'Paper profits': Fair value accounting, dividends, and corporate governance

We examine the impact of upward fair value adjustments on dividend policies in Russia, where corporate governance is weak. We discuss the case of the utility company Unified Energy System (UES), which abolished its dividends (including mandatory preferred dividends) after reporting a record profit resulting from fair value adjustments. In a large sample of Russian firms, we find a negative relationship between upward fair value adjustments and dividend changes. We suggest that fair value adjustments may introduce noise and inhibit decision making because users may have difficulties in assessing the distribution relevance of the income components. In low investor protection countries, where outsiders generally lack the power to press corporate insiders to distribute cash, this may be seized upon by corporate insiders to adjust dividends downwards. Thus, introducing fair value accounting has corporate governance implications, and it may lead to outcomes that are detrimental to the interests of outsiders.