Today’s essay is simply part of an unfinished work. If one can discover what one thinks by writing about it (see Thinking on Paper, by V.A. Howard), then this is an early attempt by me to figure out what is going on in the world of IFRS. Comments are welcomed, as I am attempting to learn by writing this essay. I probably don’t have it all figured out.
Current economic orthodoxy is based on the internationalization of financial markets and free flow of capital across any and all national borders.
It has grown from two distinct origins–German and French. The German belief in the free flow of capital stems from its unpleasant experience following World War I. International control and regulation of the German economy rankled those who believe Germany could have been better off had its capital been able to flee to other countries, thereby gaining it a degree of protection. French support for the free flow of capital stems from a realization that government control of French capital only controlled middle and working class citizen’s of capital, and not that of the richer upper class. Therefore, to afford equal treatment to workers, it is necessary to endorse the free flow of capital.
European adherence to the free flow of capital is self-serving. Proponents expect that Europe will experience a net inflow of capital if worldwide, all barriers to capital are removed. Where will the capital flow from? It will come mostly from the U.S. (that is where most of the capital resides), but also from the developing world.
Building a global financial system premised on the free flow of capital requires that no nation regulate its own capital market, or at least regulate its own capital market more stringently than does any other country. Since detailed accounting standards and active enforcement of corporate compliance are hallmarks of regulation (the additional regulation/inspection of auditors is a hallmark of U.S. regulation), then more generalized and flexible accounting standards and indictment of only the most egregious corporate frauds are absolutely essential conditions for GFS and the free flow of capital. The economic theory of free flow of capital absolutely requires accounting standards such as today’s IFRS. Because the U.S. is such a large actor in the world economy, the economic theory of free flow of capital absolutely requires the U.S to discard GAAP and adopt IFRS.
This theory has several corollaries. There is a sense that capital is indestructible. If conditions suddenly turn unfavorable for capital invested in a particular company in a specific country, then the capital can be preserved by allowing it to flee immediately to another company in what very well may be another country. There is a sense that there will always be sufficient greener pastures to absorb all capital flowing away from negative investments. There is also a sense that there is enough information publicly available that investors can always accurately value alternative investments and make the most rational investment decisions. [Accountants can interpret this to mean that accounting rules do not matter, and that executive attempts to manipulate valuations will always be ineffective.]
The U.S. has a different history (socially, economically, politically) and hence has some citizens that see the world a different way. The Great Depression of the 1930s scarred the national psyche, and has produced a mindset that financial markets should always be regulated because that preserves investor capital.
Moreover, capital is viewed as a national resource. U.S. citizens demand government policies conducive to strategic creation, maintenance and management of that capital. Capital can be viewed the same way as other national resources such as precious minerals or the productive capacity for military defense. Said another way, strategic capital management is an essential aspect of the national security.
When viewed from this piont of view, it is easy to see that U.S. GAAP and SEC enforcement and the Sarbanes-Oxley emphases on internal controls and auditor inspections are essential to the national security of the United States.
There are corollaries to this view. First, capital is destructible, it can dissipate. Moreover, greener pastures (if they exist) may be insufficient to absorb any capital flowing away from adverse circumstances. Second, markets are not efficient and intrisic valuation of companies is not possible. Therefore, accounting information does matter and the specifics of accounting rules do matter.
Having gone through this line of thought, my conclusion is that if you believe that the capital of a country’s citizens can be viewed as a national resource, then you should support the U.S. retention of its GAAP. If you believe in the free flow of capital, then you should support IFRS for the U.S.
The existence of the free trade of goods and services are not directly related to the free flow of capital.
Debit and credit – – David Albrecht
The world is not as simple as your country’s people think. Anglo-Americans are never in the post modern. Have you ever thought about the impacts of globalization of financial data on emerging economies, corporate governance, the mentality of doing business, moral, culture, taste of food, etc… why can you just talk about flow of capital !? And these are the people who dominate the world, largely becuase they speak English – the internationally standardized language.
Professor Albrecht,
your anti-convergence argument is starting to take on an isolationist tone. Undoubtedly there are many US policies and regulations that many if not most of our trading partners would like to see changed. Likewise, we encourage the Chinese to float the RMB and impose stronger IP protections, the EU to modify or eliminate industrial subsidies, and developing nations to impose what we consider fair labor practices. Accounting standards and auditor oversight are not, it seems to me, unique cases.
Just because a foreign official argues in favor of modification of a domestic policy change does not imply that the domestic policy change is against the best interests of the nation whose policy is in question.
GAAP-IFRS convergence and SOX are separate, if related, issues. There is a host of current academic research on the effects of both. SOX has fared well. It appears to have hurt both equity and debt holders while indisputably raising costs for firms. IFRS appears to be weakly beneficial but generally only to those firms that adopt voluntarily (naturally) and it appears to be much less important than the legal and institutional protections for investors in determining cost of capital, informativeness, and value relevance (again, not surprising).
If you’re aware of any current research documenting the opposite, it would be helpful if you could cite it. I realize that this is a student-practitioner level blog, but sometimes it’s tough to figure our where your arguments and assertions are coming from.
My personal view of IFRS is that it just won’t matter that much, but it is likely to be weakly beneficial in the long-run. It seems to me that we have a global financial system whether we want it or not. On the whole, I’d rather see it move in the direction of a system that is at least somewhat by design rather than purely emergent.
As the current crisis is global and harming the rest of the world more so than the US, I would expect that the inevitable (knee-jerk) regulatory (over-)response will have an international flavor. Though, the EU and the Euro may not survive in their current form. We may come to look back on GAAP-IFRS and SOX as quaint little issues.