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Accounting and stock market effects of international accounting standards adoption in an emerging economy

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Abstract

This study examines the impact of the mandatory adoption of the 1997 and 2006 Egyptian accounting standards on earnings quality and firm valuation. Extant research finds that IAS-based standards have positive effects on financial statement attributes (e.g., earnings management) and capital market-related variables (e.g., firm valuation) in some countries, and negative or neutral effects in others. Research conducted in this area on emerging markets is scant, and none in Egypt, which has adopted in 1997 an IAS-based standards (later revised twice in 2002 and 2006). Using a sample of Egyptian listed firms around the time of introducing the 1997 and 2006 EAS versions, I find insignificant empirical evidence that earnings management decreases post adoption of each of the EAS versions under investigation. Additionally, I find that firm valuation (Tobin’s q) was significantly negatively affected by both EAS versions under investigation in this study. I attribute these results to the lack of compliance by financial statement preparers, improper regulatory enforcement mechanisms, the poor accounting infrastructure, and the inadequate practitioner training, claimed by prior literature.

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Notes

  1. For the sake of enhancing the readability of the paper, I refer to both the International Accounting Standards (issued before the year 2001) and the International Financial Reporting Standards (issued 2001 and after) as IAS.

  2. I do not measure the effectiveness of the 2002 EAS version because it is outside the scope of this study, which aims at measuring the impact of the first official IAS-based standards in Egypt (the 1997 EAS) and the most recent, and hence most relevant, standards (2006 standards). It is unrelated to the research questions sought by this study to examine the impact of the 2002 EAS.

  3. The Companies Law 159/1981 is the primary law regulating private company organization and business transactions.

  4. The Capital Market Law 95/1992 governs stock market transactions and grants the CMA authority to delist violators.

  5. The Ministerial Decree 503/1997 was issued by the Ministry of Economy and Foreign Trade. This Ministry, which underwent a name change to Ministry of Economy and later to its current name, Ministry of Investment, has oversees the CMA (Egyptian Wakaea 1997) and continues to issue accounting and auditing requirements for all firms subject to CMA jurisdiction.

  6. The Permanent Committee is headed by the chairman of CMA and includes nine members representing major accounting associations, CAO, CMA, Central Bank of Egypt, and General Authority of Free Trade and Investment (World Bank 2002).

  7. Ministerial Decree 345/2002 was issued by the Minister of Economy.

  8. Ministerial Decree 243/2006 was issued by the Minister of Investment.

  9. In brief, EAS 1 requires employee and board members’ share in profits be presented as an appropriation of profit rather than an expense in the income statement, as required by IAS 1. EAS 10 narrows the use of fixed asset revaluations allowed under IAS 16. EAS 19 requires the formation of loan loss provision through the income statement, overriding IAS 30, which requires such provision to be an equity allocation. Finally, EAS 20 dictates that the lessor capitalizes and depreciates leased assets while the lessee charges the lease payments to expense in the income statement, thus overriding IAS 17.

  10. In an interview with a Chief Financial Officer of a top Egyptian firm conducted by the author in 2002, the CFO declared that income smoothing practices are prevalent and that it is commonly acceptable presumption that they are indicative of “good management” practices.

  11. Barth et al. (2007b) warn though of mislead interpretation of higher earnings variability, which may take place due to the potential effects of “big baths” (see, for example, Healy 1985) and the erroneous estimation of accruals. To the extent that “big baths” or errors may take place, it may significantly contaminate the study results.

  12. Kompass Egypt is owned by Fiani & Partners, a firm that specializes in providing financial information products primarily directed to the investment and credit community. It issues the Financial Yearbook annually in print edition. The Yearbook has two types of financial listings: full financial statements and highlights for the current year. Due to insufficient historical data, firms from the second category are not included in the sample.

  13. No significant difference was found between the sample firms over the 2 years around each event with respect to total assets, net sales, and net operating income. This suggests that the firm-year observations come from the same population of firms with similar characteristics.

  14. All variables are truncated at the first and 99th percentile to impose normality on the sample.

  15. The Jones (1991) model is not suitable for the calculation of abnormal accruals in this study because the number of firm observations per industry can be quite small (Francis and Wang 2006).

  16.  Unlike the Pearson correlation, Spearman correlation assesses how well a function could describe the relationship between two variables without making any (including normality) assumptions about the particular nature of the relationship between the variables, except those about symmetry of a gaussian-like distribution.

  17. I follow Barth et al. (2007b) and Lang et al. (2006) in analyzing small positive and large negative net income using OLS estimation rather than from logit estimation because logit models are extremely sensitive to the possible effects of heteroscedasticity (Greene 1993).

  18. Results do not change upon expanding the sample 1 year in each direction.

  19. Most earnings quality studies use 10 years of data to generate metrics. However, due to data limitations, I only use 1 year before and after each event. However, for the 1997 EAS event, I repeat the analysis using 2 years before (1996 and 1997) and 2 years after (1998 and 1999). The results are qualitatively similar to the results provided by the 1 year before and 1 year after analysis. This could not have been done for the 2006 EAS analysis because it requires data for 2008, which will not be available till the year 2009.

  20. Due to non-normality concerns, all variables are truncated at the first and 99th percentile to impose normality on the dataset.

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Acknowledgments

The author would like to thank Vivian Mehana, Magdy Samy, the participants of the 2009 AAA Annual Meeting and two anonymous reviewers for their insightful comments that helped shape this paper into this publishable form.

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  1. Department of Accounting, Faculty of Commerce, Cairo University, Orman, Giza, 12613, Egypt

    Mohamed A. Elbannan

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Elbannan, M.A. Accounting and stock market effects of international accounting standards adoption in an emerging economy. Rev Quant Finan Acc 36, 207–245 (2011). https://doi.org/10.1007/s11156-010-0176-1

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