The speech is handicapped by the absence of any explanation of what Hoogervorst takes the term “moral hazard” to mean, perhaps on the basis that it seems so obvious that it doesn’t need explaining. Paul Krugman has defined it though as “”any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly,” and it sounds like Hoogervorst is using the concept in the same general way:
- “At the root of (the financial crisis, and ongoing sources of risk) lies the enormous extent of moral hazard in the financial markets. The capital and credit markets are rife with agent-principal conflicts. There is a high potential for conflicts of interest wherever people work with other people’s money. Moral hazard becomes even bigger, when there is an asymmetry of information, when the agent has more information than the principal.”
However, it’s very hard to follow his account of how IFRS has contributed to containing this hazard. As in his other speeches, it feels as if Hoogervorst accepts an invitation to speak on a topic, and then sends some staff member to compile a list of everything in IFRS that could even vaguely relate to the issue, indiscriminately dumping the results into his text. For illustration:
- “Some years ago, the IASB and the FASB had the mother of all battles against vested interests to record the granting of stock options as an expense. There was a hugely expensive lobbying campaign to keep it that way. But there was one question that this lobby never could answer: if these stock options really cost nothing, why not give them to everybody? Almost ten years later and very few people question the logic of recording stock options as an expense. It is simply regarded as good business practice.”
Leaving aside that I personally know plenty of people who continue to question many aspects of IFRS 2, it’s clear that recording stock options as an expense has done nothing to bring more control and discipline to the area of executive compensation; on the contrary, it seems every other day brings a new report of how CEO pay has attained new levels of excess, far beyond any rational concept of incentivizing performance. I suppose the practice of recording stock options as an expense, along with upgraded regulatory disclosures in jurisdictions including the US and Canada, has made the amounts involved more visible than they would have been otherwise, but commentators frequently suggest that the main beneficiaries of this “transparency” have been the executives themselves, capitalizing in their negotiations on the information about peers and competitors. In terms of Krugman’s definition, this seems only to add to moral hazard – executives are more incentivized to take increasing risks in pursuit of greater short-term stock-price gains: if it works (whether because of or despite their efforts), they walk away with an excessive piece of the gains; if it fails, investors keep the losses. Hoogervorst’s “good business practice” looks, against this dismal picture, like flimsy symbolism at best.
Similar vagueness surrounds his next example:
“Today, we have a similar battle with leasing. The vast majority of lease contracts are not recorded on the balance sheet, even though they usually contain a heavy element of financing. For many companies, such as airlines and retail chains, the off-balance sheet financing numbers can be quite substantial.
Stripped bare, the leasing project is all about preventing the understatement of liabilities. Some might want to say it is about bringing prudence to lease accounting. Again, there is huge resistance against our bringing these liabilities to the balance sheet. I have no doubt that, five years from now, many will wonder what all the fuss was about.”
Perhaps so, but how any of that relates to the specific topic of the speech remains a mystery. The broad topic of whether financial reporting can actually contribute to controlling moral hazard seems potentially fascinating, but I don’t see anything about that in the text, beyond a seemingly unsupported assertion that “eliminating information asymmetry is the key to minimizing moral hazard.” Even by his own account though, it sounds like any anti-hazard symmetry-increasing contribution flowing from the steady march forward of IFRS, and the expansion of the information available in the notes, has been dwarfed by the other factors he mentions as contributing to short-termism.
He concludes his remarks by rehashing some of his previous comments on prudence and by defending the governance of the IASB, before quoting Theodore Roosevelt as saying: “nothing in the world is worth having or worth doing unless it involves effort, pain and difficulty.” I wonder if that includes the process of writing a coherent speech…
The opinions expressed are solely those of the author