The compliance problem of EU-IFRS? A multiple case study in the Dutch stock market

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EU-IFRS

The compliance problem of EU-IFRS?

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multiple case study in the Dutch stock market

Jered Badal January 2016

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EU-IFRS

The compliance problem of EU-regulation?

A multiple case study in the Dutch stock market

Leiden University, Campus The Hague

Master programme: International and European Governance

J.J. Badal (s1184156)

Jeredbadal@gmail.com

Supervisor (First reader) Dr. N.A.J. van der Zwan

n.a.j.van.der.zwan@cdh.leidenuniv.nl

Second reader Dr. J. Christensen

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Abstract

This study examines how the level of compliance with regard to EU-IFRS can be explained by several theoretical approaches. The research is based on the annual reports of nine AEX-listed companies. On top of that, this research uses questionnaires that are answered by members of the audit/controlling departments within each company. The empirical findings show that the companies are not fully complying with EU-IFRS. Nevertheless, the companies have moderately high average compliance rates. The average compliance rates are based on the formulated indicators. The outcome of the questionnaires (based on three theoretical approaches) illustrate that the deterrence approach and cost-benefit analysis reflect the empirical data. The voluntary approach did not seem to have a relation with the level of compliance concerning EU-IFRS. The conclusion is that the deterrence and cost-benefit analysis both cannot solely explain the level of compliance concerning EU-IFRS. The two approaches have surely impact on the level of compliance and are therefore suitable theories. During the research there occurred several alternative explanations, which were not taken into account from the start. Thus, future research about this topic can integrate the alternative explanations to improve further understanding of compliance concerning EU-IFRS.

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Acknowledgment

During my years of study, I developed a special interest for regulation and the private economic sector. There are a lot of interesting subjects to study in this field. I chose to study the International and European governance master, because I wanted to obtain more insight of the international dynamics of regulation and policy. Many courses showed me new insights and fresh winds concerning the European Union. My favourite course was: governance in the European Union. A course with a wide-range of theories, policy issues and European problems that are still going on. Because of that course I started to search for a topic for my thesis, which had to be in relation with EU-regulation. The difficulties of policy-making within the European Union inspired me to examine the successfulness of a particular EU-regulation. A good friend of my, who recently graduated at the Erasmus university Rotterdam, recommended me to take a look at EU-IFRS. The moment of reading that particular regulation turned into a moment of confirmation and satisfaction. I directly felt a good feeling about the topic. After that, I never changed the topic and started to write my research proposal. The process of writing the actual thesis was not always delightful. I encountered like every researcher several problems. Unfortunately also less delightful personal circumstances. However, I managed to get myself together and finished what I started. Therefore, I would like to give thanks to a number of people that helped me during the process. I want to thank my father for helping me with designing the figures and mental support. Would like to thank my good friend Faraaz, who brainstormed with me about the EU-IFRS. Also, I would like to thank Tirza for all the helpful comments in terms of grammar. Last and definitely not least, I would like to thank my supervisor Prof. Natasha van der Zwan for giving me all the suggestions, comments and critiques that I needed.

Leidschendam, The Netherlands

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6.2.2 Deterrence approach ... 54 6.2.3 CSR ... 56 6.3 Sub conclusion ... 57 6.4 Alternative explanations ... 58 6.5 Limitations II ... 59 Chapter 7: Conclusions ... 61 7.1 Conclusion ... 61 7.2 Reflection ... 62 7.3 Recommendations ... 63 Bibliography ... 64 Appendix A ... 68 Appendix B ... 69 Appendix C ... 72

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List of tables and figures

Table 3.2.1 Independent variable indicators Table 3.2.2 Dependent variable indicators

Table 4.1 Members of the AEX in November 2015 Table 4.3 Compliance rates of the 9 companies

Figure 2.5

Figure 4.2.1 Compliance of indicator #1 Figure 4.2.2 Compliance of indicator #2 Figure 4.2.3 Compliance of indicator #3 Figure 4.2.4 Compliance of indicator #4 Figure 4.2.5 Compliance of indicator #5

Figure 4.3 Compliance rates of the 9 companies Figure 4.3.1 Group distinction compliance rates Figure 5.2.1 Results of respondents #1

Figure 5.2.2 Results of respondents #2 Figure 5.2.3 Results of respondents #3 Figure 5.2.4 Results of respondents #4 Figure 5.2.5 Results of respondents #5 Figure 5.2.6 Results of respondents #6 Figure 5.2.7 Results of respondents #7 Figure 5.2.8 Results of respondents #8 Figure 5.2.9 Results of respondents #9 Figure 5.2.10 Results of respondents #10 Figure 5.2.11 Results of respondents #11

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Acronyms

AEX Amsterdam Exchange Index AFM Autoriteit Financiële Markten AMX Amsterdam Exchange Index

AN AkzoNobel

AScX Amsterdam Exchange Index ATM Automated Teller Machine CBA Cost-Benefit Analysis

CSR Corporate Social Responsibility DSJI Dow Jones Sustainability Index

EC European Commission

ECCS European Community of Coal and Steel

EU European Union

EU-IFRS European Union International Financial Standards IASB International Accounting Standards Board

IAS International Accounting Standards

IFRS International Financial Reporting Standards

IT Innovation Technology

UN Unilever

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Chapter 1: Introduction

1.1 Background

In 1952 there was a big step made towards an European common market, because in that same year the establishment of the European Community of Coal and Steel (ECCS) was achieved. The new alliance ultimately led to the abolishment of several barriers that interrupted and impeded the market (or internal market), for instance, import duties and individual tariffs towards neighbouring countries. The policymakers of the ECCS were in an early stadium proponents of a common market. One of the abundant actions and strategies to achieve this common market, was to harmonize the financial reporting standards of European listed companies. Moreover, national governments and regulatory agencies became more aware of the existing non-transparent accounting standards of numerous listed companies. Also, the increasingly number of accounting scandals were a crucial motivation to sharpen the regulation rules (Nisbett & Sheikh, 2007).

