The harmonization of reporting standards has come a long way since the mandatory adoption of International Financial Reporting Standards (IFRS) for public firms in the European Union (EU) and other countries in 2005. In our recent paper, we focus on private firms and examine whether an increase in accounting comparability of local financial reporting practices relative to IFRS leads to increased cross-border investment for these non-public entities. Our study reveals that firms affected by a major accounting reform, which brought local generally accepted accounting principles (GAAP) closer to IFRS, experienced a greater increase of 2-6% in foreign ownership than firms that were not affected after the reform.
Does convergence with IFRS, but not its adoption, have benefits?
Our empirical evidence suggests yes. We find that introducing even limited guidance for firms in line with IFRS results in positive economic effects via increased cross-border investments by foreign shareholders. The accounting regime change that we analyzed took place in Germany in 2010, and it was the country’s largest GAAP reform since 1985. The reform’s main objective was to increase the comparability between (local) German GAAP and IFRS to compete with international accounting standards. Using the introduction of the Accounting Law Modernization Act (“Gesetz zur Modernisierung des Bilanzrechts” or “Bilanzrechtsmodernisierungsgesetz” often abbreviated as BilMoG) in Germany in 2010 as an exogenous shock, we identify benefits in the form of higher foreign investment for our “treatment group” (German private firms). This change did not manifest for our “control group” consisting of Austrian firms that did not undergo the same change in their country.
Our choice of Austrian firms for the control group was driven by the strong cultural similarities between the two countries and the similarities in the financial reporting systems of Austria and Germany prior to the enactment of BilMoG. Before 2010, the Austrian commercial code and Austrian tax law closely followed the corresponding German rules for about 150 years with particular emphasis on the “prudence principle,” focusing on historical cost rather than fair values, high creditor protection, and high book-tax conformity. However, when German GAAP moved towards an IFRS-like reporting system through BilMoG in 2010, Austria did not follow suit.
Due to increasing comparability with IFRS in Germany but not Austria, we observe a greater increase of 2-6% in foreign ownership for German private firms compared to the pre-period and our control group of Austrian firms. Our difference-in-differences research design, based on this quasi-experimental setting, allows us to examine how convergence to IFRS within a regime, but not its adoption, allows for unique identification.
Cross-sectional results confirm that the effect is stronger for smaller, highly profitable, intangible-intensive, and more stable firms. Additional analyses suggest that shareholders with private information channels benefit less from the increased comparability in public information, while those with greater familiarity with the new standards benefit more. The findings are robust when subject to different forms of matching procedures, a placebo test, and the use of an alternative control group of German public firms.
Implications for academia and standard setters
Most countries worldwide still do not require, and sometimes prohibit, IFRS for private firms. This is primarily because local GAAP is considered to be less costly. Yet, private firms constitute most of the economy for almost every country. Given the economic significance of this group of firms, it is crucial to understand the effects of accounting changes when regulations increase comparability among private firms, aligning them with accounting standards used by publicly traded firms. Our evidence suggests that ignoring the benefits of increasing comparability with IFRS for such a significant set of economic agents in the global economy is potentially harmful to the liquidity, value, and investor base of these firms.
Moreover, while the U.S. is unlikely to ever abolish U.S. GAAP and replace it with IFRS (Rouse 2014), over the last decade, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) have jointly worked on numerous projects such as Financial Instruments, Lease Agreements, and Revenue Recognition to further an ongoing convergence between the two standards. Our evidence on increasing comparability between local GAAP and IFRS provides significant insights toward an understanding of the effect of a country not adopting IFRS but its local GAAP becoming more comparable with the international accounting standards. These findings are relevant to standard setters as more countries continue their convergence towards an endorsement of IFRS and update and improve their local GAAP.
Kristian D. Allee is a Full Professor and the Doyle Z. Williams Chair in Professional Accounting at the University of Arkansas
Tami Dinh is a Full Professor of Accounting at the University of St.Gallen
Arthur Stenzel is an Associate Professor of Accounting at NHH – Norwegian School of Economics
This post was adapted from their paper, “Cross-Border Investments in Private Firms: The Benefits of Comparability for Foreign Investors,” available on SSRN.
