Paul André

Fair Value Accounting and the Banking Crisis in 2008: Shooting the Messenger

The paper sets out to analyse the effects of the financial crisis on the international standard-setter in 2008 and the attempts made to shoot the messenger – to blame IAS 39 for creating the crisis for reporting unrealised losses, rather than the cause being bankers making bad investment decisions. It first provides a brief analysis of IAS 39 and fair value accounting for financial instruments. It then sets out the relationship with the Basel II banking regulatory regime. The main part of the paper is a chronological presentation of the events of 2008 as they impact upon the international standard-setting institution. In particular, we analyse the impact of the G20 requirements and the blunt intervention of the European Commission that led to amendments to IAS 39. The final part of the paper looks at the consequences as they are so far discernible and the damage done to the IASB by shooting the messenger.

A note on: Capital adequacy and the information content of term loans and lines of credit

Abstract This study examines the information content conveyed by the disclosure of credit agreements in a Canadian setting. We argue that the introduction of the 1988-capital adequacy requirements lead banks to reduce their level of commitment at the issuance of lines of credit to avoid their inclusion in the calculation of the capital ratio. As a result, after 1988, the disclosure of lines of credit is expected to be less informative than the disclosure of term loans since banks may exert less effort to screen and monitor firms. Our results are consistent with the argument that the difference between the market reactions at the disclosure of term loans and lines of credit is significant after 1988. We also provide evidence that firm size and concentration of borrowing affect the market reaction at the disclosure of bank credit agreements.

Are Joint Audits Associated with Higher Audit Fees

Abstract In its October 2010 Green Paper on audit policy, the European Commission suggested that joint audits might be a way of improving the audit market in Europe. However, some parties consider that a joint audit system is not an efficient solution because the perceived improvements in audit quality, if any, are not commensurate with the significant increase in audit fees. We compare audit fees paid during the years 2007–2011 by listed companies in France, where joint audits are mandatory, with those paid by British and Italian companies. Theory suggests that audit fees in countries with high investor protection, such as the UK, are likely to be greater than those in countries with lower investor protection, such as France and Italy, ceteris paribus. However, we find significantly higher audit fees in France after controlling for well-documented auditor, client, and engagement attributes, which vary across countries. Furthermore, since we do not find statistically significant differences in the magnitude of abnormal accruals, the higher audit fees observed in France do not appear to be associated with higher audit quality.

Compliance with Goodwill Related Mandatory Disclosure Requirements and the Cost of Equity Capital

Theory suggests that increased levels of corporate disclosure lead to a decrease in cost of equity via the reduction of estimation risk. We examine compliance levels with International Financial Reporting Standard 3 Business Combinations and International Accounting Standard 36 Impairments of Assets mandated goodwill-related disclosure and their association with firms’ implied cost of equity capital (ICC). Using a sample of European firms for the period 2008–2011, we find a median compliance level of about 83% and significant differences in compliance levels across firms and time. Non-compliance relates mostly to proprietary information and information that reveals managers’ judgement and expectations. Overall, we find a statistically significant negative relationship between the ICC and compliance with mandated goodwill-related disclosure. Further, we split the sample between firms meeting (or not) market expectations about the recognition of a goodwill impairment loss in a given year to study whether variation in compliance levels mainly plays a confirmatory or a mediatory role. We find the latter: higher compliance levels matter only for the sub-sample of firms that do not meet market expectations regarding goodwill impairment. Finally, our results hold only in countries where enforcement is strong.

Examining the Patterns of Goodwill Impairments in Europe and the US

Abstract We examine the patterns of goodwill impairments in Europe and in the US over the period from 2006 to 2015, for a sample of more than 35,000 firm-year observations. We define the timeliness of goodwill impairments as the frequency of accounting impairments conditional to indications of economic impairments. We measure indications of economic impairment with three metrics: equity market value minus equity book value less than goodwill, market-to-book smaller than one and negative earnings before interest, tax, depreciation and amortisation (EBITDA). Our research strategy leads us to draw very different conclusions than those in the recent EFRAG (2016) study. While median levels of goodwill on the books between US and European firms are relatively similar, we find several indications that US firms recognise timelier impairments, at least during 2008 and 2009, that is, the early years of the financial crisis. We further document that US impairers write down a much greater percentage of their beginning balance of goodwill than European impairers. During the financial crisis, the median level of impairment by US firms was 63% of opening goodwill in 2008 and 40% in 2009, whereas median European write-downs were only 6% and 7% of opening goodwill, respectively. Even though European firms are more likely to impair over multiple years, the cumulative impairments never come close to the level of US firms, be it in a single year or cumulative over multiple years. We also find that the frequency of accounting impairment is small compared to the number of firms presenting evidence of economic impairment: only 20–25% of firms recognise impairments depending on the measure of economic impairment. This has often been interpreted by academics as a sign of untimely write-offs. Accounting differences between US Generally Accepted Accounting Principles and International Financial Reporting Standards are unlikely to explain our results. One caveat of our analysis is that it does not allow us to draw conclusions on whether the observed differences between US and European firms are driven by differences in conditional conservatism and/or big bath accounting practices.

