Public Dialogue Tour:
Washington, DC
Listen to a recording of the dialogue
The struggles of the U.S. credit market and the related challenge of the valuation of assets took center stage for much of the discussion during the tenth and final stop of the Center for Audit Quality’s Public Dialogue Tour in Washington, D.C.
“We shouldn’t have this kind of volatility,” University of Delaware Professor Charles Elson said of recent adjustments in the value of some financial instruments. “You had assets that were valued at a certain level and reported as valued at a certain level that suddenly were, apparently, not as reported. And, the difficulty was that the decline in the valuations wasn’t insignificant, it was substantial. But the risk of the decline in the valuations was never really predicted,” Elson said.
In response to an assertion that some financial instruments are too complex to value and therefore should not be issued, Mark Olson, Chairman of the Public Company Accounting Oversight Board (PCAOB), said he’d let the market sort out what is too complex. “What I would focus on,” he remarked, “is where there are areas of asymmetric knowledge…where you are lining up investors that do not have the sophistication and the capacity to understand certain products and their risks.”
In a wide-ranging conversation, a panel of regulators, an institutional investor, a corporate governance expert, a business professor and a business executive also considered the value of audited financial statements and how to better tailor audits to meet investors’ changing needs; the meaning of the term “audit quality;” and a possible move by the United States to adopt international accounting standards.
CAQ Executive Director Cynthia Fornelli served as host of the event and was joined by special guest Harvey Goldschmid, a CAQ Governing Board Member, the Dwight Professor of Law at Columbia University, and a former Securities and Exchange Commission member. During her introduction of the panel, Fornelli said one of the main goals of the Public Dialogue Tour is to find the best way to modernize financial reporting. She observed that discussions to date have made clear that “key stakeholders don’t necessarily want more information, but better information.”
The panelists noted the difficulty for both businesses and auditors in assigning fair value to new financial instruments and other items in a non-industrial economy in which human capital and intellectual property make up an increasing store of business assets.
Robert Herz, chairman of the Financial Accounting Standards Board (FASB), noted that he has been a long-time advocate of mark-to-market, or fair value, accounting, but that the approach works a lot better with markets that give off strong and clear price signals. He likened some recent financial instruments to “black boxes” that lack the necessary information structure for reliable valuation.
But the panelists were uncertain about how to improve valuation or the precise role of auditors in the process. Arne Sorenson of Marriott International said auditors should review the process by which management values its assets, but that valuation itself is the responsibility of management. Venture capitalist Gene Riechers of Valhalla Partners observed that you cannot eliminate all risk from the marketplace without also sacrificing the market’s vitality.
There was general agreement that investors would benefit from more forward-looking and predictive information that provides some sense of where a business is headed. There was also support for greater investor involvement in the development of auditing standards. Sorenson said that leaving standard writing completely to the experts can lead to rules that may be “a thing of beauty” from a theoretical accounting perspective, but are almost incomprehensible in practice.
Sorenson expressed doubt about whether auditors have the knowledge base to assess business prospects. He disagreed with Minow’s suggestion that auditors should pass judgment on the effectiveness of corporate management.
Herz said the prospects for more predictive reporting are hampered “by our old friend, ‘Old Man Liability.’” He observed that management discussions in financial reports in the United Kingdom tend to be “much more informative” than such discussions in the United States because of a different legal environment in the U.K.
After moderator Terry Smith noted that past public dialogue tour participants have pointed to the issue of executive compensation as among the most impenetrable and incomprehensible, Nell Minow, editor and co-founder of the Corporate Library, suggested, “If CEOs have to report to the IRS what they've earned, they ought to be able to figure out what that number is. And I would start with that. However, I must say that the SEC has improved the reporting of CEO compensation.”
The Center for Audit Quality intends to issue a final report and recommendations based upon the ideas and perspectives presented by tour participants across this country.
