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As the world's central banks explore a change in regulatory practices, accounting professor Wayne Landsman outlines the pros and cons
International central bank representatives gathered at the Bank for International Settlements (BIS) to hear KPMG Professor of Accounting Wayne Landsman's ideas about the implications of fair value accounting for bank regulation.
The BIS, headquartered in Basel, Switzerland, is an organization that fosters international monetary and financial cooperation and serves as a bank for central banks.
The BIS commissioned Landsman to present a paper at its workshop on "Accounting, risk management, and prudential regulation" Nov. 11-12. Central bank representatives from around the world — including the U.S. Federal Reserve Bank, the European Central Bank and the Bank of Canada — listened as Landsman tackled the costs and benefits of using fair value accounting for financial instruments for bank regulation.
By definition, fair value accounting measures the price at which an asset or liability could be exchanged in a transaction between two willing and equally informed parties. In terms of banking regulation, fair value accounting would change the way regulatory capital is measured.
"Bankers are concerned about adopting fair value accounting for two primary reasons," Landsman said. "First, fair value accounting potentially takes their ability to manage their earnings and regulate capital out of their control. It also potentially increases volatility in bank income and regulatory capital arising from measurement error associated with estimated fair values."
About the Basel Accords
The Basel Committee — including members from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States — introduced a capital measurement system in 1988 commonly referred to as the Basel Capital Accord. This system provided for the use of a credit risk measurement framework that has been progressively introduced in virtually all countries with active international banks.
In 2004, the Committee issued Basel II to create incentives for banks to enhance the quality of their control processes. Pillars of the new accord:
- Make minimum capital requirements more sensitive to a bank's risk of credit losses
- Recognize the necessity of bank regulators' supervisory review of an institution's internal assessment process and capital adequacy
- Leverage market discipline to motivate prudent bank management by encouraging transparency in financial reporting
Landsman's takeaways
Basel II offers a basic framework for bank regulation, and Landsman presented three ways in which fair value accounting would serve its implementation:
- Measures the quality of a bank's investments needed for measurement of regulatory capital
- Enhances supervisory oversight by helping bank regulators better assess how banks manage their risks
- Enables the stock market to play a complementary role in bank oversight as increased transparency in financial reporting will be rewarded by market participants
Landsman also provided insight into some of the issues of fair value accounting that may serve as obstacles to its implementation. Among these, he noted that loans that are not widely traded are likely to be difficult to fair value.
Research that affects business
Landsman is no stranger to the implementation issues of fair value accounting. He has published several articles assessing the way in which fair value information is associated with bank share prices.
In addition, his paper, "Option Pricing-based Bond Value Estimates and a Fundamental Components Approach to Account for Corporate Debt," specifically addresses the obstacles of implementing fair value accounting for corporate liabilities, which, from a bank's perspective as a lender, are the key bank assets.
The future of bank regulation
Landsman was surprised that the international central bank representatives in attendance reacted so positively to his presentation about its implementation. The European Union and the United States already are planning to implement fair value standards, and the central banking community is now weighing the issues of its implementation to see if they will follow suit.
"The consensus from the discussion during my session is that the regulators think it's the right way to go," said Landsman.
For more information contact Wayne Landsman at (919) 962-3221 or .
Doug Shackelford plays role in federal tax reform
The President's Advisory Panel on Federal Tax Reform submitted two final proposals to the Treasury Department on Nov. 1. UNC tax professor Doug Shackelford has been following the panel's progress closely since he testified about corporate tax reform before the panel last March in Tampa, Fla.
Both proposals offer significant changes to the tax breaks people have come to expect, as well as to the complexity of the tax code. The panel's mission was not to reduce taxes, but to make the tax code simpler, fairer and better able to promote economic growth. The Treasury Department will use the panel's proposals as a starting point for recommendations it will make to the president, possibly by year's end.
At the March panel, Shackelford made two main points about the current system and possible reform measures.
- Don't implement book-tax conformity.
"While the argument to use the same rules for measuring taxable income as you would use to measure net income is intuitively appealing," Shackelford said, "it is a bad idea because it overlooks the fact that the two systems have entirely different purposes."
The tax system is meant to collect revenue, and book numbers are intended to provide information about companies to the markets. If the same rules are used for accounting and taxation, the quality of information going to the markets would be reduced, and the ability of the government to raise taxes would be hampered.
- The current corporate tax system has some fundamental flaws.
"The corporate tax base is under attack from many directions," Shackelford told the panel.
Corporate taxes declined steadily from the 1950s to the 1980s, and stabilized over the past two decades. A primary cause of the decline is that the current accounting system was designed to support an industrial economy when a company's wealth was measured by its hard assets. Now that the bulk of the economy is service oriented, the accounting system is struggling to measure income because the primary assets are intangibles.
"As a result," Shackelford added, "taxable income is becoming increasingly difficult to measure."
Other factors eroding the corporate tax base include:
- International competition
- Growth of "S corporations" and partnerships that "pass through"
- Employee stock options
- Tax planning
The Proposed Changes
The tax reform panel's proposals to the Treasury Department included key points that reflect Shackelford's points of emphasis:
- More research is needed on the issue of book-tax conformity. "I'm pleased that they didn't adopt it," Shackelford said.
- Eliminate the unpopular alternative minimum tax (AMT). The AMT is a parallel tax system originally intended to ensure that the wealthy pay their fair share of taxes. Because the income-exemption levels have never been indexed to inflation, the AMT adversely affects many middle-income households.
- Integrate the individual and corporate tax systems. "U.S. law has created a false dichotomy between the corporate and individual tax identity. The panel is trying to fold the two together and integrate the system. And it makes a lot of sense," Shackelford said.
