Summarizing the IFRS literature: the never-ending journey

On the University of Oxford business law blog, I came across a summary of a recent review of academic literature about IFRS adoption. Here’s the synopsis provided there:

  • “If we had to summarize 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 harmonizing 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.”

It’s a mixed bag of findings, and of course one must be wary of putting more weight on it than it can really bear. Still, it hints at a quite interesting tension. On the one hand, it suggests IFRS has a distinct symbolic value, in enhancing the external perception of jurisdictions that use it, perhaps in reducing the uncertainty that attaches to jurisdiction-specific practices. But at the same time, it suggests that users don’t actually find IFRS to be more useful in itself, for practical purposes such as contracting, performance management and so forth. The point about increased income smoothing and the like would surely cause the IASB to tear its hair out – nothing in the standards, if scrupulously applied, should lead in such a direction. But the notion that an IFRS “principles-based approach” allows too much latitude seems awfully persistent. This links no doubt to the point about the importance of enforcement (and, presumably, other aspects of the local compliance and regulatory environment) in promoting confidence about the quality of what’s being generated under IFRS.

If I were a member of the IASB, or another major participant in the standard-setting process, I’d worry about any indication that IFRS is prized more as an abstraction than as a specific source of value. It chimes with the sense that even sophisticated users place their main emphasis on non-GAAP measures, and that unsophisticated users don’t pay much attention to anything at all. I’ve written numerous times about the disconnection between IFRS and some of the key areas of importance to institutional investors. It may seem unthinkable that the steady advance of IFRS will ever go into reverse, but no matter how established and impregnable a particular practice or institution may appear, its survival will surely be challenged in the long term, if it’s not rooted in practical day to day use and value-generation (put another way, if enough people can figure out a cheaper way of doing without something, then eventually they probably will).

And as I wrote here, even the broad symbolic value attaching to IFRS might become tarnished and distorted in an age of Trump and Brexit. So despite the clear achievements of the IFRS Foundation to date, there’s really no room for complacency…

The opinions expressed are solely those of the author

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