Market reaction to the transitory effects of IFRS: an examination of disaggregated measures

• Published date: 05 March 2018
• DOI: https://doi.org/10.1108/IJAIM-04-2016-0045
• Pages: 2-37
• Date: 05 March 2018
• Author: Theresa Hilliard,Presha Neidermeyer
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Market reaction to the transitory

effects of IFRS: an examination of

disaggregated measures

Theresa Hilliard

Department of Accounting, Fort Lewis College, Durango, Colorado, USA, and

Presha Neidermeyer

Department of Accounting, West Virginia University,

Morgantown, West Virginia, USA

Abstract

Purpose –This study examines how International Financial Reporting Standards (IFRS) are applied,

disaggregates the cumulativeeffect of the IFRS transition into magnitude measurements of the standard-to-

standard differences (by standard) and management discretionary choices (by choice) and tests which

transitoryeffects at every level of disaggregation alter investorbehavior.

Design/methodology/approach –Using hand-collected data from the IFRS1 disclosures, the research

design consists of eight regression models which test fluctuations in investment behavior as a function of

varying measures of IFRS adjustments at aggregated and disaggregated levels including magnitude

measurementsof pronouncements and management choices.

Findings –Findings from the study identify specific standards and management discretionary choices

associatedwith market reaction. Evidence from this study demonstratesthe value of disaggregated measures

to obtain a more comprehensiveunderstanding of market reaction and associationswith transitory effects of

IFRS. Findings from the study suggest that the market favors management discretionary choices that

decrease retained earningsand potentially increase future net income. Overall, model resultssuggest that a

more comprehensiveunderstanding of the specific standards is obtainedthat alters market behavior and how

the market respondsto positive and negative equity adjustments.

Originality/value –This study contributesto the literature examining the capital market effects of IFRS

by decomposing the generally accepted accounting principle (GAAP) transition into magnitude

measurements of specific standard-to-standard differences (by standard) and management discretionary

choices (bychoice) to understand how the market responds to the transitoryeffects of a GAAP change. This is

important because it puts regulators, standard setters, investors and researchers on notice that the way in

which the authors analyze andmeasure equity components could be consequential to the authors ability to

assess a GAAP change. This study informs all jurisdictions which have adopted or are deliberating the

adoption of IFRS how IFRS is being implemented and which areas of application are relevant to investors.

Further, market reactions toaccounting information pertaining to a GAAP change may only be revealedat

the disaggregatedand decomposed levels of the retrospective applicationof the GAAP implementation.

Keywords International financial reporting standards, IFRS 1, Mandatory equity adjustments,

Optional exemptions

Paper type Research paper

This research is derived from Theresa DiPonio Hilliard’s dissertation at Georgia State University,

USA. The authors are grateful to Erv Black, Carol Ann Frost, Laura Swenson, Dick Riley, Joe

Callaghan and participants and an anonymous reviewer at the 2015 AAA International Accounting

Section Midyear Conference for their valuable comments and suggestions.

IJAIM

26,1

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Received29 April 2016

Revised22 August 2016

3 December2016

Accepted18 January 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 1, 2018

pp. 2-37

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-04-2016-0045

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

www.emeraldinsight.com/1834-7649.htm

1. Introduction

The transition to InternationalFinancial Reporting Standards (IFRS) is widely regarded as a

significant disclosure enhancing event (Cormier, 2013;Fifield et al.,2011;Karamanou and

Nishiotis, 2009). As mandated by IFRS 1, First Time Adoption of International Financial

Reporting Standards (IFRS 1) previously reported economic activities are presented under

two sets of accountingrules. This critical turning point in a firm’s reportinghistory provides

a unique opportunity to examine the intersection of two generally accepted accounting

principle (GAAP)systems.

The growing body of literaturethat examines IFRS as it relates to an improvement to the

quality (Barth et al., 2008;Goodwin et al., 2008;Iatridis, 2010;Soderstrom and Sun, 2007),

comparability (Callao et al.,2007;Hortonet al.,2013) and transparency(Barth and Schipper,

2008)offinancial reporting have provided valuable empirics. With potential and existing

investors stated as two of the primary user groups in the Conceptual Framework for

Financial Reporting [IASB; Financial Accounting Standards Board (FASB), 2010],

researchers have extensively studied capital market reactions[1] to the IFRS financial

reporting vehicle. Evidence from the extant literature is “almost unanimous”as to the

positive effects in capital markets attributed to IFRS adoption (Brüggemann et al.,2013).

However, the explanations as to the specific reasons underlying the positive market

reactions are mixed and speculative. The literature has identified the use of aggregate

measures such as the book value of equity (Brüggemann et al.,2013) and the challenge of

disentangling IFRS adoption from other concurrent changes (Pope and McLeay, 2011)as

explanations for these mixed and speculative results. These authors have made a call for

research that disaggregatesthe book value of equity[2]. Canada provides an optimal setting

to examine the IFRS transition in a country context with a high-qualitypredecessor GAAP,

diligently enforced. Further, IFRS was implemented in Canada without other concurrent

regulatory or institutional changes to overcome the limitations of the current body of IFRS

research.

