US vs. UK Financial Statement Disclosure: A Cross-Country Comparison

Transcription

1 US vs. UK Financial Statement Disclosure: A Cross-Country Comparison Dr. David Hossain, Associate Professor of Accounting, California State University, Los Angeles, USA Dr. Gregory Kunkel, Professor of Accounting, California State University, Los Angeles, USA ABSTRACT US capital markets are perceived to suffer from more regulatory burden than UK capital markets. Moreover, US Generally Accepted Accounting Principles (GAAP) are perceived to be more rulesbased than the principles-based standards (IFRS) followed by UK companies. This study examines the financial disclosure practices of a matched sample of US vs. UK companies. While we expected the quantity and quality of disclosure by US companies to exceed that of UK companies, we found the opposite. At least for our matched sample of companies, disclosure quantity and quality of UK firms appears to exceed that of US firms. INTRODUCTION Recently, there has been concern in the United States that US capital markets are losing their competitiveness. The 2006 Interim Report of the Committee on Capital Markets Regulation (hereinafter referred to as The Interim Report ) notes that in 2000, the US market share of IPOs (measured in terms of value) was 50%, while this number had declined to 5% in Measured in terms of numbers of IPOs, the decline is from 37% in 2000 to 10% in Another important trend is the use of private equity markets to access capital, rather than the use of public markets. According to The Interim Report, in 2005, foreign companies raised ten times more capital in US private markets than public markets ($53.2 billion vs. $4.7 billion). Moreover, in 2005, 25% of going private transactions in the United States were funded by private equity funds. Private equity funds raised $200 billion in 2005, more than the amount flowing into mutual funds (The Interim Report). The loss of public financial market competitiveness in the US is attributed to a number of factors: foreign markets have closed the technology, investor confidence, and liquidity gaps traditionally enjoyed by US markets; significant pools of capital have developed around the world outside the United States; US regulatory compliance costs and liability risks have grown compared to other developed countries and financial centers (The Interim Report). While US market share has declined, the UK financial markets have prospered. According to The Interim Report, London has increased its share of the global IPO market from 5% in 2003 to approximately 25% in Ed Balls, former Economic Secretary to the UK Treasury is quoted in The Interim Report: Our system of principles and risk-based regulation provides our financial services with a huge competitive advantage and is regarded as the best in the world. The Interim Report goes on to state: It is worth noting that London, for many years lacking the dominant position in worldwide capital or investment opportunities (which arguably it once held), has been able to retain its position as a leading 68

