Unreliable Accounts

1. Unreliable Accounts: How Regulators Fabricate Conceptual Narratives to Diffuse Criticism, by Karthik Ramanna, https://doi.org/10.1515/ael-2021-0002.

2. The Social Value of FASB, by Gregory B. Waymire and Sudipta Basu, https://doi.org/10.1515/ael-2021-0001.

3. Exploring the Relevance and Reliability of Fair Value Accounting, by Yoshitaka Fukui and Shizuki Saito, https://doi.org/10.1515/ael-2020-0086.

4. The Pluralistic Foundations of Conceptual Veiling, by Julia Morley, https://doi.org/10.1515/ael-2021-0049.

5. Unreliable Accounts: Governing behind a Veil, by Paul F. Williams, https://doi.org/10.1515/ael-2021-0107.

6. Unreliable accounts: How regulators fabricate conceptual narratives to diffuse criticism – A response to Karthik Ramanna, by Colin Haslam, https://doi.org/10.1515/ael-2020-0088.

7. “Unreliable Accounts: How Regulators Fabricate Conceptual Narratives to Diffuse Criticism” by Karthik Ramanna: A Comment on Ideological Capture, by Vera Palea, https://doi.org/10.1515/ael-2021-0054.

8. The Politics of Accounting Standards: A Comment on Ramanna’s “Unreliable Accounts: How Regulators Fabricate Conceptual Narratives to Diffuse Criticism”, by Steven K. Vogel, https://doi.org/10.1515/ael-2021-0088.

1 Introduction

The paper “Unreliable accounts: How regulators fabricate conceptual narratives to diffuse criticism” by Karthik Ramanna (2018) provides an important contribution to the debate on the accounting standards-setting governance. A key element of the study is the development of the notion of conceptual veiling, wherein accounting regulators seeking to diffuse criticism manufacture costly conceptual narratives for their actions. Conceptual veiling is well-illustrated by the revision of the Financial Accounting Standard Board’s (FASB) conceptual framework which, in a convergence process with the IASB, led to the removal of “reliability” as a fundamental accounting characteristic. Based on primary archival evidence and field interviews with regulators, Ramanna shows there is significant support for the hypothesis that purging reliability was motivated by the desire to neutralize concerns about subjectivity in fair value measurements, which had been increasingly adopted in financial reporting under the influence of the financial industry (Ramanna, 2015). As Ramanna points out, conceptual veiling is strictly related to regulatory capture, which is a pervasive phenomenon in the financial regulatory process (Carpenter et al., 2013).

The purpose of this comment is to elaborate on Ramanna’s well-documented notion of regulatory capture to develop a few more considerations that can inform further discussion and policymaking. In doing so, the comment focuses on the European Union (EU), where a significant clash emerges between financial reporting rules, captured by the IASB’s view of business and society, and the EU’s core values, which are embedded in its institutional framework and should drive law making, including financial regulation. This inevitably calls for a thorough rethinking of the whole accounting standards-setting process, aimed at solving the conflict between “financialized” techniques and calculation methods, and the societal objectives that the EU has set at its foundations.

2 Ideological Capture

One important issue emerging from Ramanna’s analysis is the pervasiveness of regulatory capture. Regulatory capture can be driven by material incentives and specific interest, in which case it is “explicit” (Laffont & Tirole, 1991). However, there is also another type of regulatory capture, which is “implicit” in expert knowledge and related to ideology or culture (Kwak, 2013). As Gramsci (1949) notes, expert knowledge is indeed by nature “ideological” because it is acquired in a specific social context, and reflects the political-economic structure and social relations that reproduce and generate that context. Being inherent in knowledge, ideological capture is impossible to eliminate. Nevertheless, it is extremely powerful in affecting the regulatory outcomes, and by these means, economy and society (e.g., MacKenzie, 2008).

