This post is by Christian Leuz of the University of Chicago.
In my paper Mandatory IFRS Reporting Around the World: Early Evidence on the Economic Consequences, co-written with Holger Daske, Luzi Hail and Rodrigo Verdi, which is forthcoming later this month in the Journal of Accounting Research, we use a treatment sample of over 3,100 firms that are mandated to adopt IFRS to analyze effects in stock market liquidity, cost of equity capital, and firm value. These market-based constructs should reflect, among other things, changes in the quality of financial reporting and hence should reflect improvements around the IFRS mandate, if there have been any.
The primary challenge of our analysis is that the application of IFRS is mandated for all publicly traded firms in a given country from a certain date on, which makes it difficult to find a benchmark against which to evaluate any observed capital-market effects. Our empirical strategy uses three sets of tests to address this issue. In our first set of tests, which use firm-year panel data from 2001 to 2005, we benchmark liquidity, cost of capital and valuation effects around the introduction of IFRS against changes in other countries that do not yet mandate or allow IFRS reporting. In addition, we introduce firm-fixed effects to account for any unobserved (time-invariant) firm characteristics. In our second set of tests, where we continue to use firm-year panel data, we examine whether the estimated capital-market effects exhibit plausible cross-sectional variation with respect to countries’ institutional frameworks. In our last set of tests, we exploit that firms begin applying IFRS at different points in time depending on their fiscal-year ends and that, as a result, the adoption pattern in a given country is largely exogenous once the initial date for IFRS adoption is set. We relate this pattern to changes in aggregate liquidity in a given country and month.
We find that, on average, market liquidity increases (modestly) 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, i.e., better firms signaling their quality through early IFRS adoption, the latter result cautions us to attribute the capital-market effects around the mandate to the switch in accounting standards per se (because voluntary adopters have already switched to IFRS by the time of the mandate). Many adopting countries have made 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.
The full paper is available for download here.