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68 Seiten, Note: A
2. Understanding IFRS
2.1 The IASB in general and its Standards
2.2 IFRS 7 Financial Instruments: Disclosures
2.3 IFRS 7 gap analysis
2.4 The expectations regarding IFRS
3. The electricity industry
3.1 The business model for electricity utilities
3.2 Accounting for commodity contracts
3.3 The relevance of IFRS 7 for electricity companies
4. Literature Review
4.1 The demand for and supply of disclosures
4.2 Corporate characteristics and disclosure levels
4.3 Prior risk disclosure studies
4.4 Regulation of disclosure
4.4.1 The need for regulation
4.4.2 Extent of regulation
5 Research Design
5.2 Measuring the extent of disclosure
5.3 Reliability and validity issues
5.4 Mapping the way of disclosure
6.1 Overall findings
6.2 Specific areas of attention
6.2.1 Credit risk disclosures
6.2.2 Liquidity risk disclosures
6.2.3 Market risk disclosures
6.2.4 Additional risks disclosed
6.2.5 Own use disclosures
6.3 Factors affecting disclosure levels
6.3.1 Listing status
6.3.2 Auditor’s size influence
6.3.3 Corporate size, Leverage and Profitability
6.3.4 Disclosure level and the extent of derivatives’ use
7 Conclusion and Discussion
7.2 Limitations and Further research
Appendix I. Major new disclosure requirements
Appendix II. List of Sample Companies in Decreasing Order of Turnover
Appendix III. Grading guidance
This paper investigates the adequacy of IFRS 7 by measuring companies’ compliance and extent of disclosure. Adequacy is defined as: to what extent does the standard achieves its objective, which is, to require entities to disclose certain information associated with the use of financial instruments. For this purpose, the annual reports of 21 European electricity companies with fiscal years ending December 31, 2007 have been examined. The author constructed an unweighted disclosure index of 103 items, based on the IFRS 7 requirements, for quantifying the extent of disclosure. The results suggest that the sample companies varied in disclosure levels. Certain required disclosures were sometimes not provided. For instance, the majority of the sample companies provided quantitative disclosures of market risk; however the market risk measurement models are insufficiently explained. The limitations inherent to the models used were usually not discussed. Further, the results show that electricity companies were not keen on providing additional disclosures. This study also seeks to find associations between the extent of disclosure and some corporate characteristics of which statistical relationships were found in prior literature, such as corporate size, listing status, profitability, leverage and auditor size. However, this ended up without any significant findings. This is likely due to the sample size which is inappropriate for statistical testing. Finally, the paper concludes that the shortcomings in disclosure call for regulation. It is expected that, if no regulation were in place, little would be disclosed with respect to risk associated with the use of financial instruments.
In recent years, more and more companies are using structured financial products in their business. The statistics of over-the-counter derivates financial instruments show an amount outstanding of USD 516,407 billion as per June 2007 (June 2006: USD 369,507 billion) in eleven industrial countries. In addition, there are also derivates traded on organised exchanges. The increased deployment of financial instruments exposes entities to financial risks. Therefore, a new accounting standard, International Financial Reporting Standard 7 Financial Instruments: Disclosures (hereafter IFRS 7) , was issued by the International
Accounting Standards Board (IASB) in August 2005. The standard is effective for annual periods beginning on or after 1 January 2007, with earlier adoption encouraged. With this standard, the IASB aims to improve the transparency about the risks that entities run from the use of financial instruments.
This paper illustrates how European electricity companies adopted IFRS 7 since its commencement through the examination of their corporate annual reports. Financial instruments account for a significant part of the balance sheet of electricity companies. The disclosure would be more extensive, and thus a good basis for explorative research. By way of illustration, derivatives represent on average 7,4% and 4,6% of total liabilities and total assets respectively for the companies within the sample.
Another reason for choosing the electricity industry is that, in general, electricity companies are having implementation difficulties with IAS 39, the standard where IFRS 7 is strongly related to (Lopes, 2007). Many of the issues stem from the interaction of IFRS fair value principles with the complex business model of electricity companies. The introduction of IFRS 7 raises questions of how companies would interpret the disclosure requirements and the need for any additional disclosures. To see the rationale behind these questions a clear understanding of the key issues faced by the electricity sector is necessary.
