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Accounting Horizons Vol. 25, No. 4 2011 pp.

837860

American Accounting Association DOI: 10.2308/acch-50049

How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? Evidence from Cross-Listed Firms in the U.S.
Jerry Sun, Steven F. Cahan, and David Emanuel
SYNOPSIS: We examine the impact of IFRS adoption on the earnings quality of foreign firms cross-listed in the U.S. from countries that have already adopted IFRS on a mandatory basis. We use the cross-listed firms as surrogates for the U.S. firms so we can observe the effect of IFRS adoption in the U.S. We examine five measures of earnings quality related to discretionary accruals, target beating, earnings persistence, timely loss recognition, and the earnings response coefficient (ERC). To isolate the effect of IFRS adoption, we use a matched sample design where each cross-listed firm is matched to a U.S. firm. We find the difference in earnings quality from the pre- to post-IFRS period is not different for the crosslisted and matched firms when earnings quality is measured by absolute discretionary accruals, timely loss recognition, or a long-window ERC. However, for the incidence of small positive earnings and earnings persistence, we find significant difference-indifferences, indicating that IFRS adoption led to an improvement in earnings quality for cross-listed firms relative to the matched firms. Our results are slightly surprising since U.S. GAAP is generally viewed as high-quality standards with little room for improvement. Keywords: IFRS adoption; U.S. rms; earnings quality.

INTRODUCTION

n November 2008, the U.S. Securities and Exchange Commission (SEC) issued a report outlining a roadmap for the possible adoption of International Financial Reporting Standards (IFRS) in the U.S. (SEC 2008). At a February 24, 2010 meeting, the SEC reafrmed its support for a single set of high-quality accounting standards and continued to recognize IFRS as the most viable option (SEC 2010).1 In a 2010 report, the SEC states that a single set of high-quality

Jerry Sun is an Assistant Professor at the University of Windsor, and Steven F. Cahan is a Professor and David M. Emanuel is a Professor, both at The University of Auckland.
We thank Terry Shevlin (editor), Debra Jeter, Steve Lin, Vic Naiker, two anonymous reviewers, and participants at the 2011 AAA Annual Meeting for their valuable comments. We gratefully acknowledge nancial support from the Odette School of Business and The University of Auckland Business School.

Submitted: December 2010 Accepted: April 2011 Published Online: December 2011 Corresponding author: Steven F. Cahan Email: s.cahan@auckland.ac.nz

The SEC denes high-quality standards as a set of neutral principles that require consistent, comparable, relevant, and reliable information that is useful for investors (SEC 2008, 23).

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standards will help it meet its goals of (1) improving nancial reporting in the U.S. and (2) reducing differences in nancial reporting across countries. In this study, we focus on the SECs rst goal. We attempt to shed light on how the mandatory adoption of IFRS by U.S. rms would affect ve common measures of earnings qualityabsolute discretionary accruals, small positive earnings, earnings persistence, timely loss recognition, and a long-window earnings response coefcient (ERC). It is difcult to predict the impact of policy changes, particularly when no precedent exists. U.S. rms are currently not allowed to use IFRS, so it is not possible to identify a set of U.S. rms that have switched from U.S. GAAP to IFRS. Even if such rms could be identied, the effect on rms that adopt IFRS voluntarily will differ from the effect on rms that adopt IFRS mandatorily (e.g., Daske et al. 2008). Consequently, we focus on foreign rms that cross-list in the U.S. and that come from countries where the mandatory adoption of IFRS was required at some point during our sample period. While we use these rms as surrogates for U.S. rms, we acknowledge that the cross-listed rms are not perfect substitutes for U.S. rms as we discuss below. Lang et al. (2003) show that, compared to non-cross-listed rms in the same country, cross-listed rms in the U.S. have less earnings management and report more conservatively. While they nd that these rms have greater transparency before the cross-listing, they also nd improvements in earnings quality around the time of cross-listing which suggests that the cross-listing event is a catalyst for improvement. This result is consistent with a bonding hypothesis where cross-listed rms rent the laws, enforcement, and monitoring of the country they are cross-listing in (e.g., Coffee 2002).2 Cross-listed rms in the U.S. face the same nancial reporting environment as their U.S. counterparts, and their nancial statements are inuenced by U.S. GAAP. For example, for most of our sample period (i.e., prior to March 4, 2008), rms cross-listed in the U.S. were required to prepare 20-F reconciliations, reconciling their domestic GAAP statements with U.S. GAAP. Barth et al. (2010) contend that a likely result would be accounting choices that are U.S. GAAP-consistent, since the rms would want to minimize the reconciling items. Thus, we use cross-listed rms that were required to switch to IFRS to capture the effect of converting from U.S. GAAP-consistent accounting to IFRS. Prior evidence indicates that reporting practices are heavily inuenced by a countrys legal framework and enforcement regime (e.g., Ball et al. 2000; Ball et al. 2003; Burgstahler et al. 2006; Lang et al. 2006). Prior research (e.g., Ball et al. 2000; Leuz et al. 2003) shows that earnings quality is higher in common law countries, which includes the U.S., than in code law countries. Thus, one objective of our research design is to ensure that institutional features in the cross-listed rms home countries are similar to institutional features in the U.S. Consequently, we identify a subsample of cross-listed rms that consists of rms domiciled in countries with a common law legal origin. Among common law countries that have switched to IFRS, Australia and the U.K. are perhaps most similar to the U.S. across a range of institutional dimensions. For example, Leuz et al. (2003) group the three countries together based on a cluster analysis involving nine institutional variables. Further, prior studies indicate that the earnings quality in these three countries is not only similar, but also is among the highest in the world (e.g., Leuz et al. 2003; Bhattacharya et al. 2003). This nding suggests that Australian and U.K. rms have similar reporting incentives to start with as U.S. rms have. Further, rms from Australia and the U.K. that cross-list in the U.S. should be even more like U.S. rms since they are exposed to U.S. institutions and markets.3
2

However, Siegel (2005) disputes the bonding argument as he argues that the SEC has only rarely been able to enforce U.S. securities laws against foreign rms. 3 Lang et al. (2006) provide evidence that rms cross-listed in the U.S. continue to have more earnings management than U.S. rms. However, their sample includes rms from 34 countries, so it is not possible to determine whether Australian and U.K. rms cross-listed in the U.S. are more similar to U.S. than cross-listed rms from other countries, although they do report the gap between the cross-listed and U.S. rms is larger for the observations from low investor protection countries than for high investor protection countries (Lang et al. 2006, 278).

