We examine whether application of International Accounting Standards (IAS) is associated with higher accounting quality. The application of IAS reflects combined effects of features of the financial reporting system, including standards, their interpretation, enforcement, and litigation. We find that firms applying IAS from 21 countries generally evidence less earnings management, more timely loss recognition, and more value relevance of accounting amounts than do matched sample firms applying non-U.S. domestic standards. Differences in accounting quality between the two groups of firms in the period before the IAS firms adopt IAS do not account for the postadoption differences. Firms applying IAS generally evidence an improvement in accounting quality between the pre-and postadoption periods. Although we cannot be sure our findings are attributable to the change in the financial reporting system rather than to changes in firms' incentives and the economic environment, we include research design features to mitigate effects of both. * Graduate School of Business, Stanford University; †Kenan-Flagler Business School, University of North Carolina. We appreciate helpful comments from

We compare characteristics of accounting amounts for firms that apply International Accounting Standards (IAS) to a matched sample of firms that do not to investigate whether applying IAS is associated with higher accounting quality and lower equity cost of capital. We find that firms applying IAS evidence less earnings management, more timely loss recognition, and more value relevance of accounting amounts than do those applying domestic GAAP. Firms applying IAS have higher variance of the change in net income, a higher ratio of the variances of the change in net income and change in cash flows, a significantly less negative correlation between accruals and cash flows, and a lower frequency of small positive net income. They have a significantly higher frequency of large negative net income and generally higher value relevance of accounting amounts. Differences between firms applying IAS and those applying domestic GAAP in the period before IAS firms adopt IAS do not explain the differences in accounting quality. Firms applying IAS generally exhibit higher accounting quality than when they previously applied domestic GAAP. The increase in accounting quality for IAS firms is generally greater than that for firms applying domestic GAAP throughout the sample period. We also find weak evidence suggesting that application of IAS is associated with a lower equity cost of capital. Overall, our results suggest improvement in accounting quality associated with applying IAS.

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Building on the Dechow et al. (1998) model of the accrual process, this study investigates the role of accruals in predicting future cash flows. The model shows that each accrual component reflects different information relating to future cash flows; aggregate earnings masks this information. As predicted, disaggregating accruals into major components—change in accounts receivable, change in accounts payable, change in inventory, depreciation, amortization, and other accruals—significantly enhances predictive ability. Each accrual component, including depreciation and amortization, is significant with the predicted sign in predicting future cash flows, incremental to current cash flow. The cash flow and accrual components of current earnings have substantially more predictive ability for future cash flows than several lags of aggregate earnings. The inferences are robust to alternative specifications, including controlling for operating cash cycle and industry membership.

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This study examines European stock market reactions to 16 events associated with the adoption of International Financial Reporting Standards (IFRS) in Europe. European IFRS adoption represented a major milestone toward financial reporting convergence yet spurred controversy reaching the highest levels of government. We find an incrementally positive reaction for firms with lower quality pre-adoption information, which is more pronounced for banks, and with higher pre-adoption information asymmetry, consistent with investors expecting net information quality benefits from IFRS adoption. We find an incrementally negative reaction for firms domiciled in code law countries, consistent with investors' concerns over enforcement of IFRS in those countries. Finally, we find a positive reaction to IFRS adoption events for firms with high-quality pre-adoption information, consistent with investors expecting net convergence benefits from IFRS adoption.

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