The rapid globalization of securities markets has forced regulators around the world to take a hard look at their accounting standards. These rules are used to assess the performance of publicly traded stocks, yet they vary significantly from country to country. Some regulators insist that developing a more uniform set of standards will make international markets more efficient.
       Others worry that watering down the rules in some countries for the sake of consistency will undermine the accuracy of financial reporting, depress trading volume, and raise the cost of capital.
       Associate Professor of Accounting Mary Barth has heard this debate firsthand as a member of the national Financial Accounting Standards Board Advisory Council. The issue is all about tradeoffs in the world of accounting standards, known in the United States as Generally Accepted Accounting Principles. "Should the overriding goal be to give up a little accuracy in the accounting because the benefits of being the same as everyone else are so great for the market, or should we be totally focused on how good an accounting number we can get?" asks Barth.
       The dilemma prompted Barth to initiate research that might cast light on the pros and cons of harmonizing global accounting standards and analyze the tradeoffs in a systematic way. Working with Greg Clinch, professor of accounting at the University of New South Wales' Australian Graduate School of Management, and Toshi Shibano, assistant professor of accounting at the University of Chicago's Graduate School of Business, Barth developed a model that investigates what happens to securities market performance in two countries when one nation's accounting rules change and the other's stays the same.
       The researchers factored in the tendency among traders to buy and sell less in countries with vastly different and complex accounting rules, where the cost of learning to assess the stocks is very high. They demonstrated that if one country makes its accounting rules more similar to a second country's rules, more outside investors from the second country are likely to learn the first country's rules. All other factors being equal, that can lead to market prices that more accurately reflect true value, increased trading volume, and a reduced cost of capital. Yet the model revealed that harmonizing can sometimes result in weaker domestic securities market performance. In those situations, prices become less accurate, trading volume sinks, and the cost of capital rises.
       The authors also suggest that sometimes there are no incentives for investors to learn new accounting rules. This can happen when market prices are so accurate that investors cannot derive much benefit from a better understanding of the accounting rules. For example, in countries like the United States, where so much detailed financial information is already available from analysts and the general economy, if more foreign traders learn American accounting principles, there might not be much change in trading volume.
       However, in emerging markets where there are fewer investors, harmonizing the accounting rules--even if it decreases accuracy--can actually improve securities market performance. This is because traders who invest in learning a new system may unearth valuable information they can profitably trade on, and then that new information is reflected in market prices. In part, the usefulness of learning a country's general accounting principles depends upon how many people choose to become experts.
       Barth, Clinch, and Shibano provide insights relevant to regulators and accounting standards setters who are concerned about the effects of such differences on investor behavior. "In particular, how well prices reflect information about firm value is of potential interest to market regulators, who are concerned with maintaining a level playing field for all investors," says Barth.
       Underlying the findings is the notion that information reduces the cost of capital. The authors conclude that harmonization among international markets may be inevitable but has to be taken step by step. They find that coordinating standards across countries can have unexpected and undesirable effects on how well a firm's stock price captures the firm's true value. "Taken together, our results suggest that regulators and standard setters should exercise caution in their harmonization efforts," says Barth.

--Barbara Buell

"International Accounting Harmonization and Global Equity Markets," Mary Barth, Greg Clinch, and Toshi Shibano, GSB Research Paper #1463, January 1998