Research Affecting Policy
Shackelford's presentation to the panel reflected years of research in taxation and business strategy. Over his career he has investigated a host of issues surrounding the impact of taxes on business activity with a focus on the corporate taxation of international commerce.
In recent years, Shackelford has analyzed the impact of shareholder taxes on equity prices. Most financial economists have long assumed that tax-exempt institutions set stock prices; and thus, the taxes paid by individual investors on their dividends and capital gains are assumed to have no effect on stock returns.
Shackelford's ongoing research with UNC Kenan-Flagler accounting professor Jana Raedy and his former UNC PhD student, Jennifer Blouin (now at Wharton), provide compelling evidence that dividend and capital gains taxes are impounded in share prices and thus do affect stock returns.
Their latest study investigates the effects of the 2003 reductions in dividend and capital gains tax rates on corporate distributions. They find that dividends increased while share repurchases remained constant. However, among firms held predominately by individual investors (the sole shareholders affected by the legislation), dividend increases were offset with reductions in share repurchases.
The Future of Tax Reform
Don't expect sweeping tax reform yet, says Shackelford. Although he thinks the tax reform panel's proposals are good, he doubts the president will have the ability in his second term to get such sweeping reform passed.
"The tax reform panel has put a lot of work into putting a document into the public domain," Shackelford said. "The best thing they can hope for is that it will become an issue in the 2008 presidential campaign."
To read Shackelford's remarks to the panel, visit http://www.accountingweb.com/cgi-bin/item.cgi?id=100656 and http://www.taxreformpanel.gov/meetings/meeting-03082005.shtml.
Alumni Entrepreneurs Do Business in Style
Dressed for success
Anna Roop (BSBA '93 and MBA '99) and Amy Kistler (BSBA '94) always dress for success. It's just a little more comfortable for them now.
Roop and Kistler — who have been friends since their undergraduate days at UNC — both spent nearly a decade in investment banking. They were constantly irritated by the wool suits and sweaters they wore to the office. When they started talking to others, they realized they were not the only women itching to find a solution to uncomfortable business attire.
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| Roop and Kistler |
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The two women's search for personal comfort led them to start autrepeau ("other skin" in French), a line of lightweight innerwear that women can wear under suits and sweaters to keep them comfortable and cut down on dry cleaning.
After a year of grueling product development, they started shipping their product in 2003, and gave up their investment banking jobs to manage autrepeau's growing business.
The autrepeau line includes camisoles, turtlenecks, a variety of short and long-sleeved tops and a new pant liner. Customer feedback and requests strongly influence their product offerings.
Revenues at autrepeau have increased 10-fold since the company launched, split about 50/50 between their Web site and retail stores. Their product is carried at over 180 high-end boutiques nationwide. The company turned a profit last year and is poised to do so again this year. Online sales are growing slightly faster than in-store sales, largely because of good publicity.
That publicity has included features in InStyle Magazine, Women's Health, the Charlotte Observer and Real Simple. Although the InStyle feature was just three lines of text with no photo, their Web site business increased by five times its normal traffic because of the mention.
Horizontal stripes are the new black
When Chris Lindland (BSBA '95) tired of working in international business development for a dot-com, his entrepreneurial spirit led him down an unusual path.
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| Chris Lindland |
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The idea for his new business was generated at a cocktail party, when Lindland jokingly asked why nobody makes horizontally striped corduroy pants. It was good for a laugh or two, but nobody took him seriously. At least, not until his current business partner, Enrique Landa, suggested a company that could manufacture them.
Lindland had a pair made and was amazed at the attention he received when he wore them. His pants became an instant topic of conversation, the perfect icebreaker at parties. It was then that he recognized, despite his lack of knowledge of the fashion industry, he had stumbled upon a fashion statement.
Lindland sells his pants online on an irreverent Web site. Through a combination of word-of-mouth, public relations, guerilla marketing, and offbeat Web copy, Lindland's pants endeavor has become a modest success. It also has garnered him a loyal audience of subscribers to his weekly updates, a quirky blog that drives up traffic to the Web site four-fold the day it is posted.
"That's the important thing with our branding," Lindland said. "We engage our audience in conversation, and even more importantly, we provide them with conversation to have with other people."
Like Roop and Kistler, Lindland has developed a loyal following of customers who are waiting for his next product release.
In addition to the horizontal corduroy pants, Cordarounds' line includes horizontal seersucker pants for summer. The company is also developing a line of clothing for women, including a skirt that was just released, in response to 400 e-mail requests.
Since they started, Cordarounds has sold 2,000 units to 1,500 customers. Cordarounds has been featured by such media as the New York Times, Newsweek, the New Yorker, Entrepreneur Magazine and the CBS "Early Show."
Fashion forward
Both companies have plans for expansion, but Kistler, Roop, and Lindland are not eager for their companies to expand too fast.
Although Roop said their ultimate goal is for autrepeau is to be in every woman's closet, she admits that they are enjoying every step of their business development.
"Starting from scratch and creating something out of nothing has been one of the most gratifying parts of the whole experience," Roop said. "But better than that is getting that validation from the customer that we have a product that people really like."
Likewise, Lindland, who plans to open a retail store in San Francisco, is enjoying the entrepreneurial experience.
"This whole process has just been a lot of fun," he said. "Riding a fad of any kind is a fascinating thing to do. It is amazing to be walking around the city and see someone wearing your clothing."
The three entrepreneurs agreed that they have relied upon their education from UNC Kenan-Flagler in their new endeavors. All three said that the introduction to the various aspects of business, from accounting to marketing, gave them the confidence to tackle those particular areas necessary to running their own companies.
Networking was a big help as well, according to the women of autrepeau. "Without our network of friends and acquaintances from Kenan-Flagler and the broad-based education we received, we never would have had the ability to do this," Kistler said.
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