The Social Economic and Environmental Impacts

Oct. 2006, Vol.2, No.10 (Serial No.17)
Journal of Modern Accounting and Auditing, ISSN1548-6583, USA
An Analysis of Globalization of Accounting Standards
based on Game Theory
SU Yue-chang, GUO Xiao-mei*
( 1. Local Tax Bureau of Zhongshan City, Zhongshan 528400, Guangdong, China;
2. Xiamen University, Xiamen 361005, Fujian, China )
Abstract: Ever since the International Accounting Standards Committee (IASC, later reorganized as
International Accounting Standards Board, IASB) completed a set of core standards which were recommended by
the International Organization of Securities Commissions (IOSCO) to be used for cross border securities listing,
the pace of globalization of accounting standards sped up. In this article, the authors used the game theory to
analyze the strategies of EU and the United States, the two largest interest groups, at different periods of
globalization efforts as carried out by ISAC. Using facts observed in the evolution of IASC, it is concluded that
globalization of accounting standards is only a temporary equilibrium among different interest groups. The
resulted international accounting standards are bound to be a compromise. The aim of establishing a set of unified
global accounting standards for public interest as advocated by the IASC is only an unrealizable dream.
Key words: game theory; Nash equilibrium; globalization; accounting standards
1. Introduction
At the end of the 20 century, the International Accounting Standard Committee (IASC) completed the
comparability project, core standards project and the strategic reorganization in succession. The new International
Accounting Standard Board (IASB) went into existence in April 2001, making its standards setting process the
most important international financial accounting phenomenon and a symbol of the new era of globalization of
accounting standards. “Accounting standard is a system arrangement to reduce transaction costs. Without the
restriction of political factors, a unified global accounting standard will decrease transaction costs effectively”
(LIU Feng, 2000). However, many literatures show that the accounting setting process is political, as well as
technical in nature (Horngren, 1973, Bromwich, 1980). Accounting standards can bring about “economic
consequences” (Zeff, 1978). So the final international accounting standards are the choice made among groups of
conflicting interests. The sharp difference in economic and political strength among different countries enhances
the conflict. Recently, globalization of accounting standards has aroused great interests in the realm of
international accounting. Research literature shows great interest in the process of global standards setting. Some
examined the power, the power distribution or the interested groups in the international accounting standard
setting (Kwok and Sharp, 2005; QU and CHEN, 2003). Some suggested the standards setting process as a game
among different interested groups (TANG and QIN, 2005; ZHANG, 2005). But few people set up models based on
SU Yue-chang(1978-), Master of Management, Xiamen University, now work in the Local Tax Bureau of Zhongshan City;
research fields: international accounting, accounting information system.
GUO Xiao-mei(1970-), PhD, associate professor, associate head of the Accounting Department, Xiamen University, visiting
scholar to Saint Mary’s University in 2000; research fields: management accounting, environment accounting, internal control.
An Analysis of Globalization of Accounting Standards based on Game Theory
game theory to explain the process of globalization of accounting standards by IASC.
Game theory was proposed by John Nash (1950, 1951), stating that a combination of mutually optimal
strategies will reach an equilibrium if each person’s choice is an optimal response to others’ choices. He assumes
that a choice is optimal if it maximizes the person’s expected utility of outcomes, conditional knowing or correctly
anticipating the choices of others. During the 1980s, there has been a progress in game theory research and its
application to economics and politics (Borgers, 1994).
In this article, using three static game models, the authors analyze the strategies of two largest interest groups
(EU and the United States) in three different periods of the globalization process of accounting standards pushed
by IASC. The conclusion is that globalization of accounting standards is only a temporary equilibrium among
different interest groups. The resulted international accounting standards are bound to be a compromise. Some
agent transaction costs are reduced but others are increased. The aim of establishing a set of unified global
accounting standards for public interest as advocated by the IASC is only an unrealizable dream. The authors hope
that this conclusion will give nations some insights in their own process of convergence of their domestic
accounting standards with IAFRS.
2. Explanation of Globalization of the Accounting Standards
The globalization of the accounting standards pushed by IASC can be broadly classified into three periods.
