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Direct Benefit and Network Effects in Countries’ Adoption of IFRS

The concept of network effects and direct benefits is extremely pervasive throughout the Global economy, and has interesting implications in the field of international financial reporting. The paper, ‘Network Effects in Countries’ Adoption of IFRS’, by Karthik Ramanna and Ewa Sletten (2013) examine the application of the concept in accounting practices adopted by nations across the world.

It has been interestingly observed that in between the period of 2003-2008, more than 50 countries worldwide decided to abandon their home standards, and mandate the adherence to IFRS (International Financial Reporting Standards) for all companies within their jurisdictions. Select other countries even initiated “convergence” programs with IFRS around the same time. Changes in financial reporting procedures is intimately linked with a country’s financial and economic policies- in particular the “monitoring and information processing capabilities of existing market institutions such as auditing, securities laws, courts and financial intermediaries.”  A change in the former would typically reflect similar modifications in these traditionally institutionalized areas. However, the period mentioned above did not see a simultaneous change in other complementing institutions, posing the question as to what kind of forces were responsible.

It was found that direct benefits and network effects are at the center of this occurrence. Many countries perceived decreased transactional costs in the adoption of International Financial Reporting  Standards (IFRS), and went ahead and adopted it. This movement towards IFRS prompted several others to follow behind. This ties in closely with the concepts we learnt in class regarding the aspects of network effects. Not only is there an indirect benefit through information cascades that causes people to follow others’ actions while abandoning their own information, but also direct benefit effects as a result of several individuals/institutions making a particular selection. In this case, the latter can be seen clearly. As more and more countries adopt the IFRS, there is greater uniformity in financial reporting and accounting standards globally , and reduced transaction costs for international economic and financial exchanges. There are consequent positive effects on foreign investment and International trade, through increased uniformity, lowered costs and increased transparency. A reinforcing effect results which causes more countries to adopt IFRS, since the increased adoption has beneficial effects for all members who ‘sign-up’. More importantly, the effects are strong enough to overcome countries’ reluctance to move away from their “status quo national standards.”

To my mind, this real-world application goes to show the prevalence of network effects in unexpected aspects of society.

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