Regulating Capitalism?

The Evolution of Transnational Accounting Governance

J. Zimmermann, J. Werner

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137309280
• Topic: Social Sciences
• Subtopic: Sociology
• Index: Social Sciences

By exploring how financial, legal and wider socio-economic systems can accelerate or decelerate the harmonization in financial markets, this book connects issues both of contemporary political science and accounting research.

Part I

Introduction

Many people believe that financial reporting is a merely technical matter, something discussed among professional circles but of only minor importance for the state, for society or for the economy as a whole. However, a closer look reveals how important financial reporting and its regulation are for the functioning of businesses and markets. Financial accounting makes an important contribution to general welfare, and consequently nation states have often intervened in accounting regulation. Traditionally, regulation has varied from country to country. Continental European countries have tended to rely more strongly on extensive legal and hierarchical regulation than have Anglo-Saxon ones, which have generally demonstrated more collaborative governance modes: i.e., types of regulation in which private actors – most prominently private standard-setters and other professional organisations – have been embedded within regulatory frameworks. Nevertheless, the different solutions have shared one common feature: they have all been rooted in the nation states in which they operated. However, in an increasingly globalised world, these national solutions have become more and more inefficient and ineffective.

As a consequence, a new constellation of accounting regulation has emerged since the 1990s. The most distinctive feature of this new constellation is the presence of a transnational standard-setter that produces financial reporting rules with global outreach: the International Accounting Standards Board (IASB). Many countries require these rules to be applied when supplying information about the financial position of economic entities or, more technically speaking, for consolidated financial reports.¹ This development marks a vast formal convergence of regulation, both in terms of applicable accounting rules and in accounting governance. However, traditional national accounting rules persist in some, mostly continental, European countries, where they remain applicable when preparing financial statements of private (i.e., unlisted) firms and unconsolidated accounts. This hybridisation has hardly been addressed in the literature, leaving two important questions unanswered. First, what are the underlying causes of the observed changes? And second, are these observable changes indicative of an overall transformation of the state? Chapter 1 aims at laying down some theoretical foundations that will help us to answer both questions in the course of this book. This explanatory framework is based on evolutionary economics. It argues that the recent changes to accounting systems can be explained as reactions of economic agents to exogenous ‘shocks’ such as globalisation. This has led to changes in national accounting systems. Bounded rationality suggests that these changes should in general lead to a convergence of accounting systems worldwide, due to mimicking, normative pressure or coercion. In the process of change, existing national institutions matter as they have a bearing on the decisions that are made. Thus, different paths and paces of change are likely to emerge. Empirical evidence taken from studies of six countries helps to validate the outlined case.

Chapter 1, which is setting the scene, is organised as follows: first we summarise the evidence relating to changes in accounting regulation (Section 1.1); then in sections 1.2 and 1.3 we develop a general framework that helps explain why some elements of accounting regulation are becoming more similar while others continue to vary from country to country. We argue that evolutionary economics, in particular, combined with neo-institutional thinking provides a comprehensive framework to explain the observed changes.

1

Explaining the Evolution of a New Accounting Framework

1.1Accounting between global convergence and national preference

In recent years a new architecture of accounting regulation has evolved. Most notably, an international private (i.e., transnational) standard-setter has emerged that develops financial reporting standards with global reach –the International Financial Reporting Standards (IFRS). The standard-setter’s efforts have been backed by many national governments, which have prescribed the adoption of the transnationally set standards for at least subgroups of firms, particularly those listed on public markets. The reporting demands are supposedly better met by globally uniform, high-quality standards developed by an international professional body. The rapid adoption of international standards has led to an increasing formal convergence of accounting standards across the world and has come about in a rather sudden and abrupt manner, as the notion of the ‘global IFRS revolution’ suggests (Benzacar 2008; Chua and Taylor 2008).

Even for listed firms, some doubts remain about whether formal convergence of the rules actually goes hand in hand with an actual convergence of accounting practices at company level (Ball 2006). This is even more the case as the revolutionary character of the regulatory changes has very often left reporting firms without any implementation guidance (Schipper 2005). As yet, enforcement mechanisms are also not consistent globally (Ball 2006; Zimmermann et al. 2008a) and the convergence process has largely been confined to the consolidated accounts of listed companies. In most countries, private unlisted companies still have to report following national accounting rules, which has resulted in inconsistencies in the national accounting systems (Werner and Zimmermann 2008). Even more strikingly, unconsolidated ‘parent-only’ accounts sometimes still have to be prepared in addition to consolidated IFRS accounts (Goncharov et al. 2009). This hybridisation implies that a single organisation has to prepare two different sets of accounts – consolidated group accounts and unconsolidated parent-only accounts – following two different sets of rules: IFRS are used for one, national rules for the other. The reason for this surprisingly robust hybrid solution is that the two accounts are said to serve different purposes: consolidated accounts inform outsiders about the financial position of the economic entity in which they are invested. Where nation states require additional (unconsolidated) accounts according to national rules, they have tied legal consequences to them: most notably, determination of dividend and tax payments.

