DRAFT Minutes
Task Force on the Valuation and Measurement of Equity
April 14, 15, 2005
Statistics Canada,
Ottawa, Canada
List of Participants
Chair: Anders Nordin, OECD
Julie Bonde, Statistics Sweden
Michael Brennan, CSO Ireland
Steven Cappoen, National Bank of Belgium
Massimo Coletta, Bank of Italy
Dominique Durant, Banque de France
Catherine Finneran, CSO Ireland
Nollaig Griffin, UK Office for National Statistics
Begoña Gutierrez del Olmo, Banco de España
Ned Howenstine, U.S. BEA
John Joisce, IMF
Toshie Koori, Bank of Japan
Christian Lajule, Statistics Canada
Susan Hume McIntosh, U.S. Federal Reserve
Ronald Nelisse, CBS Netherlands
Patrick O’Hagan, Statistics Canada
Matti Okko, Statistics Finland
David Pringle, Statistics Canada
Carlos Sanchez Munoz, European Central Bank
Ben Schreiber, Bank of Israel
Alan Tomas, Statistics Canada
Joe Wilkinson, Statistics Canada
I: Thursday, April 14, 2005
Morning session
Anders Nordin (Statistics Directorate OECD)
Introductory remarks (brief)
Karen Wilson (Statistics Canada)
Welcome address
In her view, there wasn’t sufficient attention given to balance sheet issues in The 1993
SNA. This has led to much national and international discussion about revision and
clarification. She was pleased that there is evidence of progress in these balance sheet
discussions. She offered some advice to the task force:
1. During the two-day meeting, think about what will go into the main document of
SNA 93 revisions and what will go into the supporting document.
2. Consider the valuation of goodwill. As the Canberra II Group on Non-Financial
Assets is also discussing the topic of goodwill, keep in mind that possible
differences may arise between the two groups.
3. Try to aim to get decisions and recommendations that result from this meeting on
paper.
4. Try to agree on the text describing proposed revisions and clarifications before it
is submitted to the Advisory Experts Group on National Accounts (AEG).
5. Discuss openly on this topic.
TOPIC I: GENERAL ISSUES
Anders Nordin (Statistics Directorate OECD)
The mandate of the Task Force on Valuation and Measurement of Equity (TFVME)
Anders Nordin introduced the mandate of the TFVME. The purpose of the task force is
to clarify and expand (if necessary) the treatment of the item “Shares and other equity” in
The 1993 SNA. These recommendations will be forwarded to the Advisory Expert Group
on National Accounts (AEG). As the task force works towards this goal, it should review
conceptual and methodological issues related to the valuation and measurements of all
types of equity and also consider the work of other working groups (such as IMF
BOPCOM and the IMF-OECD Direct Investment Technical Group and Benchmark
Advisory Group) who are addressing related issues.
While examining methods for valuing different types of equity, in particular unquoted
equity, the task force should consider the distinction between portfolio and intercompany (i.e. direct) investment assets in relation to the equity liabilities of corporations.
As well, attention should be paid to the significance of small unquoted incorporated
enterprises and the link between the financial balance sheet and the international
investment position. In its work, the task force should refer to the recommendations
already put forth by SNA93 and ESA95 on the matter of shares and other equities. A key
difference between SNA93 and ESA95 is that ESA95 proposes the capitalization method
be used to estimate the current market value of unquoted shares. SNA93 does not
propose any particular method.
Patrick O’Hagan (Statistics Canada)
Overview of equity issues
Presentation
Given the size and complexity of corporate equity in most developed economies, a sound
conceptual framework and methodological approach to measurement are essential, in
terms of the relevance of the statistics. SNA 93 provides minimal details about the
treatment of equity, giving limited guidance about the valuation of this complex financial
instrument. While SNA93 refers to two types of equity – quoted and unquoted – one
can propose a broader classification of equity types. In work at Statistics Canada, four
general categories have been be identified: quoted portfolio investment, quoted intercompany (direct) investment, unquoted inter-company (direct) investment, and other
equity.
While there appears to be consensus that portfolio investment in quoted shares should be
measured at market value, there seems to less agreement on how to treat unquoted shares
and handle inter-company investment and other equity. Arguably, different types of
equity may require different methods of valuation, especially if consideration is given to
the diversity of economic motivations that lie behind each type of equity investment. In
other words, an approximation to liquidation value may not necessarily be a good
reflection of the economic behaviour of all types of equity investors.
Despite its brevity on equity, a reading of paragraphs 13.74 and 13.83 suggests that there
are two approaches to perceiving equity, and potentially two ways of valuing it:
- The current market value (CMV) approach measures the market value of an
enterprise’s shares quoted on a stock exchange. The CMV of unquoted shares
may be approximated using information from quoted shares. The CMV of shares
is an external, market- specific assessment of an enterprise’s value.
- The net asset value (NAV) approach sees an enterprise’s equity as a firms’
intrinsic current value. Equity is the difference between an enterprise’s assets and
liabilities, all at fair value. It is an internal, industry-specific assessment.
The current market value and the net asset value assessments of an enterprise’s net worth
need not be equal. Even in the situation where assets, including intangible assets, are
identifiable and measurable at current value, excess demand for shares and speculative
pressures could place the CMV above or below the NAV and be more volatile in
behavior. This difference may be recognized as a residual, non-allocable net worth.