It all started with the fourth directive 78/660/EEG from 1978 and the seventh directive 83/349.EEG from 1983 (Reimers, 2010). This two directives were a important step towards harmonization of financial reporting standards. However, there was a wide-range of discretional freedom for national governments of how to interpret these two directives. As a consequence, there was still no appropriate harmonisation in the eyes of the European Commission (EC) with regard to financial reporting. In order to achieve such harmonisation, there was a need for change. The International Accounting Standard (IAS), as successor of the fourth and seventh directive, brought this particular discretional freedom to a minimum (Reimers, 2010).

Since 2005 there is an obligation for EU listed companies, with consolidated annual reports, to follow the rules of the International Financial Reporting Standards (IFRS). “Consolidated” is the common term to illustrate that all financial statements of a group are unified to a single economic (parent) company. The IFRS are based on the IAS-directive 1606/2002/EG. The IFRS are mostly considered as an actual update and elaborated version of the IAS. Next to IFRS the IAS are still operational. It is logical to assume that the IFRS can be addressed as a important addition to the existing standards. Given this concise background

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I can now draw attention to the question whether companies comply with the IFRS. Like all proper systems, there is a need for control and supervision mechanisms or institutions that provide such services. Otherwise the particular system is missing out its maximum potential of functioning properly. So, what is exactly the problem with the IFRS?

1.2 Problem definition

The rooted problem lies in the simplistic fact that rules can be broken. Sometimes the rule is not clear to anyone, which can lead to non- or less compliance by national regulatory agencies, national governments, listed companies etc. In practice, the problem of compliance occurs more often than you think. In this research the problem of compliance is specified and linked to the application of the European Union International Financial Reporting Standards (EU-IFRS) in the Netherlands. As mentioned earlier, the EU-IFRS were founded to improve the comparability and transparency of financial statements from listed business associations that trade in public. Originally the IFRS were issued by a private organization called: the International Accounting Standards Board (IASB). However, they only had a binding effect for European listed companies, if the EC approved the standards. After that, the IFRS simply switched into binding EU-IFRS (since 2005).

Furthermore, the EU-IFRS supposed to be an standard which should be easy to comprehend. Still, it seems to lack in its regulatory, monitoring and supervision activities. According to Hijink (2012), professor accounting law at Erasmus University, the EU-IFRS lacks in oversight and control. Hijnk means that the national regulatory agencies lack in enforcement concerning EU-IFRS. These national agencies lack in their supervision and controlling responsibility, because there is too much discretional freedom. As a consequence, national governments can interpret the EU-IFRS in different kind of ways (Hijink, 2012). This process leads to different ways of using, applying and controlling the EU-IFRS. If you take that perspective into account you will realize that there is a stronger necessity for sharper regulation with less discretional freedom, because sharper regulation forces more harmonisation and less deviation among national governments. Moreover, in order to maintain the sharper regulation appropriately, it is an option to make use of some sort of enforcement. According to Lodge & Wegrich (2012) that sort of enforcement is about using

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force to make sure that particular parties do things they normally would not do (deviation). It means in practice for this research that domestic companies should be appropriate in reporting their profits and balances. Thus, regulation is not only about setting a rule. It is more about moulding behaviour in order to realize objectives that otherwise would not be attained.

Further, the broader problem lies in the fact that several EU companies differ in the level of compliance with regard to the IAS/IFRS directive. The consequence is that it impedes the original goal to enhance the comparability and transparency of financial reporting by companies. It is mainly the discretional freedom of the IAS/IFRS directive that impedes the unified control mechanism on a supranational level, since that has a lot to do with the ancient sovereignty issue. Today, this classical debate of member states plays a role in the residuals of discretional freedom. That is because member states are still not willing to give up their sovereignty for a broader EU purpose. Therefore, I do not want to give too much emphasis to the classical debate. Instead, I want to bring my centre of attention to the possible problem of compliance among listed companies in the EU. The research question is as follows:

What explains whether or not AEX-listed companies (completely) comply with the formally binding EU-IFRS?

At last, the EU-IFRS is a relatively “new” legislation with no concrete prescription of how companies should be supervised. There is still room for different interpretations, which practically can manifest into a less- or non-binding rule.

1.3 Purpose

One of the purposes in light of this research is to give insight into the level of compliance concerning EU-IFRS. The main purpose of this research is to explain whether or not AEX-listed companies (completely) apply the EU-IFRS. It is an interesting purpose, because the IAS/IFRS directive has a formally binding effect. Therefore, it is logical to assume that the companies who are not (completely) comply with the EU-IFRS are

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trespassing the formal law. For that reason, it is interesting to find out how this kind of transgressing behaviour can be explained. In a broader perspective, the purpose of this research is to give insight in the successfulness of the EU-IFRS and whether there is a necessity for improvements in controlling and supervision with regard to the particular level of compliance that comes with it.

1.4 Justification

1.4.1 Societal relevance

From a societal perspective, the earlier described problem definition is very relevant for the world we live in today. As we suffered recently from the financial remedy that manifested in the beginning of 2008. Of course, there are multiple causes that eventually started the remedy. However, it is obvious that there was no appropriate supervision concerning financial systems (Nisbett & Sheikh, 2007). Especially the banking sector, as they could take advantage of that type of lack in surveillance and supervision. Banks could easily lent more money and do investments with that very same money. Whereas they actually should hold that for back up, to ensure that they could afford anytime withdrawals.

Subsequently, this banking process can turn into a critical stage where citizens are not able to withdrawal their money and at the same time lose their trust in the bank. You will face a small race to the bottom of people who withdrawal all their money in case of not seeing it back anymore. Therefore, it is in our interest to have insight in the supervision of such financial systems. That is because it affects not only the economy, companies and banks, but also the individual in society. It is in our own benefit as a global society to restrict, monitor and control these financial systems, as the slightest mistakes can have massive impact on our daily lives. If I refer to the EU-IFRS and IAS, it is more important to understand the standards and pay more attention to the effectiveness of it. In the end the EU-IFRS and IAS preserve more transparency and comparability in financial reporting, which are in line with the aims of the EU to cooperate together and form a stronger union in economic prosperity.

