Accounting Horizons American Accounting Association

Vol. 25, No. 4 DOI: 10.2308/acch-50049

2011
pp. 837860
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. fromcountries that have already adopted IFRSon 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 firmis matched to a U.S. firm. We find the
difference in earnings quality fromthe pre- to post-IFRS period is not different for the cross-
listed 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-in-
differences, 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
I
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
1
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).
837
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).
838 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
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 differ-
ence-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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 839
Accounting Horizons
December 2011
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.
840 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
LITERATURE REVIEWAND 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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 841
Accounting Horizons
December 2011
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
6
Further, Bae et al. (2008) nd one difference between U.K. GAAP and IFRS, and four differences between
Australian GAAP and IFRS.
842 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
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 pre-
IFRS 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
7
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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 843
Accounting Horizons
December 2011
period is 20012004 if there was no voluntary adoption of IFRS prior to 2005.
8
However, the pre-
IFRS 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 rm-
year 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,
8
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.
9
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.
10
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.
844 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
TABLE 1
Breakdown of Cross-Listed Firms
Panel A: Observations by Period
Period Frequency Percent (%)
Post-IFRS 880 51.83
Pre-IFRS 818 48.17
Total 1,698 100.00
Panel B: Observation by Compustat Fiscal Year
Year Frequency Percent (%)
2000 6 0.35
2001 124 7.30
2002 168 9.89
2003 201 11.84
2004 217 12.78
2005 226 13.31
2006 221 13.02
2007 287 16.90
2008 248 14.61
Total 1,698 100.00
Panel C: Observations by Home Country for Full Sample and Subsamples
Country Frequency Percent (%)
Australia 98 5.77
United Kingdom 408 24.03
Australia/U.K. subsample 506 29.80
Hong Kong 80 4.71
Ireland 64 3.77
Israel 141 8.30
New Zealand 2 0.12
South Africa 56 3.30
Common law excluding Australia/U.K. 343 20.20
Common law subsample (including Australia/U.K.) 849 50.00
Austria 8 0.47
Belgium 12 0.71
Germany 140 8.24
Denmark 17 1.00
Spain 20 1.18
Finland 32 1.88
France 177 10.42
Greece 24 1.41
Hungary 8 0.47
Italy 62 3.65
Luxembourg 53 3.12
Netherlands 202 11.90
(continued on next page)
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 845
Accounting Horizons
December 2011
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 = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH
b
6
EISSUE b
7
LEV b
8
DISSUE b
9
TURN b
10
CFO
industrydummies e
1
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 pre-
IFRS 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), b
1
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.
b
2
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 b
3
, 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., b
3
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 b
3
.
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 higher-
TABLE 1 (continued)
Country Frequency Percent (%)
Norway 29 1.71
Peru 6 0.35
Sweden 53 3.12
Turkey 6 0.35
Code law 849 50.00
Full sample (common law code law) 1,698 100.00
846 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
quality earnings (e.g., Armstrong et al. 2010), we expect that b
4
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, b
5
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 b
6
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 b
7
. Similar to equity increases, the coefcient for debt issues, b
8
,
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 b
9
will be positive. Chung and Kallapur (2003) suggest that
cash ows from operations are positively associated with accruals, suggesting that b
10
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 = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH
b
6
EISSUE b
7
LEV b
8
DISSUE b
9
TURN b
10
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 b
3
, 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 b
3
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:
E
t1
= b
0
b
1
XLIST b
2
POST b
3
E
t
b
4
XLIST 3POST b
5
XLIST 3E
t
b
6
POST 3E
t
b
7
XLIST 3POST 3E
t
industrydummies e
3
where E
t
is earnings before extraordinary items for year t, deated by beginning of period market
value of common equity. We are interested in b
7
, 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 b
7
to be positive. Alternatively, b
7
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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 847
Accounting Horizons
December 2011
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 = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH
b
6
EISSUE b
7
LEV b
8
DISSUE b
9
TURN b
10
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 b
3
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 = b
0
b
1
XLIST b
2
POST b
3
DE b
4
XLIST 3POST b
5
XLIST 3DE
b
6
POST 3DE b
7
XLIST 3POST 3DE 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, b
7
, 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 b
7
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 (b
1
) 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.
