Mandatory IFRS adoption, investor protection and earnings management. A data analysis of Germany, France and Belgium listed companies

• Published date: 05 March 2018
• Date: 05 March 2018
• Pages: 187-204
• DOI: https://doi.org/10.1108/IJAIM-07-2017-0091
• Author: Ahmed Kouki
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Mandatory IFRS adoption,

investor protection and

earnings management

A data analysis of Germany, France and

Belgium listed companies

Ahmed Kouki

Department of Accounting, Higher Institute of Business Administration,

Gafsa University and LARTIGE Laboratory, Sfax University, Tunisia

Abstract

Purpose –The purposeof this paper is to examine the effect of investor protection on earningsmanagement

before and afterIFRS adoption.

Design/methodology/approach –A sample of 106 companies listed on Germany, Franceand Belgium

stock markets for the pre-IFRS (2000-2004) and post-IFRS (2006-2011) periods was used. This research is

based on a comparativestudy between the pre- and the post-IFRS periods.

Findings –The results showed that investor protection better explains earnings management after the

transition to IFRS. The findingsrevealed that international standards and investor protection are significant

in jointlyexplaining earnings management for the secondreporting period.

Originality/value –The study givesrise to a score that is considered as a proxy of investor protectionthat

regroupsseveral macroeconomic indexes.

Keywords Agency theory, Earnings management, IFRS adoption, Investor protection

Paper type Research paper

1. Introduction

This paper investigates the impact of investor protection on earnings management before

and after mandatory adoption of International Financial Reporting Standard (IFRS) based

on panel analysis in France, Germany and Belgium context. IFRS was developed by the

International Accounting Standard Board (IASB) with the aim to establish a common

accounting language across the world (Ball, 2006). Globalization of financial markets has

provided strong motives for IFRS adoption.The principal determinant for adopting IFRS is

the quest for economic efficiency and effectiveness (Guerreiro et al.,2012). IASB seeks to

release more relevant accounting information that underwrites the making economic

decisions (Houqe et al., 2012). Hilliard (2013) suggests that investor protection is one of the

major concerns of IFRS. Shleifer and Vishny (1997) and La Porta et al. (2000) focused that

investor protection is an institutionaldeterminant of corporate choices and policy. Similarly,

prior studies provide that stronginvestor protection is a potential factor that determines the

disclosure of high-quality accounting information (La Porta et al., 1998;Ball et al.,2000;La

Porta et al.,2000;Leuz et al., 2003;La Porta et al., 2006;Houqe et al., 2012). Leuz et al. (2003)

stressed that investorprotection has a significant effect on earnings management.

JEL classification –M41, G15, F62

Mandatory

IFRS adoption

187

Received24 July 2017

Revised26 August 2017

Accepted13 September 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 1, 2018

pp. 187-204

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2017-0091

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

www.emeraldinsight.com/1834-7649.htm

In this paper, we associate the investor protection with mandatory IFRS adoption and

their effect on earnings management from the perspective of the agency theory. Jensen and

Meckling (1976) reveal that this theory aims to mitigate the conflict of interest between

manager and investor. A managertries to adopt opportunistic behaviors that maximizehis/

her personal interest based on accounting choice offered by reporting standards. However,

this behavior affects the investorinterest by limiting the decision-making power. Barth et al.

(2008) show that the inherent flexibility in principles-based standards could grant greater

opportunity for managers to manage earnings. Iatridis (2012) reveals that IFRS adoption

aims to enhance accounting quality,mitigate informational asymmetry and reduces agency

costs. In this sense, Pelucio-Grecco et al. (2014) focused that, after transition to IFRS,

enforcement of investor protection reduces earnings management. This assumption makes

the communication between the principal and the agent more confident, and accounting

information becomesmore relevant.

In our study, we use a panel data from three countries, namely, France, Germany and

Belgium as these countries are characterized as civil law legal origins. We test our

hypotheses on a sample of 1,166 firm-year observationsfrom 2000 to 2011, except 2005 (the

transition year). In the pre-IFRS period,the sample composed of firms that voluntary adopt

IFRS and those which keep their domesticstandards (DS). In the post-IFRS period, all firms

have mandatorily adoptedIFRS.

Our article contributes to the literature in several ways. First, the study has been

concerned with comparative analysis in threelevels. In the first level, we make the analysis

in the pre-adoption period (from 2000 to 2004) between voluntary IFRS adoption and

domestic standards. In the second level, we do the comparison between mandatory IFRS

adoption and voluntary IFRS adoption in the post-adoption period (from 2006 to 2011). In

the third level, we perform the analysis into both reporting periods. Second, our sample

includes three different countries from Franco-Germanic law origin. Finally, to measure

investor protection, we develop a score composed of four macroeconomics factors collected

from annuals reports of World Economic Forum (WEF). The score consists of calculating

the weighted averages ofeach index for each company (i) of each country (j) at time (t), then,

we made the sum of all indexes,and finally, we divided the sum by the number of indexes.

Therefore, the main objective of this paper is to examine the effectof investor protection

on earnings management before and after transition to IFRS. To achieve this goal, we

conducted a comparativestudy between pre- and post-IFRS periods.

The remainder of the paper is organized as follows. In Section 2, we develop the

theoretical background. Section 3 describes prior empirical literature and hypotheses

development. Section 4 explains the research design, and Section 5 presents the results and

discussion. Section6 offers conclusions and summary.

2. Theoretical background

2.1 Investor protection determinants

Investor protectionis conditioned by legal factors and economic factors.

2.1.1 Legal determinants of investor protection. The degree of investor protection

depends of the country’s legal system. In fact, theliterature highlights the existence of two

systems; civil law and common law (La Porta et al., 1998). The civil law is based on the

codification (Houqe et al.,2014). Laws obey a set of rules and regulation. However, common

law is based on the judicial decisions determined by jurisprudence (Daske et al., 2008). In

addition, the laws are established following a decentralized and controlled fashion by

several interest groups. Under common law, institutions and private organizations can

ensure the production of rules and principles.Indeed, the IASB takes its legitimacy from this

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