Over all, unconsolidated accounts are embedded more strongly in the national socio-economic systems and thus are more resistant to harmonisation. The same is true of the reporting practices of small and medium-sized firms which have not outgrown the boundaries of national regulation. Thus, the state of play is that we have increasing transnationalisation on the one hand, but some strongly persistent national differences on the other. These findings will be shown at the country level in Chapter 4, where we analyse regulatory changes in six major Organisation for Economic Cooperation and Development (OECD) countries (Canada, Germany, France, Japan, the UK and the US). We provide evidence that there were, traditionally, substantial differences in accounting regulation across countries, that there has been significant convergence, but that some elements of accounting regulation still vary from one nation state to another. Evidence for these three findings is summarised in the following:

•Traditional differences in regulation. Our six countries traditionally relied on different governance models. France, Germany and Japan belong to a group of countries with a long-standing tradition of state-dominated accounting regulation. In the 1970s these countries had accounting rules with strong legal backing, as they were mainly set by parliaments in the form of laws. The incorporation of private actors in standard-setting was of minor relevance. Professional bodies regulated their members’ behaviour but held no further powers over accounting regulation. These countries also featured a strong interrelation between financial reporting and tax accounting, and their use of accounting was predominantly payout-oriented (Werner and Zimmermann 2009). In contrast, Canada, the UK and the US represent countries where accounting regulation originated in the private sector and remained dominated by professional self-regulation. Legal backing was traditionally more limited in these countries, as rules were privately set. The legal system in these countries gives little payout relevance to financial reports, as tax and dividends were calculated by other means (Goncharov et al. 2009).

•Convergence. Over the last decades, the number of modes of governance has increasingly diminished. Accounting systems strongly reliant on the state have incorporated private actors to enhance market efficiency, while liberal accounting systems have strengthened the legal backing for accounting rules to provide them with greater legitimacy (Luthardt and Zimmermann 2009). These developments seem to have been largely influenced by harmonised requirements for accounting regulations through globalised financial markets (see Chapter 5). International competition for funds meant that the provision of information for capital markets became an increasingly important accounting function, and today it is featured in the accounting systems of all the six countries in this study. The harmonisation of regulatory needs also initiated the search for a global set of comparable accounting standards. The ongoing internationalisation of accounting standards had a major impact on most accounting systems, as international rules were adopted or mimicked in national ones. A strong tendency for accounting systems to converge can thus be seen in each country.

•Persistence. The analysis of the national case studies also reveals differences in the pace of change. With regard to the predominant uses of accounting, convergence is only visible with consolidated accounts. Single accounts in France, Germany and Japan remain largely unaffected by the harmonisation process. Their function as a way of determining corporate payouts remains unaltered, as do the accounting regulations for single accounts. Rapid change took place only in some areas, while others saw only incremental reform. Information-oriented accounting is provided for the economic entity in consolidated accounts, and single accounts, which are relevant for determining corporate payouts, still diverge between countries with different regulatory traditions. For these countries (France, Germany and Japan) a stable level of legal backing points to ongoing differences in the relationship between accounting and tax and company law.

Different paths and differences in the pace of change have not yet been addressed and explained in the literature. Comparative accounting research, the strand of literature to which we contribute, has largely focused on static comparisons: i.e., on comparing accounting systems (and their embeddedness) across countries at a given point in time (Werner and Zimmermann 2009). Differences in legal and financial systems but also in culture are identified as driving differences in accounting systems and their respective modes of governance (Werner 2008). However, there are several research gaps in this strand of literature. First, the role of the state seems to have been largely neglected in previous analyses. Second, static comparisons do not account for changes over time. The main explanation for change in static explanations would be that the variables causing differences in accounting systems – for example, legal and financial systems – change over time. Even though there is some evidence that those legal and financial systems do gradually reconfigure, the consequences for financial reporting have not been explicitly addressed in comparative accounting research. This may be due to the fact that these reconfigurations are incremental rather than revolutionary. Moreover, third, comparative accounting research has not addressed the question of why these incremental changes take place. To the degree that the institutional structures evolve, they seem to be endogenous to more fundamental drivers (or triggers) of change, which have not been identified in previous research. The latter could be related to a fundamental change in the individual national statehood that, fourth, has not been addressed in comparative accounting research.

1.2Explaining the change of accounting systems: A framework for analysis

In the following, we attempt to explain the observed different paths and paces of change in accounting regulation, which can be understood as a process of self-transformation triggered by the decisions of individual or collective actors. The process takes place in two phases:

•Agents react to exogenous ‘shocks’ such as globalisation, which require decisions to change national accounting systems currently in place. These alterations should generally lead to worldwide convergence of accounting regulation, due to mimicking, normative pressure or coercion.

