Fair value: no panacea—but no scapegoat, either
“I have problems with fair value accounting,” said Paul Volcker, former Chair of the Federal Reserve Board (and former Chair of the International Accounting Standards Board Committee Foundation), in his remarks last week to the U.S. Treasury’s Advisory Committee on the Auditing Profession (ACAP). While many have seized upon fair value as the panacea of accounting, “to solve all problems,” he said, it clearly is no such cure-all—and in fact, fair value may create a few problems of its own, especially among financial engineers. In particular, “there is a real question how to blend insights of mark-to-market accounting where there is no market,” Volcker observed, “and it may lead to exaggerated movements in the markets.”
Bear Stearns bailout, for example? Volcker’s comments preceded this week’s rescue of Bear Stearns by JPMorgan Chase & Co. (via Fed financing). But the FEI blog that reported the ACAP meeting was quick to recall that it (and other Wall Street commentators) first predicted the looming crisis in the credit and accounting worlds last summer, in “Bear Stearns Hedge Fund Crisis: The Fallacy of Fair Value?” Indeed, newsmakers worldwide are characterizing this latest financial crisis as a crisis of confidence in valuations. “Transparency is in short supply in the U.S.,” says a current Stratfor podcast, which recalls the $22 billion market valuation of Bear Stearns just fourteen months ago—and its buyout this week at $230 million, or nearly 100 times less.
Sovereign wealth funds that paid respectable prices in helping recapitalize famous Wall Street brands will be looking at the fire sale of Bear Stearns and concluding they overpaid. In fact, the low valuation offers a good example of why there’s a credit crunch. Banks don’t trust market valuations or book valuations or any valuations that aren’t based in cast-iron collateral, and they don’t trust each other, either.
“There may be more forced sales,” this source predicts. But, “putting the blame on fair value for current conditions is misguided,” says CFA Institute Centre director Georgene Palacky, in a statement released Monday. Corporations that have made poor decisions or are not complying with accounting standards are using fair value as a “scapegoat.”
Fair value is the most transparent method of measuring financial instruments, such as derivatives, and is widely favored by investors. Recent finger pointing seems merely an attempt to shift the focus from the real causes of the financial crises involving sub-prime lending practices and lack of market discipline. Indeed, fair value accounting and disclosures…[do] not create losses but rather reflect a firm’s present condition.
The CFA Institute also disagrees with those calling for a watered-down version of fair value. “This ‘shoot the messenger’ mentality will not restore investor confidence,” Palacky predicts. “Only when fair value is widely practiced will investors be able to accurately evaluate and price risk.” For the Institute’s current recommendations, see its Comprehensive Business Reporting Model: Financial Reporting for Investors.
FASB to determine useful life of intangibles
The Financial Accounting Standards Board (FASB) meets today to discuss issues related to the proposed FSP FAS 142-f, Determination of the Useful Life of Intangible Assets, and whether to finalize the FSP. The project has been underway for at least a year (see BVWire™ #55-1), and the comment period ended this past January. “Since the issuance of Statements 141 and 142, constituents have raised concerns about perceived inconsistencies in the guidance on the initial valuation of intangible assets in accordance with Statement 141 and the determination of useful life in accordance with Statement 142,” says the FASB project summary, which recaps the issues and provides a link to the proposed FSP. For links to live (and archived) FASB meetings, click here.
Look for proposal on loss contingencies. In its March 11th meeting, the FASB predicted an exposure draft of SFAS No. 5, Accounting for Contingencies, by the end of April, with a sixty-day comment period. “Users and preparers of financial statements should expect a proposal requiring entities to disclose information about all loss contingencies except those that meet certain narrow criteria,” says a current BNA report. “The guidance would be effective for annual financial statements issued for years beginning after December 15, 2008, and interim periods.”
FSP FAS 157-1 available. “Your information on SFAS 157 and [accounting for] leasing appears to be a little out of date,” writes FASB member Mike Tully, regarding the item in last week’s ‘Wire. The Board balloted the FSP shortly after the February 6th meeting and finalized the FSP on February 14th. The final FSP FAS 157-1 is posted here.
Median control premiums decline as # of deals plummets
There was no overall change in the median paid control premiums from 3Q07 to 4Q07, according to a recent search of the Mergerstat®/BVR Control Premium Study™. Surprisingly, given the way markets ended last year, the median control premium actually increased from 2006 to 2007—albeit less than a percentage point, from 17.2% to 18.1%.
What made more sense: Median control premiums for the first half of 2007 were 18.6% but dropped to 15.8% in the second half of the year. And what made the most sense: The total number of deals dropped dramatically, from 508 in the year’s first half to 143 in the second.
Automatic implied minority discounts. With our continued efforts to improve BVMarketdata (see BVWire #66-1), searches at the Mergerstat/BVR Control Premium Study database are now faster and more efficient, thanks to compressed data and the engine’s ability to accommodate larger searches. And in the near future, instead of users having to calculate the implied minority discount themselves, the database will automatically calculate it for them; this new feature will accompany requests for both summary results (aggregate data) and individual transactions.
To find out more about using the database to calculate control premiums, implied minority discounts, and valuation multiples, tune into tomorrow’s webinar, “Getting the Most from the Mergerstat/BVR Control Premium Study,” featuring Shannon Pratt, Alina Niculita, Rob Stutz, and Adam Manson. Co-sponsored by BVResources and NACVA, the event will include the panelists’ live searches of the database and an “ask the experts” session. An extra bonus: Attendees will have free access to the database for five days following the March 20th webinar. To register, click here.
Updated Q&A on the BPM
Last week’s teleconference on “Using the Butler Pinkerton Model™ Total Cost of Equity and Public Company Specific Risk Calculator™" sparked a record number of questions—so many, that the presenters agreed to answer the overflow offline. A free download of their comprehenisve Q&A digs even deeper into the model, covering its inputs/outputs, why and how it pulls data on closing stocks—and what the data really say, for example, when trading prices can vary so much from one day to the next.
“When you pull stock price data for an effective date such as a Tuesday (as opposed to a Monday),” the Butler/Pinkerton developers say, “it is much more than one more day of trading—it is actually 261 days' worth of data,” because the Calculator will pull 261 Tuesdays of closing prices. “We think this is a neat feature of the Calculator—to be able to recognize and calculate these differences.” Before, analysts may not have considered just how sensitive the calculation of beta might be to various inputs; commercial beta sources that provide only paper print-outs put them at the publisher’s mercy for the accuracy and sensitivity of the data. “Here you can control your own destiny. We believe the more information, the better.” Look for all the new information on the Butler/Pinkerton model at BVR’s Free Downloads and also at BVMarketdata.com.
March 2008 IFRIC available
The March 2008 IFRIC Update—the monthly newsletter from the International Financial Reporting Interpretations Committee—is now online. Published for the constituents and other interested parties of the International Accounting Standards Board, this month’s edition covers IFRIC D21 Real Estate Sales and IFRIC D22 Hedges of a Net Investment in a Foreign Corporation. It also summarizes IFRIC agenda and tentative agenda decisions. To obtain copies of current and past issues, click here.
In last week’s item regarding Valuing a Business (VAB), the court’s many citations to the 4th edition of this “leading treatise” in Floorgraphics, Inc. v New American Marketing In-Store Services, Inc. (U.S. Dist., Feb. 5, 2008) cited, in addition to author Shannon Pratt, his co-authors of this and prior editions, Robert F. Reilly and Robert P. Schweihs. We regret the oversight.