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.     

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.     

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.     

Economic Benefits of Adopting IFRS or US‐GAAP – Have the Expected Cost of Equity Capital Really Decreased?

Abstract:   The question of whether the adoption of International Financial Reporting Standards (IFRS) results in measurable economic benefits is of special interest, particularly in light of the European Union's adoption of IFRS for listed companies. In this paper, I investigate the common conjecture that internationally recognised financial reporting standards (IAS/IFRS or US‐GAAP) reduce the cost of capital for adopting firms. Building on Leuz and Verrecchia (2000) , I use a set of German firms that have adopted such standards and investigate the potential economic benefits of this reporting strategy by analysing their cost of equity capital through the use and customisation of available implied estimation methods. Evidence from the 1993–2002 period fails to document lower expected cost of equity capital for firms applying IAS/IFRS or US‐GAAP. During the transition period I analyse, the expected cost of equity capital in fact appear to have rather increased under non‐local accounting standards.     

Disclosure and the Cost of Capital: Evidence from the Market's Reaction to Firm Voluntary Adoption of IAS

Abstract:  Using a unique international setting where the effects of disclosure on firm value can be measured in a constant regulatory environment and in isolation of other confounding factors, this paper shows that firms can increase their value through their choice of accounting standards. Specifically, we document strong positive abnormal returns at the announcement of voluntary adoption of International Accounting Standards (IAS / IFRS) by a sample of international firms and an economically significant reduction in long-run returns, consistent with a reduction in the cost of capital. Consistent with these results we also document evidence of an upgrade in analyst recommendations after the IAS / IFRS adoption announcement and a reduction in the implied cost of capital. Finally, we find strong evidence that the documented abnormal returns are consistent with signaling and bonding benefits stemming from the reduction in asymmetric information. Our results highlight the importance of increased disclosure on minority shareholder protection and on corporate governance in general.     

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.     

Improving earnings quality: The effect of reporting incentives and accounting standards

We investigate the different effects on earnings quality of accounting standards and reporting incentives for Germany over the period 1994 to 2005. To this end, we control for reporting incentives at the firm level, instead of the country level, by using the timing of voluntary IFRS adoption as a proxy for reporting incentives. We then include reporting incentives in an analysis of earnings management and information asymmetry. Contrary to common expectation, we find that IFRS reporting potentially decreases earnings quality on average; but also that reporting incentives appear to have lower effects on earnings quality in IFRS statements than in GGAAP statements. Thus, IFRS may lead to more homogenous earnings quality across firms.     

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.     

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.     

The effect of more rules‐based guidance on expense disclosure under International Financial Reporting Standards

International Financial Reporting Standards (IFRS) are often described as principles‐based; however, we show that IFRS and Australian pre‐IFRS expense‐related standards are more rules‐based than pre‐IFRS expense disclosure in New Zealand. Thus, we examine expense disclosure in New Zealand and Australia around IFRS adoption to provide evidence on the effect of more or less rules‐based standards on voluntary disclosure. First, we add to the rules versus principles‐based standards debate by finding higher voluntary expense disclosure under more rules‐based standards (e.g. IFRS). This contrasts with expectations, as we would expect fewer voluntary disclosures under more rules‐based standards as there would be fewer possible voluntary disclosures. Second, we document that New Zealand firms have significantly less voluntary expense disclosure than size‐ and industry‐matched Australian firms in both the pre‐ and post‐IFRS period. However, all measures of expense disclosure significantly improved post‐IFRS for New Zealand, whilst little change occurred for Australian firms. Thus, there is greater financial statement comparability across these countries post‐IFRS, but not full harmonization. Third, we show that the relationship between most firm characteristics and expense disclosure is weaker post‐IFRS. In addition, cross‐listed firms and loss‐making firms have a higher level of expense disclosure, as contrasted with firms in the investment and property industry which have a lower percentage of unspecified expenses but also report fewer voluntary expenses.     

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).     

Convergence of accounting standards and financial reporting externality: evidence from mandatory IFRS adoption

Using mandatory adoption of International Financial Reporting Standards (IFRS) as a natural experiment, we examine whether reporting externalities can be magnified when financial disclosures are based on a common set of accounting standards. Specifically, we investigate and find that the changes in publicly available information of mandatory IFRS adopters (due to the convergence of accounting standards) can impact the investment efficiency of prior voluntary adopters. While we document positive externalities of mandatory IFRS, we also observe heterogeneity in these spillover effects at the firm and the country level, suggesting that externalities increase with improvements in the comparability of accounting information.     