Electricity companies are characterised by sophisticated planning and commodity risk management process to match electricity demand and production, and to manage the associated price and volume risks – the so called re-optimisation process. Part of that, commodity contracts are concluded and adjusted continuously until the final moment of delivery. However, IAS 39 does not reckon with this type of process. The fundamental issue relates to the accounting treatment of the purchase and sale contracts for commodities. Commodity contracts (derivatives) principally must be fair valued, unless they qualify as executory or own use contracts [IAS 39.5 and IAS 39.6]. In that case they are exempted from IAS 39, and thereupon accounted for on accruals basis. Yet, the re-optimisation process makes it difficult to identify which contracts are indeed for own use and which contracts are net-settled. Applying fair value to all commodity contracts creates the concern that more volatile results will be reported which do not reflect the company’s actual risk exposure. Consequently, the company faces the issue that its risk position will be misperceived with implications for firm pricing (Guay et al., 2003). This study does not deal with the classification matter, but will seek for disclosures on own use contracts as part of the research into IFRS 7. Though these disclosures are not required by IFRS 7 since own use contracts are exempted from IAS 39, these disclosures might add to the representativeness of the overall risk disclosures and therefore be provided.
The main purpose of this paper is to evaluate the adequacy of IFRS 7 within the electricity industry. Adequacy is in this case defined as: to what extent does the standard achieve its objectives. The objective of IFRS 7 is to require entities to provide disclosures that enable users to evaluate the significance of financial instruments, and the nature and extent of risks arising from financial instruments to which the entity is exposed [IFRS 7.1]. Following the discussion of the issues associated with IAS 39, questions are raised with respect to what risk information electricity companies would disclose to be in compliance with IFRS 7. The main research question is defined as: How effective are IFRS 7 disclosure requirements within the electricity industry? In order to conclude on that the following sub-questions will be addressed: To what extent do electricity companies disclose risk information to be in compliance with IFRS 7? Thus, do companies only fulfil the mandatory disclosures or do they provide additional risk information? Are there any differences between companies in how they interpret the disclosure requirements? What factors might be associated with the extent of disclosure? Is the increased regulation governing risk disclosure justified? In the end, the answer on the main question will provide some evidence on how companies react on the standard which might indicate the adequacy of IFRS 7 within the electricity industry.
This study employed a disclosure index methodology for quantifying the extent of disclosure in the annual reports of 21 European electricity companies with fiscal years ending at December 31, 2007. An unweighted disclosure index was constructed consisting of 103 items based on the IFRS 7 disclosure requirements. The results suggest that the sample companies varied in disclosure levels. Certain required disclosures were sometimes not provided. The main differences in disclosures were identified in the disclosures of the nature and extent of risks arising from financial instruments. The findings suggest that market risk quantification disclosures often suffer from a lack of details. The limitations inherent to the models used were usually not discussed. Consequently, this could limit the relevance of such disclosures. Further, the results show that electricity companies were not keen on providing additional disclosures. This might be seen as a signal for regulation. It is expected that, if no regulation were in place, little would be disclosed with respect to risk associated with the use of financial instruments. At last, no associations were found between the extent of disclosure and some corporate characteristics, such as corporate size, listing status, capital structure, profitability and auditor size. An explanation could be that the sample size was inadequate for finding any relationships.
This study has both theoretical and practical relevance. First of all, this paper makes a contribution to the existing disclosure literature. Many of the prior researches focused on the demand for disclosure (Healy and Paleplu, 2001), motives for voluntary disclosure (Verrechia, 1983; Gibbins, Richardson and Waterhouse, 1990) and factors influencing mandatory disclosures (Wallace and Naser, 1995; Owusu-Ansah, 2005). Other studies either examined corporate financial disclosures in general (see for example Abraham and Cox, 2005) or the disclosure of other types of risks. Hodder et al. (2001) and Roulstone (1999) investigated the implications of Financial Reporting Release No. 48 with partly similar disclosure requirements as IFRS 7. More recent studies addressed risk disclosure in a completely different setting. Linsley has conducted several studies in the banking industry (Linsley and Shrives, 2005; Linsley et al., 2006).
