School of Management

Royal Holloway, University of London

INTERNATIONAL EQUITY ANALYSIS UNDER IFRS: A CASE STUDY OF LONDON BASED SELL-SIDE ANALYSTS

MN5906

MSc. in International Accounting

Randolph Perry

Candidate Number: 1301003

Supervisor: Dr. John Ahwere-Bafo

18 September 2013

This dissertation is submitted as part of the requirement for the award of the

Master of Science in International Accounting

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Declaration

This Dissertation has been prepared on the basis of my own work and that where

other published and unpublished source materials have been used, these have been

acknowledged.

Word Count: 12,032

Student Name: Randolph Perry

Signature:

Date of Submission: 18 September 2013

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Abstract

This paper explores a seemingly incorrect perception among primary users of

accounting information that international accounting practices under IFRS

(International Financial Reporting Standards) are universally implemented in

different countries. Sell-side financial analysts at large investment banks are used as

a proxy for “primary users.” Data indicates that these sell-side financial analysts

produce investment recommendations for the largest institutional investment firms

in the world; making them the most likely to have significant impacts on equity

markets. Currently there is no research that examines the contemporary

responsibilities of financial analysts with relation to international accounting

information in the post-IFRS era. Prior research is used to demonstrate that

differences in accounting practices exist under IFRS despite the harmonization of

accounting standards. Therefore, even though it has been shown that differences in

accounting practices exist under IFRS, there is a perception among primary users of

accounting information that there are no such differences in practice because the

accounting standards are universally accepted.

The usefulness of accounting information in the role of financial analysts is also

further examined. The position of a London based sell-side analyst is subsequently

explored through two interviews and findings are transcribed. The results indicate

that there is no current literature detailing how primary users of accounting

information cope with international differences in the post- IFRS era, because there

is a perception among primary users that there are no differences in accounting

practices under IFRS. A secondary finding of significance indicates that financial

analysts rarely use audited annual reports and find little value in them.

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Table of Contents

1. INTRODUCTION ................................................................................................5

2. BROAD RESEARCH OVERVIEW ....................................................................7

3. RESEARCH AIMS .............................................................................................10

4. STRATEGY ........................................................................................................12

5. THEORY OF KNOWLEDGE TRANSFER.......................................................15

6. EMPIRICAL BACKGROUND AND PRIOR LITERATURE...........................19

6.1. Financial Analysts and Foreign Accounting Data .......................................19

6.2. The History of IFRS.....................................................................................20

6.3. Scope for International Differences Under IFRS.........................................25

7. PROPOSALS ......................................................................................................32

8. RESEARCH PROCESS .....................................................................................33

9. FINDINGS ..........................................................................................................35

9.1. Role of the Sell-Side Analyst ......................................................................36

9.2. Analyst Accounting Expertise and IFRS Perceptions .................................41

9.3. Usefulness of Quarterly and Annual Reports ..............................................42

9.4. Usefulness of Non-Accounting Information ..............................................43

9.5. Summary of Findings ................................................................................. 45

10. CONCLUSIONS AND IMPLICATIONS ..........................................................45

11. References ...........................................................................................................48

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1. Introduction

For the majority of financial analysts, having accounting rules in different

countries that generate completely different sets of financial reports is hopelessly

confusing (Antill & Lee 2008, p. xxiii; Nobes & Parker, 2010, p108-110). This was

very much the case in the pan-European equity market prior to 2005 (Miles &

Nobes, 1998; Clatworthy, 2008). Investors, analysts, lenders, or suppliers would

have to cope with the international differences of accounting practices in order to

understand the performance of a company (Antill & Lee 2008, p. xxiii; Nobes &

Parker, 2010, p108-110; Miles & Nobes, 1998). The desire to strengthen the EU

capital markets by establishing a standardized accounting system would become a

major driving force in the development and utilization of International Financial

Reporting Standards (IFRS) (Nobes & Parker, 2010, p108-110). Harmonization

efforts to produce a single set of high quality global accounting standards began to

move swiftly by the late 1990’s, and in 2000 the EU Commission proposed a

mandatory adoption of IFRS for the consolidated statements of all listed companies

in the EU (Nobes & Parker, 2010, p108-110).

Fast forward to today: The EU has sufficiently adopted a universal set of

financial reporting standards in the form of IFRS, and the SEC in the United States

has eliminated the need for foreign stock market registrants to reconcile from IFRS

to US GAAP (Antill & Lee, 2008, p. xxiii; Nobes & Parker, 2010, p108-110). These

two events have significantly contributed to the momentum behind IFRS adoption

around the world. Additionally, companies in emerging markets can add credibility

to their recorded performance by adhering to a universally accepted set of high

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quality accounting standards (Antill & Lee, 2008, p. xxiii; Ball, 2006). Essentially, it

is the view of the contemporary financial analyst that international accounting

standards have been developed and implemented in the EU and around the world,

affectively dispelling a potential inefficiency in capital markets as a result of

different accounting practices being used in different countries.

This singular perception is the main focus of this research study and should

be viewed as a major problem with the way primary users of financial statements

effectively process accounting information. Ball (2006) addresses a very important

subject area relating to this perception, “that converge de facto is less certain than

convergence de jure.” This point which can be applied to adoption, fundamentally

states that, “convergence in actual financial reporting practices is a different thing

than convergence in financial reporting standards” (Ball, 2006).

The works of Ball (2006) and Kvaal (2010) empirically show that

differences in accounting practices exist in different countries under IFRS even

though the accounting policies are the same. Patterns are developed from the

national accounting traditions in the domestic financial statements, which then flow

onto the consolidated statements of the large corporations examined (Ball, 2006;

Nobes, 2006; Kvaal, 2010). Scope for this exists in IFRS because there are options

for different accounting choices under IFRS (Nobes, 2006). Eight types of

opportunities for variations in accounting practices are further documented by Nobes

(2006) and in future research, as he and Kvaal (2010) conclude that “companies, in

the absence of strong incentives to do otherwise, will pursue a policy previously

adopted if it is still allowed.” Following studies by Ball (2006) and Nobes (2006),

Zeff (2007) identifies four types of cultures inherent in different countries which

present significant obstacles to global financial reporting comparability. Finally,

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research from Alexander (2006, p. 75) notes that “the use and interpretation of

financial reports requires an understanding of the context in which, and the thought

process under which they are prepared.” These findings indicate that the primary

users of accounting information still need to employ discretion when analyzing the

performance of an international company, in isolation or against its peers, to cope

with considerable international diversity in accounting practices under IFRS.

2. Broad Research Overview

In order to properly understand the specific research aims of this dissertation,

it is important to address the contextual events surrounding these objectives. This

research involves the role of accounting on stock markets and is motivated by both

empirical observations and by the prior literature. To explore the lasting effects of

international diversity under IFRS, it is important to obtain knowledge about how

accounting is used in practice on stock markets, and the coping mechanisms applied

for such diversity. These issues, which were highly under-researched in the period

prior to IFRS, are now virtually nonexistent in contemporary literature.

Companies listed on stock markets produce accounting information that is

used by investors worldwide. The transfer of information from companies to

investors is especially interesting, and a topic covered in section 5 of this research.

Marton (1998) points out that actors on stock markets are often anonymous and that

companies and their investors do not communicate directly. This leads to the

rationalization that financial reporting as a direct line of information is what makes

accounting so useful in equity markets (Marton, 1998). Accounting can therefore be

seen as a valuable source of information transfer between companies and investors

on any given stock market.

