New Financial Model Needed
Professor Haresh Sapra of Chicago’s Booth School of Business argues that a new method needs to be developed for valuing long term assets. Mark-to-market is too volatile; book value is often inaccurate and ignores market dynamics.
Instead, Professor Sapra suggests two methods: The first is to dampen the effect by valuing illiquid securities by some kind of average, for instance between fair value and historic cost. The second method is to base managers’ bonus payments on longer-term performance.
His rationale is that fair value effect subverts the efficient market hypothesis. Markets are only efficient with respect to information held by outsiders. However mark-to-marketing accounting changes the behavior of insiders. As a result fundamentals affect prices and prices affect fundamentals. The normal price mechanism is turned upside down.
The solution to this conundrum, Professor Sapra reasons, is to identify a more accurate value through averaging or by leveraging the power of compensation to assure a maximized long-term value.
Sir – averaging financial data in no way adds to transparency or more robust disclosure. There is no need for a “new” financial model, but rather a new reporting model. That is, you can let the banks have there way of using historical cost for balance sheet purposes as long as fair value estiamtes are provided for in the footnotes. In this way an investor can choose what data to rely on. What the professor should be more concerned about is ensuring that all SPE’s are placed on the books and that bank accounting does not continue to plead for off balance sheet treatment. Regarding Sapra’s comment concerning compensation; spot-on.