oped by the analyst on the basis of ratios of comparable companies in the local envi-
ronment prepared under accounting rules existing in that country. If the analyst were
to apply the same nominal benchmarks to a company whose balance sheet was pre-
pared under a different set of rules, it is not inconceivable that the analyst could ar-
rive at an inappropriate conclusion in the absence of any additional effort to interpret
that information properly.
Furthermore, the capital market’s inability to understand efficiently a company’s
performance could have a detrimental effect on the entity’s ability to raise capital at
competitive prices. For example, pricing inefficiencies may arise because the com-
pany has adopted unique accounting policies that are unfamiliar to investors and
creditors, the display of financial information in the primary statements and the foot-
notes does not follow accepted reporting conventions, and/or the company provides
relatively less extensive or transparent disclosure compared with other companies in
the market. Other things being equal, pricing inefficiencies may imply that a com-
pany’s cost of capital will be relatively higher and that the price of its equity and debt
will be relatively lower. Pricing inefficiencies could become evident in the domestic,
foreign, or international markets and, while this is not only a cross-border issue, the
area of greatest variation is perceived to exist between the reporting of companies
from different countries. However, the existence of inefficiencies implies that there
will be pressure on companies to improve their financial reporting in ways that lower
their cost of capital. To illustrate this point, anecdotal evidence from certain Swiss
companies has indicated that the adoption of more comprehensive and internationally
accepted financial reporting and disclosure standards resulted in significant increases
in their stock prices.
Perceptions about the reliability of financial reporting and disclosure made by
companies from a particular country also affect the cost of capital. This is because
the release of inaccurate information will lead to pricing errors and because a lack of
full disclosure will lead to pricing inefficiencies as well as leaving the door open for
insider trading and other forms of price manipulation. To protect the public, the is-
suer and other parties (underwriters, lawyers, accountants, etc.) associated with a
U.S. prospectus must ensure that the statements made in the prospectus are accurate
and that material facts have not been omitted. Full disclosure is believed to enhance
the credibility of the markets, to improve their efficiency, and to make the capital
markets attractive to the public. Given the liability standard associated with SEC fil-
ings, fulfilling these requirements demands a high standard of honesty and integrity.
Companies from countries that place relatively less emphasis on complete and accu-
rate reporting and disclosure may be penalized unless they take steps to adhere to
more internationally accepted reporting and disclosure practices.
In addition to the negative impact on an entity’s capital-raising ability and cost of
capital, disharmony in accounting principles makes it difficult to monitor competitive
factors. Officers whose responsibility it is to develop competitive strategies may not
fully understand the accounting rules of their foreign competitors and thus cannot ef-
fectively assess their competitors’ performance. Differences in accounting principles
have a large impact on many business decisions for other reasons as well. For exam-
ple, some have suggested that one of the reasons for the continuing wave of mergers
and acquisitions by British companies of American companies may be the differences
in accounting for goodwill in the two countries. Furthermore, accounting differences
have apparently affected the investment decisions of institutional investors from
many countries. The concerns of institutional investors typically relate to their lack
12 • 8 SUMMARY OF ACCOUNTING PRINCIPLE DIFFERENCES