This is part three of an eight-part series in which I review the seven IFRS critics (Sunder, Niemeier, Ball, Ketz, Selling, Jensen & Albrecht) of whom I am aware. The series continues over the next two weeks on regular posting dates, MWF.
In today’s essay, I review Ray Ball’s very popular paper, “International Financial Reporting Standards (IFRS): Pros and Cons for Investor.” His paper, based on the P D Leake Lecture delivered on September 8, 2005 at the Institute of Chartered Accountants in England and Wales, has since been published in a 2007 edition of Accounting & Business Research. A pre-publication version of the paper is available at SSRN.
Ray Ball’s opposition to IFRS gives instant intellectual respectability to the cause. If one of the world’s smartest professors does not favor the SEC’s push to change accounting standards, then that should give the rest of us reason for doubt.
Raymond Ball has, arguably, the biggest and greatest name in American accounting academe. His papers have changed the field of accounting research not once, but twice! “An Empirical Evaluation of Accounting Income Numbers,” Ball and Brown (1968), was written while a Ph.D. student and is worthy of a Nobel prize.
The Sydney Davidson Professor of Accounting at the Graduate School of Business at the University of Chicago, Professor Ball has taught at some of the leading schools in the world: William E. Simon Graduate School of Business Administration at the University of Rochester, London Business School, Australian Graduate School of Management, and University of Queensland. His biography at the Chicago GSB reads:
Ray Ball studies corporate disclosure, earnings and stock prices, international accounting, the Australian economy and share market, and market efficiency and investment strategies. He is coauthor of “An Empirical Evaluation of Accounting Income Numbers,” an article published in the Journal of Accounting Research in 1968 that won the American Accounting Association’s inaugural award for seminal contributions in account literature. This article revolutionized the understanding of the impact of corporate disclosure on share prices, and of earnings releases in particular. It laid the foundation for much of the modern accounting literature. Ball also is the author of “Anomalies in Relationships between Securities’ Yields and Yield surrogates,” published in the Journal of Financial Economics in 1978, the first academic reference to systematic anomalies in the theory of efficient markets. Ball is editor of the Journal of Accounting Research, associate editor of the Journal of Contemporary Accounting and Economics, and a member of the editorial board of the European Accounting Review. He is a member of the Board of Trustees of Harbor Funds and Chair of its Audit Committee. He serves on the Advisory Group for the Financial Reporting Faculty of the Institute of Chartered Accountants in England and Wales, and on the Shadow Financial Regulation Committee.
Dr. Ball starts his paper by explaining that there is good reason for why there are accounting standards. This is because they serve as an integral component in the relationship between the company and its interested parties (such as investors), “For example, if lenders agree to lend to a company under the condition that its debt financing will not exceed 60% of tangible assets, it helps to have agreement on how to count the company’s tangible assets as well as its debts.” Of course, the parties to any financing transaction have the right to specify their own set of accounting rules for how any and all accounting transactions should be reported, but in practice it makes good sense that some organization should exist to create a general set of accounting rules to provide uniformity: (1) it is a public good that replaces the need for each set of contracting parties to reinvent the wheel as they create their own set of standards, (2) they protect auditors against opinion shopping, (3) they enhance comparability amongst various companies.
He also cautions that there are three reasons to expect less than 100% uniformity in accounting rules: (1) due to differences in users and the information they desire, differences in companies and their industries, differences in countries and their cultures, it has never been shown that a unique set of standards can exist for all, (2) general standards exist because the world is too complex for rules to cover every possible contingency, so there are undoubtedly variances that occur as general standards are applied, (3) country-by-country government imposed rules are political solutions to circumstances in that country, and cannot be interpreted as optimizing all public interest (only a public interest).
Moreover, it is certainly not clear that lack of comparability arising from the preceding is a cause for across-border government action. Is there something special about accounting rules that requires uniformity when there is no uniformity in almost any aspect of human existence, such as in hotel room quality (high or low) or electrical current voltage (110 or 220) or measurement (kilometer or mile) or even which side (left or right) of the road to drive on?
The push for IFRS results from the revolution in information technology that has made the world much smaller. However, the world is still large in its differences. He says,
We have witnessed a revolutionary internationalisation of both markets and politics, and inevitably this creates a demand for international convergence in financial reporting. How far this will go is another matter. Despite the undoubted integration that has occurred, notably in the capital and product markets, most market and political forces are local, and will remain so for the foreseeable future. Consequently, it is unclear how much convergence in actual financial reporting practice will (or should) occur. [italics added by Albrecht]
Dr. Ball explains that a primary reason for having a single set of international accounting standards is to bring about convergence. He explains that it is one thing to have convergence in standards and another thing to have convergence in implementation.
Dr. Ball sees insurmountable and impossible-to-overcome barriers to uniformity in accounting practice. My summary of his words is: there will be no uniformity in the enforcement of accounting standards, from country to country, which means that there will be no reason to expect that financial reports will be comparable from companies in different parts of the world.
Uniformity in accounting standards will not produce uniformity in accounting reports. To claim so is to mislead the investment community. “Uneven implementation could increase information processing costs to transnational investors – by burying accounting inconsistencies at a deeper and less transparent level than differences in standards. In my view, IFRS implementation has not received sufficient attention, perhaps because it lies away from public sight, ‘under the rug.’ “
Dr. Ball sees problems in various parts of world financial markets. “The fundamental reason for being sceptical about uniformity of implementation in practice is that the incentives of preparers (managers) and enforcers (auditors, courts, regulators, boards, block shareholders, politicians, analysts, rating agencies, the press) remain primarily local.” The amount of power needed to bring about uniformity in these areas is impossible to imagine. Moreover, there is no reason to believe that bringing about such uniformity is a good thing. The logic of national differences is obvious.
While increased internationalisation of markets and politics can be expected to reduce some of the diversity in accounting practice across nations, nations continue to display clear and substantial domestic facets in both their politics and how their markets are structured, so increased intemationalisation cannot be expected to eliminate diversity in practice.
Dr. Ball concludes the basic structure of his argument with the following statement:
In sum, even a cursory review of the political and economic diversity among IFRS-adopting nations, and of their past and present financial reporting practices, makes the notion that uniform standards alone will produce uniform financial reporting seems naive. This conclusion is strengthened by [a] review of the weak international IFRS enforcement mechanisms that are in place, and by a review of the relevant literature on the relative roles of accounting standards and the reporting incentives of financial statement preparers (i.e., managers and auditors).
His final objection to the U.S. government mandating the use of IFRS deals with a long term issue, that “over time the IASB risks becoming a politicised, polarised, bureaucratic. UN-style body.”
In my opinion, Dr. Ball’s objection to IFRS is so well reasoned that it makes me wonder why the SEC is continuing on with its crusade. The proponents of IFRS adoption in the U.S. claim that the advantages of IFRS are self-evident. This claim is unjustifiable, at least for our lifetime and probably for the lifetimes of a few more generations. It does not take a rocket scientist (and Dr. Ball is a rocket scientist of the accounting world), to see that continuing with the road map to IFRS adoption has the clear potential to significantly impair the most valuable financial market in the world.