Critics note that such tactics wouldn’t be necessary if there were more demand for the use of fair value from users of financial statements. The CFA Institute’s passionate support notwithstanding, FEI’s Cunningham contends “there isn’t a lot of demand for [fair value] among working analysts.” Herz disputes that, noting that FASB’s user group, a committee of analysts and investors, has thrown its full support behind fair value. But Cunningham says there may be less to that than meets the eye, since analysts tend to view their ferreting out of such information from footnotes and off-balance-sheet activities as a competitive advantage. Who would need analysts if financial results were as simple and transparent as Herz wants?
The debate is likely to come down to whether the costs involved in applying fair value are worth the benefits. Here again, corporate-finance executives sharply disagree with the CFA Institute. Time Warner’s Barge, for one, warns that, “for complex multinational companies like Time Warner, ExxonMobil, or GE, the practicality of providing all of the assumptions may not be cost beneficial.”
Dismissing those objections, the CFA Institute’s McEnally notes that such disclosure would involve virtually no work that financial managers don’t already do for internal purposes. “Managers make assumptions every day for their assets,” she says.
Tellingly, FASB’s rule for expensing stock-option grants requires just those types of disclosures. And Ciesielski says he expects other new rules embracing fair value to impose similar requirements on management. “The only assurance that investors have that estimated fair values are honest is if the disclosures are robust — and actually exist.”
Ronald Fink is a deputy editor of CFO.
The End of Earnings Management?
Although fair-value accounting has been heralded as a cure for earnings management, even its supporters acknowledge that the technique is not immune to manipulation.
In a report last April, accounting expert Jack Ciesielski cited “the boundless opportunities for meeting earnings targets” based on fair-value measurement of just four types of financial instruments—equity securities without trading markets, insurance and reinsurance contracts, warranty obligations and rights, and unconditional purchase obligations. Ciesielski, publisher of The Analyst’s Accounting Observer newsletter, also noted in a cover letter accompanying the report: “Fair value was one of the ingredients in the witches’ brew that Enron’s managers concocted.”
Others point out, however, that manipulation of fair-value estimates should be easy to detect if the assumptions that managers use are disclosed. Indeed, Patricia McConnell, a managing director of Bear Stearns, conditions her support for fair value on regulatory requirements that mandate such disclosure.
Meanwhile, Robert Herz, chairman of the Financial Accounting Standards Board, says that valuation practices need to be standardized in the same way accounting rules are. With that in mind, Herz has been making presentations to conferences of valuation experts. — R.F.
Be Careful What You Wish For
While there is almost total consensus in the world of corporate finance that the current reporting system is in dire need of improvement, disagreement abounds as to how such improvement should be achieved. Fair-value measurement, for instance, is generally seen as the most reliable basis for financial accounting, but critics say it can have numerous unintended and unwelcome consequences.