value relevant in banks internationally, and whether that value relevance is moderated by country-level legal system, enforcement, and the interaction of legal system and enforcement (legal efficacy). Legal system, enforcement and legal efficacy, we argue, provide a parsimonious way of grouping countries that yields country classifications similar to more complex classification schemes. In a large sample of banks from 35 IFRS-adopting countries over 2012-2016, we find that fair value estimates are most value relevant in countries with the strongest combination of legal system and enforcement, monotonically decreasing to least value relevant in countries with the weakest combination of legal system and enforcement. In addition, these associations matter the most (least) for the least (most) reliable fair value estimates. We also show that bank size positively moderates value relevance of fair value estimates but only in countries without the strongest combination of legal system and enforcement. Our study contributes to understanding of the value relevance of fair value estimates internationally.