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Does IFRS Stand for InFormation RiSk?

In the wake of the recent financial crises, corporations, accounting firms, and regulatory bodies are debating the design of new regulations to improve the integrity of publicly available financial information. Contrary to the positions of the FASB and IASB, the convergence of current U.S. GAAP rules–based standards with proposed IFRS principles–based regulations would increase financial information risk. The veneer of similarity is not enough to ensure comparability of reported financial information across the globe. In the wake of the recent financial crises, corporations, accounting firms, and regulatory bodies are debating the design of new regulations to improve the integrity of publicly available financial information. Proponents of the United States’ adopting the International Financial Reporting Standards (IFRS) cite such benefits as a single, high-quality set of globally implemented financial reporting standards; consistency in reporting across nations; improved capital flow across national borders; and, ultimately, increased competitiveness of U.S. companies in the global capital markets. In our view, however, the ongoing debate over the convergence of IFRS and GAAP (generally accepted accounting principles) is incomplete. Contrary to the positions of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), the convergence of current U.S. GAAP rules–based standards with proposed IFRS principles–based regulations will increase financial information risk. The veneer of similarity is not enough to ensure comparability of reported financial information across the globe. We believe that the adoption of IFRS in the United States would likely increase information risk for users of the financial statements of U.S. companies and that this increased information risk would have ripple effects throughout the capital markets. In this article, we offer a perspective that discusses potential changes in the information available to users of IFRS-based financial statements. We also offer a few high-level predictions about effects on U.S. capital markets were the United States to adopt IFRS. Research to date has demonstrated that important differences among countries and cultures can affect reporting even within common standards. IFRS will not eliminate these real economic and cultural differences. Rather, we fear that common standards will hide significant underlying differences among companies domiciled and operating in different countries, papering over useful, decision-relevant information about country-level differences with a veneer of similarity. We fear that investors will lose information about real, economically significant differences among companies. The reduction in disclosure precision and the increased use of managerial discretion in reporting will lead to a reduction in the correlation between earnings and future cash flows. As a result of the predicted decrease in earnings’ predictive validity and information content regarding cash flows, we predict increased equity price volatility and, in turn, increased cost of capital for U.S. companies. We predict that trading on short-term price changes will become marginally riskier and that buy-and-hold strategies will become marginally more attractive for risk-averse investors. If IFRS is adopted in the United States, there will be no high-quality reporting model competing with IFRS in the broader “market for capital markets.”