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The U.S. Financial Reporting System, Circa 2015: Are We OK?

Robert Herz | October 27, 2015

Earlier this year I gave a guest lecture to a major university, and met with a group of accounting doctoral students informally to discuss their areas of research and current developments in financial reporting. I was rather startled (or better said, taken aback) when student from abroad asked me the following question: “Why is the U.S. falling behind in financial reporting?”

Not only was this student questioning whether the United States is the leader in financial reporting, but doing so in a way that implied that it is an accepted fact that the U.S. reporting system is lagging behind those in other countries.

My instinctive reaction was to correct the student by stating that, of course the United States is the leader in financial reporting. But instead, I took a deep breath and decided that I should try to understand why he believed that the U.S. is falling behind in financial reporting. So I asked him.

He responded that he believed that we have been slower than other counties to adopt advances in financial and corporate reporting, and cited three things: adoption of International Financial Reporting Standards; expanded auditor reporting; and integrated reporting of financial and key non-financial information, including information on environmental, social, and governance (ESG) issues.

I responded that though there would likely be differing viewpoints among informed and reasonable people as to whether the matters he cited are indicative of the United States falling behind in financial and corporate reporting, or indeed whether any or all of these represented needed changes in reporting. I also said that while I support the goal of a single set of global accounting standards for at least listed companies and favor continued convergence between U.S. Generally Accepted Accounting Principles and IFRS, I do not view IFRS as superior to U.S. GAAP, or vice versa.

I also pointed out that the Public Company Accounting Oversight Board continues to consider requiring expanded auditor reporting, and that while I am proponent of integrated reporting, many U.S. companies include key non-financial performance measures in their earnings releases and Securities and Exchange Commission filings, that many also issue separate sustainability reports, and that the San Francisco-based Sustainability Accounting Standards Boards is developing a set of industry-based standards for voluntary reporting of material ESG issues and metrics in SEC filings.                                                                        

Although I felt I had responded appropriately to the student’s question, his question and the way he stated it continued to haunt me a bit. I have been involved in financial reporting for more than 40 years, both in the U.S. and internationally. I have regarded the United States as the clear leader in financial reporting. In my view, we led in the development of accounting and auditing standards and corporate disclosure requirements, which other countries and capital markets then looked to as the gold standard. Our SEC is the largest, and I believe the most capable, capital markets regulator in the world.

In a world where other countries and regions are investing, innovating, and advancing in critical components of their infrastructures, including their financial and corporate reporting systems, we must be open to changes that improve the quality and effectiveness of our national infrastructures, including our reporting system. Otherwise, we do risk falling behind.

In my view these factors have contributed significantly to the United States having the deepest, most liquid capital markets in the world, and a place that continues to be viewed as a safe haven for investing in a turbulent world. Still, the student’s question continued to bother me. Might there be some truth that we have been slow in recent years to embrace potentially positive changes and in modernizing our reporting system, so much so that we might be falling behind?           

So I pondered it some more. Some thoughts came to mind. First, I think it is now widely accepted that vital aspects of our national infrastructure, such as our highways, bridges, airports, and passenger rail system, are in critical need of repair, rebuilding, and modernization; and that we have fallen behind those of many other countries. And while we continue to have many of the finest universities and hospitals in the world, I think evidence abounds that the quality and effectiveness of our education and healthcare systems lag those in many other countries in terms of measured costs and outcomes.

So if that is the case with other important aspects of national infrastructure, might it also be possible for our reporting system? In that regard, I thought further about whether the three matters cited by the student, as well as other aspects of financial and corporate reporting, might be indicators of the United States falling behind. And if so, why?

First, on IFRS: my view is that both U.S. GAAP and IFRS are high-quality sets of accounting standards, what I call “capital markets” accounting standards. Both the U.S. Financial Accounting Standards Board and the International Accounting Standards Board have competent board members and staff who conduct standard setting through a thorough and objective due process. While there are some specific IFRS standards that I feel are superior to the corresponding U.S. GAAP standard, there are also cases where I believe the U.S. GAAP standard is better.

So overall, while I would like to see continued convergence between the two sets of standards–not just for the sake of convergence, but also to improve both the comparability and quality of financial reporting worldwide. Our not having adopted IFRS is not at all evidence that U.S. financial reporting is falling behind.

Second, on expanded auditor reporting, while it is true that certain other countries (most notably Britain) have led the way on this, and that the International Auditing and Assurance Standards Board and the European Union have been ahead of the PCAOB in promulgating requirements for expanded auditor reporting, I think we will soon see this in our country.

And finally, on integrated reporting: Yes, it has become mandated in certain other countries and voluntarily adopted by a growing number of companies around the world. But as discussed in my February 2015 column, I believe that the SEC’s current initiative on disclosure effectiveness provides a real opportunity for enhancing and modernizing the SEC reporting system through adopting more of an integrated reporting approach to organizing and presenting financial and non-financial information, and to incorporating material information on ESG issues in SEC filings more systematically.

We will have to see how this effort by the SEC progresses, whether it results in the kinds of changes necessary to improve and modernize the SEC reporting system, and how that will stack up against those that are evolving in other parts of the world. So on this important aspect of our reporting system, I think the jury is still out as to whether we might be falling behind.                                                                      

What about the many other aspects of our reporting system compared those in other parts of the world, such as the quality of auditing and internal controls over financial reporting, the performance of audit committees, effective regulatory review and enforcement, and scrutiny of corporate information by investors and financial analysts? Although I believe that these continue to improve in other parts of the world, I feel strongly that the United States leads the world in these critical aspects of reporting.

My conclusion from this exercise is that overall the United States has not fallen behind in financial and corporate reporting. Still, there are plenty of opportunities to improve and modernize our reporting system.

At times we do seem to be slower to adopt changes in reporting than certain other countries and jurisdictions. I attribute this, at least partly, to the extensive due process and stakeholder engagement that our standard setters and regulators are required to conduct before adopting major changes in our reporting system. That is crucial to ensuring that proposed changes are likely to prove positive and cost beneficial. I also believe that concerns by U.S. companies, audit committees, and auditors over being second-guessed and potentially becoming subject to enforcement actions and litigation can sometimes, quite understandably, make them resistant to proposed changes in our reporting system.

Similarly, although the enhanced focus on internal controls has been instrumental in raising the quality of financial reporting in the United States, it has also upped the cost of implementing changes in accounting and financial reporting, which affects both the overall receptivity to change and the cost-benefit analysis of proposed changes. And there are always vested interests that want to maintain the status quo.                                      

But in a world where other countries and regions are investing, innovating, and advancing in critical components of their infrastructures, including their financial and corporate reporting systems, we must be open to changes that improve the quality and effectiveness of our national infrastructures, including our reporting system. Otherwise, we do risk falling behind.