The Matching Principle and Its Influence on Lobbying Behaviour – a Case of the Revised Proposal to Revenue Recognition

Amsterdam Business School Faculty of Economics & Business

The Matching Principle and its Influence on Lobbying Behaviour – A case of the Revised Proposal to Revenue Recognition

Master Thesis Master of Science (Accountancy & Control) Academic Year 2013 / 2014

Final Version Paul Walker 10605401 Supervisor: Dr. S.W. Bissessur Second Supervisor: Dr. I.R. Sander Van Triest

Abstract

In May 2014, the FASB and IASB jointly released the long awaited revised standard on recognizing revenue. However, before this release there was an extensive period that allowed for comment and opinion on the proposals. These comments, a form of lobbying, form an integral part of the standard-setting process. This paper focusses on these comment letters, and attempts to analyse the issues and concerns that the respondents who sent in comment letters have about the proposed standard. In particular, we want to see how the shift in the approach to financial reporting and its effect on the matching of revenue and expenses will influence a firm’s decision to lobby against the standard. By using a mixed-method approach, this paper finds that there are seven key themes that are widespread throughout the comment letters with two of these themes indirectly referring to the matching concept. Empirically, we also examine differences between firms who chose to submit a letter with a matched sample that did not submit a comment letter. In particular, we find that there are differences in earnings characteristics between these two sets. While this paper does not examine the direct effects of the new standard, it does offer an indication of which firms are going to be most affected. More interesting, however, is that these results offer a clue in to which type of firms are more likely to lobby against a proposed standard, and the characteristics that these firms possess.

Key Words

IFRS, Standard Setting, Lobbying, Matching, Revenue Recognition, Due Process, Earnings, Volatility, Persistence, IASB, FASB, Comment Letter, IFRS 15

Contents

Abstract ...... 2 Introduction ...... 4 Background ...... 4 Research Question ...... 5 Literature Review...... 6 The Matching Principle ...... 6 Revenue Recognition ...... 8 IFRS 15 ...... 10 Standard Setting ...... 13 Lobbying ...... 14 Comment Letter Thematic Analysis ...... 17 Issues Raised ...... 18 Strength of Comment Letters ...... 22 Reference to the Matching Principle ...... 25 Empirical Hypotheses and Methodology ...... 27 Hypothesis Development ...... 28 Methodology ...... 31 Empirical Results ...... 35 Conclusion, Limitations and Future Research ...... 41 Bibliography ...... 46 Appendix I ...... 49

Introduction

Background On the 28th May 2014, the FASB and IASB, together, released the long awaited standard on recognizing revenue: Revenue from Contracts with Customers. The standard, subject to endorsement by the European Commission, will become effective for annual periods beginning on or after 1st January 2017. This has been a project of the FASB and IASB (hereafter the ‘Board’) since 2002, thereby taking nearly twelve years for it to come to completion. This revision was a response to the limitations in the previous revenue recognition standards, and the accounting scandals that were a consequence of these limitations. The evolution of the business environment also required that revisions were made to the standards. The old rules were seen as outdated with regard to the complex forms of transactions that have emerged in recent years.

One of the key changes to this standard was the approach to which it addressed financial reporting. Whereas before there was a mix of the revenue-expense and asset-liability approach to reporting, this new standard full reflects the asset-liability style. Extant literature on this subject covers the costs and benefits of such an approach, however, one thing that seems unanimous is how this ‘balance sheet’ method of reporting will relinquish the importance of matching expenses with their appropriate revenues. This shift towards the asset-liability approach is widespread throughout the Board’s other projects, and matching certainly seems to no longer be a fundamental concept.

Although the ‘Boards’ are predominately the ones in charge of the standard setting procedure, the opinions of all stakeholders need to be considered so that these standard setters can obtain legitimacy. As such, both the FASB and IASB have a ‘due process’ established whereby the concerns, comments, issues and opinions of stakeholders can be deliberated. Despite it being well known that the main goal of accounting standards is to assist investors getting decision useful information, it is widely acknowledged that economic consequences also arise because of these standards. The participation in the standard setting due process can be seen as a lobbying attempt to influence the standard, and have these “non-intended” economic consequences removed. By analysing these lobbying attempts, we can further understand what issues and concerns are underpinned in the proposal. We also want to explore the characteristics of the firms who deem it necessary to lobby against the standard, and whether these characteristics help to explain their decision to do so.

This paper takes a look at this due process, and the issues raised by preparers of financial statements in regard to the Revised Exposure Draft on Revenue Recognition. This was the second Exposure Draft that was published for this standard, and was released in January 2011 after amendments were made to it following comments made in the due process. In particular, we take a look at the matching concept, and how the issues raised in the due process reflect this concern. Using a model by Dichev & Tang (2008), we use earnings characteristics that are shaped by the level of matching to explore which firms are lobbying against the standard, and which are not. Using assumptions based on cost benefit analyses, the essence of our predictions is that firms who currently benefit the most from ‘better aligned’ matching have more to lose as standards no longer see matching as an important concept.

We qualitatively assess the issues, reasoning’s, effects and solutions of the revised Exposure Draft to Revenue Recognition to identify the key themes that are reoccurring. Using this qualitative analysis, we then empirically test to see if there is a difference in earnings characteristics between firms who lobby, and firms who do not. Subsequently, we test to see if there is a difference in earnings characteristics between the firms who did lobby, based on the arguments and issues that they made in their response.

Research Question The overarching theme of this paper is to understand the concerns that preparers have with the proposed standard to recognizing revenue, and how (if at all) these issues can be related to the matching concept. Previous literature suggests that matching is becoming less of a priority, and the benefits of good matching will consequently be diminished as a result of change of priority.

By understanding the issues, we can then explore which firms are most concerned about the possible changes to the matching of revenues and expenses, and what is unique about these firms? What are the characteristics that make some firms concerned, but yet make other firms not concerned? In particular, we use previous models and assumptions to assess earnings characteristics that can be related to the level of matching, and how these characteristics can help explain if a preparer is to lobby against the proposed standard. This is predominately an exploratory investigation.

The rest of this paper is structured as follows: the next section takes an in-depth look in to the existing literature based on the topics of matching, the standard setting procedure and how

lobbying prevails in this procedure. It will also briefly explain the proposed standard of Revenue Recognition, as described in the 2011 Exposure Draft. The next section that explores the lobbying attempts made by preparers by analysing and scrutinising the comment letters that were submitted to the Board. This section describes how they were analysed, and what themes we took from this analysis. This section also documents how prevalent the matching principle was in these responses. The section after describes our method and hypotheses for empirically examining the firms who decided to comment, with the subsequent section explaining the findings of this analysis. Finally, we conclude with the overall findings to take from this study, with the limitations and ideas for future research.

Literature Review

The review of literature is set out as follows. We start with the main concept that we are interested in this paper: the matching principle. After that, we explain Revenue Recognition and what was proposed in the Revised Exposure Draft. We also examine how the matching concept has become less of a priority in financial reporting due to a shift in approaches towards accounting. Next, we detail how and why standard setting exists, and how the procedural process is carried out. Finally, and most relevant to this paper we explore how lobbying plays such a large part in the standard setting process. We examine why and how it exists, and what influence it has on the final standard.

The Matching Principle The matching principle is an essential element in recognising profit. Matching is where incurred expenses are recognised in the same period as the revenue earned from said expenses. Su (2005) demonstrates this principle with a heinously simple example. Consider an entity and assume that it bought some materials for $5 to create a product in Period 2. This product was sold in Period 4 for $10. Rather than recognise the two transactions in their own respective periods, the accountant would effectively combine them and recognise the cumulative amount in Period 4 and thus applying the matching principle. Note that this accounting does not follow the cash flows. The reasons for doing so can be demonstrated in the following table.

Table 1: Illustrating treatment of matched and unmatched accounting Scenario Period 1 Period 2 Period 3 Period 4 Mean Profit Variance Matched 0 0 0 5 1.25 6.25 Unmatched 0 (5) 0 10 1.25 39.6

As demonstrated in the table, the matched treatment has less variance and consequently is smoother. A smoother earnings is more useful for investors as it gives them greater ability to predict the future and make better decisions. More variance means a less reliable prediction for future results and obviously would lead to a less reliable decision. Su also shows how the matching of revenues and expenses reduces the variance in accounting earnings. Dechow (1994) demonstrated this effect more empirically. She too shows how accounting for cash flows creates more ‘noise’ and is less useful for investors. To mitigate this problem, accounting standards have allowed the use of accrual accounting. Despite the issues that come alongside accrual accounting (such as management discretion, earnings management etc.) it was shown that it provides a better measure of firm performance than cash flow accounting and is more decision useful.

Nevertheless, in an extensive study by Dichev & Tang (2008), it was found that the properties of good matching have decreased over the last 40 years. They developed a model that showed how a mismatch between revenues and expenses increases the volatility and autocorrelation of earnings and decreases the persistence of earnings, in so doing reducing the decision usefulness of the earnings number. They found that volatility and autocorrelation had increased over the last 40 years whereas persistence had decreased giving the conjecture that matching has between revenues and expenses has become worse over that period. The findings suggest that an increasing amount of expenses is being recognised in a different period to which it affects revenue. They show that a reason for this change is the way that the balance sheet has become the most focal part of accounting standards and moving away from the matching concept being the key principle. The results in the study suggest that as ‘matching’ declines, earnings quality will decline too. They conclude by saying that as accounting standards continue to prioritise the asset – liability approach to revenue, we can expect to see the decrease in matching continue. On the other hand Donelson et al. (2011) concluded differently. They built on this study by examining what the reasons were for the decrease in matching over the last 40 years. Their evidence suggested it was not accounting standards that were accountable for this change, but rather the increase in the incident of large special items that firms have to report. These large items are more a result of economic events and are independent of changes to accounting standards. Therefore they downplay the role accounting standards has on the matching principle – contrary to what Dichev and Tang claimed.

