Attribute differences between U.S. GAAP and IFRS earnings: An exploratory study

In this study we explore attribute differences between U.S. GAAP and IFRS earnings. Our study is motivated by the ongoing harmonization process in accounting standard setting as well as by recent convergence projects by the FASB and the IASB. We test two market-based earnings attributes, i.e., value relevance and timeliness, as well as two accounting-based earnings attributes, i.e., predictability and accrual quality. These attributes are tested for German New Market firms as they are allowed to choose between IFRS and U.S. GAAP for financial reporting purposes. Overall, we find that U.S. GAAP and IFRS only differ with regard to predictive ability. The fact that U.S. GAAP accounting information outperforms IFRS also holds after controlling for differences in firm characteristics, such as size, leverage and the audit firm. However, our results also seem to suggest that these differences are not fully valued by investors, as we do not observe significant and consistent differences for the value-relevance attribute.     

IAS Versus U.S. GAAP: Assessing the Quality of Financial Reporting in South Africa,the United Kingdom,and the United States

In this study, we investigate whether financial reporting, using International Accounting Standards (IAS) results in quality disclosures, given differences in institutional and market forces across legal jurisdictions. This study contributes to the global accounting debate by utilizing U.S.-based companies complying with U.S. Generally Accepted Accounting Principles (U.S. GAAP) as a benchmark for measuring the quality of IAS as applied by South Africa (S.A.) and United Kingdom (U.K.) companies. Although South Africa, United Kingdom, and the United States are common law countries with strong investor protection, South Africa's institutional factors and market forces vary from that of the U.K. and the U.S. South Africa's financial market is less developed than that of the U.K. and the U.S. We compare the discretionary accruals of firms complying with U.S. GAAP to the discretionary accruals of U.K. and S.A. firms complying with IAS. This allows a comparison between companies (S.A. and U.K.) operating under different institutional factors and market forces that have adopted IAS versus U.S. companies that report under U.S. GAAP. Our sample, consisting of U.S., S.A., and U.K. listed firms, contains 3,166 firm-year observations relating to the period 1999–2001. The results of our study indicate that S.A firms utilizing IAS report absolute values of discretionary accruals that are significantly greater than absolute values of discretionary accruals of U.S. firms utilizing U.S. GAAP. In contrast, U.K. firms utilizing IAS report discretionary accruals that are significantly less than the discretionary accruals of companies in the United States reporting under U.S. GAAP. This study contributes to the literature by providing evidence of the quality of financial information prepared under IAS and its dependency on the institutional factors and market forces of a country.     

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.     

Financial restatements by Canadian firms cross-listed and not cross-listed in the U.S.

Canadian financial restatements announced during 1997–2006 lower market quality and signal to market participants that expected future cash flows and their uncertainty are diminished and increased, respectively. Abnormal returns are related to downward revisions in consensus earnings forecasts, and become more negative for U.S. cross-listings, and for revenue recognition and company-initiated restatements. Total residual volatility, its information-based permanent component and the adverse selection spread component increase following such announcements. Relative spreads and a spread-depth market-quality index increase following such announcements and are lower for U.S. cross-listings. Relative spreads (unlike the market-quality index) remain higher post-announcement, and are lower post-Sarbanes-Oxley Act.     

International financial reporting standards and experts' perceptions of disclosure quality

From 2005, over 7,000 listed firms in the European Union and many more around the world are required to adopt International Financial Reporting Standards (IFRS). The introduction of a uniform accounting regime is expected to ensure greater comparability and transparency of financial reporting around the world. However, recent research has questioned the quality of financial statements prepared under IFRS standards, particularly in the presence of weak enforcement mechanisms and adverse reporting incentives ( Ball et al. , 2003 ). In this paper, we assess the quality of the financial statements of Austrian, German and Swiss firms which have already adopted internationally recognized standards (IFRS or U.S. GAAP). The study makes use of available disclosure quality scores extracted from detailed analyses of annual reports by reputed accounting scholars ('experts'). This work complements other contemporary research on the quality of IFRS financial statements where the properties of earnings are used as an evaluation metric ( Barth et al. , 2005 ). Our evidence shows that disclosure quality has increased significantly under IFRS in the three European countries we analyse. This result holds not only for firms which have voluntarily adopted IFRS or U.S. GAAP, but also for firms which mandatorily adopted such standards in response to the requirements of specific stock market segments. Although we cannot establish direct causality due to the inherent self-selection issues for most of our sample firms, the evidence shows that the quality of financial reports has increased significantly with the adoption of IFRS.     

