FEI: 19th Current Financial Reporting Issues Conference

The Global Economy & International Accounting Standards Developments

Trevor S. Harris

Managing Director, Morgan Stanley Dean WitterProfessor of Accounting, Columbia Business School

FEI: 19th Current Financial Reporting Issues Conference


MORGAN STANLEY DEAN WITTER Trevor Harris (212) 761-4713 [email protected] 2Please refer to important disclosures at the end of this report


Financial Statements: A Means or an End?

Accounting Information as a Product?

Supply and Demand

Market Equilibrium




The Supply Side

•Enforcement of property rights

•Legal form

•Sources of capital - information asymmetry

•Standard setting institutions

•Private enforcement - auditing

•Public enforcement - security regulation

•Education




The Demand Side

•Competition for Capital Allocation decisions

•Competition in M&A Barriers to Entry, Price

•Competition in Product Markets Costs/Margins

•Performance Measurement Economic Focus

•Macro Data Global Fiscal Management

•Global Regulation Preventing Chaos




Competition for Capital

•How level is the playing field today?

– How Companies Actually Trade in U.S. Markets

– Which Companies Actually Trade in U.S. Markets?

– U.S. Investments in Non-U.S. Companies

•What do analysts and investors want?




Types of ADR’s

No SECNo SEC SEC RegistrationRegistration Registration

No Capital Level ILevel I Level 2Raising

Capital Rule 144ARule 144A Level 3Raising

ADR = American Depository Receipt




Does ADR Activity Mean U.S. GAAP?

“Level I Depository Receipts are traded in the U.S. over-the-counter (“OTC”) market….The company does not have to comply with U.S. GAAP or full SEC disclosure. A Sponsored Level-I Depository Receipt Program allows a company to create a program to facilitate investment without changing its current reporting process.

The Sponsored Level-I Depository Receipt market is the fastest growing segment of the Depository Receipt market. Of the more than 1,800 Depository Receipt programs currently trading, the vast majority of the sponsored programs are level-I facilities….it is not unusual for a company with a Level-I program to obtain 5 percent to 15 percent of its shareholder base in Depository Receipt form.”

Source: Bank of New York, Depository Receipt 2000 Half-Year Market Review




Holdings of ADRs: as at 6/00

JanusFidelityCapitalAlliance

Brandes

Total of Top 10Total

FirmValue of Holdings (bill)

Source: J.P. Morgan ADR Website

$28.922.714.413.1

12.0

131.8382.3

6/00$9.217.410.1

n/a

8.2

86.9280.0

6/99




Annual Dollar Volume of Listed DRs

$ bill


0

200

400

600

800

1,000

1,200

1,400

1995 1996 1997 1998 1999 Jun-00

Year-End Projection




Total Capital Raised in Public DR Offerings

0

5,000

10,000

15,000

20,000

25,000

30,000

1995 1996 1997 1998 1999 Jun-00

$ mil


Year-End Projection




Capital Raised in Public DR Offerings

Germany12.9%

Netherlands7.1%

Taiwan8.1%

Singapore5.1%

Other10.5%

Mexico17.0%

China16.1%

Korea2.8%

U.K.17.7%

India2.7%

% by Country





Top 5 ADR’s by Volume

CompanyVolume

(YTD mil)Price10/10

Ericcson 4,119 15.37Nokia 2,663 37.68Vodaphone Airtouch Plc. 783 42.06

B.P. Amoco 678 53.06Telmex 550 50.68






Top 5 ADR: Winners and LosersTop 5 Gainers U.S.GAAP or

Company Exchange ReconciliationBiacore International AB OTC

ILOG S.A. OTCSanyo Electric Co. OTCElan Corp. NYSEProSieben Media AG 144A

Top 5 Losers U.S.GAAP or Company Exchange ReconciliationGold Fields of South Africa Ltd. OTCDanka BusinessSystems, Plc. OTCBaan Company OTCConsorcio G Groupo Dina, S.A. NYSEAsia Pulp & Paper NYSE

NONO

YESYESNO

NONONO

YESYES





Other Examples of Unregistered ADR’s

•Nestle

•Bayer

•Roche

•Nissan

•Volkswagen




U.S. Investments in Non-U.S. Companies

–American Depository receipts [ADRs] or Direct Trading in the Local Markets?

“With the globalization of financial markets, most U.S. institutional investors are now finding it increasingly easy to operate directly in foreign markets….At the end of 1998 ADRs represented only 23% of the total US Iinvestment in European equities.”

Source: Euromoney, Oct 1999, pg. 80




Current Alternative Paths

Domestic GAAPDomestic GAAP

U.S. GAAPU.S. GAAPReconciliationReconciliation Full IASFull IAS

?




What Do Analysts and Investors Want?

•Financial Measures Economic Reality

•Measures which facilitate prediction and comparisons

•Enforcement by High-Quality Auditor and Regulator




Typical Measures in Use

•P/E - Price/earnings•P/E/EPS Growth [PEG] •P/CE - price to cash earnings•P/B - price to book•EV/EBITDA - enterprise (firm) value to EBITDA•ROE - return on equity•DDM - dividend discount model•DCF - discounted cash flow•Residual Income Approaches….EVA, CFROI...




Reconciliation of Income to U.S. GAAP

Nokia



The Global Economy & International Accounting Standards Developments Reconciliation of Equity to U.S. GAAPNokia




Reconciliation of Income to U.S. GAAP

Telefonica S.A.



The Global Economy & International Accounting Standards Developments Reconciliation of Equity to U.S. GAAPTelefonica S.A.




Local GAAP

Telefonica S.A.



The Global Economy & International Accounting Standards Developments Local GAAP

Telefonica S.A.



The Global Economy & International Accounting Standards Developments Local GAAP

Telefonica S.A.



The Global Economy & International Accounting Standards Developments What are the Analysts Doing?



The Global Economy & International Accounting Standards Developments What are the Analysts Doing?




What Does the SEC Want?

“International Standards….themselves must be high quality. By that I mean useful to investors in a way that provides transparency, consistency and comparability in the way companies report in a global capital market”

Source: Arthur Levitt, “Quality Information: The Lifeblood of Our Markets” October 18, 1999.




Why Not U.S GAAP for All?

•“No Taxation Without Representation”

•Prescription vs. Relevance

•Where is U.S. GAAP Heading?–Speed Versus Due Process–Who Actually Sets GAAP?

•Can Supply Keep Up with Demand?




The Phantom Fleets:Number of Aircraft and Percent Carried Off the Balance Sheet, 1997.

British Airways

KLM Royal Dutch

0 100 200 300 400 500 600

Cathay

China Eastern

Japan Airlines

Singapore Airlines

30%

22%

41%

42%

Delta

NorthWest

SouthWest

UAL

27%American

29%

22%

20%

0%

Lufthansa

Ryanair

3%

15%

51%

5%

21%

Pacific

Qantas

Fleet Owned

Fleet Under Operating Leases

Source: Morgan Stanley Dean Witter Research




Future Directions

•Final Decision of SEC Acceptance is a Political One

•What Will U.S. Companies Do?

•What Will Happen to National Regulators?

•Will Changing Demand Force A New System?

Documents

FEI: 19th Current Financial Reporting Issues Conference