IFRS Monopoly: Pied Piper of Financial Reporting Shyam Sunder, Yale University Canadian Academic Accounting Association Toronto, May 27, 2011 www.som.yale.edu/faculty/Sunder

Better Society? Better Markets? Better Accounting?

Competition

Competition

IFRS through National Regulators

All in One Voice “Single set of high quality principles-based standards for use by all to achieve comparability”

Unintended Consequences

Promise of Uniform Currency

Ten Years Later

One Size Fits All

Quality through Standards

Quality and Coordination Standards

Co-ordination through Standards

Standardization of Financial Reporting Disclosure Format Measurement

Good and Bad Standards

Bases for Deciding Prosperity of society Inclusion of information from all Stability over time Adaptability to changes in environment Robustness against manipulation Resistance to capture Mr. Crenshaw’s proposal was passed by a vote of one-to-six with Mr. Crenshaw casting the deciding vote.

Adaptability

Non-Bases for Deciding on IFRS Statistical covariation between accounting and stock market data Promotion by interested parties 120 countries can’t be wrong

Statistical Studies of Accounting and Stock Markets

“Information Content” Criterion If statistically proximity of accounting and stock market data is to be maximized, it is trivial to achieve nirvana Fire the accountants and report change in market capitalization as income! Accounting from the markets, instead of accounting for the markets Violates the maintained hypothesis that accounting may be relevant for stock markets

But Things are Much Worse! We do not have stock price data under financial reporting regime B (because it is still being considered). We have no way of estimating R(B) for comparison with R(A) even if that comparison was of any use. What do we do? Here is the trick.

Correlate Accounting B to Price A Financial Reporting System A R(A) Price System A R*(B) Financial Reporting Price System B System B What can comparison of R(A) to R*(B) tell us about the relative desirability of financial reporting systems A and B?

Accounting-Stock Market Covariation Studies It is hard enough to derive a logical inference from comparison of R(A) vs. R(B) Comparison of R(A) to R*(B) might make sense if stock prices were the identical under A and B That is, if financial reporting were irrelevant to stock markets In which case, why bother with these covariation studies

Promotion by Interested Parties

120 Countries Can’t be Wrong

How Do We Learn What is Better? A priori beliefs Derivation from known first principles Controlled experimentation Analysis of data gathered from the field

A Priori Beliefs Truthfulness Timeliness Relevance Unbiasedness, etc. Difficult to compare IFRS has no evident advantage Your head weighs 36 pounds, same as your feet.

Derivation from Known First Principles

Controlled Experimentation

Analysis of Data from the Field

Monopoly: No Requisite Variation for Evolution or Research

Rules and Social Norms

Rules vs. Social Norms

Principles vs. Uniformity Any two transactions which have any similarity should be treated alike. Any two transactions which have any differences should be treated different.

Language and Translation A direct translation may not convey the exact meaning of the original language

Top-Down Design Cartesian view of our world Belief in our knowledge and ability to design social systems to achieve desired ends

Fatal Conceit Friedrich A. Hayek Modern civilization naturally evolved and was not planned. All of its customs and traditions naturally led to the current order and are needed for its continuance. Any fundamental change to the system that tries to control it is doomed to fail since it would be impossible or unsustainable in modern civilization.

Biological Evolution Darwin: Biological evolution through replication, mutation and selection Spenser: Social evolution through Herbert Spencer: evolution of social processes

Fit in the legal, economic and business systems

Fortunately, we do not need to select a criterion in bottom-up evolution Bottom up evolution of financial reporting can proceed with light regulatory oversight Use general criterion of investment, growth, GNP, mitigation of fraud Compare institutions across boundaries and imitate better performing ones

Fractal Reality Benoit Mandelbrot (1977) Infinitely detailed No natural limit to additional detail Structure of rules in society No such thing as “perfectly clear” Do not believe in applicability of principles rhetoric Similar processes yield similar outcomes

Dependence and Judgment

Financial Reporting and Financial Engineering Unequal battle Slow, rule bound financial reporting has no chance against agile and free financial engineering Monopoly will make it even worse

Financial reporting as eye-in-the-sky or camera-model

Thank You.