Measurement and Financial Economics Valuation

Abstract

For many years accounting was based on historical data while finance was based on expected future data. This difference creates a gap between accounting and finance regarding issues like the values of assets held by companies and liabilities, including equity, issued by them. IFRS in general and the fair value measurement as introduced by IAS in the last few years brings accounting and finance together. In this study we present, discuss and test a measurement instrument called Value Based balance Sheet (VBB). The VBB rests on three major propositions in accounting and finance; first, the accounting paradigm that describes a firm by its assets and liabilities and defines the identity between them. Second, the finance valuation model that defines the value of a firm as the discounted risk adjusted cash flows to be generated by the firm, and then allocate the actual cash flows over time to different claimants. The third proposition has two parts; in a complete and perfect market the value of the firm is independent of its capital structure, in an incomplete market with monopolistic competition the risk profile of the liabilities should be congruent with the risk profile of the assets. Ex ante Incongruence between the risk profile of the liabilities and the assets will reduce the value of the firm. The VBB focuses on the third proposition, but it also reflects the first two propositions. The VBB differs from other valuation instruments like Economic Value Added (EVA) in looking at both the assets and the liabilities of the firm and the relationships between them. We test the VBB as a way to gain better insights into the development of value over time. We do that by using a unique data set of venture capital backed (VC) young innovative companies in the software industry. The test shows that the VBB is an effective way to trace and better understand the dynamics of the value of these firms.

Keywords: fair value measurement, valuation, capital structure