Improving Creditor Protection through IFRS Reporting and Solvency Tests

Abstract

Accounting-based capital maintenance is a traditional feature of the Continental-European system of creditor protection, serving as a correlative of the limited liability enjoyed by shareholders of corporations. Due to recent developments at the EU regulatory level, this system has come under intense scrutiny. While capital maintenance and distribution rules are presently tied to individual financial statements prepared under the prudent German accounting rules, recent developments suggest that International Financial Reporting Standards (IFRS) may be finding their way into this traditional system. Since conservative capital maintenance is not the primary objective of these rules, opponents assert that their introduction into German individual accounts may weaken creditor protection. We discuss how creditor protection and accounting rules should interact in the future, proposing a new system primarily for the benefit of corporations preparing (consolidated) financial statements according to IFRS, i.e. for public parent companies to which the IAS Regulation applies directly, and other firms that apply IFRS under national law. Under that system, existing capital maintenance rules would be based on IFRS accounts. In addition, creditor protection would be enhanced by a supplemental, liquidity-oriented, forward-looking solvency test to be conducted prior to each intended distribution.