Unlike the above researches, this paper investigates the risk disclosures practices in the electricity industry, which has not been examined previously. Further, both mandatory and voluntary disclosures are included within the analysis. The emphasis of the paper is neither on the incentives of management, nor on the interpretation by the financial statement user and decision-making implications, but on the risk disclosure as a subject required by IFRS 7. A more detailed review of relevant existing literature is provided later on in this paper.
A second implication of this paper is theoretical and practical by nature. This study offers evidence on the debate on standard setting. Researchers attempted to find explanations that might justify the prevalence of disclosure regulations within different disciplines; however there are still too many questions remaining unanswered (Healy and Paleplu, 2001). The research findings are in that sense relevant that it demonstrates the need for IFRS 7 and its effectiveness.
More practical relevance could be found in its potential use to the reporting entities. The proprietary cost hypothesis assumes that companies may be reluctant to disclose information that might damage their competitive position (Healy and Paleplu, 2001). The insights provided by this paper could be used for developing a best practice framework for providing meaningful risk disclosures in the electricity industry.
At last, since IFRS 7 is to be applied for all accounting periods commencing on or after January 2007, few studies have been conducted in this respect. This means that the implications of IFRS 7 have not been thoroughly analysed yet. This study is one of the first to examine IFRS 7.
The remainder of this paper is organized as follows. The next section provides insights on IFRS 7 for developing a basic understanding. It discusses the objective of the standard and how it aims to achieve that. The section following provides an overview of the business practices in the electricity industry and some related accounting issues. Section 4 includes a review of the existing literature on disclosure issues and the justification of regulation in the accounting practice. It discusses the results and implication of prior research, and states the hypothesized determinants of disclosure. The fifth section outlines the research design including sampling and data collection. It further explains the construction of the disclosure index and the creation of the companion grading guidance. Section 6 reports the research findings followed by a discussion thereof in section 7. Finally, the paper concludes with a discussion of the implications of the research findings for future research.
This section provides insights on IFRS 7 for developing a basic understanding. Financial reporting and disclosure is mainly governed by IFRS in Europe. All European listed companies are required to follow the standards laid down by the IASB since 2005. Next, I will give a brief introduction of the IASB followed by an overview of the requirements of IFRS 7. The section ends with a discussion of the relevance of the mentioned standard.
The International Accounting Standards Board (IASB), formerly known as the International Accounting Standards Committee (IASC), was established in 2001. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements.
At first, the adoption of IFRS was on voluntary basis, until it gained its authoritative status in September 2002 through the European Union (EU) Regulation. The Regulation requires all public listed companies within its jurisdiction to prepare and present their consolidated financial statements in accordance with IFRS (as endorsed by the EU) at the latest by 2005. At present, nearly 100 countries require or permit the use of, or are in the process of adopting or converging with, IFRSs.
Currently, there are three standards dealing with financial instruments. The first standard which was endorsed in 2004 by the European Commission is IAS 39 regarding the measurement and recognition of financial instruments. The endorsement of IAS 32 followed one month later. This standard now only addresses the presentation matters concerning financial instruments. The disclosure provisions formerly in IAS 32 are incorporated in IFRS 7. Besides, IFRS 7 supersedes IAS 30 which required banks and similar financial institutions to disclose certain information in their financial statements and also adds new disclosures. Thus, all financial instruments disclosure requirements are now located in a single standard, applicable for all types of companies. The next paragraph provides more insight on the requirements set out in IFRS 7.
