Ask CFOs whether intangible assets should be calculated and reported to
convey a company’s true value, and most readily say they should. But then they stumble over questions that have stumped the financial community for
years: How can nonfinancial assets be measured, and what kind of standards will corporations be held to when reporting
“Incorporating nonfinancial performance measures is something that I
totally agree with,” says Paul Bialek, former CFO of RealNetworks, who now works as a consultant for the company that delivers audio and video
online. “But we don’t have a collective body right now saying what those numbers mean,” much less how to calculate them.
Almost everyone from CFOs to regulators to academics believes that
financial reporting under Generally Accepted Accounting Principles (GAAP) alone is inadequate to reflect value, especially in an Internet age.
The wild overvaluation of dot-com companies based almost solely on
intangibles, such as expected demand for their products and services, has only accelerated the push for some sort of standard to help companies and
investors calculate measurement of nonfinancial assets.
Multiples and More
The market, of course, has always given value to such nonfinancial
essentials as quality of management, innovation, branding, speed to market and human capital. Between 70% and 80% of many companies’ market
valuation reflects intangible assets, investment experts say. But they add that too many investing decisions are still keyed to short-term
based purely on financial data.
“We believe pretty strongly that the cornerstone for the public markets is
good, relevant and timely information” that does not necessarily show up in a quarter’s financials, says Robert Herz, a partner at
PricewaterhouseCoopers and co-author of The ValueReporting Revolution: Moving Beyond the Earnings Game.
Herz has called for a greater focus on nontraditional value reporting and he
has picked up strong support lately. A task force of academic and corporate experts that was convened by the Securities and Exchange Commission last
spring recommended that nonfinancial performance data be released to investors.
Similarly, the Financial Accounting Standards Board has called for further
review of methods to account for intangible assets. Tellingly, however, both groups recommended that disclosure remain voluntary. (See “Ambivalent
About Intangibles,” page 50.)
“Information disclosed through traditional accounting systems is incomplete,
[but] this is not the time to open up U.S. GAAP,” says Jeffrey E. Garten, dean of the Yale School of Management and chairman of the SEC task
force. “This is a time to create a supplemental framework to describe intangible assets and operating performance measures.
We are not saying
[intangibles] should be valued like bricks and mortar, only that they do have a contribution.”
Who Needs It?
A few diehards, meanwhile, say that the current GAAP accounting system
is sufficient for investors. “Traditional reporting includes a significant amount of forward-looking
information in management’s discussion and analysis that tells the investor where the company is heading,” says Anthony Knapp, the corporate
controller at Motorola. “Filing pages of disclosure based on some regulator’s or standard setter’s idea of what is important to the investor,
will, in my opinion, not add meaningful information.”
Indeed, the last thing that corporate executives want is a mandate to report
values that are amorphous and that change over time and by industry. Shareholder lawsuits because of earnings disappointments are soaring.
With expectations of further litigation fueled by the strictures of the new
Regulation Fair Disclosure (FD), an additional regulatory edict would be unthinkable to most corporations. James Knight, a partner at SCA
Consulting, a productivity consulting firm in Chicago, says that “there are ways to measure intangibles, yet they are not consistent
with the level [of
detail] found in double-entry bookkeeping.”
However, Baruch Lev, an accounting professor at New York University’s
Stern School of Business, and author of Intangibles: Management, Measurement and Reporting, says investors need to be handed more
straightforward information about intangibles from the companies that understand them best.
The Lesson from R&D
Lev points to research and development, for example, as an area that
investors can underestimate. Companies with heavy R&D expenses can be punished by investors, he says, even though R&D may fuel growth. As a
result, managers within these companies often realize stock gains four times greater than outside investors, based on their
knowledge, Lev says.
Even the most ardent proponents of valuation reform concede, however,
that changes must be made slowly. Lev suggests convening a new task force comprising representatives from the SEC, FASB and the Big Five
accounting firms to develop a best-practices approach to measuring intangibles.
“I don’t know how companies are going to report on intangibles unless an
authoritative body comes up with best practices,” says Lev, who was a member of the SEC task force.
