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Quality of IFRS Adoption

Quality of IFRS Adoption. Ann Gaeremynck Dan Thornton Arnt Verriest. INTACCT Meeting Varna, 5 March 2010. 1. General Set-up. Objective: Insight in the quality of first-time adoption of IFRS in Europe. Restatement process measured on several dimensions

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Quality of IFRS Adoption

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  1. Quality of IFRS Adoption Ann Gaeremynck Dan Thornton Arnt Verriest INTACCT Meeting Varna, 5 March 2010

  2. 1. General Set-up • Objective: Insight in the quality of first-time adoption of IFRS in Europe. • Restatement process measured on several dimensions • How well did companies comply with what the authorities demanded? • We specifically investigate the relation between adoption quality and governance on country and firm level.

  3. 2. Motivation and Literature - Consequences of IFRS adoption: * Effects on liquidity, cost of capital and information asymmetries are mixed (Daske, 2006; Daske et al., 2008; Cuijpers and Buijink, 2005). * Effects on financial reporting: - Voluntary adoption: significant effects on earnings quality metrics (Barth et al., 2008; Hung and Subramanyam, 2007) - Mandatory adoption: little evidence (Garcia-Osma and Pope, 2009; Christensen et al., 2008) * Effects depend on institutional context (Ball et al., 2003; Burgstahler et al., 2006; Daske et al., 2008) - Little research on what reporting decisions are made around the time of IFRS adoption, and what drives these decisions.

  4. 2. Motivation and Literature Adoption of IFRS for the first time in Europe: 1. Choice to apply IAS 39 in 2004, or to postpone the adoption. 2. Disclosure precision of restatements for 2004 (for net income, equity, sales and cash flow). 3. Rigor of first-time application (or earnings quality change), using same firm-year approach.

  5. 2. Motivation and Literature • We consider the role of institutional factors that may drive the incentives behind financial reporting outcomes and choices (Leuz et al., 2003; Daske et al., 2008; Holthausen, 2009). • We also considergovernancewithin the companyand ownershipstructure. • Corporate governance mechanisms determine (partially) the incentive structure of managers to report high versus low quality information (Pae et al., 2008). - Corporate governance is associated with financial reportingpractice: * Effect on disclosure (Karamanou and Vafeas, 2005) * Relation with financial reporting quality (Bowen et al., 2008, Peasnell et al., 2005; Larcker et al.,2007; Klein, 2002; Zhao and Chen, 2008), although the evidence is weak. * Effect on IFRS adoption and managerial forecasts (Goodwin et al., 2009) - Incentives to optforimmediateapplication of a newstandard “may serve as a crediblemethod of disclosing private information” (Amir and Ziv, 1997).

  6. 3. Variable Definition and Sample 3.1 Measurement of IAS 39 effect EARLYADOP = dummy is 1 for early adopters (in 2004) and 0 for late adopters (in 2005). - Large firms; most of them are affected by IAS39 - We cannot consider the effect on earnings - Effect on book value of equity (IMP_IAS39) - Effect on equity/debt

  7. 3. Variable Definition and Sample 3.2 Transparency of restated information - DISCL = Score on 5 (on 4 for financial companies) 1. Net Income of 2004 2. Book value at the end of 2003 3. Book value at the end of 2004 4. Sales or revenues 5. Cash flow (from operations) - Voluntary and mandatory disclosure items - No of pages in AR of 2005 on IFRS restatements

  8. 3. Variable Definition and Sample 3.3 Rigor of first-time Application of IFRS - DIFFACC = ІACCIFRSІ – ІACCLOCALGAAPІ - Accruals = (Net Income – Operating Cash Flow)/Total Assets - Idea: Accruals represent discretion More negativedifferences are indicative of a more serious application of IFRS (Daske et al., 2007). - Advantage: earnings number from one and the same fiscal year (2004 or 2005) - Drawback: crude measure that could be reflecting other things (e.g. differencebetweenlocal GAAP and IFRS) - Additional analyses: measure of abnormal accruals pre- and post- IFRS adoption based on DeFond and Park (2001).

  9. 3. Variable Definition and Sample 3.4 Measures of Governance • Corporategovernance: • Set of mechanismsthatinfluencemanagerialdecisions • Multidimensional and complex • Endogenous to a lot of factors • Data from Risk Metrics database for FTSE 300 (now MSCI Pan Euro Index) • Detailed data on four dimensions; score on 40 • Country governance: • Investorprotectionrights(La Porta et al., 1998) • We usecorporategovernance data from 2004 • Two-stage model:

  10. 3. Variable Definition and Sample 3.5 Sample Selection

  11. 4. Descriptive Results 1. Association between IAS 39 early application and impact on book value of equity 2. Disclosure of IFRS restatement in financial statements notes

  12. 4. Descriptive Results 3. Earnings quality measures under local GAAP and IFRS

  13. 4. Descriptive Results

  14. Disclosure Model

  15. Rigorous Application Model

  16. 6. Conclusion • Investigation of how firms adopted IFRS for the first time by means of three quality measures: 1. Time of IAS39 adoption 2. Transparency of restatements 3. Seriousness of application • Significant association of all 3 measures with governance on firm and country-level • Consequences of political involvement in adopting new standards: * IAS 39 was chosen opportunistically * No association with governance quality * In case of an unfavorable effect only applied early for well governed firms.

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