Since the late 1970s accounting standards have swayed away from matching being the fundamental concept in determining earnings, and instead moved towards the asset - liabilities approach. The joint revenue recognition project was no different, and it had always been the aim of the FASB and IASB for their project to follow such an approach. The two standard setters claimed that a revenue-expense approach yielded too many problems when defining the earnings processes and therefore it would be too difficult to consistently apply in practice. This opinion has also been shared by other, external commentators (Wagenhofer, 2014). Interestingly enough, however, is the fact that when CFO’s were surveyed on what they considered to be the most important attributes in high quality earnings, nearly 93% of participants agreed that attributes that matched revenues with expenses would were important in giving quality earning figures (Dichev, et al., 2013). So there seems to be a contradictory view between standard setters and CFO’s in which approach would yield the highest quality reports.

Revenue Recognition As stated earlier, the FASB and IASB embarked on a venture that would see them work together on a number of projects. Converging revenue recognition was quickly seen as one of the Board’s biggest priorities, and in September 2002 the FASB and IASB entered into a formal agreement that they would work together to achieve this. It had been over a decade before, on the May 28, 2014, the Boards finally issued a converged standard. . Despite its gradual and slow evolution, the newly released standard on “revenue recognition from contracts with customers” will replace IAS 18 and IAS 11 with IFRS 15 whilst ASU 2014-09 will replace the US GAAP equivalents on recognising revenue. This project has culminated following a Discussion Paper, two Exposure Draft’s, multiple agenda meetings, webcasts, conferences, public roundtables and over 1400 public submitted comment letters. Prior to the release of this new standard was IAS 18 Revenue and IAS 11 Construction Contracts, neither of which had been subject to any revisions since 1993, making them two of the most out of date standards within the whole set of IFRS. Coupled with the development of new business models, the main driving force behind this project was the fact that more complex, multi- element contracts were becoming more widespread. These new contracts were especially becoming increasingly prominent in construction and software companies. The old standards could not effectively deal with the complexity of the contracts. The FASB tried to respond to these changes by creating new standards on an ad hoc basis. As a new ‘business model’ grew, so did a new piece of US GAAP literature to accompany it. This lead to the creation of 200

pieces of literature for recognising revenue. (Schipper). Inevitably, the large and varying amount of literature on the topic lead to inconsistent application for transactions that were economically similar. The IASB’s IFRS on the other hand, with its principled approach, remained with the two standards and therefore there was limited scope for misinterpretations. However, because of the lack of revision, neither of these two standards were capable of suitably meeting the requirements of today’s business models. Consequently, the limitations in the old standards were considered to be so overwhelming that a complete overhaul was necessary. Both the IASB and the FASB decided they needed better guidance based on consistent underlying principles.

It is widely accepted that revenue is one of the most important measures of a company’s financial performance and is almost always the single largest item reported in a firm’s financial report. Not only is it important to the company, but also to those wanting to make investment decisions. Revenue is also a typical measure of the size of a company, and as Turner (2001) argued, trends and growth in the company’s revenue can act as barometers that are used to assess past and future performance. It is also useful for users of financial statements to identify the sources of a firm’s value generation. Simply put, revenue can be useful by users and investors in analysing the firm. In a survey by Graham, et al. (2005) it was found that revenue was ranked as the second most important measure reported to outsiders, secondly only to earnings. Ertimur (2003) studied investors’ response to a surprise in revenue compared to a surprise in expenses thereby showing that investors and analysts prioritise revenue when valuing firms. Revenue is also used internally and acts as a key indicator in the performance of management. Companies often use revenue as a performance target and management’s compensation can depend on whether this target has been met or not thereby encouraging a growth in revenue. This is commonly known as the stewardship objective of financial reporting.

It is clear to see, therefore, why the rules for recognising revenue are so important. There has been a lot of research that shows how the rules for recognising revenue can have a big effect on financial information. One of the most debated issues is the timing – i.e. at which point should revenue be recognised. Because of the complexity and multitude of transactions this is not always easy to decide in practice. Because there is not an objective answer to when revenue should be recognised, companies have a chance to opportunistically recognise revenue at the time which best suits them. Determining the period in which to recognise revenue can have a material effect both on a firm’s valuation and on management’s

performance evaluation. An unreliable revenue measurement could potentially lead to an investor making an incorrect decision, or a manager unjustly lose their job. Zhang (2005) examined how software firms that took advantage of early revenue recognition had less reliable revenue measurements. It was found that early recognition decreased the extent to which account receivables turn in to cash flows thereby making reported revenue more uncertain and less useful for investors. Turner, et al (2001) identified that improper revenue recognition was the most common reason for report restatements whereas former chairman of the SEC, Arthur Levitt, declared that a firm recognising revenue to inflate their performance was one of the five fundamental challenges that financial reporting faces. Similarly, differences in the methods used to recognise revenue makes it a lot harder for financial reports across entities and industries to be compared with each other (Schipper, et al., 2009). Consequently, it is understandable why the two boards embarked on this project to refine the rules on recognising revenue.

IFRS 15 The IASB and FASB had two main objectives in their project to redevelop the standard for recognising revenue. The first objective was to eliminate the shortcomings in the current standards. Whilst the FASB was aware that there were too many pieces of inconsistent literature on the topic, the IASB highlighted that the (then) current IAS 18 relied too much on the occurrence of critical events and did not adequately provide guidance for multi-element contracts. The second objective of the project was to reach convergence between U.S. GAAP and IFRSs which has been a long standing ambition of the FASB and IASB. As per the FASB, convergence will improve quality of financial reporting in the United States.

The core principle of IFRS 15 is that revenue is recognised to portray the transfer of a promised good(s) or service(s) to customers in an amount that represents the consideration to which an entity expects to be entitled upon the transfer of goods or services. IFRS 15 introduces a five-step performance obligation model, and made significant changes to the measurement, classification and timing of recognition of revenue. The process for recognising revenue under this new standard would be the following five-step process:

1) Identify the contract with a customer. 2) Identify the separate performance obligations in the contract. 3) Determine the transaction price for the contract 4) Allocate the transaction price to each performance obligation

5) Recognise revenue when a performance obligation has been satisfied.

A key addition to recognising revenue is the concept of Performance Obligations. These are defined as legally enforceable obligations of the reporting entity to a customer, under which they are obliged to provide goods or services. A single contract can be made up of multiple performance obligations, thereby addressing the lack of guidance for multi-element contracts in previous standards.

A contract can either be written, verbally agreed upon or implied in practice but must have commercial substance. All contracts are subject to the five-step model, however contracts can be combined should they meet the appropriate criteria. Once a contract has been identified, the entity must determine whether there exist any separate performance obligations. The standard provides detailed requirements for determining this, but the key determinant is whether a good or service is distinct; can the customer benefit from the good or service on its own (without the rest of the contract) and the good/service is separately identifiable from the other obligations in the contract. The transaction price is the amount of consideration the entity expects to be entitled to from the customer. This transaction price does not consider the customer’s credit risk, but there are rules that may constrain the amount because of ‘variable consideration’. The transaction price for a contract may not always be a fixed amount, and may be dependent on other events. So in the event that the amount of consideration price is variable, only the amount that is ‘highly probable’ to be received can be included. If it does not meet this criteria, then it cannot be included in the transaction price until it does become ‘highly probable’. The fourth step allocates a portion of the transaction price to each separate performance obligation. Generally this is done on a stand-alone selling price basis (although there are exceptions). These stand-alone selling prices, ideally, are taken using observable information (for example the current market price). However, if there is no direct observable information then a reasonable estimate may be used. Only if there is no observable information or reasonable estimate can a residual amount be used. Finally, the allocated transaction price for each separate performance obligation can be recognised as revenue when the respective obligation has been satisfied. The standard specifies quite thoroughly as to when an obligation has been ‘satisfied’. Whereas in the previous standards an obligation could be classed as satisfied upon the transfer of risks and rewards, IFRS 15 allows further criteria for it be satisfied.

There exists two different approaches to revenue recognition: the asset – liabilities view or the revenue – expense view. The latter was seen as the more traditional view whereby accounting should focus on the measurement of income through the matching of costs with revenues. However, the asset – liability view represents a departure from this approach, and focuses on determining income via changes in the balance sheet accounts. It gives “conceptual primacy” (Johnson, 2004) to elements in the balance sheet. Revenue, expenses and income are all generated through the changes in the values of assets and liabilities.

Prior to IFRS 15, the IASB used both approaches in its determination in recognizing revenue. IAS 11 on construction contracts adopted the revenue – expense approach whereas IAS 18 on revenue adopted the asset – liability approach. However, the new standard is primarily based on the asset – liability approach. This has been a common theme over the last few decades, with the FASB and IASB increasingly favouring the balance sheet view.

As per Biondi (2014), the key difference between the two views is that the revenue – expense approach attempts to directly follow the earnings process. This process follows the economic cycle of a revenue making transaction: starting from the investment towards contract orientation which moves to delivery of the product/service and payment. The revenue – expense approach attempts to follow this cycle. As he puts it, “the earning process has been the overarching backbone for revenue recognition in modern times”. This process allows for revenue to be distinguished from gains. Revenue requires the fulfilment of two principles before it can be recognised; it needs to be realised and it needs to be earned. For revenue to be ‘earned’ means that the entity has accomplished what it was meant to receive consideration, and to be ‘realisable’ requires that that the delivery of the good/service can be exchanged for cash. Under this method, the revenues are matched with the corresponding expenses. Ultimately, the quality of earnings under this approach will be dependent on how well the revenues can be matched with the expenses – the reporting of net income for a period would be distorted unless there is proper matching between the revenues and expenses.

So under the old revenue – expense approach, we would have seen deferred credits and debits because assets and liabilities would have been ignored. On the other hand, the favoured asset – liabilities approach does not measure revenue directly, but rather in the changes of the assets and liabilities. So under this approach any deferred debits or credits that do not meet the definition of assets or liabilities will not be recognised.

