Details
| Original language | English |
|---|---|
| Pages (from-to) | 787-808 |
| Number of pages | 22 |
| Journal | European accounting review |
| Volume | 22 |
| Issue number | 4 |
| Early online date | 20 Dec 2012 |
| Publication status | Published - 2013 |
Abstract
The European Union (EU) has been debating for several years whether to change from the legal capital regime as regulated under the Second Company Law Directive to a solvency test regime as applied in the USA, for example. Based on an analysis of direct compliance costs and capital maintenance systems in non-EU countries, the EU decided not to change the regulatory regime in the short term. This paper focuses on the indirect costs of these two regimes. The paper develops a model in which payouts are restricted by one of the two regimes and the equity holders have the choice between extending and liquidating the existing investments. I find that both regimes will create first-best incentives if their respective design parameters are properly balanced. Under a legal capital regime, however, first-best will be a random event, because accounting standards typically do not allow for the necessary interdepencies between the accounting for liabilities and investments. The advantage of a solvency test with respect to the implementation of first-best incentives diminishes if equity holders can misreport future prospects. Under the legal capital regime, misreporting incentives can be excluded by sufficiently conservative depreciation. A solvency test designed to achieve efficient decisions will always create incentives to overstate future cash flows.
ASJC Scopus subject areas
- Business, Management and Accounting(all)
- Accounting
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In: European accounting review, Vol. 22, No. 4, 2013, p. 787-808.
Research output: Contribution to journal › Article › Research › peer review
}
TY - JOUR
T1 - Investment and Liquidation Incentives under Solvency Tests and Legal Capital
AU - Wielenberg, Stefan
PY - 2013
Y1 - 2013
N2 - The European Union (EU) has been debating for several years whether to change from the legal capital regime as regulated under the Second Company Law Directive to a solvency test regime as applied in the USA, for example. Based on an analysis of direct compliance costs and capital maintenance systems in non-EU countries, the EU decided not to change the regulatory regime in the short term. This paper focuses on the indirect costs of these two regimes. The paper develops a model in which payouts are restricted by one of the two regimes and the equity holders have the choice between extending and liquidating the existing investments. I find that both regimes will create first-best incentives if their respective design parameters are properly balanced. Under a legal capital regime, however, first-best will be a random event, because accounting standards typically do not allow for the necessary interdepencies between the accounting for liabilities and investments. The advantage of a solvency test with respect to the implementation of first-best incentives diminishes if equity holders can misreport future prospects. Under the legal capital regime, misreporting incentives can be excluded by sufficiently conservative depreciation. A solvency test designed to achieve efficient decisions will always create incentives to overstate future cash flows.
AB - The European Union (EU) has been debating for several years whether to change from the legal capital regime as regulated under the Second Company Law Directive to a solvency test regime as applied in the USA, for example. Based on an analysis of direct compliance costs and capital maintenance systems in non-EU countries, the EU decided not to change the regulatory regime in the short term. This paper focuses on the indirect costs of these two regimes. The paper develops a model in which payouts are restricted by one of the two regimes and the equity holders have the choice between extending and liquidating the existing investments. I find that both regimes will create first-best incentives if their respective design parameters are properly balanced. Under a legal capital regime, however, first-best will be a random event, because accounting standards typically do not allow for the necessary interdepencies between the accounting for liabilities and investments. The advantage of a solvency test with respect to the implementation of first-best incentives diminishes if equity holders can misreport future prospects. Under the legal capital regime, misreporting incentives can be excluded by sufficiently conservative depreciation. A solvency test designed to achieve efficient decisions will always create incentives to overstate future cash flows.
UR - http://www.scopus.com/inward/record.url?scp=84890426027&partnerID=8YFLogxK
U2 - 10.1080/09638180.2012.749622
DO - 10.1080/09638180.2012.749622
M3 - Article
AN - SCOPUS:84890426027
VL - 22
SP - 787
EP - 808
JO - European accounting review
JF - European accounting review
SN - 0963-8180
IS - 4
ER -