IFRS 7 Financial Instruments: Disclosures is applicable for annual periods beginning on or after 1 January 2007. The scope of the disclosures covers all financial instruments and related risk management activities. Thus the standard impacts all entities that hold financial instruments, thereby referring to the principles in IAS 32 and IAS 39. A financial instrument is defined as any contract that gives rise to financial asset of one entity and a financial liability or equity instrument of another entity [IAS 32.11]. This includes the more complicated financial products, but also more common instruments such as cash and cash equivalents, borrowings, trade receivables and payables. The standard also applies to commodity based contracts that are net-settled, i.e. the ones that are within the scope of IAS 39 [IFRS 7.5]. The impact of IFRS 7 shall depend on the extent of the use of financial instruments and the exposure to financial risks.
The standard is intended to improve the transparency about the risks that entities run from the use of financial instruments. It requires entities to provide financial statement disclosures that enable users to evaluate: (1) the significance of financial instruments for the entity’s financial position and performance; and (2) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks [IFRS 7.1]. To this end, there are four key areas that are especially noteworthy (PricewaterhouseCoopers, 2006b) :
1. IFRS 7 requires entities to disclose risk ‘through the eyes of management’, which means based on the information provided internally to key personnel management of the entity [IFRS 7.34a]. Companies are required to communicate to the market their exposure to risk, how the risks arise, how they perceive, manage and measure risk. The standard requires both quantitative and qualitative disclosures.
2. IFRS 7 has expanded the quantitative minimum disclosures of interest rate risk and credit risk [IFRS 7.34 and on]. Companies have to disclose information about the credit quality of financial assets. Furthermore, more extensive risk disclosure on liquidity risk and the management thereof is required.
3. IFRS 7 requires entities to prepare a sensitivity analysis either for each component of market risk to which an entity is exposed (currency, interest rate and other price risk), or
one that reflects the interdependencies between risk variables [IFRS 7.40 and 7.41]. Entities need to show the impact of any reasonable shift in every relevant risk variable on profit or loss and equity.
4. IFRS 7 requires enhanced disclosure of an entity’s financial position and performance, in both balance sheet and income statement. This includes, for example: disclosure of movements on the allowance account for credit losses if such an account is used [IFRS 7.16] and disclosure of the ineffectiveness recognized in profit or loss for each type of hedge used [IFRS 7.24].
Within PricewaterhouseCoopers, a basic gap analysis has been performed to show which of the IFRS 7 standards are adopted from IAS 30 and 32 in their original form or amended and which ones are completely new. A summary of the major new disclosure requirements has been added to Appendix I. As it turns out, the last part of the standard concerning the nature and extent of risk arising from financial instruments is almost completely new. This part contains disclosures about credit risk, liquidity risk and market risks. Formerly, IAS 32 required entities to provide some disclosures of the exposures to interest rate risk and credit risk, but these were fairly limited and are now expanded in IFRS 7. For example, entities were required to disclose the contractual repricing dates or maturity dates and effective interest rates with respect to the interest rate risk exposure and the maximum credit risk exposure. These disclosures are now incorporated into paragraph 34 and 36 of IFRS 7. The analysis in Section 6 will focus on the companies’ compliance with the new disclosure requirements.
Furthermore, the paragraphs that were taken from IAS 30 were only required for banks and financial institutions. For electricity companies, it is the first time that they need to comply with these requirements. There is one main disclosure adopted from IAS 30, which is IFRS 7.16 mentioned above. The analysis will show if the electricity companies have met this requirement.
IFRS 7 arose from a project to revise IAS 30 which was only applicable for banks and similar financial institutions. However, the Board considered it would be inappropriate to limit the disclosure about risks associated with financial instruments to this type of organization since many entities are undertaking financial activities these days [IFRS 7 – BC6 and BC 7]. In July 2007, the exposure draft ED 7 was published, and The Board received 106 comment letters. The majority of these letters were sent by financial institutions. As this paper focus on a non-financial industry, primary attention is directed to those comment letters that took this perspective into consideration. For example, the comment letter from the Hundred Group which represents the finance directors of the hundred largest companies in the United Kingdom, among which one electricity company. They mentioned that they have concerns about the ability of non-financial institutions to meet the proposed disclosure requirements and the appropriateness of the information. Their main concerns were related to the disclosure of the fair value of collateral and other credit enhancements, the sensitivity analysis, and the capital disclosures. According to the Hundred Group, some disclosures seemed to be too extensive and therefore not appropriate for non-financial institutions, other disclosures might be costly to produce.