2 financial center by choice, not necessity. It has done so, in the view of many, by providing the protection to investors of well-crafted, effective laws properly enforced without unnecessary cost and undue exposure to liability risk. The key words in the above quote are unnecessary cost and undue exposure to liability risk. To make US capital markets more competitive, the Committee on Capital Markets Competitiveness had the following recommendations: Improved Cost-Benefit Analysis by the SEC and Self-Regulatory Organizations (SROs) The SEC should establish explicit principles of effective regulation that will guide its activities to meet its statutory obligations. These principles should include the systematic implementation of a carefully applied cost-benefit analysis of proposed rules and regulations. Rules should be evaluated initially at the front-end, but also should be reviewed periodically to ensure that they are achieving their intended effect at an acceptable cost. The SEC and SROs Should Adopt More Principles-Based Rules and Different Rules for Dealings with Wholesale and Retail Investors Prescriptive rules should be fashioned, where sensible, more in terms of outcomes, performance, and results rather than inputs and mandated processes. Regulations and the oversight of such regulations by the regulatory authority should be risk-based and principles-based. While recommending that regulatory bodies take a cost-benefit, risk-based, and principles-based approach to regulation, the Committee on Capital Markets Competitiveness cautioned against a race to the bottom, whereby regulators gut regulations solely to make their capital markets more competitive. In fact, the financial crisis of resulted in more regulation of the US banking system (Dodd Frank Act, 2010) and an overhaul of the regulation of the financial services industry in the United Kingdom (Financial Services Act of 2012). One aspect of financial market regulation, is the required disclosure of firm-specific financial and qualitative business information. In the United States, disclosure requirements are established by the Securities and Exchange Commission, The Financial Accounting Standards Board (FASB), and the various stock exchanges. Recently, The Financial Accounting Standards Board has been collaborating with the International Accounting Standards Board (IASB) to jointly develop international accounting standards. US Generally Accepted Accounting Principles (GAAP) are perceived to be rules-based, lengthy, and cumbersome. International Financial Reporting Standards (IFRS) are perceived to be more principles-based, outcome-based, and less cumbersome. Due to recent FASB and IASB collaboration, future standards might lie somewhere in between the two approaches. The United Kingdom adopted IFRS for listed companies in The UK regulatory and legal system for public companies is perceived to be less burdensome than the system that exists in the United States. If the UK regulatory system is less burdensome, and IFRS are more principles-based, one might expect to find financial statement disclosures for publicly traded UK firms to be less detailed and less comprehensive than disclosures for similar publicly traded US firms. There have been several studies that attempt to measure the amount and quality of corporate disclosure and financial transparency across countries (Ding, et.al, 2007), (Bushman, et. al, 2004), (Bushman, et.al, 2003), (Patel, et.al, 2002). Although there are differences in these studies, they all develop an index of transparency and disclosure by identifying disclosure items and characteristics, such as: 69

3 amount of disclosure; disclosure timeliness; disclosure of significant proprietary items; credibility of disclosures; ownership structure; investor rights; board and management structure and processes. Other studies (Asbaugh, et. al, 2001) measure company differences between US GAAP and IFRS due to absence of an international standard, differences between US and international standards and methods, and accruals (Hung, 2000). This paper updates prior studies by comparing the financial statement disclosures of a matched sample of US and UK companies of similar size in the same industries, with no cross-country listings. Given the perceived regulatory burden of US capital markets and the perceived detail-orientation of rules based US GAAP, we expect the quantity and quality of the disclosure of US companies to exceed that of the UK companies, although the most recent study reports no such difference (Patel, et.al, 2002). The rest of the paper is organized as follows: Section 2 outlines our research methodology. Section 3 summarizes our research results, and Section 4 provides a summary and conclusions and a qualitative assessment of the differences between current US and UK disclosure practices. RESEARCH METHODOLOGY Given the perceived or real regulatory burden of the US capital markets and given the principlesbased approach to financial statement disclosure under IFRS, we expect the financial statement disclosure in published reports of US companies to be more extensive than that of UK companies. Therefore, our Null Hypothesis is: There are no differences in the quantity and quality of disclosure between US and UK companies. Sample and Data Collection To test this hypothesis, we examined annual reports and 10-Ks of a matched sample of 46 similarlysized US and UK companies from various industries. To highlight differences (if any) between the disclosure practices of US vs. UK companies, we selected companies that were not cross-listed on US and UK exchanges. Our intention was to avoid disclosure convergence that may result from cross-listing on both US and UK exchanges. In this study, we use three measures of disclosure differences. The first is the Quantity of Disclosures, the second is the Prevalence of Proprietary Disclosures and the third is the Quality of Proprietary Disclosures. Measurement of Quantity of Disclosures For our matched sample of US and UK companies, we counted the number of disclosures (NDSCL) and the number of Accounting Policy disclosures (NAPOL) contained in the notes to the financial statements. According to Bushman et. el. (2004), "knowledge of accounting methods facilitates the interpretation of accounting disclosures. The results of this initial comparison are contained in Table 1. Table 1: ANOVA Results: Quantity of Disclosures 70