848 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
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 (b
2
) 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 (b
3
), 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. b
3
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
TABLE 2
Descriptive Statistics
Variable n
Cross-Listed Firms Matched U.S. Firms
t-statistic
Wilcoxon
Z-stat. Mean Median Mean Median
ADAC 1,698 0.160 0.079 0.147 0.078 0.66 1.13
SPOS 1,698 0.050 0.000 0.042 0.000 1.15 1.15
LNEG 1,698 0.090 0.000 0.097 0.000 0.71 0.48
POST 1,698 0.518 1.000 0.518 1.000 0.00 0.00
SIZE 1,698 7.889 8.568 7.673 8.074 2.51** 3.01***
GROWTH 1,698 0.158 0.119 0.173 0.088 0.31 1.71*
EISSUE 1,698 0.095 0.087 0.069 0.078 0.51 0.70
LEV 1,698 2.466 1.304 2.205 1.168 1.16 2.70***
DISSUE 1,698 0.146 0.072 0.174 0.053 0.79 1.10
TURN 1,698 0.743 0.677 0.779 0.675 1.78* 0.28
CFO 1,698 0.066 0.090 0.059 0.084 1.07 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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 849
Accounting Horizons
December 2011
TABLE 3
Results for Absolute Discretionary Accruals
Panel A: Difference-in-Difference Regression
Variable
All Countries Common Law Australia and U.K.
Coefcient t-statistic Coefcient t-statistic Coefcient t-statistic
Intercept b
0
0.178 11.28*** 0.175 6.89*** 0.236 6.77***
XLIST b
1
0.017 2.89** 0.024 1.66 0.014 1.34
POST b
2
0.019 1.45 0.017 1.01 0.021 0.68
XLIST POST b
3
0.011 1.48 0.015 0.92 0.005 0.16
SIZE b
4
0.009 2.64** 0.011 2.82** 0.021 4.50***
GROWTH b
5
0.014 1.19 0.017 1.12 0.031 1.59
EISSUE b
6
0.016 1.90* 0.018 1.69 0.020 1.20
LEV b
7
0.000 0.97 0.000 0.15 0.000 0.33
DISSUE b
8
0.049 2.67** 0.054 2.10* 0.039 1.38
TURN b
9
0.021 1.38 0.030 1.32 0.033 0.87
CFO b
10
0.264 4.00*** 0.262 3.51*** 0.163 1.51
Adj. R
2
10.15% 13.28% 16.62%
n 3,396 1,698 1,012
Panel B: Separate Group Coefcients
Separate Group
All Countries Common Law Australia and U.K.
Coefcient
Derivation
from Panel A Coefcient
Derivation
from Panel A Coefcient
Derivation
from Panel A
Matched rms,
pre-IFRS
0.178 b
0
0.175 b
0
0.236 b
0
Matched rms,
post-IFRS
0.019 b
2
0.017 b
2
0.021 b
2
Cross-listed rms,
pre-IFRS
0.017 b
1
0.024 b
1
0.014 b
1
Cross-listed rms,
post-IFRS
0.025 b
1
b
2
b
3
0.026 b
1
b
2
b
3
0.040 b
1
b
2
b
3
Panel C: Coefcient Differences between Groups
Between Groups
All Countries Common Law Australia and U.K.
Difference F-statistic Difference F-statistic Difference F-statistic
Cross-listed rms,
post-IFRS versus
pre-IFRS
0.008 1.93 0.002 0.49 0.026 1.02
Post-IFRS, cross-
listed rms versus
matched rms
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.
(continued on next page)
850 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
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 b
2
, 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 b
1
, 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 b
3
, 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 b
3
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 3E 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 3E 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.
TABLE 3 (continued)
The OLS regression model in Panel A is as follows:
ADAC = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH b
6
EISSUE b
7
LEV b
8
DISSUE
b
9
TURN b
10
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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 851
Accounting Horizons
December 2011
TABLE 4
Results for Small Positive Earnings
Panel A: Difference-in-Difference Regression
Variable
All Countries Common Law Australia and U.K.
Coefcient Wald v
2
Coefcient Wald v
2
Coefcient Wald v
2
Intercept b
0
3.648 89.25*** 2.916 12.18*** 4.704 16.65***
XLIST b
1
0.468 4.97** 0.347 0.57 0.579 0.27
POST b
2
0.110 0.16 0.024 0.00 0.495 0.97
XLIST POST b
3
0.685 3.51* 1.662 5.07** 2.515 4.11**
SIZE b
4
0.051 1.25 0.035 0.15 0.111 0.83
GROWTH b
5
0.028 0.03 0.176 1.12 0.205 0.53
EISSUE b
6
0.355 13.62*** 0.394 7.48*** 0.534 16.01***
LEV b
7
0.051 28.50*** 0.056 30.58*** 0.058 16.50***
DISSUE b
8
0.015 0.02 0.156 0.64 0.313 1.21
TURN b
9
0.249 0.86 0.207 1.08 0.250 0.22
CFO b
10
0.249 0.29 0.282 0.27 0.800 0.73
Likelihood ratio 269.43*** 112.82*** 115.41***
n 3,396 1,698 1,012
Panel B: Separate Group Coefcients
Separate Group
All Countries Common Law Australia and U.K.