Meanwhile, no one is pretending that accounting for intangibles is at the top
of the SEC’s priority list. As of this writing, new SEC Chairman Harvey Pitt had not laid out his views on intangible-asset reporting. Within
FASB, however, the issue is on a fast track, with the expectation that the board will
address the issue this fall.
“We have board members who feel strongly that [intangible accounting and
reporting] must be done,” says Wayne Upton, a senior project manager at the rulemaking body. “It ties to our business-combinations project, and there
is international interest in how we proceed.”
At least for now, however, FASB seems to be sensitive to corporate
concerns about the difficulties of valuation.
“We are not smart enough to define particular metrics specific to every
single industry,” says Upton. “We have to be careful about the language we use, because some of these intangibles are idiosyncratic.”
Techniques of Measurement
A few markets that have intangibles at their core have been tried over the
years. In 1995, rocker David Bowie issued $55 million of bonds backed by anticipated royalties from his music library.
Securitization pros expected the Bowie bonds to usher in an era in which a
broad range of intellectual property assets could be monetized. As it turns out, few such deals followed, in part because of difficulties in structuring
intangible asset-backed securities.
Another attempt at deriving values for intangibles began last February with
the launch of the Patent & License Exchange. Patent holders can use the Web-based service’s Technology Risk/Reward Unit (TRRU) system to put
a value on the patents.
For a fee, the patent holders also can list their patents on the Website
(www.pl-x.com) so that interested parties can license the patent method.
Fees vary based on the number of patents loaded into the pl-x database.
The Pasadena, Calif.-based exchange’s database now includes more than
15,000 listings from over 400 companies. Participants include Bristol-Myers Squibb, Dow Chemical, Eastman Chemical and Hitachi America. –J.S.
Ambivalent About Intangibles
The study on intangibles published last April by the Financial Accounting
Standards Board provides few clues as to how FASB will proceed on the issue of defining, measuring and reporting nonfinancial assets. Although the
report discusses various approaches to quantifying intangible assets, it stresses
that because intangibles are often unique to particular industries, the board is unlikely to ever deliver hard accounting standards. The
emphasis, it says, will be on “standards for form, presentation and disclosure
of underlying assumptions.”
Another task force, convened by the SEC, issued its report in May and puts
a heavy emphasis on the voluntary release of data on intangible assets. The report also calls on the government to create a more congenial environment
for companies to release intangible-asset data by making it more difficult for investors to sue over allegedly
inaccurate information. –J.S.
When 2001 winds to its close, everyone–from the leaders of countries and
companies, to the builders of cars and skyscrapers, to the designers of chips
and couture, to the managers of finance, to the keepers of the peace–will
breathe a sigh of relief. It has been an extraordinarily difficult year, in fact an
extraordinarily challenging and exhilarating ten years.
A decade ago the nation faced many of the same hurdles that confront us
today. In 1991, we were at the depths of a recession that forced many
companies to shutter and millions onto unemployment lines. Less familiar
hostile powers, with an untested capacity to destroy, seemed almost
inexplicably bent on crushing our open society. Technological change was
rushing over us so quickly that most justifiably feared being left behind. Little
of that has changed. But in the period of unmatched prosperity and opportunity
that followed, we became complacent to the prospects of bad things
happening, making the calamity of Sept. 11 all the more unfathomable.
Then as now, we had a George Bush and an Alan Greenspan to protect our
shores and financial markets. Then as now, we were headed to war–although
at least in 1991 we knew where our enemy was.
But forces not at play in 1991 will shape the next 10 years. The most profound
of these is the Internet. Although we are feeling a bit less awed by it these
days, the Web has brought us closer together and made our world more
immediate. Global is actually coming to mean global–even in the United
States where an island mentality and cultural arrogance has stifled the trend.
Certainly, the Asian contagion of the late 1990s demonstrated our
interconnection and interdependence.
On the financial front, many of the complaints may sound similar, but the
landscape is vastly different. Waves of consolidation have linked former
household names and transformed others into historical footnotes. We finally
got past the tedious Glass-Steagall debate; financial reporters are still rejoicing.