Standard Setting In lieu of the recently released IFRS 15, the next question to ask is why do we have accounting regulation? What is the justification for a strict prescription in how a company reports its financial information? The study of accounting regulation is important because it can help explain the nature of the accounting standards produced by the bodies that set them. Positive accounting theory would suggest that there are enough reasons for the market to disclose an appropriate amount of financial information voluntarily and without the need for intervention. In a perfect market, firms have incentives to optimally trade off the costs and benefits of voluntary disclosure. However, the motives behind regulation lie in the assumptions about market failures, and that the market is not perfect. There has been copious amounts of literature about the concerns of externalities, information asymmetries and inequity within capital markets. For example, Lev (1988) demonstrates how asymmetries can give rise to adverse social and private consequences: for example, high transaction costs, thin markets, less market liquidity. Regulation can mitigate these consequences and provide a more equitable market. Watts & Zimmerman (1990) state that in an unregulated market, accounting information would be under produced because it can be viewed as a public good. Users of the information can reap the benefits of it without having to bear the costs and therefore this would act as a disincentive for firms to produce financial reports. Accounting standards serve to underpin how capital is allocated, as well as how performance is monitored

There exists three common theories of regulation in the context of accounting standards; the Public interest theory, the Capture theory and the Ideology theory (Kothari, et al., 2010). Public interest theory describes regulation as a direct response to failures in the market and is in the interests of society as a whole – not a specific set of stakeholders. It also sees regulation as ‘incorruptible’ as the regulators as by nature they should be acting in the interest of the public. In an ideal world, standard setters would be incentivized to objectively make its decisions on what was best for everyone. Under this theory, there would be no due process or lobbying attempts as any attempt to influence the standard would be worthless. As I will discuss later, this is not the case. Polar opposite to this is the capture theory which assumes that regulators are not as infallible nor incorruptible as its counterpart theory suggests. It models regulators as economic agents who are out to maximise their own self interests. Stigler (1971) proposed that “regulation exists primarily to benefit those who are subject to regulation”. Under this theory, regulation can be influenced or ‘captured’ by the accounting profession. Interest groups demand regulation as it allows them a method of promoting their

own welfare. Producers and users of accounting standards can lobby to achieve accounting standards that serve their best interests. However, there does not seem to be much empirical support for this theory either. Abela & Mora (2012) argue that if this was the case then the public would not trust the standards, and standard setters would cease to exist. The third theory is the ‘Ideology’ theory which is situated in the middle of other two ‘extreme’ theories. This assumes that there regulation does exist to correct market failures, but is also influenced partly by lobbying attempts. As I explore further on in this section, this theory seems to be the one most consistent with the actions of standard setters.

Such examples of bodies that have been given the role of setting accounting rules are the IASB and FASB. The IASB (International Accounting Standards Board) and FASB (Financial Accounting Standards Board) are private standard setting bodies. The primary objective of the IASB is to “develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards”. Similarly, the FASB aims to establish and improve reporting standards to provide decision-useful information to users of financial reports. Despite the large differences that exist between the two bodies, they have come to work alongside each other recently. In September 2002, the FASB and the IASB signed the Norwalk Agreement. This agreement signified the intentions to eliminate the differences between US GAAP and the IFRS in order to have a single set of high quality accounting standards (FASB, 2002 & IASB, 2002). The overarching objective of this convergence project was “to create a sound foundation for future accounting standards that are principles-based, internally consistent, and internationally converged” (IASB, 2012). Collectively, this means that over 100 jurisdictions will be affected by this project. However, because of international differences between these jurisdictions, these effects will not be the same throughout. While a standard might have one effect and be preferable in one country, the impact might be felt completely different and less desirable in another country. This complicates the standard setting procedure, as it gives rise to a variety of lobbying attempts, each specific to its own national preferences. Analysing the proposed effects of a standard is not an objective task, and so the IASB and FASB have to use their own judgement to determine which constituent’s interest should be favoured, and whose should be compromised.

Lobbying Zeff (1978) claims that up until the 1970s, the effects of accounting policy making had on stakeholders was assumed to be neutral and impartial. However, this assumption has since

been questioned and these ‘effects’ have given rise to the term “economic consequences” whereby accounting policy choices can have an effect on firm value and on real decision making. It was during this period that users of financial reports began to realize that the policies that were being introduced could have material effects on decision making. It was no longer taken as a given that those in charge in implementing accounting policies, such as the FASB, were impartial. This economic consequences argument had placed doubt in the neutrality of accounting policy makers, and so it became important that these nonmarket standard setters continued to be perceived as legitimate. It is important that they continue to appear to be fair and neutral, just as they had done prior to the 1970’s.

So how do these standard setters establish institutional legitimacy? Johnson & Solomons (1984) identify three conditions that must be satisfied for a standard-setting body to establish its legitimacy; sufficient authority, substantive due process, and most appropriate to this paper, procedural due process. Procedural due process requires that interested parties are given an opportunity to be kept informed of matters being considered by the standard-setting body, as well as be given a chance to express their view. Ultimately, those who are going to be affected should be allowed the opportunity to engage in lobbying in order to “influence the nature and direction of such rule-making”. As per Johnson & Solomons (1984), standard- setting bodies such as the IASB and FASB have the processes set in place that ensure procedural due process is provided, as well as meeting the requirements to meet the two other conditions and therefore certifying its legitimacy. Similarly, Suchman (1995) agrees with this sentiment claiming that constituent participation is often seen as a key component for an organization to obtain legitimacy. One major method of lobbying that the IASB/FASB use to facilitate procedural due process is the submission of comment letters. Comment letters can be sent from the public in response to any Discussion Paper, Exposure Draft, and any other discussion document (FASB, 2014). Although the submission of comment letters is not the only form of constituents’ lobbying methods, Georgiou (2004) found that there is a strong correlation between submission of comment letters and other lobbying methods thus making comment letters a good proxy for lobbying methods.

Of course there has to be a good reason for a constituent to participate in the lobbying process. Sutton (1984) argues that only those who expect to receive financial benefits from the activity will participate in lobbying. Partaking in these activities is not cost free, and therefore there needs to be some perceived value in the activity to encourage constituents to partake in it. Kosi & Reither (2014) studied the link between lobbying behaviour and

potential consequences of anticipated accounting changes in the Exposure Draft for the IFRS’ replacement of the Insurance Contract principle and just as Sutton argued, they documented a clear positive link between them. Those who lobby are self-interested. The constituents that participated did so in order to try and avert the negative economic consequences that would arise should the principle as it is in the ED be enforced. Rational participants will only partake in a lobbying activity should the perceived benefits of doing so outweigh the costs. Likewise, Francis (1987) assessed the lobbying reactions to the FASB’s 1982 pension accounting proposals which proposed to reduce management’s flexibility in measuring pension expenses, potentially leading to larger pension expense volatility. The majority of the comment letters received were against the proposal. The authors compared the likely balance sheet and income statement effects of the proposed change for 218 companies that lobbied against the FASB’s proposals with a sample of 582 non-lobbying firms. Overall it was found that the 218 lobbying firms were more likely to suffer adverse effects of the proposed changes compared to the non-lobbying firms and therefore showing that negative economic consequences explain the decision to lobby. It was in the interest of these lobbying firms to try and prevent these consequences to try and change the standard-setters mind. Dechow et al (1996) also showed that self-interest is the core behind the motivation to lobby against proposed expensing for stock options. They found that there was a strong link between the decision to lobby and the level of public scrutiny that top executives would receive based on their high levels of stock-based compensation. Aware of the expected scrutiny, these executives and their firms submitted comment letters to the FASB opposing the proposals to expense stock options thereby, again, demonstrating that participation in the due process is based on individual self-interest.

Lobbying efforts also seem to have an apparent degree of success. Brown (1982) was a former member of the FASB and claimed that standard-setters are influenced by the arguments given by those who participate in lobbying efforts. His first-hand experience in the standard-setting process demonstrates that participants can exercise influence over the final standard. Hansen (2011) examined comment letters submitted to the IASB in reply to 5 exposure drafts and the questions that these ED asked interested parties. The study showed that changes to the final standard were made based on the comment letters’ response to 50% of the 69 questions that were asked across the 5 ED’s. Ultimately, this shows that comment letters do have a big impact on the final form of an accounting standard. McLeay et al (2000) examined the impact constituent lobbying participation had on the development of financial

regulations in Germany and found that it did have a large influence over the final decision. Moreover they measured the influence that each lobbyist group had on the final outcome. By splitting the participating lobbyists in to three key groups – preparers, auditors and academics – they found that it was the preparers that exercised the greatest amount of influence. Similarly, Rahman et al (1994) found sufficient evidence to conclude that the standard-setters in New Zealand attempted to amend their proposed standard in line with what preparers and auditors would find acceptable following their participation in the standard-setting process. Based on these findings it can be reasonably assured that lobbying attempts and participation in the standard-setter’s due process does have an effect on the final standard. Although generally overseen by one body (i.e. FASB), the development of an accounting standard is the result of a “complex interaction” among multiple parties. This result is accommodated by a due process which allows for willing lobbyists to participate and have their opinion heard in a formal way.

Comment Letter Thematic Analysis

On January 4, 2012 the FASB and IASB jointly published a second Exposure Draft: Revenue from Contracts with Customers – Proposed Amendments. Just like its predecessor, this amended exposure draft allowed for the public to provide their comments. The new, amended Exposure Draft was officially open for public comment up until March 13, 2012, however a few, limited amount of comment letters were submitted and considered subsequent to this deadline. During the course of this period, 359 unique letters were submitted in which the respondents asserted their concerns, questions or support for the revised proposal. Of these, 159 were submitted by companies (or associations) that had responsibility in the preparation of financial statements. All comment letters relate to the same time period and same exposure draft. All of them were directly obtained from the FASB website. The Board’s intent in releasing all of these letters is to expand the transparency of the due process and to ensure legitimacy.

The next part of this paper is to investigate the issues and concerns that were present within these comment letters, and see how (if at all) these letters respond to the matching problem. Our approach to this content analysis takes more of a “meaning-oriented” style by which we are focussed on the meaning behind the words. The analysis of the comment letters is motivated by the desire to better understand the perceived impacts of the new standard on recognising revenue.

Issues Raised With the help of a colleague, all 159 of these letters sent in by preparers were meticulously analysed. This equated to over 930 pages of submissions, ranging from one page long to eighteen pages long. The key motivation in reading and rereading these letters was to understand the concerns that preparers had with the new standard. A systematic method was undertaken to identify these concerns whereby responses were categorised based on the following:

a) Issues: These were described as being any matter that would lead to a tougher job in the preparation of financial statements. b) Reasons: Why would the respective issue cause a problem for preparers? c) Effects: Any tangible and realisable effect that would arise because of the respective issue d) Solution: How would the preparer propose to solve the respective issue?