2.1 The first period (1973~1987): ISAC was unnoticed for nearly 14 years
International Accounting Standard Committee (IASC) was founded in London in June 1973 as a result of an
agreement by the accountancy bodies of Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the
United Kingdom and Ireland and the United States. The aim of IASC was mainly to development international
accounting standards and to reduce the differences in accounting practices across countries. As IASC had no
authoritative to enforce the standards it issued in any member country, it was more like a research institution than
a management institution of global accounting affairs. To gain supports from its member countries and other
regions, IASC had to allow for a variety of alternative accounting treatments, which were chosen after a
comparison of the popular accounting conventions. Although by the end of the 1980s, IASC had published nearly
30 IASs, and it had little influence on the international accounting affairs. In fact it was greatly criticized.
According to GE Jia-shu (2001), setting up by professional accounting groups from many countries, IASC has no
powerful political background. Its original aim of establishing a unified accounting standard which accepted and
abided by all countries and regions were too ambitious during the early years of foundation.
With this in mind, the authors analyze the strategies adopted by the United States and EU at this stage using a
game model. The reason for having EU and US as the two agents in the model is that both nations are the most
mighty economic giants in the world and both are proud of their most prosperous capital markets. The degree to
which they accept IASs and participate in the harmonization of the international accounting standards would
directly affect the process of internalization of accounting standards. Each agent in the model has only two
strategies, accept or reject. In the model, it is assumed that each of the agents only considers the other agent’s
reaction when it makes its own strategies. The influence of other countries and IASC is too small to be considered
in this period. However, they will be treated as external factors and studied in later models by modifying the
payoff function. The payoff of the strategies of each agent is illustrated in the bimatrix game in Table 1.
An Analysis of Globalization of Accounting Standards based on Game Theory
Table 1
The payoff of the strategies of each agent (1973~1987)
United States
(-g+q), (-G+Q)
0, -G
-g, 0
0, 0
As shown in Table 1, the transition costs1 for EU and the United States to accept IASs are -g and -G,
respectively. (Here the inequalities g>0, G>0 hold to facilitate the analysis, all variables in this article are assumed
to be positive.) If both agents accept IASs, the point (accept, accept), the progress of the globalization of the
accounting standards would be accelerated. Both sides will enjoy the advantage from the resulted unified
accounting standards, which mainly take the form of lower transaction costs, or at least take the form of a unified
Suppose the benefits each acquired are q and Q respectively. When EU and the United States both adopt the
strategies of (accept, accept), the payoff function for EU and the US is (-g+q) and (-G+Q) respectively. If they
both reject IASs, neither they will have the advantage brought by the globalization of accounting standards, nor
will they suffer the transition cost in switching national standards to IASs. In this case, both agents’ utility level
will be zero. If EU accepts IASs while the United States rejects them, then EU will bear the transition cost g, but
unable to get the advantages brought by the globalization of accounting standards. While the other agent, the US
has neither transition costs nor benefits. So, the payoff function for each of them is –g and 0 respectively.
Similarly, when both EU and the United States adopt the strategies with (reject, accept), the payoff function is 0
and -G respectively.
As mentioned above, IASC met with great difficulty in its early years, it harmonized accounting practice
with “free choices” to get supports from member countries. So even when some nations and regions claimed to
have followed IASs, the specific treatments they used might be various. This means either the degree of economic
integration with unified standards or the reduction in transaction costs will not be as much as expected. Factors
that would accelerate the progress of the globalization of accounting standards can be observed today, such as the
degree of economy globalization, financial demand of multinationals in international capital market, desire of the
securities exchanges to attract foreign capital have not emerged. So the value of q and Q would not be large
enough to cover the transition cost. As a result, -g+q<0 and -G+Q<0. So, regardless of strategy adopted by the US,
EU will be better than by choosing the strategy of reject, which is the dominated action. This is also true for the
US. Hence the Nash equilibrium points in Table 1 was (reject, reject), which is the optimal strategy for both
This conclusion can be observed in reality. During the first 14 years after IASC had established, the reactions
of EU and the United States to the IASs were cold. For many years, the United States was dedicating itself to the
establishment of independent accounting standards, regarding its standards as the best in the world. The United
States not only refused to accept the IASs, but worked hard to intervene with the globalization of accounting
standards. EU paid little attention to IASs too. Instead of following IASs, EU tried to harmonize its internal
accounting standards primarily by issuing a series of directives.
2.2 The second period (1987~2000): achievement in establishment of core standards
Transition cost is the cost that occur due to transition from domestic accounting standards to IAFRS, which includes training on
professional accounting, change on other relative systems, difficulties in enforcement of IAFRs, etc.. For developing countries, this
may also include lost of accounting and audit market by accounting firms from developed countries that are more used to IAFRs.
