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Companies with Market Value Below Book Value Are More Common in Europe Than in the US: Evidence, Explanations and Implications

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Companies with market value below book value are more common in Europe than in the US: evidence, explanations and implications 2013 kpmg.com KPMG INTERNATIONAL Contents KPMG’s Global Valuation Institute Companies with market value below book value are more common in Europe than in the US: evidence, explanations and implications Mauro Bini Stephen Penman © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Foreword 2 1. Introduction 4 2. Accounting conservatism and accounting slack 8 PART ONE 3. MV < BV: S&P 500 vs. STOXX 600 14 4. Value for whom: market value vs. control value 18 5. Persistence of negative difference between MV and BV 24 6. MV < BV: analysis by sector and country 26 PART TWO 7. Goodwill impairment testing under US GAAP and IAS/IFRS 34 8. Flexibility in estimating recoverable amounts under IAS/IFRS 40 9. Accounting for loans in the banking sector 42 10. Tests of the role of value in use in determining the difference between MV and BV 46 11. Conclusions 52 References 53 APPENDIX: Country and industry breakdown 54 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 2 | Companies with market value below book value are more common in Europe than in the US: evidence, explanations and implications Foreword KPMG’s Global Valuation Institute broad range of business professionals. The paper focuses on the accounting (GVI) is pleased to introduce its third This includes illustrative papers with models for impairment testing in management paper since the launch applications and/or case studies. assessing differences between market of its research agenda. Through this process, we keep KPMG’s capitalizations and book values for the global network of 1,200 valuation different geographies and accounting We recognize that valuation is a professionals informed of emerging standards. The paper addresses a constantly evolving discipline that has valuation issues. number of interesting areas, such been shaped by practical and theoretical as describing the decline in market advances. Many high quality research This paper, Companies with market value prices and economic prospects during papers on valuation subjects never find below book value are more common and after the recent financial crisis their way to the public domain with an in Europe than in the US: evidence, and potential adjustments to market opportunity to influence the evolution of explanations and implications, is authored capitalization to reflect possible control standards and practice because of a lack by Mauro Bini and Stephen Penman. premiums, as well as a number of of exposure to practitioners. The paper compares the book issues related to the value in use Our goal is to act as a catalyst for the public values and market capitalizations concept used under IFRS. dissemination of breakthrough valuation of US and European companies in Under IFRS, impairment testing of research. To this end, KPMG’s GVI benefits the S&P 500 and the STOXX 600 goodwill is based on a comparison from the expertise of an Academic respectively, and documents a of the carrying amount of a cash- Advisory Board comprised of professors greater proportion of companies generating unit (CGU) or group of CGUs from Beijing University in China, with book values that exceed their to its recoverable amount, which is the Northwestern University in the US and market capitalization in Europe than higher of its fair value less costs to sell Oxford University in the UK. This Board in the US. The European companies and its value in use. Under US GAAP, designs a research agenda and selects and in the study report under International impairment testing of goodwill involves reviews the sponsored research. Financial Reporting Standards (IFRS) a two-step test with fair value used in while the US companies in the study We work closely with researchers to both steps. Value in use is not applied report under US Generally Accepted present their management papers in under US GAAP. Accounting Principles (US GAAP). a format that is understandable to a © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Companies with market value below book value are more common | 3 in Europe than in the US: evidence, explanations and implications Value in use is a concept that was market in this sector as well as various introduced by the IASC in IAS 36 industry specific factors such as the Impairment of Assets, but is not a use of the incurred loss model to generally recognized valuation concept determine loan losses. The incurred outside of valuations performed for IAS loss model could delay recognition of 36. Value in use is intended to measure loan losses compared to alternative the value to an entity of holding and approaches being debated by operating an asset (as opposed to fair accounting standard setters, such Doug McPhee value, which considers the exit value as an expected loss model. The fact Global Head of Valuation Services of the asset to market participants in that financial services companies a hypothetical transaction). Value in represent a larger proportion of the use involves an assessment of the STOXX 600 than the S&P 500 may recoverability of book value that directly be a significant contributor to the considers an entity’s specific facts and differences in market capitalization circumstances and may be less volatile and book value for companies in the than market prices. However, the authors STOXX 600 and S&P 500. identify potential issues with the value in The authors make a very useful Yves Courtois use concept, including its value relevance contribution to understanding Partner, KPMG in Luxembourg to share pricing. the differences between market The paper notes that many of the capitalization and book values for US companies whose book values and European companies and we trust exceed their market capitalizations that you will find it of interest. are financial services companies such This paper reflects the views of the as banks and insurance companies. authors and not necessarily those This may be the result of significant of any KPMG member firm. underperformance relative to the Jean Florent Rerolle Partner, KPMG in France © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 4 | Companies with market value below book value are more common in Europe than in the US: evidence, explanations and implications 1. Introduction This paper examines listed companies its persistence over a prolonged period The global financial crisis of 2008 in the US and Europe with market of time indicates a reluctance to make provides a natural setting for this capitalizations less than the book value impairments. This is especially the case investigation. The crisis was an adverse of equity in the years immediately for assets whose recoverable amounts event so vast in scope, so deep, so before and after the global financial are measured via models, as with Level 3 prolonged, and similar in its intensity crisis of 2008. The paper documents a fair value and value-in-use determinations. in the US and in Europe. With the higher percentage of companies in the Even with no formal requirement for coincident drop in the market value of (European) STOXX 600 with market assets to be marked to market, a situation firms, the crisis provides an important capitalization less than book value than in where market value is below book value opportunity to compare market value the (US) S&P 500. Further, the negative should invoke accounting standards that and book value differences in the US difference between market and book require the recalibration and review of and Europe, where companies use value is larger for European companies valuation models to ensure that valuations accounting standards based on similar and more persistent over time. The paper are not based on special assumptions.1 principles under US GAAP and IAS/IFRS seeks explanations for the differences. The widespread observation of market but which differ in practice. value lower than book value thus indicates Market value below book value is an an unusual situation that warrants indicator of potential impairment, and investigation. Figure 1: S&P 500 vs. STOXX 600: market prices between 31 Dec. 2005 and 31 Dec. 2010 180.00 160.00 STOXX 600 140.00 120.00 S&P 500 100.00 80.00 60.00 40.00 20.00 0.00 02-Jul-10 02-Jul-09 02-Jul-08 02-Jul-07 02-Jul-06 02-Apr-10 02-Apr-09 02-Apr-08 02-Apr-07 02-Apr-06 02-Jan-10 02-Oct-10 02-Jan-09 02-Jan-08 02-Jan-07 02-Jan-06 02-Oct-09 02-Oct-08 02-Oct-07 02-Oct-06 S&P 500 (US) STOXX 600 Source: (http://www.factset.com/): FactSet 1 International Valuation Standards, 2011: “IVS300.6. It would not be appropriate for a valuation prepared for inclusion in a financial statement to be made on the basis of a special assumption”. “IVS Definitions. Special assumption – an assumption that either assumes facts that differ from the actual facts existing at the valuation date or that would not be made by a typical participant in a transaction on the valuation date”. © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
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