Fisherian analysis, the Sarbanes‐Oxley Act of 2002, and the new Rule 702 of the Federal Rules of Evidence of 2000

Abstract

Purpose

The purpose of this paper is to contend that Fisherian analysis that is used to resolve ranking conflicts of mutually exclusive projects is misspecified, invalid, and cannot do what it purports to do. Misspecified and invalid models cannot realistically be operationalised, and are likely to result in incorrect valuations and misallocations of capital. An implication of these deficiencies is that it cannot satisfy the criteria prescribed by Rule 702 of the Federal Rules of Evidence of the USA, and as a consequence significantly impacts upon the admissibility of its use as part of expert witness testimony and the role played by the trial court in the USA. These deficiencies also place Fisherian analysis at risk of conflict with the Sarbanes‐Oxley Act of 2002, in particular Section 807 §1348 that deals with the use of invalid and unreliable valuation criteria.

Design/methodology/approach

A secondary survey of Fisherian analysis, recent USA legislation and the literature of corporate financial management was undertaken. Fisherian analysis is part of the capital controversy debate, and the Cambridge‐UK school devoted much time and effort in discussing issues germane to the controversy. The approach of corporate and managerial finance as evidenced by the literature, has been to unquestioningly recommend and implement a valuation criterion that is wrong and with little exception is based on numerical examples of such extreme disproportions as to qualify as inelegant examples of sophistry.

Findings

This paper contends that Fisherian analysis does not do what it purports to do, namely provide valid and reliable valuations for allocating capital. It is misspecified and invalid, is unlikely to be acceptable as expert witness testimony in terms of Rule 703 of the Federal Rules of Evidence, and if used for valuations and allocations of capital by listed corporations, can result in a conflict with the fundamental purpose and specific provisions of the Sarbanes‐Oxley Act of 2002. Application of Fisherian analysis effectively prostrates the definition and function of the cost of capital for it imposes the stricture of a constant cost of capital across all mutually exclusive projects with ranking conflicts irrespective of the differences in the characteristics of these projects.

Practical implications

Management of listed corporations that use invalid and unreliable valuation criteria not only endanger the financial wellbeing of the corporation by misallocating capital, but also expose themselves unnecessarily to the risk of not complying with legal requirements. The judiciary does not condone less than complete practice by those possessed of expert knowledge and skills, education, or seniority in corporate hierarchies, especially when the issues are clear cut.

Originality/value

The paper provides useful information on Fisherian analysis.

Citation

Paulo, S. (2009), "Fisherian analysis, the Sarbanes‐Oxley Act of 2002, and the new Rule 702 of the Federal Rules of Evidence of 2000", International Journal of Law and Management, Vol. 51 No. 6, pp. 389-400. https://doi.org/10.1108/17542430911005927