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Data analytics in fair value estimates

US regulators and their counterparts around the world are targeting more corporate filers for potential financial reporting mistakes and unsupportable fair value estimates. Global enterprises are particularly susceptible to inadequate oversight of the valuation process, especially companies with valuation needs arising in different jurisdictions and business units.

Facing growing scrutiny, some innovative corporate filers are investigating the use of data analytics to help make valuation activities and financial reporting disclosures more transparent, supportable, internally consistent, and efficient. These forward-looking businesses recognize the value of implementing an ethical and transparent corporate culture. They are keeping up with compliance developments and the increasing expectations of the regulatory authorities. And they are making strategic investments, such as in data analytics, to mirror the emphasis and actions of regulatory authorities.

Corporate executives and board members can apply the valuation intelligence and insights gained through analytics to improve regulatory compliance. Analytics can also help elevate the important role of investor relations and how it influences the company’s perception in the marketplace, thereby protecting and enhancing enterprise value.

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Regulatory scrutiny

One reason for considering greater valuation-related data analytics investment is the SEC’s own use of such tools. In 2009, the Commission began employing proprietary risk analytics to identify and evaluate suspicious financial returns in its investigation of hedge funds.

The SEC has continued to step up efforts to fight financial reporting improprieties and other forms of fraud, leading to an increase in enforcement actions. Regulators are making wide use of analytics to help assess corporate issuer risk and identify financial reporting irregularities that may indicate financial fraud.

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The need for policies and procedures

Fair value measurement is important and often difficult. As regulators, auditors, audit committees, and company executives are discovering, valuation is also potentially ripe for misapplication or, in the extreme, fraud. Valuations are neither art nor science, but instead emerge from bringing together many variables in quantitative and qualitative analysis and then arriving at supportable conclusions applying professional judgment. Unfortunately, tweaking the variables inappropriately is sometimes cast as “professional judgment” by those so inclined, perhaps to secure performance-based bonuses, avoid an impairment charge, or present a rosier-than-reality picture to potential investors.

In some companies, potentially hundreds of employees and numerous specialists spread around the world can be involved in providing data for fair value estimates and other related “public interest” valuations; for example, for corporate tax purposes. Fair value estimates are a significant aspect of many public companies’ financial statements, and executives who sign off on financial reports can find themselves responsible for both unintentional errors and willful manipulations, as well as inconsistencies in valuations performed for numerous other reasons.

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Opportunities and imperatives are growing

Global financial market complexity has increased at lightning speed in the last 15 years compared to the preceding 100 years. While many large organizations have ramped up personnel, technology, and other resources to accommodate an ever-changing and complex marketplace, questions remain. For instance, is the internal infrastructure truly robust enough to keep up with these increased demands? Is management forward-thinking enough?

Senior executives and boards of directors can potentially gain insights into how analytics can help address risks and opportunities through consideration of three main factors:

1. Compliance risk
2. Internal process efficiency
3. Enhanced quality

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More opportunities ahead

New challenges are likely to arise as companies strive to upgrade policies and procedures related to fair value measurements, whether performed internally or by outside valuation specialists. Companies are likely to seek improvements in how they handle the huge and growing volumes of data surrounding their business activities and, by extension, their approach to valuation for fair value measurement purposes. Refinement of data collection and normalization processes will continue. And many businesses may see fit to increase their oversight of the reasonableness and supportability of assumptions underlying internal or external valuation analyses.

The ongoing development of technology and processes should open new doors to effective compliance and improved efficiency. Looking to the near future, artificial intelligence, machine learning, and predictive analytics are likely to enter the picture. Certain elements of valuation work could become automated, allowing valuation professionals to spend even less time on detailed, quantitative calculations and more time focused on supporting assumptions made, interpreting results, and seeking ways to create shareholder value.

Whatever the future holds, companies can expect continuing scrutiny of valuation analyses and their underlying assumptions and inputs. Valuations remain susceptible to manipulation and potential management bias, while continuing to have a significant impact on the financial reporting and the reliability of financial statements for investors.