Financial Reporting and Trade Credit: Evidence from Mandatory IFRS Adoption*

We investigate the effect of mandatory IFRS adoption on trade credit. We document that firms in countries that adopt IFRS receive more trade credit from their suppliers, consistent with improved financial reporting quality and comparability playing a role in facilitating informal financing. This increase is larger for countries with a low level of societal trust, a poor pre‐IFRS‐adoption information environment, and stronger legal enforcement. These cross‐sectional results suggest that the conditions under which higher‐quality information is made publicly available affect suppliers' decisions to provide trade credit. This increase is also larger for firms with greater exposure to foreign markets, a finding that highlights the importance of more comparable international financial reporting standards in facilitating cross‐country trade credit. We also find that IFRS adoption has a stronger positive effect on trade credit for firms with greater liquidity needs. Finally, we find that firms in countries that adopt IFRS also extend more trade credit to their customers. Overall, our results support the notion that financial reporting can have a causal effect on trade credit.     

Does Mandatory Adoption of IFRS Improve Accounting Quality? Preliminary Evidence

We provide evidence on the preliminary effects of mandatory adoption of International Financial Reporting Standards (IFRS) on accounting quality for a relatively broad set of firms from 20 countries that adopted IFRS in 2005 relative to a benchmark group of firms from countries that did not adopt IFRS matched on the strength of legal enforcement, industry, size, book‐to‐market, and accounting performance. Relative to these benchmark firms, we find that IFRS firms exhibit significant increases in income smoothing and aggressive reporting of accruals, and a significant decrease in timeliness of loss recognition; however we do not find significant differences across IFRS and benchmark firms in meeting or beating earnings targets. Our findings contrast with findings in earlier studies which suggest that IFRS adoption leads to increased accounting quality. Our findings primarily hold for firms in strong enforcement countries, which suggests that enforcement mechanisms in these countries were not able to counter the initial effects of greater flexibility in IFRS relative to domestic GAAP.     

Does Mandatory IFRS Adoption Improve the Information Environment?*

More than 120 countries require or permit the use of International Financial Reporting Standards (IFRS) by publicly listed companies on the basis of higher information quality and accounting comparability from IFRS application. However, the empirical evidence about these presumed benefits is often conflicting and fails to distinguish between information quality and comparability. In this paper we examine the effect of mandatory IFRS adoption on firms’ information environment. We find that after mandatory IFRS adoption consensus forecast errors decrease for firms that mandatorily adopt IFRS relative to forecast errors of other firms. We also find decreasing forecast errors for voluntary adopters, but this effect is smaller and not robust. Moreover, we show that the magnitude of the forecast error decrease is associated with the firm‐specific differences between local GAAP and IFRS. This finding suggests that it is IFRS adoption rather than a correlated unobservable factor that is causing forecast errors to decrease. Exploiting individual analyst level data and isolating settings where analysts would benefit more from either increased comparability or higher quality information, we document that the improvement in the information environment is driven both by information and comparability effects. These results suggest that mandatory IFRS adoption has improved the quality of information intermediation in capital markets, and as a result firms’ information environment, by increasing both information quality and accounting comparability.     

Accounting Standards Harmonization and Financial Integration

We empirically examine whether adopting a uniform set of accounting standards mitigates information frictions in financial markets and facilitates market integration. Using a difference‐in‐difference design, we find that after the mandatory adoption of IFRS local stock returns incorporate more global information and at a faster speed. The effect of IFRS adoption is stronger in countries where there are larger improvements in accounting comparability and for firms with a larger increase in foreign ownership. Overall, our results suggest that accounting standards harmonization facilitates financial market integration.     

Economic Consequences of IFRS Adoption: The Role of Changes in Disclosure Quality*

This study adopts a two‐step approach to highlight the disclosure quality channel that drives economic consequences of IFRS adoption. This approach helps address the identification challenge noted by prior research and offers direct evidence on the role of disclosure quality. In the first step, we document the impact of the IFRS mandate on changes in disclosure quality proxied by the granularity of line item disclosure in financial statements. We find that IFRS‐adopting firms provide more disaggregated information upon IFRS adoption, such as more granular disclosure of intangible assets and long‐term investments on the balance sheet and greater disaggregation of depreciation, amortization, and nonoperating income items on the income statement. In the second step, we link the observed disclosure changes to the benefits and costs of IFRS adoption. We show that greater disaggregated information due to IFRS adoption enhances market liquidity and decreases information asymmetry, but does not affect audit fees differentially. Our evidence has implications for standard setters as they evaluate cost‐benefit trade‐offs when considering disclosure changes in the future.     

