IFRS adoption and firms' opacity around the world: what factors affect this relationship?.
| Autor | Mongrut, Samuel |
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Introduction
Since 2001, a growing number of countries around the world have been adopting the international financial reporting standards (IFRS), so by the end of 2018 more than 120 countries have adopted them (Fuad et al., 2019). This increase in the adoption of IFRS is supposed to bring along reduced earnings manipulation as it provides a regulatory framework for standardizing financial reports and thus brings transparency (Bozkurt and Öz, 2013). Nevertheless, there are firms' financial reports that still reveal earnings management even after the IFRS adoption.
Earnings management (EM) is the act of manipulating discretionary accounting items to show certain desirable results. Its application produces a lack of transparency in the company's financial information also called opacity. Opacity in turn generates asymmetric information between managers and the company's incumbent stakeholders (i.e. shareholders, creditors, regulators, among others) and may induce them to make bad decisions and to establish wrong relationships with the company. This manipulation is favored by the flexibility of the accounting standards and the short scope of the audit for compliance with these standards (Healy and Wahlen, 1999; Bhattacharya et al., 2003). Also, managers may have a part in this, as it is believed that IFRS adoption may act as a substitute for auditors (Mongrut and Winkelried, 2019).
Hence, our first research question is whether the mere adoption of IFRS by companies actually reduces the opacity (i.e. EM) in its accounting and financial reporting? A recent meta-analysis study by Ahmed et al. (2013) conclude that there is a positive, but not significant relationship and this result was because companies in emerging markets have poor accounting structures, and the mere adoption of the IFRS does not guarantee better information transparency.
We expand the sample of Ahmed et al. (2013) by using 36 results out of 23 studies that investigate the impact of IFRS adoption on firm's opacity published between 2005 and 2018 and find that this relationship has a negative and nonsignificant correlation as opposed to the previous study that found a positive and nonsignificant correlation. More importantly, this relationship changes depending on the context.
Our second research question is related to the context: what are the moderating factors playing a role in generating poor accounting structures (i.e. external factors that may influence the relationship between IFRS adoption and firm's opacity)? We use a metaregression from Stanley and Jarrell (1989) to identify moderating factors that mediate the relationship between the IFRS adoption and the firms' opacity.
We identify that the use of common law (COML) in a given country and the authorities' ability to enforce the regulation (rule-of-law) help to reduce a firm's opacity, while the mere IFRS adoption does not have any effect on it.
There is plenty of research about mediating factors at the country level or geographical region. Recently, Öz and Yelkenci (2018) studied the impact of legal origin upon EM in 14 countries and found that a civil law (CIVL) tradition imposes a constraint upon accrual EM, and COML imposes a constraint upon real EM. Mazzi et al. (2018) studied the effect of corruption and Schwartz bipolar cultural dimensions upon IFRS goodwill disclosure requirements in 16 European countries and found that they have significant influence. Recently, El-Helaly et al. (2020) investigated 89 non-European countries and found that the country level of corruption is negatively associated with the extent of IFRS adoption. Hence, legal origin, corruption and cultural aspects do play a role.
In a COML framework, the role of the judge is key in establishing a precedent when resolving a specific legal dispute. Meanwhile, in a CIVL framework, there are statutes and specific codes that guide the judge's decision, so the role of academics is key to determining the rules that will be in the statutes (La Porta et al., 2008). Hence, what happens usually in emerging countries subject to CIVL is lobbying and bribery to obtain a certain desirable sentence.
According to a recent literature survey conducted by De George and Shivakumar (2016), there are two main problems across the different studies that study the impact of IFRS adoption into different variables of interest (including opacity):
* authors do not agree on whether the observed results are due to IFRS adoption or other institutional changes that occur at the same time; and
* it is difficult to make cross-study comparisons because of the different empirical choices made by authors.
