Guy Ford

Goodwill Impairment - An Assessment of Disclosure Quality and Compliance Levels By Large Listed Australian Firms

The adoption of A-IFRS has resulted in the introduction of fundamental changes to the Australian accounting and reporting regime for goodwill. The impairment testing led approach to goodwill reporting required under A-IFRS results in a materially different approach to goodwill valuation for balance sheet purposes and to the nature and timing of the influence of goodwill as an asset class on the determination of periodic profit. Arguably, the transition to A-IFRS goodwill accounting and reporting also results in substantially increased complexity - both in terms of the techniques required of reporting entities in accounting for goodwill, and in the nature of disclosures required in relation to goodwill and its impairment. This suggests the possibility of inconsistent compliance and varying levels of disclosure quality by firms making their first reports under the new regime. Consequently, this paper examines the level of compliance with a variety of the provisions of AASB 136 - Impairment of Assets and the quality of disclosure provided in accordance with that standard, by reviewing the 2006 accounts of a sample of 50 large Australian listed corporations. Material levels of non compliance were found and a material degree of variation in the quality and precision of disclosures pertaining to impairment testing procedures was also evident. Policy recommendations and potential directions for future research are identified and discussed.

Intellectual Capital and Valuation: Challenges in the Voluntary Disclosure of Value Drivers

Many commentators have identified the pivotal role of intellectual capital in the valuation of firms and the determination of their future earnings. Innovation in voluntary disclosure of intellectual capital lead by European firms, such as Celemi and Skandia, has generated a plethora of new reporting frameworks such as the Balanced Scorecard. However, there has been little support by the accounting profession to recognise the value of intellectual capital or adopt a common disclosure framework. There has also been very little progress by firms in extending their voluntary reporting frameworks, beyond just rhetoric, and attempting to quantify their intellectual capital. This paper will critically evaluate the challenges faced by firms in disclosing the elements and value of their intellectual capital to the market.

Bank Credit Rating Dynamics

An increase in the credit rating on the debt of an organisation is generally perceived positively, as higher credit ratings are, in the main, associated with lower perceived volatility in the market value of the assets of the entity that has issued debt. Lower asset volatility implies more stable and sustainable cash flows, and thus a lower likelihood of default on debt, and the result is a lower credit spread on the debt. If banks price their assets to realise a target return on economic capital, then a higher credit rating will result in higher loan rates if the fall in the banks cost of capital, associated with the lower insolvency risk, is insufficient to offset the additional net income that the loan must be priced to cover. In this paper we develop a loan pricing model that assumes that financial institutions price their assets on a risk- and cost-adjusted basis and with the aim of achieving a minimum required return on the banks economic capital holding. We compare theoretically derived decreases in the banks cost of funds to actual data on bank credit spreads in order to ascertain the extent to which the increase in credit rating is beneficial to the bank. We find that the minimum decline in the cost of funds in our model generally exceeds the empirical data, meaning that the reduction in funding costs is insufficient to offset the increase on loan rates associated with higher economic capital. The divergence increases as the proportion of retail funds increases. We further find that the hurdle rate on economic capital is a significant factor in determining the value of a bank increasing its solvency standard. If the hurdle rate remains fixed regardless of the capital structure of the bank, then an upward movement in credit rating may have little impact on the value of the bank given the large divergence between the theoretical decline in the cost of wholesale funds and empirical data on bank credit spreads. However, the divergence is considerably less pronounced if the hurdle rate is varied in direct proportion to the leverage of the bank.

The Impact of Economic Capital on the Optimal Funding Equation for a Bank

This paper develops a framework for examining the impact of changes in the solvency standard of a bank (target credit rating) on the pricing of bank assets. We show that the decision of a bank to increase its solvency standard increases the price of bank assets to the extent that a bank prices its assets in order to earn a minimum return on target economic equity. However, a higher credit rating should also reduce the cost of rated-debt that a bank uses to fund its assets. We develop a loan pricing model to assess the breakeven point at which the impact of a higher solvency standard on bank asset prices is matched by the reduction in the cost of rated-debt, and compare our theoretically-derived results to actual credit spreads on bank debt rated by Standard and Poors in order to determine the if there is an optimal credit rating for a bank. Our model uses a beta distribution to derive the capital multiplier necessary to determine the target economic equity for the bank. We vary the proportion of rated-debt funding the banks assets. We also assess the impact of changes in the hurdle rate used to price bank assets, where the hurdle rate is varied in line with changes in the leverage of the bank. Our paper shows how target credit rating, funding mix and hurdle rates interact to determine the optimal asset mix for a bank. The paper also demonstrates the significance of the distribution assumptions used to determine the economic capital for a bank.

