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.     

The Effect of Mandatory IFRS Adoption on Financial Analysts’ Information Environment

This paper examines the effect of the mandatory adoption of International Financial Reporting Standards (IFRS) by the European Union on financial analysts’ information environment. To control for the effect of confounding concurrent events, we use a control sample of firms that had already voluntarily adopted IFRS at least two years prior to the mandatory adoption date. We find that analysts’ absolute forecast errors and forecast dispersion decrease relative to this control sample only for those mandatory IFRS adopters domiciled in countries with both strong enforcement regimes and domestic accounting standards that differ significantly from IFRS. Furthermore, for mandatory adopters domiciled in countries with both weak enforcement regimes and domestic accounting standards that differ significantly from IFRS, we find that forecast errors and dispersion decrease more for firms with stronger incentives for transparent financial reporting. These results highlight the important roles of enforcement regimes and firm‐level reporting incentives in determining the impact of mandatory IFRS adoption.     

Does financial reporting regulation influence the value of cash holdings?

We investigate how the value of cash holdings changes following the mandatory adoption of International Financial Reporting Standards (IFRS), which is viewed as an exogenous shock to information asymmetry between firms and outside investors. Using firm-level data from 47 countries, we find that mandatory IFRS adoption has a negative and significant impact on the value of cash holdings. This result suggests that investors reduce their valuation of cash holdings when firms can have access to external financing at a lower cost under IFRS. The negative effect of IFRS is concentrated among financially constrained firms. Furthermore, we show that the effect is more pronounced in countries with strong legal enforcement. Overall, our evidence highlights that financial reporting regulation can have a significant effect on how outside investors value corporate cash holdings across countries.     

Does Public Firms’ Mandatory IFRS Reporting Crowd Out Private Firms’ Capital Investment?

We investigate how the mandatory adoption of International Financial Reporting Standards (IFRS) by publicly listed firms in the European Union affects peer private firms. We find that private firms’ capital investment decreases significantly after the IFRS mandate, relative to public firms. Private firms also display decreased investment when benchmarked against firms relatively insulated from the impact of the IFRS mandate, but the magnitude of the effect is smaller in this case. These results are consistent with the hypothesis that mandatory IFRS reporting (combined with other reforms), while increasing public firms’ financing and investment, crowds out funding for private firms. The effect is more pronounced for larger private firms and in industries where public peers have greater external financing needs. Our evidence suggests that financial reporting regulations cause shifts in resource allocation in an economy.     

The Influence of Country‐ and Firm‐level Governance on Financial Reporting Quality: Revisiting the Evidence

This paper examines how firm‐level governance and country‐level governance interplay in shaping financial reporting quality. Using IFRS adoption as a source of variation in firms’ reporting discretion, and a large sample of European firms that mandatorily switch to the new set of standards, we find that in countries with low enforcement and weak oversight over financial reporting, only firms with strong board‐level corporate governance mechanisms experience an increase in financial reporting quality, consistent with firm‐ and country‐level governance mechanisms being substitutes. However, in countries with high enforcement and strict oversight over financial reporting, firms with either strong or weak board‐level governance mechanisms experience an increase in financial reporting quality, even if the increase is larger for the former group. Overall, our findings indicate that in the debate about the effects of governance on the quality of financial reporting, it is important to consider both country‐ and firm‐level corporate governance mechanisms.     

The impact of mandatory IFRS adoption on foreign mutual fund ownership: The role of comparability

Proponents of IFRS argue that mandating a uniform set of accounting standards improves financial statement comparability that in turn attracts greater cross-border investment. We test this assertion by examining changes in foreign mutual fund investment in firms following mandatory IFRS adoption in the European Union in 2005. We measure improved comparability as a credible increase in uniformity, defined as a large increase in the number of industry peers using the same accounting standards in countries with credible implementation. Consistent with this assertion, we find that foreign mutual fund ownership increases when mandatory IFRS adoption leads to improved comparability.     

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.     

The information content of annual earnings announcements and mandatory adoption of IFRS

This study examines whether the information content of earnings announcements – abnormal return volatility and abnormal trading volume – increases in countries following mandatory IFRS adoption, and conditions and mechanisms through which increases occur. Findings suggest information content increased in 16 countries that mandated adoption of IFRS relative to 11 that maintained domestic accounting standards, although the effect of mandatory IFRS adoption depends on the strength of legal enforcement in the adopting country. Utilizing a path analysis methodology, we find evidence of three mechanisms through which IFRS adoption increases information content: reducing reporting lag, increasing analyst following, and increasing foreign investment.     