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Moreover, while we argue that cross-listed rms have U.S. GAAP-consistent accounting, the case is even stronger for Australian and U.K. rms because differences between Australian, U.K., and U.S. GAAP were minimal. For example, Mueller et al. (1994) classify countries into groups based on similarities in accounting practices, and classies Australia, the U.K., and the U.S. in a British-American cluster. Hung (2000) develops an accrual index based on 11 accounting standards and nds that Australia, the U.K., and the U.S. have scores of 0.82, 0.82, and 0.86, respectively. Her results indicate that the three countries rely on extensive accrual adjustments and that the way they treat these 11 items is largely similar. Also, from 19922001, standard setters from the U.S., Australia, and the U.K. were part of a group called the G41 (along with the IASB and New Zealand) that met to discuss issues of mutual interest. Thus, we consider a second subsample made up of Australian and U.K. rms that are cross-listed in the U.S. We view these rms as the closest surrogates for U.S. rms.4 Daske et al. (2008) point out that a challenge in examining the effects of mandatory IFRS adoption is that all rms in a country adopt in the same period, making it difcult to identify an appropriate benchmark. In our setting, the cross-listed rms switched to IFRS while U.S. rms did not, making the latter a natural comparison group. Consequently, we use a matched sample where each cross-listed rm is matched with a U.S. rm based on year, industry, and size. Using ve common measures of earnings qualityabsolute discretionary accruals, small positive earnings, earnings persistence, timely loss recognition, and a long-window ERCwe estimate difference-in-differences regression models that allow us to examine the effect of IFRS adoption that is incremental to non-adopting rms (i.e., the matched U.S. rms), and that control for contemporaneous changes in the U.S. reporting environment that are unrelated to the adoption of IFRS. We report results for a full sample and two subsamples (i.e., common law and Australia/ U.K. subsamples). We nd no IFRS adoption effect for the absolute value of discretionary accruals, timely loss recognition, and a long-window ERC. That is, the change for the cross-listed rms from the pre- to post-IFRS period is not different from the change for the matched rms over the same period. However, we nd evidence of improved earnings quality for the cross-listed rms based on small positive earnings and earnings persistence. These results are consistent for the full sample and two subsamples. Our results for small positive earnings and earnings persistence are slightly surprising. Given that the U.S. already has high-quality standards and strong institutions, one might predict that there is little room for improvement relative to alternative standards (e.g., Hail et al. 2010). Our study directly addresses the rst goal highlighted by the SEC in its 2010 report, i.e., whether it is likely that IFRS would improve nancial reporting in the U.S. In this way, our study differs from other studies examining IFRS adoption which focus on the impact of IFRS adoption by non-U.S. rms (e.g., Daske et al. 2008; Barth et al. 2010; Li 2010). While such studies identify the effects of adopting IFRS outside the U.S., it is unclear whether U.S. rms adopting IFRS would experience the same effects.5 Our design, although based on non-U.S. rms, isolates those rms that are most similar to U.S. rms. Our results should be viewed as one piece of evidence that the SEC should consider when making its decision on the adoption of IFRS by the U.S. However, since we do not address the
4

While we expect Australian and U.K. rms to be most similar to U.S. rms, the trade-off is that we lose statistical power because of a smaller sample. 5 For example, in addition to enforcement, Daske et al. (2008) nd in separate tests that the improvement in market liquidity is greater in countries that had transparent nancial statements before IFRS, but less in countries where differences between domestic GAAP and IFRS are small and where the country has an ofcial strategy to converge with IFRS. As the U.S. has strong enforcement, high transparency, small differences between U.S. GAAP and IFRS, and a stated convergence strategy, Daske et al.s (2008) results predict conicting effects for U.S. rms adopting IFRS, suggesting that the net effect could be positive, negative, or zero.