Deviations from the Mandatory Adoption of IFRS in the European Union: Implementation,Enforcement, Incentives,and Compliance

In this paper, we evaluate the common assumption that European Union (EU) firms began using international financial reporting standards (IFRS) in 2005 when the EU formally adopted IFRS. Although the incidence of firms using local (or some other) GAAP declined between 2005 and 2012, it is still non‐trivial. By 2012 the incidence of non‐IFRS financial statements was still in excess of 17 percent (87 percent of which were fully consolidated). We estimate a model of the non‐adoption of IFRS as a function of implementation features of the IFRS regulation, country‐specific enforcement, and firm‐specific reporting incentives. As expected, being specifically required by EU‐wide and country‐specific rules to adopt IFRS is positively associated with IFRS adoption but does not constitute a complete explanation. Proxies for enforcement are significantly associated with non‐adoption, but the marginal effects of the enforcement variables are weak. We find that larger firms, firms with foreign operations and more analyst following, and firms that issue new debt and equity were more likely to adopt IFRS, both when the regulation was initially imposed and in subsequent years. We conclude that many EU firms do not use IFRS; that some firms exploited definitions, exemptions, and deferrals to avoid adopting IFRS while some firms simply failed to comply with the regulation; and that firms responded to their incentives in deciding whether to adopt IFRS.     

Mandatory IFRS Adoption and Financial Statement Comparability

This study examines whether mandatory adoption of International Financial Reporting Standards (IFRS) leads to capital market benefits through enhanced financial statement comparability. U.K. domestic standards are considered very similar to IFRS, suggesting any capital market benefits observed for U.K.‐domiciled firms are more likely attributable to improvements in comparability (i.e., better precision of across‐firm information) than to changes in information quality specific to the firm (i.e., core information quality). If IFRS adoption improves financial statement comparability, we predict this should reduce insiders' ability to benefit from private information. Consistent with these expectations, we find that abnormal returns to insider purchases ― used to proxy for private information ― are reduced following IFRS adoption. Similar results obtain across numerous subsamples and proxies used to isolate IFRS effects attributable to comparability. Together, the findings are consistent with mandatory IFRS adoption improving comparability and thus leading to capital market benefits by reducing insiders' ability to exploit private information.     

Accounting Comparability and Economic Outcomes of Mandatory IFRS Adoption

This study examines the associations between four economic outcomes of the 2005 mandatory adoption of International Financial Reporting Standards (IFRS) and concurrent changes in two important accounting constructs, accounting comparability and reporting quality. My primary purpose is to evaluate the relative importance of cross‐country accounting comparability and firm‐specific reporting quality in explaining previously documented increases in Tobin's Q, stock liquidity, analyst forecast accuracy, and analyst forecast agreement following IFRS adoption. Given that improvements in both comparability and reporting quality are primary stated objectives of the International Accounting Standards Board (IASB), it is important to understand their relative roles in shaping the information environment of financial statement users following IFRS adoption. Using 1,861 first‐time adopters in 23 countries, I find that firms with a larger improvement in comparability have larger increases in Q, liquidity, forecast accuracy, and forecast agreement following adoption, relative to other adopters. In contrast, improvements in reporting quality around adoption appear to have only a second‐order effect that is generally limited to Q effects among those adopters with concurrent improvements in comparability. These results are robust to alternative design and variable specifications. Finally, I continue to find these results for samples restricted to countries with weaker pre‐adoption institutional environments and countries that did not initiate proactive financial statement reviews, indicating that strong institutions and regulatory improvements are not driving the results. Overall, my results suggest that improvements in cross‐country accounting comparability played an important role in the previously documented economic benefits that accrued to 2005 mandatory IFRS adopters.     

