Evidence-based financial reporting regulation

In this introductory paper at the Abacus Forum on International Financial Reporting, I contend that it is difficult to argue that financial reporting and disclosure regulation around the world is evidence-based. Anecdotes and references to more systematic research and surveys of research are used to demonstrate this. 'Evidence-based' is a term that I borrow from medicine. There the term stands for basing medical patient care and health policy choices on the 'current best [scientific] evidence'. I contend that financial reporting and disclosure regulation (and perhaps practice as well) are currently not evidence-based in the specific sense of not being based on the current best scientific evidence available about accounting and auditing. Next I discuss possible causes of this state of affairs and look at future possibilities for financial reporting and disclosure regulation to become (more) evidence-based. The discussion ends by providing a link with the papers that follow in this issue.     

Evidence-based management

For the most part, managers looking to cure their organizational ills rely on obsolete knowledge they picked up in school, long-standing but never proven traditions, patterns gleaned from experience, methods they happen to be skilled in applying, and information from vendors. They could learn a thing or two from practitioners of evidence-based medicine, a movement that has taken the medical establishment by storm over the past decade. A growing number of physicians are eschewing the usual, flawed resources and are instead identifying, disseminating, and applying research that is soundly conducted and clinically relevant. It's time for managers to do the same. The challenge is, quite simply, to ground decisions in the latest and best knowledge of what actually works. In some ways, that's more difficult to do in business than in medicine. The evidence is weaker in business; almost anyone can (and many people do) claim to be a management expert; and a motley crew of sources--Shakespeare, Billy Graham,Jack Welch, Attila the Hunare used to generate management advice. Still, it makes sense that when managers act on better logic and strong evidence, their companies will beat the competition. Like medicine, management is learned through practice and experience. Yet managers (like doctors) can practice their craft more effectively if they relentlessly seek new knowledge and insight, from both inside and outside their companies, so they can keep updating their assumptions, skills, and knowledge.     

Science and proven experience: a Swedish variety of evidence-based medicine and a way to better risk analysis?

A key question for evidence-based medicine (EBM) is how best to model the way in which EBM should ‘[integrate] individual clinical expertise and the best external evidence’. We argue that the formulations and models available in the literature today are modest variations on a common theme and face very similar problems when it comes to risk analysis, which is here understood as a decision procedure comprising a factual assessment of risk, the risk assessment, and the decision what to do based on this assessment, the risk management. Both the early and updated models of evidence-based clinical decisions presented in the writings of Haynes, Devereaux and Guyatt assume that EBM consists of, among other things, evidence from clinical research together with information about patients’ values and clinical expertise. On this A-view, EBM describes all that goes on in a specific justifiable medical decision. There is, however, an alternative interpretation of EBM, the B-view, in which EBM describes just one component of the decision situation (a component usually based on evidence from clinical research) and in which, together with other types of evidence, EBM leads to a justifiable clincial decision but does not describe the decision itself. This B-view is inspired by a 100-years older version of EBM, a Swedish standard requiring medical decision-making, professional risk-taking and practice to be in accordance with ‘science and proven experience’ (VBE). In the paper, we outline how the Swedish concept leads to an improved understanding of the way in which scientific evidence and clinical experience can and cannot be integrated in light of EBM. How scientific evidence and clinical experience is integrated influences both the way we do risk assessment and risk management. In addition, the paper sketches the as yet unexplored historical background to VBE and EBM.     

Overcoming failure in infrastructure risk governance implementation: large dams journey

There is ample recognition of the risk inherent in our very existence and modes of social organization, with a reasonable expectation that implementing risk governance will result in enhanced resilience as a society. Despite this, risk governance is not a mainstream approach in the infrastructure sector, regardless of the increasing number of peer-reviewed published conceptualizations, mature procedures to support its application, or public calls to cope with systemic risks in our modern societies. This paper aims to offer a different view on the issue of risk governance, with focus in the analysis of the root causes of its relatively low degree of implementation in the infrastructure sector. We later analyze the impact of such essential causes, which we have grouped and labeled as the ontology, the concerns, the anathemas, and the forgotten, in the specific field of large dams. Finally, we describe the journey toward risk governance in the specific field of large dams, thus supporting the ultimate objective of this paper to facilitate an evidence-based approach to successful risk governance implementation within and outside the dam sector.     

