INTACCT workshop Varna, March 2010

1. Jörg-Markus Hitz Göttingen University (Ex-ER Tilburg University) Enforcement of Accounting Standards in Europe: Empirical Evidence for the Two-tier Mechanism in Germany INTACCT workshop Varna, March 2010 1

2. Agenda 1 Introduction 2 Institutional Background 3 Hypotheses 4 Sample selection and data collection 5 Results 6 Conclusion

3. Introduction • Regulation EC No. 1606/2002 (“IFRS Regulation”) • Mandatory adoption of IFRS for listed firms in the EU • Mandate for EU member states to install enforcement mechanisms, implementation and coordination delegated to CESR • Quality of enforcement matters: • Academic research illustrates the crucial role of enforcement quality for (IFRS) accounting quality and capital markets effects (liquidity, cost of capital) (e.g. Daske et al, JAR 2008; Christensen and Walker, WP 2007; Beuselinck et al., WP 2009) • Attributes of high quality accounting enforcement remain unclear, particularly for heterogeneous governance / institutional environments throughout the EU • Germany: Introduction of two-tier enforcement mechanism in 2005: • Private institution: Deutsche Prüfstelle für Rechnungslegung (DPR) • Securities market regulator: Bundesamt für Finanzdienstleistungsaufsicht (BaFin)

4. Research Questions • What are the properties of firms censured by the German enforcement system for disclosure of errnoneous financial statements? • ‚Name and shame‘ – Is the adverse disclosure mechanism potentially effective in the German institutional setting? • What are the determinants of investor reactions upone release of DPR-induced error announcements?

5. European background • Regulation EC No. 1606/2002 (“IFRS Regulation”): Par. 16 requires member states `to take appropriate measures to ensure compliance with international accounting standards’ • Coordination and supervisory role for CESR (Committee of European Securities Regulators): • “Standard No. 1 on Financial Information: Enforcement of Standards on Financial Information in Europe” (March 2003) • “Standard No 2 on Financial Information: Coordination of Enforcement Activities” (April 2004) • Review of Enforcement Practices (2007) • European Enforcers Coordination Sessions (EECS)

6. Two-tier enforcement system in Germany • Deutsche Prüfstelle für Rechnungslegung (DPR): • Investigatesannualandinterimfinancialreportsoflistedfirms • Firmsareselectedbothbased on random, risk-weightedsampling (proactive) and upon indication / information (reactive) • Communicatesinformallywitthfirmsunderinvestigation Tier 1 • Bundesanstalt für Finanzdienstleistungsaufsicht (BAFIN): • Ifrequired, BaFinforcesfirmstodivulgeinformationdemandedbythe DPR • Conductsowninvestigations in rare circumstances • Enforcesdisclosureof DPR errorfindingsbycensuredfirms Tier 2 • Objectives: • Correctionoferroneousfinancialreports • Providedeterrencebyadversedisclosure (‚nameandshame‘)

8. Hypotheses • Prior literature examines investor reactions (CARs, trading volume, liquidity) on the U.S. market: • SEC enforcement actions (Dechow et al., 1996; Nourayi, 1994; Beneish, 1999; Feroz et al., 1989; Karpoff et al., 2008) • Accounting restatements (Anderson and Yohn, 2002; Callen et al., 2006; GAO, 2002; Palmrose et al., 2004; Hribar and Jenkins, 2004; Richardson et al., 2002; Plumlee and Yohn, 2008) • No evidence so far for EU jurisdictions Hypothesis 1: Investors reactsignificantly upon thereleaseof a DPR errorannouncement Hypothesis 2: The sizeoftheinvestorreactionisassociatedwiththemagnitudeoftheaccountingerrorsandwiththeunderlyingmotivation

9. Enforcement Activities & Sample Selection

10. Error Findings

11. Characteristics of censured firms

12. Methodology: Measurement of investor reactions • Measures of investor reaction: • (Cumulative) abnormal return • Abnormal return = Realized return – expected return • Expected return based on estimation of the market model (150 prior trading days, CDAX-index as market index) • (Cumulative) abnormal trading volume • Abnormal trading volume = actual trading volume – expected trading volume • Expected trading volume: Average trading volume for the 150 trading days prior to the error announcement • (Cumulative) abnormal bid-ask spread • Abnormal B/A spread= actual B/A spread – expected B/A spread • Expected B/A spread: Average B/A spread for the 150 trading days prior to the error announcement • Event-study design: • Short term reactions around upon disclosure of the error announcements • Long-term reactions: Matched sample comparison

13. Short-term investor reactions (hypothesis 1)

14. Cumulative returns (long window): Censured firms versus control group Control sample Sample firms

15. Determinants of market reactions (hypothesis 2) / 1

16. Determinants of market reactions (hypothesis 2) / 2

17. Conclusion • Enforcement quality represents an important factor in establishing compliance with IFRS in EU member states • Effectiveness of the ‚name and shame‘ mechanism in EU member states is an open question • This paper provides evidence for one particular institutional environment, Germany: • Significant investor reactions upon the disclosure of earnings announcements suggest potential effectiveness of the ‚name and shame‘ mechanism • No evidence that investors recognize the nature or degree of the erronoeus accounting • Issues and future research avenues: • Long-term effects of enforcement action: change in auditors, change in management • Long-term impact on IFRS compliance

18. Thank you for your attention! Questions, Suggestions?

19. Propensity Score Matching

20. Long-window investor reactions

21. Long-window reactions: Bid-ask-spreads

22. Long-window reactions: Relative trading volume