The Role of Similar Accounting Standards in Cross‐Border Mergers and Acquisitions

This study investigates whether differences in accounting standards across countries create information costs that inhibit firms from investing in foreign markets. Using the frequency and dollar magnitude of cross‐border mergers and acquisitions (M&As) from 32 countries over the period 1998–2004, we find that the aggregate volume of M&A activity across country pairs is larger for pairs of countries with similar Generally Accepted Accounting Principles (GAAP), and that this increased volume of M&A activity is driven by target countries that also have strong enforcement. We also find that the 2005 mandatory adoption of International Financial Reporting Standard (IFRS) attracted more cross‐border M&As among IFRS‐adopting countries, and that this increase in M&A activity within the IFRS countries is more pronounced for country pairs with low similarity in GAAP in the pre‐IFRS adoption period. Overall, our results highlight the role of accounting standards and enforcement in shaping cross‐border M&A activity.     

Shareholder‐ Versus Stakeholder‐Focused Japanese Companies: Firm Characteristics and Accounting Valuation*

Recent research has found that the value‐relevance of accounting variables depends not only on whether a country's accounting rules are code‐law oriented or common‐law oriented, but also on the reporting incentives created by the legal and business environment in which a firm operates. Therefore, for example, the earnings of firms in some countries with common‐law oriented rules but with code‐law incentives have more code‐law‐type characteristics. We further this research by examining whether this is true for firms facing the same accounting regime and institutional environment but different stakeholder‐related incentives. We find significant stakeholder‐related incentives across 23 Japanese firms listed in the United States and 23 Japanese firms not listed in the United States that are matched by industry and size. Although these firms face the same institutional environment and the same accounting regime, consistent with the differences in stakeholder‐related incentives, the earnings and book values of the firms listed in the more shareholder‐oriented U.S. markets have significantly more explanatory power for market value than those for firms not cross‐listed in the United States. These findings are unaffected by whether the reports are based on consolidated or parent‐only accounting or whether they are based on U.S. or Japanese GAAP, emphasizing the potential influence of reporting incentives at all levels on the effect of standardization, conversion, or harmonization of accounting methods globally.     

Is Audit Committee Equity Compensation Related to Audit Fees?*

Section 301 of the Sarbanes‐Oxley Act (SOX) implicitly assumes that audit committees can independently determine audit fees. Critics of section 301 have questioned this assumption in particular, and the efficacy of section 301 more generally. In response, the SEC issued a concept release in 2015 calling for public disclosure of the process that audit committees follow for determining auditor compensation. Motivated by these calls and the widespread use of stocks and options to compensate firms' independent directors, we examine the relation between equity compensation granted to audit committee members and audit fees. Using a sample of 3,685 firm‐year observations during 2007–2015, we find a negative relation between audit committee equity compensation and audit fees, consistent with larger equity pay inducing audit committee members to compromise independence by paying lower audit fees. These findings are robust to controlling for endogeneity, firm size, alternative measures of equity compensation, alternative samples, and an alternative treatment of extreme values. We further show that larger equity compensation is associated with lower earnings quality. We also find that the negative effect of equity compensation on audit fees is stronger when city‐level audit market competition is high. However, this negative relation disappears when (i) firms face high litigation risk, (ii) auditors have stronger bargaining power, (iii) the audit committee includes a high proportion of accounting experts, and (iv) auditors are industry experts. Our results are relevant for regulators and investors.     

The Relation between Strategy,CEO Selection,and Firm Performance

We examine whether a firm's strategic priorities influence its selection of a new CEO and what conditions enable such an appointment to add value to the firm. More specifically, this study investigates the value‐adding effect when prospector firms (i.e., those pursuing a prospector‐type strategy) select a CEO with high social capital. We argue that uncertainty, driven by a firm's strategy, will determine the decision to select a CEO with high social capital; such CEOs can use their networks to mitigate the uncertainty and thus can be valuable to the firm. However, prior research indicates that CEOs with high social capital can engage in behavior detrimental to firm value. To mitigate the potential for this to occur, we assess whether corporate governance can play a role in prospector firms who appoint CEOs with high social capital. Drawing on archival data of CEO successions over a 14‐year period, we find that prospector firms have greater incentives to appoint CEOs with high social capital. We also find that prospector firms who appoint a CEO with high social capital improve their performance. Furthermore, the value‐adding effect of this selection choice is stronger in prospector firms with good corporate governance.     

