Capital Markets

Playing Cat and Mouse with Fair Value

Top-drawer investors think that mark-to-market accounting will help them read the minds of CFOs.
David KatzApril 10, 2008

Sophisticated investors—managers of hedge funds, private-equity partnerships, institutional portfolios—claim that digging out the mark-to-market value of the companies they invest in is no big whoop for them. Indeed, it’s a key part of their jobs to try to come up with more accurate market values than their competitors do.

So why have they been so gung-ho about getting corporations to move apace to the uniform system of fair-value accounting required under the Financial Accounting Standards Board’s Statement No. 157 and other fair value strictures?

You might well think the cream of the investor crop wouldn’t want such a leveling of the field that all shareholders play on. But fair value gives them an added insight into the minds of the senior executives who run the companies: how top management evaluates the companies they run. And such intelligence adds to investors’ knowledge of a key component of the companies they buy shares in—the quality of management.

Two high-powered investors speaking at a panel discussion aimed at explaining fair value to the media on Wednesday laughed at the notion posited by that the new FASB fair-value reporting regime would be the focus of a cat-and-mouse game between their ilk and senior finance executives. But they acknowledged that there was truth in it.

Under a system of fair-value reporting, “you get an idea of how good management is in rating their assets,” R. Harold Schroeder, director of relative-value arbitrage at Carlson Capital, said during the panel, which was sponsored by the CFA Institute Centre for Financial Market Integrity and held at the headquarters of the New York Society of Security Analysts. That knowledge will ultimately be factored into the share prices of the companies, he added.

Adam Hurwich, a managing member of Calcine Management LLC, a private partnership founded in 2004, mark-to-market disclosure enables investors to detect problems at the company “that much quicker” by heightening their awareness of management shortcomings via their laxity in valuations of their own companies.

Further, fair-value reporting, by providing a clearer measure of current corporate asset and liabilities, will likely lead to a better overall economy, he said. That would motivate companies to assume less unsupportable risk, Hurwich predicted.

To be sure, there are immediate practical reasons for sophisticated investors to embrace wholesale reporting at fair value. Schroeder, who oversees a team of portfolio managers, traders, and analysts, presiding over an $8 billion portfolio equally divided between short and long investments, says his firm doesn’t have time to measure the fair values of the financials of the 1,800 companies it monitors and is therefore helped by the requirement that all companies operating under Generally Accepted Accounting Principles must report them.

For that reason alone, he suggested, “it will lower the cost of debt and equity over time.”