Task Force on the Valuation and Measurement of Equity

Task Force on the Valuation and Measurement of Equity

Document for Agenda Item 2.b

DRAFT REPORT: Third Meeting of the Advisory Expert Group on National Accounts

18 – 22 July 2005, at ESCAP, Bangkok

Valuation of equity

Issue C9: Paper SNA/M1.05/32; for information

Description of the issue

Paragraph 13.73 of SNA 93 just says that ‘‘the value of shares that are not quoted on stock exchanges or otherwise regularly traded should be estimated using the prices of quoted shares that are comparable in earnings and dividend history and prospects, adjusting downward, if necessary, to allow for the inferior marketability or liquidity of unquoted shares’’, but without making reference to specific issues or methods. The issue is, however, very relevant, as unquoted shares in many countries are far more important than quoted shares. Nonetheless, little progress was formerly made in producing harmonized data on unquoted shares. There are two questions for clarifications to help harmonize the valuation of equity:

(a) the breakdown of the item shares and other equity into quoted shares, unquoted shares and other equity as done in the ESA95;

(b) recommendation of methods of valuation of different types of equity. This is not a substantive change question but one that will discuss equity from both the asset and liability side, considering both inter-company and portfolio investment in relation to listed and unlisted equity. Expansion and clarification of text about equity in the SNA will pave the way for better harmonization with other standards, in particular BPM5 (which does deal very closely with portfolio and direct investment).

Presentation

448. The paper for this session (document number SNA/M1.05/32; Issue C9) was written by Patrick O’Hagan from the Task Force on the Valuation and Measurement of Equity (TFVME) and presented by Charles Aspden. The session was chaired by Adriaan Bloem.

449. The first meeting of the TFVME was at Statistics Canada in April 2005, and it focussed on measurement-valuation questions, in particular

(a) measurement questions/options for unquoted equity

(b) measurement questions/options for inter-company (direct) investment equity.

450. Equity is a complex instrument that specifies some degree of ownership in a firm and it is an investment. In some cases, it is a marketable security for portfolio and direct investors and it is a liability of firms to shareholders in the SNA model. It also provides a measure of the underlying value (net worth) of corporations. Equity can take on different valuations, including underlying book value, acquisition cost, current value, market value.

451. Equity is a major asset (and liability) category and figures prominently in measures of sector net worth (including the international investment position) in the balance sheets. The 1993 SNA is the principal international reference document, but it includes only a minimal discussion of equity. There is a need to expand, integrate and clarify measures of equity.

452. According to the SNA, when they are regularly traded on stock exchanges or other organised financial markets, shares and other equities should be valued in the balance sheets at their current prices. The value of shares in corporations that are not quoted on stock exchanges or otherwise traded regularly should be estimated using the prices of quoted shares that are comparable in earnings and dividend history and prospects, adjusting downward, if necessary, to allow for the inferior marketability or liquidity of unquoted shares. Equity in quasi-corporations should be valued as equal to the value of the quasi-corporations’ assets less the value of their liabilities (see 1993 SNA, para 13.73). In addition, paragraph 13.83 refers to net asset value and residual corporate net worth.

453. Components of equity include:

(a) listed portfolio investment

(b) listed inter-company (direct) investment

(d) other unlisted equity.

454. Practical and analytical considerations would dictate similar detail, valuation and measurement of equity asset and liability components. The estimation of unquoted equity is currently under study; direct investment is also under discussion. The integrated nature of the SNA implies a need to harmonise the concepts of all related equity components.

455. The TFVME is in the process of reviewing conceptual and methodological questions, for assets and liabilities, including portfolio and inter-company investment, in the context of the sequence of accounts.

456. A second and final meeting of the TFVME is scheduled for October 2005 at the OECD. This meeting will review the initial redraft of the equity sections of the 1993 SNA as well as consider other questions, such as links to other chapters, links to the work on intangible assets and equity stock-flow considerations.

457. The expanded redraft of relevant sections on equity will focus on:

(a) a detailed discussion of equity types to reflect its complex nature

(b) an expanded discussion of practical questions and alternatives in the current/market valuation of corporate equity, in particular for the difficult area of unlisted equity

(d) an interpretation of residual corporate net worth, as well as its link to firm’s equity liabilities

(e) an improvement in the integration among the SNA chapters that deal with equity (chapters 11, 12, 13, 14).

458. It remains to be determined whether the draft should follow a less prescriptive approach than in the current standard (e.g. paragraph 13.73 of the 1993 SNA).

459. A final report (including a re-draft of the sections on equity in the 1993 SNA) will be prepared for the January 2006 AEG meeting.

Discussion

460. The following points were raised during the discussion:

• the TFVME should ensure it uses national accounting terminology in its reports

• work of the TFVME should be coordinated with work in similar fields undertaken in Europe by the ECB, and by the Canberra II Group

• outputs from the TFVME that are potentially going to be used in the updated SNA should focus on the underlying concepts and not be too prescriptive.

Summary conclusions

Observation

461. The AEG suggested that the Task Force should take into account the work already undertaken on this topic in Europe and related work by the Canberra II Group and, as suggested for the clarification question on non-market output, should document reasons for changes and proposals rather than simply present redrafted text.