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A review of the IFRS adoption literature

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Abstract

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.

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Notes

  1. Stojilkovic (2011) and Jarolim and Oppinger (2012) discuss these criticisms. See also Financial Director, “Long Road Ahead as IASB remedies governance concerns,” April 14, 2014.

  2. The initial evidence on IFRS effects could also be affected by the publication bias prevalent in social science research, whereby significant results tend to be published, as opposed to studies that fail to reject the null.

  3. Throughout this review, we distinguish between the contracting and valuation roles of accounting numbers, with the former referring to the use of accounting numbers within formal contracts (such as in debt covenants) and the latter referring to the use of accounting numbers for valuation decisions. We classify the effects of accounting on the initiation and terms of contracts under the valuation role.

  4. IAS were issued by the International Accounting Standards Committee (IASC) until 2000. In 2001, the IASC was succeeded by the International Accounting Standards Board (IASB), which adopted the earlier-issued IAS and started issuing new standards as IFRS. Throughout this review, we use the acronyms IFRS and IAS interchangeably to describe IFRS.

  5. Our search period starts in 1999, as we find no published papers related to IAS in these journals before then.

  6. Chan, Lin, and Mo (2010) examine the effect of IFRS adoption on tax non-compliance.

  7. For a detailed history of the IASC and its evolution into the IASB, we refer the reader to studies by Camfferman and Zeff (2007) and Zeff (2012).

  8. This regulation (Regulation 1606/2002) was adopted by the Council of Ministers of the EU on June 7, 2002.

  9. This regulation was subsequently enacted into law by the European Parliament on Sept. 11, 2002.

  10. Barth et al. (2014), who analyze reconciliations of net income across IFRS and local GAAP, find that the effect of IFRS on net income tends to be larger for firms in the UK than in many other European countries.

  11. See http://www.ifrs.org/About-us/Pages/IFRS-Foundation-and-IASB.aspx.

  12. Comment letter to SEC on allowing US issuers to prepare financial statements in accordance with IFRS (August 7, 2007).

  13. Along these lines, publicly listed companies within the EU must comply only with IFRS endorsed by the European Commission (EC). The EC is not a national standard setter per se but a transnational EU committee.

  14. On Nov. 19, 2004, the EC endorsed IAS 39 with the exception of two “carve-outs”: one relating to the Full Fair Value Option and the other to hedge accounting. In July 2005, the EU adopted an amended version of the regulation for the fair value option. Some hedge accounting requirements under IAS 39 are still to be endorsed.

  15. “IASB chairman offers respite in big impact pronouncements” (http://www.cch.co.uk/, December 17, 2004).

  16. See “IFRS under attack,” Accountancy, Sept. 1, 2005.

  17. “Publication of the first quantified explanations of the impact of IFRS heralds the start of a very different phase in their implementation—communicating the findings,” Accountancy Live, January 2005.

  18. “Avoid nasty shocks: get to grips with IFRS,” Accounting, February 2005.

  19. “IFRS sparks share price fears,” Accountancy, December 2004.

  20. “Tardy IFRS prep will lead to audit qualifications,” Accountancy, September 2004.

  21. “Investors fear IFRS surprises,” Accountancy Age, July 2005.

  22. Bartov et al. (2005) do not find evidence to suggest that US GAAP are of a higher value relevance than IAS, suggesting that their results are driven by a higher value relevance of both US GAAP and IAS over local German GAAP.

  23. Venkatachalam (1999) provides a nice discussion of alternative explanations for and interpretations of the mixed results of Harris and Muller (1999).

  24. Truong (2012) provides corroborative evidence based on analysis of New Zealand firms. He documents a significant increase in information content over the 1994–2009 period, with a marked increase immediately following the adoption of IFRS.

  25. We discuss the contamination issues associated with mandatory IFRS adoption studies in detail in Sect. 10.

  26. The eight items are listed as follows: existence of statement of cash flow, disclosure of accounting policies, disclosure of a change in accounting policies, disclosure of the effect of a change in accounting estimates, disclosure of prior period adjustments, disclosure of post-balance-sheet events, disclosure of related party transactions, and disclosure of segment information. See Table A1 (p. 438) of Ashbaugh and Pincus (2001) for specific details about their measures.

  27. For each firm, Lang et al. (2010) select matched peers from firms that are domiciled in a different country but have the same two-digit SIC classification as the first firm.

  28. To ensure that the transnational information is relevant for a domestic firm, Wang (2014) requires matched non-announcing firms to have foreign sales and to not have announced their own earnings before the earnings announcements by a global leader.

  29. Wang (2014) and Yip and Young (2012) exclude financial firms from their samples. Wang (2014) also excludes utilities.

  30. We discuss these arguments in greater detail in Sect. 4.3.

  31. DeFond et al. (2011) omit the year of mandatory adoption (i.e., 2005), arguing that investors may not fully understand IFRS-compliant financial statements or that preparers might not have applied new rules consistently in this transition year.

