Political Forces Affecting the Enforcement of IFRS

to 2011, Baudot (2014) illuminates the standard setters’ reactions to changes in economic, political, and social situations when trying to converge their sets of standards. On the one hand, calls for the convergence of IFRS and U.S. GAAP (by the G20) as well as the prospects of potential acceptance of IFRS for U.S. issuers supported the boards’ cooperation. On the other hand, the political decision to reject the adoption of IFRS for U.S. issuers in the near future discouraged the IASB from devoting attention to the needs of U.S. constituents at the expense of the needs of constituents from other jurisdictions.²⁶

While the IASB experienced only few open political interventions so far, most of them had strong symbolic relevance. The carve-out decision by the European Union in 2004 constituted a landmark case for jurisdictions’ actual willingness to deviate from IFRS as issued by the IASB. Similarly, the European Union’s intervention in 2008 forced the IASB for the first-time to change a standard solely due to political intervention and at the dispense of its own due process, which damaged its reputation (e.g., Selling,2008).

it has no authority for the actual enforcement of firms’ compliance with reporting requirements. Put differently, the IFRS Foundation has no mandate to protect the “IFRS brand name” by ensuring that only firms that fully comply with IFRS as issued by the IASB can state to prepare their financial statements in accordance with IFRS. Instead, local regulators perform this task.²⁷ Jurisdictions can thus indepen-dently decide upon the design of their enforcement systems and can deviate from enforcement recommendations provided by supranational bodies (see ESMA,2014; IOSCO,2015; OECD, 2014). Actors at the local, jurisdictional level can thereby crucially affect the creation of enforcement systems (see Albuet al.,2021). With their interview-based study on how clients, auditors, and enforcement agencies negotiate the adequacy of IFRS reporting practices, Meusburger and Pelger (2020) illustrate the substantial influence of national enforcement agencies on firms’ reporting and the possible result of national versions of IFRS interpretations.²⁸

National enforcement systems vary considerably in multiple dimen-sions. For example, there exist large differences in the staff size of enforcement agencies and their access to sufficient financial resources (Brownet al.,2014; Caramaniset al.,2015; ESMA,2017; Jackson and Roe, 2009). Based on a survey among European enforcement bodies and regulatory specialists, Johansenet al.(2020) document the varying degrees of enforcement agencies’ independence from political actors or other market participants, their freedom to decide upon the scope of enforcement, and regulatory power in case of noncompliance. Eventu-ally, a jurisdiction’s decision on how to equip its enforcement agencies with financial resources and regulatory powers is subject to political considerations and reflects the diverging interests of local constituents (Ball,2006).

27For example, the European Union mandated its members to establish enforce-ment agencies by 2005. See Brown and Tarca (2005) for a discussion of the installenforce-ment of enforcement agencies in different EU member states.

28For a discussion of the risk of local IFRS interpretations, see Schipper (2005).

Note that the SEC has also shaped IFRS reporting practices of non-U.S. firms that are cross-listed in the United States (Gietzmann and Isidro,2013).

As stated, for example, in the ESMA Guidelines on enforcement of financial information, “(e)nforcers should ensure adequate indepen-dence from government [and other market participants]. Indepenindepen-dence from government implies that government cannot unduly influence the decisions taken by enforcers” (ESMA, 2014, p. 12; OECD, 2014; see also IOSCO,2015). Research confirms the legitimacy of concerns about connections between enforcement agencies and politicians. Investigat-ing an enforcement settInvestigat-ing with a generally high reputation,²⁹ Correia (2014) shows that firms with connections to U.S. politicians or prior SEC employees are less likely to face enforcement actions by the SEC and face less severe penalties if the SEC takes action. Similarly, Heese (2019) suggests that SEC enforcement actions reflect political

prefer-ences concerning the avoidance of substantial increases in unemployment rates. In line with Tahoun and van Lent (2019)’s findings on the in-terdependence of politicians’ personal wealth considerations and their support for government interventions, Mehta and Zhao (2020) show that members of the U.S. Congress influence SEC enforcement decisions for firms domiciled in their districts. It is likely that politicians’ influence on enforcement agencies exists in other jurisdictions to a similar, if not larger, extent. For example, Piotroskiet al.(2015) document Chinese firms’ suppression of negative news in response to political incentives, such as meetings of the National Congress of the Chinese Communist Party or promotions of high-level provincial politicians. If regulators can anticipate being subject to retaliation, they will be more likely to exclude a firm with strong political connections from their scope.

More generally, it can be expected that governments will align the actions of enforcement agencies with other political objectives. For example, supervisors tend to be more lenient toward firms that were rescued through government programs (Agarwalet al.,2014). Gallemore (2021) suggests that bank supervisors were more lenient toward banks with high degrees of reporting opacity during the financial crisis. In other words, more lenience in the enforcement of capital market rules (e.g., via the selection of investigated firms or subject areas to be inspected) can

29Some even regard it as the “gold standard” for securities regulation systems (e.g., Carton,2009).

serve as a regulatory forbearance tool at times of crises, in particular when regulatory interventions are institutionally linked to accounting numbers, such as regulatory capital requirements for banks (Gallemore, 2021; Skinner,2008).

Enforcement agencies have different means toward this end. For example, the specification of the criteria for the selection of investigated firms and enforcement priorities with focus areas³⁰ can assist enforce-ment agencies in circumventing politically sensitive firms or areas of reporting while at the same time creating the impression of upholding strict enforcement principles. For some institutional insights, see the interview-based case studies of Bischof et al. (2021a) on regulatory interactions between securities and prudential regulators.

Recent case studies raise particular doubts about the European enforcement system’s ability to prevent regulatory forbearance. In Italy, local political interests affected the local enforcement agency’s opinion on the adequacy of Italian banks’ recognition of revaluation gains from available for sales assets (here, shares of the Italian Central Bank) in profit and loss instead of equity reserves as required by IAS 39 (Quagli et al., 2021). This accounting treatment resulted in overall revaluation gains of 5 billion Euro and helped enhancing the stability of the troubled Italian banking sector. The case study further shows that even the supranational institutions failed their purpose, because both ESMA and the IFRS Interpretations Committee refused to provide guidance on this accounting question, which forced the Italian banks’

auditors to rely on academic and juridical expert opinions. Similarly, focusing on the case of a Spanish bank with tight political connections, Giner and Mora (2020) show that local enforcement agencies as well as auditors refrained from pointing out significant deviations from IFRS impairment rules. In that case, the Spanish government pressured banks to recognize higher impairment losses than required under IFRS (i.e.,

30For example, the German Financial Reporting Enforcement Panel (FREP) announces priorities each year in advance for the next year (e.g., FREP,2019). While common enforcement priorities are set in the European Union by ESMA, it remains unclear how they are implemented and complemented by other priorities at the national level.

to take a “big bath”) to qualify the banks for the bailout program by the European Financial Stability Facility (EFSF).

Overall, research findings suggest that policymakers rather use lenience as a regulatory forbearance tool than openly pushing the standard setters to ease accounting rules in their transparent due process (see Subsection5.4). The observable reluctance within the European Union to harmonize enforcement practices supports the argument that local policymakers aim at maintaining some discretion over the strict application of accounting rules by local firms (Véron, 2020).