Why Do Large Firms' Prices Anticipate Earnings Earlier than Small Firms' Prices?*

This paper presents evidence that the positive association between firm size and price leads of earnings is not solely a function of private search incentives for firm‐specific information. Specifically, we find that small‐firm prices also lag large‐firm prices with respect to industry‐wide information. Our empirical analysis extends Collins, Kothari, and Rayburn 1987 and Freeman 1987, who document that security‐price leads of earnings are positively associated with market capitalization. In particular, we examine the association between firm size and the timing of security returns for two components of annual earnings changes: the average change for a firm's industry and the firm's idiosyncratic change. We find that large firms' prices have a longer lead than small firms' prices with respect to both components. Large firms' early lead on industry‐wide earnings suggests that returns of large firms predict returns of same‐industry small firms. To test this implication, we construct a portfolio of long (short) positions in small firms when the prior month's returns of large firms in their industry are above (below) average for large firms in other industries. This zero investment portfolio earns 4.5 percent over 12 months.     

Maintaining a Reputation for Consistently Beating Earnings Expectations and the Slippery Slope to Earnings Manipulation

This paper investigates whether maintaining a reputation for consistently beating analysts' earnings expectations can motivate executives to move from “within GAAP” earnings management to “outside of GAAP” earnings manipulation. We analyze firms subject to SEC enforcement actions and find that these firms consistently beat analysts' quarterly earnings forecasts in the three years prior to the manipulation period and continue to do so by smaller “beats” during the manipulation period. We find that manipulating firms beat expectations around 86 percent of the time in the 12 quarters prior to the manipulation period (versus 75 percent for control firms) and that manipulation often ends with a miss in expectations. We document that executives of manipulating firms face strong stock market and CEO pressure to perform. Prior to the manipulation period, these firms have high analyst optimism, growing institutional interest, and high market valuations, along with powerful CEOs. Further, we find that maintaining a reputation for beating expectations is more important than CEO overconfidence and is incremental to CEO equity incentives for explaining manipulation. Our results suggest that pressure to maintain a reputation for beating analysts' expectations can encourage aggressive accounting and, ultimately, earnings manipulation.     

JIT Adoption: The Effects of LIFO Reserves and Financial Reporting and Tax Incentives*

Using matched samples of JIT adopters and nonadopters, we examine the association of JIT adoption with firms' financial reporting and tax incentives, earnings‐management histories, and LIFO reserve levels. We find evidence that adoption decisions are influenced by the interaction of firms' LIFO reserves with their income smoothing, debt covenant, and tax incentives. We also find that adoption is less likely for firms historically engaging in high degrees of earnings management, particularly when such firms have no substantial LIFO reserves. Our study extends earlier research demonstrating a relation between inventory valuation method and year‐end inventory transactions, and documents a relation between earnings‐management incentives and a fundamental supply‐chain design choice.     

The Effect of CFO Personal Litigation Risk on Firms’ Disclosure and Accounting Choices

In Gantler v. Stephens (2009), the Delaware Supreme Court makes explicit that corporate officers owe the same fiduciary duty to the firm and shareholders as do board members. The decision increased the risk of non‐board‐serving officers being added as named defendants to investor litigation but did not change the risk of corporate litigation. Analyzing the effect of the Gantler ruling on non‐board‐serving CFOs, we find a significant change in their behavior as well as in their firms’ disclosure and accounting choices. Specifically, speech tone during earnings calls of non‐board‐serving CFOs becomes more negative when compared to board‐serving CFOs and the firm's CEO, and non‐board‐serving CFO firms disclose bad news earlier and report more conservatively. Results are stronger for firms incorporated in Delaware. Our findings suggest that CFOs respond to personal litigation risk over and above corporate litigation risk.     