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second goal identied in the SECs 2010 statementincreasing comparabilityor the cost of IFRS adoption, we acknowledge that our analysis is far from complete. The rest of the paper is organized as follows. The next section introduces the background. We then review the literature, develop the hypothesis, and discuss the research design. The nal sections present the empirical results and conclude the paper. BACKGROUND Over 100 countries around the world have adopted IFRS or have decided to adopt IFRS. In March 2002, the European Parliament required that all companies listed on the stock exchanges of European member states apply IFRS when preparing nancial statements for scal years beginning on or after January 1, 2005. The European Unions (EU) adoption of IFRS is unprecedented in the history of IFRS as it affected approximately 7,000 companies. The EUs adoption of IFRS signicantly increased the international harmonization of accounting standards, since the EU consists of 27 countries with an estimated 28 percent share of the world GDP. As one of the largest countries in the EU, the U.K. played a key role in adopting IFRS. Like the EU, the Australian Accounting Standards Board (AASB) mandated that all Australian companies apply IFRS in annual reporting periods beginning on or after January 1, 2005. The U.S. remains the most signicant holdout from IFRS. This situation has led to pressure for the FASB and the International Accounting Standards Board (IASB) to converge their standards. On February 27, 2006, the IASB released a memorandum in which the FASB and IASB agreed (a) to make their existing nancial reporting standards fully compatible as soon as is practicable and (b) to coordinate their future work programs to ensure that once achieved, compatibility is maintained (IASB 2006, 1). In recognition of the increasing compatibility, effective on March 4, 2008, the SEC no longer required cross-listed companies whose nancial reporting is in compliance with IFRS to reconcile with U.S. GAAP. On November 14, 2008, the SEC publicly issued a proposed rule, Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers (Release Nos. 33-8982, 34-58960), and sought comments on 70 questions. The Roadmap identies several milestones that, if achieved, could lead to the use of IFRS by U.S. issuers in 2014 if the SEC believes that the adoption of IFRS will protect investors and be in the public interest. Frost et al. (2009) comment on a few of the 70 questions listed in the Roadmap. They suggest that empirical research should be conducted to help the SEC decide whether U.S. issuers would be required or permitted to adopt IFRS. Our study responds to their call. Jamal et al. (2010) also comment on issues raised by the SEC Roadmap. They contend that establishing a global monopoly standard setter with a consistency and comparability objective will hinder innovation, and the development and testing of better quality standards. Moreover, they argue that the adoption of a single set of global nancial reporting standards is not a sufcient condition for the purpose of comparability and consistency, because the quality of nancial reporting is affected by the reporting environment itself (e.g., legal system, securities enforcement, incentives). Thus, they suggest allowing U.S. rms to choose from U.S. GAAP or IFRS rather than mandating one global monopoly set of standards. In line with Jamal et al. (2010), Bradshaw et al. (2010) make comments on the SEC Roadmap based on a review of the literature. They assert that the convergence of U.S. GAAP and IFRS may be in the public interest if the convergence can increase the comparability of nancial statements. They also argue that it is unclear whether IFRS provides higher nancial reporting quality than U.S. GAAP. Our study provides indirect evidence on this issue.
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LITERATURE REVIEW AND HYPOTHESIS There is a growing stream of research that empirically investigates the effects of IFRS adoption around the world. Daske et al. (2008) investigate the effects of mandatory IFRS adoption on market liquidity, cost of capital, and equity valuations in 26 countries. They nd that market liquidity increases after IFRS adoption. They also nd weak evidence of a decrease in rms cost of capital and an increase in equity valuations. Li (2010) examines whether the adoption of IFRS in the EU reduces the cost of equity capital. She documents evidence that the cost of equity capital decreases by 47 basis points as a result of applying IFRS. Both Daske et al. (2008) and Li (2010) nd that improvements due to the adoption of IFRS are more pronounced in countries with strong legal enforcement than in countries with weak legal enforcement. Armstrong et al. (2010) examine the market reaction to the adoption of IFRS in Europe. They nd that the stock market positively reacts to rms with lower quality pre-adoption information and higher pre-adoption information asymmetry, consistent with the notion that investors expect net information quality benets from IFRS adoption. They also document a negative market reaction to IFRS adoption for rms domiciled in code law countries, suggesting that investors are concerned with the enforcement of IFRS in those countries. Landsman et al. (2009) examine the effect of mandatory IFRS adoption on the information content of earnings announcements across 16 countries. They use two measures of information content and nd that, compared to 11 countries that retained domestic accounting standards, one measurethe abnormal return around earnings announcementsincreases after countries adopt IFRS. Beuselinck et al. (2009) examine whether the mandatory adoption of IFRS decreases rm opacity and increases stock price informativeness. Using data from EU countries, they nd that IFRS disclosures reveal new rm-specic information in the adoption period and subsequently lower the surprise of future disclosures. While these studies provide interesting ndings about the impact of IFRS adoption across a diverse set of countries, it is difcult to extrapolate their ndings to the U.S. because none of the countries had standards that were as complex and lengthy as U.S. GAAP in the rst place. To circumvent this problem, a few studies attempt to compare the quality of IFRS with U.S. GAAP using rms from the German New Market, which allowed rms to voluntarily opt for IAS (which preceded IFRS) or U.S. GAAP. Leuz (2003) examines the difference in information asymmetry between rms using U.S. GAAP and rms using IAS in this market. Using bid-ask spreads, share turnover, analyst forecast dispersion, and initial public offering underpricing as proxies for information asymmetry, he documents no signicant differences between U.S. GAAP and IAS. Bartov et al. (2005) compare the value relevance of U.S. GAAP-based earnings and IAS-based earnings of German rms. They do not nd a signicant difference in value relevance between U.S. GAAP and IAS after controlling for self-selection. However, it is also difcult to extrapolate from the German New Market to the U.S. First, the German rms had a choice between IAS and U.S. GAAP. Second, prior studies (e.g., Daske et al. 2008; Li 2010) emphasize the importance of country-level institutions, and Germanys code law tradition and reliance on debt nancing differ from the U.S. Third, New Market rms are mainly small, high-tech rms. Barth et al. (2010) examine whether IFRS adoption has made the nancial statements of non-U.S. rms more comparable to the nancial statements of U.S. rms. They nd some evidence that, compared to domestic GAAP, IFRS increases comparability with U.S. rms. The study by Barth et al. (2010) differs from ours in that it focuses on the SECs second objective, i.e., comparability. Moreover, like other studies examining IFRS adoption, they do not explicitly consider how IFRS adoption would impact U.S. rms. In the rest of this section, we consider how a switch from U.S. GAAP to IFRS would affect the reporting quality of U.S. rms.
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Both IFRS and U.S. GAAP are generally viewed as high-quality standards. Moreover, IFRS and U.S. GAAP have much in common. Bae et al. (2008) examine differences in local GAAP and IFRS for 21 accounting transactions. They nd only four differences between U.S. GAAP and IFRS.6 Given that IFRS and U.S. GAAP are similar to start with, the question is: how could the adoption of IFRS affect, and especially improve, nancial reporting? First, as Hail et al. (2010) point out, some signicant differences between U.S. GAAP and IFRS remain. For example, IFRS relies more on fair values, has less specic requirements for revenue recognition, can accelerate the recognition of stock options expenses, may classify certain nancial instruments as debt instead of equity, and may include more related entities in the consolidated nancial statements. Plumlee and Plumlee (2008) use 20-F reconciliations of 100 randomly selected foreign rms to identify major differences between U.S. GAAP and IFRS. They nd that the largest differences in net income were due to income taxes, share-based payments, post-retirement benets, revaluations of plant assets, and impairment of goodwill and intangibles. Moreover, the net difference in U.S. GAAP and IFRS net income can be substantialup to /200 percent of IFRS net incomealthough generally the differences do not exceed 15 percent. While some studies consider the usefulness of IFRS (or IFRS-like) accounting for specic standards (e.g., Barth and Clinch [1998] examine revaluations; McAnally et al. [2010] consider differences in the treatment of share-based payments), it is difcult to predict how the collective differences in U.S. GAAP and IFRS would affect earnings quality, but if on balance the IFRS treatments are superior, the net effect could be positive. Second, and more fundamentally, IFRS are viewed as principles-based standards while U.S. GAAP is seen as rules based (e.g., SEC 2008). Gill (2007) states that while IFRS comprises 2,000 pages, U.S. GAAP is made up of over 2,000 separate pronouncements. Thus, U.S. GAAP is more complex and precise than IFRS, but the implications of the extra complexity and precision are not straightforward. Rules help ensure that transactions are recorded comparably and that they are veried in a consistent manner (e.g., Schipper 2003). However, if standards are too complex, preparers and auditors may be overwhelmed by the volume of rules, which can cancel out these benets (e.g., Nelson 2003). For example, task complexity can increase with rules-based standards, and greater task complexity can lead to the use of heuristics and result in the incomplete processing of information (e.g., Bonner 1994; Tan et al. 2002). If U.S. GAAP suffers from standards overload (e.g., Beresford 1999), switching to IFRS could reduce the overload and make the accounting process more transparent. Since principles-based standards involve more professional judgment, their value depends on how preparers and auditors respond to the greater exibility embedded in those standards. On one hand, greater exibility can give room for managerial opportunism. Ewert and Wagenhofer (2005) develop a model that shows that accounting-based earnings management is increasing in the looseness of accounting standards. Trompeter (1994) nds that auditors were more likely to allow income-increasing accounting choices when standards are less precise. On the other hand, tighter standards can lead to more transaction structuring or real earnings management (e.g., Schipper 2003). Ewert and Wagenhofer (2005) show that under certain conditions, real earnings management increases as standards become tighter or more rules based. Nelson et al. (2002) nd that auditors are less likely to challenge structured transactions when accounting standards are more precise. Webster and Thornton (2004) examine the effects of principles-based standardsalthough not IFRS specically. They nd that principles-based standards enhance the accruals quality of
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Further, Bae et al. (2008) nd one difference between U.K. GAAP and IFRS, and four differences between Australian GAAP and IFRS.

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Canadian rms, but only after controlling for regulatory oversight. Their results are consistent with recent literature that nds that a countrys institutions matter when assessing the impact of alternative accounting standards. Third, the adoption of IFRS could be affected by the litigation or tax systems in the U.S. Institutional factors inside the U.S. suggest that the impact of IFRS adoption would be minimal for U.S. rms, at least in terms of earnings quality. Since the U.S. has strong legal institutions, strong regulatory oversight and enforcement, and deep capital markets that demand high-quality reporting, even if IFRS is inferior to U.S. GAAP, a dramatic decline in reporting quality under IFRS would be unlikely. However, Hail et al. (2010) point out that one unknown is how IFRS will interact with the U.S.s litigation system, which is the most litigation prone in the world. They argue that litigation against rms could increase because of the greater discretion and judgment required under IFRS. One possible response is that managers use the exibility in IFRS to report less aggressive accounting choices to reduce the higher litigation risk, particularly as the courts interpretation of cases involving IFRS evolves. This scenario would result in high earnings quality under IFRS, at least in the short run. The tax system in the U.S., which is characterized by strict tax enforcement, could also have an impact on reporting quality under IFRS (e.g., Hail et al. 2010). Guenther and Young (2000) and Haw et al. (2004) report a positive association between strong tax enforcement and nancial reporting quality, suggesting that the strict tax enforcement in the U.S. could limit the scope for opportunism, and increase earnings quality, under IFRS.7 Overall, the effects (if any) of adopting IFRS in the U.S. are likely to be much smaller than in other countries where the domestic standards are not high quality, and where the differences between domestic GAAP and IFRS are greater. Further, it is unlikely that reporting quality will suffer signicantly under IFRS since the U.S. institutional environment demands high-quality reporting. However, it remains an empirical question whether IFRS could improve nancial reporting quality in the U.S. This question is salient since the SECs 2010 report highlights improvement of nancial reporting in the U.S. as an important goal. A positive effect could arise if one or more of the following is true: (1) where differences in U.S. GAAP and IFRS exist, IFRS treatments are superior; (2) IFRS is simpler to apply and more transparent; (3) professional judgments made under IFRS allow for better portrayal of economic conditions; (4) IFRS reduces structured transactions or real earnings management; and (5) IFRS leads to more conservative reporting because of litigation/tax considerations. Thus, we consider the hypothesis that IFRS adoption would improve reporting quality if adopted by U.S. rms. RESEARCH DESIGN Sample Selection We search Compustat for foreign rms cross-listed on U.S. stock exchanges from countries that have mandatorily adopted IFRS. We dene the post-IFRS period for a rm as the period between the Compustat scal year of the rms rst mandatory IFRS statements and 2008. The preIFRS period of the rm is a period that is the same length as the post-IFRS period and that ends when the rm publishes its rst mandatory IFRS statements. Any years related to the voluntary adoption of IFRS are excluded. As an illustration, for an Australian or European rm with the scal year-end in December, January, February, March, April, or May, the post-IFRS period is 20052008 and the pre-IFRS
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While tax considerations could be a factor for U.S. rms adopting IFRS, they may not apply to cross-listed rms unless they have some operations in the U.S.

