MSc Accountancy & Control, Accountancy track
Faculty of Economics and Business, University of Amsterdam
Master Thesis:
The influence of the degree of shareholder protection
on the impact of IFRS adoption on value relevance
of financial reporting information in the EU
Robert Bakker
Student name:
Robert Bakker
Student number:
10180575
Date of submission:
19
thof June 2015
Course:
Master’s Thesis Accountancy
Course code:
6314M0244 (2014-2015)
First supervisor:
Dr. Réka Felleg
2
Statement of originality
This document is written by student Robert Bakker who declares full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
3
Abstract
I examine how the impact of IFRS adoption on value relevance of financial reporting information in the European Union (EU) is influenced by the degree of shareholder protection. I find, as hypothesized, that the IFRS impact on value relevance of financial reporting information is positively influenced by the degree of shareholder protection. This confirms my expectations that the degree of shareholder protection positively influences the IFRS impact on value relevance in the EU, due to firms’ higher incentives to provide value relevant financial reporting information. My results indicate that the degree of shareholder protection is an institutional characteristic that should be taken into account when creating and testing expectations on the impact of IFRS adoption on value relevance of financial reporting information. This study shows that the degree of shareholder protection should be taken into account by regulators when deciding on issues of accounting standards.
4
Table of content
1. Introduction ... 5
2. Literature review ... 8
2.1 Expected IFRS impact on value relevance of financial reporting information ... 8
2.2 Prior research on IFRS impact on value relevance ... 11
3. Theory and hypothesis development ... 13
3.1 Incentives for reduction of information asymmetry ... 13
3.2 Reduction of information asymmetry by private and public communication ... 14
3.3 Shareholder protection, incentives to provide credible financial statements and consequences for value relevance ... 16
4. Sample and empirical design ... 20
4.1 Sample ... 20
4.2 Empirical design ... 21
4.2.1 Shareholder protection ... 21
4.2.2 First value relevance model: 1st and 2nd metric ... 21
4.2.3 Second value relevance model, 3rd metric ... 24
5. Results ... 26
5.1 Descriptive results ... 26
5.2 Preliminary analysis ... 27
5.3 Results second value relevance model ... 30
5.4 Robustness tests ... 31
5.5 Additional analysis ... 33
5.6 Discussion ... 34
6. Conclusion ... 37
5
1. Introduction
This study examines how the impact of IFRS adoption on value relevance of financial reporting information in the European Union (EU) is influenced by the degree of shareholder protection. This study is motivated by prior studies that examine the impact of IFRS adoption on value relevance of financial reporting information. These studies find mixed results on the IFRS impact and mention the suggestion to conduct additional research on factors that might influence the impact of IFRS adoption on value relevance (Barth et al., 2008; Devalle et al., 2010).
The introduction of the IAS regulation in 2002 has been one of the major changes in the European landscape for financial reporting. This regulation requires listed firms in the European Union to adopt International Financial Reporting Standards (IFRS) to their consolidated accounts as of the fiscal year 2005. With the introduction of the IAS regulation, the European Parliament pursued some key objectives. One key objective of the mandatory adoption of IFRS is that the adoption should improve the usefulness of financial reporting information to investors (Armstrong et al., 2010).
Prior research has focused on examining whether this key objective has been achieved. The concept that is used to draw conclusions on the usefulness of financial reporting information is called ‘value relevance’, defined as the association between financial reporting information and the share price (Barth et al., 2001). Therefore, the impact of IFRS adoption on value relevance of financial reporting information is often tested in order to examine whether the mandatory IFRS adoption has led to better usefulness of financial reporting information. Authors of these studies expect to find improved value relevance due to mandatory IFRS adoption in the EU. However, these kinds of studies result in mixed findings (e.g. Barth et al., 2008; Chtourou et al., 2012; Devalle et al., 2010). Findings are mixed in that the impact of IFRS adoption on value relevance differs for different countries and different accounting amounts. Additional research can contribute to academic literature if it can provide an explanation for the mixed findings from prior literature. Furthermore, additional research can provide stronger clarification on the impact of IFRS adoption on value relevance of financial reporting information. This kind of research could enhance the understanding why IFRS adoption is effective in some cases and ineffective in others, which is of interest to regulators (Barth et al., 2008; Devalle et al., 2010).