While SNA 93 does not deal with residual net worth in any detail it is a concept that is
indirectly under discussion in groups such as Canberra II, which is examining intangible
assets.
Country experiences are varied with respect to equity measurement and valuation, and
can also differ between balance sheet accounts data and the international investment
position (IIP) data.
The main practical issue with the CMV approach has been how to estimate the market
value of shares outstanding in the case of unlisted companies. The main issue whether it
is reasonable to try and estimate CMV for unlisted firms using the value of listed firms if
the market for traded equity is thin. Other issues include the use of a liquidity discount
and the use of size thresholds.
The main practical issues with NAV are concerns over the PIM model and lack of
complete coverage of assets. The components of a NAV calculation include produced
assets (e.g. machinery and equipment, plant structures) at current cost and inventories and
land at current value. A broader NAV measure would include financial assets and
liabilities at current-market value. Ideally, natural resources and intangible assets would
be identified and measured at current value.
Keeping in mind the interest of achieving internal consistency in handling unquoted
shares on both sides of the balance sheet and also ensuring international comparability,
seven points for discussion are proposed for consideration by the TFVME as its moves
towards developing a revised SNA text:
 a discussion of equity types, so as to better reflect the integrated nature of
macroeconomic accounts in the international standards;
 a clarification of quoted and unquoted equity;
 a clarification of residual net worth;
 consideration of the two main valuation alternatives, CMV and NAV;
 consider other valuation approaches;
 examine the practical considerations of the CMV and NAV valuation options;
 explore the option of blending of the CMV and NAV alternative when treating
unquoted shares.
Questions and comments
With regards to the proposed NAV approach to valuing unquoted shares, some clarifying
questions were asked about residual net worth and the role of intangible assets.
It is accepted that present national balance sheet compilers may not have the data that
allows them to develop a complete net asset value estimate of unquoted shares. Not all
countries feature tangible non-financial assets on their national balance sheets.
While the Canberra II discussions have made progress on the subject, the identification
and measurement of intangible assets is still under debate. The use of partial NAV
estimates to value unquoted shares may mean the undervaluation of small enterprises
whose profitability is linked to its unmeasured intangible assets (for example, small
enterprises in the ICT industry).
With respect to the CMV approach, the significance of valuing unquoted shares at market
value is that there is some sort of relation to the price at which owners of shares can sell
their shares.
TOPIC II: VALUATION OF QUOTED SHARES
Round table discussion on country practices: please see the Excel file
“TFVME_natltreat_quotedshares.xls” which features a summary of each country
presentation.
Afternoon session
Patrick O’Hagan (Canada) concluded the round table discussion with the observation that
differences in valuing quoted shares among countries are largely determined by
availability of information and the propensity of enterprises to list on stock exchanges.
In regards to household sector asset holdings, Mr. O’Hagan asked who among the
countries represented use household surveys to help in the estimation of asset holdings;
such as in the establishing of benchmarks. The United Kingdom, the Netherlands, the
U.S., France and Canada all said they have such surveys. Yet, not every country uses the
information to estimate household sector asset holdings. In the case of Canada, it was
indicated that significant differences were found for certain asset categories between the
balance sheet level and the survey estimate.
TOPIC III: VALUATION OF UNQUOTED EQUITY
Anders Nordin (Statistics Directorate OECD)
Presentation of results of the OECD questionnaire on unquoted shares
The interest in valuing unquoted shares is complicated by the facts that in most countries,
only a small proportion of enterprises are listed on stock exchange and the populations of
unlisted enterprises are rather heterogeneous in regards to size and economic activity.
Given that there is not a generally accepted method of valuing unquoted shares, there is
the concern that an evolving plethora of valuation methods among countries will impede
international comparability, thus affecting the analytic usefulness of financial accounts.
The Working Group on Unquoted Share (WGUS), organized in 2002 under the auspices
of Eurostat, sought to evaluate the feasibility of operationalizing the capitalization
method recommended in ESA 95. The working group identified two issues that it felt
country financial accounts compilers would face. These issues were 1) the insufficient
size of some national stock markets to provide enough listed enterprises for calculation
purposes and 2) the use of capitalization ratios may give overvalued estimates of
unquoted shares. Through the responses of several European countries to the WGUS
questionnaire and test exercise, the working group were able to give the following
recommendations regarding the operationalizing of the capitalization method: 1. that
small quoted enterprises and large quoted enterprise included in a major stock index be
excluded from the sets of quoted enterprises used for ratio calculation, 2. that the quoted
enterprises be organized into industry groups for the calculation of industry ratios, and 3)
capitalization ratios calculated from enterprises in a pan-European database on quoted
shares may be more appropriate than national capitalization ratios given their relative
stability.
Dominique Durant (Banque de France)
The implementation of the Eurostat method: the French experience
Presentation
The valuation of unquoted shares is a significant matter for the French financial accounts
compilers. In 2000, there were about 2 million enterprises with unquoted share liabilities,
representing approximately 70% of total own funds at book value. Explorations with the
capitalization method have involved three different versions of the method: the 1995,
2000 and 2005 approaches.