Eliminating the 20-F reconciliation from IFRS to U.S. GAAP: Short-term and long-term liquidity effects

This paper examines the effects of the SEC’s 2008 decision to no longer require foreign private issuers using IFRS and trading on U.S. exchanges to reconcile their financial statements to U.S. GAAP. Extant research has found conflicting results using short event windows, while studies using longer event windows have found limited capital market impact from eliminating the reconciliation. Motivated by the SEC’s interest in understanding how disclosure rules impact market liquidity, we examine changes in effective bid-ask spreads, the price impact of trades, and quoted depth around 20-F filing dates for a sample of foreign private issuers. We find that effective spreads increase more around 20-F filing dates for filers using IFRS than for filers using U.S. GAAP, suggesting the 20-F report is more informative for filers using IFRS. We then find, in a subsample of filers using IFRS, that the increase in effective spreads for IFRS firms around 20-F filing dates is directly related to the magnitude of differences in book values between IFRS and U.S. GAAP. In sum, our results suggest a loss of useful information after the SEC’s rule change.     

Examination of real and accrual earnings management: A cross-country analysis of legal origin under IFRS

This study examines the impact of legal origin differences on accrual and real earnings management behaviors for 14 international financial reporting standards (IFRS) countries. Specifically, a cross-country analysis determines the effects of enforcement intensity and IFRS adoption on earnings management (EM) types, depending on code or common law origins. The results indicate that legal origin directly affects EM behaviors, whereas enforcement intensity and IFRS result in different accrual earnings management (AEM) and real earnings management (REM) behaviors depending on the different legal origins. In particular, the findings also suggest that an increase in enforcement strength may not produce similar EM results for each legal tradition, specifically for the expected shift from AEM to REM as recent studies have proposed. This study also offers evidence that IFRS represent a constraint on AEM in code law origin countries, and it highlights a constraint on REM only for common law countries when the enforcement intensity increases.     

The valuation properties of earnings and book values reported under IAS,domestic GAAP and U.S. GAAP: Evidence from China,Hong Kong,Japan, Korea and Singapore

This paper examines whether earnings or book value is the dominant valuation accounting measure for companies reporting under alternative accounting standards — International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS), U.S. Generally Accepted Accounting Principles (U.S. GAAP) or domestic accounting standards of China, Hong Kong, Japan, Korea and Singapore. Our sample consists of domestic firms in the five Asian countries and firms from these countries cross-listed in the United States as American Depositary Receipts (ADRs) from 2002 to 2011. For domestic firms, book value is more informative than earnings for firms from Hong Kong, Singapore, China, Japan and Korea during 2002–2011 although their accounting standards are influenced by different systems. For the ADR sample, book value is more informative than earnings for U.S. GAAP reporters and reconcilers during 2002–2007. However, earnings are more informative than book value for U.S. GAAP reconcilers from China. After 2007, ADRs in our sample from Hong Kong, Japan and Korea continued to file under U.S. GAAP. Some ADRs from China filed under U.S. GAAP and some filed under IFRS. Earnings are more informative than book value for IFRS users; however, book value has higher incremental value relevance than earnings for U.S. GAAP users. We contribute to prior research by providing evidence on the valuation properties based on accounting measures reported under different GAAPs for the Asian countries.     

The adequacy of fixed asset disclosures under U.S. GAAP

Prior to 1995, the U.S. Securities and Exchange Commission (SEC) required publicly-traded, capital-intensive registrants to prepare detailed supplemental schedules summarizing the activity in fixed asset-related accounts. This study examines these previously-mandated schedules and illustrates how current aggregated reporting requirements potentially conceal insights that could be gained with finer information. This is a significant issue, as current disclosures under International Financial Reporting Standards (IFRS) are similar to the former SEC requirements. The analysis supports the conclusion that stakeholders in capital-intensive U.S. firms are at an informational disadvantage relative to stakeholders in similar firms reporting under IFRS.     

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.     

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 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.     