The true value of any financial reporting transitionis insight into how the standard(s) is

implemented and applied and how the market reacts to the transitory effects of GAAP

changeover. In this study we explore the following research question, do we learn more

about market behavior by examining associations with particular standards or

management discretionary choices that would otherwise be concealed at the aggregate

level? The research objectiveof this study is to examine how IFRS are applied, disaggregate

the cumulative effect of the IFRS transition into magnitude measurements of the standard-

to-standard differences(by standard) and management discretionary choices (by choice)and

test which transitoryeffects at every level of disaggregation alter investor behavior.

This cross-sectional study investigates IFRS 1 first time adoption reconciliation

adjustments at the time of transition for 396 Canadian firms. IFRS 1 sets the precedent for

financial reporting under IFRS, permits accounting policy elections and prescribes various

detailed disclosures and reconciliations[3]. These mandated disclosures provide a

demarcation of the accounting treatment of cumulative economic events as measuredunder

the former GAAP (Canadian GAAP) and under IFRS, including detailed explanations and

nuances of the measurement systems under both GAAPs, management discretionary

choices and material reclassifications. In addition, explanatory language accompanies the

reconciliation detailingthe financial reporting impact of specific pronouncement differences,

management discretionary decisions made in applying IFRS and the optional exemption

choices elected.

Findings from this study suggest that disaggregating the change in the book value of

equity related to the adoption of IFRS into standard-to-standard differences and

Transitory

effects of IFRS

3

management discretionary choicesprovides enhanced explanatory power as to fluctuations

in market behavior when compared to aggregated measures. Results from the study

identified specific standardsand choices which incrementally altered investor behavior: IAS

16 Property, Plant and Equipment, IAS 27 Consolidated and Separate Financial Statements,

IAS 36 Impairment of Assets,IFRS2Share-based payments and IAS 38 Intangible Assets.

Evidence from this study indicates positive market reactions are associated with

management discretionary choices pertaining to Share-Based Payments and Employee

Benefits which remeasure assets and liabilities while increasing (decreasing) retained

earnings. Further, consistent with prior research (Henry, 2009;Cormier et al.,2009), the

market tends to favor managementstrategies that reduce retained earnings and bypass the

income statement in current and future periods. Overall, evidence from this study reveals

positive marketresponse to enhanced transparency and valuation providedby IFRS.

This study contributes to the literature examining the capital market effects of IFRS by

decomposing the GAAP transition into magnitude measurements of specific standard-to-

standard differences (by standard) and management discretionary choices (by choice) to

understand how the market responds to the transitory effects of a GAAP change. This is

important because it puts regulators, standard setters, investors and researchers on notice

that the way in which we analyze and measure equity componentscould be consequential to

our ability to assess a GAAP change. The decision by the Canadian Accounting Standards

Board (AcSB) to adopt IFRS demands ex post analysis to evaluate the cost benefit of this

financial reporting transition(Ahmed et al.,2013).This study informs all jurisdictions which

have adopted or are deliberating the adoptionof IFRS how IFRS is being implemented and

which areas of applicationare relevant to investors. Further, market reactions to accounting

information pertaining to a GAAP change may only be revealed at the disaggregated and

decomposed levels of the retrospective application of the GAAP implementation

(Brüggemann et al.,2013). Understanding the nuances of market behavior pertaining to a

particular pronouncementdifference or management discretionary choice providesvaluable

insight into GAAP transitions (Carmona and Trombetta, 2008). Data from IFRS 1

reconciliationscan have long-term effects on future IFRS financial statements (Nobes,2004).

The remainder of the paperis organized as follows. Section 2 provides information on the

context of the study and related literature.Section 3 presents the research design. Section 4

presents the findings.Section 5 concludes and discusses the implications of the study.

2. Context and literature review

2.1 Canadian context

Canada provides an optimal context for the examination of a wholesale GAAP changeover.

Canada has a large market-orientedeconomy with a common-law legal system. Leading up

to 2005, CA GAAP paralleled US GAAP[4]. The extant literature has provided evidence of

the harmonization of CA GAAP and US GAAP in the formof value relevance tests in which

CA GAAP information was indistinguishable from US GAAP (Bandyopadhyay et al.,1994;

Barth and Clinch, 1996). Motivated by the desire to expand accessto global capital markets

and reduce the cost of capital, the Canadian AcSB changed the course of the Canadian

Financial Reporting Systemby announcing its intention to adopt IFRS in January 2006 with

mandatory application by January 2011. Canada provides the first opportunity to observe

the application of IFRSin North America.

Canada did not experience many of the concurrent changes such as the introduction of

enforcement mechanisms as evidenced by studies conducted in Europe. These concurrent

changes create an identification problem in conducting IFRS research (Brüggemann et al.,

2013;Pope and McLeay, 2011). Identification problems represent the challenge of

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