Data sources and method of calculation were reviewed. Several specific issues relating to
the method were explained. The use of weighted average ratios was preferred after
excluding the Stoxx 600 enterprises and small enterprises, although the use of the median
would still be an option. There was incongruence between the prescribed NACEspecified industry groups and the ESA 95 sectors which created time-consuming
reclassifications. There were an insufficient number of enterprises quoted on French
stock exchanges (less than 800) and they were not evenly distributed among the industry
groups, affecting the reliability of industry capitalization ratios. With regards to the
valuation of foreign direct investment in unquoted shares, inward direct investment was
valued in same manner as unquoted shares of domestic enterprises. Outward direct
investment in unquoted shares was estimated using cumulating flows valued with an
index that compounds foreign stock market indices and exchange rates. This approach
raises the possibility of problems in balancing inwards and outward investment. The
French apply a liquidity discount of 25% to the capitalization ratios. The 25% factor was
estimated by a French colleague Claude Picart of INSEE.
The distribution of holdings of unquoted shares is achieved through estimating the
holdings of sectors that have sufficient information on transactions in unquoted shares.
The residual in unquoted shares is distributed among the other sectors (households, nonprofits organizations, non-financial corporation) by proportion of own funds at book
value. The estimated holdings of these sectors are quite sensitive to these proportions.
Thus there is an interest in improved usage of available data sources.
Questions and comments
1. “Thin” stock markets. It was noted that if developed market economies like France
face the problem of having an insufficient number of enterprises listed on a national stock
exchange in order to carry out the capitalization method, then the majority of national
economies will encounter this problem. The solution may lie in the development of a
multinational database of capitalization ratios like the pan-European database developed
through the WGUS test exercise. With such a database, nations would be able to use
capitalization ratios calculated from a larger pool of listed enterprises albeit non-domestic
enterprises. One non-European nation has already inquired about access to the panEuropean database. It was noted that such a database would not necessarily guarantee
stable ratios as the pan-European ratios display significant variation depending on which
enterprises are included in the calculations.
2. National differences. Yet, using capitalization ratios from a multinational database
may obscure significant structural features unique in a country. Further, a standard
classification approach for calculating industry ratios such as the 11 branches (industries)
proposed in the WGUS test exercise may not be the most appropriate for every country.
The argument was made towards the calculation of liquidity discounts and the definition
of small companies. France suggested that these specifications the methodology could be
left to the particular country to determine, preserving international comparability while
allowing for national difference.
3. International investment involving unquoted shares. It was suggested that this aspect
of valuing unquoted shares is the most daunting. Canada asked if the idea of a liquidity
discount could be introduced into the IMF-OECD discussions of the valuation of direct
investment. The IMF agreed to follow up on this point. In theory, the value of equity in a
subsidiary abroad would be factored into the share price of a listed parent company.
However, the absence of an observed share price for a non-listed parent company
prevents one from making the same assumption.
Susan Hume-McIntosh (U. S. Federal Reserve Board)
Valuation of Unquoted Shares in the U.S. Financial Accounts
Presentation
The presence of unquoted shares is not a major issue in the U.S. due the high propensity
to be publicly listed among large and mid-sized domestic corporations.
At the present, the U.S. is valuing non-inter-company unquoted shares at market value.
In 2003, the market value of unquoted shares accounted for 12% of the total quoted
market value of domestic corporations. The conventional method involves using data
from estate tax returns. This gives a split between closely-held and publicly-traded share
holdings. These proportions are applied to aggregate household sector holdings. Chief
among the disadvantages of this method is that the source of date will become
unavailable in the future.
Facing this problem, the U.S. has replicated the European capitalization method. Their
approach involves treating separately two groups of private corporations due to tax
treatment differences. S-corporations (or S-corps) are usually larger private corporations
that face the double taxation of dividends. C-corporations (or C-corps) can avoid the
double taxation of dividends providing they only have 75 shareholders who are domestic
individuals. Although they tend to be smaller in size, C-corps make up the largest
number of private corporations.
Information on the book value of the closely-held equity of S-corps is taken from tax
data. Market-to-book ratios are calculated from information on publicly-listed
companies. A median ratio is used rather than the weighted average ratio.
As for private C-corps, the unavailability of balance sheet information through tax data
has led to the use of revenue information from a private date source (Forbes magazine).
The market value of the equity of a private C-corporation is estimated using to market
value-to-revenue ratio of a publicly-listed company similar in revenue and industry. This
matching process is time-consuming and tedious.
The sum of the market values of private S-corps and C-corps is further adjusted by
adding the market value of shares involved in leveraged buyouts and subtracting the
market value of shares involved in initial public offerings.
The U.S. is quite happy with the results of this exercise and they plan to adopt the
European method in the summer 2005. They see it as more defendable than their
conventional method, which relies on estate tax data that will eventually become
unavailable.
Questions and comments
There were some questions that received immediate answers. In particular, there was
interest in the impact of applying the European method. The results from the European
exercise did not differ substantially from estimates using the conventional method. In
developing industry capitalization ratios, the median ratio was chosen over the weighted
average due to the large number of relatively small unlisted corporations. After
distributing the revalued unquoted equity among other sectors, the residual is placed into
the household sector.
Some answers were deferred until later. The IMF delegate asked why the value of initial
public offerings was subtracted from the total of revalued unquoted equity when these
corporations should already have been eliminated from the set of unlisted corporations.
Referring to the chart that compares the new estimates with the old estimates, a Canadian
delegate asked why there appear to be larger revisions in the back period than in the
current period. Ms. McIntosh thought that it may be because of stock market activity, but
she would need to confirm that.
