03 October 2014

IASB/Hans Hoogervorst: 'Keeping capitalism honest'

Hans Hoogervorst, Chairman of the IASB, participated in a panel discussion entitled: “Is improved corporate governance a key driver for sustained market development” at the 2014 IOSCO Annual Conference in Rio de Janeiro, Brazil.

Mr Hoogervorst outlined his views on the importance of high quality global accounting standards to good corporate governance.  He used lease accounting as an example of an area where further improvements are necessary to provide investors with a complete view of economic reality.

Company management is under huge pressure from what some call ‘Quarterly Capitalism’.

The pressure to deliver short-term profits is tremendous and may jeopardise long-term results. Since remuneration is often tied to earnings, management may also have strong financial incentives for short-termism. Knowing how subjective some aspects of accounting and financial reporting can be, this is sometimes a truly frightening thought.

The investor is not in a very strong position to be an effective counterweight. With the increasing complexity and globalisation of the economy, the distance between investor and investee has increased dramatically. As a result, it is very difficult for investors to keep a close eye on the companies they have entrusted their money to. Corporate governance is constantly struggling to contain conflicts of interest between management and the investor.

The IASB plays an essential role in strengthening the corporate governance of the capital markets. The IASB´s job as an accounting standard-setter is to provide transparency and to keep capitalism honest. IFRSs help to close the financial knowledge gap between management and the market.

In some areas, investors are still not able to get a complete view of economic reality. One of those areas is leases. The IASB is about to finish a new leases Standard and when it comes, it will not be one day too soon. Currently, most leases are not reported on a lessee’s balance sheet. For many companies, such as transportation, telecommunication and retail companies, the leverage caused by unreported leases can be quite substantial.

Recently, the IASB analysed five retail chains that went into liquidation during the financial crisis. The IASB compared the debt reported in their balance sheets to their off-balance sheet lease commitments. The reported debt of these companies was 7 to 90 times lower than the debt which was hidden in their leases.

The bankruptcy of Borders, the US book store, shows clearly how fatal lease liabilities can be. Borders reported debt of $379 million when it also had off-balance-sheet lease commitments of $2.8 billion, more than 7 times as big. According to some, this company had not needed to go bankrupt, since half of its stores were still profitable. Its problem was that it could not get rid of its lease commitments for its loss making stores. It just goes to show that a lease is not much different from debt in its classical form.

For the investor, it was hard to see how indebted the company had truly become. For investors to be able to hold management to account, lease liabilities need to be on the balance sheet. Information in the notes is simply not enough.

The IASB´s upcoming leases Standard will do the job and will provide investors with the information they need to obtain insight in the true leverage of companies in the economic sectors that are significantly affected by it.

Full speech

© IASB - International Accounting Standards Board