Steven B. Lilien

CEO Compensation after Deregulation: The Case of Electric Utilities

The 1992 National Energy Policy Act (NEPA) intensified competition in the electric utility industry by allowing nonutility generators to produce and sell power in wholesale energy markets. Congress expected NEPA to lead to improved operating efficiencies by substituting market forces for regulation. A data set that is unique to the utility industry allows us to test how and whether utility firms reallocated resources to improve efficiencies and, more important for this study, whether CEO compensation changed in accordance with agency theory predictions that CEO compensation would become more incentive-based and more equity-based in the competitive operating environment.

Countering Opportunism in Structuring and Valuing Transactions: The Case of Securitizations

During the financial crisis of 2008, the debate on the accounting professions role has focused mostly on mark-to-market accounting rules. We argue that other weaknesses in the accounting rules as applied to securitizations predate the current crisis. The accrual system that underlies all accounting allows revenues to be recognized in advance of cash flows but requires reserves on receivables. Similarly, the fair value system books unrealized gains, but fails to recognize reserves explicitly. In illiquid markets, fair value estimates have to be based on internal models. Compensation arrangements that are closely tied to these estimates create a perfect setting for managers to increase their compensation by inflating asset values. We propose a method of recognizing fair value reserves that builds on existing practice. Such reserve accounting, an application of conservatism, will mitigate procyclical swings in fair value estimates and reduce incentives for overly optimistic asset valuations. Our analysis is conceptual in that we describe issues and their potential causes, and we propose a solution. We neither build a formal model nor perform empirical tests. Our article is exploratory and is intended to generate debate that could lead to significant improvements in accounting standards and provide a basis for rigorous empirical tests.

Normal Turbulence or Perfect Storm? Disparity in Fair Value Estimates

The use of fair value measures in financial statements embeds managerial assumptions about the future into the reporting process. This is particularly so for Level 3 measurements that are developed from financial models of future cash flows. This article documents a case where a firm bought a majority stake of 52% in November 2009 of a subsidiary where it already had an equity holding of 29% (i.e., acquired an additional 23%). The proportionate fair value implied for the 48% noncontrolling stake as well as the 29% prior equity holding in the acquired firm using Level 3 methodology was roughly triple the amount reported as Level 1 measures for these very same holdings. The discrepancy in valuation boosted the bargain gain at acquisition wiping out the retained earnings deficit of the parent firm. In addition, the acquirer reported a US

How Fair Values and Accounting Structures Allow Triple-Counting Income: Implications for Standard Setters, Market Participants, and Academics

200 million (40%) impairment of the subsidiaries’ primary asset (housing stock) in November 2009 whereas the subsidiary reported the unimpaired value in its year-end financial statements in December 2009. While we agree that Level 3 valuations potentially provide useful information to shareholders, they can fulfill this role only if the disclosures can be effectively audited. Our primary motivation in writing this article is to show that fair value disclosures are not being audited sufficiently rigorously in practice and to make some suggestions on how these rules may be improved.

Intended or Unintended Consequences of Business Acquisitions: The Case of Financial Services Institutions

The legal and economic rationales for using off-balance sheet structures for securitizations of receivables are compelling. However, accounting standards enabled self-interested parties to participate in the securitizations in nontransparent ways. For instance, securitizing firms set up the off-balance sheet structures, sold tranches to these structures, and often booked gains on these sales based on internally determined valuations. In addition, the tranches retained by the firm were marked to market, again based on internally determined valuations. In the wake of the financial crisis, the accounting standards changed and began requiring most off-balance sheet structures to be reconsolidated. However, the standards continued to allow nontransparent treatments. Namely, the securitized assets, which had largely become nonperforming, were written down in a way to avoid income recognition, providing incentives to overaccrue allowances, which are now being released as gains in income. We provide a case study to illustrate the issues in detail, and we expand our study to the group of the largest credit card securitizers. We highlight the implications of triple-counting income for research analysts, academicians, and policy makers.

CEO Stock-Based Compensation: An Empirical Analysis of Incentive-Intensity, Relative Mix, and Economic Determinants

ASC 805 gives the management of an acquiring firm flexibility in valuation and the possibility of recognizing day one bargain purchase gains (BPG). BPG acquisitions occurred frequently in the financial services industry during the crisis of 2008 and some of these acquisitions were assisted by the FDIC which provided partially indemnification against future losses. The combination of these two events set up a unique situation to study fair value accounting. By using the data from all bank transactions, we are able to highlight the fundamental tension between relevance and reliability in fair value accounting. Our results show that in FDIC assisted transactions, fair values reflected the underlying economic transactions more accurately whereas non-FDIC assisted BPG transactions suggest that management was able to use inflated fair values to present an overoptimistic picture of the acquisition.