Therefore, this study takes the degree of shareholder protection into account in relation to the impact of IFRS adoption on value relevance in the EU. The degree of shareholder protection is an institutional factor that influences firms’ incentives to provide high quality
6 financial statements (La Porta et al., 1997; Ball et al., 2003). I argue that a higher degree of shareholder protection improves firms’ incentives to provide value relevant financial reporting information, due to higher expected costs of shareholder litigation and higher demand for high quality financial statements from investors. These incentives represent an important determinant for financial reporting outcomes (Ball et al., 2003). I therefore hypothesize that the impact of IFRS adoption on value relevance of financial reporting information in the EU is positively influenced by the degree of shareholder protection.
In order to test this expectation, data of firms out of 16 European countries is used. The hypothesis is tested with two different regression models, providing three value relevance metrics. The first and second value relevance metrics result from the Ohlson model that is based on the explanatory power from a regression of share price on the book value of equity and net income (Barth et al., 2008). The third value relevance metric results from a model with two additional variables to construct three-way interaction test variables. These three-way interaction variables allow me to test for the influence of shareholder protection on the impact of IFRS adoption on value relevance of the book value of equity and earnings respectively. I proxy the degree of shareholder protection with the anti-director rights index developed by Djankov et al. (2008), thereby following related research in which this proxy is used as well (Leuz et al., 2003; Burgstahler et al., 2006; Hope et al., 2006).
I find, as hypothesized, that the IFRS impact on value relevance of financial reporting information is positively influenced by the degree of shareholder protection. This positive influence is solely caused by a positive influence on the IFRS impact on value relevance of book value of equity, no influence is found for the IFRS impact on value relevance of earnings. Still, the hypothesis is confirmed by considering joint results for book value of equity and earnings as results for financial reporting information. Furthermore, a decrease in value relevance of financial reporting information is found for the full sample. This decrease is solely caused by decreased value relevance of book value of equity for firms others than firms from countries with a high degree of shareholder protection. Furthermore, I find no influence of the degree of shareholder protection on value relevance for the full sample, indicating that differences in value relevance due to differences in the degree of shareholder protection might only arise when a strong financial reporting framework replaces a less strong financial reporting framework.
This study contributes to academic research, since it is the first study to examine the influence of shareholder protection on the IFRS impact on value relevance of financial reporting information in the EU. My results provide an explanation for the mixed findings resulting from
7 studies that examined the impact of IFRS adoption on value relevance. My results indicate that the association between value relevance and IFRS adoption should not be tested in isolation. The degree of shareholder protection is an institutional characteristic that should be taken into account when creating and testing expectations on the impact of IFRS adoption on value relevance of financial reporting information. The IFRS impact on value relevance of financial reporting information is positively influenced by the degree of shareholder protection, but solely for book value of equity. This explains why results from prior literature differ, depending on what accounting amount is tested and the degree of shareholder protection. This study shows that the degree of shareholder protection is an institutional characteristic that should be taken in account when examining the IFRS impact on value relevance of financial reporting information.
The results of this study are of interest to regulators. The European Parliament decided to require IFRS adoption with the objective of improving usefulness of financial reporting information. The results show that adoption of IFRS is only effective in realizing increased usefulness in environments with a high degree of shareholder protection. Regulators should therefore have considered this institutional characteristic before deciding on mandatory IFRS adoption. The objective of improved usefulness could still be reached in all EU countries if the degree of shareholder protection is enhanced to a satisfying level in all countries. This study shows that the degree of shareholder protection is an institutional characteristic that should be taken into account when regulators decide on issues of accounting standards.
This study has some limitations. I do not find significant results with the Ohlson model due to the weak statistic that is used to compare adjusted R2s. Even though this is still a limitation, I address this limitation by using the results from the Ohlson model only as preliminary results. Another limitation of this study is that I take into account only one institutional characteristic - the degree of shareholder protection - when examining the IFRS impact on value relevance. However, more institutional factors could influence the IFRS impact on value relevance (Soderstrom & Sun, 2007). By increasing the number of factors taken into account, results on the examined associations could change. Future research could address this limitation by testing the influence of other factors on the IFRS impact on value relevance of financial reporting information.
This paper proceeds in section 2 with a literature review on the impact of IFRS adoption on value relevance. Section 3 describes theory that is used to develop my hypothesis. Section 4 discusses the sample characteristics and the empirical design of this study. Results are presented in section 5 and the conclusion of this study is presented in section 6.