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period is 20012004 if there was no voluntary adoption of IFRS prior to 2005.8 However, the preIFRS period would be 20002003 if this rm voluntarily adopted IFRS in 2004. For an Australian or European rm with a scal year-end in June, July, August, September, October, or November, the post-IFRS period is 20062008 and the pre-IFRS period is 20032005 if the rm did not voluntarily adopt IFRS prior to 2006. After meeting the requirements for data availability, the nal sample consists of 1,698 rmyear observations related to IFRS adopting rms.9 Panel A of Table 1 indicates that there are 880 observations in the post-IFRS period and 818 observations in the pre-IFRS period. Panel B of Table 1 presents the distribution of 1,698 rm-year observations across 20002008. Panel C of Table 1 reports the breakdown of the sample by country, which shows that the sample rms come from 23 countries.10 A total of 849 rm-year observations (50 percent of the sample) are from seven common law countriesAustralia, Hong Kong, Ireland, Israel, New Zealand, South Africa, and the U.K.and 506 rm-year observations (29.8 percent of the sample) are from Australia and the U.K. We match each of our cross-listed rms with a U.S. rm based on year, two-digit SIC industry, and total assets. Our full sample consists of a maximum of 3,396 rm-year observations (1,698 cross-listed, 1,698 matched), although for some tests, the sample size is slightly smaller because of lack of data. In addition to the full sample, we also run our tests using two subsamples, one consisting of cross-listed rms from common law countries and the other made up of cross-listed rms from Australia and the U.K. Maximum sample sizes for the subsamples are 1,698 rm-years for the common law subsample and 1,012 rm-years for the Australia/U.K. subsample. Measures of Earnings Quality Dechow et al. (2010, 344) dene high-quality earnings as earnings that provide more information about the features of a rms nancial performance that are relevant to a specic decision made by a specic decision maker. They review over 300 studies and identify nine of the most common earnings quality proxies. Since earnings quality cannot be captured by a single measure, in our study we employ ve of these proxies. We use measures related to discretionary accruals, target beating, earnings persistence, timely loss recognition, and the ERC. Dechow et al. (2010) group their nine proxies into three broad categories: properties of earnings, investor responsiveness to earnings, and external indicators of earnings misstatements. Our ve measures encompass the rst two categories. We do not include any measures related to misstatements (i.e., AAERs, restatements, internal control weaknesses) because these are infrequent events, leaving few cases of misstatements in our relatively small sample. Analyses We examine the impact of IFRS adoption on cross-listed rms using a difference-in-differences regression model that allows us to control for differences between cross-listed and matched rms,
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In Compustat, scal years ending on December 31, 2005; January 31, 2006; February 28, 2006; March 31, 2006; April 30, 2006; or May 31, 2006 are 2005, while scal years ending on June 30, 2006; July 31, 2006; August 31, 2006; September 30, 2006; October 31, 2006; or November 30, 2006 are 2006. All years addressed in this paragraph are Compustat scal years. For some rms, the length of the pre-IFRS period is less than that of the post-IFRS period, as these rms were recently cross-listed in the U.S., which results in the number of observations in the post-IFRS period being greater than that in the pre-IFRS period. Australia, European Union countries, Hong Kong, and South Africa adopted IFRS for scal years beginning on or after January 1, 2005. Peru and Turkey adopted IFRS for scal years beginning on or after January 1, 2006. New Zealand adopted IFRS for scal years beginning on or after January 1, 2007. Israel adopted IFRS for scal years beginning on or after January 1, 2008.

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TABLE 1 Breakdown of Cross-Listed Firms Panel A: Observations by Period


Period Post-IFRS Pre-IFRS Total Frequency 880 818 1,698 Percent (%) 51.83 48.17 100.00

Panel B: Observation by Compustat Fiscal Year


Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 Total Frequency 6 124 168 201 217 226 221 287 248 1,698 Percent (%) 0.35 7.30 9.89 11.84 12.78 13.31 13.02 16.90 14.61 100.00

Panel C: Observations by Home Country for Full Sample and Subsamples


Country Australia United Kingdom Australia/U.K. subsample Hong Kong Ireland Israel New Zealand South Africa Common law excluding Australia/U.K. Common law subsample (including Australia/U.K.) Austria Belgium Germany Denmark Spain Finland France Greece Hungary Italy Luxembourg Netherlands Frequency 98 408 506 80 64 141 2 56 343 849 8 12 140 17 20 32 177 24 8 62 53 202 Percent (%) 5.77 24.03 29.80 4.71 3.77 8.30 0.12 3.30 20.20 50.00 0.47 0.71 8.24 1.00 1.18 1.88 10.42 1.41 0.47 3.65 3.12 11.90 (continued on next page)

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TABLE 1 (continued)
Country Norway Peru Sweden Turkey Code law Full sample (common law code law) Frequency 29 6 53 6 849 1,698 Percent (%) 1.71 0.35 3.12 0.35 50.00 100.00

and differences between the pre- and post-IFRS periods that are unrelated to IFRS adoption. Tests involving each of our ve measures of earnings quality are described below. First, earnings management is measured as the absolute value of discretionary accruals (e.g., Klein 2002; Myers et al. 2003; Menon and Williams 2004; Ashbaugh-Skaife et al. 2008). We estimate the following difference-in-differences regression model: ADAC = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e where: ADAC = the absolute value of discretionary accruals estimated by the Jones (1991) model, computed by year within every two-digit industry; XLIST = an indicator variable coded 1 for cross-listed rms and 0 for matched U.S. rms; POST = an indicator variable coded 1 for cross-listed rms in post-IFRS periods and 0 in preIFRS observations; for matched U.S. rms, POST has the same value as the cross-listed rm it is matched to; SIZE = size, measured as the log of market value of common equity; GROWTH = growth, measured as the annual percentage change in sales; EISSUE = increase in equity, measured as the annual percentage change in common equity; LEV = leverage, measured as the ratio of total liabilities to common equity; DISSUE = increase in debt, measured as the annual percentage change in total liabilities; TURN = turnover, measured as the ratio of sales to total assets; and CFO = cash ow from operations, measured as cash ow from operations deated by total assets. In Equation (1), b1 represents the difference in ADAC between cross-listed and the matched U.S. rms in the pre-IFRS period and controls for pre-existing differences between the two groups. b2 represents the incremental effect in ADAC for matched rms from the pre- to post-IFRS period and controls for contemporaneous changes in ADAC that are not related to IFRS adoption. We are interested in b3, which reects incremental change in ADAC for cross-listed rms in the post-IFRS period relative to cross-listed rms in the pre-IFRS period and matched U.S. rms in the pre- and post-IFRS periods, i.e., b3 captures the IFRS adoption effect for the surrogate rms. If IFRS leads to less accrual-based earnings managementor better earnings qualitywe expect a negative coefcient for b3. To control for the effect of other factors affecting earnings quality, we include several variables in Equation (1). Since large rms have incentives to minimize reported earnings and have higherAccounting Horizons December 2011

