Corporate governance: One rule for all

Increasingly, it looks to have been a defining moment. In April last year an
American lawyer stood up at a conference in New York and waved two books in the
air.

The event was one run by the Institute of Chartered Accountants of Scotland
and aimed to discuss how the concept of principles-based standards could be put
into financial reporting practice. It was seen as a brave move, taking a concept
which refuted the domination of lawyers in the rules-based arena that is the
American corporate scene, to their home territory.

What the lawyer, Michael Young, was up to, was a practical demonstration of
why the days of rules rather than principles holding sway were over. In his
right hand he held a copy of the US Declaration of Independence, a slim
pamphlet. In his left he held a sprawling volume which turned out to be FAS133,
the American accounting standard dealing with derivatives. “The Declaration of
Independence is principles-based,” he declaimed. “FAS 133 is rules-based. And,
as an attorney, I’d much rather be defending the Declaration of Independence.”
His point was simple. You could defend something which was principles-based by
showing that it followed the principles. Try defending a decision which depended
on a mass of rules and you would find yourself stumbling over an arguable
transgression of a detail on page 745.

The debate rumbles on. But events in January this year suggest that the case
is won. Back in New York again, it was the turn of the six major global audit
firms to emphasise the case with the unveiling of what they termed a white paper
on principle-based accounting standards. In an audit world still dominated by
the Americans, this was extraordinary. But auditors have much to gain from
throwing off the yoke of the lawyers over there.

Part of the reason is that the growing global capture of the world’s market
by international financial reporting standards, is forcing change. The US market
is the only major one left in the world which either doesn’t use this relatively
new global reporting language, or which has not committed itself to a definite
date for implementation. From a position of global domination just a few years
ago, the US has moved to a position of feeling isolated in the world’s markets.
“We have been struck,” said the six CEOs in the opening message of the paper,
“by the breadth of support for international financial reporting standards as a
single set of high-quality accounting standards that ultimately can be used
around the world.” And then they made the crucial link which the world has been
pressing upon the US for so long. “Stakeholders,” they said, “indicated their
support for IFRS, in part, because it is more principles-based than US GAAP.”

This sudden capitulation is both a boon and a bit of a challenge for
financial directors the world over. It is obviously an advantage to have the
world’s largest capital market turn its attention and acceptance to a system
which values the concept of economic clarity in financial reporting higher than
the incomprehensible due process of lawyers.

And, if the benefits of a principles-based system do flow through, life in
the finance function should become simpler. The Chairman of the International
Accounting Standards Board, Sir David Tweedie, is fond of saying that his
ultimate goal is to hand back accounting to the accounting profession. By this
he means that if financial reporting standards can progressively become more
principles-based, then the actual judgements and decision-making over what goes
into company reports can be handed back to a process of dialogue between
auditors and financial directors. With the principles firmly emblazoned above
their desks, both the people in the finance function and the audit group will be
able to concentrate on what the emerging annual figures should look like. This,
it is hoped, will take away the need for specialists arguing over intricacies
and turning endlessly back to the standard-setters for some sort of ruling.

On the other hand, accountants, with or without bullying lawyers down the
corridor, tend to have an extraordinary ability to complicate things. And this
is why the emerging global consensus over principles-based standards may be a
challenge for financial directors in the long-term. There are clues in the white
paper. It calls for the existing conceptual framework project being run,
somewhat half-heartedly, by the IASB and FASB, the American standard-setter, to
be finalised as a priority, “even at the cost of delaying other projects”.

In the past, audit firms urging standard-setters to concentrate on conceptual
framework issues has always meant one thing. It is a smokescreen. It signals
that the big audit firms want more leeway. They want the standard-setters to do
less work on things which really limit auditors’ ability to be kind to their
clients and instead spend more time working harmlessly in the cul-de-sacs of
academic accounting arcana. It is, in short, a power play. And it has little to
do with the professed goal of faithfully representing the economics of
transactions. It has much more to do with keeping their fee-payers sweet.