Interview with Prof. Axel F. A. Adam-Müller, University of Trier
Risk reporting in Europe
RiskNET [Editor-in-chief]05.10.2014, 14:18
At this year's FIRM Offsite 2014 event, Prof. Axel Adam-Müller from the University of Trier presented the results of a study on risk reporting (Reporting Incentives and Enforcement: Impact of Corporate Disclosure), which he conducted in association with Michael Erkens, HEC Paris. The academics analysed 385 companies (not including companies from the financial services sector) from 20 European countries where stock market listed companies have to report on their risk in compliance with International Accounting Standard 7 (IAS 7). Although the companies are subject to the same accounting regulations, there are significant differences in the scope of their actual reporting behaviour.
We spoke to Axel F.A. Adam-Müller about the results of the study.
During the study, you analysed 385 companies from 20 European countries where listed companies have to report on their risks in accordance with International Accounting Standard 7 (IAS 7). What were the key results?
Prof. Axel F.A. Adam-Müller: The central result is that the companies in our sample only provide information on an average of 66 percent of the items that IAS 7 states they have to provide details for. In general terms, the average company only reports two thirds of what the standard setters demand. There are some companies that report well below half and only one company has full reporting. Overall, the study clearly shows that the IAS 7 reporting obligations are not being met.
The differences in reporting behaviour depend partly on the country in which the company is based. This is a clear indicator that regulations which apply across Europe are obviously being interpreted and thus implemented differently in individual countries. For example, the average Greek, Spanish and Swedish company reports less than 60 percent, while the figures are above 75 percent in Finland and Austria.
Perhaps it's worth saying a few words about our sample. We manually evaluated the notes to the 2007 annual accounts for 385 companies. More than 20 percent of the companies are based in the United Kingdom, just over 12 percent in Germany and almost 11 percent in France. However, the sample includes at least ten companies from each of the 20 countries. We differentiated between six sectors, with half of the companies coming from the manufacturing industry, 20 percent from logistics/transportation and 10 percent each from the retail and construction/raw materials sectors. We deliberately excluded financial service providers from the study.
How did you measure compliance with the reporting obligations?
Prof. Axel F.A. Adam-Müller: We constructed a disclosure index. This is an unweighted quotient that firstly counts the issues and figures on which a particular company has to report in accordance with IAS 7. This figure, which is a maximum of 25, is used as the denominator. If an issue is insignificant for a company, it is assigned a lower denominator in the disclosure index calculation to avoid distortion of the index. The numerator contains the figure for all issues on which the company actually reports. This gives the disclosure index as a simple percentage.
You could emphasise the importance of individual issues, such as information on exchange rate risks and interest change risks, by assigning them a correspondingly higher weighting. However, you then have to define the weightings, which is generally problematic. For this reason, we followed the normal academic approach and did not carry out weighting.
What do you believe are the reasons for heterogeneity in the quality of risk reporting?
Prof. Axel F.A. Adam-Müller: That's a tough question to answer, and of course it's impossible to draw hard conclusions about causality based on an econometric analysis. However, we look at two groups of influencing factors, one of which is company-specific, the other country-specific. We represent company-specific factors using characteristic variables for the intensity of competition and the sector, the international nature of the business, the capital structure, the size and profitability of the company and by specifying whether the certifying accounting company is one of the "big four".
For the country-specific variables, we look at diverse indices for economic freedom, the type of legal system, the efficiency of public administration and implementation of rules, the rule of law, the extent of corruption and the issue of the level of difference between IAS 7 and the previously applicable national accounting standards. We then incorporate a series of other variables that differentiate the cultural peculiarities of the countries analysed from one another.
The data analysis reveals complex patterns. It is not too much of a surprise that more is reported if rules are implemented more strictly in the affected country (greater enforcement). In an excep-tionally well developed capital market, less is reported on average; we interpret this as a substitution relationship. In a highly developed capital market there are other communication channels between companies and investors than the annual report.
Company size, international focus and leverage exert a positive influence on reporting behaviour. The larger, the more internationally focused and the more highly leveraged a company is, the more tends to be reported. We also show that companies report more if they are monitored by more analysts and if they have raised significant additional external capital in the two years after the accounting date. Less is reported if new equity capital has been raised later. The influence of a "big four" accounting company is also slightly positive across all countries, but there are differences within an accounting company between countries.
What role do cultural differences play in this context?
