Capital Ideas Blog

Regulation, but only if cost-justified

By Francine McKenna

From: Blog

The final SEC Staff report on its International Financial Reporting Standards (IFRS) Work Plan, issued in July 2012, put the kibosh on most hopes of US IFRS adoption anytime soon. The document had no recommendations to the Commission for how IFRS would ever become reality.

Why not? Because public companies opposed IFRS adoption by a 2:1 margin and total comments described opposition by an even larger margin. The July 2012 report admitted that public opinion, the opinion of company executives at firms the SEC regulates, stopped US adoption of IFRS in its tracks. According to the SEC, “it became apparent to the staff that pursuing the designation of the standards of the IASB as authoritative was, among other things, not supported by the vast majority of participants in the US capital markets.”

According to Tom Selling, PhD, CPA and author of the popular blog, The Accounting Onion, it’s been at least five years of “researching, round-tabling, surveying, conferencing, reading, analyzing, monitoring and speechifying” since the SEC released its original 2008 Roadmap towards the use of financial statements prepared according to IFRS versus Generally Accepted Accounting Principles (GAAP), the current accounting standard in the US. Dr. Selling has been a fierce opponent of IFRS and summarized his views in a 2008 manifesto, “Top Ten Reasons Why U.S. Adoption of IFRS is a Terrible Idea.” His criticism focused on what he considers the self-interested motivation for the SEC, global public accounting firms firms, the AICPA, the accounting industry trade organization and corporate executives to push for standards that he believes are contrary to the interests of US investors.

According to the IFRS Foundation website, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), the US standard-setter, first agreed to work together on standards “convergence” all the way back in 2002. The goal then was to remove the differences between international standards and US GAAP. That “vision” of global accounting standards is supported by international organizations such as the G20, World Bank, IMF, Basel Committee, IOSCO, and IFAC, according to the IFRS Foundation. Currently sixty-six jurisdictions, including all of the G20 jurisdictions, use IFRS. That’s almost everyone but the US.

The largest global public accounting firms are global firms themselves that serve other multinationals. They would benefit from efficiencies that would be realized if global accounting rules were standardized. Initially the auditors strongly supported efforts by US regulators to make IFRS happen. But in the last few years, enthusiasm waned as multinational clients with headquarters in the US reconsidered the potential cost savings of standardization and instead began complaining about the enormous cost of conversion.

One major benefit of US adoption of IFRS is supposed to be standardization and, therefore, comparability of financial information across jurisdictions for companies in similar industries or with similar business models. But some critics now say that dream is an illusion. In the July 2012 report the SEC says “enforcement structures around the world differ widely by jurisdiction” and that “rigorous enforcement is important to avoid false comparability where the requirements of the standards in each jurisdiction are the same but the interpretations and practices are inconsistent.”

Christian Leuz
of Chicago Booth has researched the issue of IFRS convergence and its advantages and disadvantages extensively. A recent paper suggests a new approach or 'thought experiment' that may help overcome current obstacles. Leuz agrees that concerns about false comparability are well founded. A 2010 paper, “Different Approaches to Corporate Reporting Regulation: How Jurisdictions Differ and Why,” is quoted in the SEC July report. But enforcement differences are not the only reason for reporting variations. Many other institutional differences across countries “in capital markets, securities regulation, investor protection and economic development, to name just a few” influence reporting practice and will continue to contribute to non-comparability even if IFRS is adopted around the world, including in the US.

Leuz suggests in the new proposal that we focus only on companies where international comparability is likely important and will yield positive capital market effects. What if, asks Leuz, we establish a ‘Global Player Segment’ (GPS) for firms that operate internationally and raise funding in international markets? Membership in GPS requires those firms to use the same reporting rules (i.e., IFRS), face the same enforcement mechanisms and have the same incentives for transparency in their reporting. Membership in the GPS would be voluntary but require submission to strict reporting regulation and enforcement once opting in. Voluntary membership, Leuz believes, would “enhance the credibility of firms’ commitment to transparency.”

Given ongoing US intransigence on the IFRS issue, international standard setters are now looking for alternatives. At recent event in Berlin, Leuz presented his GPS proposal. IASB chairman Hans Hoogervorst conceded that he no longer expect the US to adopt IFRSs for all entities. He predicts the United States will make IFRSs an option for large, internationally-oriented companies that can benefit from an IFRS adoption.

Call it regulation, but only if cost-justified.

That’s the approach that’s been applied by regulators and legislators to the Sarbanes-Oxley Section 404 requirement for reviews of internal controls over financial reporting. All but the largest companies are now exempted after smaller companies initially cried foul and then Dodd-Frank’s “emerging growth companies” complained that costs of 404 reviews outweighed the benefits. And it’s the same approach stock exchanges are taking with mandates for internal audit functions. Nasdaq recently dropped a proposal to mandate internal audit functions, even allowing for third-party outsourcing of the activity, because of widespread outcry over costs to industries such as biotechnology that believe the extra layer of oversight would inhibit growth. The New York Stock Exchange is now considering rolling back its requirement for internal audit too, in order to compete with Nasdaq for listings of new “emerging growth companies” that abhor regulation and justify that contempt with a promise of more jobs and growth in exchange for the light touch.


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