8
2. Literature review
2.1 Expected IFRS impact on value relevance of financial reporting information
International Financial Reporting Standards (IFRS) are developed and issued by the International Accounting Standards Board (IASB). The framework that underlies all IFRS is called the Conceptual Framework (IASB, 2010). Within this framework, the starting point for financial reporting as considered by the IASB is clearly stated: ‘the objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity’ (IASB, 2010, p. 9). Therefore, standards developed by the IASB are focused on enhancing the usefulness of financial reporting information. The European Parliament accepted the so-called IAS regulation in 2002, thereby making IFRS adoption mandatory for listed firms in the EU as of fiscal year 2005.
Improved accounting quality and improved usefulness of financial reporting information were the main objectives pursued by the European Parliament (Armstrong et al., 2010). Accounting quality is defined as ‘the extent to which the financial statements provide a faithful representation of the underlying economics’ (IASB, 2010, p.17). The second key objective of mandatory IFRS adoption is to improve the usefulness of financial reporting information. Useful information requires two characteristics according to the IASB’s Conceptual Framework: reliability and relevance. The definition given for reliability in the Conceptual Framework is the same as the definition of ‘accounting quality’ (IASB, 2010). The first reason for IFRS adoption, is therefore already part of the second reason. The concept that can be used to measure the two qualitative characteristics from the Conceptual Framework is value relevance (Barth et al., 2001). Value relevance is defined as ´the ability of financial statement information to capture or summarize information that affects share values´ (Hellström, 2006, p. 325). In other words, greater value relevance shows a greater association between financial reporting information and the share price. The concept of value relevance is an empirical operationalization of the two fundamental characteristics of useful information (Barth et al., 2001). The logic behind using this concept can be clearly explained: ‘An accounting amount will have a significant relation with the share price only if the amount reflects information relevant to investors in valuing the firm and is reliable enough to be reflected in share prices’ (Barth et al., 2001, p. 80). In other words, financial reporting information will only be value relevant if it is both reliable and relevant, which are the two
9 fundamental characteristics of useful information. This reasoning is presented in Figure 1. The concept of value relevance is therefore used to draw conclusions on the impact of IFRS adoption on the usefulness of financial reporting information (e.g. Barth et al., 2001; Paananen & Lin, 2009).
[Include Figure 1 here]
The first qualitative characteristic of useful information is reliability, or accounting quality. Reliability is defined as the extent to which the financial statements provide a faithful representation of the underlying economics (Ahmed et al., 2013; IASB, 2010; Ball, 2006). The presumption by the European Parliament that reliability will improve due to IFRS adoption is adopted by for instance Barth et al. (2008) and Ahmed et al. (2013). They provide arguments to underpin this presumption. First of all, IFRS eliminate a number of accounting alternatives, which should result in a reduction of possibilities for earnings management (Barth et al., 2008; Ahmed et al., 2013). Second, IFRS are principle-based standards, which are more difficult to circumvent (Agoglia et al., 2011). This should result in higher reliability of financial reporting information (Barth et al., 2008; Ahmed et al., 2013). Third, IFRS permit the use of fair value accounting, which should improve the ability to faithfully represent the underlying economics of a business (Ahmed et al., 2013). Despite these arguments in favor of IFRS adoption, there are some arguments why IFRS adoption could reduce the reliability of financial reporting information. First of all, since IFRS are considered principle based, the standards do not provide specific implementation guidance, and therefore provide managers with flexibility. This flexibility provides managers with some ability to manage earnings (Barth et al., 2008; Ahmed et al., 2013). The second argument against IFRS adoption with respect to reliability of financial reporting information has to do with the elimination of accounting alternatives, which could lead to an elimination of alternatives that are the most suitable for representing the underlying economics of a business. However, firms are allowed to use these eliminated alternatives if they can convince their auditor that it benefits the extent to which the underlying economics of a business are represented. The last argument is about the use of fair value accounting. Management’s flexibility will increase after using fair value accounting, resulting in better ability to manage earnings (Schipper, 2005; Ball, 2006). Despite the arguments against the adoption of IFRS with regard to the reliability of financial reporting information, Barth et al. (2008) maintain the expectation that IFRS adoption will lead to an improvement of the reliability of financial reporting information. They consider the arguments in favor of IFRS
10 adoption to be stronger than the contra-arguments, thereby supporting the view of the European Parliament (Barth et al., 2008).