Mannaerts and Veuger (2007) argue that the IFRS 7 disclosure requirements are perceived as potentially harmful. Companies are required to disclose competition sensitive information, e.g. pricing assumptions used as input for valuation models. This type of information is also defined as proprietary information. Within current disclosure literature (see Verrecchia, 1983; Dye, 1986; and Wagenhofer, 1990) it is hypothesized that companies have an incentive not to disclose proprietary information.
From another point of view, the reason for increased regulation governing risk disclosure could be found in the market development. Investors, creditors and other stakeholders became increasingly concerned about how entities use derivative financial instruments and their risk exposure after the collapse of companies like Enron (Brunet and Shafe, 2007). In response to that, more transparency is desired to restore stakeholders’ confidence in the energy trading industry and regulation.
This section outlines the business practices within the electric utilities sector. It explains the role of financial instruments for a utility’s operation and the difficulties of accounting for that. At last, this section discusses how the accounting complications may have an influence on the relevance of IFRS 7 for this particular industry.
The electricity utilities value chain is commonly divided into five key stages – fuel sourcing, generation, trading, transmission and distribution, and retail (PricewaterhouseCoopers, 2006a). Many utility companies have organised themselves in business units along these stages, albeit larger companies are usually vertically integrated to some extent. Vertical integration creates competitive advantage. It provides electricity companies opportunities to take a “short” position in a given area and “long” in another one, hence to build a well-balanced portfolio of business which is less sensitive to market risk than its components (Cibrario, 2007). To accomplish this, integrated utility companies usually have a centralized trading or risk management unit for managing their portfolio and the associated risks. This paper concentrates on this unit and the associated energy trading activities where financial instruments are often used.
Energy trading plays an essential role in portfolio and risk management. It mainly serves two purposes (Brunet and Shafe, 2007). First, it allows electricity companies to benefit from profit opportunities (Cibrario, 2007; Ku, 2003). Such profits could be derived in three ways, namely through (1) arbitrage trading; (2) speculative trading; and (3) trading around assets thereby using own assets as financial position.
Second, electricity companies might trade for risk management purposes. Electricity utilities are exposed to price fluctuations inherent in the electricity market. In order to hedge this exposure companies might utilize commodity based derivative financial instruments, like fuel purchase contracts, emission right or allowance trades, futures and options. Guay (1999) found supporting evidence which indicates that firm risk declines following derivative use.
In practice, electricity companies engage into a mix of commodity contracts, with several means, and they are continuously adjusting their contract exposure in the run up to delivery. It is the dynamic developments in electricity demand, the unique nature of electricity as a commodity which cannot be stored and the limited possibilities to store gas that result in the need for continuous balancing supply and demand and commodity risk management. This process is also known as re-optimization. In the end, some commodity contracts are settled physically (by supplying electricity) and other ones are settled financially (by cash payment). As a consequence of that, the contracts have to be accounted for in a different way, either using accrual accounting or fair value accounting.
The various uses of commodity contracts lead to different accounting treatments. In principle, IAS 39 requires fair value accounting of all derivatives, with all movements in fair value recognised in the profit and loss accounts [IAS 39.46-47 and IAS 39.55]. This also applies to contracts to buy or sell a non-financial item, i.e. commodity-based contracts, that can be settled net in cash or another financial instrument, or by exchanging financial instruments, except for those contracts that qualify as executory contracts, also known as the own-use exemption [IAS 39.5-6]. Executory or own use contracts are those contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a nonfinancial item (commodity) in accordance with the entity’s expected purchase, sale or usage requirements. These contracts shall be accrual accounted. The own-use exemption exists to overcome the unnecessary volatility in profit or loss for companies that have own-use contracts of which the price risk is basically eliminated by delivery or sale of the nonfinancial item.
