Financial Reporting Goes Global

Globalization is the key issue in determining the future of financial accounting, says professor Gregory S. Miller. And as more countries consider adopting an international accounting standard, India is positioned to be a strong leader.
by Cynthia Churchwell

As business goes global, pressure is increasing for adoption of a single set of accounting standards worldwide. In this e-mail interview, Harvard Business School professor Gregory S. Miller discusses this trend and India's unique position to be a leader in the international accounting environment.

Miller and colleague V.G. Narayanan have made this case to the Institute of Chartered Accountants of India, and wrote "Accounting Standards and the Globalisation of Indian Businesses," which appeared in the July 2005 issue of The Chartered Accountant.

Cynthia Churchwell: What prompted you to write about globalization, accounting standards and, in particular, Indian accounting standards?

Gregory Miller: Globalization is the major issue in determining the future of financial reporting. As financial and product markets become global, the need for a global set of accounting information to facilitate global transactions has really become overwhelming. This is clear in practice, both with the International Accounting Standards Board attempting to pull together one set of global standards and with the U.S. Financial Accounting Standards Board agreeing to an attempt to converge U.S. standards with international standards. I can't say what accounting standards will look like in ten years, but I can say that globalization will have been a major force in determining what they are. Given this situation, many accounting researchers and practitioners are spending a large amount of their time considering the implications of a set of global standards.

My work, and that of others in the area, shows that global differences in accounting have important economic impacts. For example, in my peer-reviewed research I have examined how global differences in accounting impact investment around the world (we find non-domestic investors are more likely to invest in firms with accounting similar to that used in their home country) and in looking at whether a single set of standards really will be applied in a consistent global manner (cross-country accounting information becomes closer, but we still find systematic differences in some components of the accounting output). Findings like these indicate that the focus on overcoming accounting differences is important. Further, while we will be able to make some headway as we focus on the issue, it also appears that some aspects of accounting are very "sticky," suggesting there will need to be a strong set of actions and incentives to get us to truly comparable global accounting.

The insights from the body of literature I just mentioned are important, but mostly provide broad guidance on the attributes and importance of global accounting. As V.G. Narayanan and I were discussing the work on international accounting issues, it became clear that India was a very interesting case of many of these forces coming together. For example, while India's capital markets are still emerging, they have a highly trained set of chartered accountants (CAs) who practice in India and around the world. Further, the CAs in India have much more control over the standards than in many other countries, where standard setting and practice are more separated. Additionally, there is no real leader in international accounting in Asia. Thus, India has a unique opportunity to grab that position. When we combined V.G.'s knowledge of accounting and institutional features in India with the research in the area, it really became compelling to us that we should make this case to the CA institute in India.

Q: What role do accounting standards play in the globalization of Indian businesses, U.S. businesses, and businesses of other countries?

A: This really comes back to what makes India unique. India is having an amazing growth spurt that has led to having global leadership in some industries while moving forward in many other aspects of developing globally competitive businesses. Much of their growth is driven by a wealth of smart, hard working, well-educated individuals. In other words, great human capital. However, they do not have fully formed financial markets and have not been able to generate large amounts of financial capital, particularly from international sources. This acts as a constraint on growth. Thus, by adopting International Accounting Standards and really becoming a leader in the field, India could lower their domestic firms' barriers to international markets. When you think of the human capital of all the talented CAs in India, this really is another way to use the human capital they have to fuel economy-wide growth.

Globalization is the major issue in determining the future of financial reporting.

Compare that to the U.S., which has a strong pool of human capital but also the world's largest financial capital markets. You can see that the U.S. has less reason to feel the need to move quickly to IAS. However, even the U.S. is feeling pressure to have similar standards to be a fully functioning part of the global economy.

For an in-between example, think of Europe. The EU decided long ago that creating one financial market across the Union was crucial to allowing true coordination within the Union. They quickly realized that having one set of accounting was a necessary component in making the "one market" concept work. Thus, they have required adoption this year. This is an example of moving towards globalization to create the scale needed for business today.

Q: Is there a benefit of International Accountings Standards being recognized at the national level rather than by voluntary adoption by individual companies?

A: Definitely. If you adopt the standards nationally then all the regulators, auditors, analysts, management teams, etc. know that they have a single set of standards to understand and implement. This allows all of those entities to focus resources on making that single set of standards work in the intended manner. Without that strong knowledge base, even well-intentioned practitioners just may not have the skill set to properly implement the standards. In the study of international adoption of standards I mentioned previously, one of the things we find is that oversight by a regulator who is actively involved with the standards (in our case the SEC) greatly increases the comparability of implementation across countries. So you can see that country-level adoption could be both economically more efficient and make the accounting much more credible to outsiders who need to rely on it.

In addition to the domestic scale issue, there is also an international scale advantage. As discussed previously, my research shows that once outsiders realize that understanding the accounting is much less of a barrier, they are more likely to invest in a company. By adopting at a country level, this accounting decision becomes very visible to outsiders. If only individual companies adopt, they then must also attract the attention of investors to let them know that the company is using the familiar form of accounting. Add to that the credibility issues from above, and you can see the advantage an individual firm gets from countrywide adoption.