The Value Relevance of Accounting Numbers Under International Financial Reporting Standards

We study the market reaction to the mandatory adoption of International Financial Reporting Standards (IFRS) in Spain by examining the value relevance of the information contained in the IFRS reconciliation adjustments in relation to the local generally accepted accounting principles (GAAP). The two‐staged IFRS disclosure in the transition period is specific to Spain: the aggregated numbers of accounting differences are disclosed in stage 1, and the IFRS individual adjustments on book value of equity and earnings are disclosed in stage 2. This unique reporting timeline provides an opportunity for the market both to assess the impact of those new accounting policies adopted by firms and to assess differences when compared to the previous GAAP. We find no evidence of increased value relevance after IFRS adoption. However, our results from the incremental value relevance test show that investors consider the individual reconciliation adjustments in the second stage to be valuable and significant, specifically in relation to marked‐to‐market adjustment to financial instruments, adjustments to intangibles, provisions and impairment adjustments to property, plant and equipment, adjustments to inventories, and adjustments to pension benefits. Moreover, the results are significantly higher for low leverage firms. Our findings indicate that the market prices the informativeness of the reconciliation adjustments once the transition to IFRS disclosure cycle is complete.     

A review of the IFRS adoption literature

This paper reviews the literature on the effects of International Financial Reporting Standards (IFRS) adoption. It aims to provide a cohesive picture of empirical archival literature on how IFRS adoption affects: financial reporting quality, capital markets, corporate decision making, stewardship and governance, debt contracting, and auditing. In addition, we also present discussion of studies that focus on specific attributes of IFRS, and also provide detailed discussion of research design choices and empirical issues researchers face when evaluating IFRS adoption effects. We broadly summarize the development of the IFRS literature as follows: The majority of early studies paint IFRS as bringing significant benefits to adopting firms and countries in terms of (i) improved transparency, (ii) lower costs of capital, (iii) improved cross-country investments, (iv) better comparability of financial reports, and (v) increased following by foreign analysts. However, these documented benefits tended to vary significantly across firms and countries. More recent studies now attribute at least some of the earlier documented benefits to factors other than adoption of new accounting standards per se, such as enforcement changes. Other recent studies examining the effects of IFRS on the inclusion of accounting numbers in formal contracts point out that IFRS has lowered the contractibility of accounting numbers. Finally, we observe substantial variation in empirical designs across papers which makes it difficult to reconcile differences in their conclusions.     

The Effect of Mandatory IFRS Adoption on Conditional Conservatism in Europe

We study the effect of mandatory adoption of International Financial Reporting Standards (IFRS) in Europe in 2005 on conditional conservatism. We capture conditional conservatism with a modified version of the Khan and Watts measure (C_Score) that also controls for potential shifts in unconditional conservatism and cost of capital. From a sample of 13,711 firm‐year observations drawn from 16 European countries spanning the 2000–2010 period, we document an overall decline in the degree of conditional conservatism after the adoption of IFRS. We show that the decline in conditional conservatism is less pronounced for countries with high quality audit environments and strong enforcement of compliance with accounting standards using the Brown et al. audit and enforcement index. As asset impairment tests are a key mechanism ensuring conditional conservatism in the IFRS framework, we further examine these. We show that firms booking an asset impairment present a smaller decline in the degree of conditional conservatism relative to firms that do not. We also demonstrate that firms that do not book an asset impairment when evidence suggests the probable need to do so experience a more pronounced reduction in conditional conservatism. We argue that IFRS are conceptually conditionally conservative but that inappropriate application of conditional conservatism principles is likely to prevent financial reporting from reaching the level of conservatism targeted by the International Accounting Standards Board (IASB).     

Mandatory IFRS adoption and management forecasts: The impact of enforcement changes

We examine how concurrent enforcement changes affect the positive relationship between mandatory IFRS adoption and firms’ voluntary disclosure. We show that the increase in the issuance of management forecasts after IFRS adoption is smaller for firms from IFRS-mandating countries with concurrent enforcement changes than for those from countries without such changes. We find no difference in the increase of forecast informativeness between firms from IFRS-mandating countries without concurrent enforcement changes and firms from non-IFRS-mandating countries; however, firms domiciled in IFRS-mandating countries with concurrent enforcement changes exhibit a significantly smaller increase in forecast informativeness. Our findings suggest that better IFRS enforcement distinctly weakens (strengthens) the positive effect of IFRS adoption on voluntary (mandatory) disclosure.     

