Shareholder Value Creation by Acquiring Firms in Emerging Markets - Research Paper Example

Shareholder Value Creation by Acquiring Firms in Emerging Markets - How feasible is Fair Value Measurement using current valuation techniques ID #: 19714 Order No. 284030 [Name] [University Name] [Course Name] [Supervisor] [Any other details] 28 March 2009 Table of Contents: Background and Context: Given the spurt of accounting scandals in the past and the current financial crisis witnessed in the US, the UK, the Europe and the rest of world, the Financial Accounting Standards Board has modified the desired accounting standard under the Generally Accepted Accounting Principles (GAAP) from "costing" of an item to "fair valuation" of the item vide statement number 159 that is an immediate follow up of statement no. 157 that describes the fair value reporting system much in detail. Effective from January 1, 2009 all publicly listed companies shall be required to report fair value based accounting statements that shall include market value of all assets owned by the organizations - like real estate, intellectual properties, patents, brands & trademarks, copyrights, research databases, etc. Given that this is a completely new type of accounting, a number of questions are popping in the minds of accounting professionals:- 1. What will be the acceptable methodology for fair value computation 2. How will rise and fall of fair values be assessed and tracked 3. What are the chances of manipulations 4. Was lack of fair valuation the result of the recent Sub-Prime crisis 5. How will fair valuation mitigate the risk of material misstatements and overvaluations in the accounting statements as per ISA (UK & Ireland) 315 6. What will be the trust factor on the sources of data that shall be used for fair valuations Given that this is an entirely new governance system, a number of experts are trying to answer such questions or raise more questions. The author proposes to undertake a broad educational perspective of this subject by assessing the current company valuation techniques and then try to evaluate if these techniques are feasible to carry out fair value measurements of company assets. [Mard, Michael J. 2008] Research Questions Fair value measurements have been in discussions for many years but post the current Sub-Prime crisis the same is in the process of getting mandatory for publicly listed organizations and a number of private companies as well. This new requirement is expected to trigger a number of researches in the industry trying to answer the questions that is raised by practicing accountants of the industry. The author proposes to contribute by trying to answer the following Research Questions pertaining to the proposed research: (a) How effective are the current company valuation techniques in determining the fair value of company assets (b) What are the possible fair value measurement methodologies that companies should be following (c) Will these fair value measurements effectively mitigate the risks of overvaluation of company assets The research will be conducted in academic style and hence will be a mix of academic theorizing as well as investigation into limited practical implications. Literature Review In an interview with Mr. Robert H Herz, FASB Chairman, he emphasized that the SFAS 157 is not the first introduction of the concept of Fair Value measurements. Fair Value has appeared in many standards in the last few decades and hence is not a new concept. However, a consolidated standard of fair value from GAAP perspective was needed and SFAS 157 was introduced to fulfil this criteria. The emphasis of fair value is to provide accurate information to those individuals that study financial statements and then take decisions on investments & credits based on such statements. Fair value is not essentially a replacement of historical costs but is an additional projection to the users of the accounting statements about the current market valuation of assets whereby cash assets and cash equivalents should be depicted separately. Mr. Herz insisted that accounting professionals have all the rights to accommodate both fair value & historical costing in one accounting model but fair value is mandatory. He informed that prior to working on SFAS statement 157 they interviewed some of portfolio managers and financial analysts that follow companies that handle energy trading regarding feasibility of fair value. The portfolio managers and financial analysts preferred "fair value with additional disclosure" taking the learning from Enron meltdown. [Kranacher, Mary-Jo and Morris, Tom. 2007] Now here is the point presented by the author - why should people learn & adopt best practices only after major scandals, scams or crisis has occurred and billions of dollars and future of thousands have been drained down If FASB has concluded that fair value measurement should be the way of life of the accounting professionals, they must have gone through loads of analytics before making this mandatory. The accounting professionals should develop detailed methodologies of implementing fair value in accounting statements by coming out of the comfort zones because the accountability of such professionals is to protect the interest of investors in public listed companies and overall protect the nation from financial crisis that causes enormous embarrassment, loss of money, unemployment, and an overall reputational loss of the country in front of the world. The SFAS statement no. 157 defines the fair value, establishes a framework for measuring fair value in GAAP and elaborates disclosure requirements for fair value measurements. As per SFAS 157, fair value is the "exit price" of an asset that would be realised on making its sale or else transferring the liabilities between market participants via an orderly transaction. Fair value is not measured as the "entry price" (price at which the asset can be acquired on the measurement date). The valuation techniques required by SFAS 157 are - market Approach, Income Approach and Cost Approach. The approach or combination of approaches for fair value measurements depends on case to case basis. However, it is expected from reporting entities that all valuation techniques should be used to measure fair value techniques. In the market approach, comparison with identical or comparable assets prevailing in the market needs to be carried out. In income approach, the assumptions by market participants on the future cash equivalent value of the asset (like discounted cash flow). The cost approach takes into account the replacement cost of the asset. [Fuglister, Jayne and Bloom, Robert. 