II: Friday, April 15. 2005
Morning session
Begoña Gutiérrez del Olmo Moreda (Spain: Banco de España)
Valuation of Shares and Other Equity in the Financial Accounts of the Spanish
Economy
Presentation
In the Spanish financial accounts, three general valuation approaches to equity are
recognized: market valuation in the strict sense, approximation to market valuation and
book value. Stemming from these three general approaches are five specific valuation
techniques: market capitalization, net asset value, own funds at book value, the
capitalization technique and the discounted value of future profits (DVFP) approach.
These five valuation techniques are applied to corporate share aggregates according to the
nature of the equity. The discounted value of future profits (DVFP) approach gives an
approximation to market value and is an alternative to the capitalization method. In
Spain, the DVFP method is used to estimate the approximate market value of unquoted
non-financial public limited companies.
The discounted value of future profits methods grounds itself on recommendations in the
both SNA 93 and ESA 95. This method was chosen for unquoted non-financial
corporations because they aren’t well represented by quoted non-financial corporations
and their associated capitalization ratios, due to the insufficient number of quoted nonfinancial corporations in Spanish Stock Exchange. Also, there was concern that the use of
capitalization ratios from a multinational database would be problematic due to the
heterogeneity of countries’ financial structures. On the other hand, the DVFP method is
used by financial analysts.
The presentation went on to outline the data requirements of the DVFP method. The
formula or model developed to estimate the market value of unquoted shares was
introduced. A primary assumption underlying the model is the perpetual generation of
profits by quoted corporations. This assumption is not held to unquoted corporations, as
their life is considered to be finite. The key variable “ordinary net profit” was defined and
how it is calculated was described. Future ordinary net profit is calculated from past
profit data. The method of calculating a discount rate for unquoted companies was
discussed. The formula features an illiquidity premium that includes not only the risk
premium, but also the different time horizon of companies included in each aggregate.
Assumptions regarding risk figure significantly in the model that estimated a discounted
ordinary net profit which approximates the market value of an unquoted corporation. The
operationalizing of the DVFP method was then discussed, noting the data sources used by
the Spanish financial accounts and how they the aggregate is projected (“grossing up”)
from the sample of unquoted non-financial corporations. Lastly, Spain explained how
they handle the valuation of shares in unquoted non-financial corporations that
experience persistent losses. The convention is to measure the equity at nominal capital.
The complete explanation of the methods applied in the Spanish Financial Accounts to
calculate the valuation of shares and other equity of the Spanish economy can be found in
a document (Statistical notes nº 2, of Banco de España), distributed before the meeting.
Questions and comments
1. In general. A perceived disadvantage of the approach is that it requires a lot of specific
types of data. It will be hard to implement in countries that have fewer statistical
resources. Yet, it was also felt that it is a good alternative to consider. An advantage is
that it can be applied to small corporations, whose approximated market value may be
distorted by the capitalization method through the presence of large listed corporations.
The delegate from Canada suggested that it might be useful for other countries to carry
out this exercise as a test and compare the results. He also said that the decision table on
page 15 of the Spanish paper is useful.
2. Testing the model. Spain was encouraged to try to test the DVFP as well as the
capitalization method, and compare the results. The delegate from France said that there
has already been a comparison of this method with the capitalization method in a 1998
joint Eurostat-OECD report.
3. Model specification. There were questions about the variables featured in the model
and how they are specified. For example, the discount factor on unquoted shares may
feature bias due to the fact that it is being calculated from information on quoted shares.
4. The issue of expectations. This model attempts to estimate the discounted value of
future profits. Underpinning this model is the expectation assumption that the future
stream of profits will be similar to past profits. In fact, past profit data is used to estimate
ordinary net profit. However, the historical nature of this data does not capture the
expectations of the present moment, expectations that may be changing. This drawback
of the model is minimized by the fact that the ordinary net profit used in the formula,
obtained from past profit data, is being corrected by the expected growth rate of profits
from the first year forwards. This rate is implicitly included in the discount rate and is
obtained from the prospects observed in the Stock Exchange.
Allan Tomas, Joe Wilkinson and David Pringle (Statistics Canada)
Use of Capitalization Ratios in a Canadian Context
Presentation
In Canada, four types of equity are presently recognized: listed corporate equity included
in portfolio investment, listed inter-company (direct) equity investment, unlisted
corporate equity (largely included in household assets), and unlisted inter-company
(direct) equity investment. Two national balance sheet accounts are published: one
where all four types of equity are valued at underlying book value; and one where only
listed corporate equity included in portfolio investment is valued at market value. The
other three types have been kept at book value until a decision on the treatment of these
equity types is made.
Two of these equity types involve unlisted or unquoted shares. Unquoted shares are a
significant feature of the Canadian economy, accounting for 70% of total share liabilities
(measured at book value) and approximately 10% of the total financial assets in the
personal sector. Canada is presently exploring two approaches to the valuation of the
unquoted shares: the current market value (CMV) and net asset value (NAV) approaches.
Three principal sets of concerns have arisen during development work with the CMV.
The first relates to the size of corporations included among unquoted shares to be
measured at market value. Experiments with size thresholds have shown that the
inclusion of small corporations can significantly increase the total market value of
unquoted shares. The impact of this is largely observed in the rise of unquoted share
assets of the personal sector. This evidence underscores the importance of the question of
whether or not small incorporated businesses are comparable to quoted corporations and
whether or not they should be valued as such.