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In order to formulate and understand the hypotheses, it is required to ground my research on existing literature. I am not only using the theories to analyze and find similarities or distinctions between them. I am also trying to test the particular theories to my research problem. In this process of theory testing I will eventually evaluate the actual relevance of the three theories to my research. There are several scholars that explain the three different theories that I use in my research. The first theoretical approach is the cost-benefit analysis. Dreze & Stern (1987) elaborate on the initial purpose of the cost-benefit analysis and how it practically works. I am using their definitions to frame the approach for my research. Maack & Davidsdottir (2015) bring in a recent article, with a more elaborated and detailed explanation. I am using their knowledge to give more insight into the (economic) reasoning behind the cost-benefit analysis approach. Also, Posner & Adler (1997) point out some critical arguments in opposition to the cost-benefit analysis. As well, Vogel (2006) who argues about voluntary regulation and how it is in contrast to the deterrence approach of Lodge & Wegrich (2012). All these scholars give great perspectives and interpretations, which I embrace in this research and try to use in order to explain the level of compliance concerning EU-IFRS. The linkages of these theories to the EU-IFRS is rare, because there are no explicit publications released with such combination For that reason, this research can be considered as more valuable.

1.5 Structure and thesis design

In order to place this research in context, I describe in the introduction a short history and development of the EU-IFRS. Subsequently, in the second chapter I outline three different theoretical approaches of several scholars and translate the approaches to measurable variables. On the basis of that knowledge I formulate three hypotheses. The third chapter is dedicated to the methodology of this research. In this section I justify my methods and explain how the research is conducted. I am using two methods to collect data for my research, namely online structured questionnaires and a document analysis. In chapter four I will present purely the empirical data and results. Also, I will operationalize the key concepts,

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variables and indicators that are set out in chapter two and three. In the fifth chapter I will try to find correlations between the independent- and dependent variables. Consequently, with the empirical findings and possible correlations I will reject or confirm the earlier formulated hypotheses. The last chapter is dedicated to the conclusions. I will reflect back to the central question and recommend future improvements.

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Chapter 2: Theoretical framework

2.1 Introduction

The theoretical starting point in this research is based on factors that possible influence the level of compliance with regard to the application of the EU-IFRS. As mentioned before, I apply three theories, namely the cost-benefit analysis, the deterrence approach and the voluntary approach. I seek to find out whether these approaches have an influence on the level of compliance by companies. Subsequently, I translate this three approaches into measureable variables to formulate the causal mechanism and draw hypotheses from these approaches.

2.2 Cost-benefit theory

The cost-benefit analysis (CBA) is in general a broadly used approach within business associations, companies and governments agencies. It is often a suitable contribution in decision-making processes. The purpose of the CBA is to give insight in to the possible consequences of particular decisions. It is actually a process of estimation that is not only suitable for economic purposes, for instance, national policymaker’s asses and estimates certain decisions on the basis of their potential outcome and impact. According to Dreze & Stern (1987) cost-benefit analysis is the assessment of a decision in the light of its costs and benefits or consequences. Maack & Davidsdottir (2015) share this same definition. However, they argue more from an individual point of view, which allows them to go more in detail and depth with explaining the CBA mechanism. They argue that the CBA is about individuals that continuously out weight their best possible outcome. Those individuals seek to find and accomplish maximum utility. In that matter those individuals indirectly optimize their own economic welfare.

Sen (2000) is on the same page as Maack & Davidsdottir (2015), because he argues that the CBA is a matter of trade-off between disadvantages and advantages. Although his definition is more abstract, it has the same perspective. The idea is that things are worth doing if the benefits from doing it exceed the costs (Sen, 2000). In other words, it is a process of

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optimizing your own economic welfare as an individual. Also, Sen (2000) states that the usage of CBA’s are a daily practice among individuals, organizations and governments, even though, these actors maybe have no intended relation with the CBA approach. For instance, assume that you want to be as quickly as possible at work in the morning and you only have the choice between walking and riding a bike. Unintended and unaware you make a short cost-benefit analysis to the possible costs of walking, which is more time-consuming, and benefits of taking the bike. Eventually, on the basis of that short analysis you will make a decision and accept the possible consequences. This simplistic example shows that the CBA has a widespread reach and can help in choosing possible alternatives for a particular problem.

As with every part of theory or model, there is divergence about what the correct approach should be. A definite fact is that the CBA is certainly not perfect. Kennedy (1980) emphasizes that imperfection, but also relates with his definition of CBA to the scholars that I mentioned earlier. For instance, he argues that the original rationale for CBA came from the government concerning big public projects. The CBA gave insight in to who would gain and who would lose. If the benefits exceed the costs or factors that are hurt, the project should be continued. With the latter Kennedy is on the same page as the earlier mentioned scholars. However, Kennedy is sceptical about that simplistic reasoning, because it is not easy to value diverse types of benefits and costs (Kennedy: 1980: 389). The usual method to value such types is to take the position of the affected party and understand the situation of the affected parties. To achieve that understanding it is required to obtain rooted information about the particular parties, which is time-consuming to gather and can generate substantial desk-research costs. Together you can categorize these costs under transaction costs. As a organization it is desirable to keep certain transaction costs to a minimum. That is most cases not easy to achieve, because it is difficult to value costs and benefits.

Moreover, from a critical point of view Posner & Adler (1999) give a moral argument against the usage of CBA. They argue that the CBA occasionally can create a morally unjustified outcome. Posner & Adler seek to point out that a moral unjustified outcome can lead to losses concerning weak parties. Also, they emphasize that the CBA should be used in the correct way. The CBA should be used in small steps with periods of evaluation to detect possible mistakes or miscalculation. Otherwise it will not produce accurate results and will be useless in decision-making.

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Furthermore, according to Baze et al. (2006) the costs of compliance by companies can be a substantial burden that can drain the resources out of a well-run business. Their article describes several facts that confirm the impact of compliance among companies. They give the example of the Gartner’s 2005 Research Compliance Survey. The survey was conducted among 300 boards of directors of privately held companies. This survey concludes that the expenditures for Innovation Technology (IT) financial compliance management will rise between ten and fifteen percent of the total IT budget. That is a huge percentage and has a lot of impact on the distribution of available budget. Also, the respondents mentioned that several projects were forced to be cancelled in order to save budget for future compliance costs. According to Baze et al. (2006) the costs of compliance are severe and require a CBA approach, because the company’s resources are limited and need a trade-off approach between potential benefits and costs. They argue that the CBA can help to clarify the benefits and costs of compliance.

