This is part five 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 the anti-IFRS views of Tom Selling, Ph.D., as summarized in his recent blog post, “Top Ten Reasons Why U.S. Adoption of IFRS is a Terrible Idea.” I consider Selling’s argument to be top notch and an essential component to the IFRS opposition. It is a must read.
Dr. Selling, a retired accounting professor, has written a popular blog on financial accounting–The Accounting Onion since July, 2007. “Blogging has emerged as an important way for independent professionals to gain exposure that could lead to opportunity.” He blogs about financial reporting because:
You’re supposed to blog about what you know. I know that financial reporting is often unnecessarily complex and far from perfect. … From my years of teaching, I … learned how to peel away layers of jargon and complexity to expose what lies at the core of an accounting rule: sometimes a valid concept, and other times an unpleasant surprise.
After receiving his Ph.D. in 1982 from Ohio State University, Dr. Selling has taught at the Dartmouth College Amos Tuck School of Business Administration, Massachusetts Institute of Technology Sloan School of Management, Wake Forest University Babcock Graduate School of Management, and the Thunderbird Garvin Graduate School of International Management, before retiring to private practice in 2006. He also served a year as Academic Accounting Fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission.
In his private practice he has lead and produced approximately 200 management education programs in 14 countries, teaching courses on SEC reporting, accounting for international operations, and International Financial Reporting Standards. He provides consulting services to companies on matters including SEC compliance, U.S. GAAP, international accounting standards, operational and strategic decision making, and control of international operations. He also serves as an expert witness and provide litigation support on a broad range of accounting topics, including foreign accounting standards and valuation. In addition, he is co-founder of Grove Technologies, LLC, “producer of easy-to-use, hosted, web-based collaboration tools.”
Dr. Tom Selling’s Opposition to the U.S. Adoption of IFRS
Dr. Selling has written several essays crtical of the SEC’s push to have IFRS adopted as the GAAP of the United States. He recently summarized his views in his excellent manifesto, “Top Ten Reasons Why U.S. Adoption of IFRS is a Terrible Idea.” [September 16, 2008] This essay is a must read because of its two themes. He lambasts the self-interested motivation for the SEC, CPA firms, AICPA, and corporate executives to push for something that runs so contrary to the interest of U.S. investors. He has also identifies several irrefutable reasons for why the push for IFRS is non-sensical. When reading his essay, be prepared for how he thoroughly integrates the two themes.
In his essay, Dr. Selling presents nine reasons against the U.S. adoption of IFRS.
Reason 1. IFRS adoption will encounter many similar problems to SOX-404 adoption. Dr. Selling recounts how SOX 404 required certification of internal controls has produced many billions of cost with little benefit. It is not yet required for smaller companies because for theme there is an acute problem of excessive cost for too little benefit.
He sees the IFRS conversion process as encountering very similar difficulties: too much cost for too little benefit. The “direct costs of conversion to IFRS will be in the billions of dollars, and much of it will go to auditors…” He also says “It is also a safe bet that initial estimates, bearing the imprimatur of the audit firms and/or the SEC, will understate the actual costs by orders of magnitude.” For all this cost to U.S. corporations, the cost of capital to U.S. companies will probably go up instead of down. In addition, an important issue no one is yet discussing why and how small U.S. companies should covert to IFRS.
Whether you accept this point made by Dr. Selling depends on how much you value the SOX emphasis on internal controls. Charles Niemeier, for one, would not ascribe to this point.
Reason 2. By pushing for IFRS, financial stewards are acting in their own self-interest instead of fulfilling their trust to investors. Dr. Selling says the the primary groups pushing IFRS for the U.S. are CPA firms and their AICPA advocacy group, who stand to benefit by many billions of dollars for conversion-related services. He estimates the benefit to cpa firms will exceed the wind-fall benefit they received from SOX conversion. In addition, he says that CPA firm litigation costs will decrease. In contrast to this, he says that investor groups do not favor the switch in standards. He says that recent SEC disregard for investor sentiments (on discontinuing the GAAP-IFRS reconciliation for foreign registrants) will work against investors voicing their opposition to the IFRS Roadmap. Because IFRS adoption is not in the interest of investors, the CPA firm push for IFRS is contrary to the AICPA code of ethics, “Ask yourself whether the AICPA’s one-sided promotion of IFRS constitutes an attempt to serve or to fleece the public.”
