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Hans Hoogervorst speaks about "accounting and moral hazard"

  • Speech — dark green Image

Apr 10, 2014

IASB Chairman Hans Hoogervorst recently delivered the 2014 Ken Spencer Memorial Lecture, titled "Building trust in financial markets: Accounting and moral hazard."

In his speech, Mr. Hoogervorst looked at the moral hazard that is always present wherever people work with other people's money and he explored the question of what the role of accounting standards is against this backdrop of moral hazard.

According to the IFRS Foundation Constitution, the goal behind accounting standard-setting is to require entities to provide high quality, transparent, and comparable information in their financial statements so that investors can make informed decisions. Mr. Hoogervorst claimed, however, that the mission of the IFRS Foundation was much more far reaching — according to him it was "building trust in financial markets" and one way to do so would be to minimize moral hazard through discipline and rigor and through eliminating information asymmetry.

In addition to some historical examples of what the IASB has achieved in this area, Mr. Hoogervorst pointed at the current battle fought in the leases project. "Stripped bare, the leasing project is all about preventing the understatement of liabilities." He stated that there was huge resistance against bringing these liabilities to the balance sheet and yet he said he had no doubt that discussing leasing liabilities in the boardroom and with investors would soon be as much routine as discussing pension liabilities is now.

However, he also conceded, sometimes the IASB did not manage to do what it set out to do. He cited the incurred loss model for impaired financial assets that was designed to prevent earnings management by banks. However, the global financial crisis showed that that model could actually be used to delay showing the true financial situation of companies. Nevertheless, Mr. Hoogervorst refused to connect the financial crisis with the current debate on reintroducing the concept of prudence into the Conceptual Framework:

But I also want to be clear about what Prudence as a concept cannot mean. It cannot mean a return to old-fashioned accounting with hidden reserves. It cannot lead to a systemic bias toward conservatism that is at odds with neutrality. Prudence should not be invoked to create a taboo on using current measurement. There is nothing more imprudent than to measure derivatives at cost or to measure an insurance liability at historic interest rates.

Speaking about governance and moral hazard, Mr. Hoogervorst turned to the question of whether the fact that the IASB is privately organized does not make it vulnerable to pressure from private interests. Although he conceded that this question deserves a serious answer and should not be shrugged off lightly, he also pointed out that a public governance structure of standard-setting was in itself no guarantee for avoiding moral hazard. He cited as an example public sector accounting where in most jurisdictions the public accounting standards are set by the public authorities themselves. "Whether these standards always lead to a complete picture of a country's financial position is in doubt," he added. Therefore, he concluded that the key to successful standard-setting was its ability to fend off capture by special interests irrespective of its provenance and the key to preventing moral hazard in standard-setting was to find the right balance between independence and accountability.

A transcript of Mr. Hoogervorst's speech is available on the IASB's Web site.

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