Harmonisation of accounting standards: disclosure policies and practices of european commercial banks

Chapter 2

2. LITERATURE REVIEW

In this part of the work, we have examined the meta-theoretical foundation of authors' works relevant to our topic. In the process, we have summarized the main ideas and theories discussed in contemporary literature within the world of our topic. We have also assessed its evolution by citing earlier writings using both textbooks and journals. Both sources have helped us to improve our knowledge on harmonization and practices, by looking at the insights in the state of current knowledge. We have identified the gaps, contradictions, inconsistencies and relations in existing literature on harmonization and disclosure, which of course has greatly influenced our perception and work. Below is a discussion of the relevant literature.

2.1 REPORTING POLICIES AND PRACTICES VS REGULATIONS

Companies reporting policies and practices are influenced by three major factors: their company culture; laws and regulations; and the international business environment. The company's culture stems from the corporation's objectives, especially its reporting motives. A company that targets customers adopts a reporting spirit that fills its annual reports with customer oriented information. A company that targets investors prepares information to meet investors' needs. The modern corporate annual report has become a major tool for promotion by large listed companies. «Poorly packaged, statute-driven accounts are increasingly being replaced by a professionally designed glossy brochure in which the financial statements seem to play only a supporting role. Photographs, graphs and text are often prominently presented at the front, with the balance sheet, income statement and notes to the accounts being regulated to the back. The annual report has become part of corporate public relations» (Beattie, et al, 1996). The forgoing quotation gives us a clear picture of the annual report of SEB, FöreningsSparbanken, Dresdner, Deuchsche Bank, Barclays and HSBC holdings. The focus is no longer on the figures, but to convince the general public on the achievements and plans of the company. This attitude of concentrated decorative reporting impairs harmonization a great deal. Information disclosure is made available in the report where they are suitable for the interest of the company and not necessarily for those who need this information.

Most multinational enterprises (MNEs) that seek international listing (i.e. to have their securities listed in a foreign stock exchange) adopt a policy that to some extend deviates from national laws. They sometimes prepare two sets of accounts - one using the national and the other in accordance with the international standards.^2(*) In order to reduce the cost of capital, most firms give information even beyond the recommendations of national laws. However, Verrecchia (1999) argues that the compelling evidence indicates more disclosure results to more liquid markets. The perception that the greatest disclosure leads to lower cost of capital is only true when public disclosure is governed by cost-of-capital considerations, given that the existence of information asymmetries in securities markets may ameliorate the cost of capital during disclosure, thereby providing an economic basis for evaluations of costs and benefits of accounting information. His argument was counteracted by Huddart, et al (1999) who believe that public disclosure requirements tend to increase trading costs that, in turn, affect listing decisions of corporate `insiders' and allocation of liquidity flow. Trading is usually concentrated on highly disclosed exchanges as exchanges try to outperform each other. Therefore, to maximize trading volume and lower trading costs, corporate `insiders' give away important information to disguise their trades.

Despite the above argument, it is a popular view that the issue of disclosure practice is very much influenced by the culture and needs of the banks, rather than the legislative requirements. According to a study by Vanalaines (2001), he shows that a considerable difference in risk disclosure exists between major European banks. Despite the existence of EC Directives, the differences are to a greater extent due to cultural differences between geographical areas and especially due to differences in size of banks. According to Vanalaines, Nordic, German and Swiss banks tend to be best at presenting disclosures on risk, although British and Spanish banks are also among the top performers in terms of disclosure. His results show that large banks tend to disclose more information than smaller ones. This research adds to our earlier perception that the size of the business unit is another significant determinant of reporting practice. It is obvious that the size of the firm has a positive correlation with the level of disclosure. The larger the firm the more the information to disclose. Vanalaines further identified a wide gap between the poor performers and the best performers. He rated the top ten European banks (in terms of disclosure) as follows:

1999			2000			2001
SEB			UBS			UBS
SUB			MeritaNordbanken			Credit Suisse
FSB			Barclays			HSBC Holdings
UBS			SEB			BSCH
Barclays			Dresdner Bank			Barclays
MritaNordbanken			Societe General			Nordea
ABN Amro			Alled Irish Banks			HypoVereins Bank
Deutsche Bank			The Royal Bank of Scotland			Dresdner Bank
HypoVereins Bank			Den Danske Bank			San Paolo IMI
Standard Chartered			Bank of Ireland			SEB

FIGURE 1: BEST PERFORMING BANKS IN RISK DISCLOSURE 1999-2001

Source: Trema Management Consulting, 30 Jul. 2001

It is not our goal to rate or classify banks in terms of disclosure practices. However, it is important to note that 4 of our 6 sampled European banks featured in this survey, assuming varying positions in the «top-ten» classification above. What is of interest in this survey is that it gives a clear picture of disclosure differences existing among banks within one internal market (the European Community).^3(*)