Dr. Selling also says that “top executives of public companies push IFRS because it will be easier to make their numbers, and they won’t be second-guessed by auditors, disgruntled investors or the SEC?.”
Along with Bob Jensen, Tom Selling has provided an important contribution to the anti-IFRS argument by emphasizing this point. The push for IFRS cannot be supported if for no other reason than the motives of the proponents are tainted. The big cpa firms will lose much respect over this. The image of the accounting profession took a major hit over the scandals and excess of the 1990s and early 2000s. For the most part, the image of the profession has been reclaimed. The big firms risk throwing it all away by pushing their own self-interest and IFRS.
Reason 3. IFRS Is No More “Principles-Based” Than US GAAP. Dr. Selling has written extensively about this. In contrasting the ‘bright lines’ of U.S. GAAP with usually more vague guidelines in IFRS, he says that “fuzzy lines in accounting standards have come to be exalted as ‘principles-based’ and bright lines are disparaged as ‘rules-based.’ ” He strongly disagrees with this interpretation, citing the accounting for leases as an example. He argues that a principle-based standard on leases would require all leases to be capitalized, reporting both an asset and a future liability for lessees. Instead, both GAAP and IFRS have rules that permit a compromise approach. In this case the GAAP rules are more definite than IFRS rules, and hence have brighter lines. Neither are based on principle.
Dr. Selling has hit the nail squarely on the head with this point. Dr. Ed Ketz certainly agrees with him.
Reason 4. Academic research verifies the value of U.S. GAAP. In “Accounting Research Slam Dunks SEC Proposal to Allow IFRS without Reconciliation to GAAP”, Selling reviews Congressional testimony by Teri Lombardi Yohn of Indiana University. He emphasizes these conclusions from her summarization of academic research: (1) “investors use the [IFRS to GAAP] reconciliation in their decision making. (Huge point!)” (2) “U.S. investors appear to prefer U.S. GAAP over IFRS.” (3) “Uniform standards across countries would not result in uniform implementation.” (4) “Enforcement of accounting standards is currently not, and unlikely to be uniform. (Nothing in other regulatory regimes compares to the vigilance of the SEC.)” (5) The SEC already has difficulty enforcing rigorous implementation of IFRS by 20-F filers, and would likely become less effective if it were forced to monitor IFRS reporting by foreign issuers–over whom its jurisdiction is more subject to question.” (6) “Evidence from reconciliations indicates greater opportunities for earnings management under IFRS, as reported income is higher on average than U. S. GAAP.” (7) “Foreign firms cross-listed in the U.S. appear to be valued higher than their counterparts, because it improves the quality of the information provided to investors.”
Selling is very dissatisfied that the SEC and FASB have chosen to disregard the reliable results from academic research in favor of politically advantageous IFRS. As have all other IFRS critics, he points out that there are no theoretical advantages to adopting IFRS. To claim that IFRS will produce benefit is a leap of untested faith.
Reason 5. GAAP Is Better Than the IFRS. In Dr. Selling’s words, In 1999, the FASB concluded, in its extensive report on the similarities and differences between IFRS (technically IAS at the time) and US GAAP, that IFRS was lower quality than GAAP. Very little has happened in the ensuing eight years … to change that conclusion.” He argues that IFRS was adopted by the EU to combat the growing influence of U.S. GAAP. I agree. IFRS was adopted by Europe not necessarily because of its merits, but because of its existence as a semi-plausible alternative to U.S. GAAP. European resistance to American influence is not a valid reason for getting rid of GAAP.