2.3 Deterrence approach

In every issue where compliance plays a role, there always raises the question why certain organizations do not voluntary comply with rules and standards. The upcoming theory can possibly explain why voluntary compliance is less common. The deterrence approach is about organizations or individuals who calculate the utility of breaking a certain rule (Lodge & Wegrich, 2012). Those actors make a short calculation for themselves of the costs and benefits of complying and not complying with a certain standard. This process is also known as “amoral calculation”. The main difference between the CBA and the deterrence approach is the freedom to calculate utility. The CBA is not directly restricted by a specific regulation and does not calculate the consequences of breaking that specific regulation. In contrast, the deterrence approach calculates rule-breaking impact, because it is restricted by a specific regulation. Also, reputation plays a more important role in the deterrence approach than the CBA, since the deterrence approach calculates reputation into their account and the CBA does not.

Furthermore, compliance with standards is often addressed as forcing costs on companies. This sort of companies are more likely to comply if their non-compliance is

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straightforward to be detected and sanctioned (Lodge & Wegrich, 2012). For that reason, the level of compliance is a reflection of weighting out the costs and benefits of the regulatory standard. The basis of that weighting lies in three aspects: the probability that the sanction will really be operated, the probability of detection and the level of punishment (Lodge & Wegrich, 2012). As a consequence of dealing with compliance in this matter, there is necessity for enhanced enforcement. There should be a compensation for low detection in the form of increasing the level of punishments, because these tough sanctions necessitate companies to follow the rules and accomplish more compliance.

Nevertheless, Lodge & Wegrich (2012) address an essential issue about calculating compliance, as penalties have no deterrent effect if there is no decisive detection. In other words, if there is no credible detection strategy by regulatory agencies to pursue rule-breaking activity, the tough penalties will have no effect. The reason why there occurs no effect is, because the fines will never be bring into play. In that case the modifications in behaviour will not be accomplished. Eventually, it is the observable rate of detection and real sanctioning that generates compliance.

In addition, the deterrence approach has its shortcomings and critics. There is a possibility that the approach can be abused, because individuals (managers) within the companies honestly can think that they are acting the right way. However, they turn out to be infringing the rules and get punished for their way of management. Subsequently, it can result in a decreased interest to partner with inspectors and regulatory agencies (Lodge & Wegrich (2012). What is more is that the deterrence approach has different effects on different companies. According to Haines (1997) small- and medium-sized companies are more affected by deterrence than large organizations, since the larger companies have tasks and reliabilities that are widespread and complex. Once small- and medium-sized companies are prosecuted, they will have less reliabilities and leverage to minimize the deterrence effect.

In the end, the deterrence approach still has a strong basis in relation to the level of compliance. It can actually work quite simple, because companies can be deterred by earlier sanction cases of other companies. In this way companies can use these cases to rethink about the possible consequences of impeding a particular rule. There is also a crucial issue with reputation. Companies can face preceding fines or penalties, which can have enormous impact on their reputation. A recent example that illustrates such reputation damage is the issue of

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Volkswagen. The company claimed to be minimizing the environmental damage in terms of emission and pollution. However, it turned out to be a lie and resulted in several punishments for Volkswagen. A world-wide broadcasted issue that has certainly damaged the image of the company. Therefore, companies will be more cautious and more motivated to comply with regulation (Lodge & Wegrich, 2012). At last, it is essential to ask the question: to what extent non-compliance is tolerable? It is rarely the case to accomplish 100 percent compliance. Even if this would be achieved, the enforcement costs would be high (Lodge & Wegrich, 2012). On top of that, the final percentages of compliance would relatively be expensive to achieve and maybe not worth it.

2.4 Corporate social responsibility

The last sentences of the previous paragraph indicate that final percentages of compliance are costly to enforce. It is arguable that the final percentages of compliance should be left out for voluntary principles. Can a voluntary approach explain the level of compliance? According to Brammer et al. (2012) Corporate Social Responsibility (CSR) can be important to the level of compliance, because “CSR” can increase the reputation of companies. Consequently, reputation can have a positive effect on complying with regulation, because companies will try to ensure their reputation by complying with the rules. At first, it is required to understand the definition of “CSR”. According to Vogel (2006) “CSR” consists of acts or operations that improve the workspace and have an excellent effect upon society. He also mentions that this type of acts have consequences that cannot have been foreseen by companies. Vogel means that these acts are not formally required for companies and are often unforeseen beneficial for society.

Another angle comes from Green Paper, which is a reflection of the EC policy makers’ attempts to initiate debates about possible future policies in a given area. This angle sees social responsibility more as a step-by-step integration process by companies. The companies integrate environmental and social issues into their operations on a voluntary basis (Brammer et al., 2012). The difference with the perspective of Vogel is that he puts emphasis on the impact of voluntary involvement (consequences), while Green Paper emphasizes on step-by step integration of voluntary activity. Why would companies integrate such social issues?

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Private companies obviously want to achieve maximum profit. Therefore, it seems to be fair to assume that they use “CSR” to increase their companies’ performance. Nevertheless, Brammer et al. (2012) argues that such arguments are misplaced, because there are many forms of “CSR” that differ per country and region. A good example is that there are enough multinationals and successful companies that do not engage with CSR. If engagement significantly would lead to more profit there would be a global shift to it, which is not the case (Brammer et al., 2012).

In contrast, Vogel (2006) argues that there are multiple reasons why that kind of companies have the drive to apply “CSR” into their practices. One of those reasons is that some companies can use “CSR” as defence or public publicity, while others use it more in a strategic way. The incorporation of “CSR” can be beneficial for companies’ reputation, because pressure from socially responsible investors and boycotts will be minimal or at least at a lower level. Nonetheless, it forces companies to make several important changes to their social and environmental activities. They should do that, because they play an important role in society. The decisions and behaviour of the company can affect not only their shareholders, but also the broader community of stakeholders like: governments, other organizations and individuals (Vogel, 2006)

In addition, there are limitations with “CSR”. Proponents of “CSR” assume that some companies that behave responsible in a particular area, also can be expected to behave more responsible in other areas. According to Vogel (2006) that is a wrong way of reasoning, because there are also many competitors that are less responsible in the same area. In the end, “CSR” can really help to promote social and environmental aspects and stimulate companies to adopt new standards and policies. As a consequence it can create social benefits. On the other hand, “CSR” remains a voluntary system that can lead to the fact that companies only engage with “CSR” if it is valuable enough. Unlike the deterrence approach, it is not possible to force companies to make socially useful decisions (Vogel: 2006).