An Analysis of Globalization of Accounting Standards based on Game Theory
From 1987 on, IASC realized that allowing for too many alternative treatments in the IASs will seriously
damage the comparability of accounting information and abate its influence in promoting the globalization of
capital market. So in 1987, IASC launched its comparability project to revise its 29 standards. While working hard
to increase the quality of IASs, ISAC actively looked for the support of authorities. Obviously, if recognized by
the International Organization of Securities Commissions (IOSCO), IASs can be used as standards for public
companies listed in international capital markets in the preparation of financial reports. At the same time, the
status of IASC would be changed from an unofficial research institute to a supervising organization. From 1987
on, IASC began to work with IOSCO to eliminate accounting alternatives. When issued the draft on the
Comparability of Financial Statements, which was nodded by IOSCO, IASC asked member countries to consider
the opinion of IOSCO when selecting the basic treatments and the alternatives. In 1993, an agreement of
establishing a set of core standards was reached between IASC and IOSCO, which was endorsed by IOSCO
formally later in 1995. IASC completed the core standards ahead of time at the end of 1998. But due to the
intervention of the United States, the core standards did not get IOSCO’s endorsement immediately. It is not until
May 2000 that IOSCO proclaimed to endorse the 30 core standards by IASC provides for “supplementary
treatments” at the election of national and regional regulators. In one word, IASC has made eye catching
achievements in this period. Its role in international accounting standards setter has enhanced.
In order to become an economic and political power, EU began its effort to harmonize its accounting
treatment among its member states as early as 1960s, long before IASC was founded. EU issued a series of
directives, among which, the No.7 issued in 1978 and the No.4 issued in 1983 were the most important. But the
effect was not satisfactory due to various reasons, including the drawbacks of the directives themselves. Although
many EU member countries have the directives passed by their parliament as laws or regulations, the enforcement
of the directives was under the control of each country. As a result, the directives were not carried out in a
consistent and effective way. In 1990, EU established the Accounting Advising Forum (AAF). But as the
accounting environment in each member country varied, each country on the Forum insisted on its own opinion
for the sake of its country’s benefit. As a result, the forum had achieved no substantial results. AAF failed to fulfill
its mission.
Discouraged by the failure of internal accounting harmonization, EU set its eyes on the achievement of IASC.
Why not directly follow the steps of IASC? Firstly, most EU members are the members of IASC too, some of
them, including accounting professional bodies of France, Holland and England are initiators of IASC. This
makes it easier for these countries to accept IASs as standards in the harmonization process. As a result, the
possible political resistance in the harmonization of process and the transition cost would be reduced. Secondly,
the headquarters of IASC was located in London and many positions were occupied by Englishmen for years.
These would make it easier for EU to exert its influence on IASC, a useful way to reduce the difference between
IASs and its domestic accounting standards. Having close relationship with IASC has get EU better prepared for
accepting IASs. In addition, the accounting occupation groups had contacted with IASC chronically, which helped
to build up the necessary knowledge for EU to accept the IASs. All these factors would contribute to a lower
transition cost. Thirdly, if EU was the first to declare to accept the IASs, it would set examples to other countries
and press on the US.
From above, it can be seen that in this period, the payoff function for each agent in Table 1 has changed again.
Supposing EU’s transition cost for accepting IASs is –g, once accepting the IASs, EU would save the opportunity
cost of having other harmonization projects, which is assumed to be g1. So total cost of accepting IASs for EU can
An Analysis of Globalization of Accounting Standards based on Game Theory
be expressed as: Δg= -g+ g1. Since the transition cost is lower than the opportunity cost, ie. g is lower than g1, so
Δg>0. But if EU rejects IASs, it will suffer the lost of-Δg, -Δg= -g1+g. So the payoff during this period can be
illustrated in Table 2.
Table 2
The payoff of the strategies of each agent (1987~2000)
United States
(Δg +q), (-G+Q)
-Δg, -G
Δg, 0
-Δg, 0
From this model, it can be concluded that the dominated action for EU is accepted, regardless of the strategy
adopted by the US. But as for the United States, if it deems that the benefit of accepting the IAS will not be
enough to cover its transition cost, i.e. -G+Q<0, it will still choose the rejection strategy (and this was exactly the
case for the US during this period, which will be explained later). So the Nash equilibrium at this time is (accept,
reject), which is quite unsteady: For EU, the optimal utility will be achieved at the point (accept, accept), where its
payoff would be Δg+q rather than Δg. If something happens to make -G+Q>0, i.e. G<Q, then the Nash
equilibrium will move to the point of (accept, accept). Both agents at this time will have Pareto efficiency.