Making a Reality of Evidence-Based Practice: Some Lessons from the Diffusion of Innovations

The 1990s saw an upsurge of interest in using research evidence to inform public sector policy and practice. Yet, if such evidence is to have impact, ways must be found to move beyond the simple dissemination of research findings. Strategies need to be developed which encourage the uptake and utilisation of evidence. In exploring ways in which evidence-based practice might be achieved, the lessons gleaned from an examination of the literature on the diffusion of innovations are presented. The implications of these lessons for ongoing organizational learning are also outlined.     

How costly is the Sarbanes Oxley Act? Evidence on the effects of the Act on corporate profitability

The Sarbanes-Oxley Act (SOX) was intended to protect investors by improving the accuracy and reliability of corporate disclosures. However, critics have argued that the costs of SOX far outweigh its intended benefits. Prior studies based on stock-price reactions to SOX-related events document mixed evidence on the expected impact of SOX. In contrast, we provide evidence on the net realized costs of SOX by examining its impact on operating profitability. We find that average cash flows decline by 1.3% of total assets after SOX. These costs are more significant for smaller firms, for more complex firms, and for firms with lower-growth opportunities. Annually, these costs range from $6 million for smaller firms to $39 million for larger firms. Further, we document that net SOX-related costs are not limited to one-time expenses associated with internal-control design and implementation. In aggregate, for the 1428 firms in our sample, these costs amount to about $19 billion per year. Profitability is lower for up to four years post-SOX. To our knowledge, ours are the first estimates of the realized net costs imposed by SOX.     

Capital investment and momentum strategies

The main purpose of this paper is to investigate whether capital investment can affect stock price momentum. We provide empirical evidence that momentum strategies tend to be more profitable for stocks with large capital investment or investment changes. We present a simple explanation for our empirical results and show that our finding is consistent with the behavioral finance theory that characterizes investors?? increased psychological bias and the more limited arbitrage opportunity when the estimation of firm value becomes more difficult or less accurate.     

Arzthaftung auf der Grundlage von Statistiken

The evidence-based medicine describes the effectiveness of medical therapies by statistical success rates. It’s results can serve as standards of healthcare in medical malpractice liability cases. In the following paper it is shown that these success rates depend on the subjective judging what success is. They further depend on the way how the won data are mathematically processed. The main problem however is that the success rates are of statistical nature. It is known from mathematical statistics that a statistic result does not give any information about the behaviour of a single and specific element, in case of medicine about the effect of a therapy on a concrete patient. In consequence competitive therapies cannot be compared on the basis of statistical information in a specific medical malpractice case. A doctor must therefore inform the patient prior to a therapy about this situation.     

Factors associated with internal audit function involvement with XBRL implementation in public companies: An international study

We examine the relationships of national legal system, company size, and corporate governance quality with internal audit function (IAF) involvement with eXtensible Business Reporting Language (XBRL) implementation in public companies. Our data source is The Institute of Internal Auditors' Global Internal Audit Common Body of Knowledge (CBOK) database, from which we extract responses from 692 chief audit executives (CAEs) for our investigation. We find evidence of differential effects of company size on IAF involvement with XBRL implementation, depending on the national legal system. In civil law countries, IAFs of small companies have significantly higher levels of XBRL involvement than do IAFs of large companies, whereas, in common law countries, IAFs of large companies have higher levels of involvement than do those of small companies. Finally, we find evidence that corporate governance quality is positively associated with IAF involvement with XBRL implementation.     

Client importance and audit partner independence

We use data from Taiwan where audit partners are required to sign audit reports to examine whether audit partners compromise their independence for economically important clients. Uniquely, we include both listed and unlisted clients in audit partners’ client portfolios and separately study these clients for Big N and non-Big N auditors. We employ multiple proxies for auditor independence, including various abnormal accruals measures, the propensity of audit partners to issue modified audit opinions, and the probability that clients meet or just beat earnings targets. We fail to find evidence that Big N audit partners compromise their independence for economically important clients; however, we find such evidence for non-Big N auditors. Our results are robust to a battery of sensitivity analyses. While our inferences are limited to the Taiwanese capital market, our study may be of interest to market participants and regulators in other well developed capital markets.     