Coefcient
Derivation
from Panel A Coefcient
Derivation
from Panel A Coefcient
Derivation
from Panel A
Matched rms,
pre-IFRS
3.648 b
0
2.916 b
0
4.704 b
0
Matched rms,
post-IFRS
0.110 b
2
0.024 b
2
0.495 b
2
Cross-listed rms,
pre-IFRS
0.468 b
1
0.347 b
1
0.579 b
1
Cross-listed rms,
post-IFRS
0.327 b
1
b
2
b
3
1.339 b
1
b
2
b
3
1.441 b
1
b
2
b
3
Panel C: Coefcient Differences between Groups
Between Groups
All Countries Common Law Australia and U.K.
Difference v
2
statistic Difference v
2
statistic Difference v
2
statistic
Cross-listed rms,
post-IFRS versus
pre-IFRS
0.795 9.68*** 1.686 12.19*** 2.020 9.78***
Post-IFRS, cross-
listed rms versus
matched rms
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 v
2
statistics are computed after clustering observations by years.
(continued on next page)
852 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
The variable of interest is the coefcient for XLIST3POST3E. 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 3POST 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 3DE 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 XLIST3POST3DE 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
TABLE 4 (continued)
The logistic regression model in Panel A is as follows:
SPOS = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH
b
6
EISSUE b
7
LEV b
8
DISSUE b
9
TURN b
10
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.
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 853
Accounting Horizons
December 2011
TABLE 5
Results for Earnings Persistence
Panel A: Difference-in-Difference Regression
Variable
All Countries Common Law Australia and U.K.
Coefcient t-statistic Coefcient t-statistic Coefcient t-statistic
Intercept b
0
0.008 0.49 0.021 1.10 0.001 0.05
XLIST b
1
0.010 1.42 0.012 1.57 0.009 0.95
POST b
2
0.002 0.14 0.006 0.48 0.001 0.12
E
t
b
3
0.696 4.28*** 0.589 3.63*** 0.511 2.71**
XLIST POST b
4
0.005 0.68 0.001 0.10 0.001 0.09
XLIST E
t
b
5
0.310 1.90* 0.174 1.96* 0.117 0.99
POST E
t
b
6
0.247 1.40 0.150 0.81 0.193 0.81
XLIST POST E
t
b
7
0.511 2.96** 0.413 2.99** 0.329 1.92*
Adj. R
2
25.89% 26.61% 26.68%
n 3,025 1,495 907
Panel B: Separate Group Coefcients
Separate Group
All Countries Common Law Australia and U.K.
Co-
efcient
Derivation
from Panel A Coefcient
Derivation
from Panel A Coefcient
Derivation
from panel A
Matched rms,
pre-IFRS
0.696 b
3
0.589 b
3
0.511 b
3
Matched rms,
post-IFRS
0.449 b
3
b
6
0.439 b
3
b
6
0.318 b
3
b
6
Cross-listed rms,
pre-IFRS
0.386 b
3
b
5
0.415 b
3
b
5
0.394 b
3
b
5
Cross-listed rms,
post-IFRS
0.650 b
3
b
5
b
6
b
7
0.678 b
3
b
5
b
6
b
7
0.530 b
3
b
5
b
6
b
7
Panel C: Coefcient Differences between Groups
Between Groups
All Countries Common Law Australia and U.K.
Difference F-statistic Difference F-statistic Difference F-statistic
Cross-listed rms,
post-IFRS versus
pre-IFRS
0.264 11.74*** 0.263 3.73*** 0.136 2.29*
Post-IFRS, cross-
listed rms versus
matched rms
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:
E
t1
= b
0
b
1
XLIST b
2
POST b
3
E
t
b
4
XLIST 3POST b
5
XLIST 3E
t
b
6
POST 3E
t
b
7
XLIST
3POST 3E
t
industrydummies e:
E
t
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.
854 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
TABLE 6
Results on Timely Loss Recognition
Panel A: Difference-in-Difference Regression
Variable
All Countries Common Law Australia and U.K.