Some of these letters were very extensive and so it was necessary that we organised these letters in to “manageable pieces” so that further research could be conducted on the letters. Naturally there are limitations in this method in ensuring reliability and reproducibility. However, all of these “chunks” were taken directly from the comment letters ensuring that there was no obtrusion involved.

In each case, an issue that was raised by a preparer would be followed up by finding the reasoning, the effects and a proposed solution. The level of detail varied in each respondents comment letter, and so while some identified all four ‘categories’, some less comprehensive responses just laid out their issues. This was done for each comment letter that was submitted to the board. It is through going through this systematic method that my colleague and I were able to fully understand the issues and concerns that each respondent had with the proposed standard. A summary of the number of unique identifications is presented below in Table 2. The principle aim of this method was to ensure that a consistent approach to analysing these comment letters was adhered to throughout. By analysing the letters using the same framework, we can make sure that theoretical saturation was reached. It is through the observation of issues, reasoning’s, effects and solutions that we can deduct identifiable themes which will be used in depth later on in the paper.

Table 2. Breakdown of Observations # of unique observations

Issues 772 Reasons 951 Effects 520 Solutions 555 Total 2798

In total, by analysing each individual comment letter we identified a total of 772 issues. This equates to an average of just over 5 issues per comment letter. In a lot of cases, there were multiple reasons and effects for one particular issue. This would explain why we observed more Reasoning’s than Issues themselves. All of these items were recorded between my colleague and me, and combined together to create one master file. This file contained the issues that were mentioned in every single comment letter sent in by a preparer, or an association of preparer, of financial statements. Adjacent to the issue were its respective reasoning’s, effects and proposed solutions.

Most letters were quite clear in their position. Any letters that left either my colleague or me in any doubt were closely re-examined. In total, of the 159 letters submitted by preparers, 154 disagreed or had issue with at least one point in the revised Exposure Draft. Only 5 expressed unilateral support for the Board’s revised proposal.

Although each respondent acutely expressed any concerns they had with the standard from their own companies point of view, it quickly became evident that many companies shared similar concerns. Upon identifying issues, reasoning’s, effects and solutions the next step was to look for common themes within the responses. Identifying ‘themes’ can be an abstract process and it can be difficult knowing when a theme has been found. Some themes can be very broad and can be conveyed under many different expressions whereas others can be much more focussed and specific. We took an inductive approach to find themes within the comment letters. None of the themes could be anticipated prior to the examination of the data collected from the comment letters. Before accepting that a theme had arisen, we asked the question “what is this observation an example of?” If we could answer this question whilst rereading the observations in the data file then we would accept that a theme had risen.

In total, seven key themes were identified. These were considered to be salient and widespread throughout the comment letters. Every comment exhibited at least one of these

themes whereas most include more than one. Table 3 describes these themes. Further on in this section are the descriptive statistics behind these themes.

The Board solicited comments for all matters that the public may have with the Revised Exposure Draft, but they did specifically request that respondent’s address six specific issues: (1) whether they agree with the criteria in which a good or service is satisfied over time, (2) whether they agree with the proposal to present uncollectible consideration as a separate line item, (3) whether they agree with the proposal to constrain recognisable revenue to an amount to which the entity is reasonably assured to be entitled, (4) whether they agree with the scope of the onerous test, (5) whether they agree with the level of disclosures proposed to be provided in an entity’s interim financial reports, and (6) whether they agree with the proposals that an entity should apply the proposed control and measurement requirements for the transfer of non-financial assets that are not an output of an entity’s ordinary activities. Unsurprisingly, the majority of respondents addressed at least one of these issues in their letters.

Table 3: Theme Taxonomy I. Customer Credit Risk – There was strong opposition for the proposal to present customer credit risk as a separate line item adjacent to revenue. Reporting it as such would suggest that the impairment expense would relate entirely to the current period when it is much more likely that it would relate to revenue recognised in previous periods. Comments were also raised on whether it would be appropriate to refer to ‘revenue’ as the amount before the adjustment for credit risk and thus potentially confusing users. II. Accounting Information Systems – Respondents were particularly vocal over the necessary changes that they would need to make to their accounting information systems in order to adhere to the new standard. They noted that the costs to do this would be significant and that time would be needed to have these installed and have staff appropriately trained to use them. Currently, the systems set in place would be unable to cope with the some of the demands in the revised Exposure Draft. III. Retrospective Application – The Revised Exposure Draft proposed that the new standard should be applied retrospectively. Many preparers made it quite clear that this would not be practical and that it would put an unnecessarily large burden upon them. It was claimed that the costs to do so would not outweigh the benefits of retrospective application IV. Disclosure Overload – Preparers commented that the revenue disclosures proposals were excessive, overly prescriptive, potentially too revealing and ultimately of not much benefit to users of financial statements. Many respondents claimed that the benefit of the proposed disclosures would not outweigh the costs. In particular, concern over the volume of disclosures and questioned how much use some of the disclosures would be.

V. Onerous Contract Tests – Respondents raised strong concerns about the scope of the testing of onerous contracts. In particular they were concerned about two points: (1) limiting the test to contracts that are satisfied over a period of time greater than one year, and (2) undertaking onerous tests at the performance obligation level as opposed to the contract level. Regarding point (1), respondents questioned why there was no justification for excluding all the other contracts. They claimed that this could lead to two economically similar transactions being reported differently, and therefore would be of little use to users of financial statements. Point (2) refers to counter intuition involved in claiming a performance obligation to be onerous, yet the overall contract to be profitable. This is claimed to be economically nonsensical. They also object to the costs of testing for onerous contracts at the performance obligation level. VI. Represent Economics of Transaction – Many respondents questioned whether some of the directions for recognising revenue in the new standard would faithfully represent the economics behind the transaction. This could potentially lead to preparers abusing the rules to manage when they recognise revenue. Similarly, they asked about how relevant the financial statements would be to users if it is not a representation of the actual goings on in the business. VII. Misinterpretations –Preparers raised concerns about the possible misinterpretations that users and preparers of the financial statements might have following the new standard. Some issued unease over how the numbers on the statements could mislead users in to believing something that might not reflect reality. They also fear that the preparers might have to bare significant costs to prevent this from happening. Other respondents raised the issue of how the ambiguous nature of the wording in the Exposure Draft could lead to inconsistent application for contracts that have similar economic characteristics.

Upon the completion and verification of the ‘master file’, it was necessary to scrutinise it further. This file was examined in detail to identify which of the seven themes were represented in the respondent’s letter. Any of the comments that came under any of these themes were coded as such. The grouping methodology has an element of subjectivity. At this point, all work was done without the assistance of a colleague. Therefore it is possible that the potential limitations that arrive from this subjective approach will be heightened. For example, in any instance where it was not clear if a theme was represented or not, it would no longer be possible to confer about opinions to see if they matched or differed. Instead, in these instances, the comment letter was reread in its entirety to see if any clearer interpretations could be made. Overall, it was felt that the seven different themes accurately represent the information content contained in the letters. It is important to note that this was not a “one issue – one theme” method. Some of the content in the letters apply to multiple themes, and it was felt that it was necessary to select all the categories that the issue applied to.

Table 4: Distribution of Comment Letter Firms by Industry N Percent

Advanced Technology 3 1.8 Aerospace and Defence 4 2.5 Construction 13 8.2 Electricity, Gas and Water Supply 5 3.1 Electronics 19 11.9 Energy 11 6.9 Financial Intermediation 2 1.3 Financial Services 12 7.5 Health and Social Work 2 1.3 Information Technology 17 10.7 Manufacturing 11 6.9 Mining and Quarrying 3 1.8 Other Community, Social and Personal Service Activities 7 4.4 Software Services 19 11.9 Telecommunication 14 8.8 Transport, Storage and Communications 6 3.8 Wholesale and Retail Trade; repair of motor vehicles and Personal and 11 6.9 house hold goods Total 159 100%

In particular, there is a strong concentration of respondents from the Telecommunications and software industry. This is somewhat expected because these are the industries that have the most variety in their types of contract. Also, and more relevant, firms in this industry are more likely to feel the effects of the new standard. The new standard requires the revenue from each contract to be allocated to each individual separate performance obligation on a relative standalone selling price. Especially within the telecommunications sector, the stand alone selling price can be constantly changing and therefore difficult to know. Due to the sheer volume of contracts, and varying prices, this will place considerable strain on resources to make sure the new standard is applied. As such, it is no surprise that firms from this industry are so prevalent amongst the lobbyists.

Strength of Comment Letters As we are mainly interested in the seven themes that were uncovered earlier, we want to focus on the comment letters that raise concerns about at least one of these issues. In total, 145 (94.2%) of the comment letters included at least one ‘themed’ issue. This is a strong majority, and reaffirms our claim that the themes we uncovered were indeed widespread

throughout all of the comment letters. By analysing our data file, we selected which themes were present in each letter. From the figures presented in Table 5 it is evident that the most comment theme that arose in the comment letters were to do with the excessive disclosure requirements that were proposed. 62% of preparer submitted comment letters expressed concern or disagreed with these requirements. The ‘least common’ themed issue was to do with the retrospective application that was recommended in the revised Exposure Draft. However, this was still presented in nearly a third of the submitted letters. This table is evident that all 7 themes were prevalent across the 140 comment letters submitted by preparers that included at least one theme. Only 9 (6%) of the total (159) submissions were deemed to mention none of the seven themes, instead focussing on other more ‘unique’ issues. 5 (3%) of the letters gave no concerns at all, instead submitting a letter to issue its support for the proposal instead.

While this reassures us that the themes that were uncovered are indeed prevalent throughout the submissions, it does not give us much information on lobbying efforts. In order to get a richer indication of lobbying efforts, rather than just a simple “for” or “against” categorisation, or “thematic analysis”, we wanted to explore further characteristics of the submissions. The next examination that was undertaken was to see if there was any discerning difference in the ‘strength’ of the letters for each theme. For example, are the letters that feature concerns about Theme 1 different in strength compared to the letters that feature concerns about Theme 2? This method of content analysis studies whether respondents who are primarily concerned with

Table 5: Recognition of Themes N Percent

At Least one Themed Issue 140 90.9 CRED_RISK 54 35% INFO_SYSTEM 59 38% RETRO_APP 45 29% DISC_OVERLOAD 95 62% ONEROUS_TEST 72 47% ECONOMICS 55 36% MINSINTEPRET 67 44%

No Theme Issue 9 6% No Issues 5 3%

one theme attempt to argue their position in a different way to respondents who are concerned with a different theme. Doing so may add further information concerning how lobbyists perceive the significance of their responses to Exposure Drafts.

