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Volume 17, Number 11
November 2011

Assessing stewardship

Darren Henderson finds that fair value accounting provides useful information on managers’ stewardship. But it doesn’t tell the whole story

For many years accounting standards have used historical costs to value assets. For example, a piece of land purchased 50 years ago for $10,000 would be carried on the books for that amount, even though it’s now worth a lot more.

Over the past decade there’s been a gradual movement from historical costs to fair value accounting. Ivey Professor Darren Henderson looks at how to improve financial reporting so that investors and creditors get the possible information. “Fair value accounting says that a 50-year-old number is not useful to investors - we should be providing a current value,” says Ivey Professor Darren Henderson. “The trade-off with fair value is that coming up with a current number is often just a matter of opinion.”

There are two main goals in accounting: to provide valuation information and stewardship information. Valuation is simply what a company is worth. Stewardship, on the other hand, focuses on management’s responsibility as custodian of firm resources, including the effective and efficient use of those resources. For example, the valuation objective aims at measuring profit, whereas stewardship aims to evaluate profit commensurate with risk.

A key stewardship-related issue is management compensation. If a CEO gets a bonus for simply turning over assets, then analysts will question whether the CEO is motivated to be a good steward. “The focus of valuation has been to get the most up to date information, whereas the stewardship focus has been to give an objective measure of how management has done,” says Henderson.

The traditional view has been that fair value accounting achieves the valuation objective and historical costs achieves the stewardship objective. In a recent study Henderson questioned whether both financial reporting objectives – valuation and stewardship – could be achieved through fair value accounting. For his study he used a unique data set, the financial statements of 75 UK real estate firms over a ten year period from 1995 to 2005. The UK, unlike other countries, has been using fair value accounting for investment properties since 1981. The UK accounting rules have also required companies to report historical costs in the notes to the financial statements, giving a good basis for comparison.

Henderson found that fair values do provide useful stewardship information and help to assess managerial performance. However, his findings come with a caveat. To be useful for stewardship purposes, fair values must be supported by reliable and consistent external appraisals. “It’s important that the manager doesn’t have control over these figures,” he says. In addition, he found that fair value changes provide more useful stewardship information when corporate governance is strong.  

Although fair values are useful, Henderson found that optimal stewardship reporting should include both fair value and historical costs. “You still need historical costs to have a full assessment of management stewardship,” he says.

In today’s corporate environment, managers need to demonstrate that they have been strong stewards of provided capital.  Henderson’s research shows that in order for managers to provide credible information on stewardship they have to convince investors and creditors of the reliability of that information. 

Henderson expects that future accounting standards will require that managers reveal a greater amount of stewardship information. “Over the last decade we have seen a trend that companies disclose more detailed information about their compensation packages and how the compensation committees came up with them,” says Henderson. “That trend will continue in the future. Investors and creditors want stewardship information from managers beyond the profit number.”

International Financial Reporting Standards (IFRS), which Canada has adopted this year, allow firms the option of reporting fair value or historical costs for investment properties. “My research tells standard setters that just providing fair value, without historical costs, is a net loss of information,” he says. “Although fair value provides useful information on management stewardship, it doesn’t give you the full story.”

Professor Henderson's Homepage