Effects Of Managerial Discretion In Fair Value Accounting Regulation And Motivational Incentives To “Go Along” With Management On Analysts’ Expectations And Judgments

Running Head: Article 3 - WEEK 5

Effects of Managerial Discretion in Fair Value Accounting Regulation and Motivational Incentives to “Go Along” with Management on Analysts’ Expectations and Judgments

Group A

Polytechnic University of Puerto Rico

Master Program in Engineering Management- On Line
Managerial Accounting (MGM 5500-OL)
Professor:

1. Summary: what is a main conceptin the case or article?
This article presents a study on the ethics of Fair Value estimations in light of conflicting or misleading information from companies and the effect of analyst incentives on stock valuation for these same companies. The study presents a questionnaire that presents a company with asset impairment loss. The analysts were given each a different questionnaire thatevaluated whether the company provided misleading information on the Fair Value of the impairment loss contrasted with non- misleading information. In addition, the questionnaires presented a contrast on whether the analyst had interests in the company performance or not.
This ethical concern derives from the issuance of the Financial Accounting Standards Board Statement No. 157 in September 2006.This statement provides three levels for the measurement of an asset or liability Fair Value (SFAS 157).
* Level 1: The asset or liability is traded in an active market and can be measured from a quoted instrument of this market and multiplied by the amount of asset on hand.
* Level 2: The asset or liability is not traded on an active market but similar assets are traded and a value can bemeasured from the traded values and possible asset valuation in the active market.
* Level 3: The asset or liability is not traded on an active market and no similar assets are traded. Fair value can be measured based on unobservable inputs, asset costs and an estimate for future trading value.
The Level 3 measurement provides greater flexibility to analysts when determining the Fair Valueof an asset or liability. This flexibility may be used by an analyst to under value a liability or over price an asset in favor of a company. Thus, be influenced by external factors in the decision especially when having interests in the evaluated company.
The article results showed that analysts were able to discern when companies presented misleading information. In addition, the analysthad a tendency to minimize the potential loss of an impaired asset and had provided higher estimates of company stock price regardless of the misleading information provided when they had incentives on the company. The analyst perceptions of the potential loss ranged close to $237 million regardless of the misleading information from the company. This contrasted with the numbers involvingincentives, where analyst estimated loss at close to $190 million when the company provided truthful information but lowered the estimate at close to $169 million when the company provided misleading information.
The stock price estimates followed a similar behavior to the estimates in potential loss. Stock price estimates with no incentive present a ranged between $49 and $51 regardless of truthfulor misleading information provided by the company. A noticeable gap in stock prices occurs in the presence of incentives. The Stock price estimate for the case of truthful information provided ranges around $55 while the stock price for the misleading information case yielded an estimate of $59. This represents a difference of around $4 per share.

2. Situations that arise in the case orarticle
This study on Fair Value Measurements propose that such values introduce subjective estimation and thereby provides managers with opportunities for earnings manipulation. The investigation examines the effect on analysts-judgments when managers intentionally issue misleading information regarding the valuation of an asset impairment loss, where there is no active exchange market for...