The second set of concerns relates to the statistical integrity of estimates of unquoted
shares at market value. In Canada, the current market value method relies on
capitalization ratios derived from data of surveyed domestic corporations that are listed
on Canadian stock exchanges. While many of Canada’s largest corporations are
represented among the set of surveyed listed corporations, two issues come to mind. One
is the question of whether it is appropriate to apply the capitalization ratios of larger
corporations to the unquoted equity of smaller ones. The other is that there are many
large unlisted corporations (foreign subsidiaries and family-controlled enterprises) that
would seem to defy representation by the relatively small sample of capitalization ratios.
The prospect of a measurement error being introduced by the current market value
method seems probable.
The third set of issues ties in with the specifications of the European capitalization
method. Replication of the European method for one period found that the size and
variation of capitalization ratios are very sensitive to the choices associated with industry
groupings, the exclusion of large and small corporations and the use of a liquidity
discount. These choices affect the magnitude of the total market value of shareholders’
equity, which impacts significantly the estimates of financial assets of the personal sector.
Given these issues related to the CMV method, the net asset value approach has been
explored as an alternative and/or supplement to the CMV. Preliminary work has
involved transforming unquoted equity at underlying book value to net asset value using
an aggregate current cost ratio calculated for total corporations. The current cost ratio is
calculated by dividing corporate net worth with non-financial assets at current cost by
corporate net worth with non-financial assets at historical cost. As this current cost ratio
calculation does not yet factor in the current value of financial assets and liabilities
(currently available) and intangible assets (not currently available), only a partial NAV
treatment is afforded by this approach. Nevertheless, preliminary estimates of unquoted
equity at net asset value show levels that are less volatile and more conservative than
CMV estimates (as CMV estimates tend to follow movements in stock prices). While
NAV ratios are never below one, CMV ratios can drop below one, especially with a
liquidity discount factor included. The use of a CMV ratio less than one would signify a
discounting of equity lower than its OFBV.
Several data and conceptual issues relating to both the CMV and NAV approaches will
be addressed in continued development work. Key to this work is maintained awareness
of developments in international discussion circles on the subjects of balance of payments
practices, international accounting standards and the treatment of intangible assets.
Questions and Comments
1. Minor clarifications. In developing the NAV ratios, land (residential, non-residential
and agricultural) is re-valued at a current value. With regards to residential and nonresidential land, only the land surrounding the structure is valued.
2. The CMV-NAV gap. When comparing the two series that result from the CMV and
NAV valuations, we observe the difference between NAV and CMV estimates. This
difference may be explained by two things. The partial NAV technique that is used does
not include financial assets and liabilities and intangible assets. The other factor
explaining the difference is that we expect fluctuations in the CMV due to stock market
activity. In comparing the two series, one observes in the early 1990s that the CMV
estimate is below the NAV. In these quarters, the CMV ratio is less than 1, a period with
lower market activity relative to the late 1990s.
3. Purpose of market valuations. As the task force meeting confronts two approaches to
treating unquoted shares, the delegate from the IMF asked the delegates a more general
question: what kind of series do we want? The NAV, which attempts to capture the
intrinsic underlying value of an enterprise, gives a smooth series. The CMV method
introduces volatility into a series as capitalization ratios are calculated using prices from
the stock market. In asking what kind of series do we want – one that is smooth or
volatile, we must also ask what are we trying to measure?
4. Economic motivations of the investor. Concern was expressed about introducing
assumptions about the identities and motivations of economic agents (specifically, the
investor) into valuation approaches. The delegate from Canada replied that he stands by
the argument for distinguishing portfolio investment from direct investment for
compilation purposes. Beyond this, a fundamental question in the valuation of equity is
whether we are trying to measure liquidation value or a value which best reflects the
economic behaviour of two basic classes of investors – portfolio and direct investors.
Assuming that their motivations are identical may do nothing more than simplify
compilation.
5. Partitioning the equity. In compiling the Canadian national balance sheet accounts, the
portfolio/direct investment distinction is made for both equity assets and liabilities,
allowing observation of the different types of equity holding by sector (e.g. household
portfolio assets, corporate inter-company assets). The delegate from Canada remarked
that the idea of valuing an enterprise’s company’s equity with different methods, where
the enterprise’s equity is broken down and partitioned for valuation treatment, is
interesting conceptually, but has practical challenges.
Canada asked to clarify which countries currently publish unquoted at market value.
France, the US, Spain and Japan currently publish unquoted shares at market value.
Japan mentioned that they are presently addressing the challenge of valuing intercompany investment in unquoted shares.
On the subject of the category “other equity”, the delegate from the United Kingdom said
that UK is classifying real estate acquisition abroad by British households as “other
equity”. She said that her agency is interested in working with other national statistical
agencies on this issue.
TOPIC IV: INTER-COMPANY (DIRECT) INVESTMENT
Patrick O’Hagan (Canada: Statistics Canada)
Summary of issues for balance sheet compilers
To introduce this session, Mr. O’Hagan indicated that inter-company investment had two
dimensions in the balance sheet accounts:
- domestic inter-company investment, which depends on the level of consolidation in
balance sheet accounts; and,
- foreign direct investment, which is the topic to be discussed.