Managerial academic experience,external monitoring and financial reporting quality

This study examines the effect of managerial academic experience on firms’ financial reporting quality. Using data from China, we find that firms with top managers possessing academic experience exhibit lower levels of both accrual and real earnings management, along with a lower probability of future restatements. This effect is more pronounced for firms with inefficient external monitoring, suggesting that the higher financial reporting quality is mainly explained by the managers’ intrinsic motivation to report truthfully. The results hold when we use firm fixed‐effect regressions, instrumental variable two‐stage regressions, and a propensity score matching (PSM) approach to mitigate the omitted variable and endogeneity concerns. Our study suggests that academic experience can serve as a source of valuable expertise for corporate executives.     

Auditor Independence,Non‐Audit Services,and Restatements: Was the U.S. Government Right?*

Do fees for non‐audit services compromise auditor's independence and result in reduced quality of financial reporting? The Sarbanes‐Oxley Act of 2002 presumes that some fees do and bans these services for audit clients. Also, some registrants voluntarily restrict their audit firms from providing legally permitted non‐audit services. Assuming that restatements of previously issued financial statements reflect low‐quality financial reporting, we investigate detailed fees for restating registrants for 1995 to 2000 and for similar nonrestating registrants. We do not find a statistically significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements, but we do find some such association for unspecified non‐audit services and restatements. We find a significant negative association between tax services fees and restatements, consistent with net benefits from acquiring tax services from a registrant's audit firm. The significant associations are driven primarily by larger registrants.     

Statement of the Financial Economists Roundtable on the International Competitiveness of U.S. Capital Markets

The Committee on Capital Markets Regulation issued an Interim Report (known as the “Paulson Report”) near the end of 2006 that concluded that the U.S. “is losing its leading competitive position as compared to stock markets and financial centers abroad.” This report was quickly followed by a study, which reached similar conclusions, that was commissioned by New York Mayor Michael Bloomberg and Senator Charles Schumer and prepared by McKinsey & Co. At its July 2007 annual meeting, the Financial Economists Roundtable (FER) — a group of senior financial economists at universities and other organizations recognized as having made significant contributions to the finance literature—discussed the issues raised by the Report and decided to publish its own report. The report makes the following four policy recommendations:

• 1 Securities class action suits —Abolish enterprise liability under rule 10b‐5 in situations arising out of security purchases and sales in the secondary trading market among outside shareholders, while retaining managerial and firm liability where the company itself or its insiders (officers and directors) transact to their own benefit. Imposing massive liability on a company that is not a party to the securities transactions and does not benefit from the fraud does not serve a deterrence function since it is the continuing shareholders of the corporation who bear the burden of what the company must pay if found guilty, either directly or indirectly through insurance premiums.
• 2 Shareholder rights—Require all corporations to obtain shareholder approval to adopt a poison pill, regardless of whether a company has a staggered board. This requirement would conform to the broad principle that the board of any company should not be able to deny its shareholders the opportunity to decide on the merits of a takeover bid, and it would help restore the market for corporate control as an effective disciplinary mechanism for poorly performing boards and managers.
• 3 Compliance costs associated with SOX §404—Adopt a statutory amendment that makes it optional for a company to adopt the §404 procedures for a management assessment and auditor attestation of the effectiveness of its internal controls, with the requirement that if the company chooses not to comply it must explain why in its financial statements. Thus, in effect, the FER effectively recommends that the market be allowed to determine the value of §404 compliance. If a company chooses not to comply, the market will assess its explanation for non‐compliance and will value the company accordingly.
• 4 Maintaining open markets—Allow both foreign and U.S. firms to choose to report in conformity with either IFRS or U.S. GAAP. The FER recognizes both IFRS and U.S. GAAP as high‐quality accounting standards that provide reasonable foundations for financial reporting for investors. Allowing both foreign and U.S. firms to adopt whichever of these standards they believe to be the most cost‐effective provides an opportunity for the market and investors themselves to sort out which reporting standard best serves their interests.