Ordinary people now watch the stock markets as closely as portfolio managers
at Fidelity. Although the process seems slower than globalization would
demand, international financial standards in accounting, disclosure, corporate
governance, commerce, capital markets, and intellectual property are starting
Through it all, Treasury & Risk Management has attempted to document
change and give it context. To commemorate T&RM’s decade of operations,
the magazine has assembled a collection of business leaders to muse on the
past 10 years and give focus to the coming 10. Most of the interviews were
conducted when the tragic events of Sept. 11 were still inconceivable, and our
speakers were cautiously optimistic. But if we are to give our children the
same kind of promise we realized in the last decade, we cannot forsake
optimism about the future. For while a frightening picture is developing of what
the world has become, we cannot afford to lose our far-reaching vision of
what it could be.
Richard Grasso, Chairman and CEO
New York Stock Exchange
When the New York Stock Exchange emerges from the shadow of the World
Trade Center disaster, it will refocus its attention well beyond Broad Street,
says its homegrown chairman. “We’re going to have to become more global in
our product offerings to investors,” says Grasso, 55. “We’ve got to bring more
non-U.S. companies to the U.S. market faster. Just the top one-third [of the
3,000 companies that qualify to list] would produce roughly four times the
market value of the entire market-cap opportunity available to us from
NASDAQ and the [American Stock Exchange].”
To reach his goal, he expects the Big Board to significantly expand its work
hours. “I don’t think [operating] 24/7 is near-term, but I do think that 16/5 over
the next two to three years is something that has got to be seriously
considered,” he says.
Grasso also predicts more exchange-to-exchange competition, and to that end
he promises that the NYSE will remain “insatiable” in its appetite to recruit
qualified NASDAQ companies to the Big Board. Indeed, he says he has no
plans to close the NYSE’s Silicon Valley recruiting office, despite the
downturn there. “[We] are banging on those doors as we speak.”
Larry Marks, Director
“Ten years ago everyone knew that electronic payment systems would be the
end game. They were wrong. The paper-based system is as healthy and
strong as ever, while electronic payment systems are coming on more slowly.
The mechanic that has brought the promise of change has been the Internet,
[but] there are regulatory issues that were never really addressed: taxation in
different countries [and] different laws for moving money cross-border. One
area I see as particularly crucial: How do you transact business electronically
but not over land lines? If we can find safe and secure ways over
mobile-phone connections, we are going to see something that will look like a
Robert Glauber, Chairman, President and CEO
National Association of Securities Dealers
In 1991, the National Association of Securities Dealers was a tenacious
terrier. It pursued high-tech companies to list on the exchange, it regulated
their capital-raising activities, and it served as their loudest cheerleader to
potential investors. Today, a much-sobered NASD has emerged as a
single-minded, self-regulatory body that by mid-2002 hopes to reduce its
current 27% stake in NASDAQ to zero. “When you have a for-profit
exchange, it should be totally independent and separate from its regulator,”
says Glauber, a former undersecretary for finance in George H. W. Bush’s
Once it severs ties with NASDAQ, NASD could sell its services as a
regulator to world exchanges, and computerized trading systems such as
Instinet may register as exchanges. “Now that we don’t own one of the
competitors, we can make a credible argument to other exchanges that they
ought to think about outsourcing to us. We can do it cheaper, and we think we
can do it better,” he says.
James Grant, Editor
Grant’s Interest Rate Observer
“The most striking change in corporate capital raising is [that] a sizable class
of corporate securities is in the hands of highly leveraged people. There is no
due diligence. There is a boom in convertible bonds [being sold] to highly
leveraged hedge funds that buy them not for intrinsic value, and not to convert
the stock, but to hedge the equity against the debt. The arbitrageurs want price
volatility so companies are selling their price volatility, which is scary because
it’s not clear to whom [they] would sell these bonds if they had to.
“The last 10 years also have been a laboratory in dip buying, seizing evidently
bad news and making a great investment, with almost no regard for valuation.
The hallmark of this bubble was the systematic mispricing of capital and risk
so when the price of capital shot up, the great swath of the new economy
Ted Benna, Founder and President
The “father of the 401(k)” says he laments having launched the first plan in
1981 without providing plan participants with a structure to help them make
smart investment choices.
Though he crows over the multi-billion dollar defined-contribution market he
helped spawn–plan assets soared to $1.7 trillion at the end of 2000 from $385
billion in 1990, according to Access Research–Benna is now hawking a
structured portfolio plan to remedy its shortcomings.
