IFRS adoption, value relevance and conditional conservatism: evidence from China

• Date: 07 October 2019
• Pages: 529-546
• Published date: 07 October 2019
• DOI: https://doi.org/10.1108/IJAIM-09-2018-0101
• Author: Cyrus Isaboke,Yan Chen

IFRS adoption, value relevance

and conditional conservatism:

evidence from China

Cyrus Isaboke

School of Accounting, Dongbei University of Finance and Economics, Dalian,

China and Department of Finance, Karatina University, Karatina, Kenya, and

Yan Chen

School of Accounting, Dongbei University of Finance and Economics,

Dalian, China

Abstract

Purpose –This study sought to evaluatethe relationship between value relevanceof financial information

and conditionalconservatism of non-financial companies listedin China.

Design/methodology/approach –Using panel data comprising of 28,723 firm years, the authors

determine the value relevance of financial information before and after mandatory International Financial

ReportingStandards (IFRS) adoption while incorporating the relationshipwith conditional conservatism. The

authors furtherexamined how this relationship varies betweenstate and non-state owned companies.

Findings –Conditional conservatism is positively (negatively) related to value relevance prior (post) to

mandatory IFRS adoptionwhile it makes no difference as to whether a company is state or non-state owned,

as IFRS has a positive and significant effect on value relevance. Conservatism, on the other hand, has a

negative and insignificantrelationship with market value of both state and non-state owned firms during the

pre- and post-IFRSperiod.

Originality/value –By exploring an emerging economy, the authors provide evidence on the

variations in value relevance amongst state and non-state owned firms. In particular, the authors

establish the positive effect of IFRS on the value relevance of non-state firmsascomparedtostate-

owned institutions.

Keywords China, IFRS, Value relevance, Conditional conservatism

Paper type Research paper

Introduction

Value relevance is a distinctive feature of financial reporting that is desirable at least

according to International Accounting Standards Board (IASB). Tohmatsu (2010)

indicates that where stock markets exist, in 123 jurisdictions, domestic listed companies

are required to report according to International Financial Reporting Standards (IFRS)

while 95 worldwide jurisdictions require unlisted companies to report according to the

provisions of IFRS. Accounting standards in China have developed through time in

accordance with the country’s transformation to a mixed market-oriented economy. The

Chinese accounting system was adopted from the Soviet Union that was primarily

designed to provide accountability to the central government but they have gradually

evolved to facilitate private ownership and foreign investment, (Lee et al., 2013)China

applied a largely rules-based accounting regime that was industry specific thus it was

difficult for diversified companies to produce consolidated accounts (Shields, 2010).

IFRS adoption

529

Received9 September 2018

Revised11 November 2018

Accepted13 November 2018

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 4, 2019

pp. 529-546

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-09-2018-0101

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

The Ministry of Finance of the People’s Republicof China issued a new set of accounting

standards for business enterprises (ASBEs), which substantially converged with IFRS. All

listed companies in China were required to apply ASBEs for the preparation of their

financial statements while applicationof IFRS as issued by IASB is not permitted (Deloitte,

2017). The standards covernearly all topics in line with IFRS except for a few modifications

made to cater for Chinese uniqueenvironment. Deloitte Touché Tohmatsu highlighted that

the essential difference between IFRS adopted in China from that adopted in the EU is the

import of fair value. Before mandatory adoption of IFRS in China, accounting information

was mainly based on historical cost instead of fair value. The introduction of fair value

measurement resulted in a mixed model that uses both fair and historical values. Further

evidence indicates a significant drop in accounting conservatism after IFRS adoption.

Numerous studies exist on the effects of IFRS adoption on accounting quality with mixed

results, however, many researchers (Lang et al.,2003;Covrig et al.,2007;Chen et al.,2010)

found the effects to be positive. Although IASB de-emphasizes the importance of

conservatism, prior research (Watts, 2003) emphasizes on the importance of conditional

conservatism regarding contractual processes and decision-making. Recent studies have

emphasized on the effects of mandatory IFRS adoption while accentuating the western

world. Manganaris et al. (2015) analyzed the effects of mandatory IFRS adoption and

conditional conservatism on banks value. Using a sample of European banks, the authors

found out that conditionalconservatism is positively related to value relevance priorto IFRS

adoption but negativelyrelated after IFRS adoption. Notably absent is a studythat explores

this relationship among emerging markets while factoring in their unique characteristics

and how the markets reacted during the pre- and post-financialcrises period.

Basu (1997) and Khan and Watts (2009) suggested a significant reduction in accounting

conservatism after IFRS adoption. Decreasing accounting conservatism can have opposite

effects on accounting performance measures and their use in evaluation. It should increase

the value relevance of accountinginformation because timely recognition ofboth good news

and bad news makes accounting information more reliable (Manganaris et al.,2015). In this

study, we seek to examine the level of value relevance before and after IFRS adoption and

determine its relationship to conditional conservatism. We will further seek to determine

how this relationshipchanged after mandatory IFRS adoption.

Using a sample of 28,723 firm years’observationsfor A-share listed firms in China from

1998 to 2016 period, we determine the effect of mandatory IFRS adoption on conditional

conservatism. Using Basu (1997) and Khan and Watts (2009) model to measure

conservatism and Aharony et al. (2010) approachto measure value relevance, we document

evidence that answersthe following empirical questions; What is the level of value relevance

before and after IFRS adoption, the relationship with conservatism and how did it change

after mandatory IFRS adoption? Aftercontrolling for industry and year effects our findings

indicate that conservatismis negatively (positively) related to value relevance prior to (post)

mandatory IFRS adoption.

Our study contributes to the IFRS literatureby distinguishing itself from closely related

studies by Luo et al. (2008),Ran and Huili (2008),Xue et al. (2008) and Zhang and Zhang

(2008) in the following ways; we focus on an emerging market by comprehensively

analyzing the relationship between mandatory IFRS adoption, value relevance and

accounting conservatism in both the pre- and post-IFRS period. We further undertake

additional subsample analysisbased on whether a company is state or non-state owned and

further analyze value relevance during the pre- and post-crisis period. Our research further

investigates whether non-linearity between profit and loss entitieshas an effect on the value

of a firm. These analyses suggest that IFRS adoption in China has been driven mostly by

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