The Value of Accounting: The Case of Greece
George Serafeim | August 25, 2015 |
Why is Greece having such a hard time recovering? There are many factors that could explain this failure but I believe one major reason is the lack of high-quality government financial information, which reduces accountability for decision making, distorts incentives, and leads to bad decision making and systematic value destruction.
I teach managers and executives from all around the world and use a framework that I call MACC that showcases the fundamental importance of accounting. This framework is used to measure, analyze, create, and communicate (MACC) value:
- Measure the value of the assets, liabilities, and net worth so they can be analyzed.
- Analyze performance over time and relative to other organizations so it can be used as an input on what needs to change to create value.
- Create value by adopting policies and processes that will increase the value of the assets.
- Communicate the value creation story to build trust and confidence in the organization and attract investments.
I recently authored a Harvard Business School case study on the Greek crisis (“Greece’s Debt: Sustainable?”). The case explores the issue of fair valuation of financial liabilities. All accountants understand that over the last ten years we have experienced a revolution in accounting—moving away from historical cost and closer to fair value accounting, which takes into account market inputs and present value techniques. But in the case of Greece, we are completely ignoring both market inputs and present value techniques.
Ask yourself the following question: how much is Greece’s debt? The International Monetary Fund (IMF) and the press usually quote a debt-to-GDP ratio of close to 180%. Given that Greece’s debt consists to a large extent of concessionary loans and securities, I started wondering how it could be that the debt is so high. The answer is simple: the debt number that is used is based on nominal value. As a result, it does not reflect the very long maturities of loans made to Greece, the below market interest rates at which Greece is borrowing money, and the rebates of interest and profits that are agreed with the European Central Bank.
Is this important? Incredibly so. This is the number that the IMF is using to design policies and measures to assure debt sustainability. The higher the debt number, the stricter the austerity measures, the higher the primary surpluses that are imposed as a condition, etc. Perhaps even worse are the decisions that are being made on the basis of wrong numbers. Examples include spending 11 billion euros at the end of 2012 to buy back debt in order to reduce the nominal value by close to 31 billion, or the decision to use 25% of the proceeds from the recently announced bailout fund to repay the debt. Instead of using the money for badly needed investments, Greece, pressured by the creditors, keeps pouring money into repaying debt in order to reduce its nominal value.
Another piece of the puzzle in the case of Greece is using gross instead of net debt. Net debt is debt minus the financial assets that a government holds. Believe it or not, Greece had a lot of financial assets at the end of 2013. Actually Greece had more than 90 billion euros in financial assets. But there is very limited transparency about those assets and very limited public debate about their management. What is the result? Greece has wasted more than 30 billion euros in assets in the last year. Would this have happened if we were concentrating on net debt? Perhaps not, as policies would be more closely scrutinized for their effect on the financial assets of the country.
From a management standpoint, it will be impossible to stop destroying value and start creating value if we do not start from the first pillar of MACC: measure. Greece needs to adopt accrual accounting, take an inventory of its assets and liabilities, and publish a balance sheet. This is not only a matter of good management, it is also a matter of democracy, as citizens are called to vote on how well a government is managing their future. The recent Greek referendum, when Greek citizens were asked to vote on economic policy measures, makes this clear.
But Greece is not alone in this. Many countries, including Germany, have poor government accounting practices using cash accounting, even today. This needs to change. Taxpayers need to know that, in economic terms, an x% haircut on the nominal value of debt is equivalent to a y% lengthening of the maturity of a loan. Resistance to a haircut of the nominal value of debt but openness to a lengthening of maturities or lowering of interest rates is not driven by economic logic and proper stewardship of the taxpayer assets. It is driven by the poor accounting practices of many European governments that hides losses on the loans to Greece from the eyes of their taxpayers.