Direct investment itself has may be viewed in two dimensions: the location of the
investment (domestic versus foreign) and the direction of the investment flow (inward
versus outward).
Christian Lajule
Direct investment -- alternative estimates for Canada
Presentation
The initiative to convert Canada’s international investment position to market value has
brought the publication of portfolio assets and liabilities (specifically equity and bonds) at
market value in June 2004. Foreign direct investment in equity is scheduled to be
published at market value in June 2006.
The proposed method for estimating the market value of both inward and outward foreign
direct investment relies heavily on capitalization ratios derived from surveyed listed
domestic corporations. The capitalization method will be applied to direct investment
equity in both listed and unlisted corporations, regardless of whether located in Canada or
abroad. In the case of Canadian direct investment equity, there is the possibility of
using foreign stock indices to augment the market-to-book ratios. Estimating the market
value of foreign direct investment in Canada faces the challenge of numerous large
unlisted Canadian subsidiaries. In these situations, the market-to-book ratio of the
foreign parent corporation may be investigated if listed.
Further items under consideration in the development of a valuation method is the use of
observed transaction process to derive better market value positions for both listed and
unlisted corporations, the development of discounted market value ratios and the periodic
updating of market-to-book ratios using Canadian and foreign stock indices. The current
cost approach to valuing both inward and outward direct investment is also being
examined. Industry-level current cost-to-book value ratios would be used to adjust the
direct investment equity from book value.
These approaches to the Canadian IIP are consistent with the methods being studied by
the Direct Investment Technical Experts Groups (DITEG). As well, there is the
possibility that Canada could follow the example of the U.S. Bureau of Economic
Analysis and publish two measures of foreign direct investment: one at market value and
one at current cost.
Afternoon session
Questions and comments
1. Transaction prices. There was a question about how transaction prices would be used
for valuation. The prices would be used to the value the FDI equity in the year of the
transaction (e.g. a take-over or a purchase), after which the FDI equity would be revalued using capitalization ratios. It was asked whether or not any of the delegates were
aware of how private sector analysts (for example, those employed in an accounting firm)
value enterprises that are about to be purchased. Related to this is the question of whether
there would be any difference in value if the enterprise was public or private.
2. Discounts and premiums. In addition to the suggestion that DITEG consider the use of
liquidity discounts when re-valuing foreign direct investment, the question was raised of
whether or not there is a direct investment premium. An example cited was the high
price Japanese investors were willing to pay for U.S. real estate holdings during Japan’s
economic boom of the 1980s.
3. Own funds at book value. It was clarified that the capitalization ratio that would be
applied to Canadian direct investment abroad (CDIA) would be calculated using the own
funds at book value of domestic corporations. Extending from this was the question of
whether there were any definitional differences of own funds at book value (OFBV)
when considering equity in a foreign subsidiary.
4. Valuation issues. Concern was expressed that valuing different types of equity with
different approaches (e.g. market value and current cost) could also lead to problems.
Ned Howenstine (U.S. Bureau of Economic Analysis)
Valuing the U.S. direct investment positions
Presentation
Mr. Howenstine provided a historical overview of the U.S. International Investment
Position (IIP) that is compiled and published by the Bureau of Economic Analysis. The
IIP features the direct investment position for both inward and outward investment, a
position that includes both equity and debt funding. The BEA presently publishes an IIP
with the equity positions revalued at market value and current cost. The debt component
of the direct investment positions is not revalued.
Previous to the methodological revision of the early 1990s, the BEA published the IIP
with direct investment positions valued at historical cost. While this practice was
consistent with the survey data where surveyed units reported in book value terms,
recommendations in international standards to measure at current prices rather than
historical prices, combined with mounting questions about the accuracy of the IIP
estimates led the BEA to temporarily suspend publication of the IIP and develop a new
methodology.
In 1991, the BEA began publishing the IIP with equity positions revalued at market value
and current cost. The challenge facing the compiler was that most affiliate corporations
feature a 100% equity ownership stake by parent corporations, preventing any directly
observable current price valuations. In both revaluation methods, the equity position at
historical cost is adjusted. The current cost approach revalues direct investors’ shares in
the tangible assets of the subsidiary corporation from historical cost to current cost. In
the direct investment position estimates, owners’ equity is adjusted to correspond to the
revalued tangible assets. The published series begin with 1976 estimates.
The market value approach involves making an initial market value estimate of owners’
equity positions using one of two methods (capitalization ratios or dividends divided by
market yield). The equity positions are progressively adjusted using stock market indices
and additions of new equity investment. The published series begins in 1982.
Historical cost measures are published separately from the U.S. IIP. As expected, there
are differences between the three measures, with the market value and current cost
revaluations being higher than the historical cost estimates. All three measures are
sensitive to the specific assumptions underlying their methods.
Questions and Comments
1. The debt component of foreign direct investment. The possibility of re-valuing debt is
constrained by lack of information on long-term debt. Only debt securities would be revalued, not loans or trader credit.
2. The re-valuation of foreign subsidiaries. The method used by the BEA to adjust the
own funds at book value of foreign subsidiaries using foreign shares prices. The example
of Canadian subsidiaries of U.S. enterprises, such the auto manufacturers, was discussed.
The delegate from the BEA hadn’t realized until this conference how “thin” the Canadian
stock market, “thin” meaning the lower propensity of Canadian enterprises to list on a
stock market. This knowledge has suggested to him that maybe the BEA should
reconsider its method in some cases.