  32. Given that IFRS adoption is associated with an increase in the issuance of annual reports in English (Jeanjean et al. 2015), the evidence related to cross-border capital flow around IFRS adoption may also reflect the benefits of lowering language barriers rather than those of IFRS reporting.

  33. Young and Zeng (2015) assess the performance of multiples-based valuation using three criteria: pricing accuracy (defined as the difference between the actual stock price and valuation implied by foreign peers), the ability of the implied values to explain cross-sectional variations in observed stock prices, and the ability of foreign peers’ valuation multiples to predict firms’ future market-to-book multiples.

  34. Although Bae et al. (2008) do not focus on IFRS adoption, in a supplementary analysis, they document that analysts familiar with IAS are more likely to start following a firm after its voluntary IAS adoption.

  35. For each industry-country, DeFond et al. (2011) measure accounting uniformity as the number of firms in that industry and country using IFRS in the post-IFRS-adoption period, divided by the number of firms in that industry and country using local accounting standards in the pre-IFRS-adoption period.

  36. In an economy where the level of disclosure is the same for all firms, estimation risk can be diversified away. However, Barry and Brown (1985) show that differential information (i.e., cross-firm differences in the amount of available information about the firm) affects pricing.

  37. Easley and O’Hara (2004) develop a model in which firms with less public and more private information face a greater information risk and higher expected returns. They argue that, due to their information disadvantage relative to informed investors, uninformed investors end up holding suboptimal portfolios with too many stocks with pending bad news and too few with pending good news. As this risk cannot be diversified away by holding more stocks, the risk gets priced in equilibrium. However, Lambert et al. (2007, pp. 396–397) point out that the information effect on stock prices is diversified away when the number of traders becomes large.

  38. Daske et al. (2013) use three proxies to identify major changes in firm-level reporting incentives related to voluntary (and mandatory) IAS adoption. The first is the primary factor drawn from factor analysis of a variety of firm attributes, such as size, leverage, profitability, book-to-market ratio, percentage of closely held shares, and percentage of foreign sales to total sales. The second is the negative of the ratio of absolute value of accruals to the absolute value of cash flow from operations. The final proxy is the number of analysts following a firm. The authors then use the changes in these proxies over six years around IAS to sort firms into “serious” and “label” adopters based on whether the changes are above or below the median change.

  39. Li (2010) measures cost of equity capital as the average implied cost of capital measures estimated from the four different valuation models.

  40. In Duffie and Lando’s (2001) model, the transparency of the accounting system is specifically characterized as the variance of the noise in asset values, which directly affects creditors’ ability to estimate the probability of default. Bhat et al. (2015) empirically measure transparency using analyst forecast dispersion and error.

  41. For US stocks, Francis et al. (2005) and Bharath, Sunder, and Sunder (2008) provide evidence of a negative relationship between reporting quality and the cost of debt using accrual quality as a proxy for reporting quality.

  42. Florou and Kosi (2015) limit their sample period to years before 2008 to avoid the financial crisis period. Chen et al. (2015b) end their sample period in 2011. In addition, Florou and Kosi (2015) limit their sample to senior term loans, revolvers, and 364-day facilities.

  43. In Florou and Kosi’s (2015) study, the indicator variable for mandatory IFRS adoption has a positive but insignificant coefficient in most of their regressions on the cost of private loans. Florou and Kosi’s (2015) sample has 8628 observations versus the 11,238 observations included by Chen et al. (2015b) for the same period, i.e., 2000–2007. In addition, Florou and Kosi’s (2015) regression models include variables measuring default risk, such as O-score and distance to default, which load significantly.

  44. Ball et al. (2015) provide the following reasons for why fair value emphasis lowers the relevance of IFRS numbers for inclusion in debt contracts. First, fair value gains and losses from shocks to the cash flows of assets are transitory, making current-period earnings a poorer predictor of future debt service capacity. Second, fair value gains and losses include shocks to the expected returns of assets. To the extent that these shocks are expected to reverse before debt maturity, they are irrelevant for debt contracting. Third, as debt contracts require repayment of the principal and interest and not the fair value of the debt, the IFRS option to fair value certain financial liabilities lowers the contracting value.

  45. Timely loss recognition removes incentives for managers to continue loss-making projects and invest in new unprofitable projects, particularly when the negative consequences of such projects will be unknown to outsiders for long periods. However, such concerns do not arise for managers continuing profit-making projects. Furthermore, conditionally conservative reporting can aid outside directors by attenuating managerial biases to report favorably. Finally, timely recognition of gains involves greater managerial subjectivity and lower verifiability, which lowers demand for contracting and stewardship purposes.

  46. See studies by Bushman and Smith (2001), Armstrong et al. (2010b), and Shivakumar (2013) for reviews.

  47. For example, Indjejikian and Matejka (2009) find a decrease in the reliance of CFO bonus contracts on financial performance after SOX and attribute this finding to firms’ wanting to decrease CFOs’ incentives to misreport.