Nevertheless, it appears that many companies’ trading activities may fall outside this exemption even when essentially directed at fulfilling production and customer requirements because of the ability to ‘net settle’ (Jenkins, 2005; Mannaerts and Veuger, 2007; PricewaterhouseCoopers, 2003). As previously explained, electricity companies are characterised by sophisticated planning and commodity risk management to achieve a balanced portfolio. Therefore, contracts might need to be net settled prior to delivery or offset with an inverse contract, for reasons such as to benefit from arbitrage opportunities or to anticipate on changes in demand forecasts or pricing structures. For example, a straightforward coal purchase contract will be accrual accounted. However, if a company has a practice of selling the coal purchase contract before taking delivery or taking delivery of the underlying and selling it within a short period after delivery, then the purchase contract must be fair valued. And consequently, fair value accounting applies to all net-settled contracts and also to all similar contracts, with implications for earnings volatility [IAS 39.6]. In order to qualify for the own-use exemption, it is therefore required that the contract is designated as own use at inception.
Another aspect to be mentioned is the accounting treatment of electricity generation capacity. An electricity company typically holds long positions in generation capacity and short positions in fuels. The long position is mostly accrual accounted, because there is no net settlement. However, the fuel purchase contracts are accounted either on accruals basis or fair value depending on the way of settlement. Thus, the timing of financial reporting could be inconsistent with the economic value development. The same holds for the customer consumption forecast, also called customer profile, which is also accrual accounted.
Recent studies by Van der Tas and Veuger (2007) and Wognum (2008) demonstrated that electric utilities used different approaches to report on commodity contracts. The following three methods are distinguished: full fair value, full own use and the labelling method. It should be noted that these accounting methods concern commodity contracts that might qualify as own use if physically settled and not the contracts that are initially entered for the purpose of purely trading. The trading portfolio is accounted at fair value at all times.
The full fair value method assumes that part of the commodity contracts is net-settled, but it is difficult to exactly identify which ones. For that reason, all contracts are fair valued based on the rule of similar contracts as required under IAS 39. The increased volatility in the income statement could be reduced by applying hedge accounting.
The full own use method could only be applied when no net settled contracts exist, then it is allowed to use full accruals accounting. This could be the case when the company solely purchase fuels to generate power which in turn will be sold to the end user.
At last, the labelling method, this is in fact a mixed model. It requires a separate administration for registering own use and fair value contracts in an own use book and a fair value book respectively. The own use book is accrual accounted and the fair value book is fair valued with any changes in value through profit and loss. The extent to which contracts are labelled as own use depends on the expected rate of physical delivery determined by management and the intent of the contract. Own use contracts should be transferred to the fair value book when the intention to deliver physically is uncertain. However a transfer the other way around is not allowed .
The choice of accounting approach will have an impact on the volatility of the income statement and the structure of the balance sheet. The full fair value approach will generally lead to more volatility in earnings. This could be reduced by hedge accounting, then the volatility is transferred to equity (in case of a cash flow hedge) or compensated by a revaluation of another item (in case of a fair value hedge). The full own use approach will only show the volatility of the trading portfolio (e.g. speculative and arbitrage trading) in income. The extent of volatility using the labelling method is expected to be in between the two methods. Prior research into the accounting choice between the methods did not yield any significant results (Wognum, 2008).
The current accounting practice for commodity contracts as required by IAS 39 creates considerable complexities. It is not sufficiently comprehensive to capture the economic impact of derivatives use on a company’s financial condition and performance accurately. The problems associated with fair value measurement are apparent. It can potentially induce volatility in the income statement and/ or balance sheet that does not reflect the underlying business realities (Jenkins, 2005). With the introduction of IFRS 7 more complexities will arise. IFRS 7 requires qualitative and quantitative disclosures that are based on the information provided internally to key management. The collection of this type of information may require significant effort due to the gap between management reporting and accounting figures (Mannaerts and Veuger, 2007). This paper shows how electricity companies have dealt with the disclosure requirement in the standard.