For regional unity of economy and politics, EU realized that having IASs as the standards in the process of
accounting globalization would bring more benefit to itself than to other countries and regions. Driven by this
incentive, EU’s actively support IASC during this period, and gradually became the main pushing power in the
globalization progress of accounting standards. In 1995, EU formally endorsed IASs, permitting foreign
enterprises whose stocks are traded on the open market of Europe to prepare their finance reports according to the
Moreover, EU took further steps to negotiate with IASC. As a result, IASC also made great concession to EU
and took the European interests into account. After IOSCO endorsed IASC’s core standards conditionally in May
2000, European Committee (EC) issued a proposal that requested more than 7000 EU listed companies to use
IFRs2 no later than 2005. On February 12, 2001, EC announced an exposure draft, reiterating its determination to
adopt IASs from 2005, and encouraging the public companies to adopt IASs before 2005, it also encouraged the
private companies to use IASs too. Ever since then, IASs had become the preferred standards in European
As to the United States, it had spent quite a lot including human and financial resources in study of
accounting standards, and had established a system of accounting standards that it was boasted as the most
detailed and best one in the world. With a history of more than 60 years, its GAAP had always been the example
to follow by other countries. Accepting IASs means giving up GAAP, which is difficult to accept by the United
States. And FASB, as the standards setter, would become the first victim in this system transition. Therefore, the
transition costs for the United States of accepting IASs including not only the training expenses for accountants
and the cost of updating accounting systems, but also those indirect economic and political cost of lobbing by
related professional bodies or organizations (such as FASB). Moreover, GAAP of the United States are rule-based,
while IASs by IASC are principle-based. For companies who are used to GAAP for many years, they will feel
confused at the time of transition. So, adverse impact on the US economy would be greater than on other
Include future standards to be issued by the IASB as well as International Accounting Standards (IAS) issued by the former
International Accounting Standards Committee.
An Analysis of Globalization of Accounting Standards based on Game Theory
This is why the author suggested that -Q+G>0 and also why US started a discussion on high quantity of
accounting standards led by its capital market regulator, SEC in September 1997, when IASC had made
substantial achievements in its work. In 1996, SEC enunciates 3 “key elements”3 that must be found in the core
standards. In February 2000, SEC issued a blockbuster “concept release” stating that IASC standards are not
enough, implying a much more daunting assessment of how IASC’s standards are rigorously interpreted and
applied. Obviously, the purpose of SEC and FASB was to find a better excuse to reject IASs, and to hamper the
endorsement of core standards. What worried the United States was that being a member of IOSCO, once the core
standard were endorsed by IOSCO, it had excuse to refuse IASs, which means huge burden of transition cost. In
addition to that, endorsement of IASs would encourage other countries and regions to accept IASs soon. If the US
insisted on refusing IASs, the capital market will become difficult to enter for foreign companies. As a result,
capital may flow to other capital market in the rest of the world, which would seriously damage the benefit of the
United States. What had happened during that period showed that US’ worry was true. The turning point came
when IASC began its strategic reorganization at the end of the 20 century.
2.3 The third stage (2000~present): strategic reorganization of IASC
At the end of the 20 centuries, many great changes have been seen on the stage of international accounting.
IASs were recognized by more and more countries and regions other than EU. According to a survey made by
major accounting firms in 2002, 90% of the 59 surveyed countries intended to converge with IFRs (Street,
2002).Countries such as Singapore, Malaysia and Hong Kong, directly have IASs as their own standards with
slight modification. Some newly arisen market economy countries and transformation economy countries,
including many countries in Asia, middle-Europe and former Soviet Union, established their own accounting
standards according to the IASs. Even some developed countries, such as Canada and Japan, expressed their
supports for IASs. Obviously, IASB is viewed as the appropriate body to develop a global accounting language.
Under this circumstance, the United States can not afford but to participate in the globalization of accounting
standards. If it insisted on refusal of the IASs, it would not only lose the advantages brought by the globalization
of accounting standards, but also parts of the capitals markets.
