Little Economic Benefit in U.S. to Adopting IFRS: MIT Study

Back a few months this blog reported that the IFRS Roadmap calling for replacement of U.S. GAAP with IFRS by 2014 is coming under increased scrutiny. We cited a paper written by academics from Wharton, MIT, and other reputable universities discussing the implications on the U.S. economy of adopting IFRS.

The last nine months have been controversial for both U.S. GAAP and IFRS. Political pressures have been brought against both the U.S. standards and IFRS as a result of controversy over fair value/mark to market accounting.

The specter of political issues haunting accounting essentially could pit the SEC and the FASB against with the International Accounting Standards Board (IASB). In announcing the roadmap a few months back, the SEC called for improvements to funding and governance of the IASB. In more recent statements, the SEC has criticized IFRS as inadequate.

The same sources now argue in another paper that there are reasons to slow down the change to IFRS.

The new paper examines the economic consequences of mandatory IFRS reporting around the world. It analyzes the effects on market liquidity, and cost of capital and market value of a company's stock compared to a company's equity book value in 26 countries using a large sample of 3,100 firms that are mandated to adopt IFRS.

Some findings at the time of adoption of IFRS:

Market liquidity increases “In our firm-year analyses, the effects range in magnitude from 3% to 6% for market liquidity relative to levels prior to IFRS adoption,”

Cost of capital decreases

Equity valuations increase

However the authors find that IFRS adopters that are cross-listed on U.S. exchanges experience lower, if any, liquidity benefits. That is because “In countries like the U.S., there may be minimal room for improvement because U.S. GAAP is already considered a high-quality accounting regime.”

The authors note that while some argue that adopting IFRS in the U.S. would make it easier for investors to compare firms with those in other countries and decrease costs of reconciliations, this study provides “weak” evidence of any comparability benefits. “This is an area where more research will occur, but as of now there is no general agreement as to how large this type of benefit could be. The adoption of IFRS is a hot topic and it will take a few more years to get a full understanding of the long-term consequences.”

Capital-market benefits occur only in countries where firms have incentives to be transparent and where legal enforcement is strong, underscoring the central importance of firms' reporting incentives and countries' enforcement regimes for the quality of financial reporting.

Comparing mandatory and voluntary adopters, the capital market effects are most pronounced for firms that voluntarily switch to IFRS, both in the year when they switch and again later, when IFRS become mandatory. They however caution that the former result is likely due to self-selection, and that the latter result is a caution to attribute the capital-market effects for mandatory adopters solely or even primarily to the IFRS mandate.

Many adopting countries have made concurrent efforts to improve enforcement and governance regimes, which likely play into the findings. Consistent with this interpretation, the estimated liquidity improvements are smaller in magnitude when analyzed on a monthly basis, which is more likely to isolate IFRS reporting effects.

The paper is: Mandatory IFRS Reporting Around the World: Early Evidence on the Economic Consequences