2.6 The International Accounting Standards Board’s Governance structure: independence and legitimacy

The first independent standard setting was pioneered by the US with the creation of the Financial Accounting Standards Board in 1973. At that moment, there was no similar initiative in the rest of the world, including in Europe.1 Instead, part-time committees of professionals with other interests were set-up and the International Accounting Standards Committee followed this model, being composed by part-time members. In 2000 the International Accounting Standards Board was reorganized in the same model as Financial Accounting Standards Board. This way of reorganization has since been subject of discussion. Although until then there was no precedent in Europe, its independence is mostly accepted as positive. The International Accounting Standards Board’s independence has been subject to intense debates, questioning how far should it go and whether it should be obliged to further accountability, beyond public accountability. The apparent justification of adopting the IFRS is their technical quality, which is ensured by independence. However, democratic legitimacy means that the International Accounting Standards Board must also in one way or the other be accountable to national authorities e.g. responding to the EU. These debates led, among others, to the creation of the Monitoring Board.

In a speech on the 16th of October of 2013, Michael Prada, the Chairman of the IFRS Foundation pointed out that the structure of the International Accounting Standards Board will always be controversial and that the idea of global accounting standards as a form of economic globalization is not always supported. The standard-setters need a strong Governance structure to protect the independence of the standard-setting process, which is not always popular.

The International Accounting Standards Board is part of the IFRS Foundation, which is an independent non-for-profit organization. The Governance structure of the IFRS Foundation, further designated the Foundation, is organized as follows. The Foundation’s independent standard-setting body is the International Accounting Standards Board. The International Accounting Standards Board has the responsibility of developing the IFRS and its technical work, structure and the strategy is overseen by the Foundation. Public accountability of the Foundation is assured by the International Accounting Standards Board, the work of the Trustees, who are responsible for the Governance and oversight of the International Accounting Standards Board through the Due Process Oversight Committee but also by the Monitoring Board, to which the Trustees are accountable.2 Together, the International Accounting Standards Board, the Trustees and Monitoring Board contribute to enhancing public accountability of the Foundation (through transpar ency, mandatory public consultation with all interested parties, accountable to public interest). Since the 1st of February of 2009 the Monitoring Board provides a link between the Trustees and public authorities, and contributes to ensuring that the EU and respective national securities regulators’ concerns, namely with investor protection, market integrity and stability, and the public interest are taken into account during the development of the IFRS.3

Figure 2 below illustrates the IFRS Foundation’ Governance model, as represented by the IFRS Foundation itself.4

Figure 2– Governance structure of the IFRS Foundation and of the International Accounting Standards Board

Sourse: IFRS Foundation5

Another way of showing the dynamics of the IFRS Foundation’ Governance model is through the explanatory table of Deloitte.6 See, below in figure 3.

Figure 3– Governance structure of the IFRS Foundation and of the International Accounting Standards Board

Sourse: Deloitte7

One way to explain how the International Accounting Standards Board has balanced political influences and interests from the EU and the US in governing global finance, and in the process of developing the IFRS, is using the Principal- Agent (PA) framework.8 In Leblond’s PA framework the International Accounting Standards Board is the agent of the EU, in particular of the European Commission; and of the US, in particular the Securities and Exchange Commission, which are the principals.9

This framework allows to explain how to control the agent (International Accounting Standards Board) once the delegation of developing financial reporting standards has taken place, and of how the agent behaves considering the “controls put in place by the principals”. Using the PA framework, Leblond concludes that if the International Accounting Standards Board wants to keep or enhance its legitimacy as a global financial reporting standards setter, it has to accomplish the balancing of three aspects: i) convergence of the IFRS with the US-GAAP, cooperating with Financial Accounting Standards Board and the SEC to allow US and foreign listed companies to prepare their financial reports according to the IFRS; ii) ensure a convergence process independent from the US-GAAP influence, which means working on equal basis and not only following the US-GAAP; iii) balance its independence, neutrality and technical expertise with managing the EU’s requirements for endorsement (this aspect is further discussed below in section 8).10

As suggested by the work of Bushman and Landsman (2010) the International Accounting Standards Board’s technical expertise is too valuable to be influenced and led by politics. Its true potential can only be maximized if there are no pressures. Accounting standards are at risk of becoming affected by political pressure and attempts at control which might bear significant consequences in the future.11 The discussion of the importance of keeping the standards-setter organizations independent from political influence has been discussed in the literature (see among others, Leblond, P. (2011) and Ruder, D.S. et al. (2005)12) as an argument in favor of keeping out vested interests, making sure the accounting standards are set in the public interest or in the interest of investors but also to facilitate the convergence between different financial accounting standards. Particularly for supporting the IFRS and the US-GAAP’s convergence of standards as further explained below in section 7.

The legitimacy of the International Accounting Standards Board comes from the extent of its Governance, of its consultation process, but also from the transparency of its activities.13 Convergence relates to efficiency, and independence relates to legitimacy. In my point of view, Francis Fukuyama contributes to understanding the difficulties of balancing efficiency and legitimacy.14 Fukuyama argues that international organizations have to deal with the constant balancing of the “competing challenges of efficiency and legitimacy” and refers that organizations such as the UN have high levels of legitimacy but controversial levels of efficiency. He goes on to explain that a “UN-style consensus-based decision” does not contribute to the development of rigorous accounting standards which is a limitation to discipline and to comparing corporate financial reporting. The International Accounting Standards Board needs to balance its legitimacy to act in the public interest with its efficiency for the private sector.

The system for developing high quality, transparent and comparable accounting standards can also be looked at through two different possible approaches.15 One is the “independence approach”, in which legitimacy should be based on independence and competence; the second is the “representativeness approach” in which legitimacy should be based on geographical consensus and approval.16 The first approach has been supported by the standard setters International Accounting Standards Board and FASB, which believe that “economic and political pressures will result in low quality standards, enabling companies to obscure bad news, distort financial results, and prevent comparisons”.17 The second approach is largely supported by the business community and Governments, which want to have the influence and power to shift the standards towards their particular interests and of their countries.

What is important to retain is that when an international body issuing quasi-law as the International Accounting Standards Board is set-up, a strong opposition from different sides is expected. In the case of the International Accounting Standards Board, pressure has come from international and domestic politics (including the EU), the corporate sector, accounting profession, the US financial standard-setter (FASB), the regulator (SEC) and the investors. When the European Commission enabled all the member-states to adopt the IFRS in 2002, it became mandatory to all EU listed companies to issue their annual report using the IFRS. After this moment there was a stricter financial reporting regulator, stricter public oversight by the member-states’ financial markets authority on the application of IFRS by listed companies (in the Netherlands by AFM, the Netherlands Authority for the Financial markets), and enforcement mechanisms in place. This context created the conditions for higher political and corporate lobbying (higher pressure on the standard-setter).18

The discussion and future development of a single international sustainability reporting framework has much to learn from the way the EU is leading with the International Accounting Standards Board and the IFRS. Further research is needed to understand how important the expert’s knowledge is when potentially influenced by politics and Governmental interests. Also how can financial and non-financial standard-setters maintain independence and at the same time be in line with the principles of EU company law.19 The potential EU endorsement of a particular framework for sustainability reporting (e.g. Global Reporting Initiative or International Integrated Reporting Council) must be in full accordance with European law provisions, whether financial or non-financial (e.g. environmental, social and governance legal requirements).