Auditors’ turn to needle Greece

Greece, Greece, Greece… all types of economists, political analysts, simply dilettantes, and  pseudo specialists are trying to comment on the issue of sovereign debt, Eurozone and the role of Greece in this mess. So I think it is time for us, accountants and auditors to make our pedantic and diligent (as we always do ;) contribution to process of pointing finger at Greece J

I have been recently interested in IFRS adoption in different countries and implications of this rather painful process. There are remarkable research papers dedicated to this topic, among which is study by Siqi Li (2010), who analyses impact of IFRS implementation on the cost of equity capital in Europe. I am going to use his analysis to raise some issues about Greece.

Lots of Requirements and No Enforcement

The author of research took into consideration the fact that effective implementation of IFRS depends on country’s institutional arrangements. In other words, benefits from mandatory IFRS adoption in terms of reduction in the cost of equity are expected to be sensitive to whether the new rules are effectively enforced (Li 2010). So, the scholar compared the European countries using such variables as law enforcement (utilizing studies by La Porta et al. (1998); Leuz et al. (2003)), additional disclosures and inconsistencies in standards. This interesting and appealing analysis was presented in Table 5 of his study, which is attached to this post.

Following observations could be made from this table.

First, the best “mutual friends”, Germany and Greece, are among top 4 countries, which had the greatest number of inconsistencies between local GAAP and IFRS. So here we see that Greece is not alone in it is remoteness from modern accounting practice. If you noticed, Spain is leader in terms of inconsistencies with IFRS.  

Second, considering the number of additional disclosures required per IFRS, Greece as well as Spain remain under our focus as leaders of the list. Germany occupied middle ranks. This shows that financial statements of the Greek and Spanish entities based on local GAAP were less transparent than the other European countries. Even newly accepted Poland and Czech Republic did better job in a convergence process.

Finally, according to the table the worst enforcement ratings belong to Greece, Italy, Spain, and Portugal. Does it remind you something? The problems with sovereign debt and liquidity touched exactly the same list of countries. I wonder if investment analysts use the enforcement ratings as factor to hedge investments of their clients, it would be good thing to do so.

But what can we infer from Greece’s ratings? Having the biggest number of inconsistencies and necessity of additional disclosures under IFRS the country faced huge challenge to enforce accurate financial reporting. On the other hand, low level of legal enforcement and development of institutions impeded this process.

This pattern of reasoning might leads us to the same conclusion regarding Greek tax system. As my Greek acquaintances evidence that the tax and legal system in Greece is overcomplicated and not easy to comply with. Thus, in the situation of low level of law enforcement, the efforts to evade taxes might be rather successful.  As a result this impacts tax collectibility and ability of country to meet its debt service obligations.

Quite another issue is the level of indebtedness of the Greek private businesses, particularly banks. Given the information above, can we rely on their IFRS financial statements and do they reflect actual financial position of businesses?

By the way

Kebab mix

By the way, I do not have anything against Greece or Greek people. In fact, last week I was in Greek restaurant and had fabulous dish of mixed kebab, which comprised of chicken, pork, and lamb meat as well as sheftalia… yummm, delicious! J

References

La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny. 1998. Law and finance. The Journal of Political Economy 106 (6): 1113–1155.

Leuz, C., D. Nanda, and P. Wysocki. 2003. Earnings management and investor protection: An international comparison. Journal of Financial Economics 69 (3): 505–527.

Li, S. 2010. Does Mandatory Adoption of International Financial Reporting Standards in the European Union Reduce the Cost of Equity Capital. The Accounting Review 85 (2):  607-636

Nobes, C., ed. 2001. GAAP 2001: A Survey of National Accounting Rules Benchmarked Against International Accounting Standards by Andersen, BDO, Deloitte Touche Tohmatsu, Ernst & Young, Grant Thornton, KPMG, PricewaterhouseCoopers. New York, NY: J Wiley & Sons.

Event Study: Audit Report Announcements

Event study methodology is widely used in researches dedicated to the impact of audit opinion on investors’ decisions. This methodology requires specification of date of audit opinion announcement, date when the information about type of audit opinion becomes available to public. This date is event and days (allowed to capture pre- and post- effects) around the date are ‘event window’ (Campbell et al. 1997). See illustration of Time Line:

Source: Campbell, J.Y., Lo, A.W. and MacKinlay, A.C. (1997). The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press, p. 157.

