The implementation of IFRS in Europe: Some preliminary evidence

1. The implementation of IFRS in Europe:Some preliminary evidence Bernard Raffournier University of Geneva

2. Since 2005 all listed companies in the E.U. must comply with IFRS • In Continental Europe, IFRS adoption represents a major change: replacement of stakeholder-oriented accounting regulations by market-oriented standards heavily influenced by the Anglo-Saxon accounting model • Aim of this presentation: Review the empirical evidence on the economic consequences of IFRS adoption

3. The expected consequences of IFRS adoption • Information asymmetry should decrease: • IFRS are more market-oriented • IFRS disclosure requirements are larger • Earnings management should decrease: • IFRS are more precise • They admit a limited number of options • Hidden reserves are prohibited

4. Accounting data should be more value relevant • Value relevance: Ability of accounting data to reflect contemporaneous market prices or returns • IFRS-based earnings should be more value relevant: • IFRS are more market-oriented • Earnings management is more difficult under IFRS • IFRS make a larger use of fair value • The cost of capital should decrease

5. Effect on information asymmetry • Has the bid-ask spread declined? • YES: • Germany: Leuz & Verrecchia (JAR 2000), Gossen & Sellhorn (WP 2006): Companies using IFRS exhibit smaller bid-ask spreads than those using German GAAP • Europe: Platikanova & Nobes (WP 2006): On average, the bid-ask spread declines after IFRS adoption • BUT: • Switzerland: The effect is limited to small companies: Dumontier & Maghraoui (CCA 2006)

6. Are analysts' forecasts more accurate? • YES: • Ashbaugh & Pincus (JAR 2001): Analyst forecast accuracy improves after IFRS adoption • Hodgdon et al. (JIAAT 2008): Compliance with IFRS reduces analyst forecast errors • Germany: Ernstberger et al. (WP 2008): Forecast accuracy is higher for estimates based on IFRS or US GAAP data than for those based on German GAAP figures • NO: • Germany: Maghraoui (PhD 2008): Compliance with IFRS does not reduce the dispersion of analyst forecasts or forecast errors • Europe: Cuijpers & Buijink (EAR 2005): Dispersion of analyst forecasts is higher for firms using IFRS or US GAAP than for those using local GAAPs

7. Effect on earnings management • Does IFRS compliance restrict earnings management? • NO: • Germany: Van Tendeloo & Vanstraelen (EAR 2005): IFRS adopters do not present different earnings management behavior compared to companies reporting under German GAAP • Sweden: Paananen (WP 2007): IFRS adoption does not reduce income smoothing. • Germany: Lin & Paananen (WP 2008): Earnings management is higher in the post IFRS-adoption period • YES: • Barth et al. (JAR 2008): In the post-adoption period, firms applying IFRS evidence less earnings management

8. Effect on the value relevance of accounting data • Has value relevance of earnings increased following IFRS adoption? • YES: • Barth et al. (JAR 2008): Firms applying IFRS exhibit more value relevant accounting figures than other companies • Germany: Bartov et al. (JAAF 2005): The value relevance of IFRS-based earnings is higher than that of German GAAP-based earnings • Germany: Jermakowicz et al. (JIFMA 2007): The value relevance of earnings is higher for DAX-30 companies using IFRS or US GAAP • NO: • Germany: Hung & Subramanyam (RAS 2007): IFRS adoption has no effect on the value relevance of book value and net income • Sweden: Paananen (WP 2008): The value relevance of accounting figures is not affected by IFRS adoption • Germany: Lin & Paananen (WP 2008): The value relevance of equity and earnings decreases after IFRS adoption

9. Effect on the cost of capital • Has the cost of equity capital declined after IFRS adoption? • YES: • Germany: Ernstberger & Vogler (WP 2008): The cost of equity capital is lower for companies that adopted IFRS or US GAAP • Kim & Shi (WP 2007): The cost of equity capital is significantly lower for IFRS adopters • NO: • Europe: Cuijpers & Buijink (EAR 2005): No evidence of a lower cost of equity capital for IFRS adopters • Germany: Daske (JBFA 2006): Voluntary IFRS adopters do not exhibit lower cost of equity capital • Has the cost of debt declined after IFRS adoption? • YES: • Kim et al. (WP 2007): IFRS adopters have lower interest rates, larger amount of loan facility, less restrictive loan covenants, and they attract more foreign lenders

10. Summary of the empirical evidence • No clear conclusion can be drawn from these studies because: • The evidence is mixed • Many studies were conducted in a single country (Germany in particular) • Most studies deal with voluntary adoption

11. Explaining the conflicting evidence • The impact of IFRS adoption is a function of the degree of compliance with IFRS • Vogel et al. (WP 2008): There is considerable variation in the level of IFRS compliance among European companies (compliance index ranging from 13% to 100%) • Daske et al. (WP 2007): "Serious" IFRS adopters experience stronger effects on the cost of capital and market liquidity than "label" adopters • Hodgdon et al. (JIAAT 2008): Compliance with the disclosure requirements of IFRS enhances the ability of financial analysts to provide more accurate forecasts

12. The impact of IFRS adoption is a function of the firm's incentives to comply with IFRS • Germany: Christensen et al. (WP 2008): Improvements in accounting quality are confined to firms with incentives to adopt IFRS • Daske et al. (JAR 2008): The capital-market benefits of IFRS adoption occur onlyin countries where firms have incentives to be transparent and where legal enforcement is strong • Wang & Yu (WP 2008): Better accounting standards are helpful only in countries with proper reporting incentives i.e. in common-law countries, in countries with better shareholder protection and effective legal enforcement • Kim & Shi (WP 2007): The cost of capital-reducing effect of IFRS adoption is greater when the IFRS adopters are from countries with weak institutional infrastructures

13. Conclusion • The adoption of IFRS will probably not be sufficient to standardize the quality of earnings throughout Europe • Strong enforcement mechanisms (laws and corporate governance systems) also are necessary • Adopting high quality standards might be a necessary condition for high quality information, but not a sufficient one (Ball et al., JAE 2003)