Finally, according to Al Iannuzzi (2002) there is a relation between social responsibility of companies and their level of compliance. Al Iannuzzi gives the example of a special stock fund for companies that are proactive in environmental and social sustainability. His special stock example is about the American Dow Jones Sustainability Index (DJSI). The DJSI is a stock which has been developed for investors that only want to invest in social

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responsible companies. This Index motivates companies to comply with regulation, because companies can increase their reputation on a voluntary basis. Especially, customers will feel better using services of a social responsible company (Al Iannuzzi, 2002). Therefore, companies are more aware of their voluntary responsibility and will comply with regulation that can sustain or increase their reputation. Thus, the level of compliance stands in relation to the company’s reputation that can be obtained by increasing their voluntary responsibility.

2.5 Variables

In order to use the three theoretical approaches in my research, I have to translate those approaches into measurable variables. In my central research question there are two concepts that need to be translated into variables. The research question is as follows: what explains whether AEX-listed companies comply with legally binding EU-IFRS? The two concepts are “comply” (form compliance) and “EU-IFRS”. In the figure below I translated the concepts into variables.

Figure 2.5

The first variable is “maximum utility”, which is translated from the CBA approach. The second variable is “deterrence” and is translated from the deterrence approach. The last variable is “voluntary”, which is translated from the “CSR” approach.

Compliance EU-IFRS

Maximum utility Deterrence Voluntariness

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2.6 Causal mechanism and operationalization

At first, the starting point of this research is “y” variable based. I am trying to find out how the “y” variable can be explained by several “x” variables. The “y” variable is the dependent variable. In this research the dependent variable is the level of compliance concerning the legally binding EU-IFRS. The “x” variables are the independent variables that can possible influence the dependent variable. Those variables are extracted out of the theoretical framework, namely the cost-benefit analysis, deterrence approach and voluntary regulation. Given the research question, you can distinguish two parts of this question. The first part is the independent variable which contains the “why” question and refers to the independent variables, because they can be a possible explanation. The second part of the question is the dependent variable, which is the level of compliance concerning the legally binding EU-IFRS. In this causal mechanism I assume that each of the three independent variables: maximum utility, deterrence and voluntariness, might influence the level of complying with the EU-IFRS.

Additionally, on the basis of this theoretical framework I can formulate three hypotheses. In the first hypothesis I assume that companies that pursue maximum utility are complying at lower level to the legally binding EU-IFRS (H1). The theoretical reason is simply the fact that the CBA is a matter of maximum utility and optimizing the economic welfare. The costs of completely complying with the legally binding EU-IFRS are too high and therefore not beneficial for companies. In the second hypothesis I assume that companies that encounter deterrence by regulation enforcement are complying at a higher level to the legally binding EU-IFRS (H2). The theoretical reason is that companies want to have a good reputation legacy and do not want to risk that for rule-breaking activity with the EU-IFRS. Also, they can be deterred by sanctions that other companies encounter. In the last hypothesis I assume that companies that incorporate voluntary activity into their practices are complying at a higher level to the legally binding EU-IFRS (H3). That is because from the theory you can assume that most companies only bring “CSR” in practice if they can get an useful profit out of it. If that is not the case, they will try to neglect social and environmental engagement.

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Chapter 3: Methodology

3.1 Introduction

To hold a better grip on the generalisation of the findings I will use a multiple case study design. In this way I can properly compare the level of compliance concerning the legally binding EU-IFRS between several companies. I will elaborate on methods in this chapter. Now that I formulated and defined the key concepts in the literature review and distinguished the independent- and dependent variable, I can convert these practically abstract concepts into observable indicators. Along these lines it is possible to detect, measure and classify the less abstract concepts in the empirical world.

3.2 Variables & operationalization

3.2.1 Independent variables

As mentioned earlier, I translated the theoretical approaches into variables. In order to measure the variables, I have to link them to observable indicators. So, to clarify the separation and indicators, I have made an overview table for the dependent and independent variables (see tables 3.2.1 and 3.2.2). Also, I used structured online questionnaires to obtain data. I used an online questionnaire engine to design and perform the questionnaire. Subsequently, I sent the links to the general email of the audit departments of each selected company. After that, I made several calls to each company to ensure that the audit department received the links and passed them through the audit department members. I promised not to present their identity in this research and therefore only asked for a specific function. At last, the structured questionnaire consists of eleven questions and should take only two till five minutes of time to answer (see appendix B).

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Table 3.2.1 Independent variable indicators

Variable Definition Indicators Data sources

Maximum utility

A standard procedure which weights the costs and benefits

- The number of CBA’s concerning EU-IFRS - The costs of organizational changes

- Structured questionnaires in online format

Deterrence Calculating the utility of rule-breaking

- The number of supervision fines or penalties - The number of detected failures

- Structured questionnaires in online format Voluntariness More responsible

behaviour of companies with the absence of legal requirements

- The number of charity projects - The number of social projects

- Structured questionnaires in online format

(table made by author)

3.2.2 Dependent variable

In this paragraph I give a short explanation of the indicators of the dependent variable, because the indicators are relatively technical. Therefore, it is crucial to give a good oversight of what they mean and contain in terms of financial accounting. In this way this research can simultaneously be technical and comprehensive for readers with different levels of knowledge about financial accounting.

