Accounting and Convergence in Corporate Governance

Convergence in corporate governance – the adoption by various countries of similar governance laws and practices – and whether it is even occurring have been a hot topic of debate over the past 20 years, particularly in the legal and the law-and-economics literature. The legal literature, however, has sometimes neglected the important role of accounting and financial disclosure in corporate governance.

Proponents of convergence theories have suggested that certain laws and practices would be an advantage in a competitive and globalizing economy. Firms subject to efficient norms would be better run and more successful in the product market, and they would be better able to attract investment across borders.[1] One would expect the same to be true for financial accounting. Firms using the best set of accounting standards might be better run, and they would be able to reduce agency cost by disseminating the right amount and best type of information to investors. And yet, publicly traded firms largely still use two sets of accounting standards: U.S. GAAP (Generally Accepted Accounting Principles) in the United States, and IFRS (International Financial Reporting Standards), set by an international body based in London, in most other nations with securities markets. That is not to say that there have not been considerable efforts toward convergence in accounting. Partly in reaction to scandals involving companies such as Enron and WorldCom, the SEC contemplated the adoption of IFRS during the 2000s; only foreign issuers have been permitted to use IFRS since 2008 without a reconciliation by the SEC.

One could interpret this situation differently in light of the convergence debate. Maybe neither standard is clearly superior, and an efficient international market favors competition between two sets of standards. An alternative viewpoint is to explore hurdles that have prevented convergence, which are usually explained under the rubric of path dependence. In the presence of path dependence, a jurisdiction will persist in using a certain set of rules because it embarked on a path in the past from which it is difficult to deviate. Even if change would be economically efficient in principle, switching could be prohibitively costly. This is particularly problematic when the cost would primarily fall on an interest group that has the power to block change.

In corporate governance, scholars usually emphasize the interests of groups that have an inherent stake in a firm.  Well-coordinated and locally powerful interests such as controlling shareholders or unions might resist corporate governance reform to preserve their own rents. However, path dependence can also be driven by transition costs created by the legal system. The cost would not only result from writing new rules, but also from learning by legal intermediaries such as lawyers, who may have to familiarize themselves with a new set of norms, and who would be more exposed to competition to new entrants in the market, thus losing some of the competitive advantage linked to their human capital.

The latter explanation has been described as “doctrinal path dependence” in the legal context and seems to account at least in part for the lack of convergence in accounting practices.[2] While it is not possible to infer causation, a comparison between Europe and the U.S. reveals that the interests of large international accounting firms, such as the Big Four, were differently aligned, which may help explain the continued divergence between accounting standards.

In the U.S., IFRS would not have served the accounting industry well. While the federal courts have generally stated that following GAAP does not create a safe haven from criminal or civil liability,[3] in practice the “standard of quality” was “conformity with GAAP,”[4] at least until Enron. Subsequently, GAAP were criticized as too rules-based, which is why there was a debate about the possible adoption of IFRS in the U.S. As others have pointed out, the heavy reliance on litigation as the key disciplinary mechanism in corporate governance likely contributed to the shaping of accounting standards.[5] On this point, the U.S. is distinct from the UK, whose GAAP are often thought to be closest to IFRS. A high level of enforcement generates higher financial risks and insurance premia. Thus, great risk on the procedural side is linked to pressure by accounting professionals and issuers to develop accounting standards substantively in a way that will help them avoid liability.

This stands in contrast with European jurisdictions where the “internationalization” of accounting served the interests of large accounting firms, as well issuers seeking investment from abroad. The introduction of IFRS suited the domestic branches of the large accounting firms, which are favored in terms of market share in the audit market, relative to more local professionals. Large firms such as the Big Four are typically better able to scale human capital by training staff in IFRS across countries and applying uniform methods. Moreover, they may be better able to handle the complexity of IFRS, having been more involved in the standard setting process. In addition, there may be audit tasks at which large firms are better than small ones, such as reviewing the fair valuations under IFRS. While using IFRS certainly suited the large accounting firms’ interests, and adopting U.S. GAAP as a foreign standard was politically not palatable, the EU’s IFRS regulation embodies another compromise: It permits member states to require or allow non-publicly traded firms to continue using domestic accounting standards, and even publicly traded firms may continue to use them for their entity-level (as opposed to consolidated accounts). This compromise allows member states to avoid certain legal consequences (such as switching to IFRS for purposes of calculating corporate tax), but it also preserves a market for the domestic accounting industry.


[1] For a summary of this argument, see e.g. Jeffrey N. Gordon, Convergence and Persistence in Corporate Law and Governance, in The Oxford Handbook of Corporate Law and Governance 28, 28 (Jeffrey N. Gordon and Wolf-Georg Ringe eds. 2018).

[2] Eva Micheler, English and German securities law: a thesis in doctrinal path dependence, 123 L.Q. Rev. 251, 254 (2007).

[3] United States v. Simon, 425 F.2d 796 (2d Cir. 1969); In re Global Crossing, Ltd. Sec. Litig., 322 F. Supp. 2d 319, 340 (S.D.N.Y. 2004); Lawrence A. Cunningham, A Prescription to Retire the Rhetoric of Principles-Based Systems in Corporate Law, Securities Regulation, and Accounting, 60 Vand. L. Rev. 1409, 1468 n.254 (2007).

[4] Stephen A. Zeff, A Perspective on the U.S. Public/Private-Sector Approach to the Regulation of Financial Reporting, 9 Acct. Horizons 52, 65 (1995).

[5] E.g. Lawrence A. Cunningham, Accounting and Financial Reporting: Global Aspirations, Local Realities, in Oxford Handbook, supra note 1, at 489, 497-8.

This post comes to us from Professor Martin Gelter at Fordham University School of Law. It is based on a forthcoming book chapter, “Accounting and Convergence in Corporate Governance: Doctrinal or Economic Path Dependence?”, a working-paper version of which is available here.

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