3. Future of the U.S. IIP. The present valuation methods used by the BEA are not under
review at the moment. The BEA is interested in the development of international
standards. Of greater concern is the trade in services statistics compiled in the balance of
payments, as this relates to the outsourcing debate in policy circles. There are three
studies underway.
John Joisce (IMF)
Report on the OECD-IMF Direct Investment Technical Expert Group (DITEG)
Presentation
Before the report on the work of DITEG was given, Mr. Joisce reminded the task force
that DITEG is not a decision-making body, but rather it offers recommendations to the
IMF-sponsored Balance of Payments Committee and the Workshop on International
Investment Statistics.
His report is drawn from the summary contained in the DITEG Outcome Paper #1(A)
(December 2004 and March 2005). Among its recommendations, there are eleven
options that DITEG sees as acceptable approaches to the valuation of unquoted shares.
The group did not rank the options by acceptability for the reason that economic
circumstances can vary from year-to-year and country-by-country.
The seven options that DITEG considered generally acceptable/desirable were:
- recent transaction prices (within the previous twelve months);
- net asset value, including intangibles and goodwill;
- net asset value, excluding intangibles and goodwill;
- apportioning global value of a group to a local operation, using an appropriate
indicator;
- own funds at book value;
- use of capitalization ratios (stock market indices) to own funds at book value of
listed companies;
- use of models that revalue non-financial assets.
Three further options that would assist in obtaining data on unquoted direct investment
equity, data that would require adjustment to bring it closer to market value were:
- use of stock price indices to revalue cumulated flows;
- historic or acquisition cost;
- summing transactions;
- book value.
The group recognizes that the book value approach may be the only means for obtaining
and valuing bilateral data on unquoted direct investment equity, although there is no
standard definition of book value.
DITEG did not discuss the use of a illiquidity discount, but Mr. Joisce indicated that it
would be introduced in future DI meetings.
Question and comments
1. Relations between DITEG and TFVME. There seems to be some convergence
between the two groups on valuation approaches. Both the capitalization ratio method
and the net asset value method have been discussed in these forums. There have been
some topics that have not been discussed by both groups; for example, the discounted
value of future profits method proposed by Spain. Yet, while there is interest in
convergence, the question of whether convergence on issues of method will allow
comparability remains important. At this moment, there are seemingly only two methods
that appear to allow international comparability: the capitalization ratio method and the
own funds at book value (OFBV) conventional treatment. The data needed to carry out
these two methods is usually available for national accounts compilers. There is
uncertainty about whether the other two methods discussed at this conference, namely the
NAV and the Spanish method, can be widely adopted due to data requirements.
2. The treatment of intangibles. While there wasn’t much serious discussion on the
treatment of intangibles at this TFVME meeting, at least one delegate mentioned its
interest in moving towards re-valuing intangibles, providing they can be identified. One
obstacle is that it is uncertain how much guidance will given by the recommendations of
the Canberra group. At the present moment, the Canberra group only recommends the
measurement and valuation of transactions. Thus, an intangible such as goodwill would
only be valued at the moment of transaction.
3:50 p.m. Conclusions and Follow-Up
Anders Nordin proposed a tentative summary drawn from the two-day meeting. They are
summarized below:
Presentation
Tentative summary
1. Quoted shares.
 Current market valuation. While there are different approaches to the valuing
of quoted shares at market value, these differences are caused by data
availability. They do not present important problems.
 Definition of quoted versus unquoted shares. There needs to be clear
definitions in any future recommendatory text.
 Share buy-backs. There is an outstanding question about whether or not to
include a discussion of share buy-backs in any future text.
2. Unquoted shares.
 The main method that has been has been considered by participants is the
capitalization method where capitalization ratios are used to derive the market
value of unquoted shares. An advantage of the capitalization method is that
the data required by the method is often available in the participant countries.
 Certain procedural choices in the capitalization method may be left to the
country to decide; for example, the calculation of ratios using medians or
weighted averages after excluding small and large corporations.
 As well, countries are encouraged to consider the calculation liquidity
discounts on a national basis.
 There is a need for clearer definitions of unquoted shares and “other equity”.
This issue especially affects the treatment of small unquoted companies.
 The group examined the use of capitalization ratios for valuing foreign direct
investment at market value.
 As some countries may not have sufficiently large numbers of domestic
enterprises listed on national stock exchanges to allow the calculation of
appropriate capitalization ratios, there is interest in the development of an
international database of capitalization ratios, such as the Pan European
database, that could provide smaller economies with capitalization ratios.
3. Outstanding issues regarding unquoted shares.
 A question was raised about what kind of measures of shareholders equity do
users of financial accounts data want to have. Do users want a time series that
features the more stable “fundamental value” (i.e. net asset value) of unquoted

shareholders equity or a more volatile series where unquoted shares are at
“market value”?
In regards to direct investment abroad, a question remains about whether to
use ratios calculated by branches (industries) of domestic enterprises to value
the equity position of direct investment abroad or to somehow obtain and use
capitalization ratios from the investee country.
