Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 7 1.4 Importance of the Framework for Assessing Capital Adequacy The capital adequacy framework can be a very useful managerial tool. Many CCRO participants appreciate the value of the framework in improving stakeholder confidence, managing performance, and promoting competition. 1.4.1 Improving Stakeholder Confidence Financial stakeholders include shareholders, debt providers, rating agencies, analysts, and auditing companies to mention a few. The confidence of these stakeholders is crucial because they effectively set the company’s cost of capital. The capital adequacy framework is aligned with the needs of stakeholders because it can help management assess the long-run viability of the company’s business model. Through the processes of performing the risk analyses necessary for determining capital adequacy, management brings forth valuable information that can be used to bolster stakeholder confidence. Supporting the Concept of “Going Concern” External auditors play an important role in creating the degree of stakeholder confidence, and the capital adequacy framework is aligned with audit standards. Through the concept of “going concern,” auditing standards emphasize the importance of demonstrating capital adequacy. One definition of going concern is “…entity’s ability to continue to meet its obligations as they become due…without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations or similar action.” The “going concern” concept is well aligned with the CCRO’s definition of capital adequacy in that both the liquidity and the economic value aspects are included. Supporting a Robust Future Growth Rate In performing the capital adequacy analyses, a company must evaluate outcomes for its operations and financing activities. These evaluations are designed not simply to communicate a single “expected” value,” but also to focus on the uncertainty around that expected value. This evaluation requires consideration of a range of alternate scenarios for market conditions, business environment, and the ultimate success of a business plan. The capital adequacy framework can be used to evaluate a company’s growth plan with its capital and risk implications. A company’s internal growth plans must be integrated with externally driven, uncertain market conditions and an uncertain competitive environment. As a result, aggressive growth rate assumptions need to be created by first examining their impacts on capital adequacy. Decision-makers can gain much more confidence when given well-defined scenarios and transparency into the potential downside implications of new business ventures and the ability of the firm to weather adversity.