Impact of Mandatory IFRS Adoption on Conditional Conservatism in Europe

We study the effect of the mandatory adoption of IFRS in Europe in 2005 on conditional conservatism. To capture conditional conservatism, we use three measures: the Basu (1997) measure, the Khan and Watts (2009) measure, and a measure controlling for potential shifts in unconditional conservatism and cost of capital after the adoption of IFRS. From a sample of 7,251 firm-year observations drawn from 16 European countries, we document an overall decline of the degree of conditional conservatism across our three measures. While there is no change in weak enforcement/governance countries which remain less conditionally conservative than strong enforcement/governance countries, the latter exhibit a significant decrease. Further, we demonstrate that the decline is more significant for firms carrying intangible assets and goodwill in their balance sheets, items for which impairment tests rely on unverifiable fair value estimates. We argue that IFRS are conceptually conditionally conservative but that inappropriate application of conditional conservatism principles may have prevented financial reporting from reaching the level of conservatism targeted by the IASB.It is argued that IFRS put more emphasis on neutrality than conservatism. We examine the impact of the mandatory change to IFRS in 2005 by European firms on the level of accounting conservatism and check whether well documented differences in conservatism across countries and varied institutional and legal settings survive the change. We document that accounting conservatism has decreased after the adoption of IFRS overall and more specifically across French and German law origin countries and countries with important debt markets and with less developed equity markets. We also find a reduction in conservatism in countries where the tax book conformity was high. More importantly, we document that differences across countries, institutional and legal settings disappear after mandatory IFRS adoption. We only find weak evidence that insider economies with weak enforcement (Leuz et al. 2003’s cluster 3 which includes Greece, Italy, Portugal, and Spain) continue to have a lower level of conservatism. Finally, the decrease in conservatism is most significant in countries which had the greatest difference with the new IFRS standards. Overall, we conclude that accounting standards do matter!

The Role and Current Status of IFRS in the Completion of National Accounting Rules – Evidence from European Countries

Abstract I present a summary and analysis of a series of papers from this special issue of Accounting in Europe that examine the role and current status of International Financial Reporting Standard (IFRS) in the completion of National Accounting Rules applicable to large ‘non-listed in a regulated market’ non-financial undertakings trading for gain in 25 European countries following the recent implementation of the new European Accounting Directive 2013/34/EU. IFRS has had a varying degree of influence across European countries. Some refer and are closely aligned to IFRS or to IFRS for small and medium-sized entities, some while influenced by IFRS retain complete independence and some show limited influence mostly when accounts are for other purposes such as taxation, dividend distribution or creditor protection. I present a number of classification schemes and contrast these with Nobes [(2008). Accounting classification in the IFRS Era. Australian Accounting Review, 18(3), 191–198] two group accounting classification of European accounting systems as strong equity/commercially driven versus weak equity/government driven/tax-dominated systems.

Board Effectiveness and Short Termism: BOARD EFFECTIVENESS AND SHORT TERMISM

We examine whether more effective boards in terms of size, experience, shareholding and independence, as discussed in the 2010 UK Corporate Governance Code, limit excessive short�?term risk taking or short�?termism. We use a state�?of�?the�?art asset pricing model that enables the disentangling of short�?term risk (related to short�?term returns) and long�?term risk (related to long�?term returns), and use the former as a proxy for short�?termism, where the short�?term component not only represents the time horizon for which we are interested but also the risk that is not related to fundamentals. We examine 916 firms in the UK over a possible horizon of 18 years, January 1992–December 2010, and find that more effective boards are associated with lower levels of short�?term risk and this result is robust to various types of short�?term risk (overall, downside) and specifications.

Incentives for consolidation of finance subsidiaries: evidence from France

The focus of this study is to improve understanding of the incentives underlying a particular type of off-balance sheet financing: the non-consolidation of finance subsidiaries. We examine a sample of French firms that had finance subsidiaries during the 1990–1997 period. More than 32% of these firms did not consolidate their finance subsidiaries during the period studied. This contrasts with Anglo-American countries where established GAAP have eliminated the non-consolidation option. The direct consequence of not consolidating these highly leveraged subsidiaries is the reduction of debt-to-capital ratios. As suggested by economic theory, results show that firms are less likely to consolidate their finance subsidiaries the higher their level of indebtedness, the larger their size, the greater their ownership concentration and the larger the extent of their credit activities. The predictable results support the moves to limit exception to consolidation and to increase disclosure with respect to off-balance sheet activities.

Mandated Disclosures Under IAS 36 Impairment of Assets and IAS 38 Intangible Assets: Value Relevance and Impact on Analysts’ Forecasts

ABSTRACT Drawing on a large sample of European firms, we examine whether variant compliance levels with mandated disclosures under IAS 36 Impairment of Assets and IAS 38 Intangible Assets are value relevant and affect analysts’ forecasts. Our results indicate a mean (median) compliance level of about 84% (86%) but high variation among firms and disclosure levels regarding IAS 36 being much lower than those regarding IAS 38. In depth, analysis reveals that non-compliance relates mostly to proprietary information and information that reveals managers’ judgment and expectations. Furthermore, we find a positive (negative) relationship between average disclosure levels and market values (analysts’ forecast dispersion). Results, however, hold more specifically for disclosures related to IAS 36, and these also improve analysts’ forecast accuracy. Our findings add knowledge regarding the economic consequences of mandatory disclosures, have an appeal to regulators and financial statement preparers and reflect on the IASB’s concerns to increase the guidance and principles on presentation and disclosure.