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quality earnings (e.g., Armstrong et al. 2010), we expect that b4 will be negative. Managers in growth rms may have more discretion in reporting earnings (e.g., Smith and Watts 1992) and more incentives to manage earnings upward (e.g., Skinner and Sloan 2002). Thus, b5 is expected to be positive. Shivakumar (2000) suggests that managers have incentives to engage in upward earnings management prior to new equity and debt issues. Since large increases in EISSUE will be a consequence of new equity issues, we expect that b6 will be positive (e.g., Lang et al. 2006; Barth et al. 2008). As Klein (2002) nds that nancial leverage is positively associated with earnings management, we expect a positive b7. Similar to equity increases, the coefcient for debt issues, b8, is expected to be positive (e.g., Lang et al. 2006; Barth et al. 2008). Following Barth et al. (2008), we control for turnover and expect that b9 will be positive. Chung and Kallapur (2003) suggest that cash ows from operations are positively associated with accruals, suggesting that b10 will be positive. Finally, we include industry dummies in the model to control for xed industry effects.11 Second, we measure earnings management as the frequency of small positive earnings. Burgstahler and Dichev (1997) document unusually low frequencies of small negative earnings and unusually high frequencies of small positive earnings, which suggest that reported earnings are managed to avoid losses. Thus, the frequency of small positive earnings is used as a measure of earnings management (e.g., Lang et al. 2003; Lang et al. 2006; Barth et al. 2008). We estimate the following logistic regression model: SPOS = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e 2

where SPOS is an indicator variable that is coded 1 if net income scaled by total assets is between 0 and 0.01, and 0 otherwise. Similar to Equation (1), in Equation (2) we are interested in b3, which represents the incremental effect on SPOS for cross-listed rms in the post-IFRS period. If IFRS improves earnings quality leading to fewer small positive earnings, we expect that b3 will be negative. Third, we consider earnings persistence (e.g., Penman and Zhang 2002; Francis et al. 2004; Li 2008). Earnings persistence is important because more persistent earnings can result in better inputs to equity valuation models and to higher equity market valuations (e.g., Dechow et al. 2010). Following prior research (e.g., Sloan 1996; Francis et al. 2004), we estimate persistence by regressing period ahead earnings on current earnings. To examine the impact of IFRS adoption, we include XLIST and POST, and estimate the following difference-in-differences model: Et1 = b0 b1 XLIST b2 POST b3 Et b4 XLIST 3 POST b5 XLIST 3 Et b6 POST 3 Et b7 XLIST 3 POST 3 Et industrydummies e 3

where Et is earnings before extraordinary items for year t, deated by beginning of period market value of common equity. We are interested in b7, which is the incremental effect on persistence for cross-listed rms in the post-IFRS period. If IFRS leads to more persistent or higher-quality earnings, we expect b7 to be positive. Alternatively, b7 could be positive if the decrease in persistence was less for IFRS than for the matched sample group. Fourth, we use a measure of timely loss recognition. Timely loss recognition can be particularly important from the standpoint of corporate governance and debt agreements (e.g., Ball and Shivakumar 2005). For example, recognizing losses on a more timely basis can discourage managers from investing in projects with ex ante negative NPV and can force managers to exit investments with ex post negative cash ows more readily. Timely loss recognition can also benet
11

We winsorize continuous variables at 1 percent and 99 percent.

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creditors by providing better information for loan pricing, and triggering covenant-related repricing or restrictions more quickly when the debtors circumstances deteriorate. We follow Lang et al. (2003) and Barth et al. (2008), and use an indicator measure for large negative net income. Our logistic model, which is similar to Equation (2), is as follows: LNEG = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e 4

where LNEG is coded 1 for observations where annual net income scaled by total assets is less than 0.20, and 0 otherwise. Since more timely loss recognition will result in more rms having large negative net income, a positive b3 would be consistent with IFRS improving earnings quality.12 Fifth, we consider a market-based measure, i.e., a long-window ERC. Following Hanlon et al. (2008), we regress annual returns on the annual change in earnings where the coefcient on the latter represents the ERC. Adding our indicator variables, we estimate a difference-in-differences model as follows: RET = b0 b1 XLIST b2 POST b3 DE b4 XLIST 3 POST b5 XLIST 3 DE b6 POST 3 DE b7 XLIST 3 POST 3 DE industrydummies e 5

where RET is holding period stock return, including dividends, over the scal accounting year, and DE is change in earnings, measured as the annual change in earnings before extraordinary items, deated by beginning of period market value of common equity. The coefcient for the three-way interaction, b7, represents the incremental ERC for cross-listed rms in the post-IFRS period. To the extent that the ERC is a measure of overall decision usefulness for equity valuation (Liu and Thomas 2000), a positive b7 is expected if IFRS leads to higher quality. EMPIRICAL RESULTS Table 2 provides descriptive statistics for the three rm-specic earnings quality variables and the control variables. Even though we match on size, we nd that the cross-listed rms are signicantly larger than the matched U.S. rms. We also nd some evidence that cross-listed rms have higher growth, higher leverage, and lower sales turnover, conrming the need to control for these variables in our multivariate tests. Pearson correlations between the independent variables (untabulated) are generally low, with only two pairwise correlations exceeding 0.25, i.e., 0.48 between size and operating cash ows, and 0.37 between growth and debt issuance. Table 3 provides the results of our difference-in-differences regression for ADAC. Panel A of Table 3 shows the model coefcients. The coefcient for XLIST (b1) represents the incremental effect of cross-listed rms in the pre-IFRS period relative to matched rms in the pre-IFRS period. This coefcient is positive and signicant in the model, using observations from all countries, but is insignicant for the common law and Australia/U.K. subsamples. For the full sample, the results suggest that, before IFRS, cross-listed rms had larger absolute discretionary accruals than their U.S.-based counterparts. Conversely, before IFRS we nd no difference in the absolute discretionary accruals between cross-listed and matched U.S. rms for cross-listed rms from countries that are more similar to the U.S. These ndings are roughly in line with Lang et al. (2006), who nd that earnings management of cross-listed rms is greater for rms from low
12

A limitation of our timely loss recognition measure is that LNEG will pick up excessive write-offs (i.e., big baths) that are undesirable.