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Given this assumption, it is expected that the role of a modern day financial

analyst will heavily involve the use of accounting information. Pre-IFRS studies

discussed in section 6.1 empirically research this function, which included coping

mechanisms for international diversity. This research, explores the post-IFRS

perception of London based financial analysts, who appears to believe that

accounting differences from different countries no longer exist due to the adoption

of IFRS. Today, very little is understood about how equity analysts utilize financial

information and cope with international diversity. In fact, so little is known

publically about the roles of those in financial markets, that a London based

publication recently conducted 70 interviews in the financial industry and produced

a piece titled The Voices of Finance (The Guardian, 2013).

The ultimate providers of capital for equity markets are investors and the

London Stock exchange is widely considered to have the largest internationally

oriented financial market in the world (Miles & Nobes, 1998; Clatworthy, 2007).

Over the past few decades, this capital market has seen substantial increases in

international investments dominated by institutional investors (Myners, 2001;

Clatworthy, 2007). In lieu of credible sources of information for UK institutional

investor data, a comparable analysis produced by an SEC commissioner in the

United States shows that in 2009, institutional investors owned an aggregate 73% of

the outstanding equity in the 1000 largest US corporations (SEC Filings, 2013).

With regard to the use of accounting information, this data suggests that financial

analysts producing investment recommendations to the world’s largest institutional

investment firms, are the most likely to have a significant impact on stock markets.

Investment banks in the UK play the role of the middle man for almost all

aspects of the London equity market (Marton, 1998; Clatworthy, 2008). As financial

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intermediaries, investment banks receive data and information produced by listed

companies and sends the processed results to institutional investors who ultimately

make investment decisions. Employees for the bank who receive and process the

data and information from companies are called sell-side analysts. The sell-side

analyst constructs reports that are used by investment firms to make investment

decisions. The investment bank also works as a brokerage house and makes money

in the form of commissions from securities trading. The financial analysts of the

investment bank are called sell-side analysts because they work for the firm that

sells securities. Portfolio managers at large institutional investment firms also

employ financial analysts called buy-side analysts. Buy-side analysts directly use the

reports produced by sell-side analysts in conjunction with their own knowledge of a

company in question to produce a report that is in turn analyzed by the portfolio

manager. This chain of analysis that leads to large institutional investment decisions

begins with the sell-side analyst.

Sell-side analysts represent a clearly definable group, and their investment

decisions have been shown to be the most influential on stock markets (Barker,

1998; Marton, 1998). From an accounting perspective, professional bodies are most

concerned with the way users interpret accounting information. The IFRS

Framework classifies primary users of general purpose financial reporting as

“present and potential investors, lenders, and other creditors, who use that

information to make decisions about buying, selling, or holding equity or debt

instruments and providing or settling loans or other forms of credit” (IFRS

Framework, 2013). Barker (1998) and Marton (1998) also both characterize sell-side

analysts of large investment banks, as amongst the most important users of financial

statements. Miles & Nobes (1998) showed that 7 out of 8 fund managers assumed

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that analysts made all adjustments necessary for international diversity in accounting

information. This paper proceeds by using the sell-side analyst as a proxy for the

defined “primary user” in the IFRS Framework, and focuses on the sell-side analyst

as the main receiver and interpreter of financial information from companies on the

equity market.

To conclude this section, it is important to define accounting information in

this study as annual and quarterly reports issued by companies. Accounting

information is only used in reference to financial reporting, while managerial

accounting is not examined in this research. The investors and analysts considered in

this research are employed by large investment banks and other financial institution.

They are assumed to be the most informed users for interpreting accounting

information and the most influential in effecting equity markets.

3. Research Aims

This paper examines the pan-European equity market after the mandatory

implementation of International Financial Reporting Standards. The main objective

of this research is to explore the incorrect perception among primary users of

accounting information that international accounting practices under IFRS are

universally implemented in different countries. The role of this perception and how

it may ultimately affect investment decisions is also subsequently investigated.

In order to accomplish this primary objective, the following secondary

research aims must be accomplished:

1. Demonstrate that differences in IFRS practice exist.

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2. Examine the role of the sell-side analyst.

3. Explore the extent to which accounting information is useful in the

work of a sell-side analyst.

Aim number 1 provides the fundamental context for this dissertation. The

purpose of this paper is to explore a disturbing perception among primary users of

accounting information that differences in IFRS practice do not exist. It is therefore

crucial to establish that differences in IFRS practice do exist.

Achieving Aim number 2 satisfies the general relationship between this

secondary objective and the main objective. The perceptions developed by the

primary users of accounting information cannot be adequately explored without

properly understanding the contextual events surrounding the users. Therefore, the

role of the sell-side analyst as a proxy for primary users must be understood.

Additionally, as this role appears to be shrouded with mystery (The Guardian,

2013), it is important for this research to help shape a view of the current position

for future research, as the role has significant implications in financial markets.

As with aim 2, there is a general relationship between aim number 3 and the

main objective. An interaction between aim 2 and aim 3 also exists, as exploring the

latter is helpful in examining the prior and vice versa. With regard to the main

objective, if accounting information is useful to the work of sell-side analysts, then

incorrect perceptions about it may have serious implications for equity markets.

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4. Strategy

An explorative case study is used in this research to enlighten readers and

satisfy the primary objective. The rationale behind this explorative research was

developed due to a significant lack of current research on how primary users of

accounting information cope with differences in accounting policies post-IFRS.

Previous research conducted by Miles & Nobes (1998) discusses foreign accounting

data in UK financial institutions, but a more contemporary analysis after the

adoption of IFRS has yet to be determined. Clatworthy (2008) makes references to

the continual challenges of accounting harmonisation under IFRS, but his statistical

work and data collection was performed before the mandatory implementation of

IFRS. The primary motivation of Clatworthy (2008) was to expand on the work of

Miles and Nobes (1998), while further examining the coping strategies undertaken

by UK analysts and fund managers for international analysis. Zeff (2007) continues

to elaborate about the detailed harmonisation problems exposed by research

developed in the wake of a dramatically changing accounting landscape. There are a

handful of contemporary studies on the existence of differences in international

financial reporting practices pre-&-post-IFRS. Ball (2006), Nobes (2006), and Kvaal

(2010 & 2012) are some of the most notable. However, none of them discuss how

analysts or primary users cope with these issues post-IFRS.

The intention of this paper is to utilise a multi case study strategy to

determine how international financial reports are assessed by sell-side analysts.

Using the case study as a research strategy for this paper provides a number of

benefits to the researcher and also compliments the purpose of this paper in terms of

data collection and observation. The aim is to design two good case studies that

explore contemporary accounting issues in the London equity markets. This paper

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will conclude the research by presenting the findings and answering the objectives.

The case study strategy best represents real life scenarios, and this is a primary focus

encouraged by this explorative research. As no current research has been done on

the topic of this paper, the information that can be explored will provide a more

enlightened view for future empirical research. This information can be used to

better quantify future observations and draw up better conclusions with the

collection of more precise data.