Reason 6. IFRS is not the best way to improve U.S. GAAP. Dr. Selling argues the nonsense of attempting to improve U.S. GAAP by switching to inferior IFRS that is subject to economic and political lobbying from other influential countries. This is only common sense.
Reason 7. IFRS Is Not Compatible with US-Style Corporate Governance. This is Dr. Selling’s most valuable contribution to the anti-IFRS argument, and what originally attracted me to his thinking (“Is IFRS Compatible with U.S.-Style Corporate Governance?“, December 10, 2007). In my opinion, this is the primary reason to oppose IFRS adoption by the U.S. It is based on theory and is difficult, if not impossible, to refute. His argument is so compelling that I repeat it here verbatim.
As I wrote in a previous post, John Coffee of the Columbia Law School sees the corporate scandals taking place in Europe as fundamentally different from those in the U.S., due to significant differences in ownership structure. The scandals in Europe generally involve majority-owned corporations and do not feature an accounting manipulation. There are two reasons for this. First, financial reporting is less important to the majority owners because they rarely sell shares. Second, fraud is more easily accomplished by authorization of related-party transactions at advantageous prices, below-market tender offers, and other forms of misappropriation. Any trading that takes place between minority owners has less to do with recent earnings reports, and more to do with an assessment of how minority shareholders will be treated by controlling interests.
In dispersed-ownership corporations that are prevalent in the U.S., stock price can have a significant effect on a manager’s compensation, providing them with strong incentives to manipulate accounting earnings. Thus, it stands to reason that accounting should be difficult to manipulate if it can be used to rip off shareholders. The evolution of U.S. GAAP can be seen as a response to the need for specific rules that minimized the role of management judgment because of management’s a strong self-interest in the reported earnings and financial position. Lacking empowered gatekeepers to prevent accounting fraud, we have had to place our hopes on very inflexible accounting rules, the SEC and private attorneys to catch the cases where management has attempted to surreptitiously cross the bright line.
Thus, it should be self-evident that IFRS-style accounting, replete with fuzzy lines, “judgment” and “reliable measurement” tests, would be a gift to U.S. managers. Outright fraud would be replaced by more subtle means of “earnings management,” rendering the SEC and private attorneys much less potent.
Reason 8. Would You Have the United Nations Rewrite the US Uniform Commercial Code? Selling provides such a succinct point that I quote its entirety.
Such was the way that Bob Jensen expressed the problem of lack of sovereignty over IFRS. No matter what motions the SEC will go through, or resolutions Congress may enact, the risk of near total loss of US influence over accounting standards is a real possibility. Rising economic powers like China will have their own agendas, virtually assuring that any place at the table we would be given in exchange for abdicating our sovereignty over accounting standards used by US companies would be temporary.
I certainly consider this to be a plausible, if not a likely result. The U.S. should not adopt IFRS unless it has veto power over new rules. Unfortunately for the U.S., competing governments will also insist on a veto power if the U.S. gets it. This will reduce the IASB to intractable gridlock. It can never be more effective than the ill-fated League of Nations.
Reason 9. If It Ain’t Broke, Don’t Fix It! Dr. Selling scribes to “logical incrementalism.” He says that for very complex systems, it is usually better to make small changes (instead of large-scale) because it is so difficult to predict all results. It is safer and less risky to make “small course adjustments”.
I definitely agree with this point. I’ve heard it said that if the U.S. experiment with IFRS fails, it can always go back to GAAP. You can never simply reverse course and go back completely. Upheaval and much wealth transfer will accompany the U.S. adoption of IFRS. Those that benefit from the conversion (i.e., European interests) will be unwilling to give their gains back to the U.S. I liken the futility of reversing course to what happens when a straight metal rod is bent. Chemical bonds have been altered. The rod can never be restored to its original position simply by bending it back. The metal has been stressed and simply bending it back does not destress it.
In conclusion, I have been an interested observer as Dr. Selling has been developing his position, and I agree with it. If only someone from the other side would respond to the merits of his argument. I am inclined to think that because no response has been forthcoming, there probably is no meritorious response.