The strength of the responses is measured through the number of pages in each comment letter (Ang et al, 2000). As you would expect, there are limititations in this approah as well. Different respondents are going to have different styles of submitting comment letters, whether that be by font, grammatical style, page breaks, etc. In order to contest these shortcomings we tried to systematically fix for any ‘anomaly’ styles in comment letters. In some instances, the font size in the letter was significantly larger than its counterparties, thereby naturally giving it a larger page length (and thus suggesting it was a ‘stronger argument’). To counter these instances, the letters were replicated but in a font size that was more consistent with the majority of the other letters. In other cases, there was a whole page dedicated to the signatories of the respondent. These signatures did not add any value to the respondents arguments, and so these pages were also ommitted from the total page length. Limitations in this approach were still present, but hopefully by making these adjustments we are able to get a more realistic picture of the strength of the responses.

As Gable 6 shows, the average page length of all the comment letters was 6.1 pages in length. But, as before, we are primiarly interested in the 140 letters that mention at least one of the themed issues. The average length of the letters that met this criteria was 6.4 pages. Table 6 also goes in to greater detail and shows the average page length per theme that was uncovered

earlier. Here we uncover that all comment letters that raised concerns about how the standard will not represent the true economics of the transcation (ECONOMICS) tended to have the longest letters, being on average 8 pages in length. On the other end of the scale, the shortest letters that included a ‘themed issue’ were the letters that raised concern about presenting customer credit risk as a separte line item adjacent to revenue (CRED_RISK). The letters that included a response to this theme were on average 6.7 pages in length.

On the surface, it appears that those that have concerns about the ECONOMICS of the proposal submit ‘the strongest’ letters. As a follow up to this, we tested to see if there was a significant difference among the thematic groups. Because of the nature of the data (non- independent sample, uneven sample size) it is not possible to conduct either a Kruksil-Wallis analysis nor a Wilcoxon rank-sum test to test for pair-wise differences. So instead, to infer if there are any signifinciant pair-wise differences across the 7 themes, we use t-tests to compare the mean page length of each pair of theme groups. We used a two-tail, heteroscedastic, t-test to counter the problem of overlapping data. The results of the 21 (pairings) t-tests can be found in the appendix. It was found that there was no significant difference in mean page length across any of the pairings. However, this could be because of the lack of indepdence of each data value. Further studies could perhaps disect the comment letters even further and work out the number of lines dedicated to each thematic issue. This way we could have non overlapping data points and better test if there was any signficant difference in the way respondents argue their positions.

Reference to the Matching Principle Besides looking for references to the seven themes, we also made an active attempt at looking to see if the responses made any direct mention of the effects the new standard would have on the matching principle. One thing that was particularaly noticable in the thematic analysis was the sparse ‘direct’ mentioning of this concept. As discussed in the Background section of this paper, the new standard shifts away from the revenue-expense approach (IAS 11) towards an asset-liability approach. We expect this shift to contribute to an increase in profit margin volatility, and a decrease in the predicatbilty of future performance. Should the preparers expect this to be the case, we would imagine that this would be a main point raised in the submitted letters. However, despite these expectations, only 9 (5.8%) of submissions from preparers made any direct reference to the matching concept. This shift would therefore also represent a shift away from the matching principle. A couple of these concerns to the matching concept are provided:

Comment Letter 198 “The current method of presenting doubtful debt provision as an operating expense is preferred for the following reasons: As impairment of receivables would typically be assessed in subsequent years (after revenue is recognised), there will be a mismatch between revenue and impairment expense for the period.”

Comment Letter 215 “However, the point is that a mismatch between revenues and impairment losses presented in the income statement does not provide accurate information on “ultimately” collectible amounts. As a result, we do not see how a separate presentation of impairment losses adjacent to revenue would result in any benefit for users of financial statements. “

Both of these examples (and the majority of the remaining seven that made a direct reference to the matching concept) relate the matching concept to the problem of showing the uncollectible revenue as a separate line item adjacent to revenue. Their basis for the concern stems from how an impairment resulting from a customer’s credit risk in one period would suggest that it embodies that particular period. However, it is entirely possible that the impairment could result from uncollectible revenue from previous periods, and it is only in the current period that it was declared uncollectible. Effectively this punishes the wrong period for an impairment and does not appropriately match the revenues with the correct period’s expenses. Hereby lies a concern with the matching concept.

So although very few of the comment letters make a direct reference to the matching concept, many of them do indirectly. In fact, many of the the letters that made reference to Theme I (CRED_RISK) made the same argument that was presented in the example provided above. Using this information, we assume that those 54 respondents who directly raised the issue of having uncollcectible amounts shown as a separate line item also raised an indirect issue of the effects the standard will have on the matching principle.

Similiarly, we can also argue that respodnents who raised an issue with the ECONOMICS of the proposed standard also indirectly expressed concern with the matching concept. As Wagenhofer (2014) said: “a typical concern with the asset-liability approach is that it might not fully reflect the economics of the contract with the customer”. So despite only 5.8% of respondents making a direct reference to the matching concept, we can assume that many more respondents made an indirect reference to it. In total, we assume that 89 (57.8%) unique respondents raised an indirect issue with the matching concept, whether it be by raising an

issue with ECONOMICS, CRED_RISK or both of the thematic issues. For what it is worth, each of the 9 respondents who made a direct reference to the matching concept also made a direct reference to either the ECONOMICS or CRED_RISK theme – therefore strengthening the assumption that these two themes can be associated with the matching principle.

Empirical Hypotheses and Methodology

As well as undertaking a qualitative approach to analysing the submitted comment letters, we also take on a quantitative analysis thus making this study a piece of mixed method research. As also described, we use the qualitative analysis in collecting and analysing the comment letters. We will also use this analysis to set the basis for which sample we will use in our empirical tests. In combination, these methods will allow for us a better understanding of what it is that influences a firms decision to lobby against the proposed standard (Yin, 2003). This mixed design is a two-stage consequential design, in which the qualitative and quantitative approach are carried out sequentially.

Why do we utilise such an approach in this paper? The primary reason is that examining only one data source is insufficient to address our research objective. In our thematic analysis, very few firms made direct reference to the matching concept, however many firms made an indirect reference to it. Which firms made such references? Which characteristics do these firms possess that made it so that they would lobby which other non-lobbying firms do not possess. Just by analysing the letters and analysing the content alone does not allow us to realise this information. As such, a second approach must accompany it.

One of the main advantages of utilising this ‘third research paradigm’ is that it can increase the validity of our conclusions. Further on in this paper, it is described how we empirically test a subset of firms depending on the findings in the qualitative analysis. These subsets are made on the basis on the themes that were uncovered in the comment letters, and how they relate to the concept of matching revenues with expenses. However, by empirically examining these subsets, we can strengthen our claim that these firms are more concerned about matching. It offers us a dual approach to looking at data sources. Of course, it also promotes greater understanding of our findings. Although the quantitative analysis can describe to us what is different, it is only when accompanied with the qualitative analysis involved in analysing the comment letters that we can truly understand why these differences are occurring.

Naturally there are limitations in using a mixed approach, none least of which is that the researcher must be familiar and capable in both qualitative and quantitative methods. There is also a question on the strain of resources taking a mixed approach requires. Two methods requires two sets of data collection, and two sets of analysis. This can take a heavy toll on time and effort and is important that these costs are considered. As later described, the two methods cannot always work hand in hand. Many firms that were qualitative analysed could not have been empirically examined because lack of data availability. However, despite these limitations and after considering these preliminary considerations it was deemed appropriate that further quantitative analysis should also be undertaken. The next section explores this empirical analysis, and the research methodology used for this particular stage of the mixed method research approach.

Hypothesis Development Using Dichev and Tang’s (2008) model of matching, we concentrate on the differences in earnings characteristics between firms who lobbied against the proposed standard on Revenue Recognition and those who did not lobby. Under their theory section in the paper, they explicitly mention that the quality of matching can be affected by many reasons, but most appropriate for this paper is that it can be affected by “accounting rules”. They show that over the last 40 years, the quality of matching expenses with associated revenues has decreased, and they owe this change to the standard-setters goal of focussing on the asset- liability approach to financial reporting. IFRS 15 also follows this goal, with standard-setters making it a stated goal of theirs to focus on the asset-liability approach as opposed to the revenue-expense approach

What Dichev and Tang find in their model is that poor matching has implications for earnings quality. Their model is supported by empirical results that show that as the matching of revenues and expenses gets worse, the nose in earnings increases. Consequently, this noise adds volatility to earnings and decreases the persistence of earnings; consistent with what we would see if declining earnings quality. However, because the standard has only just been released, we are not yet able to check if these claims will come in to fruition. However, instead

Table 6 Strength of Themed Submissions

Variable29 N Mean Std. Dev Min Q1 Median Q3 Max

All Responses 154 6.1 3.84 1 3 5 7.75 18 All Themed Responses 140 6.4 3.88 1 4 5 8 18 CRED_RISK 54 6.7 3.75 1 4 6 8 18 INFO_SYSTEM 59 7.2 3.93 1 4.5 7 8.5 18 RETRO_APP 45 7.9 4.53 2 5 7 11 18 DISC_OVERLOAD 95 6.8 3.79 1 4 6 8 18 ONEROUS_TEST 72 7.3 3.87 2 4 6.5 9 18 ECONOMICS 55 8.0 4.68 1 4.5 7 11 18 MISINTERPRET 67 7.1 4.26 2 4 6 9 18 No Themed Responses 9 3.0 0.87 1 3 3 3 4 No Issues 5 3.0 1.87 1 2 3 3 6 what we can examine is to what extent firms are concerned by the possibility of a decrease in matching, and the effects that this will bring upon earnings quality. We will be able to assess the extent to which the effects of poor matching have on a firm’s decision to submit a comment letter to the Board.