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TABLE 2 Descriptive Statistics


Cross-Listed Firms Variable ADAC SPOS LNEG POST SIZE GROWTH EISSUE LEV DISSUE TURN CFO n 1,698 1,698 1,698 1,698 1,698 1,698 1,698 1,698 1,698 1,698 1,698 Mean 0.160 0.050 0.090 0.518 7.889 0.158 0.095 2.466 0.146 0.743 0.066 Median 0.079 0.000 0.000 1.000 8.568 0.119 0.087 1.304 0.072 0.677 0.090 Matched U.S. Firms Mean 0.147 0.042 0.097 0.518 7.673 0.173 0.069 2.205 0.174 0.779 0.059 Median 0.078 0.000 0.000 1.000 8.074 0.088 0.078 1.168 0.053 0.675 0.084 t-statistic 0.66 1.15 0.71 0.00 2.51** 0.31 0.51 1.16 0.79 1.78* 1.07 Wilcoxon Z-stat. 1.13 1.15 0.48 0.00 3.01*** 1.71* 0.70 2.70*** 1.10 0.28 0.84

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). Variable Denitions: ADAC = absolute value of discretionary accruals; SPOS = small positive earnings, coded 1 if net income scaled by total assets is between 0 and 0.01, and 0 otherwise; LNEG = large negative net income, coded 1 for observations where annual net income scaled by total assets is less than 0.20, and 0 otherwise; POST = IFRS adoption period, coded 1 for observations in the post-adoption period, and 0 otherwise; SIZE = size, measured as the log value of market value of common equity; GROWTH = growth, measured as the annual percentage change in sales; EISSUE = the annual percentage change in common equity; LEV = leverage, measured as the ratio of total liabilities to common equity; DISSUE = the annual percentage change in total liabilities; TURN = turnover, measured as the ratio of sales to total assets; and CFO = cash ow from operations, measured as cash ow from operations deated by total assets.

investor protection countries than for rms from high investor protection countries (investor protection is strongly correlated with the common/code law dichotomy used in this study). The coefcient for POST (b2) is not signicant for any sample. This result indicates that for the matched rms, there is no change in absolute discretionary accruals between the pre- and post-IFRS periods. Since the matched U.S. rms did not actually adopt IFRS, the interpretation is that there were no contemporaneous events that affected the discretionary accruals of the matched rms between these two periods. The coefcient of interest, XLIST 3 POST (b3), captures the difference-in-differences, i.e., whether the pre- to post-IFRS change for the cross-listed rms is different from the pre- to post-IFRS change for the matched rms. b3 is not signicant in any of the samples. The change in absolute discretionary accruals is not incrementally different for cross-listed and matched rms, suggesting that mandatory adoption of IFRS by cross-listed rms did not affect earnings quality, at least as measured by absolute discretionary accruals. Panel B of Table 3 provides separate group coefcients, derived from Panel A, for three subgroups (cross-listed, pre-IFRS; cross-listed, post-IFRS; matched, post-IFRS) relative to the baseline group, i.e., matched rms in the baseline industry in the pre-IFRS period. Since we include
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TABLE 3 Results for Absolute Discretionary Accruals Panel A: Difference-in-Difference Regression


All Countries Variable Intercept XLIST POST XLIST POST SIZE GROWTH EISSUE LEV DISSUE TURN CFO Adj. R2 n b0 b1 b2 b3 b4 b5 b6 b7 b8 b9 b10 Coefcient 0.178 0.017 0.019 0.011 0.009 0.014 0.016 0.000 0.049 0.021 0.264 t-statistic 11.28*** 2.89** 1.45 1.48 2.64** 1.19 1.90* 0.97 2.67** 1.38 4.00*** 10.15% 3,396 Common Law Coefcient 0.175 0.024 0.017 0.015 0.011 0.017 0.018 0.000 0.054 0.030 0.262 t-statistic 6.89*** 1.66 1.01 0.92 2.82** 1.12 1.69 0.15 2.10* 1.32 3.51*** 13.28% 1,698 Australia and U.K. Coefcient 0.236 0.014 0.021 0.005 0.021 0.031 0.020 0.000 0.039 0.033 0.163 t-statistic 6.77*** 1.34 0.68 0.16 4.50*** 1.59 1.20 0.33 1.38 0.87 1.51 16.62% 1,012

Panel B: Separate Group Coefcients


All Countries Separate Group Matched rms, pre-IFRS Matched rms, post-IFRS Cross-listed rms, pre-IFRS Cross-listed rms, post-IFRS Common Law Australia and U.K. Derivation Derivation Derivation Coefcient from Panel A Coefcient from Panel A Coefcient from Panel A 0.178 0.019 0.017 0.025 b0 b2 b1 b1 b2 b3 0.175 0.017 0.024 0.026 b0 b2 b1 b1 b2 b3 0.236 0.021 0.014 0.040 b0 b2 b1 b1 b2 b3

Panel C: Coefcient Differences between Groups


All Countries Between Groups Cross-listed rms, post-IFRS versus pre-IFRS Post-IFRS, crosslisted rms versus matched rms Difference 0.008 F-statistic 1.93 Common Law Difference 0.002 F-statistic 0.49 Australia and U.K. Difference 0.026 F-statistic 1.02

0.006

1.12

0.009

1.09

0.019

0.54

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). t-statistics are computed after clustering observations by years.

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TABLE 3 (continued)
The OLS regression model in Panel A is as follows: ADAC = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e: Separate group coefcients in Panels B and C are relative to the baseline group, i.e., matched rms in the baseline industry in the pre-IFRS period. The variables are dened in Table 2.

industry dummies, the intercept will differ across industries. Panel C of Table 3 provides two additional between-group comparisons. First, we nd that the pre- to post-IFRS change in the absolute discretionary accruals for cross-list rms is not statistically different. This comparison is analogous to b2, which captures the pre- to post-IFRS change for the matched rms. Second, in the post-IFRS periods, there is no difference in absolute discretionary accruals between the cross-listed and matched rms. This comparison is analogous to b1, which captures the difference between cross-listed and matched rms in the pre-IFRS period. Table 4 provides the results for small positive earnings. Similar to Table 3, we nd a signicant positive coefcient for XLIST, but only for the full sample. This nding indicates that compared to the matched U.S. rms, cross-listed rms had more small positive earnings, an indicator of earnings management. However, since this result disappears in the common law and Australia/U.K. subsamples, the signicance in the full sample is driven by cross-listed rms from code law countries. Also, similar to Table 3, the coefcient for POST is not signicant for any of the subsamples, indicating that the pre- to post-IFRS change in small positive earnings for the matched rms is not signicant. However, for b3, we nd signicant and negative coefcients in all three models. This result indicates that the cross-listed rms had a larger decrease in small positive earnings than the matched rms. Since the proportion of small positive earnings is negatively related to earnings quality, a larger decrease indicates less earnings management. Thus, in terms of small positive earnings, Table 4 provides evidence that adopting IFRS led to an incremental improvement in earnings quality for cross-listed rms relative to the matched U.S. rms over the same period. Further, the magnitude of b3 decreases monotonically from the full sample to the Australia/U.K. subsample, indicating that the largest decrease in small positive earnings actually occurred in the two countries that are most similar to the United States. Panels B and C of Table 4 provide evidence that the change was due to improvement on the part of cross-listed rms (rather than deterioration among the matched rms), as the between-group comparison shows a signicant decrease for the cross-listed rms pre- and post-IFRS, and this difference increases moving from the full to Australia/U.K. subsample. Table 5 reports the ndings for earnings persistence. The coefcient for XLIST 3 E captures pre-existing differences in persistence between the cross-listed and matched rms. This coefcient is negative and signicant for the full and common law samples. The negative sign indicates lower earnings persistenceor lower earnings qualityfor those two subsamples, which again is broadly consistent with Lang et al. (2006). However, the coefcient for XLIST 3 E is not signicant for the Australia/U.K. sample, supporting the notion that cross-listed rms from these countries had similar earnings quality to U.S. rms even before IFRS was imposed. The coefcient for POST 3 E is not signicant for any of the samples. This result indicates that for the matched rms, there was no change in persistence between the pre- and post-adoption periods.
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TABLE 4 Results for Small Positive Earnings Panel A: Difference-in-Difference Regression


All Countries Variable Intercept XLIST POST XLIST POST SIZE GROWTH EISSUE LEV DISSUE TURN CFO Likelihood ratio n b0 b1 b2 b3 b4 b5 b6 b7 b8 b9 b10 Coefcient 3.648 0.468 0.110 0.685 0.051 0.028 0.355 0.051 0.015 0.249 0.249 Wald v
2