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.     

International Financial Reporting Standards,institutional infrastructures,and implied cost of equity capital around the world

Using a sample of 21,608 firm-years from 34 countries during 1998–2004, this study evaluates the impact of voluntary adoption of the International Financial Reporting Standards (IFRS) on a firm’s implied cost of equity capital. We find that the implied cost of equity capital is significantly lower for the full IFRS adopters than for the non-adopters even after controlling for potential self-selection bias and firm-specific and country-level factors that are known to affect the implied cost of capital. This result holds irrespective of institutional infrastructure determining a country’s governance and enforcement mechanisms. We also find that the implied cost of equity capital decreases with the efficacy of institutional infrastructure. Moreover, we provide evidence that the cost of capital-reducing effect of IFRS adoption is greater when IFRS adopters are from countries with weak institutional infrastructures than when they are from countries with strong infrastructures. The above results are robust to a battery of sensitivity checks.     

Are analyst stock recommendation revisions more informative in the post‐IFRS period?

This paper investigates whether the mandatory IFRS adoption has affected the informativeness of analyst recommendation revisions in Europe. Although prior studies document that IFRS adoption improved analyst forecast attributes, the impact of IFRS cannot be completely assessed without examining how the market reacts to information‐rich events in an environment with enhanced disclosure. To examine this question we utilize a difference‐in‐differences design using as main control sample firms that had voluntarily adopted IFRS before the EU's mandated switch. Overall, our evidence suggests that after the mandatory adoption of IFRS, both analyst upgrades and downgrades are more informative. These results hold after controlling for a number of variables that capture analyst, firm and information environment characteristics and are robust to a number of sensitivity analyses including the use of a US control sample. Finally, we examine whether our results are sensitive to the level of accounting enforcement. We find that analyst downgrades are more informative in the post‐IFRS period for firms in both high and low enforcement environments. Analyst upgrades, however, are more informative only if they are issued for firms in high enforcement countries.     

The Effect of Fair Value Adjustments on Dividend Policy Under Mandatory International Financial Reporting Standards Adoption: Australian Evidence

Using a sample of firms from the financial sector of the Australian Securities Exchange, we examine the effect of the fair value adjustments of financial instruments on firms’ dividend distributions in the context of mandatory International Financial Reporting Standards (IFRS) adoption. We find a positive relationship between the fair value adjustments of financial instruments and firms’ dividend payouts, suggesting that the frequent use of fair value adjustments of financial instruments by financial firms following mandatory IFRS adoption has the potential to increase the proportion of transitory earnings in reported earnings and cause changes in dividend policies. Our results add to the ongoing debate on the unintended economic consequences of fair value accounting (FVA) and provide empirical support for regulators’ concerns that unrealized FVA gains from asset revaluation during booms may encourage the distribution of those unrealized gains.     

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.     

The roles of book‐tax conformity and tax enforcement in regulating tax reporting behaviour following International Financial Reporting Standards adoption

This study investigates whether increasing the level of tax enforcement can potentially offset the primary cost of a reduction in the level of book‐tax conformity (BTC) following International Financial Reporting Standards (IFRS) adoption – increased tax avoidance. We find that after the decrease in BTC and the concomitant increase in tax enforcement that followed IFRS adoption in Israel, tax avoidance declined significantly. Our results imply that one of the primary costs of reducing BTC can be avoided. Moreover, the results suggest that rather than one strict regulatory approach to deal with reporting manipulations, a combination of trust and control is more effective and less radical.     

Relevance of Differences between Net Income based on IFRS and Domestic Standards for European Firms

Net income adjustments resulting from mandatory 2005 IFRS adoption in Europe are value relevant for financial and non‐financial firms. Differences in relevance of the aggregate adjustment and adjustments related to several IFRS standards, for financial and non‐financial firms and across country groups, suggest differences in domestic standards and institutions affect investors’ assessment of the relevance of IFRS accounting amounts. Despite these differences, except for French/German non‐financial firms, investors view net income measured using IAS 39 Financial Instruments: Recognition and Measurement as more relevant than that measured using domestic standards, which is notable because IAS 39 was highly controversial in Europe.