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Table 3.2.2 Dependent variable indicators

Variable Definition Indicators Data sources

EU-IFRS International standards that are approved by the EC and have a binding effect to member states

- Total comprehensive income

- The revaluation reserve is not permitted to be included in the income statement

- The amortization of intangible assets - The obligation to include provision for deferred taxes

- The actual value should be the fair value

- Printed documents - Annual reports from AEX-listed companies - Auditing reports by independent agencies - University hand-outs

3.2.2.1 Total comprehensive income

According to IAS 1.7 the total comprehensive income consists of two elements. The first one is the profit or loss from a particular period. The second one is the direct mutation of own equity (‘other comprehensive income’). Examples of the particular mutations are: revaluations of tangible and intangible assets, financial instruments and cash flow hedges etc. Also, companies have to record a consolidated statement of changes in equity. It presents a mutation overview of own equity, which is separately presented from mutations with the shareholders.

Furthermore, there is an option in how to present the total comprehensive income. Companies can choose to record a consolidated statement of comprehensive income, in which both elements are embedded and presented. Or companies can have a separate approach, in which they use a traditional consolidated income statement and a consolidated statement of comprehensive income. Also, the total comprehensive income has to be presented in the statement with one number.

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3.2.2.2 The revaluation reserve is not permitted to be included in the income statement

In contrast to the Dutch law, the revaluation reserve is not permitted to be included in the income statement. The IAS 8 states that value alternations from financial activity beneath their cost price, need to be restored in the owner’s equity. This restoring process is often done with a revaluation reserve, which in this case is not permitted to be recorded into the income statement. Basically, the consolidated income statement is a reflection of a company’s revenue and expenses in a particular period.

3.2.2.3 The amortization of intangible assets

In case of an infinite intangible asset and in accordance to IFRS (IAS 38.107/108), it is required to apply a procedure of amortization over useful life of intangible assets despite the length. Some examples of intangible assets are: computer software, patented technology (mostly pharmaceutical products), import quotas, licensing etc. According to the Dutch regulation intangible assets should be amortized within a maximum useful life of 20 years. In contrast, the IFRS imposes that every year the indefinite intangible assets need a “impairment” test. That is a test which measures whether an item on the balance sheet still has the same worth as stated on the balance sheet. If the test has a result that is lower than the value on the balance sheet, the sheet number should be diminished.

3.2.2.4 The obligation to include provision for deferred taxes

According to IAS 12.20 it is obligated to record a provision for deferred (income) taxes in the owner’s equity. This provision is charged and moulded to the revaluation reserve. If a company does not record a provision, they have to make a mention of it under quantitative effects. Also the provision for deferred taxes needs to be appraised to nominal values and not cash values. (IAS 12.53).

3.2.2.5 The actual value should be the fair value

As the headline is formulated, the actual value must be identical to the fair value. In other words, to fill in the actual values there is an obligation to use the fair values concerning investment property. This is in accordance to the IAS 40. The fair value is the price that

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would be received to sell an asset, or to transfer a liability on the measurement date under the current market conditions. The Dutch law differs into this aspect, for instance, it is legal to have more options in how to fill in the actual value. There is no one procedure or one way to fill in the actual values. It strongly depends on the current circumstances to decide which option should be used. Also, IAS 40.16 indicates that investment property should be recognised as an asset in the annual reports. Especially, when there are future economic benefits associated with the particular property. As well, this type of reorganization gives a reliable measure of the costs of the property.

3.3 Methods

3.3.1 Qualitative data analysis

First of all, what is qualitative analysis? According to Babbie (2007) it is basically a method to examine social research data without converting them to a numerical format. In this research I make use of a qualitative approach, because I use the purpose of qualitative analysis to discover underlying meanings and patterns of relationships concerning the quantitative data. With the help of that particular data I am trying to move in to a process of explanation, understanding and interpretation of the meaningful content. This method is characteristic for the qualitative method and allows to go more in-depth and detail. Further, in this analysis I will try to label three separated groups on the basis of their differences and similarities. Companies with a lower level of compliance, companies that are between high- and low compliance and companies with a higher level of compliance.

In addition, according to Babbie (2007) induction starts with observations and tries to find a pattern within them, while deduction starts with an expected pattern that is tested against observations. Given that knowledge, I persist to a deductive approach in analysis. The reason is that I developed hypotheses on the basis of existing theories and designed a research strategy to test the hypotheses. At last, this approach fits rightly in to the limited time and resources of this research.

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27 3.3.2 Case selection

In order to refine the concepts and measurements, I have to decide from which population I am going to draw conclusions. As I mentioned earlier, I will use a multiple case study design. With this qualitative type of research I can address several characteristics with possible relations, in order to eventually explain the specific phenomenon of the EU-IFRS and the compliance (un)success of it. I am using data collected from organizations to generalize on the organizational level. It is also important to note that there are certain limitations to the case selection strategy of this research design. It is in general known that it is not possible to include all observations of the particular population. There is, for instance, in this research no incorporation of all case studies. The disadvantage is that there is a chance of missing out the essential cases. The whole Dutch stock market has approximately over 70 companies that are listed. There is simply no time and enough resources, to analyse all those companies.

Therefore, this research requires a selection procedure or case selection. I actually already started selecting a sample when I only chose the AEX-Index of the Dutch stock market (see chapter four). I have tried to select nine AEX-listed companies who reflect the same characteristics as the population of the AEX. Subsequently, I approached each company via mail and telephone. After several unanswered emails, I called the particular audit department of each company to ensure that they received the online questionnaire. The following companies are selected: Ahold, AkzoNobel (AN), ASML, Heineken, ING, Philips, Shell, Unibail-Rodamco (UR) and Unilever (UN). Further, I chose the AEX-Index for the reason that it is the leading index of The Netherlands. This index represents the companies with the highest weighted percentages of stocks and for that reason a good reflection for the whole Dutch stock market.

Also, I use a sampling strategy with regard to the questionnaires, because I specifically formed the questionnaires for members of the audit department. I chose to rely on 3 (out of 4 till 6) members, for the reason that some internal auditors are currently not living in The Netherlands and are difficult to reach. As a result, it is more reliable to have three certain responses of all companies.