Common Law Coefcient 2.916 0.347 0.024 1.662 0.035 0.176 0.394 0.056 0.156 0.207 0.282 Wald v
2

Australia and U.K. Coefcient 4.704 0.579 0.495 2.515 0.111 0.205 0.534 0.058 0.313 0.250 0.800 Wald v2 16.65*** 0.27 0.97 4.11** 0.83 0.53 16.01*** 16.50*** 1.21 0.22 0.73 115.41*** 1,012

89.25*** 4.97** 0.16 3.51* 1.25 0.03 13.62*** 28.50*** 0.02 0.86 0.29 269.43*** 3,396

12.18*** 0.57 0.00 5.07** 0.15 1.12 7.48*** 30.58*** 0.64 1.08 0.27 112.82*** 1,698

Panel B: Separate Group Coefcients


All Countries Separate Group Matched rms, pre-IFRS Matched rms, post-IFRS Cross-listed rms, pre-IFRS Cross-listed rms, post-IFRS Common Law Australia and U.K. Derivation Derivation Derivation Coefcient from Panel A Coefcient from Panel A Coefcient from Panel A 3.648 0.110 0.468 0.327 b0 b2 b1 b1 b2 b3 2.916 0.024 0.347 1.339 b0 b2 b1 b1 b2 b3 4.704 0.495 0.579 1.441 b0 b2 b1 b1 b2 b3

Panel C: Coefcient Differences between Groups


All Countries Between Groups Cross-listed rms, post-IFRS versus pre-IFRS Post-IFRS, crosslisted rms versus matched rms Difference 0.795 v statistic 9.68***
2

Common Law Difference 1.686 v statistic 12.19***


2

Australia and U.K. Difference 2.020 v2 statistic 9.78***

0.217

4.24

1.315

7.59**

1.936

9.52***

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). Wald v2 statistics are computed after clustering observations by years.

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TABLE 4 (continued)
The logistic regression model in Panel A is as follows:

SPOS = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e:
Separate group coefcients in Panels B and Care relative to the baseline group, i.e., matched rms in the baseline industry in the pre-IFRS period. The variables are dened in Table 2.

The variable of interest is the coefcient for XLIST 3 POST 3 E. Panel A of Table 5 shows that this coefcient is positive and signicant in all three samples. Thus, the increase in persistence for the cross-listed rms over the two periods is greater than the increase for the matched rms over the same periods. Based on both Panels A and B, the increase in persistence is greatest for the full sample, perhaps because rms from code law countries, which are included in this sample, have more room for improvement. Alternatively, the slightly weaker results for the two subsamples could just reect smaller sample sizes. In any case, the ndings in Table 5 indicate an improvement in earnings quality due to IFRS. Table 6, which contains the results for the timely loss recognition tests, shows that the coefcients for XLIST, POST, and XLIST 3 POST are not signicant. The latter suggests that there is no difference in the differences for cross-listed and matched rms across the two periods, indicating no discernable change in timely loss recognition due to IFRS adoption by the cross-listed rms. Similarly, as reported in Table 7, we nd no change in the long-window ERC. As expected, we nd a positive and signicant coefcient for DE for all three samples. Interestingly, for the full sample, we nd that XLIST 3 DE is signicant and positively signed. This nding indicates that returns are more responsive to earnings for cross-listed rms in the pre-IFRS period. Since XLIST 3 DE is not signicant for the common law and Australia/U.K. samples, the full sample results are driven by code law rms. Thus, long-window ERCs are higher for cross-listed rms from code law countries than from common law countries. The higher ERC is consistent with Barton et al. (2010), who nd the income (variously dened) is more value relevant in code law countries than common law countries. One reason may be that in code law countries, there are fewer alternative information sources so investors are forced to rely more on reported earnings. In any case, the coefcient for XLIST 3 POST 3 DE is not signicant for all three samples. The ERC falls (signicantly) for the cross-listed companies, but it also falls for the matched rms. Thus we nd no evidence that the difference in the long-window ERC in the pre- and post-IFRS periods is any different for cross-listed and matched rms. For this measure of earnings quality, we nd no evidence that IFRS would lead to improvements. CONCLUSION This study examines the impact of IFRS adoption on earnings quality of rms cross-listed in the U.S. that are domiciled in countries that have adopted IFRS on a mandatory basis. We focus on these cross-listed rms because earnings, regardless of the domestic standards they
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TABLE 5 Results for Earnings Persistence Panel A: Difference-in-Difference Regression


All Countries Variable Intercept XLIST POST Et XLIST POST XLIST Et POST Et XLIST POST Et Adj. R2 n b0 b1 b2 b3 b4 b5 b6 b7 Coefcient 0.008 0.010 0.002 0.696 0.005 0.310 0.247 0.511 t-statistic 0.49 1.42 0.14 4.28*** 0.68 1.90* 1.40 2.96** 25.89% 3,025 Common Law Coefcient 0.021 0.012 0.006 0.589 0.001 0.174 0.150 0.413 t-statistic 1.10 1.57 0.48 3.63*** 0.10 1.96* 0.81 2.99** 26.61% 1,495 Australia and U.K. Coefcient 0.001 0.009 0.001 0.511 0.001 0.117 0.193 0.329 t-statistic 0.05 0.95 0.12 2.71** 0.09 0.99 0.81 1.92* 26.68% 907

Panel B: Separate Group Coefcients


All Countries Common Law Australia and U.K. Derivation from panel A b3 b3 b6 b3 b5 b3 b5 b6 b7 CoDerivation Derivation Separate Group efcient from Panel A Coefcient from Panel A Coefcient Matched rms, pre-IFRS Matched rms, post-IFRS Cross-listed rms, pre-IFRS Cross-listed rms, post-IFRS 0.696 0.449 0.386 b3 b3 b6 b3 b5 0.589 0.439 0.415 0.678 b3 b3 b6 b3 b5 b3 b5 b6 b7 0.511 0.318 0.394 0.530

0.650 b3 b5 b6 b7

Panel C: Coefcient Differences between Groups


All Countries Between Groups Cross-listed rms, post-IFRS versus pre-IFRS Post-IFRS, crosslisted rms versus matched rms Difference 0.264 F-statistic 11.74*** Common Law Difference 0.263 F-statistic 3.73*** Australia and U.K. Difference 0.136 F-statistic 2.29*

0.201

14.92***

0.239

3.94***

0.212

2.04*

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). t-statistics are computed after clustering observations by years. The OLS regression model in Panel A is as follows: Et1 = b0 b1 XLIST b2 POST b3 Et b4 XLIST 3 POST b5 XLIST 3 Et b6 POST 3 Et b7 XLIST 3 POST 3 Et industrydummies e: Et is earnings before extraordinary items for year t, deated by beginning of period market value of common equity. Separate group coefcients in Panels B and C are relative to the baseline group, i.e., matched rms in the pre-IFRS period. The other variables are dened in Table 2.