2008; Zacharski, Anthony. H. and Rosenblat, Alan et al. 2007] The SFAS statement 157 also requires three levels of valuation in a fair value hierarchy whereby the first level has highest priority and the third level has lowest priority. Level 1 corresponds to "quoted prices" in the active markets for identical or equivalent assets/liabilities that the reporting entity has access to on the day of measurement. Level 2 corresponds to observable quoted prices of identical or equivalent assets in the active & inactive markets or the market inputs on the asset/liability such as interest rates, yield curves, etc. or the market inputs not directly observable but from some observable inputs that can be useful in deriving the value of identical assets or equivalents on the measurement date. Active markets are those where the transactions pertaining to the asset or liability occurs at sufficient frequency or volumes (the degree of sufficiency is not defined however). Level 3 corresponds to unobservable inputs based on self made assumptions by the reporting entity. For inputs based on bid-ask prices, the statement requires that the best price within the bid-ask spread shall be used irrespective of the hierarchical position (Level 1, 2 or 3) of the inputs. For restricted stock prices, the statement requires that the pricing of an identical unrestricted security from the issuer traded in the public market shall be adjusted to facilitate the market participants in incorporating the restrictions in pricing the restricted asset. In the section of disclosures, the statement has defined that the reporting entities should not only disclose the accounting statements with fair value estimates but also disclose the inputs & hierarchical levels in arriving at the estimates. If fair value estimations have been carried out using too many unobservable inputs (level 3), then the reporting entity is supposed to disclose gains & losses within the estimation period and the purchases, sales, issuances, settlements and transfers. [Zacharski, Anthony. H. and Rosenblat, Alan et al. 2007] A complete view of Fair Value Hierarchy is presented in the following Figure: Figure 1: The three levels of the Fair Value Hierarchy (Source: Fuglister, Jayne and Bloom, Robert. 2008. pp2] Miller and Bahnson (2007) reinforce the statement of Mr. Robert Hetz that "fair value estimates have been introduced in GAAP through a number of standards in the past decades" by further stating that after introduction of SFAS 157 and 159, the fair value accounting is no longer a theoretical abstraction of some kind of a philosophy but has now become an practically executable accounting practice possessing clear cut guidelines & accountabilities. It should be in the interest of the CPAs to quickly practice this new system and get ready to publish SFAS 157 compliant accounting statements. The fair value hierarchy defined by SFAS 157 clearly sets forth the requirement of "precision of valuation" by the reporting entities. Ratcliffe, Thomas A. (2007) argues that companies & auditors should target to achieve substantial improvement in financial reporting by making use of SFAS 157 & 159 rather than just producing compliant accounting statements. This statement has definitely raised the bar of disclosure but also has provided an opportunity for improvement in the legacy accounting system that has so many flaws with respect to market valuation of organizational assets. S & P rating services argue that accounting for assets & liabilities based on market inputs can hide the detailed economics of certain businesses when the markets are facing volatility & uncertainty. In such cases, as per S&P, the reporting entities should disclose much more information for the benefits of the users - like underlying risks, valuation methodologies, assumptions made, volatility witnessed, market adjustments, sensitivities and such other factors in order to provide the bigger picture amidst the uncertain & volatile situations. [Anonymous Author report in CPA journal in Vol.78. No.7. 2008] The sub-prime crisis is said to have occurred due to increasing uncertainties about the fair value of mortgage backed financial instruments especially the Collateralized Debt Obligations (CDOs). The CDOs were extraordinarily complex whereby it became almost impossible for the investors to get insight into underlying financial data verify the details of the CDO asset valuation including discounted cash flows. Had SFAS 157 & 159 existed before the sub-prime crisis, the analysts would have concluded that the CDO valuations were all in the level 3 of the fair value hierarchy which, in the current context requires increased disclosures about every transaction pertaining to the assets during the valuation period. In fact the valuation aspects of majority of the sub-prime financial instruments had dropped from level 1 to level 3 in the spurt of selling loan products to even poorest of the borrowers against property mortgages. [Young, Michael R. and Miller, Paul