Participants who want an easy answer “can put their money all in a single
portfolio regardless of their age, go to sleep and forget about it, letting
somebody else oversee and manage it for them. The level of risk automatically
ratchets down as they get older,” he says. Self-directed employees,
meanwhile, could choose an open fund window, making their own investment
choices or picking from a wide range of advisers.
Current efforts by plan sponsors to “educate” participants about lifestyle
investing generally fail, he says. The structured alternative not only should
draw in more participants but also help plan sponsors avoid fiduciary liability
since participants will choose the investment structure. “The problem with
advice as a solution is that…only about 10% or 20% of participants are using
advice when it is available. You can’t turn 40 million or more participants into
sophisticated investors through education or through advice.”
Sir David Tweedie, Chairman
International Accounting Standards Board
Ten years ago, efforts to establish global accounting standards were far down
on the wish lists of regulators and the companies they oversee. But things
changed after the Asian financial crisis of 1997 and 1998. “Companies in Asia
went belly up and it was a great shock because the statements had looked all
right,” says Tweedie, formerly chairman of the UK’s Accounting Standards
The accounting czar urges the business community to embrace accounting
uniformity, even if implementation is initially disruptive. It will encourage
“confidence in the markets, lower cost of capital [and] help further
investment,” he says. “And it [will] mean you can pick up a set of accounts
anywhere in the world and understand them.”
The IASB over the next few years will “settle upon the best-of-breed
[standards]. In many cases that will be the United States, but it won’t be with
all of them,” he says.
Henry Kaufman, President
Henry Kaufman & Co.
Though he may never shake his 1980s reputation as Dr. Doom on the state of
the economy, Kaufman is surprisingly low-key about the consequences of last
month’s terrorist attacks on the nation.”The events of Sept. 11 have increased
the chances of a brief recession, and, at the same time the economic recovery
next year will be of a very modest proportion,” says Kaufman, the former
research chief of Salomon Brothers, who now runs an eponymous economic
consulting firm. “The intermediate consequences of the attacks in New York
and Washington will include some very sharp declines in profits in a number of
industries, significant increases in government spending and, therefore, the
sharp falloff in the U.S. government’s surplus in the fiscal year beginning Oct.
Kaufman says it’s too early to discuss the long-term impact of the attacks in
light of unanswered questions about the scope of the “war” against terrorism
and its effect on various industrial sectors and the possibility of further terrorist
Turning to the dot-com craze, Kaufman says that human nature has not
changed and that continuing cycles of boom and bust are inevitable. “We get
into periods of financial and economic excesses periodically because we tend
to forget the past,” he says. “The dilemma is that very few people, despite
being well grounded in quantitative risk analysis, have historical perspective.”
Judy Lewent, CFO
Merck & Co.
Her advice for treasurers aspiring to become CFOs is simple: “Look outside,
use all of the networks and contacts you have to provide the best information
on what’s going on with capital markets. Being insular or parochial is the
worst.” She ought to know. A 21-year veteran of Merck, Lewent leapt to
CFO from treasurer in 1993. “I always take issue with people who take the
treasury function as being separate from the business,” she says. “If you don’t
understand the underpinnings of the business, you cannot be a top-flight
treasury person,” let alone a competent CFO. She also advises treasurers to
embrace technology. “Technology doesn’t supplant analytics and people. It
may help transfer funds, but when you’re talking about state-of-the-art
treasury functions like risk management and enhancing shareholder value, that
Samuel Hayes, Professor of Investment Banking
Harvard Business School
“W hen you become an 800-pound gorilla, you are muscle-bound, not nimble,”
says Hayes of the continuing consolidation in the financial services sector. “I
have real doubts that in the long term these financial behemoths will return to
shareholders the profits that they are envisioning.” Within 10 years, Hayes
says the number of banks with significant global reach could dwindle to
perhaps six, which is bad news for corporations. He also says that while
corporate clients have for many years been the dominant partners in banking
relationships, that is rapidly changing. “Banks are intent on redressing the
lopsided balance of power,” he says. “This [consolidation] is a reaction to that
sense of impotence that many commercial banks have felt.”