Our contribution lies precisely in finding a common result between different authors concerning the institutional context. Using a meta-regression, we find that IFRS adoption reduces opacity in countries with COML and with more authorities' oversight and power to enforce the rules. Furthermore, to achieve this result, we consider the different empirical choices made by authors, especially the sample size, and found that it matters.
Section 2 reviews the relevant literature on the relationship between IFRS adoption and firms' opacity. Section 3 presents the two methodologies that we use to get our results: metaanalysis and meta-regression, while in Section 4 discusses our results. Section 5 concludes.
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International financial and reporting standards adoption and firms' opacity
We consider 52 studies where 24 of them favored a positive relationship between the IFRS adoption and the reduction of firm's opacity, and 28 did not conclude that there was a positive relationship or concluded that the relationship was negative. Given the higher proportion studies (54%) that favor that the mere adoption of IFRS has no effect or increases firm's opacity we establish the following hypothesis:
H1. The relationship between the IFRS adoption and firm's opacity is positive and significant.
Given these divided results between different authors, it is interesting to determine what factors are affecting these results: are they geographic? Or institutional? In what follows, we first review literature related to the different regions and then to the institutional factors.
The adoption of IFRS by the European Union (EU) began in 2003, becoming mandatory as of 2005. Callao and Jarne (2010) conducted a study on 1,408 nonfinancial listed firms in the EU and found that the use of discretionary accruals increased after IFRS adoption. Recently, Cereola et al. (2017) found that IFRS 8 adoption resulted in a significant number of companies reporting disaggregated revenues at the individual country level in companies from Europe, Australia and New Zealand.
According to Timm et al. (2016), EM is greater in Latin American firms than in continental and Anglo-Saxon European firms, even in the case of Latin American companies listed on US stock exchanges. This reveals that there must be strong incentives in each country for firms not to use discretionary accruals. Accounting standards in China began to converge to IFRS in 2006 and Indonesia in 2012, while in India IFRS standard was adopted from 2016. Wang and Campbell (2012) concluded that IFRS adoption discourages earnings smoothing, but it motivates earnings aggressiveness in accounting reports. Given the abovementioned review, we derive the following hypothesis:
H2. There is a different and significant relationship between the IFRS adoption and a firm's opacity across different geographical regions.
Perafan and Benavides (2017) establish that the legal system of a country significantly influences the effectiveness of IFRS adoption on the quality of financial statements. This occurs in those countries where COML exists, as in the UK. Takamatsu and Favero (2017) pointed out that in countries with a French legal system (civil law) it is possible to detect a higher level of earnings smoothing. So, we derive the following hypothesis:
H3. IFRS adoption is more effective in reducing opacity in countries with COML rather than in countries with CIVL.
The government oversight and enforcement power could also be another institutional common factor between previous studies that assess the impact of IFRS adoption on firms' opacity. High oversight and enforcement power can guarantee compliance with the accounting regulations of the country because there is a greater probability that companies will be discovered and penalized if they are not complying with the IFRS adoption. Byard et al. (2011) studied the change in the quality of information after the IFRS adoption from the point of the ability of analysts to make accurate predictions. They found that countries' high oversight power is necessary to reduce prediction errors.
Hence, our last hypothesis is the following:
H4. There is a negative relationship between IFRS adoption and a firm's opacity in countries with higher oversight and enforcement power.
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Methodology
To answer our first research question, we tested the first hypothesis using the meta-analysis introduced by Hunter et al. (1982), and to answer our second research question we tested H2, H3 and H4 using the meta-regression introduced by Stanley and Jarrell (1989).
We collected 67 studies between 2005 and 2018 that investigate the relationship between IFRS adoption and a firm's opacity. The earliest year when the adoption of IFRS became mandatory for companies in all studies was 2005. We consulted several databases, such as Web of Science, SCOPUS, Emerald and Science Direct, using different keywords such as IFRS adoption, EM, opacity, IFRS effects, IAS adoption, discretionary accruals and their combinations.
We then excluded studies that measure EM differently, for example, by the ability of analysts to make predictions or by the probability of incurring in manipulating accounting...
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