     

The quality of financial reporting in China: An examination from an accounting restatement perspective

This study uses restatements to reveal the poor quality of past accounting information reported within China’s capital market. We show that up to a quarter of listed firms in mainland China explicitly admitted the poor quality of their financial information by restating their previous financial reports between 1999 and 2005. Many of these firms managed their earnings mainly via below-the-line items to avoid losses and promote survival, rather than to support refinancing goals. Such poor-quality financial reporting is more likely among firms that have weaker profitability and a shareholder base that is state-controlled, with diffused ownership and a relatively low proportion of shares held by institutional investors. Furthermore, we find the market to be relatively insensitive to such admissions. Investors’ reactions capture only the earnings information of the current reported year, rather than also reflecting the concurrently revealed correction of past financial reporting. However, the equity market does not completely ignore the earnings information. Investors’ reliance on earnings is merely low relative to the mature US market. These findings demonstrate that accounting credibility in China has low value; providing poor-quality financial information bears little cost because various market mechanisms fail to deter such behavior. Nevertheless, regulators’ ongoing efforts to enhance the quality of financial information and disclosure among listed firms are still fruitful. The frequency of restatements decreased over our sample period, which reinforces the current regulatory prospects and strategies for further improving China’s capital markets.     

IAS Versus U.S. GAAP: Information Asymmetry–Based Evidence from Germany's New Market

Motivated by the debate about globally uniform accounting standards, this study investigates whether firms using U.S. generally accepted accounting principles (GAAP) vis‐à‐vis international accounting standards (IAS) exhibit differences in several proxies for information asymmetry. It exploits a unique setting in which the two sets of standards are put on a level playing field. Firms trading in Germany's New Market must choose between IAS and U.S. GAAP for financial reporting, but face the same regulatory environment otherwise. Thus, institutional factors such as listing requirements, market microstructure, and standards enforcement are held constant. In this setting, differences in the bid‐ask spread and share turnover between IAS and U.S. GAAP firms are statistically insignificant and economically small. Subsequent analyses of analysts' forecast dispersion, initial public offering underpricing, and firms' standard choices corroborate these findings. Thus, at least for New Market firms, the choice between IAS and U.S. GAAP appears to be of little consequence for information asymmetry and market liquidity. These findings do not support widespread claims that U.S. GAAP produce financial statements of higher informational quality than IAS.     

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.     

Litigation risk,financial reporting and auditing: A survey of the literature

This paper surveys the literature on the determinants and consequences of securities class action lawsuits against firms and auditors from a financial reporting quality perspective. The survey is motivated by the important role that law plays in protecting stakeholders' interests against managerial misdeed. Litigation is, thus, an important topic and numerous studies investigate the determinants and consequences of firm and auditor lawsuits. The underlying premise of these studies is built on the notion that large financial and reputational penalties associated with successful securities class actions can discipline management and deter them from future wrongdoing. The survey documents that poor quality financial reporting as evidenced in earnings restatements has been the primary antecedent for class action lawsuits against the firm and auditors. Lawsuits against auditors affect audit fees, audit planning decisions and client portfolio adjustment decisions. Although significant progress has been made in terms of further understanding the causes and consequences of litigation against auditors, major challenges remain in the area of proper measurement of litigation risk.     

Contracts valuation assessment noise and cross-border listing of equities on U.S. and U.K. stock markets

This study develops and tests the hypothesis that firms in the home country have capital market incentives to cross-border list on foreign stock exchanges that have similar financial reporting with local generally accepted accounting principles (GAAP). Non-U.S. firms' contracts and the underlying GAAP are based on the home-country culture and institutional climates. This connection with culture and institution makes the local GAAP's assessment of the contracts less spurious relative to foreign GAAP. Ball et al. [J. Account. Econ. 29 (2000) 1] note that contracting with stakeholders in the home markets is based on local GAAP's numbers, while cross-border listing provides settings in which the value relevance of local GAAP-based contracts is assessed based on foreign GAAP. Therefore, foreign investors' assessment of the contracts using foreign stock exchange GAAP or mindset of foreign GAAP is likely to result in an assessment noise, which is value irrelevant. The level of assessment noise depends on the differences between foreign and local GAAP. Because of the valuation implications of the assessment noise, we expect cross-border listing to diminish as the likelihood of assessment noise increases.As predicted, we find that assessment noise undermines cross-border listing on U.S. stock exchanges. Because U.S. and local GAAPs are based on different cultural and institutional environments, assessment noise arises if U.S. investors use the mindset of U.S. GAAP financial reports to assess local GAAP-based contracts of cross-border firms. The results are robust in the London Stock Exchange in which assessment noise is induced by interpreting local GAAP contracts as if they were based on U.K. GAAP. As expected, the influences of assessment noise on cross-border listings are more robust in the United States than in the United Kingdom. Our results suggest that harmonization of financial reporting is critical in attenuating the influences of assessment noise on global capital market developments.