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28 3.3.3 Data collection

One of the fundamental aspects of research is the way of collecting data. In this research I rely on two methods of gathering the desired information, which are: a document analysis (analyzing official documents) and conducting structured questionnaires in an online format (see appendix B). The existing available data that I have collected, is mainly obtained from annual reports or structured texts of AEX-listed companies (public records). It is obvious that these annual reports have a quantitative aspect, because the data consist of numbers with a particular meaning. One of many examples concerning the quantitative aspect is the number of gross profit and net income of a company. I want to note that I do not refer specifically to all nine annual reports. However, I used all nine annual reports to analyze the indicators and therefore listed them into my bibliography. According to Babbie (2007) a quantitative research approach is about numerical representation of observations to explain and describe certain phenomena. However, qualitative research can also use numerical data with a small N. On the basis of that knowledge, I can state that I use a qualitative approach, because I use numerical representation of observations with a small N=9 (annual reports). Also, I make use of a qualitative approach with the structured questionnaires, because the use of questionnaires are also characteristic for a qualitative method. In order to get a good overview of the data results, I convert the data of the respondents in to a numerical form. In this way I can easily compare, aggregate and summarize the data. Further, it is important to note that I will use structured questionnaires that are not focused on further in-depth information.

3.3 Reliability and validity

There are several strengths and weaknesses concerning the reliability and validity of this research which should be taking into account. According to Babbie (2007) reliability is the quality of measurement that indicates that the same data of one phenomenon can be retrieved repeatedly at all times. On the one hand, I can assume that my measurement technique with the questionnaires is less reliable, as the questionnaires have a time aspect in it. The next example illustrates why. If you would follow my method and format over ten

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years, you could have other respondents and probably other outcomes with the same questionnaires. However, it also depends on who took the questionnaire and how the questionnaires were conducted. So, the reliability of my questionnaire measurement remains arguable. On the other hand, I also conducted a more reliable technique, since I analyzed public official documents that give consistent and stable results despite the influence of time.

Furthermore, I can assume that my empirical measurement adequately reflects the real meaning of my concepts and indicators. Of course, that assumption needs to be tested and verified. On the basis of validity terms, I can really measure what I am suppose to measure. The formulated indicators have a strong face validity. It means that there is common agreement or sense that the indicator does a reasonable measurement of the variable (Babbie, 2007). That is because the goals and objectives are clearly defined and operationalized. Therefore, it is logical that the indicators measure what need to be measured. The generalization is limited, because I observe particular companies in a specific area or nation. As a consequence, you will have limitation in the external validity. The results are limited to generalize to other situations and phenomena.

3.4 Limitations I

The main limitation of this research is the boundary of time. As mentioned earlier, there is not enough time to analyse all listed companies in the Dutch stock market. In order to realize accurate generalizations, it is required to minimize selection bias. As mentioned before, I have tried to select nine AEX-listed companies that reflect the same characteristics as the population of the AEX. I can justify those selections, because of the weighted percentages they represent in the AEX-Index. Nevertheless, it should be noted that there is still a chance of missing out a crucial sample.

Another limitation comes out of the questionnaires, because there is a chance of non responding respondents or incorrect responding with the outcome of the questionnaires. As a consequence, the data availability can be harmful towards this research. Nonetheless, I am not purely dependent on the questionnaires as a resource. As mentioned earlier, I can only rely on 3 (out of 4 till 6) members of the audit department of each AEX-listed company that I

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selected. That is because some internal auditors are not living in the Netherlands. Also, the answers of the respondents can be based on perceptions and will not always be accurate facts.

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Chapter 4: Empirical results

4.1 Introduction

In this chapter and the coming paragraphs, I present the results of the dependent variable with the help of the earlier formulated indicators. At first, a short introduction of the Dutch stock market to give a better overview and understanding of the whole market. The focus in this research lies within the AEX-Index. It is a free-float adjusted market and weighted index of the leading Dutch stocks that are traded on the Amsterdam Exchange. The AEX-Index members consists of the 25 biggest companies, which are based on a weighted relative percentage. That weighted percentage depends upon the development of the different kind of stocks, for instance, an increase in a particular stock leads to a higher weighted percentage for the company that provides that stock.

What is more, as mentioned earlier there are approximately over 70 listed companies in the Netherlands. In order to understand my selection procedure, I give an overview of all three stock markets. The second major index in The Netherlands is called: the Amsterdam Midkap Index (AMX). This index consists of the less negotiated stocks and places room for the ranked members from 26 till 50. These members are usually representing midrange stocks. In comparison to the AEX, the AMX has lower weighted percentages and therefore less influential. There is also a last and third stock index, which is called: the Amsterdam Small Cap Index (AScX). It is logical that the ranked members are from 51 till 75. It is the smallest index for listed companies. Given this short introduction, I will now focus on the AEX-listed companies and present the findings. The current 25 members of the AEX are shown in table 4.1. Given the limited time and resources, I had to make a considerable sub selection of the 25 members. As mentioned in chapter three, I will focus on the nine largest members of the AEX in November 2015, which are based on weighted percentages (see appendix A). At last, I will use a combination of figures and tables to present all empirical data (dependent and independent), because this way of presentation clarifies the findings. The figures are based on tables. (see appendix C). In the final paragraph of this chapter I use a multi-indicator variable to make an overview of the compliance rate of the companies. I measure this compliance rate with the help of the indicators that are set out in table 3.2.2.

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Table 4.1 Members of the AEX in November 2015 Aalberts Industries Aegon Ahold Akzo Nobel Altice

Arcelor Mittal ASML Boskalis Delta Lloyd DSM

Gemalto Heineken ING Group KPN Nationale

Nederlanden OCI Philips Randstad Holding Reed Elsevier Royal Dutch

Shell TNT Express

Unibail-Rodamco

Unilever Vopak

Wolters-Kluwer (table made by author)

4.2 Results of the dependent variable

4.2.1 Total comprehensive income

Figure 4.2.1 Compliance of indicator #1

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There are basically three points in the presentation of annual reports that companies are required to have on the basis of EU-IFRS (IAS). One of those requirements is the choice between a separate approach, in reporting the traditional consolidated income statement and the consolidated statement of comprehensive income. This first point relates to the title “separate” in figure 4.2.1. The second point is the use of a correct heading and presentation of one number for the total comprehensive income. The second point relates to “correct” in figure 4.2.1. The last point, has to take in to account that the annual report must have recorded a statement of changes in equity. This point relates to “equity” in figure 4.2.1.