One important strength of Ramanna’s paper is to show that accounting standards-setting does not represent an exceptional case within the financial regulatory domain: accounting rules, too, are deeply permeated by standards-setters’ views of business in society and the levels of priority they give to certain stakeholders over others. Given that accounting is not just a metric but a calculative practice that shapes social and economic processes (Miller & O’Leary, 1987), regulatory capture in financial reporting standards-setting becomes a significant matter. Accounting serves as a basis for determining several social rights and obligations, thus affecting a great variety of constituencies, not only financial market participants.

Acknowledging regulatory capture by the interests of financial markets raises the issue of the potential inconsistency of standards-setters’ views of business with the interest of society at large. To discuss this point, I consider the case of IFRS adoption by the European Union, which is a paramount example of a clash between the IASB’s ideology, on the one hand, and societal goals embedded into the law, on the other.

3 The EU Case

In 2002, by mandating IFRS adoption for consolidated financial statements of listed companies starting from 2005, the EU granted legislative delegation on accounting standards-setting to the IASB, which is a private and independent British law organization. The IASB is controlled by the IFRS Foundation, a non-profit private-sector organization registered in the US state of Delaware, financed – beyond international and public organizations – by large companies and auditing firms, and by the EU (IFRS Foundation, 2021). IFRS adoption therefore meant that EU countries moved from domestic GAAP based on European directives adopted by the European Parliament and the European Council, to the financial reporting rules of a private body.

A few studies (e.g., Nolke & Perry, 2007) have already investigated the IASB’s governance, highlighting its capture from financial interests. This is witnessed by the IASB’s conceptual framework, according to which financial statements rules are primarily thought for investors, with strong emphasis on the information needs of securities markets and equity investors (IASB, 2018). Other parties, such as regulators and members of the public other than investors may also find financial reports useful, “however, those reports are not primarily directed to these other groups” (IASB, 2018).

Clearly, the IASB’s conceptual framework has an elective affinity with the proprietary view of business, according to which the firm is an exclusive vehicle for its proprietors to increase their wealth (Friedman, 1970; for critical insights Biondi, 2011, 2013; Robé, 2012; Stout, 2012). Along these lines, the IASB has over time increased the use of fair value accounting to inform market participants’ current expectations about the amount, timing, and uncertainty of future cash flows (IASB, 2018).

Given the ideological nature of expert knowledge, the IASB’s view of business must be compared with alternative views and tested against societal fundamental objectives. By focusing on the EU, Palea (2018) has highlighted that the IASB’s Conceptual Framework, and the view of business that it incorporates, are inconsistent with the institutional view of society as set out by the Treaty on the European Union. The Treaty represents the institutional framework of the EU and drives law-making, including in the field of financial regulation. In contrast to the IASB’s view of business, social welfare is one of the EU’s fundamental objectives and all societal stakeholders are on the same level. In fact, the Treaty states that the EU shall “work for the sustainable development of Europe based on […] social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment.” Art. 9 of the Treaty further adds that “in all its activities, the Union shall observe the principle of the equality of its citizens, who shall receive equal attention from its institutions, bodies, offices and agencies”.

As Palea (2018) points out, the description of the socio-economic model that the Treaty aims to pursue is more in line with the entity view of the firm. Indeed, it can be said that the EU’s fundamental principles provide the entity view of the firm with strong legal legitimation. From an entity perspective, the firm is not merely a private association created for the purpose of personal enrichment of proprietors. On the contrary, it is embedded in a socio-economic context with multiple constituencies such as employees, suppliers, customers, and creditors.

European institutions are supporting this view of business with several actions. The draft directive on corporate due diligence and corporate accountability adopted by the European Parliament requires businesses to incorporate human rights, the environment and good governance in their operations. Member States must also guarantee the right for trade unions and workers’ representatives to be involved in the establishment and implementation of the due diligence strategy. Along the same lines, the European Commission (2019) (EC) mentions the need for companies of a social license to operate. Against this background, it has started to work towards strengthening firms’ duties to report the environmental and social impact of their activities.

