IFRS adoption in China and foreign institutional investments

We examine the effectiveness of China’s IFRS adoption from the perspective of an important set of financial report users, foreign institutional investors. We find that foreign institutional investment does not increase after China’s IFRS adoption, and some evidence that it actually declines, particularly among firms with weaker incentives to credibly implement IFRS, or with greater ability to manipulate IFRS’s fair value provisions. We also find that the association between earnings and returns generally declines after IFRS adoption, consistent with reduced earnings quality. In addition, we find that foreign institutional investors’ returns decrease after China’s IFRS adoption. Finally, the decline in foreign institutional investment is greater among investors from countries with weak institutions that have also adopted IFRS. Taken together, our evidence suggests that the weak institutional infrastructure in China’s transitional economy impairs IFRS’s intended goal of attracting institutional investment through improved financial reporting quality. Further, financial information users’ home country institutions and IFRS adoption experience affect the effectiveness of IFRS adoption.     

Adopting a Label: Heterogeneity in the Economic Consequences Around IAS/IFRS Adoptions

This study examines liquidity and cost of capital effects around voluntary and mandatory IAS/IFRS adoptions. In contrast to prior work, we focus on the firm‐level heterogeneity in the economic consequences, recognizing that firms have considerable discretion in how they implement the new standards. Some firms may make very few changes and adopt IAS/IFRS more in name, while for others the change in standards could be part of a strategy to increase their commitment to transparency. To test these predictions, we classify firms into “label” and “serious” adopters using firm‐level changes in reporting incentives, actual reporting behavior, and the external reporting environment around the switch to IAS/IFRS. We analyze whether capital‐market effects are different across “serious” and “label” firms. While on average liquidity and cost of capital often do not change around voluntary IAS/IFRS adoptions, we find considerable heterogeneity: “Serious” adoptions are associated with an increase in liquidity and a decline in cost of capital, whereas “label” adoptions are not. We obtain similar results when classifying firms around mandatory IFRS adoption. Our findings imply that we have to exercise caution when interpreting capital‐market effects around IAS/IFRS adoption as they also reflect changes in reporting incentives or in firms’ broader reporting strategies, and not just the standards.     

Mandatory IFRS Reporting around the World: Early Evidence on the Economic Consequences

This paper examines the economic consequences of mandatory International Financial Reporting Standards (IFRS) reporting around the world. We analyze the effects on market liquidity, cost of capital, and Tobin's q in 26 countries using a large sample of firms that are mandated to adopt IFRS. We find that, on average, market liquidity increases around the time of the introduction of IFRS. We also document a decrease in firms' cost of capital and an increase in equity valuations, but only if we account for the possibility that the effects occur prior to the official adoption date. Partitioning our sample, we find that the capital‐market benefits occur only in countries where firms have incentives to be transparent and where legal enforcement is strong, underscoring the central importance of firms' reporting incentives and countries' enforcement regimes for the quality of financial reporting. Comparing mandatory and voluntary adopters, we find that the capital market effects are most pronounced for firms that voluntarily switch to IFRS, both in the year when they switch and again later, when IFRS become mandatory. While the former result is likely due to self‐selection, the latter result cautions us to attribute the capital‐market effects for mandatory adopters solely or even primarily to the IFRS mandate. Many adopting countries make concurrent efforts to improve enforcement and governance regimes, which likely play into our findings. Consistent with this interpretation, the estimated liquidity improvements are smaller in magnitude when we analyze them on a monthly basis, which is more likely to isolate IFRS reporting effects.     

Learning about Mutual Fund Managers

We study capital allocations to managers with two mutual funds, and show that investors learn about managers from their performance records. Flows into a fund are predicted by the manager's performance in his other fund, especially when he outperforms and when signals from the other fund are more useful. In equilibrium, capital should be allocated such that there is no cross‐fund predictability. However, we find positive predictability, particularly among underperforming funds. Our results are consistent with incomplete learning: while investors move capital in the right direction, they do not withdraw enough capital when the manager underperforms in his other fund.     

Geographic earnings disclosure and trading volume

Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, most US multinational firms no longer disclose geographic earnings in their annual reports. Given the recent growth in foreign operations of US firms and the varying operating environments around the world, information (or lack thereof) related to geographical performance can affect investors’ information set. Using empirical tests that closely follow the [Kim, O., Verrecchia, R., 1997. Pre-announcement and event-period private information. Journal of Accounting and Economics 24, 395–419] model, we find results consistent with their predictions. Specifically, using a sample of firms with substantial foreign operations, we find evidence of a decrease in event period private information following adoption of SFAS 131 for firms that no longer disclose geographic earnings. These results suggest that decreased public information (i.e., non-disclosure of geographic earnings) reduces the ability of investors to utilize or generate private information in conjunction with the public announcement of quarterly earnings, which dampens trading. We also find evidence of a decrease in pre-announcement private information following adoption of SFAS 131. This is consistent with an overall improvement in public disclosures that has the effect of reducing differences in the precision of private information across investors in the period prior to the earnings announcement. However, such an effect is observed for both firms which no longer disclose geographic earnings and for firms that continue to disclose geographic earnings.     

