The impact of mandatory IFRS adoption on capital markets: evidence from Korea

• Pages: 38-58
• Date: 05 March 2018
• Published date: 05 March 2018
• DOI: https://doi.org/10.1108/IJAIM-05-2016-0049
• Author: Saerona Kim,Haeyoung Ryu
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

The impact of mandatory IFRS

adoption on capital markets:

evidence from Korea

Saerona Kim

Soongeui Women’s College, South Korea, and

Haeyoung Ryu

Hansei University, Gunpo, South Korea

Abstract

Purpose –The purpose of this paper is to examine the effects of adoption of the mandatory

International Financial Reporting Standards (IFRS) on the cost of equity capital in a unique Korean

setting. In Korea, individual financial statements were taken as primary financial statements. Before the

adoption of IFRS, consolidated financial statements were taken as supplementary financial statements.

Design/methodology/approach –The authors measure the costof equity using the average estimates

from the implied cost of capital models proposedby Claus and Thomas (2001), Gebhardt et al. (2001), Easton

(2004) and Ohlson and Juettner-Nauroth(2005), using it as the primary dependent variable. Mandatory IFRS

adoption, the independent variablein this study, is assigned a value of 1 for the post-adoption period and 0

otherwise.

Findings –Using a sampleof listed Korean companies during the periodfrom 2000 to 2013, the authors find

evidence of a significant reduction in the costof equity capital in Korean listed companies after mandatory

adoptionof the IFRS in 2011, after controlling for a set of market variables.

Originality/value –This study is one of a growing body of literature on the relations between

mandatory IFRS adoption and the cost of equity capital (Easley and O’Hara 2004;Covrig et al. 2007;

Lambert et al. 2007;Daske et al. 2008). According to the results of this study, increased financial

disclosure and enhanced information comparability, along with changes in legal and institutional

enforcement, seem to have had a jointeffectonthecostofequitycapital, leading to a large decrease in

expected equity returns.

Keywords IFRS, International financial reporting standards, Cost of equity capital,

Mandatory IFRS adoption

Paper type Research paper

1. Introduction

The International Financial Reporting Standards (IFRS) were adopted as the standard

financial language of the world during the early 2000s. Specifically in Korea, many

companies frequently abused the K-GAAP, the former standards for preparing financial

statements for individual firms, committing accounting fraud by creating special purpose

entities (SPE). The credibilityof Korean companies in the global context diminished because

of this fraud, which became the grounds for introducing the IFRS. In these new accounting

standards, the parent company and subsidiary companies are treated as a single entity. As

national barriers gradually disappeared and capital flows increased rapidly with

deregulation of the international capital market, countries around the world recognized the

importance of using and improving this uniformaccounting standard. The global financial

crisis in the latter half of 2008 greatly elevated the status of the IFRS because high-quality

IJAIM

26,1

38

Received4 May 2016

Revised2 September 2016

2 December2016

31January 2017

Accepted3 February 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 1, 2018

pp. 38-58

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-05-2016-0049

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

www.emeraldinsight.com/1834-7649.htm

accounting standards are criticalto the development of a superior global financial reporting

structure.

In Korea, the IFRS was used to settle the ‘Korea discount’problem caused by the lack of

transparency in financial reporting.In addition, Korean firms began to enjoy the benefits of

the IFRS and its principle-oriented accounting standards, as their real status was properly

reflected. As for investment analysis by foreign investors in Korean companies, it was

predicted to become easierfor companies to raise foreigncapital. Because the IFRS was only

formally implemented in 2011, there is a need to verify the effects of IFRS adoption on

Korean companies. This study is an empirical investigation of these effects on capital

markets.

There still is great controversy over the effects of mandatory IFRS adoption on the cost

of equity. First, proponents of theIFRS argue that it generally requires more comprehensive

disclosure than most local accounting standards because companies are obliged to utilize

fair value accounting, and credibility, liquidity and market risk are also important.

Theoretical studies arguethat this increased disclosure reduces the cost of equity capital by

decreasing information asymmetry (Diamond and Verrecchia, 1991;Easley and O’Hara,

2004). From a different perspective, mandatory IFRS adoption can enhance comparability

between financial statements, especially for foreign investors, who may have difficulty

understanding and comparing financial statements from many countries that have their

own accounting systems. Introduction of the IFRS can, therefore, facilitate investment by

foreign investors (Covrig et al., 2007). In addition, greater comparability may decrease the

cost of equity capital (Dye, 1990). As a result, adoption of the IFRS can reduce the cost of

equity by increasing additionaldisclosure and enhancing information comparability among

countries (Li, 2010). On the other hand, others argue that the quality of financial reporting

cannot simply be increased by introduction of a new accounting standard; rather, financial

reporting is interlinked with various factors, such as incentives of the persons utilizing the

accounting standards and preparing financial reports, the degree of regulation by

supervising institutions and other economic circumstances. These factors can have

unintended effects on the capital market (Holthausen, 2003;Ball, 2006). Accordingly, the

relationship betweenmandatory IFRS adoption and the cost of equity capital is an issue that

should be empiricallyverified.

The purpose of this study is to determine whether mandatory IFRS adoption in 2011

reduced the cost of equity capital. Also, in a recent study, it was argued that the effectsof a

new accounting standard on economic outcomes differ according to the incentives for

financial reporting[1].Therefore, the relationship between mandatory IFRS adoptionand the

cost of equity capital is examined in this study with consideration of those incentives. The

effects of mandatory IFRS adoption on firm value are alsoconfirmed. Consistent with prior

research, we measure the cost of equity using the averageestimates from the implied cost of

capital models proposed by Claus and Thomas (2001),Gebhardt et al. (2001),Easton (2004)

and Ohlson and Juettner-Nauroth (2005), using it as the primary dependent variable.

Mandatory IFRS adoption, the independent variable in this study, is assigned a value of 1

for the post-adoptionperiod and 0 otherwise.

To analyze the effects of mandatory IFRS adoption on the cost of equity capital, we

selected a sample including 1,658 firm-years from the Korea Stock Exchange (KSE) for the

period between 2000 and 2013. A significant negative relationship was shown between

mandatory IFRS adoption and the costof equity capital after 2011. This result verified that

mandatory IFRS adoption decreases thecost of equity capital by increasing disclosure and

information comparability. However, during the sampling period ending in 2011, no

Impact of

mandatory

IFRS adoption

39