The second fundamental characteristic of useful financial information is relevance, in which ‘relevant information is capable of making a difference in decisions made by users’ (IASB, 2010). Standard setters like the IASB believe that the use of fair-value accounting improves the relevance of financial reporting information (Barth, 2006). This view is expected to be partially true according to prior literature. Ball (2006) for example, mentions the increased informativeness for investment decisions by investors as one of the main advantages of IFRS. Ball (2006) sees this increased informativeness as a direct consequence of the use of fair value accounting over historical cost accounting. Furthermore, the relevance of financial reporting information should improve since more information is disclosed (Ball, 2006). Barth (2006) supports this view, since fair value accounting reflects present economic conditions more accurately than historical cost accounting. This provides users with more relevant information to base their decisions upon (Barth, 2006). The improved comparability of financial reporting information represents another reason why the relevance of financial reporting information is expected to improve after IFRS adoption. The adoption of IFRS, which are already used in over a hundred jurisdictions, is expected to improve the harmonization and comparability of financial reporting information throughout the world (Barth, 2006). On the other hand, Ball (2006) mentions the increased discretion of management as main risk of fair value accounting under IFRS. He warns for increased noise in financial reporting information due to wrong estimations (Ball, 2006), a view strongly supported by Schipper (2005). Despite this drawback of fair value accounting, the general expectation is that the relevance of financial reporting information improves under IFRS due to the increased informativeness, the use of fair-value accounting and the better comparability of financial reporting information (Barth, 2006; Ball, 2006).
In sum, improved accounting quality and improved usefulness of financial reporting information were the main objectives pursued by the European Parliament (Armstrong et al., 2010). Useful financial reporting information requires the two qualitative characteristics of relevance and reliability according to the IASB’s Conceptual Framework. The concept that is used to measure both characteristics is value relevance of financial reporting information, since value relevance is an empirical operationalization of the two fundamental characteristics of useful information (Barth et al., 2001). The reliability of financial reporting information is expected to improve after the adoption of IFRS due to the elimination of accounting alternatives, the use of principle-based standards and the use of fair-value accounting (Barth et
11 al., 2008; Ahmed et al., 2013). The relevance of financial reporting information is expected to improve after the adoption of IFRS as well, due to the increased informativeness, the use of fair-value accounting and the better comparability of financial reporting information (Barth, 2006; Ball, 2006). Prior academic research and regulators therefore argue that IFRS adoption is expected to cause improved value relevance of financial reporting information.
2.2 Prior research on IFRS impact on value relevance
Prior research has focused on the impact of IFRS adoption on value relevance of financial reporting information. The starting point of prior studies is the expected positive IFRS impact on value relevance of financial reporting information, as discussed in section 2.1. Although the studies differ from each other in several aspects, the hypothesis tested remains comparable: IFRS adoption is expected to have a positive impact on value relevance of financial reporting information. The studies differ from each other in whether they are performed in a single-jurisdictional setting or in a multi-single-jurisdictional setting. Kargin (2013) and Liu et al. (2011) test the impact of IFRS adoption on value relevance of financial reporting information in a single-jurisdictional setting. The study of Kargin (2013) covers the period 1998-2011 for Turkish firms, in order to test for changes in accounting quality due to IFRS adoption, which is required since 2005. Kargin (2013) concludes that value relevance increased for the reported book value of equity, but decreased for the reported earnings. The study of Liu et al. (2011) focuses on the impact of IFRS adoption on accounting quality in China, which became mandatory for Chinese firms in 2007. Liu et al. (2011) find that value relevance improved for the reported earnings, but it did not change significantly for the reported book value of equity.
In contrast to the studies discussed above, Devalle et al. (2010), Barth et al. (2008) and Chtourou et al. (2012) conduct a study on value relevance of financial reporting information in a multi-jurisdictional setting. Devalle et al. (2010) find increased (decreased) value relevance of earnings in Germany and France (Italy). Also, they find that value relevance of the book value of equity increased only in the United Kingdom, and decreased in Germany, Spain, France and Italy (Devalle et al., 2010). Although the authors expect similar and positive changes in value relevance, they find different developments, dependent on the kind of reported financial information and countries used (Devalle et al., 2010). Barth et al. (2008) take even a greater number (21) of countries to test the impact of IFRS adoption on value relevance. They find significant results with one of the three used models. The results from the other two models indicate that value relevance of financial reporting information did not change significantly (Barth et al., 2008). From the significant model, they found that value relevance of financial
12 reporting information - based on the explanatory power (adjusted R2) and the coefficients of
earnings and book value of equity - is greater for IFRS firms relative to non-IFRS firms (Barth et al., 2008). This study does not report a breakdown of results to specific countries. The authors conclude that value relevance increased after the adoption of IFRS, although two of the three models did not support this conclusion (Barth et al., 2008). Chtourou et al. (2012) use observations of firms from 15 European countries to test for the impact of mandatory IFRS adoption on value relevance. They find that value relevance of both book value of equity and earnings decreased after the adoption of IFRS. The authors conclude that the usefulness of financial reporting information decreased after the adoption of IFRS (Chtourou et al., 2012). Therefore, findings are mixed in that the impact of IFRS adoption on value relevance differs for different countries and different accounting amounts.