This form of research strategy focuses on “how and why” topics, and does

not require control of behavioural events as these are merely observational (Yin,

2009, p8). As no current research has been done on the topic, this paper will have to

focus on contemporary events. According to previous work conducted on using

correct research methods, the situations described above dictate that a case study is

the most relevant research method to use (Yin, 2009, p8). “How” and “why”

questions are more likely to lead to the use of case studies as a research method, and

in the cases of this study, help explore the subject area (Yin 2009, p9). Such

questions often deal with operational links which need to be traced over a period of

time and in the case of our studies it needs to answer questions based on work

conducted pre-IFRS and link them to this paper’s formulated objectives and

questions relating to post-IFRS research. In comparison to other studies which focus

on “how” and “why” questions, for instance history studies, case studies add an

extra two sources of evidence: “direct observation of the events being studied and

interviews of the persons involved in the events” (Yin 2009, p11). This added depth

of focus towards contemporary events is very important and a crucial aspect towards

gaining enlightenment in the subject area. Although case studies and historical

studies can overlap, a case study’s unique quality lies in its strength and ability to

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deal with a “larger range and variety of evidence—documents, artifacts, interviews

and observations,” aspects of which are beyond the scope of conventional historical

studies (Yin 2009, p11). Though like historical studies, experiments are a systematic

method of research, they are also not relevant to this study because there is no

examination of behavioural outcomes by the investigator (Yin 2009, p11). It seems

then, utilising case studies is the best strategy for this paper.

The essence and central tendency among this research strategy is that, “it

tries to illuminate a decision or set of decisions, why they were taken, how they

were implemented, and with what result” (Yin, 2009, p14; Schramm, 1971). For this

paper, a set of outcomes will not be relevant, as the study is exploratory in nature

and does require a clear or evident result. However, the objectives are clearly set,

and providing insight to those objectives should leave implications to the

phenomenon and the context. Two case studies through the use of face to face

interviews were conducted in this research. Sell-side financial analysts were asked a

series of questions regarding their occupation within an investment bank to satisfy 3

of the 4 objectives. Aim number 1 is satisfied by citing the previous literature that is

continually promoted throughout this dissertation.

The remainder of this paper is organized as follows: The next section

employs a theoretical system of information transfer in the business environment.

Continuing from this development, prior research is analysed and used as a

contextual basis for the main objective. Proposals outlining the direction of the case

studies are presented, followed by the research process. Findings are stated, and the

dissertation concludes with answered objectives and implications of the research.

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5. Theory of Knowledge Transfer applied to Capital Markets

Further inquiry into the role of financial analysts requires a theoretical

understanding of how information is transferr ed on equity markets. This paper will

clarify the process of information or “knowledge transfer” between companies and

analysts using financial reports with business related theories of information transfer

from Lin (2005). From an accounting perspective, what is interesting about the stock

market is the way anonymity plays a role in the set up of this “transfer,” in that listed

companies and their investors often communicate using the intermittent issuance of

financial reports, but often never communicate directly (Marton 1998). According to

Beaver (1989), “direct two way communication is often impossible” because there

are a large number of “players” or “middle men” between companies and investors.

The “path of communication” between them is also often restricted by regulators

where any form of private communication is stringently controlled (Marton 1998).

As a result, financial reports have the potential to be vital sources of information

between the “path of communication," as they form an important bearing in stock

market transactions (Marton 1998). To clarify this “path of communication,” a

simple model (figure 1) using the “sender-receiver” concept in knowledge transfers

will be used, and the roles of the “players” or “actors” within this path will be

elaborated on.

Lin (2005) proposes a “sender-receiver framework for studying knowledge

transfer” and discusses the barriers which exist for parties seeking knowledge. For

the purpose of this paper, knowledge seekers will be analysts and investors in the

stock market, while knowledge itself will represent financial information. Lin (2005)

states that knowledge transfer is increasingly distributed between “geographically

dispersed individuals” and that “outsourcing and globalisation” implies knowledge

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transfer which crosses national boundaries. This supports globalisation issues within

the accounting field leading to more internationalised financial reporting (Nobes,

2006). Lin (2005) also states that shifts towards more “distributed forms of

organisations have presented new challenges to knowledge transfer,” and that

“information incompleteness” may negatively impact the transfer of knowledge.

Figure 1 is a very simple and intuitive model proposed by this study based on

the work by Lin (2005), for describing the interrelationship between companies

(senders) providing financial information (knowledge) to analysts/investors

(receivers). The model will be used to describe the transfer of knowledge (financial

information) between companies and sell-side analysts. The sell-side analyst’s

perception of this information is then relayed to the buy-side analyst/ institutional

investor. Figure 1 displays knowledge transfer of financial information in capital

markets:

Figure 1

* *

*arrows signify direction of knowledge transfer

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COMPANY

(SENDER)

SELL SIDE ANALYST

(PRIMARY RECEIVER)

BUY SIDE ANALYST/

INSTITUTIONAL INVESTOR

(SECONDARY RECEIVER)

Differences in financial reporting between international companies can cause

problems to analysts (knowledge seekers) as their ability to share knowledge might

be affected by limiting the ability to assess and understand the different international

financial reports. To elaborate further, there are two types of information structures

which are common settings of knowledge transfer within business settings: sender-

advantage asymmetric information structure and symmetric incomplete information

structure (Lin, 2005).

The first structure is where the sender has more existing information than the

receiver about the knowledge transfer, and that with this asymmetry, there is a

possibility of leading to a failure or malfunctioning of the knowledge market (Lin,

2005). This is typically the feature in capital markets as it is knowledge senders or

companies who post financial reports which provide information about the company

to the investors/analysts who in turn, without the same prior knowledge of the

financial information, are seeking the utility of that information to make investment

decisions. Failure or malfunctioning of the market in the context of stock markets

can be expressed using examples of companies providing financial information

which are then misinterpreted by analysts who wrongfully advise investors into

making investment decisions.

This structure of information transfer was a large problem in the pan-

European equity markets prior to the implementation of IFRS. To improve the

sender-advantage asymmetric information structure, Lin (2005) proposes “signalling

mechanisms” to cope with such potential failure in knowledge transfer. For financial

reporting, IFRS can be viewed as a “signalling mechanism” designed to alleviate the

problems of international accounting. However, it is a purpose of this paper to

demonstrate that the correct interpretations of financial reporting under IFRS cannot

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be achieved without a thorough understanding of how accounting practices can

differ across borders.

Symmetric incomplete information structure, is where “neither the sender

nor the receiver has complete information about the knowledge transfer” (Lin 2005).

In capitals markets, our research uses an example of less than adequate accounting

practices and options being applied in foreign countries. For instance, Ball (2006)

discusses how foreign subsidiaries of an international company may not report

timely losses due to sub-standards in foreign regulations; thus incentives to report

such losses are decreased. Such information manipulation by the hand of

subsidiaries can lead to a phenomenon known as “signal-jamming” where the

integrity of the knowledge transfer has been compromised (Lin 2005). In this case,

there could be a compromise in accounting numbers as net income/net asset figures

in these subsidiaries may be misrepresented to the parent company by using

incomplete financial information in reports (Ball 2006). This international parent

company is unaware of the fact that it is now the sender of such incomplete financial

information to a receiver or analyst who is likely to be even more unaware of the

incomplete information sent in the consolidated reports. Ball (2006) goes on to

further outline certain “pros and cons for investors” in relation to IFRS policy, but

focuses more on the “volatility” in financial reporting with arguments for and

against IFRS. He believes “implementation is the Achilles heel of IFRS,” and that a

uniform set of accounting standards will not necessarily lead to uniform reporting

behaviour (Ball, 2006).

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6. Empirical Background and Prior Literature

6.1 Financial Analysts and Foreign Accounting Data

For the majority of analysts, the major material of analysis is “those streams

of income derived from core business activity, i.e. sales of core products and

services” (Antill & Lee, 2008, p.91). An analyst must be able to clearly recognise

revenue issues in their field/sector in order to understand and able to valuate

companies properly, thus assisting financial investment making decisions (Antill &

Lee, 2008, p.90). Interpreting financial accounting information provides the

foundation for revenue recognition issues within a specific sector. Financial analysts

must therefore be able to competently forecast investment influencing issues through

the use and interpretation of accounting data.

