This week in Research Office Hours, Christian Leuz (Chicago) presented a paper that he wrote with Luzi Hail (Penn) and Peter Wysocki (MIT), entitled “Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors.” The paper is a comprehensive review of the literature on international convergence and was included as one of two attachments to the FAF’s comment letter to the SEC on the proposed roadmap to IFRS adoption.  Christian’s slides are available here.

The Hail, Leuz, and Wysocki paper begins by laying out the costs and benefits of improving financial reporting quality and comparability, and then goes on to consider what role financial reporting standards are likely to have in that process.  Having addressed these fundamental questions, the authors turn to the question of what costs and benefits the US can expect in adopting IFRS (political and otherwise), and concludes with a discussion of 7 possible scenarios for the future of US standard setting.

The session attracted a great crowd and generated a lot of interesting Q&A, especially in the latter half of the hour.  This was another week where the hour slipped by too quickly and we could easily have gone on longer.  One of the key takeaways for me was the notion that the accounting standards one adopts for financial reporting can have, at best, only a limited role in ensuring high quality and comparable financial reporting.  This is due partly differential enforcement because regulatory oversight can differ widely from country to country.  But the issue of heterogeneous enforcement only tells half the story because all standards (even those that are strictly enforced) contain some discretion, either in what specific accounting policies are allowable or in how to apply a given standard.  Where there is discretion, incentives will influence the use of that discretion, and a firm’s reporting incentives will be shaped by many factors beyond the control of standard setters.  (For more discussion on a related challenge, see Ray Pfeiffer’s post on the issue of translating IFRS to the domestic languages of adopting countries.)

For these reasons, Christian and his co-authors make a compelling argument that the focus on accounting standards as the sole (or even primary) issue for achieving informative and comparable reporting is not only too narrow, it is also misleading.  Toward the end of his presentation, Christian raised the provocative question of what might be gained from further convergence to, or improvement in, IFRS, given that heterogeneity of practice will remain regardless of such changes.  I imagine there are widely divergent opinions on that question and that the answer will continue to be hotly debated.