Prof. Axel F.A. Adam-Müller: We have some empirical findings here that even surprised us somewhat. It is clear that the cultural environment can significantly influence human behaviour. There are also certain interrelationships between this cultural environment and the type of legal system, and we excluded these from the calculations in our analysis as far as possible. What remains is a significant influence of the cultural environment on reporting behaviour. We first carried out a cluster analysis using cultural variables. The result was that the 20 countries can be grouped into five clusters. Cluster 1 includes Germany, Austria and Switzerland, Cluster 2 covers Denmark, Finland, the Netherlands, Norway and Sweden. Cluster 3 is made up of Belgium, France, Italy, Luxembourg and Poland, while Ireland and the UK make up cluster 4. Cluster 5 consists of Greece, Spain, the Czech Republic, Hungary and Portugal. This clustering appears obvious. We show that membership of a cluster results in a noticeable difference in reporting behaviour and almost all of these differences are statistically significant. The average company from cluster 1 reports 73 percent, from cluster 2 68 percent and from the remaining clusters 66, 65 and 58 percent respectively.
Why the cultural differences established in this way have such a significant effect is not currently clear. One possible interpretation is that managers and accountants are shaped by their cultural environment and exhibit reporting and certifying behaviour that reflects this. This cultural environment supersedes standardised European accounting rules which, at least in part, do not have the desired effect. From this perspective, harmonisation of accounting standards does not lead to harmonised risk reporting. Although you have to be careful with this kind of interpretation, the resulting verdict for harmonisation of accounting standards is not a good one.
National culture also appears to have a more significant influence than corporate culture within one of the "big four". In other words, our data indicates that there could not be a uniform auditing cul-ture in the "big four", as the auditing culture in a country is more important.
In what way do management incentives influence the level of risk reporting?
Prof. Axel F.A. Adam-Müller: The data shows a moderating effect here. Generally, more is reported if enforcement is stronger. However, there are different levels of this positive influence depending on the information needs of the capital market. In more simple terms, managers tend to report more if the information needs of the capital market are viewed as high.
How do you rate the risk reporting of German companies? Has the study provided any interesting findings?
Prof. Axel F.A. Adam-Müller: Our sample included 45 German companies, all of which are in the DJ STOXX 600. On average, the reporting obligations are almost 75 percent met, putting Germany in third place after Finland and Austria, followed by Norway and the Netherlands. Although our sample included a total of 103 companies from these five countries, I would be very careful about making any generalisations.
If harmonisation of accounting standards alone is not sufficient to ensure homogeneous risk reporting in Europe, what else needs to be done? Is there a lack of sanctions? Or do companies perhaps have no real interest in excessive transparency?
Prof. Axel F.A. Adam-Müller: Although this was not covered by our study, it seems to me that there is a lack of effective enforcement of existing regulations. Harsher sanctions could help here.
But I think the more problematic finding is that, despite almost universally having incomplete risk reporting, all of these annual accounts have received the required certification. Perhaps mech-anisms are at work here that have escaped our analysis or that we have overlooked. But simply the fact that external users of financial statements cannot find the information that they should be able to expect under the harmonised accounting standard in force, does not exactly paint a picture of a successful, uniformly implemented accounting standard. And the fact that such significant differences in actual reporting behaviour exist between groups of countries in which the harmonised rules apply across the board could be interpreted as evidence that uniform harmonisation is still a long way from being sufficient to induce uniform reporting behaviour. Ef-fective harmonisation would have painted a different picture.
Overall, there does not seem to be any interest in transparent risk reporting, otherwise that mandatory information would actually be provided. However, for as long as people external to companies and academics alike are restricted to analysis of annual accounts, we should not really be surprised how little knowledge there essentially is about what companies are actually doing in terms of risk management. I do not believe this is a satisfactory solution for the long term.
[Interview by Frank Romeike, Managing Partner of RiskNET GmbH, board member and chairman of the Society Of Risk Management and Regulation, and editor in chief of RISIKO MANAGER magazine; the interview was originally published in issue 20/2014 of the german magazine RISIKO MANAGER]
Prof. Axel F.A. Adam-Müller, born 1967, studied economics in Göttingen and Konstanz, doctorate in 1994, post-doctoral qualification in business studies 2005 in Konstanz. 1994 to 1996 BHF Bank, 2003 to 2007 Assistant Professor of Finance at Lancaster University Management School (LUMS), since 2007 holder of chair in corporate finance and capital markets at Trier University. Other activities on MBA and Masters programmes at Warwick Business School, in Lancaster and at the Norwegian School of Economics in Bergen. Publications on various aspects of risk management and other financial issues.
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