JARAF Editorial, Volume 3 (2) December 2008

Abstract

As 2008 closes, the world finds itself in the grip of increasingly dire economic circumstances. The world’s advanced economies are either mired in or well advanced on their journey towards recession. Meanwhile, rapidly emerging economies such as China are showing evidence of far greater fragility than had commonly been supposed possible only a few short months ago. The consequences of the collapse of perhaps the greatest ever episode of Ponzi financing continue to reverberate throughout the world.

That such a shock has been visited on the world’s financial system and on its real economy has invited intensive rumination on the nature and dimensions of an appropriate suite of policy responses. In turn, it appears that a broad consensus has quickly been reached that the appropriate antidote to the accelerating malaise is recourse to forceful monetary and fiscal stimulus. But these are by no means the only weapons being touted as the appropriate tools with which to respond to a situation increasingly described as unprecedented.

In some quarters, it would appear, a view has formed that the most direct route to salvation lies in the removal of market value based accounting. According to this view, mark to market accounting, not poor asset quality, represents the dominant explanation for the gaping voids so spectacularly opening within the balance sheets of so many entities within the finance complex throughout the world. High profile individuals associated with the promotion of this view include Newt Gingrich, former Speaker of the US House of Representatives.

While the message being promulgated as a consequence of the continued application of a market value based approach to financial reporting may seem consistently depressing, this is no reason to reject either the force of the message being so clearly and consistently articulated at present or the mechanical apparatus through which that message is being generated.

The refusal to accept an accounting technique as a convenient scapegoat explanation for a problem with far more profound roots cannot however be equated to an intimation of satisfaction with the reporting regulatory edifice as it presently stands. The frustrating reality is that there is much to be troubled about in the content of the rules governing financial reporting, a matter frequently adverted to in the pages of this journal. More than ten years have passed since then SEC Chairman Arthur Levitt declared his conviction that management appeared all too frequently to be being trumped by manipulation, integrity by illusion, with the result that that bellwether metric of financial performance, earnings, had been too often debased to the status of reflecting the desires of management rather than underlying financial performance.

A similar view led Walter Schuetze to form the burning conviction that the path to representational faithfulness in financial reporting lay not in process based tinkering, but with the wholesale removal of the means of manipulation from the hands of financial statement preparers, an objective best achieved in his view by the application of market based approaches to accounting.

Whatever might be said about the merits of market based accounting it seems an incontrovertible truth that this alone can not represent a panacea for all ills. Vigilant surveillance of the potential hazards in the design of and gaps within and between reporting standards represents a vital enterprise. Few authors have been more persistent in translating that ideal into a practical reality than Professors Comiskey and Mulford, whose insightful work on the highly topical subject of hedge accounting we are very pleased to present in this edition.

Preparers, auditors and consumers of financial reports in many jurisdictions are presently grappling with the implications of the implementation of IFRS. This being so, the work of Professor O’Connell and Katie Sullivan on the impact on net income of conversion to IFRS from local standards among large European enterprises is most timely.

While reporting rules come and go, some issues are of ever- green concern. Incentive sets, compensation structures and the decisions driven by this potent combination of factors represent a case in point. Given the tectonic dislocations presently battering the global banking system, Guy Ford’s contribution on the impact of compensation structure on bank portfolio selection decisions represents a source of guidance and insight we believe can be of very substantial benefit to a wide audience, particularly within the regulatory community.

As another tumultuous year closes, we express our sincere appreciation to the authors who have entrusted their work to JARAF, the members of the journal’s editorial board for the support they continue to lend and in particular to the reader- ship for the strong and growing level of interest they have shown over the past twelve months.

Keywords: financial reporting

JEL Classification: M40, M41