IFRS adoption and analysts’ earnings forecasts: Australian evidence

We study 145 large listed Australian firms to explore the impact of international financial reporting standards (IFRS) adoption on the properties of analysts’ forecasts and the role of firm disclosure about IFRS impact. We find that analyst forecast accuracy improves, and there is no significant change in dispersion in the adoption year, suggesting that analysts coped effectively with transition to IFRS. However, we do not observe the expected relationship between firms’ IFRS impact disclosures in their financial statements issued at the end of the transition year with forecast error and dispersion in the adoption year. The results question the timeliness and usefulness of financial statement disclosure, even in a setting where disclosure was mandated by accounting standards (AASB 1047 and AASB 1) and firms had strong incentives to provide information to analysts.     

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.     

Home Bias, Foreign Mutual Fund Holdings, and the Voluntary Adoption of International Accounting Standards

We test the assertion that a consequence of voluntarily adopting International Accounting Standards (IAS) is the enhanced ability to attract foreign capital. Using a unique database that reports firm‐level holdings of over 25,000 mutual funds from around the world, our multivariate tests find that average foreign mutual fund ownership is significantly higher among IAS adopters. We also find that IAS adopters in poorer information environments and with lower visibility have higher levels of foreign investment, consistent with firms using IAS adoption to provide more information and/or information in a more familiar form to foreign investors. Taken together, our findings are consistent with voluntary IAS adoption reducing home bias among foreign investors and thereby improving capital allocation efficiency.     

The role of unaffiliated bankers on conditional conservatism: Evidence from IFRS information shock

We exploit IFRS mandatory adoption as a source of variation in the demand for conditional conservatism to examine the role of unaffiliated bankers on the level of conditional conservatism. We show that firms with unaffiliated bankers on boards of directors experience a significant increase in the level of conditional conservatism compared with firms without unaffiliated bankers on boards. These findings hold after we account for other country‐level factors that shape the demand for conditional conservatism. Additional analyses show that the role of unaffiliated bankers on conditional conservatism depends also on firm‐specific incentives arising from the contracting environment. Taken together, our findings provide new insights into the role of corporate governance arrangements on financial reporting outcomes.     

IFRS adoption and stock misvaluation: Implication to Korea discount

Analyzing publicly traded stocks in Korea surrounding IFRS adoption in 2011, we find that the gap between stock price and firm value, value-to-price (V/P) ratio, narrows following the IFRS adoption and that this narrowed gap is observed only for higher V/P firms. We further find that the return predictability of V/P decreases in the post-IFRS period. Using a path analysis, we report further evidence that mandatory IFRS adoption decreases idiosyncratic volatility and improves trading volume and market liquidity, thereby contributing to the narrowed gap between value and price. We conclude that IFRS adoption contributes to resolution of Korea discount.     

Timing Equity Issuance in Response to Information Asymmetry Arising from IFRS Adoption in Australia and Europe

This study examines the association between changes in reported financial performance resulting from mandatory adoption of International Financial Reporting Standards (IFRS) and equity issuance during the transition period leading up to IFRS adoption for listed firms in Australia and Europe. We hypothesize that firms affected by the accounting standards change strategically time equity issuance around the time the firm discloses the effects of IFRS adoption on reported financial performance. We document circumstances where market returns are associated with the reconciliation of net income between local GAAP and IFRS. We find that a firm's likelihood of equity issuance and equity issue size during the three years prior to the IFRS reconciliation disclosure are negatively associated with the unexpected change in net income resulting from the conversion to IFRS.     

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.     

Why do firms rarely adopt IFRS voluntarily? Academics find significant benefits and the costs appear to be low

Kim and Shi (Rev Account Stud, doi:10.1007/s11142-012-9190-y, this issue) document that voluntary IFRS adoption is associated with significant benefits and argue that the effect is causal??a conclusion that is similar to many published papers on IFRS adoption. Yet voluntary IFRS adopters constitute only a small percentage of the global population of firms, which implies that either practitioners behave irrationally or the benefits are incorrectly estimated by academics. In this discussion I argue that the error is on the part of academics, not practitioners, and that it is mainly due to the lack of exogenous variation in accounting standards. This conclusion is based on inconsistencies between the estimated benefits and costs of IFRS adoption, as well as the accounting standards choices of presumed rational managers. I also propose a contracting explanation for the capital market benefits around IFRS adoption in which managers behave rationally, but IFRS per se is not the cause.