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.     

Mandatory IFRS adoption and executive compensation:Evidence from China

This study investigates how the mandatory adoption of International Financial Reporting Standards(IFRS) affects the contractual benefits of using accounting information to determine executive compensation in China. After controlling for firm and corporate governance characteristics, we find strong evidence supporting the positive role of mandatory IFRS adoption on the accounting-based performance sensitivity of executive compensation. Subsample analysis suggests that improvements in accounting-based performance sensitivity after IFRS adoption differ across regions with various levels of institutional quality and across firms that are affected to a different extent by the adoption. Additional analysis supports the argument that the positive effects of IFRS adoption on the use of accounting performance in executive compensation are driven by the reduction in accounting conservatism associated with IFRS adoption.     

The Effect of IFRS Adoption Conditional Upon the Level of Pre-adoption Divergence

Prior studies on whether or not International Financial Reporting Standards (IFRS) adoption improves earnings quality have found mixed results. We note that some of the countries that have adopted IFRS had national accounting standards similar to IFRS prior to adopting IFRS, while others had national accounting standards divergent from IFRS. We examine the effects of IFRS adoption by taking into account the level of divergence prior to the adoption of IFRS. We find that countries experience a greater drop in earnings management when they have a higher level of divergence from IFRS prior to IFRS adoption. More specifically, high divergence countries with higher levels of enforcement benefit the most followed by high divergence countries with lower levels of enforcement. Lower divergence countries with higher levels of enforcement do not significantly benefit from IFRS adoption. Lower divergence countries with lower levels of enforcement do not benefit from IFRS adoption at all. Our results support the contention that countries with lower quality local accounting standards prior to IFRS adoption benefit more from IFRS adoption.     

Analyst Following and Forecast Accuracy After Mandated IFRS Adoptions

This study investigates how accounting harmonization affects one particular group of financial statement users—financial analysts. We find that mandatory International Financial Reporting Standards (IFRS) adoption attracts foreign analysts, particularly those from countries that are simultaneously adopting IFRS along with the covered firm's country and those with prior IFRS experience. We also find that mandatory IFRS adoption improves foreign analysts’ forecast accuracy. The change in analyst following increases with the distance between prior local Generally Accepted Accounting Principles (GAAP) and IFRS and with the extent to which IFRS adoption eliminates GAAP differences between the firm's country and the analyst's country. IFRS adoption also attracts more local analysts, particularly those with prior IFRS experience and with an international portfolio prior to mandated IFRS adoption in their home country. Local analysts’ forecast accuracy is not affected by IFRS adoption. Overall, our results suggest that accounting harmonization brings comparability benefits that enhance the usefulness of accounting data.     

Accounting comparability and relative performance evaluation in CEO compensation

We investigate whether accounting comparability is associated with the likelihood that CEO compensation is tied to relative accounting performance (e.g., return on assets). We predict that higher accounting comparability increases the risk-sharing benefit of accounting-based RPE because peer firm performance better controls for common risk in RPE firm performance. Thus, firms that have higher accounting comparability with potential performance peers will be more likely to include accounting-based RPE as a component of the total CEO compensation contract. We find support for this prediction using (1) an explicit test design that relies on the ex ante terms of CEO compensation contracts obtained from proxy disclosures, and (2) an implicit design that relies on the actual realizations of CEO compensation. To provide further evidence, we examine the association between accounting comparability and the selection of performance peers when the CEO compensation contract includes an accounting-based RPE component. We find that higher comparability between the RPE firm and a potential peer firm increases (decreases) the potential peer firm’s likelihood of being selected into (dropped from) the peer group. Cross-sectional analyses show that this association is less pronounced, or not present, when the relative performance measure is price-based (as opposed to accounting-based), indicating that these results do not merely reflect a more general role of comparability in all RPE contracts.     

Accounting Standards Harmonization and Financial Statement Comparability: Evidence from Transnational Information Transfer

This paper investigates whether accounting standards harmonization enhances the comparability of financial information across countries. I hypothesize that a firm yet to announce earnings reacts more strongly to the earnings announcement of a foreign firm when both report under the same rather than different accounting standards. My analysis of abnormal price reactions for a global sample of firms supports the prediction. Next, in an attempt to control for the underlying economic comparability and the effects of changes in reporting quality, I use a difference‐in‐differences design around the mandatory introduction of International Financial Reporting Standards. I find that mandatory adopters experience a significant increase in market reactions to the release of earnings by voluntary adopters compared to the period preceding mandatory adoption. This increase is not observed for nonadopters. Taken together, the results show that accounting standards harmonization facilitates transnational information transfer and suggest financial statement comparability as a direct mechanism.     

