The rise of valuation-based accounting in the 1990s

Driven by globalisation and inherent institutional change (Crouch et al., 2007) in the after-math of the Cold War and German reunification, some of Germany’s largest firms decided to access important and more liquid foreign equity capital markets through cross-border listings.

5 The representation of employees on German companies’ supervisory boards dates back to several acts, par-ticularly the 1951 Act on Co-determination in the Coal and Steel Industry (“Montan-Mitbestimmungs-gesetz”), the 1972 Works Constitution Act (“Betriebsverfassungsgesetz”, BetrVG), the 1976 Co-determination Act (“Mitbestimmungsgesetz”) and the 2004 One-third Participation Act (“Drit-telbeteiligungsgesetz”). Companies with more than 100 employees are required to have an economic commit-tee that is informed about the company’s economic situation on a regular basis (§ 106 BetrVG). In that re-gard, the committee has the right to have the annual financial statements explained to it by management (§ 108 (5) BetrVG).

This step led to the rise of a valuation-based, capital market-oriented accounting philosophy in Germany in the early 1990s. In other words, companies from a credit-insider economy, interested in equity-outsider markets, voluntarily adopted accounting systems from the Anglo-American hemisphere (Nobes, 1998). The first German company that was admitted for listing by the New York Stock Exchange (NYSE) was Daimler Benz in 1993. Accordingly, Daimler was required to reconcile its consolidated equity and net income figures from HGB to US GAAP. To reduce that burden, Daimler moved its HGB consolidated—but not single—

financial statements closer to US GAAP by taking advantage of accounting options and dis-cretion (Bruns, 1998). Other German global players followed, for example, Deutsche Tele-kom in 1996, E.On (formerly VEBA) in 1997, SAP in 1998, Allianz in 2000, BASF in 2000, Deutsche Bank in 2001, Siemens in 2001 and Bayer in 2002. Despite a 2002 peak of 22 com-panies (Pellens et al., 2004), the absolute number of cross-listings remained low. Other Ger-man firms, for example, Puma in 1993 and Bayer, Heidelberg Cement and Schering in 1994, voluntarily adopted the International Accounting Standards (IAS), the predecessor of IFRS, in their consolidated financial statements. These firms committed to greater transparency in fi-nancial reporting and a shareholder value orientation, but did not consider a US listing.

The adoption of US GAAP and IAS by prominent (but few) German companies shows that these firms were able to balance their accounting demands by providing valuation-oriented information in their consolidated accounts while retaining contractible information in their HGB legal entity financial statements. Eventually, the moderate rise of valuation-based accounting did not affect contracting consequences. The requirement to prepare HGB consol-idated financial statements, however, was increasingly called into question. In response to political pressure by large public firms (e.g., Pellens et al., 2014; Sellhorn & Gornik-Tomaszewski, 2006), the German legislature codified two seminal acts: the German Capital Raising Facilitation Act (“Kapitalaufnahmeerleichterungsgesetz”, KapAEG) and the Corpo-rate Sector Supervision and Transparency Act (“Gesetz zur Kontrolle und Transparenz im Unternehmensbereich”, KonTraG). The KonTraG strengthened the valuation-role of public firms’ HGB group accounting by adding requirements from valuation-based systems (i.e., cash flow statements, statements of changes in equity and segment reports). Further reforms extended these requirements to all firms and geared consolidated financial reporting further towards valuation, for example, by excluding tax-driven elements (Haller, 2002; Haller &

Eierle, 2004). Moreover, the KonTraG implemented a German private standard setting body, the German Accounting Standards Board (GASB), primarily to provide guidance on the aforementioned accounting novelties. Second, the KapAEG introduced the (desired) option

for listed companies to prepare their consolidated financial statements in accordance with either IAS or US GAAP instead of HGB. Interestingly, since 1997 the German stock ex-change has required preparation of IAS or US GAAP figures on a quarterly basis from com-panies listed in the newly established new-market segment (d’Arcy & Leuz, 2000). With the de facto deregulation of group accounting, the number of IAS and US GAAP adopters in-creased in the following years. As of 2001, of the approximately 550 German companies listed in the Prime Standard, approximately one-third followed IAS and US GAAP, respec-tively (Weißenberger et al., 2004: 175; Zwirner, 2010: 530).

Despite the relatively low number of adopters and the restriction to consolidated state-ments of cross-listed public firms, the moderate rise of IAS and US GAAP raised awareness of non-domestic accounting standards with a stronger investor orientation and valuation role.

For the first time, German accounting practice involved the parallel application of multiple accounting systems. Accordingly, the longstanding link between country and accounting sys-tem eroded and the prior distinction among countries shifted towards a polarity between the traditional German HGB and the valuation-based systems—either within a single country or even within a single reporting entity (Sellhorn & Gornik-Tomaszewski, 2006). That notwith-standing, survey research shows that in the early 1990s, German managers were sceptical about US GAAP accounting because it was perceived to promote short-term thinking and to lead to the neglect of long-term investments. Moreover, the US GAAP were not considered superior to German accounting (Glaum & Mandler, 1996), even in terms of valuation. Early empirical results were not able to disprove that notion (e.g., Harris et al., 1994). In addition, the vast majority of German companies were not affected by international reporting demands and continued to prepare both legal entity and consolidated financial statements in accordance with the HGB. The German regulator preserved the HGB commercial law accounting tradi-tion on the single financial statement level (Haller & Eierle, 2004), which means that all Ger-man firms, including adopters of international standards, were able to satisfy their contractual demands (and legal contracting consequences) with accounting data from single financial statements. Over time, however, managers of large listed companies acknowledged that Ger-man accounting might indeed reduce share attractiveness on foreign markets and thus were increasingly willing to accept the adoption of international accounting rules for the benefit of information value (Förschle et al., 1998; Glaum, 2000) and lower cost of capital (Pellens &

Tomaszewski, 1999). Related empirical research shows economic benefits, i.e., lower infor-mation asymmetry, for German firms that voluntarily commit to increased levels of disclosure under international reporting strategies (Leuz & Verrecchia, 2000).