As discussed earlier, the decision to lobby is mainly based on a cost-benefit analysis. Firms will decide to lobby if the benefit of doing so (or the cost of not doing so) is greater than the cost. This should be no different, and we should only expect a firm to lobby if it makes economic sense to do so. Therefore, if the effects the new standard will have on earnings quality as a result of poor matching are large enough, then we would anticipate that effort would be made towards lobbying against the proposal. On the other hand, some firms may not consider the effects to be material enough to warrant the expense of lobbying against the proposal. Instead, these firms would not consider it a viable option to bother spending resources on lobbying.

If, as anticipated, matching will decrease as a result of this new ‘balance-sheet heavy’ standard, then which firms will be most affected by this? It is these firms that we would expect to put the effort in to lobbying against the proposed standard.

Dichev and Tang used their model to show how poor matching increases the volatility of earnings. This is because mismatched expenses act as noise, and are unrelated to the economics behind the process of generating earnings. Mismatched expenses therefore add an extra level of volatility. Therefore, although it is too early to test, we can anticipate that the new standard could contribute to an increase in earnings volatility. It is reasonable to assume that no firm wants the volatility of their earnings to increase, but recall that only if the

benefits outweigh the costs should a firm put effort in to lobbying. So in which instances are the benefits of lobbying greater than the costs? A firm who currently (pre-IFRS 15) benefits with very smooth earnings has to more to lose in an increase in earnings volatility than a firm that already experiences volatile earnings. Based on this, we predict that these are the firms that have more to lose, and are the firms in which it would make more economic sense to ‘spend’ resources in lobbying against the proposal. Therefore, our first hypothesis is as such:

Firms who submit a comment letter opposing the proposed standard have less volatile earnings than firms who do not submit a comment letter.

Similarly, Dichev and Tang also used their model to demonstrate how poor matching can contribute to a decrease in earnings persistence – another proxy used to measure the quality of earnings. They exhibited how the persistence of earnings has decreased as standards have neglected the matching principle. Thereby, although it cannot be studied immediately, we can anticipate that matching will decrease as a result of IFRS 15 taking the asset-liability approach to financial reporting. As a result of this, earnings persistence can also be expected to decrease (as modelled by Dichev and Tang). Just like no firm would want more volatile earnings, we can assume that no firm wants to have less persistent earnings. So why would all firms not attempt to lobby against the proposed standard if this is expected to be the case? Why was it that only 159 preparers submitted a comment letter expressing concern over the proposition? As before, only those who would face large enough costs should this happen would find it worthwhile to attempt to lobby against it. If the costs of lobbying against the standard are greater than the cost of having less persistent earnings, (or smaller than the benefits of maintaining current levels of earnings persistence) then it does not make sense to both lobbying. So the question, again, is which group of firms does it make most economic sense to lobby against the proposed standard in relation to earnings persistence? We take the assumption that firms who currently benefit from very persistent earnings have more to lose if their earnings persistence decreases than firms who do not benefit from persistent earnings. We presume that it is these firms that have more to lose, and have the greatest incentive to lobby against the proposed standard. Therefore, our second hypothesis is as such:

Firms who submit a comment letter opposing the proposed standard have more persistent earnings than firms who do not submit a comment letter.

Based on the thematic analysis conducted earlier on, it was clear to see that there were seven particular issues that consistently arose in the submissions. As a further part of this study, we

31 try to see if there is any association between these themes and earnings characteristics. Although very few respondents made a direct reference to the matching concept, we made the claim that many made a reference to indirectly. In that section, we accepted that Theme I & VI (CRED_RISK & ECONOMICS) made reference to the matching concept, and how it may deteriorate as a result of the proposed standard (albeit in an indirect way). Although we expect there to be lower volatility and higher persistence for all firms that submitted a comment letter, we expect this finding to be more prominent in the 89 firms that made reference to these two specific themes. The fact that these 89 respondents put special effort in to lobbying against these specific changes that (could) affect matching suggests that this is a greater issue to them than other firms. Based on these presumptions, we expect that the earnings characteristics will suggest that these 89 firms have a stronger incentive to lobby against the possible changes to matching as opposed to their counterparts who chose not to mention these two themes in their response. As such, our third and fourth hypotheses are:

Firms who submit a comment letter that make an issue of Theme I and/or VI (CRED_RISK and ECONOMICS) have less volatile earnings than firms who do not submit a letter including such issues.

Firms who submit a comment letter that make an issue of Theme I and/or VI (CRED_RISK and ECONOMICS) have more persistent earnings than firms who do not submit a letter including such issues.

Methodology To empirically analyse the earnings characteristics between lobbying and non-lobbing firms we need to create two samples. Sample one, Lobbying Group, consists of the preparers that submitted a comment letter that disagreed or had an issue with the proposed standard. These are our main test firms. The second sample, Non-Lobbying Group, consist of companies that did not submit a comment letter to the Board regarding the revised proposed standard. In order to ensure that we are finding out the only treatment that is being assessed is whether a firm is a lobbyer or not, we match the two samples together. All Non-Lobbying Groups firms will be matched with the industry and country of the Lobbying Group firms to reduce the effects of confounding.

To collect our test firms (Lobbying Group) we went through all 159 comment letters and obtained the company name and company code so that we could extract the appropriate financial information. Because 5 (3%) of the firms who submitted a comment letter to the

Board expressed nothing but support for the proposals1, these firms will be omitted from the Lobbying Group sample. This leave us with a potential 154 firms who will be in this sample.

To get the Non-Lobbying Group which we will use to compare the test sample with, we matched each Lobbying Group firm with all firms that were in the same industry and same country. For the Non-Lobbying Group sample we used all possible firms that were available to us. This means that some Lobbying Group firms are likely to be matched with more firms than others.

Because of the way the IASB and the FASB operates its due process, it is not possible to obtain the necessary financial information for all the respondents. The Board make it clear that the due process is open for everyone. Responses are not limited to just those organisations of a particular size or a perceived importance. Instead, all responses are considered and are made public. Therefore this means that the financial information for the smaller, more independent respondents are unlikely to be available. As a consequence of this, we only obtained financial information for 99 (64%) of the 154 firms who potentially could have been in the Lobbying Group sample. Using the country and the industry that they were classified under, these 99 firms were matched with 4931 firms who did not submit a comment letter. These 4931 firms make up the Non-Lobbying Group sample.

Descriptive statistics for the both sample groups are presented in Table 7. To avoid the influence of extreme observations, we winsorise the top and bottom 1 percent for all variables which

Table 7 Descriptive Statistics Relating to Variables Used in Analyses

Lobbying Group (N=99) Non-Lobbying Group (N=4931)

Standard Standard Mean Deviation Median Mean Deviation Median Assets 17.22 2.196 17.438 11.667 3.545 12.330

1 This finding is based on what was discovered in the Thematic Analysis earlier in the paper.

Earnings -0.073 1.771 0.035 -0.958 4.499 0.009 Revenues 0.653 0.619 0.540 0.796 1.019 0.467 Expenses 0.774 2.386 0.487 1.804 4.879 0.667 COGS 0.478 0.594 0.307 0.606 0.853 0.312 SGA 0.330 1.845 0.152 1.168 4.025 0.269 DEPR 0.049 0.036 0.041 0.055 0.068 0.038 TAX 0.011 0.020 0.004 0.016 0.019 0.010 SI 0.000 0.000 0.000 0.000 0.000 0.000 OTH 0.033 0.290 0.024 0.116 0.512 0.032 Assets is the natural logarithm of assets (Datastream item wc02999) as of the end of the year. Earnings is earnings before extraordinary items (Datastream item wc01551) deflated by average assets. Revenues is net revenues (Datastream item wc01001) deflated by average assets. Expenses is the difference between Revenues and Earnings deflated by average assets. COGS is cost of goods sold (Datastream item wc01051) deflated by average assets. SGA is selling, general and admin expenses (Datastream item wc01101) deflated by average assets. DEPR is depreciation expense (Datastream item wc01151) deflated by average assets. TAX is tax expense (Datastream item wc03063) deflated by average assets. SI is special item expenses composed of discontinued operations expense (Datastream item wc01269), gains/loss on disposal of assets (Datastream item wc01306), goodwill written off (Datastream item wc03491, impairment of goodwill (Datastream item wc18225), impairment of other intangibles (Datastream item wc18226), impairment of property, plant & equipment (Datastream item 18274) and impairment of financial fixed assets (Datastream item wc18275) all deflated by average assets. OTH is the residual amount of these five components and the expenses amount.

will be included in the empirics. Expenses are estimated by taking the difference between revenues and earnings before extraordinary items. All variables are deflated by average assets which should help mitigate scale issues. It appears that the firms in the Lobbying Group sample are larger in asset size than the Non-Lobbying Group. This is not unexpected and is consistent with previous studies examining the association between firm size and the decision to lobby (Sutton, 1984, Francis, 1987). Larger firms are the most likely to bear the heaviest economic consequences of a new standard.

The first analysis we want is to see the relation between revenues and expenses and how this relation differs between the two sample groups. We hypothesised earlier that firms who submitted a comment letter are much more concerned with the effect the new standard is going to have on matching than firms who did not submit a comment letter. Based on the cost-benefit argument, we expect that firms are more concerned when they have more to lose (gain) from not lobbying (lobbying). As such, we expect there to be a stronger relation

between revenues and expenses for the Lobbying group sample. Dichev and Tang provide a formal proof of how the correlation between revenue and expenses decreases as matching gets worse. It stems from the fact that poor matching “scatters” some of the expenses across periods that are not related to their associated revenues. We examine the correlation of these two items by taking the correlation of deflated revenues and deflated expenses. To test this hypothesis, we examine the coefficients in a regression of revenues on one-year-back, present, and one-year-forward expenses. Our initial regression model is the following:

Correlation = + + + (1)

𝑅𝑅𝑅𝑅𝑅𝑅𝑡𝑡 𝛽𝛽0 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡−1 𝛽𝛽2𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡 𝛽𝛽3𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡+1 We will first run this regression for both individual sample groups to examine and compare the coefficients. However, to further explore whether there is a significant difference in correlation between firms that submit a comment letter and firms that do not, we utilise an interaction variable. This interaction variable, LOBBY, will have the value of 1 for firms that did submit a comment letter, and 0 for firms that did not. The coefficient for current-period expense (EXPt) estimates the extent to which current-period expenses varies with revenue in the current period, and the coefficients for one-year-back and one-year-forward expenses

(EXPt-1 and EXPt+1) estimate the extent to which expenses are scattered to adjacent periods.

