Phillip Ormrod

The Impact of the Change to International Accounting Standards on Debt Covenants: A UK Perspective1

Abstract This paper examines the impact on covenants in the debt contracts of companies of the impending change to international accounting standards (IAS). The primary focus of the paper is the UK debt market, but comparisons are drawn with other EU countries that will also be affected by the adoption of IAS. Existing evidence of the nature of debt covenants and the impact of accounting regulation change on such covenants is briefly reviewed. It is argued that the adoption of IAS will have a significant impact both on reported earnings and on balance sheet values. Moreover, it is argued that the adoption of IAS will increase the volatility of earnings. It is further argued that, as a consequence of these effects, there will be a significant impact on debt covenants given the widespread use of rolling GAAP. A number of cases and hypothetical examples are provided to illustrate the impact of the adoption of IAS.

Boards of Directors and Financial Risk during the Credit Crisis

Research Question/Issue: This research examines the relationship between board processes and corporate financial risk. Using a unique questionnaire survey about board behavior, several measures related to board processes are developed and used to explain certain aspects of financial risk during the recent crisis. Research Findings/Insights: In a sample of 141 companies with complete data collected from company chairs on both board structure and process, board process is found to be an important determinant of financial risk during the crisis of 2008-2009. In particular, financial risk is lower where non-executive directors have high effort norms and where board decision processes are characterized by a degree of cognitive conflict. The impact of cognitive conflict is however found to be less pronounced in boards with high levels of cohesiveness. Theoretical/Academic Implications: The study provides theoretical and empirical advancement of the governance literature towards an understanding of group process-oriented views of boards’ work and effectiveness. This study identifies the significance of board processes and their impact on financial risk supported by quantitative empirics. Findings of a strong relationship between board process and financial risk augment existing theories to suggest that the effects of boards work through group processes that bring executives and non-executives together in relations laced with control and collaboration.Practitioner/Policy Implications: Regulators, acting post the financial crisis have produced governance codes that emphasize risk management as a key responsibility of boards. The link between board process and financial risk established in this paper provides evidence for company chairs and other directors on the possibilities and potential effectiveness of boards in discharging this responsibility.

Credit agency regulation and the impact of credit ratings in the international bond market

The use of credit ratings in financial and other legal documents — both in the USA and Europe —, has led to a situation in which the major rating agencies have become (largely unwilling) participants in the legislative process. This situation has become partly formalized in the US (and is being repeated elsewhere in the European Union, Eastern Europe and Latin America) through the creation of officially ‘recognized’ agencies whose ratings now carry the imprimatur of the Securities and Exchange Commission. The purpose of this paper is to contribute to the debate on the necessity for formal legal status to be sustained in the market for bond credit ratings. In this context, the criteria for a credible rating agency are examined and evidence is provided on one element of the criteria which is under-researched: namely, the impact of the ratings in the market place. The influence of rating agencies in international capital markets is assessed through an analysis of the impact of ratings on the yields of bonds, represented by a comprehensive sample of actively traded debt. The sample contains analysis of ratings introductions on both new and seasoned debt and also examines the impact of ratings revisions. It is concluded that official recognition has no market-based role and it is argued that ratings are used by regulators because of the success of the major agencies in performing their market function.

Executive stock options: volatility, managerial decisions and agency costs

Abstract This paper proposes a new rationale for understanding managerial contracts which set-out to induce stock price volatility in the form of granting of executive stock options. First, we suggest that previous research focuses too much on short term volatility effects and offering neither a theoretical or empirical perspective on incentives which might influence long-term behaviour. To address this, we offer a theoretical structure of why managerial incentives might be important in determining the evolution of volatility over the life of an option contract and provide empirical support for our views. Second, we examine the impact of option moneyness on managerial behaviour over time and provide an analysis, with supporting empirical work, of the unintended incentives thereby created. Our approach suggests that volatility-inducing contracts do not work in the intended manner and supports a growing body of work which indicates that option-based remuneration does not incentivise managers to enhance corporate performance. Our evidence is within a UK context, based on a near-population sample size.

Impact of international financial reporting standards on the profit and equity of AIM listed companies in the UK

Abstract This study examines the extent to which the change from UK GAAP to IFRS has affected companies listed on the Alternative Investment Market (AIM) in the UK. The results suggest that, on average, profit reported under IFRS is higher than that reported under UK GAAP; however, the difference is much smaller for AIM listed companies as compared to what existing literature suggests for firms listed on main stock markets. The Grays partial analysis results indicate that despite the extensive programmes for improving convergence over time there is still a considerable discrepancy between IFRS and UK GAAP.