•In the process of change, existing national institutions matter as they constrain the agents’ scope in altering system elements. As a consequence, the exogenous ‘shocks’ can result in different paths and differences in the pace of change.

The explanatory approach thus calls for an investigation into the role of two distinct types of explanatory variables. First, we consider the influence of variables triggering agents’ decisions in regard to general system change (triggering events or exogenous shocks). Here we examine, in particular, the role of globalisation, emerging professional networks and corporate crises. Unconstrained by institutional arrangements, these factors should lead to coercive, normative and mimetic isomorphism of accounting regulation. However, the existing institutional frameworks within countries do limit the agents’ decisions and create path dependencies. Thus, we have to take into account a second group of variables that characterise the institutional framework giving rise to path dependencies. Here we analyse the role of national socio-economic systems, in particular the legal and financial system and the type of welfare state in place.

Our framework refers to evolutionary economics, which seems a promising starting point. Evolutionary economics is an approach that helps to explain processes of change by looking at the individual behaviour of agents assumed to act under bounded rationality. The application of evolutionary theory to economic phenomena has produced a lot of research findings in recent years. Meanwhile, it can be regarded as an established school of thought in analysing economic problems (Witt 2008). It is one of the few research paradigms that are not static in nature and thus can be particularly useful when analysing phenomena of economic change or other dynamic processes. While it is often thought that evolutionary theory is, more or less, an adaptation of the Darwinian theory of natural selection, this is not necessarily true for evolutionary economics. The main reason for this is that natural selection does not necessarily extend to ‘selection’ processes in social systems, because human beings are capable of thoughts and feelings and of social interaction. As Witt (2002) argues, evolutionary economics instead understands evolution as a self-transformation process of a particular system. Even though there does not seem to be a generally agreed definition of evolutionary economics, it is usually built on the following three premises:

•Evolution of economic systems can be understood as a process of self-transformation triggered from within by the learning and innovations of economic agents, who are characterised by bounded rationality.

•Preferences, technologies and institutions are not treated as exogenous but become explicit objects of analysis.

•Evolutionary processes are not erratic but follow regular patterns, on which explanatory hypotheses can be based.

In the following, we briefly outline how the three premises are applied to explain the emergence of a new constellation of accounting regulation. System change is triggered from within by learning and by innovating economic agents who are characterised by bounded rationality. Our explanatory model assumes that regulatory and other economic actors induce change when triggering events occur. Owing to the fact that individual and collective actors are embedded in the systems which are subject to change, system transformation is always self-transformation (Witt 2008). We thus follow an actor-centred view when explaining processes of change, referring to DiMaggio and Powell (1983), who describe the behaviour of economic agents as showing three different ways of institutional learning, which they label as mimetic, normative and coercive (Csigó 2006). In what follows, we outline how these types of institutional learning by economic agents may affect accounting regulation:

•Coercive isomorphism. This type of isomorphism stems mainly from pressure by other organisations and by cultural expectations. We argue that coercive isomorphism in accounting regulation stems mainly from reporting demands on globalised capital markets. As projects continue to grow in size, firms need to compete for funds internationally. Self-financing from retained earnings or tapping into national markets is no longer sufficient. Competing for international funds makes it necessary to respond to the demand of financial investors for comparable highquality information. Financial reports that are hard to understand deter investors, or they require a risk premium. High-risk premiums either devalue the firm or squeeze it out of the capital markets as competing projects from other firms gain preference. Globalised financial markets introduce pressure for financial accounts to look alike, leading to coercive isomorphism. Chapter 5 of this book takes a closer look at the role of coercive isomorphism.

•Mimetic isomorphism. In general, mimetic isomorphism refers to the reactions of organisations facing environmental uncertainty or doubts about organisational technologies. They tend to model themselves on other organisations that are considered successful at that time. We argue that, in particular, cases of fraud, accounting scandals and business crises lead to a mimicking reaction by accounting regulators (Chua and Taylor 2008). The reason is that such events raise public doubt about the suitability of national regulation. Regulators react to public concerns by creating new regulation. New regulation, then, is likely to be a transplant of regulation found in other countries that at that time do not suffer from scandals or fraud. There are primarily two paths by which crises can lead to mimetic isomorphism. First, a revision of its own system starts in one country because accounting scandals have occurred there. It may then subsequently adopt reforms modelled on regulation in other countries. Second, the appearance of accounting scandals in another country may alert the home regulator. In both cases uncertainty about the stability of particular elements or about the stability of the system as a whole is the driving force behind the search for different solutions. From a legitimacy perspective, the regulator is threatened by a loss of confid...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• List of Figures and Tables
• Acknowledgements
• List of Abbreviations
• Part I: Introduction
• Part II: Accounting between Global Convergence and National Preference
• Part III: Explaining Global Convergence
• Part IV: Explaining National Preference
• Part V: Conclusion
• Notes
• References
• Index