Incentives or Standards: What Determines Accounting Quality Changes Around IFRS Adoption?

Abstract

We examine the impact of managerial financial reporting incentives on accounting quality changes around International Financial Reporting Standards (IFRS) adoption. A novel feature of our single-country setting based on Germany is that voluntary IFRS adoption was allowed and common before IFRS became mandatory. We exploit the revealed preferences in the choice to (not) adopt IFRS voluntarily to determine whether the management of individual firms had incentives to adopt IFRS. For comparability with previous studies, we assess accounting quality through multiple constructs such as earnings management, timely loss recognition, and value relevance. While most existing literature documents accounting quality improvements following IFRS adoption, we find that improvements are confined to firms with incentives to adopt, that is, voluntary adopters. We also find that firms that resist IFRS adoption have closer connections with banks and inside shareholders, consistent with lower incentives for more comprehensive accounting standards. The overall results indicate that reporting incentives dominate accounting standards in determining accounting quality. We conclude that it is unwarranted to infer from evidence on accounting quality changes around voluntary adoption that IFRS per se improves accounting quality.

IFRS – 10 years later

“…They report that the former are associated with market liquidity and cost of capital benefits, but the latter are not. From a study of German IFRS adopting firms, Christensen et al (2015) conclude that when higher quality accounting standards are mandated, accounting quality improvements are only observed in firms with incentives to comply. Cascino and Gassen (2015) study the effect of IFRS adoption on compliance and comparability among German and Italian firms.…”

The effects of accounting standards on the financial reporting properties of private firms: evidence from the German Accounting Law Modernization Act

“…Hence, their results are most likely driven by listed companies that have switched to IFRS and that should not be comparable to our results for private companies. Furthermore, although in line with Christensen et al (2015), the ROA coefficient indicates a strong negative association between IFRS adoption and ROA.…”

“…Hence, industry classification can influence accounting choices, and we therefore include industry fixed in our probit regression. Following Christensen et al (2015), we include size, leverage and return on assets. These authors found a positive association between size and voluntary IFRS adoption and a negative association between IFRS adoption and leverage as well as return on assets.…”

“…However, propensity score matching applied to our discretionary accrual investigation reveals no significant differences, indicating that our results are most likely attributable to differences in firm characteristics. As with recent IFRS adoption studies (Daske et al 2013;Christensen et al 2015), we assume that changes in financial reporting properties may only be observable for those companies that will benefit from the German Accounting Law Modernization Act. We identify two sets of companies that might benefit from the application of the new rules.…”

IFRS adoption and investor perceptions of earnings quality: evidence from Korea

“…However, regarding IFRS adoption, researchers and practitioners consider low reliability in accounting information to be problematic, because the principle-based regulation in IFRS leaves accounting practice choices to the manager's discretion. Concurrently, this regulation leads implicitly to earnings management, which is motivated by managers who have incentives to exploit IFRS regulation (Christensen et al, 2008). Furthermore, the disclosure of consolidated financial statements and the fair value of assets on financial statements necessarily cause accounting numbers to fluctuate between pre-and post-IFRS adoption periods, providing earnings information that is barely connected to the historical financial statement information under non-IFRS (Choi et al, 2011).…”