The Journal of Applied Research in Accounting and Finance
The Journal of Applied Research in Accounting and Finance (JARAF), Vol. 6, No. 1, July 2011
7 Pages Posted: 9 Nov 2011 Last revised: 18 Aug 2014
Date Written: July 9, 2011
As this issue goes to press, the world has witnessed a massive retreat from stocks and commodities following the downgrading of the United States’ triple-A credit rating. The rating agency Standard & Poor’s argued that there was evidence of diminished creditworthiness in the world’s largest economy, finally making the unprecedented decision to downgrade the US credit rating to AA on 5 August 2011. This action, along with continued concerns over European sovereign debt, has shocked global equity markets which eroded up to US$7.8 trillion in value since the end of July.
Such a reaction by global markets might suggest that investors had assumed that there would never be a situation where the US would lose its AAA credit rating, let alone a situation where choruses of nation states cry in unison as they stand on the edge of sovereign default. Without the benefit of such hindsight, events such as these were not considered reasonable assumptions by the consensus of financial decision makers; and it is exploring this consensus that sits at the heart of this issue of JARAF.
In understanding decision-making, managers need to reflect on how their bias, beliefs and experiences influence their perceptions of new situations. While the problem of managers being misled by untested assumptions is not new, the effect witnessed in global equity markets demonstrates that it can be fatal.
In this issue of JARAF, we focus on three significant assumptions that commonly underpin financial decision-making: modern portfolio theory, credit ratings and asset valuation. For each of these focus areas, our contributors highlight flaws in the way that managers rely on this information and they offer guidance on ways to better approach decision-making in these domains.
We start with an article from hedge fund manager Scott Vincent on the flawed assumption underpinning Modern Portfolio Theory (MPT). The consensus view has been that a well-diversified, index-type portfolio will deliver superior returns and it is this belief that has underpinned the unfathomable flow of capital to index fund over the past decades. However, as Vincent explains, there is compelling evidence that a sub-set of active managers persistently outperform indexes, suggesting a result inconsistent to the consensus view.
Next, Ulrich Schroeter from the University of Mannheim provides a timely overview of credit rating agencies and discusses the growing risks from their widespread use and increased dependence in trade, commerce and market operation.
Finally, and of particular interest to investors and analysts, Charles Mulford and Eugene Comiskey shine a spotlight on the valuation of deferred tax assets, an ever-growing intangible asset found sprouting on many corporate balance sheets. This research investigates the tax planning strategies supporting their valuation and the underpinning assumptions regarding a firm’s future profitability. It is evident from their research that there is much inconsistency, and as such, uncertainty regarding the valuation of this burgeoning asset class.
Keywords: financial reporting
JEL Classification: M40, M41
Suggested Citation: Suggested Citation