Because we expect there to be a difference in the associations of revenue and expense between lobbying and non-lobbying firms, we expect there to be implications on volatility and persistence. Our next model addresses our first empirical hypothesis; the qualities of earnings volatility for firms that lobbied against the proposed standard. Based on our hypothesis reasoning, we expect to see that lobbying firms have less volatile earnings than their non-lobbying counterparts. To test this, we compute the firm specific volatility of earnings by calculating its standard deviation. We then take the mean of these firm specific volatilities for each sample, the Lobby Group sample and the Non-Lobby Group sample. Utilising a two tailed t-test, we compare to see if there is any significant difference between the levels of volatility. In terms of measuring persistence, we follow a similar approach that we used for testing correlation between Revenues and Expenses. We regress current Earnings against Earnings for the time period before. In doing so, we can examine how much of last year’s earnings can explain this year’s earnings (i.e. how much will last year’s earnings persist or transmit in to the present year’s earnings). We will do this for both samples to get two different persistent

levels. To test if the decision to lobby or not has a significant impact on these persistence levels, we employ an interaction variable (EARN_PAST*LOBBY). The regression model with the interaction variable is described in the Empirical Results section. But our main model for testing earnings persistence is as follows:

Persistence = + (2)

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡 𝛽𝛽0 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡−1 Empirical Results

Our first empirical test examines the correlation between revenues and expenses. We test the correlation of revenues in the current period against expenses from the past, current, and future period. The greater the correlation is between revenues and expenses in the current period, then the better matched they are (as per Dichev & Tang). The results of this are presented in Table 8. The findings from this correlation show that the coefficient is significantly higher for the Lobby Group firms than it is for the Non-Lobby Group firms. Immediately then, this suggests that firms who lobbied against the proposed standard match their expenses with the appropriate revenues ‘better’ than the firms who chose not to lobby. This results bodes well for our two hypotheses, as the effects of the two earning properties we wish to study can be proven to be affected by the level of matching. A significant difference between the levels of matching should therefore lead to a significant difference in earnings volatility and persistence.

Table 8 Regression on Revenues on Previous, Current, Future Expenses = + + +

𝑡𝑡 0 1 𝑡𝑡−1 2 𝑡𝑡 3 𝑡𝑡+1 𝑅𝑅𝑅𝑅𝑅𝑅Coefficient𝛽𝛽 on𝛽𝛽 Past𝐸𝐸𝐸𝐸𝐸𝐸 Coefficient𝛽𝛽 𝐸𝐸𝐸𝐸𝐸𝐸 on Current𝛽𝛽 𝐸𝐸𝐸𝐸𝐸𝐸 Coefficient on Future Expenses ( ) Expenses ( ) Expenses ( ) ** ** Lobbying Group 0.292 𝛽𝛽1 0.656 𝛽𝛽2 0.036 𝛽𝛽3 Non-Lobbying Group 0.061*** 0.113** 0.028* Difference 0.231 0.543 0.008

Interaction Variable 0.209* 0.554* 0.019 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

Table 9 provides the results for our first hypothesis: that Lobbying Group firms have less volatile earnings than Non-Lobbying Group firms. Here, we took the standard deviation of earnings for each specific firm. This table contains the results of this, providing mean values of the standard deviations for both samples. An inspection of these results reveal that earnings are more volatile for firms that did not lobby against the standard compared to those that did lobby against it. By conducting a two-tail t-test we can see if there is a significant difference between the volatilities of the two different samples. The results indicate there is a difference between the two at a highly significant level. The inspection also shows that there is a significant difference in the volatilities of revenues and expenses between the two different samples. This finding suggests that the behaviour of these fundamentals, such as earnings, revenues and expenses, offers an explanation as to which firms are lobbying against the standard and which are not.

Table 9 Volatility of Earnings and its Components over Time

n Vol (Earnings) Vol (Revenue) Vol (Expenses) Lobbying Group 92 0.154 0.159 0.458 Non-Lobbying Group 3393 0.928 0.297 1.140 Difference 0.775 0.139 0.682

p-value on Difference 0.0033*** 0.0012*** 0.0132** *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

As well as test Lobby Group firms against Non-Lobby Group firms, we also want to see if there is any difference in earnings properties depending on the issues raised in their comment letters. Table 10 and 11 has these results. In particular we focus on Theme I and VI (CRED_RISK & ECONOMICS). Firstly, Theme I (CRED_RISK). We split the Lobby Group sample up in to two; the lobby firms that did raise the issue of CRED_RISK, and the lobbying firms that did not raise this issue. The firms that did not raise this issue were subsequently named in to a new group: Non-Theme 1 Group. We then conducted the same test using these

two groups in order to examine if earnings properties were different between those that raised a CRED_RISK concern and those that did not.

Despite identifying 56 respondents that raised a CRED_RISK issue, we could only obtain sufficient financial data for 29 (52%) of these firms. These were then compared with the 632 that did respond, but did not mention the CRED_RISK issue.

Table 10 presents the results from this test. Whilst looking at the results of this test on the surface, it appears that the mean volatility was a lot smaller for the 29 ‘Issue I’ firms than the 63 ‘Other Issue’ firms. On top of this, the volatility in the revenue and expenses appeared to be relatively similar between the two groups. This would suggest that the increase in volatility in earnings is not because of volatility in business activity, but rather instead because of the way revenues and expenses have been matched. However, unfortunately after undertaking a two tailed t-test, no significant difference could be found between the two figures. This perhaps suggests that the earnings volatility that is expected to increase as a result of poor matching has no real bearing on whether a firm raises a specific issue with CRED_RISK. Alternatively, it could be because the sample that was tested was far too small to ever give any significant results.

Table 10 Volatility of Earnings and its Components over Time

N Vol (Earnings) Vol (Revenue) Vol (Expenses) Theme 1 Group 29 0.035 0.148 0.461 Non-Theme 1 Group 63 0.209 0.164 0.452 Difference 0.174 0.016 0.009

p-value on Difference 0.2744 0.785 0.994 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

We did a similar test for Thematic Issue VI, ECONOMICS in which we expected there to be a difference in earnings volatility between the lobbying firms that did raise this issue, and the

2 We were able to obtain sufficient financial data for 92 respondents for this specific test. 92 minus the 29 who raised Thematic Issue I gives a remainder of 63 who submitted a letter, but did not raise this issue.

lobbying firms that did not raise this issue. Earlier in the paper we made the assertion that ECONOMICS issues were indirect issues with the matching concept. Subsequently, we expected the firms that raised this issue up to be much more wary of the changes to matching, and its effects on earnings volatility.

Table 11 shows the results of the test, which was carried out in the same manner as the test for CRED_RISK. For this test, we were able to obtain sufficient financial data for 35 (60%) of the 58 respondents who raised the issue of ECONOMICS. These 37 firms were compared with the 55 respondents who did not raise this issue (that we had sufficient data for). Again, although it appeared that the earnings volatility was lower for the firms that raised the issue (as per the mean standard deviation), the difference between the two figures was insignificant.

Table 11 Volatility of Earnings and its Components over Time

n Vol (Earnings) Vol (Revenue) Vol (Expenses) Theme 6 Group 35 0.040 0.154 0.414 Non-Theme 6 Group 57 0.224 0.162 0.486 Difference 0.184 0.008 0.072

p-value on Difference 0.298 0.877 0.857 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

So although it is difficult to infer that the type of issue raised in the comment letter had any bearing on earning volatility which can be influenced by the matching concept, we can accept hypothesis 1; that firms who did lobby did have significantly less volatile earnings than the firms who did not lobby.

The second hypothesis relates to the second earnings characteristic that we expect to change in response to changes to the matching concept; persistence. The results for persistence of earnings are presented in Table 12. Based on the hypothesis made, we expect to see firms that lobbied against the proposed standard to have more persistent earnings than the firms that did not lobby. As Panel A suggests, the persistence does indeed seem to be higher for firms that partook in the lobbying process, in line with our hypothesis. The persistence across the 99

lobbying firms was 1.034 whereas earnings persistence was only 0.385 for the firms in the Non-Lobbying Group sample. This does seem like a very large difference. However, this could be down due to the large difference in observations between the two samples. Naturally, the lobbying group is going to have to a much larger standard error due to the smaller sample size, and thereby we would expect to find less statistical significance in the results. But, as the table below does show, significance was found at the 1% level for both samples, despite the small sample in the lobbying group.

Table 12 Panel A: Persistence in Earnings = +

𝑡𝑡 0 1 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 Persistence in n Earnings Lobbying Group 99 1.034*** Non-Lobbying Group 4498 0.385*** Difference 0.649

Panel B: Persistence with Interaction Variable = + + +

𝑡𝑡 0 1 𝑡𝑡−1 2 3 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 n𝐸𝐸 𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝐿𝐿𝐿𝐿 𝛽𝛽 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 ∗ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 Interaction Variable 4597 0.385𝛽𝛽1 0.832𝛽𝛽2 -0.042𝛽𝛽3 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

However, on further inspection it appears that this difference is insignificant as displayed in Panel B. By utilising the interaction variable, we could find not any statistical significance between firms who sent in a comment letter and the effect it has on earnings persistence. This is despite the apparent large difference situated in Panel A. is the coefficient that we want

to pay attention to for this. The coefficient for this interaction𝛽𝛽3 variable is, despite being negative, completely insignificant. Consequently, we cannot accept our second hypothesis that firms who lobby have more persistent earnings that firms that do not lobby.

Our next part of the analysis based on our second hypothesis is based on how the issues raised in the comment letter reflect the firms earning properties. We expect there to be significant difference in the persistence of earnings between the Lobbying Firms that raised the issue of CRED_RISK or ECONOMICS against those Lobbying Firms that did not raise

these two issues in their response. Table 13 explores this issue for Theme I (CRED_RISK). As per the results, it is apparent on Panel A that those firms that raised this issue actually have less persistent earnings than the 70 respondents who did not bring up this issue. This goes against our prediction. However, upon testing the difference between the two persistence figures, it showed that the difference was not significant and no inferences can be made. By utilising the interaction variable, Theme1, we could not find a significant difference between the two levels of persistence. Thereby we cannot claim that the persistence levels of the respondents who raised the CRED_RISK issue are any different to the respondents who did not raise this issue.

