In our paper, Mandatory IFRS Reporting and Changes in Enforcement, which was recently made publicly available on SSRN, we examine the underlying sources of the capital-market benefits around the introduction of mandatory IFRS reporting. Prior work finds significant capital market benefits and also shows that the effects around IFRS adoption are significantly stronger in countries with stricter and better functioning legal systems, and that they are stronger in the EU than in other regions of the world. We argue that this evidence is consistent with several interpretations and that it is still an open question to what extent these positive effects around mandatory IFRS adoption are indeed attributable to the switch to arguably better, more capital-market oriented, and globally harmonized accounting standards.
We focus on market liquidity and rely on within- and across-country variation in the timing of IFRS adoption and of other institutional changes to disentangle several possible explanations. Specifically, we explore whether (i) the switch from local GAAP to IFRS reporting played a primary role for the observed capital-market benefits; (ii) the introduction of IFRS had capital-market benefits, but only in countries with strong institutions and legal enforcement; or (iii) the switch to IFRS reporting itself had little or no effect and, instead, concurrent changes to countries’ institutions drive the observed capital-market benefits.
We show that, across all countries, mandatory IFRS reporting had little impact on liquidity. Consistent with prior work, the liquidity effects are concentrated in the EU. When we probe deeper, we find that the liquidity effects are limited to only five EU countries that made significant changes to their enforcement infrastructure. They created specific enforcement bodies for financial reporting and/or started to proactively review financial statements concurrent with the introduction of IFRS. Liquidity generally does not increase in the other EU member states even if they have strong legal systems or a proven track record for implementing regulation and government policies. Thus, it does not appear to be the case that, in general, the IFRS mandate has an impact as long as countries have strong legal institutions and high quality regulatory quality.
Furthermore, the enforcement changes, such as the introduction of proactive reviews, in the five EU countries largely explain the liquidity effects for voluntary IFRS adopters around the IFRS mandate. For these firms, the standards do not change around the mandate but they are affected by countries’ enforcement changes. We show that the liquidity benefits do not extend to voluntary adopters in countries without changes in reporting enforcement (or are much smaller). This differential reaction among voluntary adopters makes it unlikely that comparability (or other spillover) effects from the mandate are responsible for the findings as otherwise we should see them for all voluntary adopters. Thus, the results suggest that changes in financial reporting enforcement are a primary source of the observed liquidity changes.
In a final set of analyses, we exploit that some EU countries moved to a proactive review process at a different time than the IFRS mandate. For these countries, the effects of mandatory IFRS reporting and changes in the review process are potentially separable because they initially apply to financial statements from different fiscal years. When we focus on such countries, we can estimate separate coefficients for the effects of the IFRS mandate and the enforcement changes. The spread regressions suggest that the liquidity effects stem entirely from the enforcement changes, but the coefficients likely are not precisely estimated. The zero-return regressions suggest that both the IFRS mandate and the enforcement changes are associated with modest liquidity effects. Thus, while these results do not rule out that the move to IFRS or countries’ institutional environments play a role for the observed liquidity changes, the effects appear to be largely attributable to changes in financial reporting enforcement.
In sum, our findings show that the liquidity benefits around the IFRS mandate are much more limited than previously thought, extending primarily to countries with major enforcement changes. The paper suggests that we need to revisit prior findings that partition samples based on cross-sectional differences in countries’ legal frameworks and should pay special attention to institutional changes around the IFRS mandate. An important caveat about our study is that the analysis focuses on market liquidity. We need more research to assess whether the results extend to other capital-market effects. However, it is important to keep the reasoning for this focus in mind. Liquidity can be measured over short intervals and with reasonably high frequency, which in turn allows us to disentangle the effects of the IFRS mandate, enforcement changes and other institutional effects. Our analysis is difficult to conduct with slow-moving outcomes and with variables that are highly anticipatory in nature (like stock returns or the cost of capital).
The full paper is available for download here.