  48. Although Paul (1992) predicts that the valuation role of earnings is independent of the managerial-incentive contracting role of earnings, Bushman, Engel, and Smith (2006) and Banker et al. (2009) extend the analysis and show empirically that earnings can play a role in both valuation and compensation contracts simultaneously.

  49. In addition, Wu and Zhang (2009) examine the sensitivity of employee layoffs to accounting earnings after voluntary IAS adoption and find results consistent with those for CEO turnover.

  50. Christensen et al. (2013, Appendix A) provide a detailed discussion of enforcement changes within the EU.

  51. They specifically calculate a country-level measure of concurrent reforms using data from the Annual Executive Opinion Survey conducted by the Institute for Management Development. Although the primary purpose of the survey is to provide quantifiable measurements of management practices, labor relations, and corruption, the survey explicitly asks respondents to evaluate the extent to which auditing and accounting practices are implemented in their firms adequately and the extent to which corporate boards supervise company management effectively. The authors measure the changes in these scores from the pre-IFRS to post-IFRS periods.

  52. See Barth (2006), Laux and Leuz (2009), and Ball et al. (2015) for detailed discussions about fair value accounting.

  53. Elad (2004) provides a discussion of the implementation of IAS 41 and offers a detailed comparison of US GAAP and IFRS in terms of the measurement of agricultural assets. Giner and Arce (2012) and McAnally, McGuire, and Weaver (2010) provide useful background information about the adoption of IFRS 2 and its comparison with SFAS 123 under US GAAP.

  54. See Quagli and Avallone (2010) for a detailed discussion of IAS 40. The authors also provide empirical evidence that a firm’s decision to adopt fair value accounting for investment properties under IAS 40 is a function of information asymmetry, contractual efficiency, and managerial opportunism.

  55. See Appendix 1 of Goncharov et al. (2014) for a full list of countries in relation to this issue.

  56. In theory, firms can choose between the fair value and historical cost model under IFRS. However, in practice, all of Liang and Riedl’s (2014) sample firms use the fair value model. They attribute this to the UK’s legacy of using the fair value model for investment property assets under domestic UK GAAP.

  57. Stolowy, Haller, and Klockhaus (2001) provide a detailed comparison of IAS 38 and French and German GAAP.

  58. Effective January 1, 2016, IFRS require firms to account for bearer biological assets such as property, plant, and equipment.

  59. Of the studies adopting a single-country research design, five focus on firms cross-listed in the US, and one uses firms cross-listed in the UK. We count these studies as using the US or UK as a single treatment country.

  60. Horton and Serafeim (2010) provide a detailed discussion of the effects of IFRS relative to local UK GAAP for key accounting areas, i.e., leases, employee benefits, share-based payments, deferred taxes, goodwill and intangibles, and financial instruments.

  61. Christensen et al. (2013) present a test in Table 6 of their study to separately identify the liquidity effects arising exclusively from enforcement changes. They investigate liquidity changes for Japanese firms around 2004, when Japan changed its enforcement practices without changing its accounting standards. Although their analysis provides some evidence that supports the enforcement changes affecting stock liquidity, it is unclear whether these results can be generalized to other contexts or countries, as Japan saw large changes in the functioning of its banks and capital markets between 2001 and 2007, when regulators introduced new laws aimed at decreasing non-performing loans on banks’ balance sheets.

  62. For details about the options available to EU member states in relation to mandatory IFRS adoption, see Table 1 of Pownall and Wieczynska (2012).

  63. Although insignificant values for β 1 and β 2 in Eq. (1) would provide some comfort that IFRS-adopting and control firms are comparable and that IFRS adoption does not affect control samples, the values for these coefficients are not often reported separately, as they are subsumed by the inclusion of fixed effects in the difference-in-differences model.

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Acknowledgments

We thank Mary Barth, Ulf Bruggeman, Elizabeth Gordon, Martin Glaum, Luzi Hail (discussant), Sudarshan Jayaraman, Bjorn Jorgensen, Alon Kalay, Peter Pope, Karthik Ramanna, Nemit Shroff, Brian Singleton-Green, Stephen Taylor, Rodrigo Verdi, Martin Walker, Holly Yang, Stephen Zeff, participants at the 2015 Review of Accounting Studies Conference, and an anonymous reviewer for their comments and suggestions. We also thank Han-Up Park for research assistance.

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Authors and Affiliations

  1. London Business School, Regent’s Park, London, NW1 4SA, UK

    Emmanuel T. De George & Lakshmanan Shivakumar

  2. Fox School of Business, Temple University, Philadelphia, PA, 19122, USA

    Xi Li

  3. London School of Economics and Political Science, Houghton Street, London, WC2A 2AE, UK

    Xi Li

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  1. Emmanuel T. De George
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  2. Xi Li
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  3. Lakshmanan Shivakumar
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Correspondence to Lakshmanan Shivakumar.

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De George, E.T., Li, X. & Shivakumar, L. A review of the IFRS adoption literature. Rev Account Stud 21, 898–1004 (2016). https://doi.org/10.1007/s11142-016-9363-1

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