Questions of Value

Is fair-value accounting the best way to measure a company? The debate heats up.

Despite 29 years as an accountant in the United States and abroad, Robert H. Herz still considers himself an economist by training and disposition. “I got into accounting to get a job, basically,” he says.

Which, as casual career plans go, worked out pretty well. Last July, Herz became chairman of the Financial Accounting Standards Board. That puts him in charge of setting the generally accepted accounting principles used in the United States — standards whose perceived global superiority has been called sharply into question by a year of accounting scandals and market turmoil. What’s more, Herz came to FASB from the International Accounting Standards Board (IASB), and is now in a position to exert powerful influence on the efforts by both those bodies to massage U.S. GAAP and international accounting standards as they coalesce into a worldwide standard.

Although highly regarded among his peers for his knowledge and proficiency as an accountant, it is the economist in Herz that should make CFOs sit up and take notice. He has strong opinions about what’s wrong with accounting and financial reporting in the United States. “Accounting has historically not defined income as change in wealth, or change in net worth or value,” he explains. “It has defined it by thousands and thousands of conventions that measure allocations of historical costs.” In other words, accounting hasn’t really defined income.

These “pure accounting fantasies,” Herz declares, have helped create “a basic schism in U.S. industry” between company management and investors. He believes CFOs and CEOs — and current accounting methods — focus on meeting annual budgets and reporting those financial metrics that they control (and for which they are held accountable).

What’s wrong with that? “Unfortunately for people who invest in companies,” he says, “that’s a very incomplete exercise. Investors also want to know what the impacts of external events on enterprise value are.”

CFOs may bemoan the fact that this view deemphasizes their own role in creating value, but given the fragile state of the capital markets, they may have ample cause to welcome Herz’s focus. “If I can achieve anything good” as FASB’s chair, he says, it will be to improve management’s and investors’ understanding of their different perspectives. After all, absent investor confidence, the most strenuous efforts to create value can’t amount to much.

To be sure, the concept of fair value is far from problem-free. And while FASB has long believed in fair value, years will pass before that belief fully becomes practice. But in Herz, the board has a strong proponent of fair value at its helm, and he thinks it’s high time the process was accelerated.

Fair Use

Herz’s views reflect his education at England’s University of Manchester, cradle of Hicksian economics, a branch that focuses on changes in overall economic value when measuring economic growth and productivity. For Herz, in practical terms that generally means reporting the fair value of — or marking to market — assets and liabilities whenever it can be reliably determined.

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