Many financial analysts in London work within sectors which scope out

internationally. International Financial Reporting Standards exists to eliminate

differences in financial reporting in order to increase efficiency in the capital

markets. The EU adopted the use of IFRS in 2005 for listed companies, and this has

contributed to the gradual adoption of IFRS globally (Nobes & Parker, 2010, p108-

110). However, differences in international financial reporting still survive under the

practice of IFRS (Nobes, 2006; Ball 2006; Zeff. 2007; Kvaal, 2010).

These differences should affect the way analysts interpret financial data

within their sector and influence investment making decisions. Before the

widespread adoption of IFRS, research done by Choi and Levich (1991), Miles and

Nobes (1998), Marton (1998), and Clatworthy (2008); was designed to identify the

coping strategies of financial analysts for such inefficiencies. Miles & Nobes (1998)

conducted interviews of17 London-based international analysts and fund managers.

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The research indicated that most analysts were unaware of international accounting

differences, with only some cases of specialist sector analysts being aware of only

UK and US practices (Miles and Nobes 1998). Marton (1998) shows that financial

reports provide a useful source of information on the stock market, but finds that

there are negative implications from combining international trading with

domestic/national financial reporting systems. The work done by Choi and Levich

(1991) interviewed users of cross-border data in 52 organizations in five major

financial centres. Over half of the users were found to report an effect on their

market decisions due to international accounting diversity. Clatworthy’s (2008)

results indicate a substantial reliance on sources other than the annual report by

analysts when analysing overseas companies. His work also states that the process

involved in the analysis of overseas equities remains a largely unexplored area of

research.

The EU’s mandatory adoption of IFRS gave way to much research

speculating its effectiveness with regard to extinguishing international accounting

practices. Several specific research issues using empirical observations and data

collection were able to address and measure prevalent national accounting practices

that remained under IFRS. This study will attempt to identify an existing gap in

industry research, by exploring the use of accounting data and financial reports from

listed companies and how they are used by analysts post-IFRS.

6.2 The History of IFRS

International Financial Reporting Standards (IFRS) are issued by the IASB

(International Accounting Standards Board), an independent organisation based in

the UK (Nobes & Parker, 2010; Ball, 2006, Antill & Lee; 2008). Purported to be a

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set of financial reporting rules which would apply equally to public companies

worldwide, IFRS was originally produced to achieve higher quality standards, while

striving to improve the “harmonisation of preparation and presentation of financial

statements” (Antill & Lee, 2008, pg xxii; Ball 2006). For financial analysts and

investors, the differences in financial reporting internationally as discussed above

can provide obstacles towards the understanding of a company’s performance and

reported earnings. International standards in accounting have been set up to try and

eliminate these differences and decrease the potential inefficiency in capital markets

these differences might cause (Antill & Lee, 2008).

IFRS has been adopted in many parts of the world. It is important to clarify

the meaning of “adoption” as in context to financial reporting. It means that national

accounting rules are set aside and replaced by IFRS using a level of national

jurisdiction (Nobes & Parker, 2010, p108-109). According to Ball (2006), global

adoption of IFRS will be beneficial to investors using financial reports by increasing

the quality of information provided. A number of potential advantages for using

IFRS can be determined for investors; for instance the costs needed to compare

alternative investments will be reduced as a result of eliminating the need to make

adjustments in international financial reports (Ball, 2006). For investors, this could

reduce costs of processing such financial information and therefore provides

beneficial appeal to investors in the global adoption of IRFS (Ball, 2006).

Companies providing financial statements using IFRS are also expected to benefit

from the adoption as international investors will be more likely to invest in these

companies. For example, reducing international differences in accounting to some

degree helps to remove barriers to cross-border acquisitions and divestitures, “which

in theory will reward investors with increased takeover premiums” (Ball, 2006;

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Bradley, 1988). Thus the financial incentives for the adoption of IFRS worldwide

are clear.

Towards the end of the 1990s, the IASC (International Accounting Standards

Committee and precursor to the IASB) had been clearing a path toward international

harmonisation with the inception of IASs (International Accounting Standards)

(Nobes & Parker, 2010, p108). Previous EU directives for financial reporting were

being left behind, so in 2000, the EU commission proposed the launching of a new

guideline, that by the year 2005, it would be compulsory for all companies listed

within the EU to adopt IFRS for all their consolidated financial statements (Nobes &

Parker 2010, p108-110). This would cause an outlawing of European domestic rules

and US rules for the purpose of accounting (Nobes & Parker, 2010 p110). The

motives for this initiative was part of a desire to increase the strength of EU capital

markets by establishing a more harmonised accounting system by providing a set of

more standardised policies under IFRS (Nobes & Parker, 2010, p110). Although the

existence of US GAAP provided a means to fit this purpose, it was deemed unfit for

use within the EU due to it being regarded as too complicated and “too immune

from European influence to be politically acceptable” (Nobes & Parker, 2010,

p110). The move towards the adoption of the IFRS was subsequently facilitated by

large European companies who had garnered a burgeoning acceptance of

international standards. For instance, in Germany, a large number of companies

from 1994 onwards started to use international standards like US GAAP for their

financial statements in order to reduce the costs of raising finance. By 1998, a policy

was enforced by the German government that allowed listed companies to use

international standards without the need to comply with regular national accounting

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principles or requirements for consolidated statements (Nobes & Parker, 2010,

p111).

A draft Regulation in 2001 was published by the EU commission and by

2002 was approved by the European Parliament and Council of Ministers. It

required listed companies within the EU to use international standards for their

consolidated financial statements onwards from 2005 (Nobes & Parker, 2010, p111).

Other companies and states that had formerly utilised other acceptable set of

standards (i.e. US GAAP) were allowed an extended the deadline to 2007. However

it is the European Parliament’s opinion that, “new and revised standards cannot be

endorsed in advance for EU use” (Nobes & Parker, 2010, p111). In order to gain

approval for endorsement the Accounting Regulatory Committee (ARC) was set up

to provide assistance to the EU Commission to determine whether IFRS can be

endorsed within the EU (Nobes & Parker, 2010, p111). The ARC is composed of

representatives from each EU member states and it is through this that the EU was

able to achieve influence over the IASB. A consequence of this was the creation of a

form of “EU-endorsed IFRS” which was slightly revised from the original IFRS set

by the IASB (Nobes & Parker, 2010, p111). For instance, there is a difference in

IAS 39 of the IFRS to the EU-endorsed version which provides more flexibility on

the use of hedge accounting (Nobes & Parker, 2010, p111-112). The EU

commission’s liaison with the IASB ensured that IFRS took into account issues

which are considered important within Europe and by 2004 most of the existing

content of the IFRS was endorsed (Nobes & Parker, 2010, p112-113). However,

according to Nobes & Parker (2010) “the fact that the EU-endorsed IFRS is not the

same as IFRS has led to confusion and to audit problems.” For instance Nobes &

Parker (2010) discuss an auditors’ opinion on GlaxoSmithKline’s consolidated

23

statements for 2008; they state that GlaxoSmithKline’s “group financial statements

give a true and fair view...” and this complies with the EU-endorsed IFRS’ policy.

Interestingly, IAS 1 of IFRS requires instead a “fair presentation” of the financial

statement (Nobes & Parker, 2010, pg 113). Confusion therein lies among the

practical assumption that these two assessments are the same when in actuality they

are not. This problem however disappears when presented in other languages such

as French or Italian because “true and fair view” and “fair presentation” is translated

using the same expression (Nobes & Parker, 2010, p113).

