Chapter 6Valuing Financial Services – The Evidence

Market-consistent frameworks address the theoretical and practical challenges of valuing risk-based, capital-intensive businesses. In spite of this, they are not universally embraced.

Some in the industry characterize market-consistent valuations as “too volatile” and not reflective of the long-term economics of the business. But what if market-consistent approaches better reflect the way that our shares are actually valued? In this case, value managers who do not like either the volatility in the measures or in their share price should address the underlying business model rather than shoot the messenger.

Others blame mark-to-market accounting for procyclical behavior, such as the forced sale of assets or capital raising at distressed prices during a crisis. A contrary view is that forced actions are the result of poor capital and risk management practices: crises occur with amazing regularity, so why aren't we prepared? Again, rather than shooting the messenger, management should build a robust and resilient capital structure and risk appetite if it doesn't like being forced to take action during the next crisis.

This chapter presents compelling evidence that market-consistent approaches reflect actual share price developments far better than other, more stable accounting approaches. The implication for value managers? Don't shoot the messenger – read the message, understand what influences share value and manage accordingly. ...

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