Are Global Standards Bad for America?

It has been only five months since the Federal Reserve reported that the wealth of American families plunged nearly 18 percent in 2008 -- a loss that was equal to the combined annual output of Germany, Japan, and the U.K., the Wall Street Journal explained.

It's no secret that more than half of U.S. households invest their savings in the market. In fact, no other country comes close to the number of households participating. It's just this sort of local wealth disaster that invites public scrutiny of subjects that ordinarily may not have appeared ripe for public consumption.

IFRS is just such a topic. Its very acronymic identity could tame even the heartiest of appetites among business news addicts. However, when $11 trillion of American wealth suddenly vanishes, something as seemingly arcane as International Financial Reporting Standards becomes a viable menu option. And, as luck would have it, the inclusion of IFRS on the public menu could not be better timed. It appears that America's wealth debacle has occurred just as the U.S. prepares to outsource the very guts of its regulatory operating system. Or to put it another way, if America's regulatory system were an IBM computer, IFRS would be on the verge of becoming the next MSDOS.

And while to this day business school students still debate how IBM management could have somehow been blinded to the strategic consequences of not owning the system within, America seems to be orbiting in a similar state of impairment -- one fueled by a simple assumption: that the adoption of IFRS by the United States will reduce the cost of capital by achieving comparability of financial reporting through a common global accounting language. It's a rational assumption, even an intuitive one. But it's a distraction. Whatever fruits the adoption of global standards may bear, the forfeiture of America's sovereignty over accounting standard-setting may be at a price too high -- at least when you consider the political and opportunity costs that America will incur if and when it opts to outsource its system of standard-setting.

"The larger cost of IFRS is what we will be giving up in terms of the technology of standard-setting and having a set of standards that, frankly, work with our regulatory system -- by that, I mean standards that work with how the SEC sees financial reporting, how investors see financial reporting," explains Karthik Ramanna, a Harvard University professor who has recently published a number of studies examining the convergence of accounting standards globally. Among the more noteworthy conclusions is the notion that multiple standard-setting bodies, rather than one international body, would result in better standards globally.

"One advantage of competing standard-setters is that these alternate accounting systems can coexist, and companies rather than regulators will have a choice of selecting into a particular accounting system -- this allows innovation in performance measurement and innovation in control to happen," says Ramanna, who believes that the financial crisis was in part caused by the failure of accounting systems to keep up with the level of innovation taking place within financial securities. "The innovation of accounting systems has been kept at the regulatory level as opposed to the firm level, and regulators don't have the types of incentives to innovate that firms do," Ramanna explains.