4 Measurement of the Prevalence of Proprietary Disclosures We counted the presence or absence of seven proprietary (company-specific) disclosure areas contained in the notes to the financial statements. According to Bushman et al. (2004), proprietary disclosures are "highly useful to outside investors for valuing firms' securities as well as monitoring managerial decisions." The seven proprietary disclosures are: -Revenue Recognition Disclosure (REV); -Property, Plant & Equipment Disclosure (PPE); -Intangible Asset Disclosure (INTG); -Segment and Geographic Information Disclosure (SEGM); -Long Term Debt Disclosure (LTD); -Stock Based Compensation Disclosure (STCMP); and -Pension Plan Disclosure (PENS). The results of this examination are contained in Table 2. Table 2: ANOVA Results: Prevalence of Proprietary Disclosures Measurement of Quality of Disclosures Finally, for those disclosure areas in Table 2 for which there were no significant differences between US and UK companies, we examined the financial statements of 6 US and 6 UK companies in more detail, to see if a detailed reading of their financial statements would more clearly identify differences in disclosure. Our detailed examination focused on four key disclosure properties as follows: 1. Separate Disclosure (SEPD): Was there a separate detailed disclosure beyond what was contained in the accounting policy description; 2. Detailed Discussion (DETD): Was there an extensive/detailed discussion in the financial statements beyond boilerplate language contained in the accounting policy statement; 3. Detailed Schedule (SCHD): Were schedules presented providing detailed analysis of the disclosure area; 4. Important Element (ELEM): Did the disclosure include important assumptions, information, etc. For example, was there a discussion on impairment in Property, Plant & Equipment (PPE) and Intangible Asset (INTG) disclosures; was there any meaningful discussion of various methods beyond boilerplate language in revenue recognition (REV) disclosure; was there a discussion of off balance sheet liabilities such as purchase commitments, contingencies and/or operating leases related to long-term debt disclosure; were there disclosures on post-retirement medical/health care benefits and interest rate assumptions in pension plan (PENS) disclosure, and finally, was the potential number of dilutive shares disclosed under stock-based compensation (STCMP) disclosure. 71

5 The results of this analysis are contained in Table 3. Table 3: ANOVA Results: Quality of Disclosures RESEARCH RESULTS Quantity of Disclosures As Table 1 indicates, the UK companies financial statements contained, on average, more disclosures than that of their US counterparts as measured by the number of disclosures (NDSCL) and the number of Accounting Policy disclosures (NAPOL). The mean of disclosures for UK firms was 32.0 while the mean for US firms was Similarly, the mean of accounting policy disclosures was 25.5 and 19.7 for UK and US firms, respectively. The analysis of variance (ANOVA) test in Table 1 shows that the mean for the number of disclosures and mean for the number of accounting policy disclosures for UK firms are significantly higher than that of the US firms at the level. Therefore, we reject the null hypothesis that there are no differences in the quantity of disclosure between US and UK companies. In other words, the perceived regulatory relief enjoyed by UK firms and the principles-based approach of IFRS does not result in less disclosure of UK firms compared to their US counterparts. Prevalence of Proprietary Disclosures Focusing on seven proprietary disclosures (See Table 2), the UK companies provided much more disclosure in the area of Segment and Geographic Information (SEGM) disclosure than did their US counterparts. A careful reading of US and UK company financial statements clearly reveals that UK companies disclose much more in the area of segment reporting than do their US counterparts. As Table 2 also indicates, amount of disclosure in the other proprietary areas was not significantly different at the level between US and UK companies. Except in the area of segment disclosure, our analysis of seven proprietary disclosure areas reveals no difference between US and UK disclosure. Quality of Disclosures Table 3 presents differences in the quality of disclosure for those disclosure areas in Table 2 for which there were no significant differences between the prevalence of disclosure for US and UK companies A detailed examination of the financial statements for the six US and UK companies reveals slightly more disclosure quality on an overall basis for the UK companies than for the US companies. The mean for all four disclosure properties for UK companies is higher than US companies, although only the mean for Separate Disclosure (SEPD) is significantly higher at the 0.10 level. 72