The International Accounting Standards (IASs) regulation of 2002 went into

effect in 2005, and about 8000 listed companies within the European Union (EU)

adopted the use of IFRS to prepare their consolidated financial reports (Zeff, 2007).

In addition to the EU, many Asian countries have also adopted IFRS or are in the

process of doing so; for instance China in 2007, albeit with a few minor differences

in regulation. A problem arises in the fact that countries like China, India and Japan

adopt local variations of IFRS, thus creating differences in financial reporting when

compared to nations which fully converge with IFRS (Clatworthy, 2008). In the US,

IFRS is not used, and the nation’s standards are governed by US GAAP (Nobes &

Parker, 2010, p114). However in 2007, the US Securities and Exchanges

Commission (SEC), enforcers of US GAAP, formally proposed a rule to accept

foreign registrant’s financial statements prepared in accordance with the English

language version of IFRS as published by the IASB without reconciliation to US

GAAP’ (Zeff 2007, SEC 2007). This provided a major step forward in strengthening

the global position of IFRS. Such particular standardisation of IFRS rules in the US

may be viewed by some as an example of `convergence’ (Nobes & Parker, 2010, p

110). The proposed convergence of US GAAP to IFRS is however, very unlikely in

24

the near future. One of the aims of the IASB is to secure support and acceptability of

IFRS in all of the major capital markets (Zeff, 2007). It was therefore of great value

and importance that the IASB was able to get the SEC on board in accepting IFRS

as an equivalent to US GAAP on the US equity market. (Nobes & Parker, 2010,

p108).

6.3 Scope for International Differences under IFRS

The compulsory use of IFRS in the EU and its variants elsewhere implies

that the study of differences in international accounting is becoming less relevant.

Nobes (2006) reports that international differences in IFRS are still a cause for

concern, whereby the motives and opportunities allowing international accounting

differences under IFRS to exist cannot be overlooked. Factors such as the legal

systems and tax systems (discussed below) still provide opportunities for differences

to exist under IFRS (Nobes, 2006). For instance, the principles of IFRS reporting

standards are the same in the UK and Germany, but the enforcement and monitoring

of the standards remain a national responsibility (Nobes, 2006). As a result, “the

nature and regulation of audit, the stock exchange rules, the activities of the stock

exchange regulator, and any other of the monitoring or reviewing bodies” also

remain nationally enforced so international differences in these areas also continue

to exist (Nobes, 2006). As described below, UK and German based markets

represent a Common/Roman law dichotomy which subsequently affects differences

in enforcement of financial reporting practice within these countries (Nobes, 2006).

Sticking with the UK and Germany as comparative examples, Lamb et al. (1998)

suggest a stronger operational linkage between tax and financial reporting within

Germany. Such taxation dominated financing systems have been a typical feature in

Germany where one set of accounting rules are used for both tax and financial

25

reporting. In the UK under national requirements there are two sets of rules for

several accounting issues: “one for taxation and one for financial reporting” (Nobes,

2006). Different approaches to tax practices also predetermine IFRS consolidated

financial statements where national practices of individual company accounting will

flow onto the consolidated statements (Nobes, 2006). For instance, asset

impairments are tax deductible in Germany but not in the UK, so they are

encouraged in financial statements in Germany displaying a level of bias in favour

of them. As a result, they may survive in German IFRS consolidated statements,

“given the room for judgement in IFRS impairment procedures” (Nobes, 2006). This

shows that national accounting traditions are likely to continue to survive into

consolidated financial reporting as long as they comply within the scope of IFRS

rules (Nobes, 2006).

So why do differences occur in international financial reporting? Major

differences in international financial reporting are far from obvious, even to

accountants (Nobes & Parker, 2010, p29). This study would like to show how this

may impact non accountants such as financial analysts, where most analysts lack

any sort of accounting qualifications (Nobes, 1998). Several factors are linked to the

differences in financial reporting internationally:

Culture

Financial reporting/Accounting is affected by its environment so the culture

of the country has its effects too (Nobes & Parker, 2010, p29). Accounting is seen as

a sub-structure to the way individuals of a certain culture would like their society to

be structured (Nobes & Parker, 2010, p29). Gray (1988) applied Hofstede’s study

(1984) on defining basic cultural patterns and dimensions to explain international

26

differences in the behaviour of accountants and the nature of financial reporting

behaviours and practices. For instance, Gray’s study suggests that a country with

high uncertainty avoidance (the degree to which members of a society feel

uncomfortable with uncertainty and ambiguity thus compelled to maintain codes and

beliefs which are intolerant to deviant ideas/persons) will be “more likely to exhibit

conservative measurement of income with a preference to limit disclosure to those

closely involved in the business” (Gray, 1998; Nobes & Parker, 2010, p30).

Research has also identified many direct potential influences to the accounting

environment and culture: legal systems, corporate financing and tax systems (see

below) interact with culture in a complex way which in turn seem to affect the style

of financial reporting within the country’s accountancy profession (Nobes & Parker,

2010, p31). Zeff (2007) reports that differences in cultures across borders is one of

the factors that “could impede or interfere” with the promotion of genuine

convergence and comparability of financial reporting worldwide. Zeff’s report also

categorises culture into four branches: business & financial, accounting, auditing,

and regulatory cultures; these all influence the way in which financial reports are

created worldwide and might also explain the tendencies towards differences in

international financial reports.

Legal systems

Legal systems in most countries can usually be identified as either “common

law” or “code law” (Nobes & Parker, 2010, p32). These categories developed by

Nobes (2010, p 32), have defining characteristics with some countries and states

embodying elements of both. Essentially, those countries designated “common law,”

have a long history of utilizing equity markets and producing financial reports that

service investors. This accounting information is not used for tax purposes, which is

27

developed separately. “Code Law” legal systems generally refer to those countries

that have a history of using accounting information explicitly for tax purposes. Their

financial systems commonly have a bank central structure, whereby large banks and

companies have an interdependent relationship.

The nature of accounting regulation within a country is influenced by its

general system of laws (Nobes & Parker, 2010, p32-33). For instance, Bushman and

Piotroski (2006) and Ball (2006) observe how in common law countries there are

greater incentives to report losses in a timelier manner; while Jaggi and Low (2000)

report that there are also higher levels of disclosure in common law countries. Below

is a table illustrating examples of developed countries’ legal systems and where they

fall under these two categories. Although a country’s regulatory system for financial

reporting and accounting is affected by the nature of its legal system, financial

reporting rules and practices are probably even more affected by other issues such as

IFRS policies (Nobes & Parker, 2010, p33).

Table 1 * (countries and their legal systems; taken from Nobes & Parker, 2010 p33)

La Porta et al. (1997) state that there is a strong statistical connection

between common law countries and strong equity markets (Nobes & Parker, 2010,

28

Common Law Codified Roman Law (Code Law) Elements of both

England & Wales France Scotland

United States Germany South Africa

Canada Japan Philippines

Australia Spain Germany

p34). In code law countries such as Germany, France, and Spain, there has been a

very significant provision of capital from banks. By contrast however, common law

countries such as the UK and US rely on millions of private shareholders to finance

the large number of companies within them (Nobes & Parker, 2010, p 33). This

difference in business organisation and ownership is influenced politically and

determines the extent to which governments can intervene and enforce requirements

thus affecting the way in which financial data is disclosed (Nobes & Parker, 2010

p34-36). For instance, due to the lack of outside shareholders in comparison to

common law countries, many European code law countries and places like Japan

have used external financial reporting to protect finance providers/creditors. (Nobes

& Parker, 2010, p34-36).