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 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.     

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.     

An analysis of the effect of mandatory adoption of IAS/IFRS on earnings management

This paper examines whether mandatory adoption of international accounting standards, IAS/IFRS, by French companies is associated with lower earnings management. In addition, the impact of six factors that may be related to earnings management level are also considered: the independence and the efficiency of the board of directors, the separation of roles of CEO and Chairman of the board, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets.Based on a sample of 353 French listed groups relating to the period 2003–2006, our results show that the mandatory adoption of IAS/IFRS is associated with a reduction in the earnings management level. In addition, the independence and the efficiency of the board of directors, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets are important factors for enforcement of IAS/IFRS in France. Mandatory adoption of IAS/IFRS has decreased earnings management level for companies with good corporate governance and those that depend on foreign financial markets.     

The Effect of IFRS Adoption and Investor Protection on Earnings Quality Around the World

This study examines the effects of mandatory IFRS adoption and investor protection on the quality of accounting earnings in forty-six countries around the globe. The results suggest that earnings quality increases for mandatory IFRS adoption when a country's investor protection regime provides stronger protection. This study extends the current literature that shows that accounting practices are influenced by country-level macro settings. The results highlight the importance of investor protection for financial reporting quality and the need for regulators to design mechanisms that limit managers' earnings management practices.     

The effect of mandatory IFRS adoption on real and accrual-based earnings management activities

This study examines the effect of mandatory adoption of International Financial Reporting Standards (IFRS) on both accrual-based and real earnings management. While prior literature has mainly examined the effects of IFRS adoption on accrual-based earnings management, no study to date has focused on the impact of IFRS adoption on real earnings management. Using a sample of 15,206 observations from 22 European countries between 2000 and 2010, this study employs a control sample of voluntary adopters and applies a differences-in-differences design to control for confounding concurrent events. The results suggest that mandatory IFRS adoption had no significant impact on either real or accrual-based earnings management practices. Additional analysis on a sub-sample of firms with relatively strong earnings management incentives supports a dominant role for firm-level reporting incentives over accounting standards in shaping financial reporting quality.     

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.     

Mandatory IFRS adoption: the trade-off between accrual-based and real earnings management

This paper examines whether firms substituted real earnings management for accrual-based earnings management after the International Financial Reporting Standards (IFRS) became mandatory. Using a sample of 101,331 firm-year observations from 33 countries between 2000 and 2010, we show that IFRS adoption came with the unintended consequence of certain firms substituting real earnings management for accrual-based earnings management, especially among firms in countries with strict enforcement regimes. Furthermore, we document that the trade-off is confined to EU countries in which strong firm-level characteristics (i.e. the firm-level mechanism of control, the market’s level of scrutiny, and firm-specific incentives to provide transparency) are coupled with strong enforcement. We also show that IFRS had an effect in countries outside the EU, albeit at a different time. Overall, the results suggest that accounting regulators’ efforts to increase earnings quality might have had the unintended consequence of increasing real earnings management activities.     

The Differential Impact of IFRS Adoption on Aspects of Seasoned Equity Offerings in the UK and France

We examine the potential for IFRS to influence the market for SEOs in the UK and France. The divergence between the UK domestic accounting standards and IFRS is minor (low-divergence firms) whereas domestic accounting standards in France differ materially from IFRS (high-divergence firms); however, both countries have similar legal enforcement and institutional settings that might confound the effect of IFRS adoption. We argue that IFRS adoption serves to mitigate information asymmetry and improve accounting quality. Accordingly, we find that, following IFRS adoption, earnings management activities decrease among high-divergence firms prior to issuing SEOs. As a result of the lower levels of earnings management and information asymmetry, we predict and find that the market reaction to issuing SEOs improves significantly for high-divergence firms following IFRS. Given that equity financing becomes less costly, we find that the propensity to issue new SEOs increases among high-divergence firms after IFRS adoption. We find no similar changes among low-divergence firms. The results persist after running a matched-sample analysis and controlling for potential self-selection bias.     

