Economic benefits of IFRS adoption

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earnings forecast. They argue that when analysts issue cash flow and earnings forecast for a firm, they indirectly provide forecasts for accruals as well, helping investors better assess the implication of accruals on future earnings. Using cross-sectional and time-series designs, they collectively provide evidence that earnings and cash flow forecast firms have less accruals mispricing and cash flow mispricing than firms with earnings forecast.

2.2. Economic benefits of IFRS adoption

2.2.1. Improvement in information environments

IFRS is a set of high quality financial statements and its objective is to provide relevant and comparable information to users of accounting information (Leuz 2003;

Bartov, Goldberg, and Kim 2005). The mandatory IFRS adaption benefits capital markets in many ways. For example, Horton et al. (2013) observe that prior researches often provide conflicting evidence and fail to separate between information quality and comparability, the benefits of IFRS adoption. Therefore, they investigate which attributes of IFRS cause an improvement in the information environment proxied by decrease in analyst forecast errors. Employing individual analyst level data and isolating settings where analysts would benefit from either improved comparability or higher information quality, they find that the improvement in the information environment is driven both by information and comparability effects.

An increasing body of research analyzes the quality of accounting information associated with IFRS adoption, and provides mixed evidence whether the accounting amounts from such accounting standards exhibit higher quality than those do from domestic accounting standards (Leuz and Wysocki 2008). Landsman et al. (2012) add to this literature by investigating whether the information content of earnings announcement, one dimension of accounting quality, increases in countries that

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mandate IFRS adoption relative to countries that remain domestic accounting standards. They find that increases in the information content of earnings announcement, abnormal return volatility and abnormal trading volume, for countries mandating IFRS adoption.

DeFond et al. (2011) examines the assertion that the mandatory IFRS adoption increases financial statement comparability, which in turn attracts more cross-border investment, by testing whether the mandatory IFRS adoption in EU in 2005 results in improved comparability that leads to increased investment by foreign mutual funds.

Knowing that the improvement to comparability is likely to vary across adopters, they predict standards uniformity to improve comparability only when the standards are credibly implemented. Using a difference-in-differences test, they find that following the mandatory IFRS adoption foreign mutual funds increase their ownership in mandatory IFRS adopters that are in countries with strong implementation credibility, and that the increase in ownership is more pronounced in firms experiencing greater increases in uniformity.

In addition to focusing on the advantages of increased comparability among IFRS adoption countries, existing literature also address the improved comparability between IFRS adopted countries and non-IFRS adopted countries. Barth et al. (2012) investigates the extent to which the application of IFRS by non-U.S. firms results in accounting amounts that are comparable to those resulting from the application of US GAAP by U.S. firms. Using two approaches to assess the comparability, the results are relevant to the debates relating to possible use of IFRS by U.S. firms. They find that non-U.S. firms applying IFRS have significantly greater accounting system and value relevance comparability with U.S. firms applying US GAAP when they apply IFRS than when they applied non-U.S. domestic standards. This comparability could give better access for U.S. investors to interpret the accounting information presented

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in the financial statements and thus may reduce the mispricing among foreign firms.

2.2.2. Benefits in debt markets

Existing literature has a strong focus on how the improvements in information environment under IFRS benefit the equity and debt capital markets. For example, Beneish et al. (2012) investigate whether the mandatory IFRS adoption has a differential impact on debt and equity markets by providing macroeconomic evidence.

They find that IFRS adoption has a greater effect on foreign debt than on equity investment markets. Moreover, they find that increases in equity markets are limited to countries with high governance quality. Finally, they provide evidence that increases in equity and debt investments derive from the U.S. and other non-IFRS adoption countries, rather than from other adopting countries. This result suggests that the benefits from the mandatory IFRS adoption are more likely attributed to improvement in financial reporting quality rather than greater comparability.

Chan et al. (2013) examine whether the credit ratings of foreign firms cross-listed in the U.S. are affected by the mandatory adoption of IFRS in their home country.

They contend that the switch from domestic standards to IFRS could affect the financial reporting quality for two reasons. First, IFRS provides firms with more flexibility to disclose forward-looking information to reduce the information asymmetry with outsiders. Second, IFRS improves the cross-border comparability of financial information and in turn reduces the ability of firms to distort their performance through their domestic accounting standards. Using a difference-in-difference test design, they find that a significant increase in credit ratings among firms cross-listed in the U.S. from countries that mandated IFRS, relative to their comparable U.S.-domiciled firms. Moreover, they observe that the increase in more pronounced among those firms from countries where the difference

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between the previous domestic standards and IFRS is greater. Therefore, combining these findings, they infer that the increased credit rating effect can be attributed to improved financial information quality under IFRS.

2.2.3. Benefits in equity markets

Daske et al. (2008) examine the economic consequences of mandatory IFRS reporting in equity markets. In particular, they analyze effects in stock market liquidity, cost of capital, and firms’ equity valuations. For the first economic effect, they find that mandatory IFRS adopters experience larger increase in market liquidity than a random sample of non-adopting benchmark firms. Moreover, they document that the cost of capital decreases and valuation increases when they account for the possibility that markets already anticipate the effects of mandatory IFRS adoption and measure the effects one year before the official adoption date.

Prather-Kinsey et al. (2008) investigate the stock market reactions associated with IFRS adoption in EU by comparing the value relevance of book values before and after IFRS adoption and examining the cost of capital effect. Using a sample of 157 European firms in 2005, they find that capital markets participants consider financial reports of IFRS adopters more value relevant and informative. Moreover, they observe that these improvements in information quality lead to a decrease in cost of capital.

Li (2010) provides further evidence for the cost of equity capital effects of mandatory IFRS adoption. She tests whether the mandatory IFRS adoption affects the cost of equity capital in 18 EU countries during the period from 1996 to 2006. The findings are that the mandatory adopters experience significant decreases in the cost of equity of 47 basis points and that these decreases are significant only in countries with strong legal enforcement. Finally, she finds that increased disclosure and

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improved comparability associated with the adoption of IFRS are two mechanisms behind the reduced cost of equity.