Wednesday, September 19, 2012

The Use of Institutional Theory in IFRS Convergence Research: What Researchers Have Missed

By: Ersa Tri Wahyuni

This article is part of my submitted assignment at Manchester Business School for my first PhD year. I like the analysis and I hope this article may help other PhD students and researchers to look deeper in the IFRS Convergence issue.

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New Institutional Theory (NIS) has been widely used by various researchers in sociology, political science, business and management as well as Information system and technology. The increasing use of institutional theory in other research areas is also prevalent over the years. As it is exhibited in table two, institutional studies has been utilized in 511 research papers published in 210 journals over the past 20 years (Weerakkody, et,al., 2009).

The corner stone year of the new institutional theory would have to be 1977 when John Meyer published his paper “The Effect of Education as an Institution” in American Journal of Sociology. John Myer with Brian Rowan (1977) also published another important paper in the same journal edition, “Institutionalized Organization: Formal Structure as Myth and Ceremony” which provides the central components of the new institutional theory.

In the Accounting research area, NIS has been used to explain many case studies in management accounting, auditing, and international accounting. Accounting as one of tool to produce information from the organization cannot be separated from the organization norms, value and behavior. Many longitudinal case study of management accounting use NIS as a powerful tool to understand the behavior or an organization over time. Not only in the micro level as company and organization, NIS also being utilized to explain the behavior of a country or a state in adopting accounting standard.

One example of management accounting case study is Yazdifar, et.al. (2008) who look a parent-subsidiary relationship over 8 year period of time. Yazdifar, et.al, use NIS and OIE (Old Institutional Economics) theory to explain the dynamic of the process of change in the subsidiary. NIS is utilized to explain the coercive isomorphism from the parent company to the subsidiary. Drawing on observations from a longitudinal case study (from 1993 to 2001), the study specifically investigates the extent to which a parent imposes its (management accounting) systems, rules and procedures on a subsidiary. In addition, the study also seeks the role which (local) political, cultural and institutional factors in a subsidiary play in shaping the dynamics of such change implementation

NIS is also powerful to explain processes in non-profit organization. There is a presumption that in competitive markets, only the goal of profitability matters which force non-profit organization that they must act as if their goal is for profit in order to survive. Non-profit and less competitive environments have sufficient slack to allow more institutional effects influence the organization (Carruthers, 1995). The example of NIS in non-profit organization is another longitudinal study by Parker (2007) which explains boardroom strategizing in two professional associations. The study reveals that private sector philosophies are imported to the non-profit boardroom.

Not only in company or non-profit organization, NIS also has been used to explain the decision process of a state. A paper by Carpenter & Feroz (2001) uses NIS in explaining the decision of four US State Governments in adopting General Accepted Accounting Principles (GAAP). The study utilizes institutional theory to explore how institutional factors exerted on four state governments (New York, Michigan, Ohio and Delaware) influenced the decision of these governments to adopt or resist GAAP for external financial reporting. The study identifies resource dependence as potent form of coercive institutional pressures that associated with early adoption of GAAP.

NIS in the research area of IFRS convergence.

In the context of IFRC convergence initiatives, institutionalization can be viewed as a social process through which a country accept that national accounting standards are absorbed in the interests of international accounting harmonization. (Rodrigues and Craig, 2007) Some existing studies reveal that the processes of isomorphism have exhibited for many years, in many countries. IFRS is not only used in Anglo Saxon Countries which mostly based on microeconomics, shareholder oriented, judgement-based financial reporting (Doupnik & Salter, 1995; Nobes 1998) but IFRS harmonization are also evident in countries in a different accounting regime such as code law countries. China for example, from the Rusian style accounting standard in the past, China has been gradually accepting IFRS since 1997 (Ding&Su, 2008). Kazakhtan, a former USSR country, also try to adopt IFRS since its independence in 1991 (Tyrall et.al. 2007).

In the field of international accounting research, especially research on IFRS adoption/convergence, NIS has been used both in quantitative and qualitative research. As suggested by Rodrigues and Craig (2007), NIS is useful in explaining development in international accounting over period of time. One widely held myth is that a formally announced practice of an organization (e.g total compliance with IFRS) does not differ from its actual, or informal practice (e.g less than total compliance to IFRS). The concept of decoupling in NIS can be utilized to explain if such evidence exists (Rodrigues & Craig, 2007)

When a country decides to adopt IFRS and abandon their previous accounting standard, the main reason should be economical such as IFRS will bring economic benefit to the country. The economic benefit can be the decline in the cost of capital or the significant increase of foreign investors in the country’s capital market. However, some studies suggest that the reason of a country adopting IFRS is not economical but more on achieving institutional legitimization. The three type isomorphism is powerful to understand what force a country in adopting IFRS.

