A new approach to financial valuation, international accounting standards, and prudential standards
Philippe Foulquier, Ph.D., Director of the research centre in financial analysis and accounting, introduces the centre, the themes it works on, and its publications.
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Today, cultural and technological changes allow multiple dynamic analyses in several areas, the cornerstone of which is the discount rate: risk is the essential element. A profound change has been underway for a decade now; the aim of the change is to improve stakeholders' views of the risks actually taken by companies. Faced with increasingly complex risks, accounting and prudential standards (IFRS, US GAAP, Solvency II, and Basel III) are undergoing a complete revision. These reforms have an impact on the management of financial or non-financial firms (enterprise risk management, economic capital models, management control, internal control, and so on).
There may be a large body of research into the determination of the discount rate in general and on risk more particularly, but the gap between academe and the business world seems to be growing wider by the day. In practice, those who do the valuations often oversimplify, invalidating their reasoning; they may even ignore theory and transform the discount rate into a black box to hide the absence of objective and academic foundations for the determination of the risk premium and of beta.
The aim of the EDHEC Financial Analysis and Accounting Research Centre is to shed new light on risk integration (the impact on management, strategy and financial communication, valuation, and discount rates) and to recommend new practical solutions of management in general as well as methods suited to the frameworks for accounting and prudential standards.
The great diversity of backgrounds is one of the advantages of the research centre (specialists in financial analysis, in corporate finance, in accounting on one hand and from academe or from business on the other), and it allows the centre to take a multi-disciplinary approach to company valuation and management: the impact of IFRS on risk valuation and risk pricing; the impact of IFRS and Solvency II on insurance company management; bank-insurance and optimal capital allocation; the financial structure of family firms and cost of capital; optimisation of steering tools (internal control, management control, enterprise risk management, market-consistent embedded value, asset/liability management, economic capital).
The EDHEC Financial Analysis and Accounting Research Centre is working on five research programmes:
The mission of the EDHEC Financial Analysis and Accounting Research Centre is also to accompany businesses in a tailor-made implementation of the Centre's research results and thus to offer consulting and financial engineering services.
The great diversity of backgrounds is one of the advantages of the research centre (specialists in financial analysis, in accounting, in law, researchers from academe or from business), and it allows the centre to take a multi-disciplinary approach to financial analysis.
Philippe Foulquier, Accounting Professor - Director of the Research Centre.
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Liliana Arias Arellano, Research Engineer
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Mohammed El Hedi Arouri, Professor, University Auvergne CRCGM
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Pierre-Laurent Bescos, Research Associate
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Guillaume Déderen, Research Associate
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Philippe du Jardin, Professor
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Paul Klumpes, Research Associate
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Alexandre Le Maistre, Research Associate
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The EDHEC Financial Analysis and Accounting Research Centre studies company valuation. Cultural and technological changes now make it possible to use multiple dynamic analyses, the cornerstone of which is the discount rate. There is an abundance of academic research into the determination of the discount rate, but the gap between academe and business seems to be growing wider by the day. In practice, those who do the valuations often oversimplify, invalidating their reasoning; they may even ignore theory and transform the discount rate into a black box to hide the absence of objective and academic foundations in the determination of the risk premium and of beta.
The objective of the EDHEC Financial Analysis and Accounting Research Centre is to call into question certain financial paradigms, in particular that which consists of separating idiosyncratic riskbecause it is diversifiablefrom the risk premium to provide the financial markets (financial analysts, investors, companies, rating agencies, auditors) with new light on the discount rate and to recommend new ways to determine it. To do so, five research programmes have been set up:
This programme is the foundation of the Financial Analysis and Accounting Research Centre. It monitors the discount rate. Indeed, the aim of this programme is to review academic theories on the cost of capital and, in an attempt to understand the reasons for which they are not used in practice, point out the drawbacks of each. The goal is to create an EDHEC valuation model that reconciles academic and operational demands.
The ideology of the Centre is that company valuation should incorporate an operational risk premium that includes a systematic accounting risk that should be emphasised more greatly by IFRS demands for the qualification and quantification of risk. In this respect, the aim of the programme is to call into question the financial paradigm that separates idiosyncratic risk from the risk premium and thus to contradict the dogma according to which international reporting standards are neutral with respect to the perception of risk; instead, our work shows that there is an impact either on the financial aggregates analysts base their work on or on the strategy used by companies to counter the accounting effect.The first study done by this programme, entitled The Impact of IFRS and Solvency II on Asset-Liability Management and Asset Management in Insurance Companies and undertaken in conjunction with the EDHEC Risk and Asset Management Research Centre, was sponsored by AXA IM and presented at the European Parliament in Brussels as well as in Paris and London, at round tables and conferences involving insurance professionals and European regulatory authorities.
In recent years, the subject of this research programme has been a recurring theme in valuation as done by the financial community. In general, analysts operate intuitively when, in view of the quality of corporate governance, they make adjustments to the discount rate. We want to bring greater scientific rigour to this practice.The first study in this programme is sponsored by Décathlon and deals with optimising the financial structure of family companies, the cost of capital, and valuation. As it happens, the particular features of family companies invalidate many of the findings of modern financial theory, in particular with respect to the analysis of company performance, of governance systems, of financing structures, and of investment policy.
The aim of this research programme is to show how the management of risks can generate value for companies, and thus how it can have an impact on their cost of capital and their valuation. Value creation is currently assessed and steered through residual result indicators (such as economic value added) or through strategic management control tools (such as the balanced scorecard) that take the management of risks into account little or not at all.
Initially, this programme will focus on the definition of the concepts necessary to the implementation of a rigorous method of determining risk-adjusted capital, of value creation (depending on the return on risk-adjusted capital and the cost of capital), and of the optimisation of the allocation of own capital per business unit. Once this conceptualisation is completed, our objective is to make improvements to the tools currently available to the management controller by complementing them with risk management indicators.
The use of these indicators should be evident both in external financial communication transmitted to investors and in the internal performance management of the companies.
The goal of this research programme is to study the conditions for the optimisation of bankruptcy prediction models, in particular through research into relevant indicators and methods of depicting the early signs of bankruptcy. These indicators and signs are an essential source of information for financial analysts and evaluators, especially when the company is believed to be in trouble.
First, from a perspective of forecasting bankruptcy risk, the role of the methods of indicator selection in model performance is analysed, in particular the ways the greater or lesser fit of the methods and the modelling techniques can affect the accuracy of forecasts. Here, the aim is to propose means, not yet fully explored, of improving the models.
Then, this time from a perspective of bankruptcy prevention, ways to portray the processes leading to bankruptcy will be studied; an attempt will be made to describe characteristic trajectories. Ultimately, the idea is to propose a tool for the early diagnosis of bankruptcy, a too that relies on a dynamic vision of the financial health of the company.