B. et al. 2008] What did these literatures lack in explaining: Banks wanted to make maximum money out of the booming housing markets but had to pay the price when the property markets crashed substantially (and rather suddenly) in the US and the UK. The sub-prime experience, however, does challenge the requirement of market inputs at levels 1 & 2 of SFAS 157. The market information itself was comprised of full of bubbles given that even the third party valuation firms also messed up the markets badly - and off course we should not forget to mention the internal credit & liquidity risk management failures of the banks. We should not forget that the CDO markets were extremely active and hence the corresponding asset quotes could have qualified to level 1 of the fair value hierarchy of SFAS 157. Hence, the fair value reporting requirements of SFAS 157 cannot be perceived as strongly proposing the asset values to be marked-to-active market values at prevailing rates as emphasized by Ma and MacNamara (2009). We have already seen what has happened to Asset Based Securities (ABS), Collateralized Debt Obligations (CDOs), Collateralized Loan Obligations (CLOs) and the Credit Default Swaps (CDSs) that were making headlines in volumes & transactions hardly a year back. The markets do comprise of substantial exaggerated quotes which can defeat the fundamental philosophy of this statement. Hence, this study shall attempt to discover the detailed valuation techniques that can be most feasibly considered as compliant to SFAS 157 & 159. Objectives of Study The objectives of the study are proposed to be the following: (a) To establish few empirical generalizations pertaining to the subject of this research. (b) To become a sound academic reference document pertaining to answers of the questions raised herewith that is bothering the financial accounting professionals in the industry as well. (c) To form a baseline research for future aspirants that may be interested in taking the research further to help in establishing more empirical generalizations on the subject. Methodology The proposed methodology of this research shall comprise of the following steps: (a) In depth Literature Review - much wider and deeper than what has been presented in this proposal (b) Theorizing - Development of a sound theoretical framework as an outcome of the research review (c) Defining required data - based on the theoretical framework the data definitions required to be collected shall be concluded (d) Data collection procedure - the procedure by which data shall be collected (e) Qualitative analysis of data - Analysis of how, what & when with the help of data collected. At this stage of the proposal, the author proposes the following methodology to be used post building of sound theoretical framework: (a) Data definition - The author shall evaluate the published financial accounting statements of at least two listed companies in the past four years from the data sources like the company's official website, databases, periodicals, journals, market analysis websites, experts, etc. (b) Data presentation and analysis - The author shall populate all the data collected in tables and then carry out mean & variance analysis. (c) Based on the analysis of data, the author shall present critical analytics of the trend and present comments on their fair values. For example, if the total asset value of an organization suddenly ramps up (say from 500 million to 2 billion in just one quarter), the financial fundamentals shall be analyzed to find out what went so well with the company that has led the asset value to ramp up like this. The viewpoints shall be raised from auditor's perspective as if the author is an external auditor building viewpoints about the accounting statements of the chosen organizations. (d) The final step of the research shall be conclusions and generalizations. [Malterud, Kirsti. 2001] Conclusion: In this proposal, the author has presented the proposal to carry out research on a burning topic that is related to analysis of current valuation techniques with respect to fair value measurements in line with SFAS 157. The author has presented the research questions, brief literature review, objectives and proposed methodologies pertaining to the research. Reference List: Anonymous Author. (2008). Fair Value Accounting works well but is not perfect. The CPA Journal. Vol.78. No.7. ABI/INFORM Global. pp9. Kranacher, Mary-Jo and Morris, Tom. (2007). An Exclusive Interview with FASB Chairman Robert H Herz. The CPA Journal. Vol. 77. No. 11. ABI/INFORM Global. pp20-26. Fuglister, Jayne and Bloom, Robert. (2008). Analysis of SFAS 157 - Fair Value Measurements. Accounting and Auditing. The CPA Journal. Vol. 78. No. 1. ABI/INFORM Global. pp36-39. Ma, Sindi and MacNamara, Andrew. (2009). When Fair Value is Not Fair. The CPA Journal. Vol. 79. No.1. ABI/INFORM Global. pp10-11. Malterud, Kirsti. (2001). Qualitative Research - Standards, Challenges, and Guidelines. Qualitative Research Series. The Lancet Publishing Group. Vol. 358. pp485. Mard, Michael J. (2008). Valuation - What's it Worth. SFAS 157 - Fair Value Measurements. The Licensing Journal. pp33-37. Miller, Paul B W. and Bahnson, Paul R. (2007). Refining Fair Value Measurement. Journal of Accountancy. Vol. 204. No. 5. ABI/INFORM Global. pp30-34. Ratcliffe, Thomas A. (2007). The Finer Points of Fair Value. Journal of Accountancy. Vol.204. No.6. ABI/INFORM GLOBAL. pp58-61. Young, Michael R. and Miller, Paul B. et al. (2008). The role of Fair Value Accounting in the Sub-Prime Mortgage Meltdown. Journal of Accountancy. Vo. 205. No. 5. ABI/INFORM Global. pp34-35, 37, 39. Zacharski, Anthony. H. and Rosenblat, Alan et al. (2007). FASB Statement on Fair Value Measurements. Journal of Investment Compliance. Vol. 8. No. 1. pp36-39. End of Document Read More