In sum, these studies all start with the expectation to find an improvement of value relevance of financial reporting information after IFRS adoption. Although some studies actually find an improvement of value relevance, there are continuous doubts about the impact of IFRS adoption on value relevance of financial reporting information due to the mixed findings. Some of the authors explicitly mention the suggestion for additional research on factors that might influence the relationship between IFRS adoption and value relevance. Additional research can contribute to an explanation on the mixed findings from prior literature, and thereby contribute to a stronger clarification on the impact of IFRS adoption on value relevance. This kind of research could enhance the understanding why IFRS adoption is effective in some cases and ineffective in others.
13
3. Theory and hypothesis development
3.1 Incentives for reduction of information asymmetry
Underlying all theories, concepts and constructs in this study is the agency relationship, described in the agency theory. An agency relationship knows capital providers of firms who are called ‘principals’ and managers of firms who are called ‘agents’ (Jensen & Meckling, 1976). A conflict of interest occurs due to the separation of ownership and management, which is referred to as an agency problem. The agency theory assumes that everyone maximizes his or her own interests: agents are mainly driven by self-interest, although they are supposed to serve the best interests of the (prospective) principals (Jensen & Meckling, 1976). This situation is considered a problem, since the agents have, relative to their (prospective) principals, better information regarding the firm value and their own behavior. This information advantage for agents is called information asymmetry (Myers & Majluf, 1984).
Information asymmetries cause two kinds of problems for principals, which differ in whether the investment decision by (prospective) principals already has been made (Wallace, 1980). The first kind of problems are called adverse selection problems, which occur in situations in which prospective principals have to decide whether to invest in the firm, regardless of the type of (debt or equity) external financing (Wallace, 1980). They will base their decision on their assessment of the expected ability of the firm to generate future cash flows and the ability to repay its loans. However, agents have an information advantage over prospective principals, which might result in wrong assessments and therefore in poor investment decisions. In other words, agents are exploiting their information advantage at the expense of principals (Scott, 2011). The adverse selection problems create strong incentives for principals to reduce the information asymmetry with the agents. Likewise, agents have related incentives to reduce the information asymmetry as well. In their investment decision, principals will consider both the risk of the investment and the return of the investment. The greater the information asymmetry, the more difficulties prospective principals face to make an adequate assessment of the expected ability of the firm to generate future cash flows and the ability to repay its loans. However, agents that consider their firms as attractive investment opportunities (‘good type’), have incentives to reduce this information asymmetry, in order to communicate their type and separate their firms from ‘bad type’ firms (Akerlof, 1970). Without asymmetry reduction that follows from the communication, good type firms would be undervalued in terms of their share price, since they are pooled with bad type firms that are overvalued. Furthermore,
14 when the information asymmetry is reduced, principals of good type firms require a lower return on their investment in terms of interest (debt financing) and dividend or share price increases (equity financing) due to the lower degree of risk involved with the investment (Wallace, 1980). The higher share price and the requirements for a lower return are favorable for agents. Just like their principals, agents have strong incentives - related to the adverse selection problems - to reduce the information asymmetry (Akerlof, 1970; Wallace, 1980).
The second kind of problems is called moral hazard problems. Moral hazard problems occur in situations in which principals already made their investments in the firm (Wallace, 1980). Principals want agents to work in their best interests, but they cannot monitor agents’ behavior continuously. As a result, agents have better information on their own behavior and performance relative to principals. Agents can exploit this advantage over principals, for instance by reducing their effort or by engaging in behavior that maximizes their own interests instead of principals’ interests (Scott, 2011). The moral hazard problems create strong incentives for principals to reduce the information asymmetry with agents. Likewise, agents have incentives to reduce this information asymmetry as well. In the moral hazard situation, principals face difficulties to monitor whether agents behave in their best interests, due to the information asymmetry. Principals therefore assume that agents do not behave in their best interests when agents’ behavior cannot be monitored adequately (Wallace, 1980). Anticipating the inefficient behavior of the agents, principals propose to lower the compensation given to agents. This creates an incentive for agents to reduce the information asymmetry (Wallace, 1980). Therefore, both principals and agents have strong incentives - related to moral hazard problems - to reduce the information asymmetry.