Former U.S. Trade Representative
As the Clinton administration’s chief advocate of open trade, she had a
reputation as a tough negotiator on controversial issues such as the North
American Free Trade Agreement and the cultivation of China as a trading
partner. From her vantage point now as a partner at the law firm of Wilmer,
Cutler & Pickering, she shakes her head at the lessons learned from the failed
General Electric-Honeywell merger that was quashed by the European Union.
“Government regulation is not only the bane of a company’s existence in the
U.S., it’s the bane of the global company’s existence [wherever] it wants to
locate and wishes to invest,” she says.
She nevertheless is bullish about the expansion of free trade, and celebrates
last month’s acceptance of China into the World Trade Organization. And
though she’ll be watching to see if China can balance the WTO requirements
for open markets with its closed political system, she thinks that China’s entry
will impact trade with such countries as India, now “the de facto spokesman
for the developing countries in Asia.”
Templeton Asset Management Ltd.
Coming out of one of the toughest years he’s endured since launching his first
emerging markets fund in 1987, Mobius remains upbeat about the
developing-country sector. He still spends 250 days a year on the road as
manager of $8 billion of emerging-market assets, scouring the economies and
companies of nations that most money managers shun. “Emerging markets
exhibit all of the dangers that people who are risk adverse get scared
about–corruption, political upheaval, et cetera,” he says. “[It's what] makes
emerging markets look pretty cheap.” So where does he see a bright future?
These days it’s in South Africa (“a First World environment in a Third World
image”), Mexico (which he sees adopting both a political and corporate
governance sensibility modeled on the U.S.), Indonesia and Thailand (full of
potential for those willing to put up with political risk).
FAS 133/Risk Management
William Fall, Head of Global Risk Management
Bank of America
In the wake of the FAS 133 mark-to-market accounting rule that became
effective last year, “we have seen some customers cease activity altogether,
although they are, fortunately, a rarity,” says Fall. “I don’t think 133 slowed
derivatives trading nearly as much as we feared it might. It amazes me that
we still seem to see some quite complex transactions.”
To be sure, customers have had to work hard to figure out how to deal with
FAS 133, but he notes that issues such as the shrinking number of dealers still
weigh on the minds of financial executives. “There’s almost an oligopoly [of
six banks] emerging that are very broadly capable across a number of
different asset classes.” That’s leading customers to take “a much more
integrated approach” to managing risk, which he believes is for the best.
John Sinnott, Chairman and CEO
“Ten years ago, corporate insurance brokers focused on arranging for
earthquake coverage, third-party liability, marine cargo insurance and other
property and casualty coverage,” says the head of the world’s biggest
insurance broker. “If [I had been] asked about risks that get into the broad
financial or operational or strategic areas…I probably would have said, ‘you
need to talk to someone else.’
“[Today] the scope of risk that clients want to look at is broader than just
hazard risk, and it gets into broader solutions. I would have identified [those
solutions] as the capital markets 10 years ago,…but it has turned out to be
insurance capital or financial guarantee capital that has [most] expanded the
definition of the risk we’re willing to underwrite.”
John Heimann, Senior Adviser
Merrill Lynch & Co
The Glass-Steagall Act separating commercial from investment banking
activities may have fallen at the end of the ’90s, but Heimann says that the
regulatory system overlying financial activities still needs work, as it is
“antiquated [and] out-of-date with the realities of the financial system in the
globe today.” The proposed new Basle international banking standards are
based on a simple theory: the higher the risk, the greater the capital required.
“Restrictions are the father of innovation. I don’t know all of the things people
will come up with [to manipulate the standards], but they surely will. And then
it’s up to supervisors to clamp down.”
Robert Monks, President
Lens Investment Management
“When [shareholder activism] started 20 years ago, it was considered a rogue
act. Now it is widely recognized by those involved in ownership that it
produces a better company. But the problem is that [the activists] are mostly
the public employee pension plans…The IBMs and GMs [are not] getting
involved. As long as CEOs continue to be unwilling to instruct their pension
plans to obey the government law, there will only be a fringe [group of
corporate] activists. ERISA clearly says that trustees of pension plans must
manage assets solely for the benefit of plan participants. They have been
unwilling to, because it might jeopardize business relationships. Unfortunately,
government has acquiesced in not enforcing the law.”