On the relation between managerial power and CEO pay

We study how friendly boards design the structure of optimal compensation contracts in favor of powerful CEOs. Our study yields unexpected results. First, powerful managers receive higher pay and a contract with a higher pay-performance sensitivity (PPS) if firm performance is low and vice versa. Moreover, we identify conditions where expected pay and expected PPS are both increasing in the friendliness of the board. Second, we show that friendly boards provide managers with higher salaries, more shares, but less options. Third, friendly boards offering contracts with a higher PPS also make more intensive use of relative performance evaluation (RPE). Overall, our results suggest that frequently used indicators of poor (or sound) compensation practices should be interpreted with care. Extending the scope of our model beyond executive pay, we show that powerful managers underinvest in capital but have less incentives to manage earnings.     

Earnings Quality and Market Values of Indonesian Listed Firms

We find that earnings quality (EQ) is reliably negatively correlated with the market values of equity of firms listed on the Jakarta Stock Exchange (IDX). The financial reporting process produces earnings viewed as increasingly ‘incomplete’ for valuation purposes by the capital market despite moves towards high‐quality financial reporting standards (IFRS) during the sample period 1995–2015. Time‐series analyses reveal that EQ decreases rather than increases through time. The role of earnings in valuation is replaced by other attributes, most notably net dividends. Firms that pay out dividends are valued significantly higher, and firms that issue equity are valued lower. These results are robust regardless of other accounting, market and governance controls. Large and closely held firms are valued higher than smaller firms, consistent with some aspects of the political cost hypothesis. Shares with higher idiosyncratic risk are valued higher, consistent with option value, as are shares where the volume of shares traded is more volatile. Collectively, the results indicate that the mere adoption of high‐quality accounting standards (IFRS) and other nominal changes in capital market regulations do not automatically increase the quality of the financial reporting process.     

Does accounting conservatism pay?

We investigate whether or not there is a link between conservative accounting practices and the sensitivity of executive pay to accounting performance. Using several accrual‐based measures of accounting conservatism as well as alternative measures of accounting performance, we estimate an econometric model of CEO compensation that incorporates the interaction of accounting conservatism and accounting performance. Consistent with optimal contracting theory, we find that the sensitivity of executive pay to accounting performance is higher for firms that report conservative accounting earnings. These results support the hypothesis that accounting conservatism, by limiting earnings management opportunities and improving the reliability of accounting performance measures, allows firms to formulate contracts that tie executive compensation more closely to accounting performance.     

The Impact of Mandatory International Financial Reporting Standards Adoption on Investment Efficiency: Standards,Enforcement, and Reporting Incentives

This paper investigates whether mandatory adoption of International Financial Reporting Standards (IFRS) is followed by a decline in firms’ suboptimal investments. On average, we find that the probability of under‐investment in capital expenditure declines for firms from 23 countries requiring mandatory adoption of IFRS relative to firms from countries that do not have such requirements; meanwhile the probability of over‐investment remains unchanged. However, this real effect becomes smaller when we control for concurrent changes to the enforcement of financial reporting along with the introduction of IFRS in some countries, suggesting that the switch in standards is only one of the drivers for the observed benefits. Moreover, we find that the reduction in suboptimal investments is driven by firms with high reporting incentives to provide transparent financial reports from countries where the existing legal and enforcement systems are strong. We further show that the real effect increases with the predicted changes in accounting comparability. Finally, we find that after mandatory IFRS adoption, capital investment becomes more value‐relevant, less sensitive to the availability of free cash flows, and more responsive to growth opportunities. Our findings provide new insights into the real effects of mandatory IFRS adoption.     

IFRS adoption,reporting incentives and financial reporting quality in private firms

This study examines financial reporting quality (FRQ) effects around voluntary International Financial Reporting Standards (IFRS) adoptions by German private firms across two important dimensions, earnings quality and disclosure practices. To capture differences in the motivations for IFRS adoptions, we identify four different types of IFRS adopting firms based on a comprehensive set of firm characteristics. We observe earnings quality improvements around IFRS adoptions primarily for one type of firm, which is young, fast growing and seeking access to public equity markets. Using a matched sample of private German GAAP and IFRS reporting firms, we find some evidence suggesting that IFRS also contribute to higher earnings quality. Recognizing that our earnings quality metrics are only incomplete measures of FRQ, we also compare the disclosure practices of IFRS and German GAAP firms. We find that all IFRS firm types disclose significantly more information in their financial reports and show a higher propensity to publish their financial reports voluntarily on the corporate website. Our findings indicate that failure to identify earnings quality changes around IFRS adoption cannot be automatically interpreted as IFRS adoption having no effect on the FRQ of (private) firms. Collectively, our results suggest that both incentives and accounting standards shape private firms’ FRQ.