Some researchers tries to find empirical evidence of reasons behind the adoption of IFRS and exploit the NIS as their theoretical framework. Research by Judge, et,al. (2011) or Lasmin (2011) proxy three isomorphism with quantitative data. For normative isomorphism those two research use the enrollment level of secondary education and with coercive isomorphism, the percentage of foreign aid as total of country GDP is used. For mimetic isomorphism, the Lasmin (2011) use the average percentage of market capitalization to the GDP while Judge, et,al. (2011) use import penetration as their independent variable. The result of two studies is not consistent. While all three independent variables have predictive value to which IFRS has adopted across hundreds of countries with varying degrees of adoption, Lasmin (2011) found coercive isomorphism is the most predictive while Judge, et.al (2011) found normative isomorphism has more predictive value.

Having personally involved in the IFRS convergence process in Indonesia for the past three years before coming to UK, I found the quantitative research using the proxy for isomorphism are not convincing. For example the enrollment of secondary education as a proxy for professionalism (normative isomorphism) is perplexing for me as the relationship is quite remote. I believe the number of accountants practicing in a country can be a better proxy for normative isomorphism as professionalism is relevant. Or the number of accountants certified by international recognition certification in the country. However for such kind quantitative research and statistical test, the data availability is a major issue which is acknowledged by researchers in this area (Judge, et.al, 2011).

I believe NIS isomorphism is more suitable for qualitative research as the first intention of NIS theorist is to find theory to explain how an institution endures. In Weerakkody et.al.(2009) survey, the quantitative research methodology comprise only 36.3% of the total papers that utilized NIS, while qualitative and conceptual/theoretical methodology comprises total of 56.9%. Table three below exhibits the percentage of research methodology applied in the research papers using NIS.

In the earlier stage of NIS, the researcher focus was more to companies or non-profit organization. However as the NIS diffused and widely used in other research area, the institution are expanded in to cities, countries, or a set of institutional arrangement such as accounting standards. The NIS framework to explain IFRS convergence in a particular country has been utilized in qualitative case study for Sweden (Collin, et.al., 2009), Egypt (Hassan, 2008), French (Touron, 2005), Pakistan (Ashraf & Gani, 2005), and Bangladesh (Mir & Rahaman, 2004).

In the country’s study mentioned above except for French, all authors argued that coercive force has been the major factor in the IFRS convergence process. Either it is coercive pressure from the international donor organization such as IMF to a country or a coercive pressure from the government’s rule to the companies. Touron (2005) case study of French is a little bit different as the study investigates the motivation of two companies in using IAS (predecessor of IFRS) in 1970s far before IAS become mandatory in Europe. Mimetic isomorphism has been used in Touron (2005) study to explain the motivation of these two companies in applying IAS far before they are mandated to. Nevertheless, companies in European Union faced a strong coercive pressure in adopting IFRS in 2003 when European Commission approved the proposal to adopt IFRS in 2005 (Whittington, 2005)

However the country specific case studies I mentioned earlier, always assume that the institutional factor of the agent such as the national standard setter board is constant. This might not be the case in the some adopting countries such as Indonesia and Japan. In both countries the leadership change to pro-IFRS leader in the accounting standard board has been a plausible factor of the country’s convergence in to IFRS. Rosita Uli Sinaga, the chairman of Indonesian Accounting Standard Board, an IFRS partner of Deloitte, appointed as chairman in 2009 when the country was slipping away from their IFRS adoption year target. Ikuo Nishikawa, the chairman of Accounting Standard Board of Japan (ASBJ) was the Japanese delegation in IASC Board during 1993-1998 before he assumed the ASBJ leadership role in 2007 replacing Professor Shizuki Saito.

Another potential institutional factor is the change of the governance structure in the accounting standard board. Australian Accounting Standard Board (AASB) has become a quasi-public sector body which is funded by Government in 1991 from the previous independent Board which is profession-driven and self funded. However contrary to Australia case, In other country the national standard setter board has been spun off from the government (usually ministry of finance) to the independent private sector before the process of IFRS Convergence. This has been the case in Korea where the Government decided to establish an independent accounting standard board in 1999. Japan also established an independent private board (ASBJ) in 2001 which previously the responsibility of accounting standard setting is within the ministry of finance.

IFRS adopting countries also create a new oversight body around the decision of adopting IFRS. Australia established FRC (Financial Reporting Council) in 2001, Malaysia in 1993, and Indonesia is in the process of establishing similar FRC as the bill is being developed by the government. This oversight body usually consists of stakeholders including the government, financial report preparers, capital market, industrial association as well as accountant academics.

These changes in the structure of national standard setter board have been overlooked by researchers. There has been a structural or governance changes among the institution during the process of their IFRS adoption or convergence. Therefore there is a big possibility that the success of a country adopting IFRS mainly come from the structure isomorphism rather than coercive isomorphism. Researchers should include these structural changes as the determinant factors for IFRS convergence by countries.


Manchester, September 2012