Finally, countrywide adoption allows the nation more ability to influence the standard-setting process. We have recently seen Europe push for a stronger position in influencing the IASB based on being the largest user of the standards. By adopting as a country, it is much easier to push for a board position or some other method of impacting standard setting.

Q: Have you spotted any country or regional trends in the implementation of IAS?

A: Europe is really the leader right now. The EU decision to adopt IAS (the actual standards are now called International Financial Reporting Standards, or IFRS) pushed them to the forefront in this area. After that, individual countries such as Australia and Canada announced they would be converging with IAS soon. By this point, many countries have indicated they intend to be on IAS within the foreseeable future, so it has really picked up steam.

I think most [global managers] would love to have one set of solid accounting standards, rather than having to deal with "translation" issues.

There is even some evidence of impact in the U.S., which has traditionally been very firm on sticking to GAAP—Generally Accepted Accounting Principles. The IASB is working closely with the FASB to converge the U.S. and IAS standards. The Securities and Exchange Commission has even considered letting foreign companies list on U.S. exchanges using IAS.

Q: What position do you encourage the Institute of Chartered Accountants of India to take on the adoption of IAS by Indian businesses? Why is this important?

A: V.G. and I recommend that they announce a desire to fully adopt IAS countrywide. They could have a tiered actual adoption, so the larger international companies adopt first and smaller companies get a little more time to adjust. Since many of the large companies already provide IAS-based information, the first step could happen quickly.

We believe that only full adoption of IAS will give the benefits we discuss above. That is, it will make the basis of accounting clear to international investors and also position India and its CA institute to be one of the important forces in shaping IAS. There is a narrow window for the second benefit; if the institute waits too long they will not be able to influence the direction of IAS. Further, while they currently have what is probably the largest and strongest set of trained accountants in Asia, China is rapidly moving to get on board with IAS. That makes the window even tighter.

Q: Are there any other changes in accounting standards and practices you've identified that provide further evidence of a globalizing trend?

A: Between the adoption of IAS in Europe and the U.S. consideration of allowing IAS for listings here, I think it is clear that globalization has arrived. Discussions with management at top global companies from an operational perspective also make it clear that they feel they are really financially global—many are listed on exchanges in multiple countries and undertake international investor relations programs—including visits by top management around the globe. I think most would love to have one set of solid accounting standards, rather than having to deal with "translation" issues. Absent that single set of accounting standards, more and more companies are using whatever accounting choices they have within their current standards to make their accounting as comparable to their international competitors as possible. We also have observed an increase in the number of firms providing reconciliations between their accounting numbers and U.S. or IAS GAAP. All of this suggests that the market supports the push for a global set of standards—the issue is what that set of standards should really look like.

Q: Has anything you observed in the last few years about accounting standards and the international marketplace surprised you?

A: I have been surprised by the speed with which IAS/IFRS was overhauled once the EU decided to adopt the standards. I truly did not think the board would be able to pull it off. They really should be commended for the speed with which they created a high quality and coherent set of standards.

I also have been surprised about the push for fair value accounting. While the FASB also is heading in this direction, the IASB really led the push. It is a major change in our basis for accounting and I think business leaders are just catching on to the dramatic impact on financial statements. I think this is actually likely to lead to a heated debate internationally and in the U.S.—I am still not sure the standard setters will win out on this issue. There is a lot more that could be said in that area, but since it is not a purely international issue I will leave it at that.

Q: What are the latest research projects you are working on?

A: In addition to my ongoing international work, I am looking into how firms use investor relations to impact the visibility and understanding of their firms. For example, I have a new study that looks at whether investor relations can impact firm visibility for smaller U.S. firms. There we find that investor relations can lead to increased institutional investing, analysts following, share turn, and even have some valuation impact. That work was inspired by some of the international work that indicated how important visibility is in making firm communication work. I also am working on a few studies that look at the role of the media in disseminating and interpreting financial information. The media has been largely ignored in studies of financial information intermediaries. Given the importance of the media in information flows, I believe this is a ripe area for study.

Of course, there are also political issues and disagreements that are slowing the progress of the IASB. The IASB has had problems getting some standards through in Europe. They recently had to withdraw guidance on hedging because some large countries, such as France, said they would not require it. Further, there has been a strong push back from European managers who feel the new IFRSs are too "ivory tower." This has forced members of the IASB to have meetings with these executives to better understand their concerns.

I think a lot of this is due to growing pains as the IASB truly becomes an important standard setter in the world. The requirement that firms use IASB has really pushed the board into the spotlight. Before IAS was widely mandated, they were able to make rules without that much outcry. Now they are learning how hard it is to balance the needs of all the constituency groups. These are the same issues FASB has long faced in the U.S. (for example, stock option accounting), and I think we will see that the IASB will find itself dealing with more and more of these items.

About the Author

Cynthia Churchwell is a business information librarian at Baker Library, Harvard Business School, with a specialty in the international economy.