In the new CGR Working Paper Financialized Accounting: Capitalization andleveraging the intangible Professor Colin Haslam and Dr Nick Tsitsianis argue that financialization is about the way in which speculative ‘intangible’ value gets wrapped up as collateral to generate additional financial leverage for on-going asset recapitalisations. In speculative capital markets asset values tend to inflate ahead of earnings. That is, the ‘vendibility’ of assets is promoted at the expense of the ‘serviceability’ of these assets. 

The International Accounting Standards Board (IASB) conceptual framework and extant International Financial Reporting Standards (IFRS’s) encourage the use of ‘fair value’ or ‘mark to market’ accounting. A position reinforced by recent European Directives on the construction of a firm’s annual financial statements. Thus accountants can value balance sheet assets using information from benchmarks based on active secondary speculative markets or employ judgement to model valuations in the absence of an active market pricing assets.

In this working paper the authors make two significant and critical points. First, the system of double entry book-keeping transmits financial disturbance between line items in a firms financial statements. And because these line items are not equivalent a relatively small disturbance in one can trigger large adjustments and instabilities in another. This is illustrated with ‘goodwill’ recorded in balance sheets as the difference between the market and book value paid for acquisitions. The author’s estimate that around one-quarter of US and European corporates have reported goodwill that now exceeds 75 per cent of shareholder equity funds.  If this goodwill is impaired it could trigger a large adjustment in shareholder funds and compromise solvency. Second, the authors argue that asset values reported in corporate balance sheets are de-temporalised. Asset values recorded in current time also embody uncertain and speculative assessments about future value.  Relatively small changes in judgements about the future, for example, cash flows, discount rate and risk can have a material impact upon assets values recorded in current time. 

In financialized accounts speculative recapitalisation of asset values are now, more and more, woven into the fabric of corporate financial statements. This increases the potential for financial instability and reinforces what economists describe as a moral hazard because in times of difficulty investors will protect their positions against other stakeholders.

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Continue reading the complete working paper:

Financialized Accounting: Capitalization and leveraging the intangibleby 
Colin Haslam & Nick Tsitsianis