Questions and comments
1. Alternative methods. Begoña Gutiérrez del Olmo (Spain) requested that among the
tentative conclusions, there be mention of a certain level of flexibility concerning
alternative methods (such as the NAV and the discounted value of future profits
approach) to valuing unquoted shares. John Joisce (IMF) responded to this request with
the concern that the goal of international comparability may be obstructed when there are
too many valuation options recommended in the SNA 93. Carlos Sanchez Munoz (ECB)
seconded this concern. Ned Howenstine (USA: BEA), in support of including the
mention of alternative methods, expressed that having a variety of valuation options is
useful for national accountants who face less-than-ideal statistical conditions in terms of
data availability. As well, the diversity of institutional features among national
economies may require a plurality of valuation methods that compilers can draw upon
according to country needs. Anders Nordin (OECD) responded that the capitalization
method proved to be feasible among the European countries who took part in the test
exercise, suggesting that in the case of the European countries, the common use of the
capitalization method would be appropriate and would allow international comparability.
2. Legal structures of enterprises. Dominique Durant (France) expressed that attention
should be given to the legal structures of countries and ask how these structures influence
the incidence of small corporations and non-corporate businesses. This affects the
presence and extent of “other equity” in the decomposition of shareholders equity in the
financial accounts. The specific definition of “other equity” would vary among countries
due to differences in legal structures, and thus its statistical presence would vary among
countries. She suggested that “shares and other equity” be split into quoted shares,
unquoted shares and other equity. For the purpose of clarification and ensuring
international consistency, the definitional distinction between unquoted shares and other
equity should be made at a general level.
3. Types of capitalization ratios. Ms. Durant (France) clarified the point about procedural
choices in the capitalization method. The median ratio is the recommended ratio when
no enterprises are removed from the sets of enterprises. If enterprises are removed from
the sets, then the weighted average is recommended. These are based on the results of
the test exercise.
4. Foreign direct investment and capitalization ratios. Ms. Durant (France) and Carlos
Sanchez Munoz (ECB) said that there may be balancing issues related to the use of
capitalization ratios in valuing the equity component of foreign direct investment. One
way to ensure consistency both within national balance sheets and among national
balance sheets is the use of single aggregate capitalization ratios by investee country to
value inward and outward foreign direct investment. The use of a single country ratio
seems more practical than attempting to gather industry-specific capitalization ratios by
investee country.
Anders Nordin (Statistics Directorate OECD)
Investment Funds Shares
Presentation
The reason behind this set of proposed revisions to SNA 93 regarding investment share
funds is that SNA 93 does not provide a breakdown of financial instrument F.5 (“Shares
and other equity”) into “Shares and other equity, except mutual fund shares” and “Mutual
fund shares”. The definition of “mutual fund shares” given in ESA 95 could be adopted
for SNA 93.
It was proposed that instrument F.5 be broken down in F.51 (“Shares and other equity,
except mutual fund shares”) and F.52 (““Mutual fund shares”). Second, instrument F.52
be re-named from “mutual funds” to “investment funds”, a term used to classify all types
of collective investment schemes. Third, instrument sub-category F.52 (“Investment
funds shares”) is defined as consisting of all transactions in investment shares, i.e. shares
issued by investment funds. Investment funds collect money from investors and use this
money to purchase financial assets and/or real estate. The investors receive shares in the
investment funds, and, thus, indirectly, own a proportion of the financial assets that the
investment fund itself owns. Investment funds are divided into open-end investment
funds and close-end investment funds. Last, the following classification scheme of
investment funds shares was proposed:
F.521: money market funds;
F.522: real estate funds;
F.523: bond funds;
F.524: balance/mixed funds;
F.525: equity funds;
F.526: other funds.
Questions and Comments
1. Terminology. The term “collective investment funds” is a general term than can be
used to describe pension funds and insurance, creating some potential ambiguity.
2. Motivations behind this proposed breakdown. There has been recent interest in being
able to provide detail to household investment fund holdings, partly to show the exposure
of households to the risk associated with different types of investment funds. There are
alternative ways of classification; for example, investment funds could be organized by
geography or by risk. Also, the question was raised whether the breakdown should be
displayed in the core accounts or in a satellite account. Interest was expressed in
breaking out money market mutual funds in the core accounts in order to prominently
display household exposure via institutional investors.
Scheduled presentations on intangibles and stock-flow issues (by Canada) were omitted.
Future Work
The role of this group is to offer advice to the AEG (Advisory Expert Group) on
proposed revisions to SNA 93 with regards to the treatment of equity. Also, the group
needs to communicate its tentative conclusion to other groups.
There will be four meetings in the immediate future. There will be an Advisory Expert
Group (AEG) meeting in July 2005. In October 2005 in Paris, there will be a meeting of
the OECD Working Party of National Accounts / Financial Statistics. Coincident with
this meeting it is planned that there will be a second TFVME meeting. In January 2006,
there will be a meeting of the AEG where a formal submission of recommended revisions
to The 1993 SNA with respect to equity will be made.
An information note based on the minutes of the TFVME will be written and sent to the
AEG before their July meeting. A proposed revised text of the relevant SNA 93 section
will be drafted in August. It will be circulated to task force delegates for comments by
September 2005 and made available for the October meeting. Mr. O’Hagan (Canada)
volunteered to draft the text. Ms. Durant (France) and Mr. Munoz (ECB) indicated their
interest in helping with the text. Ms. McIntosh (US: Federal Reserve) volunteered to help
review the text. Mr. Joisce (IMF) wants to be kept involved in the draft’s development.
Meeting adjourned