Tag: Accounting


Audit Committees: 2015 Mid-Year Issues Update

Rick E. Hansen is Assistant Corporate Secretary and Managing Counsel, Corporate Governance, at Chevron Corporation.

Board audit committee agendas continue to evolve as companies are faced with a rapidly-changing global business landscape, the proliferation of standards and regulations, increased stakeholder scrutiny, and a heightened enforcement environment. In this post, I summarize current issues of interest for audit committees.

The Audit Committee And Oversight

During her remarks at the Stanford Directors’ College in June 2014, SEC Chair Mary Jo White observed that “audit committees, in particular, have an extraordinarily important role in creating a culture of compliance through their oversight of financial reporting.” [1] Since then, various Commissioners of the SEC and its Staff have reinforced this message by reminding companies of the audit committee’s duties under federal securities laws to:

  • oversee the quality and integrity of the company’s financial reporting process, including the company’s relationship with the outside auditor;
  • oversee the company’s confidential and anonymous whistleblower complaint policies and procedures relating to accounting and auditing matters; and
  • report annually to stockholders on the performance of these duties.

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CFO Narcissism and Financial Reporting Quality

Sean Wang is Assistant Professor of Accounting at the University of North Carolina at Chapel Hill. This post is based on an article by Professor Wang, Mark Lang, Professor of Accounting at the University of North Carolina at Chapel Hill, and Chad Ham and Nicholas Seybert, both of the Department of Accounting & Information Assurance at the University of Maryland.

In Kurt Eichenwald’s Conspiracy of Fools, the author details the collapse of the Enron empire and places the majority of the blame on their CFO, Andrew Fastow. Fastow is credited with being responsible for engineering the special purpose entities, which hid the majority of Enron’s debt from their balance sheets. The excess leverage created risks that were opaque to Enron’s shareholders, and were largely responsible for Enron’s bankruptcy. Eichenwald’s interviews with Fastow’s colleagues portrayed him as a narcissist who would do anything for his own self-interest at the expense of the welfare of those around him.

In our paper, CFO Narcissism and Financial Reporting Quality, which was recently made publicly available on SSRN, we examine whether CFO narcissism can impact financial reporting outcomes. We focus on CFOs because of their primary role in financial reporting decisions. We conjecture that the traits of narcissism, which include exploitativeness, the domination of group decisions, a sense of self-entitlement, inflated self-perceptions, and a constant need for recognition, will result in narcissistic CFOs being more willing to exploit power and information asymmetry to engage in misreporting.

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Foreign Institutional Ownership and the Global Convergence of Financial Reporting

Vivian Fang is an Assistant Professor of Accounting at the University of Minnesota. This post based on an article by Professor Fang, Mark Maffett, Assistant Professor of Accounting at the University of Chicago, and Bohui Zhang, Associate Professor at the School of Banking and Finance, University of New South Wales.

In our recent paper, Foreign Institutional Ownership and the Global Convergence of Financial Reporting Practices, forthcoming in the Journal of Accounting Research, we examine the role of foreign institutional investors in the global convergence of financial reporting practices. Regulators frequently espouse comparability as a desirable characteristic of financial reporting to facilitate investment decision-making and allocation of capital. Over the past 15 years, significant regulatory effort has gone into promoting comparability, the most prominent example of which is the International Accounting Standards Board’s (IASB) push for global adoption of International Financial Reporting Standards (IFRS). However, recent research (e.g., Daske, Hail, Leuz, and Verdi [2008], Christensen, Hail, and Leuz [2013]) shows that mandating the use of a common set of accounting standards alone is unlikely to achieve financial reporting convergence.

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Fixing Public Sector Finances: The Accounting and Reporting Lever

Holger Spamann is an assistant professor at Harvard Law School. This post is based on the article Fixing Public Sector Finances: The Accounting and Reporting Lever recently published in the UCLA Law Review and co-authored by Professor Spamann and James Naughton of Kellogg School of Management.

Detroit’s bankruptcy highlighted the precarious financial situation of many states, cities, and other localities (collectively referred to as municipalities). In an article just published in the UCLA Law Review, we argue that part of the blame for this situation lies with the outdated and ineffective financial reporting regime for public entities and that fixing this regime is a necessary first step toward fiscal recovery. We provide concrete examples of advisable changes in accounting rules and advocate for institutional changes, particularly involvement of the Securities and Exchange Commission (SEC).

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SEC Enforcement Developments in 2014, and a Look Forward

The following post comes to us from Bill McLucas, partner and chair of the securities department at Wilmer Cutler Pickering Hale and Dorr LLP, and is based on a WilmerHale publication by Mr. McLucas; the complete publication, including footnotes, is available here.

