What is "Fair Value"?

Aswath Damodaran on Fair Value:

What is the fair value of an asset? Sounds like a simple question but the question has taken on a life of its own, given recent changes in both accounting and legal standards. In both contexts, the rule makers contend that their objective is to ensure that assets are recorded at fair value and have created rules to ensure that this happens.

Let us start with accounting. The push towards fair value accounting has now become an article of faith for accounting standards boards. In the United States, FAS 157 (the very fact that we are at rule number 157 tells you something about how accountants think - the more rules the better) provides a synopsis of what the accounting definition of fair value. I have expressed my skepticism about fair value accounting before on this blog and made my case for why this is not only a good idea. 

In legal circles, the hypocrisy about fair value is even greater. Appraisers are supposedly unbiased and fair in their estimates in value, no matter who they work for or which side of the legal divide pays them. The Internal Revenue Service has made this requirement explicit in its guidelines for appraisers. All of the valuation appraiser organizations - The National Association of Certified Valuation Analysts (NACVA), American Institute of Certified Public Accountants (AICPA), American Society of Appraisers (ASA), Institute of Business Appraisers (IBA)- argue that their members provide fair, unbiased estimates of the values of businesses.

I have a simple definition (and test) of fair value. If an asset is valued at fair value, the appraiser (or his client) should be indifferent to being either  a buyer or a seller at that value. If you are an appraiser valuing your business for tax purposes, would you really be willing to sell your business at the appraised value? If the answer is yes, you have stayed true the notion of fair value. If the answer is no, the talk about fair value is just talk... If you are the tax authority valuing the same business (for tax purposes), would you be willing to buy the business at the appraised value? If the answer is no, you too are guilty of hypocrisy.

Let's be honest. Asking "biased" appraisers to estimate fair value is a hopeless task; the bias comes from the way appraisers get compensated/ paid.  Either change the way that we hire/pay appraisers or accept that each side's appraisers are going to come up with valuations that reflect which side of the divide they are coming from.