Over a decade has passed since the EU mandated International Financial Reporting Standards (‘IFRS’) for all companies listed on the main European stock exchanges in 2005. Several other countries have followed suit since then, with over 100 countries currently requiring firms to prepare their financial reports either under IFRS or under a closely linked accounting standard. Although the EU adoption of IFRS was a major regulatory transition affecting several tens of thousands of companies, its costs and benefits were unclear at the time of its adoption. Now, with the hindsight of over 10 years of IFRS reporting, we briefly review the academic literature to better understand the effects of IFRS adoption.
Our review, available here, aims to cohesively evaluate the empirical archival evidence on how IFRS adoption affects capital markets as well as firms’ financial reporting quality, corporate decision making, stewardship and governance, debt contracting, and auditing. Our review emphasises similarities and differences across the various studies, not only in terms of their findings and conclusions, but also in their hypothesis development, and methodological and sample choices. In addition, we also provide detailed discussions of research design choices and empirical issues with which researchers have grappled when evaluating IFRS adoption effects.
If we had to summarise the development of the IFRS literature, the majority of early studies paint IFRS as bringing significant benefits to adopting firms and countries in terms of (i) improved financial reporting transparency, (ii) lower costs of capital, (iii) increased cross-border investing, (iv) better comparability of financial reports, and (v) increased following by foreign analysts. However, these benefits appear to vary significantly across firms and countries. More recent studies now attribute at least some of the earlier documented benefits to factors other than adoption of new accounting standards per se, such as concurrent changes in reporting enforcement. Other recent studies examining the effects of IFRS on the inclusion of accounting numbers in formal contracts (which we refer to as the contracting role of accounting) point out that IFRS has lowered the contractibility of accounting numbers. Specifically, our review reveals the following:
- Mandatory IFRS adoption has improved the association between accounting numbers and stock prices (i.e., value relevance), but at the same time has also increased earnings management by firms. IFRS-adopting firms tend to have more income smoothing, more reporting of aggressive earnings, and delayed recognition of losses.
- By harmonising accounting standards across countries, IFRS adoption has improved comparability of listed firms’ financial reports across countries, but has worsened comparability of listed firms’ financial reports with those of domestic non-IFRS firms (such as EU private firms). Also, IFRS adoption is not sufficient to achieve full comparability of financial reports across firms.
- Cross-country studies document that voluntary IFRS adoptions improve firms’ financial reporting quality. But results based on analysis of voluntary adopters need to be cautiously interpreted due to potential biases associated with these firms self-selecting to report under IFRS.
- Early studies on effects of IFRS adoption find that stock liquidity increases and cost of equity capital decreases following mandatory IFRS adoption. However, recent studies point out that these benefits occur only in countries that change enforcement concurrently with IFRS adoption.
- There is consistent evidence that IFRS adoption triggers greater interest from foreign investors and foreign analysts.
- IFRS adoption has improved investment efficiency, especially for cross-border transactions and has also increased cross-border flow of capital. Studies generally attribute these findings to improved transparency and comparability under IFRS.
- Firms and lenders are more reluctant to use accounting-based covenants in debt contracts following IFRS adoption. This finding reflects lower relevance of IFRS numbers for use in formal debt contracts.
- Greater comparability of IFRS financial reports across countries has increased reliance on foreign firms for relative performance evaluation in executive compensation decisions; however, there is some evidence that firms are avoiding compensating managers on IFRS numbers, as IFRS numbers are potentially more easily managed.
- The principles-based and fair-value-oriented nature of IFRS has increased the effort needed to audit firms’ financial reports, leading to greater audit fees;
- There is substantial variation in empirical design across papers, which impedes reconciliations of differences in findings and conclusions across studies.
Emmanuel T De George is an Assistant Professor of Accounting at London Business School, Xi Li is an Assistant Professor at Temple University, and Lakshmanan Shivakumar is Term Chair Professor of Accounting at London Business School.