I wrote about this kind of studies in audit area in one of my posts (click link) on February. The issue here is difficulty to identify correct date of event as this would influence the whole research. There are number of researchers who emphasized this issue, e.g. Craswell (1985), Martinez et al. (2004), Soltani (2000). Especially this problem arises when it is necessary to compare studies in different countries, i.e. jurisdictions.

In following paragraphs I want to discuss briefly the features on event identification process in different countries.

Anglo-Saxon system

The countries with a case law system are suggested here: USA, UK, Canada, Australia. I would consider two key relevant characteristics:

·        Work of stock exchange commissions (let us name ‘SEC’ all similar authorities) with financial/annual reports, e.g. US companies are obliged to file 10-K (which contains audited FS) within 90 days after fiscal year end and after filing 10-Ks almost immediately become available to public via US SEC site (see sec.gov)

·        Transparency, e.g. it is more common for US companies to announce audit opinions before the annual general meeting or 10-K filing date.

Reasonable methodic in date selection was used by Menon and Williams (2010). They chose earlier of:

(1)   10-K filing date;

(2)   Date of press release of financial statement and audit opinion.

Continental European (Roman) Legal tradition

Following could be outlined as features in relation to opinion announcements (based on example of France and Spain):

·        SEC do not make audited financial statement available to public as soon as possible (see below some peculiarities in Spain) with deadline of 90 days after fiscal year end;

·        Audited financial statement must be provided (France and Spain) to shareholders at least 15 days (or any other number of days prescribed by law to notify shareholders about AGM) before annual general meeting (AGM). At the same time reports are to be send to SEC and only after this they are to be published by SEC ;

·        Listed companies are reluctant to announce publicly audit opinions (Soltani 2000).

To solve this issue for French market Soltani (2000) defined and calculated results for following three event dates:

(1)   Date of audit opinion signature;

(2)   15 days before the AGM date (most precise as was mentioned by Soltani);

(3)   Average date between the (1) and (2)

Martinez et al. (2004) identified that law requires listed companies to file audited financial statements (FS) within Spanish SEC (which has to publish them aftermath) before the date of AGM announcement. So Martinez used the earlier of:

(1)   Date when Spanish SEC makes FS and audit reports available to public;

(2)   15 days before the AGM date.

Russian jurisdiction

Russian modern corporate laws also belong to continental legislation system with specifics of emerging market economy and socialistic overregulated past.

Following matters to be considered:

·        All open joint stock companies have to file their audited FS to Tax authorities within 90 days after year end, but Tax authorities must not release them to public (Accounting Law, ФЗ 129);

·        Audited FS must be distributed to shareholders at least 20 days before AGM (Open Joint Stock Companies Law, ФЗ 208);

·        Audited FS must be also included in the quarterly report of issuer (ежеквартальный отчет эмитента) for the first quarter, which must be issued not later than 45 days after 1^st Quarter end, i.e. 15^th of May,

·        Announcement about the issue of quarterly reports and AGM must be placed by companies on the state authorized news wire available to public via internet (State Provision about Disclosure Information by Issuers, Приказ ФСФР N 06-117/пз-н).

 So in selection correct event date it would be reasonable to consider the earlier of:

(1)   Announcement of 1^st Quarter report issue on statutory news wire;

(2)   20 days before the AGM date.

Conclusion

I hope above summary and considerations about Russia would help researchers involved in accounting/reporting area to do event studies. I am going to use these ideas in my coming dissertation and I would like my readers to share with me information about report release legislation in their countries.

References

Campbell, J.Y., Lo, A.W. and MacKinlay, A.C. (1997). The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press.

Craswell, A. T. (1985) Studies of the information content of qualified audit reports, Journal of Business Finance and Accounting. No 12(1), pp. 93–115

Martinez, M., Martinez, A. and Benau, M. (2004). Reactions of the Spanish capital market to qualified audit reports. European Accounting Review. Vol. 13, No. 4, pp. 689-711.

Menon, K. and Williams D.D. (2010). Investor Reaction to Going Concern Audit Reports. The Accounting Review. Vol. 85, No. 6, pp. 2075-2105.

Soltani, B. (2000) Some empirical evidence to support the relationship between audit reports and stock prices – the French case. International Journal of Auditing. No 4, pp. 269–291.