6 SUMMARY AND CONCLUSION Given the perceived regulatory burden of US capital markets and the rules-based approach to standard setting practiced in the US, we expected the quantity and quality of financial disclosure in the US to be greater than that in the UK. Our analysis does not support this presumption. The following is a summary of our comparison of US and UK financial reporting. Some of our observations are qualitative in nature, based upon impressions formed when reading the financial statements of US and UK companies. These qualitative impressions are not easily captured by statistical analysis or rigorous logic. 1. If US companies are suffering regulatory overload compared to their UK counterparts, it does not appear to be due to the amount of required, published disclosure. In fact, UK disclosure appears to be of greater quantity and quality than US disclosure. 2. US 10-K reports read like dull, regulatory/compliance documents, although US annual reports (if provided) are more lively in nature. UK annual reports appear more informative in nature, in many cases providing more detailed insights into the company s business, strategy, risk factors, etc. 3. UK annual reports provide more information about key judgements and assumptions underlying the financial statements. This is a requirement of IFRS, and this requirement appears to have resulted in more detailed disclosure. 4. UK annual reports provide information about the management of capital and capital investment decisions. This is a requirement of IFRS. US GAAP has no such requirement. 5. Although not the focus of this study, UK companies provide more information about Corporate Governance in their annual reports, including: A Governance Report; A Discussion of Corporate Responsibility; a detailed Audit Committee Report, and a Nominations Committee Report. There appears to be more of an emphasis on the qualitative characteristics of corporate governance in the UK than in the US. REFERENCES Ashbaugh, H. & Pincus. M. (2001). Domestic Accounting Standards, International Accounting Standards, and the Predictability of Earnings. Journal of Accounting Research 39: Bushman, R.M. & Smith, A.J. (2003). Transparency, Financial Accounting Information, and Corporate Governance. FRBNY Economic Policy Review. April, Bushman, R.M., Chen Q, Engel, E & Smith, A.J. (2004). Financial Accounting Information, Organizational Complexity and Corporate Governance Systems. Journal of Accounting and Economics. 37: Bushman, R.M., Piotroski, J.D. & Smith, A.J. (2004). What Determines Corporate Transparency. Journal of Accounting Research. 42: Committee on Capital Market Regulation. (2006). Interim Report of the Committee on Capital Markets Regulation. November Ding, Y., Hope, O., Jeanjean, T. & Stolowy, H. (2007). Differences between Domestic Accounting Standards and IAS: Measurement, Determinants and Implications. Journal of Accounting and Public Policy. 26: Ernst & Young. (2012). The SEC s Opportunity to Consider Disclosure Overload. To the Point Perspective. No : 1-4. Fox, M. B. (1996). Required Disclosure and Corporate Governance. Law and Contemporary Problems. 62: Frost, C. & Lang, M. (1996). Foreign Companies and U.S. Securities Markets: Financial Reporting Policy Issues and Suggestions for Research. Accounting Horizons. 10:

7 Hassan, O. & C. Marston. (2010). Disclosure Measurement in the Empirical Accounting Literature-A Review Article. Department of Economics and Finance, Brunel University. July. Working Paper No Hope, O. (2003). Firm Level Disclosures and the Relative Roles of Culture and Legal Origin. Journal of International Financial Management and Accounting. 14: Hung, M. (2000). Accounting Standards and Value Relevance of Financial Statements: An International Analysis. Journal of Accounting and Economics. 30: Dhananjay, N. & Wysocki, P. (2011). Relation between Trust and Accounting Quality. Unpublished paper. University of Miami School of Business. November Patel, S. & Dallas, G. (2002). Transparency and Disclosure: Overview of Methodology and Study Results-United States. Standard and Poors. SSRN: Patel, S., Balic, A. & Bwaqkira, I. (2002). Measuring Transparency and Disclosure at Firm-level in Emerging Markets.Emerging Markets Review. 3: