Presentation by Joshua Ronen

1. Presentation by Joshua Ronen Fourth International Workshop on Accounting & Regulation Siena, Italy – 20-22 September, 2007 Joshua Ronen, Stern school of Business

2. fair values under FAS 157 • Consistent with the asset-liability approach • Consistent with the principle-based approach to the setting of standards • Relies on exit values from the perspective of external, hypothetical markets • Three levels of measurement Joshua Ronen, Stern school of Business

3. The assets-liability approach • Earnings are not informative about future earnings • An income statement approach helps predict value added Joshua Ronen, Stern school of Business

4. FAS 157 exit values • Reliability of levels two and three are an issue • Hypothetical market-based Exit values do not help in predicting enterprise cash flows • Market bubbles would be transplanted into the income statement. • But exit values may help assess aspects of risk and opportunity costs • We ultimately need both exit values and management's forecasts of use values Joshua Ronen, Stern school of Business

5. A comprehensive accounting framework • Reports management’s present value of subjectively predicted cash flows Discounted at a general market risk-determined rate • Reports exit values as a measure of downside risk (abandonment value) and opportunity cost • Specific advantage and specific residual • Reporting past realizations and de-realizations distinguishing between the expected and the unexpected Joshua Ronen, Stern school of Business

6. The reports • Balance sheet: historical cost, exit values, and specific advantage • costs and benefits statement: Expected cash and changes in risk • Income statement: Expected and unexpected historical and economic income • Change in assets composition statement: realizations and de-realizations Joshua Ronen, Stern school of Business

7. Moral hazard and misrepresentation • Managers may misrepresent their expectations • It is however possible to elicit truth through a revelation mechanism • But this may not be in the interest of short-horizon shareholders • Hence we need reform in the gate keeping function Joshua Ronen, Stern school of Business

8. Reform of the auditing structure • Financial statements or restatements insurance • Auditors' and managers' interests become aligned with those of long-term shareholders • Ex ante publicization of the premium signals financial statements quality, completes the market, and channels savings to socially useful projects • To reduce the premium and decrease the cost of capital managers will be provided with incentives to improve the quality of financial statements Joshua Ronen, Stern school of Business

9. Restructuring of compensation arrangements • Managers periodically purchase stock or are granted restricted stock at a price randomly chosen ex-post at the end of the period. • Sales of stock would be restricted till some time after exit • Management will be induced to create value over the long run wild not inflating value over the short run in order to pay less for the purchased stock • This scheme may have to be mandated because it is not incentive compatible Joshua Ronen, Stern school of Business

10. Let there be a market maker • The CEO, CFO or an informed member of the Board of Directors can be charged with the task of making a market in the firm's stock. Dishonest bid or ask quotes would penalize him or her. • Correlation between quotes and financial statements content would be a useful check on the quality of the latter Joshua Ronen, Stern school of Business