The Use of Extended Reporting Frameworks in Australia

This paper explores extended reporting frameworks, catalogues various typologies and investigates the use of one international framework in Australia. We outline the background to the development of new reporting frameworks by examining the academic literature in the area of sustainability research. We identify and catalogue 11 new reporting and social accounting guidelines and they are catalogued in table 1. Following this analysis, we focus on the development of one particular framework, the Global Reporting Initiative (GRI), and investigate its use in Australia. We find that 38 Australian entities have voluntarily adopted the GRI and these entities are disclosed in table 2.

A Loan Pricing Model: The Influence of the Lender's Credit Rating

Within the context of a banking institution, economic capital is a statistical measure of the amount of resources required to meet unexpected losses over a specified time period and specified level of certainty. The amount of economic capital held by banks is thus a function of their target insolvency rate (the probability that losses will exceed a certain threshold) and is linked to an implied credit rating. In Australia, for example, the top four banks maintain sufficient economic capital to achieve a target credit rating of AA, which is equivalent to a 0.03% probability of insolvency. The benefits that accrue to banks from a high credit rating, in general, are access to lower cost funds in debt markets and low counterparty margins in swap and foreign exchange markets. However, as banks increase their economic capital to achieve a higher credit rating, the breakeven price on their asset portfolios will rise to the extent that the bank prices these assets to achieve a minimum return on economic capital. Ceteris paribus, the increase in loan rates may make the bank uncompetitive in specific asset markets, depending on the extent to which loan rates and other asset prices are market driven. Thus an increase in the solvency standard for a bank has two opposing effects on bank asset prices. To the extent that a bank prices its assets to achieve a target return on economic capital, an increase in economic capital will increase the net income that the bank needs to earn on its assets, resulting in higher asset prices. Offset against this, is the impact of a higher solvency standard on the cost of funds and market credit spreads for the bank. We propose that a bank that carries a large proportion of its funding book in retail funds may not benefit by targeting a high credit rating, depending on the sensitivity of retail depositors to incremental changes in credit rating. We model this relationship to ascertain an optimal economic capital requirement, varying the relative proportion of retail funds in the funding book. We compare the results of our model to empirical data on bank credit spreads in capital to markets to assess the extent to which an upgrade in the credit rating of a bank will be beneficial to the bank.

Do Hybrid Instruments Lower the Firm Cost of Capital

The issue of hybrid instruments by firms is often justified on the grounds that these instruments allow issuers to achieve a lower cost of capital than would be the case under issues of straight debt and equity. In order to assess the validity of such claims it is necessary to examine the economic impact of hybrid instruments on the issuing company. If a firm can genuinely achieve a lower cost of capital than would otherwise be the case with the issue of either straight debt or equity, we argue that this is directly linked to regulatory (reporting) arbitrage, rather than the outcome of financial synergy that arises when debt, equity and option instruments are combined to form a hybrid security. We evaluate the argument that hybrid structures lower the cost of capital from an opportunity cost and risk perspective. We focus our analysis on two main structures: convertible debt and reset preference shares.

The Options holding concentration problem : evidence from Australian listed corporations

The literature on executive options has burgeoned over the past decade. While early literature tended to expound the benefits associated with the adoption of options plans, more recent literature has taken on a more cautionary tone. Recent empirical research has suggested a range of conditions under which the adoption of options plans might result in unanticipated outcomes. This paper adds to the literature by discussing options holding concentration, which we define as the proportion of options outstanding under a firms executive options plan held by a firms board and the top five non-board executives. We examine previous empirical literature on executive options plans and some of the incentive problems associated with the implementation of such plans, which have been reported in the literature. On the basis of these discussions, we discuss why it might plausibly be expected that options holding concentration could represent a variable with the power to explain the degree to which incentive problems are encountered by organisations, which employ executive options schemes. We report observed options holding concentration for a sample of Australian listed corporations between 1997 and 2002, but demonstrate that while significantly inversely associated with firm size, holdings concentration does not appear to be associated with factors which point towards organisational risk taking and cash payment policy choices. We discuss possible reasons for our findings and suggest potential future research extensions flowing from our work.

Executive Options Plans and Firm Performance - Bigger Isn't Better

Executive options represent a phenomenon of particular economic significance. Just as their use has ballooned over the past decade, so too has the literature concerning their nature, cost and impact. However, despite the growth in the volume of literature devoted to the topic of executive options, there appears to be little agreement as to the performance impact brought about in consequence of the decision by firms to introduce executive options into their remuneration mixes. This paper contributes to the literature by providing evidence relating to the impact of options plans on firm financial performance. In particular, evidence is presented which suggests that option plan size (as measured by the portion of outstanding equity capital covered by options grants) and options holding concentration (the degree to which options granted under a plan are concentrated into the hands of the firms most senior managers) have a significant impact on the manner in which executive options plans impact on firm financial performance.