Given all nine annual reports of 2014, it is noticeable that all companies have reported the traditional consolidated income statement and the consolidated statement of comprehensive income. However, It is remarkable that only Unibail-Rodamco applies a consolidated statement of comprehensive income, in which both elements are embedded and presented. This is different in comparison to the others and shown on page 149 of their annual report (Unibail-Rodamco, 2015). The second point shows more differentiation among the companies, because Ahold presented one number under the heading: comprehensive income attributable for common shareholders.

Also, Unibail-Rodamco presented one number under the heading: net comprehensive income. AkzoNobel, Philips and Shell presented one number under the heading: comprehensive income for the period. Till now all those previous headings are incorrect in presentation in accordance to EU-IFRS, only ASML, Heineken, ING and Unilever are using the correct heading namely: total comprehensive income. The last point of requirement is successful applied, as the equity statement is recorded by all companies. Thus, Ahold, AkzoNobel, Philips, Shell and Unibail-Rodamco are not fully complying with the total comprehensive income standard of the EU-IFRS.

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4.2.2 The revaluation reserve is not permitted to be included in the income statement

(figure made by author)

As mentioned in paragraph 3.2, it is required (in accordance to the IAS 8) to not record the revaluation reserve into the consolidated income statement. The consolidated income statement is simply the presentation of the revenues and expenses of a regular company in a particular period. Remember that the term “consolidated” is nothing more than an aggregate of all financial statements of a group, that are unified to a single economic (parent) company. This indicator is relatively straightforward to detect in all annual reports, because it is merely a matter of checking whether there is a revaluation reserve absent in the consolidated income statement or not. From figure 4.2.2 you can observe that the revaluation reserve is not recorded by any company in the consolidated income statement. It is noticeable that the figure does not show any chart or line. For that reason, there is no broad description or special remarks with regard to the results that are found. Thus, the conclusion is that each company does not include the revaluation reserve into their income statement and in that way fully complies with the standard of the EU-IFRS.

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35 4.2.3 The amortization of intangible assets

According to IAS 38.107/108 it is required to apply a procedure of amortization over useful life of an intangible asset despite the length of that particular intangible asset. Assets that have an indefinite useful life are required to be annual tested by the “impairment” test. To regain understanding of this indicator I remind you that examples of intangible assets are: computer software, patented technology, import quotas etc. So, the indicator illustrates that the annual reports should attain impairment losses or reclassifications of intangible assets (mostly found in balance sheet). It is important that the annual report consistently show that these impairment tests are done on a yearly basis. From figure 4.2.3 it is noticeable that all nine companies conducted the yearly “impairment” test (for intangible assets) in their description notes concerning the consolidated balance sheet and consolidated income statement. I want to clarify that if a company would not have conducted an “impairment” test, the company would not have been shown in this figure. Thus, given all annual reports, it is clear that each company complies with this standard of EU-IFRS.

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4.2.4 The obligation to include provision for deferred taxes

This indicator can be reflected on three aspects that are in accordance to the IAS 12. The first one is the presence of a specific provision for deferred (income) taxes. It means that the annual report specific mentions a provision for deferred taxes. The term “specific” relates to this point in figure 4.2.4. The second aspect indicates whether the particular tax is recorded directly in to the owner’s equity (relates to “equity” in figure 4.2.4). The third and last aspect is about presenting the numbers under nominal values and this aspect relates to “nominal” in figure 4.2.4.

Furthermore, from figure 4.2.4 it is noticeable that Ahold, AkzoNobel, Heineken, Shell Unilever and Unibail-Rodamco have not recorded a specific provision for deferred taxes. Also, those mentioned companies (except for Unilever) did not change the alternations of the provision directly into the equity. Only ASML, ING and Unilever changed the alternations of the provision in to the owner’s equity. However, ING and Unilever did not recorded a specific provision for deferred taxes. Philips is the other way around in comparison to ING and Unilever, because Philips recorded a specific provision and did not change alternations into the owner’s equity. Lastly, all companies presented the numbers under nominal values. It is remarkable that only ASML applied all requirements of the EU-IFRS.

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37 4.2.5 The actual value should be the fair value

| (figure made by author)

First of all, according to the IAS 40 there is an obligation to use the fair values concerning investment property. I remind you that the fair value is the price that would be received to sell an asset or paid to transfer a liability on the measurement date under the current market conditions. In figure 4.2.5 the headline “fair value” relates to whether the company uses fair values in their reporting duty. It is usually mentioned in the notes that relate to the consolidated income statement and consolidated balance sheet. The headline “recognized” indicates whether investment property is recognized as an asset in the consolidated balance sheet.

From figure 4.2.5 you can observe that the results not only show that Ahold, Heineken, ING and Philips are using the fair values, but also that they report and mention them in an appropriate way. This is in contrast to the rest of the companies, as they seem to lack in mentioning and thereby reporting the fair values. However, all nine companies recognize the investment property as an asset and recorded that in their annual reports. Thus, on the basis of these empirical findings only Ahold, Heineken, ING and Philips fully comply with EU-IFRS.

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4.3 Chapter conclusion

In this last paragraph I present a scoreboard table of the multi-indicator variable, which clarifies per company the rate of overall compliance on the basis of five the described indicators in table 1. All indicators are equally assigned in the process of calculating the rate averages. The percentages that flow out of the results of the indicators are rounded. The total rate number is rounded off with one decimal (see table 4.3 below).

Table 4.3 Compliance rates of the 9 companies

Indicator Ahold AK ASML Heineken ING Philips Shell UR UN

I 66% 66% 100% 100% 100% 66% 66% 33% 100% II 100% 100% 100% 100% 100% 100% 100% 100% 100% III 100% 100% 100% 100% 100% 100% 100% 100% 100% IV 66% 66% 100% 66% 66% 66% 66% 66% 66% V 100% 50% 50% 100% 100% 100% 50% 50% 50% Average compliance rate 86,4% 76,4% 90% 93,2% 93,2% 86,4% 76,4% 69,8% 83,2%

Figure 4.3 Compliance rates of the 9 companies

The compliance problem of EU-IFRS? A multiple case study in the Dutch stock market

EU-IFRS