Taxation

The need for a calculation of taxable income (mainly government imposed)

demands a need for annual financial reporting (Nobes & Parker, 2010 p37). As a

consequence tax considerations form a major part of financial reporting rules. The

degree to which such taxing regulations determine accounting measurements can

also differ and be due to the legal systems of the countries as stated above. For

instance the study of deferred taxation has amounted to much controversy within the

UK and US accounting standards, whereas in Germany and France, this problem is

minor; in code law countries it is largely the case that the tax rules are the

accounting rules (Nobes & Parker, 2010, p37-39). Another example of differences in

taxation is that “asset impairments losses are tax deductible in Germany but not in

the UK” (Zeff, 2007; Nobes, 2006). As mentioned before, the consequence of this is

that a German company might prefer to use this as a means of tax deduction and

may be more willing to disclose such losses in their financial statements, but a UK

29

company might not recognise such an impairment loss (Zeff, 2007). Many

companies in code law countries have notoriously focussed on reducing taxable

income and thus take advantage of options to report a lower accounting income

(Zeff, 2007). This conservative way of accounting was a result of the link between

taxation and financial reporting, but is becoming less relevant among the largest

corporations due to international competition.

Globalization

Since the Second World War there has been a globalisation of economic

activity (Nobes & Parker, 2010, p7). This has lead to a global spread of “not just

goods and services but also of people, technologies and concepts” (Nobes & Parker,

2010, p7). This in turn has caused an increased use of foreign financial information

and thus the need for international comparability of such financial information has

grown (Miles & Nobes, 1998). Capital markets have also become more globalised

and thus methods of internationalisation in the global stock markets have become

more prevalent. For instance, “cross border listings and the extent to which

international companies translate their annual reports into languages for the benefit

of foreign investors” (Nobes & Parker, 2010, p10). In most markets various

mechanisms such as these are used to cope with international differences in financial

reporting/accounting (Miles & Nobes, 1998). The main reasons for globalisation and

foreign listing within these international companies are to attract extra investors and

widen the pool of shareholders within these companies (Nobes & Parker, 2010,

p10). Accounting information is therefore becoming used as an international

communication device so that a broader level of investment can be acquired.

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Other factors

Stock market motivated countries such as the UK and US have a larger more

substantial body of private shareholders and public companies than countries that

have notoriously been “bank” driven (i.e. Germany, France, Italy, Spain etc). This

means that there is a higher need for auditors in countries like the UK and US (Zeff,

2007). Being a stock market driven country is a major factor as to why the

accountancy profession is found to be larger, stronger, and more competent than in

non-stock market driven nations (Zeff, 2007). Financial reports are thus more

detailed in stock market driven countries, as there is a greater need to supply timely

information to the larger investor dependent market.

The nature of the profession and how it can influence the practice of

financial reporting provides a considerable obstacle to significant harmonisation of

financial reporting between some countries (Nobes & Parker, 2010, p39-41). Nobes

& Parker (2010, p 41-42) proposes that an “important direct cause of financial

reporting differences is a two way split of countries into: (I) those with important

equity markets and many outside shareholders; and (II) those with a credit-based

financing system with relatively unimportant outside shareholders.” Common law

countries are associated with the equity/outsider system as it leads to more

“decision-useful’” financial reporting that affects large auditing professions and the

separation between tax and accounting rules (Nobes & Parker, 2010, p41-42).

Some factors also exist that may affect financial reporting internationally,

but are considered too vague to be useful. Factors such as language, religion,

education, geography and others have not been addressed. The history of a country

is also a major factor, although it is the history of the country’s equity market or

31

legal system which is more relevant rather than the general history itself (Nobes &

Parker, 2010 p42). For instance, a good predictor of a former colonial country’s

accounting system is that it will be similar to that of its former colonial power

(Nobes & Parker, 2010, p42). This can be a significant factor and have a larger

bearing on the country’s financial reporting than other factors such as tax or the

corporate financing system. For example, some former British colonies in Africa

utilise an accounting system based on that of the UK, though lack any sort of equity

market (Nobes & Parker, 2010, p42). For many common wealth countries however,

the International Accounting Standards Board (IASB) has replaced the former

British influence over financial reporting and accounting (Nobes & Parker, 2010,

p42). Zeghal & Mhedhbi (2006) have also shown that in developing countries with

capital markets and Anglo-American culture, international standards in accounting

(i.e. IFRS) are more likely to be adopted.

7. Proposals

This dissertation can now draw on a summary of the research to this point

and establish a set of propositions with regards to the perceptions of sell-side

analysts. These propositions are suggested in the context of examining the London-

base equity analyst after the implementation of IFRS:

1. Sell-side analysts are not qualified accountants and do not recognise that

there are options for different accounting practices under IFRS.

2. Quarterly and annual reports are a useful source of information for sell-side

equity analysts.

3. Sell-side analysts rely more on non-accounting information than on actual

accounting data for information.

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8. Research Process

Using a set of two case studies, this paper reports on interviews conducted

with two London based sell-side analysts working for two of the ten largest

international investment banks. Interviews for this study were exceptionally hard to

come by, and it can only be assumed that financial analysts are incredibly busy as

the role is very competitive. The two interviewees for this study were found over a

period of 5 weeks, whereby trial and error techniques in several different areas

finally produced results .The initial and obvious step was to contact large investment

firms via email and telephone. HR departments as well as all other relevant

departments with posted contact information were targeted. Unfortunately, this

process failed miserably as none of the parties contacted were remotely interested in

helping with this study. To seek other alternatives, resources from prior research

were utilized. An organization called the UK Society of Investment Professionals

was incredibly helpful for the research by Miles& Nobes (1998) and Clatworthy

(2007). However, this organization had merged with the CFA (Chartered Financial

Analyst) society of the UK and changed its name to such. The CFA society is an

international non profit organisation which issues certifications for Chartered

Financial Analysts (CFA) and other investment professionals. It is also the awarding

body for the Investment Management Certificate (IMC), the UK’s leading entry

level qualification for investment professionals and through the provision of training

and education, aims to promote high ethical and professional standards in the field

of investment (CFA Society, 2013). As emails and phone calls for large investment

banks had already failed, the first route for attempting introduction with this

organization was face to face contact by cold calling on their headquarters. Several

names and business cards of employees that might be able to help were collected

33

and followed up with subsequent emails and phone calls. As this method also proved

to be quite fruitless, a second attempt was made to catch relevant employees in the

office. This study’s sense of urgency was noticed by several employees and one with

access to a probable interviewee finally agreed to help set up an interview. “Friend

of a friend” networking techniques were employed to locate another interviewee.

People in the investment banking field were contacted via LinkedIn, a business

social networking site, and followed up with via more networking. Several potential

candidates in the field were located; unfortunately none specialized in equity

analysis. Ultimately, following up on a few leads given by the first interviewee

finally materialized into an email response from the second interviewee, who was

returning from a holiday abroad. Interviewee number two agreed to meet before he

was due back in the office.

The interviewees were “self-selecting” in terms of the sense that they

personally agreed to take part in the study (Miles & Nobes, 1998).This problematic

process of finding interviewers may introduce a bias in the fact that certain analysts

are now excluded from the study i.e. the analysts who refused to respond because

they might be “opposed to assisting outside research” (Miles & Nobes, 1998).

Although, the initial goal was to produce several interviews for a larger set of data,

time constraints led this study to proceed with just 2 interview subjects. The two

interviewees worked for two of the top ten largest investment banks in the world.