As we noted last year in our memorandum focused on 2013 developments, Securities and Exchange Commission Chair Mary Jo White has called for the SEC to be more aggressive in its enforcement program. By all accounts, the Enforcement Division has responded to that call. The past year saw the SEC continue the trend, started under Enforcement Director Robert Khuzami in 2009, of transforming the SEC’s civil enforcement arm into an aggressive law enforcement agency modeled on a federal prosecutor’s office. This should not come as a surprise since both Andrew Ceresney, the current Director, and George Cannellos, Ceresney’s Co-Director for a brief period of time, like Khuzami, spent many years as federal prosecutors in the Southern District of New York. And the Commission itself is now led for the first time by a former federal prosecutor, Mary Jo White, the US Attorney for the Southern District of New York from 1993 to 2002. Given the events of the past decade involving the Madoff fraud and the fallout from the 2008 financial crisis, we believe both the aggressive tone and positions the SEC has taken in recent years will continue.

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Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

The following post comes to us from John Core and Rodrigo Verdi of the Accounting Group at MIT, and Luzi Hail of the Department of Accounting at the University of Pennsylvania.

Whether mandatory disclosure regulation and insider ownership affect a firm’s cost of capital is an important question in financial economics. In our paper, Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital, which was recently made publicly available on SSRN, we examine this question on a large global sample of more than 10,000 firms across 35 countries.

Theory predict that disclosure regulation is negatively related to the cost of capital due to two separate effects: (i) an information effect in which better disclosure improves investors’ prediction of future cash flows, or (ii) a stewardship effect in which better disclosure improves managerial alignment with shareholders and therefore increases expected cash flows. The stewardship effect is not unique to disclosure, but is also present in other governance mechanisms that increase managerial alignment such as inside ownership. As a result, these alternative alignment mechanisms potentially reinforce or substitute for the stewardship effect of disclosure. We test this argument by examining whether inside ownership is negatively associated with the cost of capital and how inside ownership affects the relation between disclosure and the cost of capital.

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A New Tool to Detect Financial Reporting Irregularities

The following post comes to us from Dan Amiram and Ethan Rouen, both of the Accounting Division at Columbia University, and Zahn Bozanic of the Department of Accounting and MIS at Ohio State University.

Irregularities in financial statements lead to inefficiencies in capital allocation and can become costly to investors, regulators, and potentially taxpayers if left unchecked. Finding an effective way to detect accounting irregularities has been challenging for academics and regulators. Responding to this challenge, we rely on a peculiar mathematical property known as Benford’s Law to create a summary red-flag measure to capture the likelihood that a company may be manipulating its financial statement numbers.

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PCAOB Adopts New and Amended Auditing Standards

The following post comes to us from Michael Scanlon, partner in the Securities Regulation and Corporate Governance and Corporate Transactions practice groups at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert by Mr. Scanlon.

On June 10, 2014, The Public Company Accounting Oversight Board (“PCAOB”) adopted new and amended auditing standards that expand audit procedures required to be performed with respect to three important areas: (1) related party transactions; (2) significant unusual transactions; and (3) a company’s financial relationships and transactions with its executive officers. The standards also expand the required communications that an auditor must make to the audit committee related to these three areas. They also amend the standard governing representations that the auditor is required to periodically obtain from management.

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How America’s Participation in International Financial Reporting Standards Was Lost

Chris Cox is partner and member of the Corporate Practice Group at Bingham McCutchen LLP and president of Bingham Consulting LLC. Mr. Cox served as Chairman of the Securities and Exchange Commission from 2005 to 2009. The following post is based on Mr. Cox’s recent keynote address to the 33rd Annual SEC and Financial Reporting Institute Conference. The complete publication is available here.

The modern quest for an “Esperanto” of business has been underway for nearly half a century. And though it was initiated by the United States, after 48 years, it has yet to gain our full support. That is unfortunate, because the promise of a global standard is truly dazzling.

An international language of disclosure and transparency would significantly improve investor confidence in global capital markets. Investors could more easily compare issuers’ disclosures, regardless of what country they came from. They could more easily weigh investment opportunities in their own countries against competing opportunities in other markets. And a single set of high-quality standards would be a great boon to emerging markets, because investors could have greater confidence in the transparency of financial reporting.

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Whose Trojan Horse? The Dynamics of Resistance against IFRS

The following post comes to us from Martin Gelter, Associate Professor of Law at Fordham University. The post is drafted based on a paper co-authored by Professor Gelter and Zehra G. Kavame of Fordham Law School.

The US is the last major economy that has not yet adopted International Financial Reporting Standards (IFRS) while, from Europe to Canada, from Australia to China, around 120 countries are already requiring or permitting IFRS; this figure will likely rise to 150 countries in the near future. The introduction of IFRS has been debated in the United States for several years. The Securities and Exchange Commission (SEC) first issued a paper that includes a plan for possible implementation, and several SEC Staff Reports followed up until the July 2012 Final Staff Report with regard to the work plan. However, whether domestic issuers should be permitted to use IFRS is still very controversial.

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