This paper draws upon the literature that examines disclosure models, and in particular prior studies related to risk disclosure. Financial reporting and disclosure are important means of investor communication for a company’s management regarding its performance and governance. Financial disclosure is defined as “any deliberate release of financial information, whether numerical or qualitative, required or voluntary, or via formal or informal channels” (Gibbins, Richardson and Waterhouse, 1990). It plays a critical role in promoting the optimal allocation of financial resources from the investor to investment opportunities and protecting investors’ interests (Healy and Paleplu, 2001). Thus it is essential to understand disclosures practices.
Under ideal conditions of complete and perfect markets, there would be no substantive role for financial disclosure, hence no demand for accounting or accounting regulation (Fields et al., 2001). However, the market shows imperfections which have given rise to demand for disclosure. Healy and Paleplu (2001) discussed two major problems in capital markets: information asymmetry and the agency problem.
Companies’ management typically have an information advantage relative to investors about the value of the business and incentives to overstate this value. This problem is known as the “lemons” problem or information asymmetry. A potential mechanism to control this problem is the disclosure of relevant information. The relationship between information asymmetry and disclosure is captured by the capital markets transactions hypothesis. It assumes that managers who anticipate making capital market transactions have incentives to reduce the information asymmetry problem through increased voluntary disclosure, thereby reducing their cost of capital.
A large number of studies have examined the link between disclosure and the company’s cost of capital. Diamond and Verrecchia (1991) showed that corporate disclosure reduces information asymmetry between the company and the market, which in turn improves market liquidity. The increased liquidity attracts demand from large institutional investors with the result that a company’s security prices increases, or, equivalently the cost of capital decreases for the company. In another study on disclosure levels and cost of capital, Botosan (1997) documents a significant negative association between her self-constructed disclosure index and the company’s cost of capital only for companies with low analyst following. It is argued that the lower cost of capital also holds for increased risk disclosure. Funds providers which have better information to evaluate the company’s risk profile will require a lower risk premium which results in a lower cost of capital (Dobler, 2005; Linsley and Shrives, 2005).
 The Bank of International Settlements (BIS) releases semiannual OTC derivatives statistics based on information obtained from the G10 countries (made up by Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom and the United States) and Switzerland. Statistics regarding exchange traded derivatives are provided as well, but are reported within a different timeframe (as per December 2007: USD 80,623.3 billion outstanding measured by notional amount). Refer to:
 References to a specific paragraph of an IAS/ IFRS standard are placed between brackets.
 Ernst & Young investigated the application of IAS 39 within the European utility industry. Utility companies usually have extensive guidelines included in their accounting policies on the classification of commodity contracts as either ‘own use’ or commodity derivates. These guidelines seem quite similar over the companies, however differences in practice may arise and it is still difficult to assess whether the classification is consistently applied (Ernst & Young, 2006).
 IFRS 7 applies to contracts to buy or sell a non-financial item that are within the scope of IAS 39 (see paragraphs 5-7 of IAS 39) [IFRS 7.5].
 The IASC came into existence on 29 June 1973 was a result of an agreement by professional accountancy bodies in Australia, Canada, France, Germany, Japan, Mexico, The Netherlands, The United Kingdom and Ireland, and the United States of America.
 As stated in IFRS (2007).
 Regulation EC No. 1606/2002 of The European Parliament and of the Council of 19 juli 2002.
 IAS 39 was not fully endorsed in 2004. One part was endorsed later on in 2005. The other part, related to certain hedge accounting requirements in IAS 39 has been refused by the European Commission. Further, IAS 39 has been amended several times since its endorsement.
 The comment letter from the Hundred Group is comment letter no. 70 in the index. This comment letter was obtained from the official IASB website: http://www.iasb.org/Archive/Archive+IASB+Project++Comment+Letters.htm
 Vertical integration is limited by regulation. Directive 2003/54/EC concerning common rules for the internal market in electricity (“the Electricity Directive”) requires the legal and functional unbundling of distribution and transmission system operators that are vertically integrated. “Unbundling" refers to the separation of energy network activities from production and supply activities. In September 2007, the European Commission adopted the third legislative package which also emphasized the network unbundling. For more information:
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