The interviewees both worked in the food retail sector which involved foreign

markets. The findings of this study can therefore only be regarded as suggestive and

ultimately may not accurately portray UK equity analysts as a whole.

Interviewing the subjects rather than using questionnaires has a huge

advantage because it can improve the ability to collect a series of more relevant and

34

richer answers by reducing ambiguity and focussing on more direct and interesting

lines of enquiry (Miles & Nobes, 1998). To alleviate the problem of interviewer

bias, a likely disadvantage of this method of enquiry, the interviews were recorded.

The interviews were informally structured and followed a set template of open

ended questions leaving room for follow up questions and further exploration.

Questions may not have been asked in the same particular order. The informal

approach to the interviews allowed the interviewees to feel comfortable when asked

more probing or personal questions about their work and therefore reduced the

difficulty in obtaining the answers needed.

9. Findings

The findings from the two interviews are further explained and cover the

three proposition topics. However, in order to properly understand the contemporary

circumstances of each proposition, this study has added a special section titled, The

Role of the Sell-Side Analyst. As is the goal of any exploratory case study, this

section is dedicated to understanding the contemporary responsibilities of the

interviewees, while shedding light on the real life context to which their roles entail.

Two sell side analysts were interviewed for this study. To recap, both analysts

worked for the London branches of two of the top ten largest investment banks in

the world. Each interviewee works in the Food Retail sector, and examples of

companies analysed by each analyst are listed in Table 2. Both interviewees

preferred to remain anonymous and will further be identified as R1 and R2. R1 has

worked as a sell-side analyst for 4 years while R2 has 3.5 years of experience. These

interviewees therefore fall into the category of analysts hired well after the

35

mandatory adoption of IFRS by the EU. Their perceptions could therefore differ

from those who have worked in the field since the adoption of IFRS in 2005,

although due to extremely high industry turnover, such analysts are quite scarce.

This potential weakness and others in the study are discussed in the conclusion.

Company by Country of Origin-Food Retail

Table 2

9.1 The Role of Sell-Side Analysts

Each interview began with an open ended question asking each interviewee

to explain their role in the equity market. The following information is taken directly

from R1 and R2.

Sell-side analysts effectively liaise with companies and provide advice to

investors. So that’s buy-side clients, which are mostly large institutional

clients. That’s where we mostly get the revenue from. So that’s Fidelity,

Blackrock, Schroders, etc. (R1)

36

Company Country of Origin

1. Tesco UK2. Carrefour France3. Metro Germany4. Morrisons UK5. Sainsbury’s UK6. Colruyt Belgian7. Ahold Holland8. Delhaize Belgian

What we do on the sell side as an analyst, is we have to provide good ideas.

Because without ideas the sales people aren’t selling anything and the bank

isn’t making any money. (R2)

The interviewees stated that the ideas or advice they produce using the analysed data

is passed on to the buy-side analysts who are incentivised to act on stocks for the

interest of the institutional investment firms they work for. In essence the objective

of the advice/ideas from sell-side analysts is to influence whether a buy-side analyst

purchases, sells or places hold on a stock. The sell-side analyst makes money

(incentive) by being the liaison or acting as the “middle man” between successful

investment decisions; if sell-side analysts cannot provide the best ideas/advice then

their banks will not be able to broker the transactions the buy-side analysts are

interested in and no money can be made. The sell-side analyst is therefore heavily

incentivised to produce good ideas/advice and importantly must get these ideas

heard over other competing analysts.

You’re brokering ideas to buy-side analysts. The buy-side analysts are

putting their money and reputation on the line by investing in that company.

So as a sell-side analyst in a competitive world you’ve got to be able to

authoritatively say you know this business. (R2)

Using the prior research and work on Knowledge transfer (Lin 2005), this research

derived a basic model (figure 1), which represents the communication between the

37

parties described as senders and receivers of financial information. The interviewees

further elaborated on aspects of figure 1 tying it in to specific roles and aims of sell-

side analysts in particular. As equity analysts, it was the interviewees’ jobs to

analyse data and information provided by listed companies (senders in our model);

they are then heavily incentivised to use this data to produce advice or provide good

ideas to pass on to buy-side analysts working for large institutional investment

companies. A few names of such institutional investment firms like Fidelity,

Blackrock and Schroders, were thrown around and these companies operate by

specialising in large asset based funds such as mutual or pension funds. Fidelity

Investments is one of the largest financial services groups in the world. As of

February 28, 2013, the company was currently managing over US$1.7 trillion of

assets (Fidelity Investments, 2013).

The interviewees each described the same main three methods of obtaining

information from companies:

1. The first method involves complete access to the company’s information. This

includes access to management i.e. CEOs, CFOs, and the investor relations team.

Let’s say, on the day of results at 7am their statement comes out. I’ve read it,

but I want to hear what the company has to say, so I call them up at 5

minutes past 7 and say hey, can you guide me through this. Well they can’t

guide, but they can help you narrow things down. (R2)

38

If you really get on well with the management they can tell you stuff that’s

sort of not publishable. And you would never publish it because you have an

understanding; but it can just sort of shape you view of things. (R1)

Additionally, access to the physical retail locations in the form of store visits is also

an option. The major advantage of this access is that it allows for more detailed

probing and fact finding rather than just number crunching.

You’re building up a flavour of what the company does, why they do things,

and what the impact could be. (R2)

One interesting aspect of their work involved the use of corporate road shows. In

these road shows a sell-side analyst sets up a meeting between the companies and

institutional investors’ buy-side analysts. It presents an opportunity for buy-side

analysts to communicate directly with company CEOs/CFOs and investor relations.

It is through these meetings where the line of communication is able to essentially

cut out the “middle men” of sell side analysts and allows the sharing of sensitive

information between the two parties.

2. Quarterly reports are used by sell-side analysts as one way of obtaining a

company’s financial information. These reports contain unaudited financial results

often called preliminary results for that specific quarter of the year. The reports are

laid out in a manor advantageous to analysts and are often referred to as trading

statements. Facts and figures of a company’s performance are stated in the financial

39

information of these reports and they can include notes from the management.

Quarterly reports allow the analysts to see trends in a company’s performance and

allow them to generate a forecast in models which are created and used for investor

presentations.

3. The final major method of information gathering is Investor Presentations.

Presentations are generally given by the CFO or CEO of the company. Details of

any specific changes or significant events i.e. supplier problems, mergers

&acquisitions, etc are also given at these presentations.

So I was talking to people in Pharma (Pharmaceutical Sector); for them it

was something like drug pipelines. It’s something that accountants don’t tag,

but it makes massive differences in the value of the company. That’s the sort

of information you’ll get in an Investor Presentation. (R1)

The key element to investor presentations is finding out the details that drive the

numbers in the trading statements. Quarterly reports or trading statements will come

out at 7am and presentations are usually held between 9am and 11am afterwards.

Questions, answers, and discussions are held in the presentation to gather more

information. It is at these presentations where the analyst must ask the right

questions to immediately gather information needed to create ideas for investors.

The next section lists the findings from the interviews for the contemporary analysis

of this paper’s proposals.

40

9.2 Accounting Expertise and IFRS Perceptions.

The analysts were asked what academic or professional qualifications they had in

order to determine if they held any sort of accounting qualifications. R1 had a

degree in economics and R2 had a degree in business & computer science. Both

were CFA qualified and held no formal vocational accounting qualifications such as

an ACCA or ACA qualification. This supports proposition 1 in the fact that these

analysts are not qualified accountants. In the process of describing their roles as sell-

side analysts, the interviewees were asked several open ended questions to gauge

awareness of international differences existing under IFRS. The topics of

international company comparison were brought up between Carrefour (French),

Metro (German), and Tesco (British). Interviewees were asked if there were any

differences in the way one company establishes accounting numbers vs. any other

under IFRS.

