Created in 1973, the Financial Accounting Standards Board sets standards for public companies and other organizations that follow generally accepted accounting principles. Mohan Venkatachalam, an accounting professor at Duke University's Fuqua School of Business, set out to discover whether new standards introduced by the FASB actually add to shareholder value -- and found that most do not. That research, Do the FASB's Standards Add Shareholder Value? is forthcoming in The Accounting Review. Venkatachalam worked with Urooj Khan and Shivaram Rajgopal of Columbia University and Bin Li of the University of Texas.
Venkatachalam discusses his work in this Fuqua Q&A.
You examined the market reaction to 138 accounting standards issued by the FASB from 1973 to 2009, and found that only 15 of them increased shareholder value - just 11 percent. Only 19 decreased value, and the other 109 had no effect. Why is that important?
The fundamental objective of the Securities and Exchange Commission - which designated the FASB as the guardian of accounting regulations - is protecting the needs of investors through the flow of information. If more useful and timely information is available to the marketplace, that helps keep the market disciplined and avoid crises. Equity investors are one of the principal users of that information, and arguably the most important. So we looked at the FASB through that lens.
We evaluated the stock market reactions of firms affected by the standards to important events related to the issuance of a new standard. We studied whether the market reactions were related to affected firms' agency problems, proprietary costs, contracting costs, and changes in estimation risk.
After all these years of setting accounting standards that establish how firms provide and disseminate information about their actions, stock market investors seem to view FASB's standards as mostly negative or inconsequential. What is most disconcerting is that on average, the market reaction to new regulations was zero. Which suggests that, on average, FASB's work has no impact from a shareholder perspective. After 40 years, I would have expected the tilt to be more towards positive.
Could some of the impact of the new rules result from the market simply misunderstanding them?
It's unlikely. We looked at events throughout the process, which is not a one-shot deal. It's a long, drawn-out process that includes setting an agenda, developing a proposal and an exposure draft, receiving and responding to comment letters, updating the exposure draft, and only then issuing the the final regulation. We evaluated the market reaction to every step of that process, so it's hard to imagine the market was completely lost to the effect of these regulations.
What were some of the common threads among the regulations that did see a positive impact?
Standards related to the securitization of mortgage-backed securities were associated with the highest positive returns. They were introduced at a time when investors were really curious about what people were doing with these complex instruments. When the FASB mandated disclosure rules, it was something investors cared about and the market reacted in a very positive way.
We also found standards based on general principles were associated with more positive stock price reactions than rules-based standards. To understand the difference, think of speed limits: A rules-based standard is an explicit speed limit, which results in everyone driving as much over the limit as they think they can without getting into trouble. A principles-based equivalent would be advising drivers to drive appropriately for the conditions, which of course is open to broad interpretation.
Of course we cannot ask the drivers on the road what the speed limit should be. By and large, firms are trying to provide honest information to the capital markets, but subjectivity can lead to potential egregious behaviors.
How should these finding affect the way companies and shareholders see the FASB?
There are many critics who say the FASB is overreaching and is too rules-based, without any corresponding benefit. This is a debate that rages on. What these results do is allow us to ask how we can improve. Maybe we should revisit the boundary conditions of the rules and regulations.
This result doesn't mean standard-setting is bad, and it does not imply we should give the FASB a failing grade. We don't know what crises might have happened in the last 40 years if the FASB had never existed.
But one thing is certain: This evidence should make us step back and rethink the role of the FASB and the care with which they should set standards. Perhaps this can be a shot in the arm for when the Financial Accounting Foundation determines its next steps. It's an opportunity to reflect, and have a serious conversation about how best to make standard-setting useful in a cost-effective way.