Investment allocation decisions,home bias and the mandatory IFRS adoption

We examine the familiarity hypothesis of home bias by studying how foreign ownership of Swedish firms is affected by the mandatory adoption of IFRS. We decompose foreign investors into institutional and non-institutional investors. Foreign investors are further decomposed into EU (IFRS adopting countries) and non-EU residents (non-IFRS adopting countries). We analyse the equity investments of these foreign investor groups in Sweden during the period of 2001–2007. We find that after the mandatory adoption of IFRS, foreign ownership/owners from countries that adopted IFRS and particularly those from the EU increased. These effects are particularly strong in small firms. Foreign institutional investors increased their ownership stake after the mandatory IFRS adoption, whereas foreign non-institutional investments were not affected significantly by the IFRS adoption. In contrast to ownership from non-adopting countries, ownership from the EU increased in firms with both more and less tangible assets. Similarly, foreign ownership from the EU increased in firms with both concentrated ownership and dispersed ownership after the adoption. Because Sweden has already had strict legal enforcement and a low level of earnings management prior to the adoption, our results suggest that increased foreign ownership is due to better abilities to compare firms rather than an improved quality.     

Order submission behaviors and opening price behaviors: evidence from an emerging market

Recent studies document that mutual funds demonstrate an overnight information advantage over foreign investors in Taiwan, a fast emerging market. However, this inequality contradicts the documented foreign investors’ growing market dominance and information advantage. Motivated by the inconsistency, we apply intraday data to examine the linkage between investors’ order submission behaviors and the opening price behaviors of the top net-trade stocks of professional institutional investors. We find that mutual funds exhibit a more persistent and aggressive trading pattern than foreign investors. The order submission behavior of aggressive individuals, following closely mutual funds’ trades, mainly drives the observed informational differences.     

Institutional ownership and credit spreads: An information asymmetry perspective

Recent literature has documented a link between institutional equity ownership (IO) and cost of debt capital, and interpreted it as a corporate governance effect. However, institutional equity investors may also affect cost of debt through their influence on information asymmetry condition of firms. To distinguish between the two effects, we break down institutional investors into different groups: transient institutional investors (TRA who are sensitive to information asymmetry but unlikely to participate in corporate governance, and the dedicated ones (DED) who act oppositely. Based on a most up-to-date and comprehensive bond data spanning the past 20 years, we find that credit spreads narrow (widen) with an increase in equity ownership by TRA (DED). The effects are most prominent among short-term bonds, bonds with lower ratings, higher leverage and higher volatilities. The results persist after controlling for potential endogeneity and other information asymmetry measures, and are unlikely due to an asset substitution effect. Overall, our findings provide strong support for the effect of information asymmetry on credit spread, and highlight the importance of distinguishing various types of institutional investors.     

Tax avoidance and ex ante cost of capital

This study examines the association between tax avoidance and ex ante cost of equity capital. Based on prior research, we develop two proxies for investors’ expectations of tax avoidance and explore whether deviations from those expectations result in higher ex ante cost of equity capital. We find that the ex ante cost of equity capital increases with tax avoidance that is either below or above investor expectations and that the increase is larger for tax avoidance that exceeds investors’ expectations. We then examine whether firms that alter their future tax avoidance exhibit a lowering of their ex ante cost of equity capital and find that tax avoidance decreases (increases) from the prior year for firms that were above (below) investors’ expectations in the prior year. These results are consistent with the trade‐off suggested by the Scholes and Wolfson framework and reinforce the notion that balancing tax benefits and non‐tax costs is an important feature of firms’ tax planning.     

Product market effects of IFRS adoption

Prior literature finds that International Financial Reporting Standards (IFRS) adopters enjoy lower financing costs subsequent to IFRS adoption. We predict and find that mandatory IFRS adopters exploit lower financing costs to increase market share vis-à-vis non-adopters. This effect is robust across several different model specifications in a sample capturing the universe of public and private firms in the EU, in a matched sample of public and private firms, and in a public firm sample comparing mandatory and voluntary IFRS adopters. We further find that IFRS is associated with an increase (decrease) in industry sales concentration (competition), consistent with large public firms increasing market share. In supplemental analyses, we find that mandatory adopters issue more equity and debt after IFRS adoption and that larger market share gains accrue to those mandatory IFRS adopters that issue more equity and debt after IFRS adoption. Overall, we provide evidence of unintended product market consequences of IFRS adoption.