Coefcient Wald v
2
Coefcient Wald v
2
Coefcient Wald v
2
Intercept b
0
0.745 4.63** 0.585 1.15 0.293 0.27
XLIST b
1
0.160 0.64 0.107 0.32 0.244 0.50
POST b
2
0.114 0.24 0.024 0.01 0.017 0.01
XLIST POST b
3
0.475 1.81 0.382 0.97 0.194 0.18
SIZE b
4
0.418 110.29*** 0.384 65.62*** 0.456 29.41***
GROWTH b
5
0.015 0.01 0.016 0.02 0.022 0.01
EISSUE b
6
0.456 5.96** 0.452 5.41** 0.197 1.51
LEV b
7
0.016 0.84 0.021 2.97* 0.016 0.53
DISSUE b
8
0.220 3.98** 0.176 28.97*** 0.046 0.18
TURN b
9
0.142 2.74* 0.227 1.55 0.579 9.88***
CFO b
10
8.211 50.38*** 7.335 29.40*** 6.697 42.62***
Likelihood ratio 1203.32*** 782.11*** 561.56***
n 3,396 1,698 1,012
Panel B: Separate Group Coefcients
Separate Group
All Countries Common Law Australia and U.K.
Coefcient
Derivation
from Panel A Coefcient
Derivation
from panel A Coefcient
Derivation
from Panel A
Matched rms,
pre-IFRS
0.745 b
0
0.585 b
0
0.293 b
0
Matched rms,
post-IFRS
0.114 b
2
0.024 b
2
0.017 b
2
Cross-listed rms,
pre-IFRS
0.160 b
1
0.107 b
1
0.244 b
1
Cross-listed rms,
post-IFRS
0.201 b
1
b
2
b
3
0.251 b
1
b
2
b
3
0.033 b
1
b
2
b
3
Panel C: Coefcient Differences between Groups
Between Groups
All Countries Common Law Australia and U.K.
Difference v
2
-statistic Difference v
2
-statistic Difference v
2
-statistic
Cross-listed rms,
post-IFRS versus
pre-IFRS
0.361 2.25 0.358 1.45 0.211 0.24
Post-IFRS, cross-
listed rms versus
matched rms
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 v
2
statistics are computed after clustering observations by years.
(continued on next page)
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 855
Accounting Horizons
December 2011
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 measuresdiscre-
tionary 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.
TABLE 6 (continued)
The logistic regression model in Panel A is as follows:
LNEG = b
0
b
1
XLIST b
2
POST b
3
XLIST 3POST b
4
SIZE b
5
GROWTH b
6
EISSUE b
7
LEV
b
8
DISSUE b
9
TURN b
10
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
856 Sun, Cahan, and Emanuel
Accounting Horizons
December 2011
TABLE 7
Results for Earnings Response Coefcient
Panel A: Difference-in-Difference Regression
Variable
All Countries Common Law Australia and U.K.
Coefcient t-statistic Coefcient t-statistic Coefcient t-statistic
Intercept b
0
0.178 1.74 0.192 2.29* 0.218 2.55**
XLIST b
1
0.014 0.58 0.020 1.14 0.011 0.28
POST b
2
0.119 0.65 0.141 0.79 0.087 0.54
DE b
3
0.388 5.74*** 0.358 2.05* 0.358 2.87**
XLIST POST b
4
0.038 0.89 0.086 2.58** 0.064 1.32
XLIST DE b
5
0.393 2.62** 0.428 1.06 0.293 0.65
POST DE b
6
0.086 0.29 0.193 0.66 0.358 1.08
XLIST POST DE b
7
0.196 0.59 0.346 0.78 0.090 0.18
Adj. R
2
8.93% 8.97% 4.16%
n 3,164 1,576 949
Panel B: Separate Group Coefcients
Separate Group
All Countries Common Law Australia and U.K.
Co-
efcient
Derivation
from Panel A Coefcient
Derivation
from Panel A Coefcient
Derivation
from Panel A
Matched rms,
pre-IFRS
0.388 b
3
0.358 b
3
0.358 b
3
Matched rms,
post-IFRS
0.302 b
3
b
6
0.165 b
3
b
6
0.000 b
3
b
6
Cross-listed rms,
pre-IFRS
0.781 b
3
b
5
0.786 b
3
b
5
0.651 b
3
b
5
Cross-listed rms,
post-IFRS
0.499 b
3
b
5
b
6
b
7
0.247 b
3
b
5
b
6
b
7
0.203 b
3
b
5
b
6
b
7
Panel C: Coefcient Differences between Groups
Between Groups
All Countries Common Law Australia and U.K.
Difference F-statistic Difference F-statistic Difference F-statistic
Cross-listed rms,
post-IFRS versus
pre-IFRS
0.282 14.63*** 0.539 14.41*** 0.448 5.18***
Post-IFRS, cross-
listed rms versus
matched rms
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 = b
0
b
1
XLIST b
2
POST b
3
DE b
4
XLIST 3POST b
5
XLIST 3DE b
6
POST 3DE
b
7
XLIST 3POST 3DE industrydummies e:
(continued on next page)
How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? 857
Accounting Horizons
December 2011
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