Financial reporting rules should also be consistent with this view of business, thus determining profit for distribution to all the stakeholders (Müller, 2014). In the entity view of the firm, what counts is the generation of revenue that enables the firm to meet all the various stakeholder claims, from equity capital providers to employees and tax authorities (Biondi, Canziani, & Kirat, 2007; Palea, 2018). Prudence is key for the purpose and financial capital maintenance ensures the economic sustainability of the entity in the interests of all its stakeholders, including shareholders. Prudent information about the ongoing financial position of business firms reassures creditors that there are sufficient revenues and collaterals to support their loans, and employees that the firm is solvent and stable over time (Autenne et al., 2018; Biondi et al., 2007). Being prudent, historical cost accounting is crucial to protect firm stakeholders, including long-term financial investors (Palea, 2018, 2020). Using Richard’s words (2012), fair value and historical cost accounting models reflect clashes not only between different views of economic productivity and financial performance, but also between profoundly different ideals of socio-economic models.

4 Policymaking Implications

By applying Ramanna’s main considerations to the EU context, a thorough rethinking of the whole standards-setting process emerges as an urgent issue. If financial markets and their regulations, including financial reporting rules, are deeply modeled by ideology, it can be claimed that they should then be designed, modified, and improved according to the system of societal ideals and in a way that serves people. Ramanna’s work provides a well-informed and evidence-supported background for claiming a reversion of the privatization trend in accounting standards-setting, with backing of the public actor, and rules debated within a democratic arena. As Chiapello and Medjad point out (2009), the choice of adopting IFRS was driven by the European Union’s inability, at that time, to get its members to agree on a common accounting system. To overcome this obstacle, the European Union therefore decided to take a secondary role and delegate the standards-setting process to the IASB.

A return to democratic scrutiny on financial standards-setting would be coherent with Habermas’s understanding actions (1987), which are oriented to reach consensus around common values and, thereby, the only ones compatible with democracy. Importantly, in Habermas meaning consensus is the opposite of compromise. The Convention on the Future of Europe, which led to the Treaty on the European Union, was a successful example of understanding actions aimed at reducing plurality to unity based on shared laic values (Habermas, 2001). In contrast, the current financial reporting standards-setting is based on instrumental actions in Habermas’ meaning (1987), which are oriented toward attaining a certain goal efficiently and effectively for individual usefulness. Instrumental actions by IFRS were made possible by little opposition from the general interest, which created a “thin political market” in Ramanna’s (2015) words for accounting regulation.

The institutional and political forces that can lead to a significant change in financial reporting standards-setting are, however, now manifesting. In a special issue of CONVIVIUM, Ramanna (2013) highlights how cultural proximity to the IASB and political power affect the likelihood of adopting IFRS. Haas (2013) also acknowledges the political nature of standards-setting, and therefore its ideological nature, pointing out that the fate of IFRS depends on several geopolitical and macroeconomic factors that make institutional arrangements unstable, thus affecting IFRS desirability and the critique to them. Accordingly, Haas notes that “one thing is for sure, given all the above: the future of the globalization of accounting standards is not written and may well surprise us” (Haas, 2013). Indeed, after decades of laissez-faire in financial regulation (Hein, Detzer, & Dodig, 2016), the EU is now adopting a more critical approach to IFRS and the current standards-setting governance. Accordingly, it has taken several important steps to regain some sort of control of the process. The European Commission’s Action Plan on Sustainable Finance (2018a), for instance, has called for a fitness check of the consistency of accounting rules with the EU’s sustainable development objectives (European Commission, 2018a, 2018b), which implicitly make it possible to rediscuss the current standards-setting. The Commission’s consultation document on the “Renewed Sustainable Finance Strategy” (2020) has also reiterated the key role of corporate reporting in strengthening the sustainability and resilience of the EU society and how its economy functions.

Importantly, this new context at the EU level may pave the way in transforming the course of events concerning accounting standards-setting and the spread of the financialisation that IFRS entails, instead making financial reporting more consistent with broader societal objectives. In this respect, critical research such as Ramanna’s provides a significant contribution to this transformation, laying the groundwork for socially engaged discussion on the reform of the standards-setting governance.