No, no everything is the same between countries. Because it’s IFRS, it’s

basically everything excluding the US. (R1)

No, if it’s under IFRS I’m going to have to assume that the same accounting

policies are in place in each country. (R2)

To follow up on this line of questioning, the interviewees were asked about a

country’s culture and level of conservatism, and how it applied to their reporting.

Specifically they were asked about Germany’s Metro, and if they ever had to

41

compensate for a level of conservatism in the reporting when comparing the

company to the UK’s Tesco.

As an analyst you write what you expect from a company. All companies give

conservative guidance on numbers as they always want to beat them. But

there are no cultural implications to that. (R1)

No, there are no cultural differences with large companies. Or at least I

never saw that. (R2)

These corroborating views also support proposition 1 and essentially tells us that

sell-side analysts do not acknowledge financial reporting differences under IFRS.

Since the overwhelming perception of the contemporary sell-side analyst seems to

be that accounting practices between countries do not differ, any apparent

differences do not seem to affect their work.

9.3 Usefulness of Quarterly and Annual Reports

Both analysts stated that they used quarterly reports when compiling data for

equity analysis. These reports are laid out in the form of trading statements, which

make the data more user friendly. However, one of the most astonishing findings in

this study was that both analysts stated they generally do not use audited annual

reports and regard the audited information to be relatively valueless. The methods

analysts use to ascertain information (described in section 9.1 The Role of Analysts)

rely mostly on the use of quarterly reports. This is because audited annual reports

42

are released one to two months after the final results of the year are released to

investors.

So the thing is, when the annual report comes out, it’s obsolete. (R1)

At the investor presentation, you’ve already got the numbers from the

trading statements, you’ve got the investor presentation which has all the

extra information, and if you’ve got any further questions ask management,

and then you’re done. (R2)

So let’s say it’s the final results of the year, results come out, you’ve got all

your information, you’ve updated your model, and the stock price has

already moved. Two months later the annual report comes out. Does the

stock price move? No, because there is no new information coming to

market. (R1)

I used it (annual report) just to double check my numbers and for things like

PP&E, but it doesn’t move the market. (R2)

9.4 Usefulness of Non-Accounting Information.

Much like the previous segment, section 9.1 The Role of Analysts, has

already provided insight into how sell-side analysts obtain non-accounting

information from companies. Exploring the usefulness of non-accounting

information is important to the objectives, and highlights the gaps in knowledge that

must be filled with accounting information. Corporate road shows as mentioned

43

before, introduce opportunities for companies to communicate directly with

institutional investors at events organized by sell-side analysts. These events can

allow for the transfer of sensitive information related to investment between the two

parties and temporarily circumvents the need for accounting information. However,

the purposes of the shows are indeed to illicit or maintain investment, and can

therefore be assumed to be inherently biased. The interviewees were asked about the

significance of non-accounting information and to gauge the importance of the three

main methods for obtaining information highlighted in section 9.1.

The numbers are used in everything. But let’s say our company’s key

supplier is soon to go bust. And we haven’t had anything delivered in the last

2 weeks, customers are going away faster than we thought, and there’s a

profit warning. The numbers couldn’t have caught that. (R1)

So the model is all about the financial reports. For the success of you as an

analyst, you want to focus on knowing the companies really well, so you

have something to say that’s interesting. And from the perspective of trying

to understand what the company might do in the future, you need to be on

those analyst trips with the company’s management. (R2)

So I’d say a third, a third, a third to a certain degree (in regards to the

importance of the three methods used to obtain information described in

section 9.1) . But, you can’t get anywhere if you have a sh*t model. You have

to make sure your model is very robust and that comes from the trading

reports. (R2)

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9.5 Summary of findings

Consistent with Miles & Nobes (1998), this explorative research indicates a

strong reliance on accounting numbers. A notable finding was that sell-side analysts

generally do not use audited annual reports. The perception that international

differences in reporting do not exist under IFRS is compounded by the analysts’

apparent perception that cultural differences (used with regards to the questions on

conservatism) do not exist between large international companies.

10. Conclusions and Implications

Exploring a seemingly incorrect perception among primary users of

accounting information that international accounting practices under IFRS are

universally implemented in different countries is the study’s main objective. The

research process undertaken has led to one main conclusion: There is no current

literature on how primary users of accounting information cope with international

differences under IFRS, because there is a perception among primary users that

there are no differences in accounting practices under IFRS.

The secondary objectives in this research were designed to complement the

main objective, and they are accomplished as follows:

Aim 1: The existence of international differences under IFRS has been

demonstrated using the prior literature. This information is presented throughout the

dissertation and is specifically referenced in section 1, section 6.1, and section 6.3.

45

As noted in section 1, the findings of Kvaal (2010) show that companies will pursue

accounting practices previously adopted if scope for it is allowed.

Aim 2 & 3: As discussed in sections 9.1, 9.3, and 9.4, the role of a sell-side

analyst is to act as a liaison between listed companies and institutional investors.

Although it has been shown that differences in accounting still exist under IFRS,

there is a perception among analysts that there are no such differences in

international financial reporting. This perception seems to be innervated by the fact

that analysts are not qualified accountants so therefore would not recognise such

differences. Differences in financial reporting under IFRS seem to elude the work of

analysts, as it is assumed all accounting is the same under the principles put forth by

IFRS. Findings have shown that quarterly reports are a more useful source of

financial information for equity analysis than annual reports (which are often not

used at all) and that although analysts significantly rely on non-accounting

information, there is still a strong reliance on accounting numbers.

Research limitations

The major limitation in this research is the sample size. In order to obtain

more reliable information, a larger sample size of sell-side analysts should be

utilised. Unfortunately, due to time constraints, lack of funding, and the immense

difficulty in procuring test subjects, this limitation could not be solved in this study.

An additional problem with both interviewees is that they began their careers as

analysts in the post-IFRS era, and do not have experience conducting work when

international coping strategies were deemed necessary for the pan-European market.

This however, seemed to be the case with most contemporary analysts due to the

demanding nature of the job and the high employee turnover.

46

Due to the lack of literature surrounding the work of financial equity

analysts, a full preparation for each interview was not possible. This led to an

agreement with interviewees for follow up questions. These however, were very

difficult to get answered, as the analysts were very busy. A larger sample size again

would probably have made it easier to obtain additional data from follow up

enquiries. Another limitation to this study was the lack of direct observation in the

work environment of the analysts. Any information gathered was from the analysts

themselves during the interview process and subject to interviewee bias on the

topics. Nevertheless this research should be regarded as reliable. The interview

subjects should be viewed as experts in their field, due to positions at two of the top

ten investment banks in the world. Thus the interviewees can be regarded as equally

or better informed than the average analyst/investor.

Implications

The results of this research show that accounting information is useful to the

work of sell-side analysts. However, any incorrect perceptions of sell-side analysts

with regard to financial information should be of great interest to institutional

investment firms and accounting bodies such as the IASB (International Accounting

Standards Board) and the CFA (Certified Financial Analyst) Society. Another major

issue to be further expanded upon is that of audited annual reports. If the most

significant primary users in equity markets are not interested in the information

provided by annual reports, then the resources involved in preparing them may need

be evaluated. Further research into the roles of financial analyst and their use of

accounting information should be a primary concern of the IASB and the CFA

Society.

47

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