Therefore, the payoff function for each agent changed again, as illustrated in Table 3. When EU and the
United States adopt the strategies of (accept, reject), the lost that the United States suffered due to lost of parts of
the capital markets, would be -a. While the benefit for EU due to the transfer of some capital from US to it, would
be b. Here b≤a, because the international capital turns out from the United States may flow into other countries
other than EU. If EU and the United States adopt the strategies of (reject, accept), to facilitate the analysis, assume
the lost of EU is -a, while the benefit the United States is b4. For EU, the dominated strategy is still accepted. But
for the US, whether to reject or accept depends on the relationship of (-G+Q) and a. If -G+Q>-a, i.e. G<Q+a, the
US will take the action of acceptance, so Nash equilibrium point will be (accept, accept). But if G>Q+a, the US
will take the action of reject, and the Nash equilibrium point will remain at the point (accept, reject). So the
determining factor is the transition cost G. As in Table 2, if there are some factors that make G<Q+a, both agents
will realize the Pareto improvement. The only difference is that it is easier to satisfy G<Q+a in Table 3 than to
satisfy G<Q in Table 2. With the increase momentum of economic globalization, the lost would be larger if the
Support infrastructure, transition issues and interpretation and application issues.
Of course, the benefit and lost that bring forth by the international capital flow would not necessarily be the same to either EU or
US, but this would not affect the result of the game.
An Analysis of Globalization of Accounting Standards based on Game Theory
United States went by itself in rejecting IASs. That means, even the equilibrium point of (accept, reject) can come
into existence for a while, it is bound to change. Both agents would try every effort to move to the equilibrium
point of (accept, accept) in Table 3.
Table 3
The payoff of the strategies of each agent (2000~present)
United States
(Δg +q), (-G+Q)
-Δg-a, -G+b
Δg+b, -a
-Δg, 0
The strategic reorganization of IASC was one of the factors to cause the change. When the core standards
were completed, IASC began its strategic reorganization to involve national standard setters and streamline its
operation. In December 1998, IASC issued an exposure draft and restructured the International Accounting
Standard Committee into International Accounting Standard Committee Board (IASB). As a response, at the
beginning of 1999, Finance Accounting Foundation (FAF) of the United States and FASB issued a report,
International Accounting Standard Setting: A vision for the future, similar to the draft of IASC. In October 2002,
IASB and FASB signed “The Norwalk Agreement” to formalize their commitment to the convergence of US and
international accounting standards. Obviously, the strategy of the United States switched quickly from boycotting
the IASs to actively participation. SEC dictated that the restructured board must be similar in composition and
operation to the FASB, which was approved by IASC. The reconstructed IASB began operation in 2001. The
board of it has 14 members, 5 of them are from the US. IASB has larger research staff and more elaborate due
process, and meetings in sunshine (like the FASB). In fact, the US has worked hard to take the opportunity of the
reorganization of IASC, to participate in the reorganization, to control or exert it influence on IASB, and make the
new IFRS or the revised IASs giving more preference to the US, all of which are ways to lower transition cost of
the US.
EU understood that only by concede some power to the US during the process of reorganization, will
transition cost of the United States be reduced, which would in turn lead to a win-win strategy of both parties.
After all the United States is the most prosperous country in the world, and its capital market—NYSE—is the
biggest securities exchange in the world whose turnover alone exceed the total of that of Tokyo, London and
Frankfurt’s securities exchange. Without the United States’ participation and support, European companies won’t
be able to fully enjoy the benefit of globalization. After a December 2005 meeting between US SEC Chairman
Christopher Cox and Arthur Docters van Leeuwen, chairman of the Committee of European Securities Regulators
(CESR), EU and the US established a joint work plan for bridging differences between the US and International
accounting standards publicly listed companies rely on for financial reporting.
Because of the active efforts of EU and the US, after reorganization, the internal structure, the arrangement of
personnel and the plans of establishing new IFRS and revising original IASs, gave more preference to the
developed countries such as the United States and European countries. This distribution and exercise of power
was determined by the economic and political strength of EU and the United States. There won’t be much change
in the future, but the internal conflicts are unavoidable.
An Analysis of Globalization of Accounting Standards based on Game Theory
3. Conclusion
At each stage of the globalization of accounting standards, the result is a temporary equilibrium among the
interest groups. When a certain interest groups discerns some external benefits, that is, when benefit to change is
higher than the cost, it will have the motive to set up a new system (LIU Feng, 2000). And then a new game starts.
Because of the difference in economy and politics among the participating agents, the equilibrium resulted usually
transfer benefits from some countries to others. As mentioned above, EU and the United States realized Pareto
improvement in this case by their economic and political strength. However, their benefit was based on the lost of
other countries, especially the developing countries. So, being on the weak sides, the developing countries should
have a clear understanding of the situation. While follow IASs, they should take their own interest into account. At
the same time, they should participate actively in the globalization of accounting standards.
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