Do Accounting Firm Consulting Revenues Affect Audit Quality? Evidence from the Pre‐ and Post‐SOX Eras

In recent years, public accounting firms have experienced a steady increase in the proportion of their revenues generated from consulting services. Although growth in consulting revenue following the Sarbanes‐Oxley Act (SOX) has been generated primarily from services provided to nonaudit clients, regulators have expressed concerns about the potential implications of this increase for audit quality. In contrast, accounting firms assert that the expertise developed by their consulting professionals helps them to provide better quality audits. We examine the relation between the proportion of accounting firm consulting revenue to total revenue and audit quality and investor perceptions of audit quality. Because SOX drastically altered the source of consulting revenues for public accounting firms, we also separately examine these relations in the pre‐ and post‐SOX eras. We find evidence suggesting that before SOX, higher proportions of audit firm consulting revenues negatively impacted both audit quality and investor perceptions of audit quality. However, we do not find a statistically significant association between audit firm consulting revenues and either audit quality or investor perceptions of audit quality following SOX. Our analyses suggest that even if these relations exist following SOX, the potential economic magnitude of the effect is small.     

Auditor Choice and Its Implications for Group‐Affiliated Firms

We examine which of two opposing financial reporting incentives that group‐affiliated firms experience shapes their accounting transparency evident in auditor choice. In one direction, complex group structure and intragroup transactions enable controlling shareholders to pursue diversionary activities that they later hide by distorting reported earnings. In the other direction, as outside investors price‐protect against potential expropriation, controlling shareholders may be eager to improve financial reporting quality in order to alleviate agency costs. To empirically clarify whether group affiliation affects company insiders' incentives to address minority shareholders' concerns over agency costs, we examine auditor selection of group firms relative to stand‐alone firms. In comparison to nongroup firms, our evidence implies that group firms are more likely to appoint Top 10 audit firms in China, especially when their controlling shareholders have stronger incentives to improve external monitoring of the financial reporting process. After isolating group firms, we find that the presence of a Top 10 auditor translates into higher earnings and disclosure quality, higher valuation implications for related‐party transactions, and cheaper equity financing, implying that these firms benefit from engaging a high‐quality auditor. In additional analysis consistent with our predictions, we find that group firms that are Top 10 clients pay higher audit fees and their controlling shareholders are more constrained against meeting earnings benchmarks through intragroup transactions and siphoning corporate resources at the expense of minority investors. Collectively, our evidence supports the narrative that insiders in firms belonging to business groups weigh the costs and benefits stemming from auditor choice.     

Can Shareholders Be at Rest after Adopting Clawback Provisions? Evidence from Stock Price Crash Risk

Using a propensity score matched sample and a difference‐in‐differences research design, we find that stock price crash risk increases after a firm voluntarily incorporates clawback provisions in executive officers' compensation contracts. This heightened crash risk is concentrated in adopters that increase upward real activities‐based earnings management and those that reduce the readability of 10‐K reports. Based on cross‐sectional analyses, we also find that the increased crash risk is more pronounced for adopters with high ex ante fraud risk, low‐ability managers, high CEO equity incentives, and low dedicated institutional ownership. Collectively, our results suggest that the clawback adoption per se does not curb managerial opportunism but rather induces managers to use alternative channels for concealing bad news, which may contribute to a greater stock price crash risk; and the increase in crash risk is more likely in cases where incentives are strong or monitoring is weak. Our results should be of interest to regulators and policymakers considering the effects of clawback adoption on the investing public.     

CEO与CFO股权激励的治理效应之比较:基于盈余管理的实证研究

在西方发达国家,CFO与CEO拥有相同的法律地位,负有监督CEO的责任,在公司治理结构中拥有重要的地位。本文从盈余管理角度研究我国CFO股权激励的公司治理效应,并比较CFO与CEO股权激励的公司治理效应,发现:尚未实施股权激励计划的公司,其CFO股权和期权占总薪酬比率与盈余管理呈负相关关系,而实施股权激励计划的公司,其CFO股权和期权占总薪酬比率与盈余管理的负相关关系显著变弱;尚未实施股权激励计划的公司,其CFO股权和期权占总薪酬比率对盈余管理抑制的程度显著小于CEO。这表明,正式实施股权激励会诱发盈余管理行为,其它类型的CFO持股则会抑制盈余管理行为,并且CFO股权激励的积极治理效应显著小于CEO。