Evidence-Based Social Care: Wheels off the Runway?

British social services departments are a beleaguered species. Political ideology continues to play a major role in shaping policy and practice, despite a change of government. Sheltering beneath the ideological umbrella are more considered views of the need to rethink structures developed as a means of solving social problems and delivering services, some of which have themselves become problematic, some of which are simply too expensive. These influences have combined radically to reframe the roles and responsibilities of many who work face-to-face with service users and carers. It is in this context of change and threat to professional identity that the implementation of evidence-based approaches to policy and practice within social work has to be considered.     

DRG-based prospective pricing and case-mix accounting—Exploring the mechanisms of successful implementation

Escalating health care expenditures have brought on the need for restructuring health care delivery. A common response to this problem has been to seek market-based solutions. In the literature, however, increasing concern has been expressed that hospital management reforms will fail or will have only a limited impact. This longitudinal case study extends our understanding of the effects of implementing DRG-based prospective pricing and case-mix accounting systems for hospital management control in a specific health care setting. Moreover, this study contributes to current knowledge by focusing on the mechanisms explaining successful implementation of new accounting and control systems in the health care sector. A deep understanding of these mechanisms may help us to design better management control systems, and thus circumvent problems in implementing these systems. Our study suggests that successful implementation in the studied context is strongly dependent on the involvement of clinicians in this process. Integrated clinical and financial accountability, assigning responsibility for implementation to clinicians, freedom in choosing appropriate control tools, and flexibility in adoption all facilitated implementation. Furthermore, we argue that this process has also been advanced by the gradual implementation of these reforms and intensifying institutional pressures.     

Enhancing student engagement in large management accounting lectures

The education literature suggests a student-focused teaching strategy to improve students’ engagement in a lecture. However, in traditional accounting lectures students take the role of passive and anonymous recipients of knowledge. This paper reports on two cycles of an action research project, developing and refining a blended learning model, with the purpose of enhancing students’ engagement in the lectures of a large management accounting course. Results of our study find that engagement was enhanced with the implementation of this model. This study contributes to the accounting education literature through reporting evidence from action research and the effective implementation of a blended learning model that accounting educators can use.     

The Impact of Evidence on Transport Policy-Making: The Case of Road Construction

For many years, lack of consensus about the goals of transport policy resulted in evidence being used selectively to justify particular policies—rather than to establish whether (when judged against suitable criteria) the policies were actually working. Forecasts of traffic growth were taken as evidence of the need for road construction programmes; now, the phenomenon of 'induced traffic' has led to a re-think, and a more evidence-based approach to transport policy.     

The valuation impact of reconciling pro forma earnings to GAAP earnings

Regulation G requires all companies to quantitatively reconcile pro forma earnings with GAAP earnings. This paper provides three findings related to the impact of reconciliations on mispricing of pro forma earnings. First, prior to Reg G, we find that mispricing of pro forma earnings is limited to firms with low reconciliation quality. There is no evidence of mispricing for firms with high reconciliation quality. Second, we find no evidence of mispricing after Reg G. Third, there is a cross-Reg G reduction of mispricing for firms whose reconciliation quality improves, and there continues to be no mispricing for firms that have high reconciliation quality both before and after Reg G. Together, our results support the notion that better reconciliations reduce the extent of mispricing.     

Risk aversion vs. individualism: what drives risk taking in household finance?

Despite a considerable premium on equity with respect to risk-free assets, many households do not own stocks. We ask why the prevalence of stockholding is so limited. We focus on individuals’ attitudes toward risk and identify relevant factors that affect the willingness to take financial risks. Our empirical evidence contradicts standard portfolio theory, as it does not indicate a significant relationship between risk aversion and financial risk taking. However, our analysis supports the behavioral view that psychological factors rooted in national culture affect portfolio choice. Individualism, which is linked to overconfidence and overoptimism, has a significantly positive effect on financial risk taking. In microdata from Germany and Singapore, as well as in cross-country data, we find evidence consistent with low levels of individualism being an important factor in explaining the limited participation puzzle.     