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TABLE 6 Results on Timely Loss Recognition Panel A: Difference-in-Difference Regression


All Countries Variable Intercept XLIST POST XLIST POST SIZE GROWTH EISSUE LEV DISSUE TURN CFO Likelihood ratio n b0 b1 b2 b3 b4 b5 b6 b7 b8 b9 b10 Coefcient 0.745 0.160 0.114 0.475 0.418 0.015 0.456 0.016 0.220 0.142 8.211 Wald v
2

Common Law Coefcient 0.585 0.107 0.024 0.382 0.384 0.016 0.452 0.021 0.176 0.227 7.335 Wald v
2

Australia and U.K. Coefcient 0.293 0.244 0.017 0.194 0.456 0.022 0.197 0.016 0.046 0.579 6.697 Wald v2 0.27 0.50 0.01 0.18 29.41*** 0.01 1.51 0.53 0.18 9.88*** 42.62*** 561.56*** 1,012

4.63** 0.64 0.24 1.81 110.29*** 0.01 5.96** 0.84 3.98** 2.74* 50.38*** 1203.32*** 3,396

1.15 0.32 0.01 0.97 65.62*** 0.02 5.41** 2.97* 28.97*** 1.55 29.40*** 782.11*** 1,698

Panel B: Separate Group Coefcients


All Countries Separate Group Matched rms, pre-IFRS Matched rms, post-IFRS Cross-listed rms, pre-IFRS Cross-listed rms, post-IFRS Common Law Australia and U.K. Derivation Derivation Derivation Coefcient from Panel A Coefcient from panel A Coefcient from Panel A 0.745 0.114 0.160 0.201 b0 b2 b1 b1 b2 b3 0.585 0.024 0.107 0.251 b0 b2 b1 b1 b2 b3 0.293 0.017 0.244 0.033 b0 b2 b1 b1 b2 b3

Panel C: Coefcient Differences between Groups


All Countries Between Groups Cross-listed rms, post-IFRS versus pre-IFRS Post-IFRS, crosslisted rms versus matched rms Difference 0.361 v -statistic 2.25
2

Common Law Difference 0.358 v -statistic 1.45


2

Australia and U.K. Difference 0.211 v2-statistic 0.24

0.315

1.92

0.275

0.93

0.050

0.30

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). Wald v2 statistics are computed after clustering observations by years.

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TABLE 6 (continued)
The logistic regression model in Panel A is as follows: LNEG = b0 b1 XLIST b2 POST b3 XLIST 3 POST b4 SIZE b5 GROWTH b6 EISSUE b7 LEV b8 DISSUE b9 TURN b10 CFO industrydummies e: Separate group coefcients in Panels B and C are relative to the baseline group, i.e., matched rms in the baseline industry in the pre-IFRS period. The variables are dened in Table 2

use, are likely to be inuenced by U.S. GAAP (e.g., Barth et al. 2010) and because they are exposed to U.S. institutions. In other words, we use the cross-listed rms as surrogates for the U.S. rms so we can observe the effect of IFRS adoption. We use a matched sample design, where each cross-listed rm is matched to a U.S. rm so we can disentangle the effect of IFRS adoption from other contemporaneous events affecting the reporting environment in the U.S. We tabulate results for three samples, i.e., a full sample, a subsample of cross-listed rms from common law countries, and a subsample of cross-listed rms from Australia and the U.K. We use ve measures of earnings quality related to discretionary accruals, target beating, earnings persistence, timely loss recognition, and the ERC. For three of these measuresdiscretionary accruals, timely loss recognition, and the ERCwe nd no difference in the change in earnings quality from the pre- to post-IFRS period for the cross-listed rms and the matched U.S. rms. However, for the other two measuresthe incidence of small positive earnings and earnings persistencewe nd evidence that the earnings quality of the cross-listed rms improved after they adopted IFRS, and that this improvement is incremental to pre-existing differences between the cross-listed and matched rms, and incremental to the change in earnings quality for the matched rms over the identical period. Our results are consistent for our full sample and two subsamples. This study differs from prior research (e.g., Leuz 2003; Barth et al. 2008; Daske et al. 2008) by directly addressing an important policy issue, i.e., would adopting IFRS lead to an improvement of earnings quality for U.S. rms? We construct a sample of rms that are comparable with U.S. rms with respect to institutions, accounting contexts, and reporting environments. Our results indicate that IFRS could improve earnings quality if U.S. rms adopted IFRS by reducing target beating and increasing earnings persistence. These results are slightly surprising, since the U.S. is thought to have high-quality standards that leave little room for improvement (e.g., Hail et al. 2010). By addressing the rst goal stated in the SECs 2010 report, our results may be of interest to the SEC as it decides whether to progress with mandatory adoption of IFRS for U.S. rms. However, some caveats are in order. First, we have not attempted to quantify the benets of improved earnings quality, e.g., it is not clear what economic impact a reduction in the number of rms reporting small positive earnings might have. Second, we have not considered any possible benets for U.S. rms associated with convergence. Third, we have not considered the cost of adopting IFRS for U.S. rms. Thus, our results should be viewed as just one piece of evidence that the SEC should consider. Like Frost et al. (2009), we believe that academic research has a role to play in the debate over the future of IFRS in the United States.
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TABLE 7 Results for Earnings Response Coefcient Panel A: Difference-in-Difference Regression


All Countries Variable Intercept XLIST POST DE XLIST POST XLIST DE POST DE XLIST POST DE Adj. R2 n b0 b1 b2 b3 b4 b5 b6 b7 Coefcient 0.178 0.014 0.119 0.388 0.038 0.393 0.086 0.196 t-statistic 1.74 0.58 0.65 5.74*** 0.89 2.62** 0.29 0.59 8.93% 3,164 Common Law Coefcient 0.192 0.020 0.141 0.358 0.086 0.428 0.193 0.346 t-statistic 2.29* 1.14 0.79 2.05* 2.58** 1.06 0.66 0.78 8.97% 1,576 Australia and U.K. Coefcient 0.218 0.011 0.087 0.358 0.064 0.293 0.358 0.090 t-statistic 2.55** 0.28 0.54 2.87** 1.32 0.65 1.08 0.18 4.16% 949

Panel B: Separate Group Coefcients


All Countries CoSeparate Group efcient Matched rms, pre-IFRS Matched rms, post-IFRS Cross-listed rms, pre-IFRS Cross-listed rms, post-IFRS 0.388 0.302 0.781 Derivation from Panel A b3 b3 b6 b3 b5 Common Law Australia and U.K. Derivation from Panel A b3 b3 b6 b3 b5 b3 b5 b6 b7 Derivation Coefcient from Panel A Coefcient 0.358 0.165 0.786 0.247 b3 b3 b6 b3 b5 b3 b5 b6 b7 0.358 0.000 0.651 0.203

0.499 b3 b5 b6 b7

Panel C: Coefcient Differences between Groups


All Countries Between Groups Cross-listed rms, post-IFRS versus pre-IFRS Post-IFRS, crosslisted rms versus matched rms Difference 0.282 F-statistic 14.63*** Common Law Difference 0.539 F-statistic 14.41*** Australia and U.K. Difference 0.448 F-statistic 5.18***

0.197

4.94***

0.082

3.05**

0.203

1.08

*, **, *** Indicate signicance at the 10 percent, 5 percent, and 1 percent levels, respectively (two-tailed tests). t-statistics are computed after clustering observations by years. The OLS regression model in Panel A is as follows: RET = b0 b1 XLIST b2 POST b3 DE b4 XLIST 3 POST b5 XLIST 3 DE b6 POST 3 DE b7 XLIST 3 POST 3 DE industrydummies e:

(continued on next page)

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TABLE 7 (continued)
RET is holding period stock return, including dividends, over the scal accounting year; DE is change in earnings, measured as the annual change in earnings before extraordinary items deated by beginning of period market value of common equity. Separate group coefcients in Panels B and C are relative to the baseline group, i.e., matched rms in the pre-IFRS period. The other variables are dened in Table 2.

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