2.1.1 The Influence Of Culture

Radebaugh and Gray (1997) discuss the issue of cultural influence on reporting practice in detail. Through a comparative study, they conclude that despite the existence of standards,^4(*) each country's reporting practice is greatly influenced by its culture and history. They even identify the differences in reporting among countries in the same grouping, and state that banks in the same country have reporting features that are unique. This perception highlights the fact that even in any family, individuals have their unique traits, different from others. Radebaugh and Gray (1997) blame history and culture as the cause of uniqueness in reporting practice. In their study, they made the following five groups of countries with identical practices:

Group				Countries in-group
Anglo-Saxon	United States
	United Kingdom
Nordic	The Netherlands
	Sweden
Germanic				Germany
				Switzerland
Latin				France
				Italy
Asian				Japan

FIGURE 2: GROUP OF COUNTRIES WITH IDENTICAL ACCOUNTING PRACTICES.

Source: Adapted from Radebaugh and Gray (1997)

Anglo-Saxon accounting is clearly different from other country groupings with particular emphasis on investor interest and the securities market. Nordic accounting has many features similar to Anglo-Saxon and Germanic accounting, while Germanic and Latin accounting have many features in common, but also differ in areas such as uniform reporting. The Japanese accounting system is unique, though it has been viewed as having some influences from the Anglo-Saxon and Germanic traditions. The authors concluded with a hypothesis that the growing quest for international listing by multinationals would bring about some convergence in accounting practices.

Nobes and Roberts (1999) used an analytical approach to explain the sources of accounting systems. Applying the concept of causality (cause and effect), they perceived that most authors believe legal systems influence accounting systems. According to them, one model of accounting rests on two variables, colonial influence and the equity market. This suggests that the type of accounting is an influence on the regulatory system of accounting, the reason why the Netherlands has Roman Law but practices (approximately) the Anglo-Saxon accounting. Another example why they think the accounting system a country adopts is influenced by the regulatory system is the extensive use of the US rules by many continental European companies. We will add to this collection, as we believe it is also for such a reason that the EC is reducing the pressure mounted by allowing EU multinationals to use IASs to prepare one set of accounts by 2005.

Through its Contact Committee the European Commission (EC) has been fighting for uniform reporting by issuing Directives, especially in the area of consolidation accounting.^5(*) The effort for complete harmony of consolidation practices within the EC has gone a long way in addressing the issue raised by Radebaugh and Gray (1997). The issue of raising standards will not only ease the free movement of securities within the internal market, but also internationally. The EC started by focusing on the internal market, producing Directives with content relevant for the internal market. This led to high cost for companies producing financial information using two standards - the International Accounting Standards and the National standards influenced by the Directives. This aspect of high cost will not be discussed here, as it would be addressed later in this work.

The Contact Committee of the EC has quickly identified this as one of the shortcomings of the Directives, hence the recent call in June 2000, resulting in «the EU's Financial Reporting Strategy: The Way Forward.» The `forwardness' of the `reporting strategy', we suspect, was to integrate the EC Directives into the systems of the International Accounting Standards (IASs) so that EU based multinationals will no longer face the psychological and financial trap of information duplication. It is worth recalling that EU based multinationals had to first prepare financial statements using both the internal laws (Directives) and then re-prepare the same accounts using the IASs for international recognition and international comparability. This exercise was not only very costly, but also misled investors and the general public who received different figures in different environments.

In order to solve this problem, the International Accounting Standards Committee (IASC) and the International Organization of Securities Commission (IOSCO) agreed on a joint working program to produce by 1998 a core set of International Accounting Standards (IAS) to be applied by companies seeking international listing of their securities. European companies that sought international listing outside the EU had to prepare their accounts in IASs. The European Commission had to either waive its Directives or accept the IASs, or on the other hand, the IOSC-IASC agreement had to be successful so that IASs issued by the IASC are comparable with the European accounting Directives, and acceptable worldwide.

Agreement on comparability became a point of contention within the profession and academics of accounting as IASC's publication were said to be pro-Anglo-American. On the 14^th of November 1995, the EC adopted a «New Accounting Strategy», aimed at satisfying EU multinationals by letting them prepare their accounts according to the IASs on the condition that IASs conform to the European Accounting Directives. Adjustment had taken place at both ends. The EC now recommends that by 2005, all EC companies listed on a regulated market would be required to prepare their consolidated accounts in accordance with the IASs. This is due to the EC's recognition of the fact that accounts prepared by European transnational companies in accordance with national legislation based on the Accounting Directives do not satisfy the different standards required elsewhere in the world for international capital market purposes.

* ² Standards of the foreign country where the firm seeks listing.

* ³ It is presumed that these banks use the EU Directives as reporting standards.

* ⁴ The EU Directives in our case.

* ⁵ This accounting area is covered in the 4^th and 7^th Directives