Culture Matters: How Our Culture Affects the Audit*

If the influence of national cultures on the implementation of global standards is not taken into account, the result will be inconsistent implementation at best and outright failure at worst. The experiences in fields such as medicine, peacekeeping, aviation, and environmental protection offer insight into possible difficulties with the implementation, beginning in 2010, of International Standards on Auditing (ISAs) by members of the International Federation of Accountants. Some countries may have difficulty with implementation because of the differences between their cultural assumptions and those embodied in the standards to be adopted. It is too soon to know if and where that will happen, especially because the data on first experiences will not begin to be available until 2013. However, cultural‐comparison data can be used to foresee which countries may have difficulty with implementation. But if unintended consequences do become evident, it will be important not to assume that the standards and the standard‐setting process are defective; it is more likely that practitioners will need help in interpreting the ISAs in light of their local culture. A useful first step would be for standard‐setting bodies to identify explicitly the cultural assumptions inherent in the standards they produce. The standard setters can then give that information to those responsible for standards implementation at the practitioner level to help promote consistent application of the standards globally.     

Differential effects of regulation FD on short- and long-term analyst forecasts

In this paper, we provide evidence that the quality of short-term analyst forecasts improved but the quality of long-term analyst forecasts deteriorated after the implementation of Regulation Fair Disclosure (FD). More specifically, our results show that the precision of the idiosyncratic information component of short-term forecasts improved in the post-FD period, whereas the precision of both the common and idiosyncratic information components of long-term forecasts declined. We attribute this result to the reduced disclosure of long-term, future-oriented information in the post-FD period. Thus our results support assertions by some analysts that FD has had a chilling effect on information that is relevant to long-term forecasts.     

Learning with futures to realise progress towards sustainability: The WBCSD Vision 2050 Initiative

This paper addresses the limited evidence of how futures work bears fruit in the present by exploring a specific, yet significant, empirical case study. The results of our longitudinal study into the WBCSD Vision 2050 Initiative shed light on how organisations are harnessing the perspective of the long term future to identify what can and should be done in the near term to keep progress towards sustainability on track. We provide evidence of the expected and realised benefits of this collaborative futures initiative. These benefits extend beyond direct decision support, manifest at multiple levels and vary over time. We note that shift from single client to collaborative futures work is inherent to addressing sustainability challenges and call for more research into how collaborative futures practices are evolving to deal with new puzzles and wicked problems.     

Information,uncertainty, and behavioral effects: Evidence from abnormal returns around real estate investment trust earnings announcements

In this study, we examine the influence of real estate market sentiment, market-level uncertainty, and REIT-level uncertainty on cumulative abnormal earnings announcement returns over the 1995–2009 time period. We first document the relative coverage of analysts' earnings forecasts on U.S. REITs, as well as REITs from several countries (i.e., Australia, Belgium, Canada, France, Hong Kong, Japan, the Netherlands, and UK). We show that coverage outside of the U.S. is limited, and we consequently focus our analysis on U.S. REITs. We find strong evidence that earnings announcements contain pricing relevant information, with positive (negative) earnings surprises relative to analysts' forecasts resulting in significantly positive (negative) abnormal returns around the announcement date. Consistent with the findings from the broader equity market literature, we find limited evidence of a pre-announcement drift in the cumulative abnormal returns. However, in sharp contrast to the existing equity literature, we find no evidence of a post-earnings announcement drift in our aggregate sample or when the sample is restricted to the largest negative surprises. We find evidence of a post-earnings announcement drift for only the largest positive earnings surprises. These results are consistent with REIT returns more quickly impounding information relative to the broader equity market, in part because of the parallel private real estate market and because of the U.S. REIT structure and information environment. Finally, in our conditional regression analysis of cumulative abnormal returns, we find that real estate investor sentiment, market-wide uncertainty, and firm-level uncertainty significantly affect the magnitude of abnormal announcement returns and also influence the effect of unexpected earnings on abnormal returns.