Table 13 Panel A: Persistence in Earnings based on Thematic Analysis Issue I = +

𝑡𝑡 0 1 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 Persistence in n Earnings Theme 1 Group 29 0.049 ** Non-Theme 1 Group 70 1.038*** Difference 0.989

Panel B: Persistence with Interaction Variable = + + 1 + 1

𝑡𝑡 0 1 𝑡𝑡−1 2 3 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 𝐸𝐸N𝐸𝐸 𝐸𝐸𝐸𝐸 𝛽𝛽 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝛽𝛽 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 ∗ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 Interaction Variable 99 1.038𝛽𝛽1 0.157𝛽𝛽2 -0.902𝛽𝛽3 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

However, when we used the interaction variable for the ECON issue (Theme VI), we actually find a significant correlation, but not in the direction that we expected. Despite expecting firms who raised the ECON issue to have a positive correlation with persistent earnings, we find the opposite. There is a significant negative correlation between submitting a comment letter with the ECON issue and earnings persistence. What we can take from this is that firms from the Lobby Group sample who raised the ECON issue have less persistent earnings than the Lobby Group firms who did not raise this issue.

The overarching conclusion to take, however, from the second set of results is that we cannot accept hypothesis 2. We could not find a significant correlation between the level of earnings persistence and the decision to submit a comment letter to the Board. Despite not finding any significant relationship between Lobby Group firms and Non-Lobby Group firms, we did find a significant relationship between the respondents based on the issues that they used in their response. This seems somewhat surprising, and contradictory. Why would there be a difference between firms who did not raise the issue of ECONOMICS in the manner of not submitting a comment letter and firms who did not raise this issue and yet did submit a comment letter. Ultimately, neither groups have submitted an issue with the ECONOMICS, and yet we infer different conclusions from the tests. This could possibly be an area of future research.

Table 14 Panel A: Persistence in Earnings based on Thematic Analysis Issue VI = +

𝑡𝑡 0 1 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 Persistence in n Earnings Theme 6 Group 39 0.025 Non-Theme 6 Group 60 1.469 Difference 1.444

Panel B: Persistence with Interaction Variable = + + 1 + 1

𝑡𝑡 0 1 𝑡𝑡−1 2 3 𝑡𝑡−1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝛽𝛽 𝛽𝛽 𝐸𝐸n𝐸𝐸 𝐸𝐸𝐸𝐸 𝛽𝛽 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝛽𝛽 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 ∗ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 *** Interaction Variable 99 1.469𝛽𝛽1 0.074𝛽𝛽2 -1.444𝛽𝛽3 *, **, *** represent significance at the 10 percent, 5 percent and 1 percent levels respectively.

Conclusion, Limitations and Future Research

The principal aim of this paper was to examine how the characteristics of good matching on earnings quality played a part in the lobbying behaviour of firms on the proposed changes to recognising revenue. Previous literature indicates how standard setters are swaying away from the revenue-expense approach to financial reporting, and more towards the asset-

42 liability approach. Consequently, this means that the matching of revenues with their appropriate expenses is going to be compensated. The proposed standard for recognising revenue follows this trend, and as such we examine to see if this threat has any influence on the decision to lobby against the proposed standard.

This paper starts by examining the due process used jointly by the FASB and the IASB in relation to its proposed revision to how companies will recognise revenue from contracts. The principal insight in to this examination is to understand what concerned preparers about the revised Exposure Draft, and the issues that they identified with this proposal. By systematically going through 155 submitted comment letters, we identified seven key issues that repeatedly came up in the responses. Despite only a handful of responses make direct reference to the matching concept, two of the seven themes make an indirect reference to this, and the negative effects that the proposed standard will have on this concept. By doing this, we differentiate the respondents in to those that are more concerned about the effects of matching and those that are less concerned. Firms that raise these two issues are assumed to be indirectly raising the issue of the matching concept, and how it will be tarnished should the proposed standard come to fruition. As a minor test, we wanted to see if the strength of the comment letters (as proxies by the number of pages) bared any association to the themes that were included in the letter. The results of this study did not find any significant findings, but due to the nature of the data this was hard to appropriately test for.

Using Dichev & Tang’s (2008) model of perfect matching, we incorporate their observations that better matching results in less volatile and more persistent earnings. We compare these characteristics between the firms that chose to lobby against the proposal against a matched sample that did not choose to lobby. Based on previous literature, we only expect firms to lobby against the standard if the benefits of doing so outweigh the costs. Firms who have more to lose as a result of the changes have more to gain if the standard is changed or bought to a halt. As such, we hypothesised that the firms who currently reap the most benefits from the current standard (i.e. more persistent and less volatile earnings) have more to lose should the new standard eliminate these benefits.

The results concluded that earnings volatility was significantly greater for the firms that did not lobby. This suggests that firms who benefit from less volatile earnings have a greater incentive to lobby against the proposed. On the other hand, we found that there was no significant difference in earnings persistence between those who lobbied and those who did

not lobby against the standard. However, we did find that the respondents who had an issue of how the new standard would fail to reflect the true economics of the transaction had significantly less persistent earnings than the respondents who did not raise this issue. This finding went against our predictions, and seems somewhat contradictory. This finding could provide an opportunity for further research to explain why this was the case.

Therefore, what we can take from this study is that there is a strong association between earnings volatility, a consequence of poor matching of revenue and expenses, and a preparer’s decision to lobby against the proposed standard to revenue recognition.

Naturally, there are some limitations in this study which need to be addressed. Firstly, the comment letters that were analysed were only those that responded to the Revised Exposure Draft to Revenue Recognition. The comment letters that were submitted as part of the original exposure draft were ignored. While this was necessary to ensure that we only considered issues with the most up to date proposal, it also means that potential issues were missed. It is possible (and likely) that some respondents responded to the original Exposure Draft, but not to the Revised one, despite not having their issue addressed. This means we potentially miss out on a larger sample of firms who were still not happy with the Revised Exposure Draft. It is unlikely that all of the preparers who responded to the original Exposure Draft, but not the revised one, had their issues and concerns appropriately addressed. By including the firms who lobbied against the original Exposure Draft, we would have a greater sample and ultimately more data to work with. Naturally, there would be some limitations that would need to be addressed in including these firms, but it would offer as a chance to have a greater insight in to the preparer’s thoughts on the proposed standard.

Secondly, there is a natural limitation in the way that we interpreted the comment letters. This was done with the help of a colleague. Due to time constraints, it was not possible to ensure that each individual letter was interpreted the same by both my colleague and myself. Therefore it is possible that there was a difference in the way my colleague interpreted a comment letter and the way that I would have interpreted it. We make a deliberate agreement to share with each other any comment letters that we were unsure about which mitigates this problem, however.

Thirdly, due to the nature of the respondents, we had to omit a lot of them from the empirical analysis. Not all of the firms had available data, and so a sizeable chunk of the Lobbying Group was not able to be included in the empirical tests.

Fourthly, in the literature section we make a point of how firms will only lobby if the benefits of doing so exceed the costs. However, just because this is the case it does not necessarily mean that they will lobby. A number of firms may have it in their best interest to expend the resources in lobbying to the Board, but choose not to do so for other reasons. Francis (1987) explains how the free-riding problem can also be applied to lobbying. Despite it being in the interests of a firm to lobby, it might not do so in the hope that other like-minded firms will lobby on behalf of it. Again, this limits the potential Lobby Group sample, and excludes many firms that might otherwise be in it. Furthermore, there are also multiple other methods of lobbying against a proposed standard. This study only considers the comment letter approach, but it is possible that other firms who have issue with the proposed standard took other, more direct approaches. This could include having face to face meetings with them, making their issues known over telephone, or making their frustrations known indirectly through commenting in the media or sponsoring particular research studies for example. Because we only considered one lobbying approach it is likely that we also miss out on an entire subset of respondents who prefer different methods. Though, naturally, because of the ease of obtaining these comment letters, using this approach is a lot less time and resource intensive. But it is important to understand that lobbying does not just equate to the submission of a comment letter.

This paper is primarily descriptive in nature. Both the quantitative and qualitative analysis aim to describe the firms that lobby, and how characteristics in matching can help further describe these firms. Whilst we found, for example, that firms who lobbied had less volatile earnings than the non-lobbying firms, the paper offers no rationale for why other ‘low volatile’ firms that were in neither sample chose not to lobby. Obviously, there are more than 99 firms with the available data that have low volatility in their earnings. Would it therefore not be the case that we would expect these firms to lobby against the standard too?

Last but not least, it is important to consider that Dichev and Tang place the ‘blame’ of the worsening of the matching principle solely on the standard setters active decision to move towards the asset-liability approach. However, other papers, such as Donelson et al (2011), argue that the decrease in matching is not down to the standard setters. Instead, it is due to the ‘special items’ that have been progressively more common in financial reporting. Although they could not totally rule out the effect of accounting standards on matching, subsequent studies could build upon this paper by utilising the effects special items have on the earnings characteristics.

In terms of further research, there are a lot of possibilities. IFRS 15 has only just been released at the time of writing. Therefore, it is impossible to examine what effects it will actually have on a preparer’s financial statement. Based on the previous literature, we expect it to worsen the matching of revenues and expenses, and consequently have an effect on volatility and persistence. However, it is not yet possible to see if this will actually be the case. Future research, when the data becomes available, could study to see if these predicted effects actually come to realisation. Further research could also examine whether other projects which are swaying from the revenue-expense approach to the asset-liability approach are being met with concerns in relation to the matching concept.

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Appe ndix Table showing t-test significance levels between the length of different themed responses I 1 2 3 4 5 6 7 1

2 0.445339 1 3 0.152399 0.432146 4 0.874251 0.483136 0.154468

5 0.352426 0.901225 0.475888 0.37105 6 0.107912 0.350307 0.920053 0.104431 0.386448 7 0.549186 0.874094 0.359803 0.60553 0.771658 0.285224