In sum, the separation of management and ownership creates an information asymmetry between agents and principals, in which agents have an information advantage relative to principals. Information asymmetries cause both adverse selection problems and moral hazard problems. Although agents have an information advantage, both agents and principals have incentives to reduce the information asymmetry.
3.2 Reduction of information asymmetry by private and public communication
In order to reduce information asymmetries, two types of communication between the agents and principals can be used: private communication and public communication. Private communication takes place between agents and representatives of only one type of principal, all other people are excluded and cannot access the information provided by agents (Ball et al., 2003). It is a way of insider communication, which reduces the information asymmetry between
15 the firms and the principal (La Porta et al., 2006; Ball et al., 2003). Public communication takes place between agents and everyone that is interested in the published information. This also means that disclosures are available to everyone at zero cost. This way of communication takes place in situations in which the firm is not able to communicate privately with (a representative of) all principals that it wants to communicate with (Ball et al., 2003).
One way of public communication is disclosure of financial statements, which present financial information about the firm. Disclosure of financial statements is a common way of reducing the information asymmetry between agents and principals, since listed firms in most jurisdictions are required to make these disclosures (Wallace, 1980). Firms are required to adhere to a financial reporting framework (for instance IFRS) for the preparation of its financial statements. The degree to whether financial statements are considered as credible by principals determines whether disclosure of financial statements is effective in reducing the information asymmetry between agents and principals (Wallace, 1980). The quality of the financial reporting framework is critical in adding credibility to disclosure of financial statements, since both the preparation and the audit of financial statements are based on the financial reporting framework (Sutton, 1997). Levitt (1998), former chairman of the U.S. Securities and Exchange Commission (SEC), believes that the success of capital markets is directly dependent on the quality of the financial reporting framework. Levitt (1998) thinks that disclosure systems based on a high quality framework, result in investor confidence in credibility of financial statements. Brown (2011) emphasizes this: ‘accounting standards are important - if not crucial - in a complex financial market because they underpin how capital is allocated and performance is monitored and rewarded’ (Brown, 2011), thereby referring to the problems following from the agency relationship. Therefore, disclosure of credible financial statements prepared in accordance with a high quality financial framework - as a manner of public communication between principals and agents - is an effective way of reducing information asymmetries between agents and principals.
In sum, both principals and agents have incentives to reduce the information asymmetry. The primary way in which this is done is through communication between agents and principals. Communication can be distinguished into private and public communication. Private communication is only suitable in situations in which the firm is able to communicate privately with the vast majority of capital providers. In the remaining situations, public communication is used for reducing information asymmetry. A common way in which this is done, is through the disclosure of financial statements by firms. The degree to whether these disclosures are considered as credible by principals determines whether disclosure of financial
16 statements is effective in reducing the information asymmetry between agents and principals. Adherence to a high quality financial reporting framework adds credibility to financial statements. Information asymmetries can therefore be reduced in an effective way by disclosure of financial statements - as a form of public communication - when financial statements are prepared on a high quality financial reporting framework.
3.3 Shareholder protection, incentives to provide credible financial statements and consequences for value relevance
The origin of examining institutional characteristics as determinants of financial reporting outcomes is a study conducted by Alford et al. (1993). They found differences between value relevance of financial reporting information across different countries. They suggested that future research should focus on factors that can explain these differences (Alford et al., 1993). La Porta et al. (1997) and Ball et al. (2003) develop the basis for shareholder protection as one of these factors. La Porta et al. (1997) considered the degree of shareholder protection as strongly associated with concentration of firms’ ownership. Ball et al. (2003) empirically tested the impact of the degree of shareholder protection on financial reporting outcomes, thereby creating expectations based on the outcomes of the La Porta et al. (1997) study.
La Porta et al. (1997) analyze the degree of shareholder protection in 49 different countries. Their analysis is based on multiple measures, which are summarized as the strength of laws and the strength of enforcement of laws in a country (La Porta et al., 1997). They chose the 49 countries with the greatest stock market capitalization in 1993. La Porta et al. (1997) conduct a questionnaire-based study with answers from attorneys worldwide. In this way they obtain data, which they use to construct variables that measure the degree of shareholder protection in every single country (La Porta et al., 1997). By using this data, they are able to draw a relation between the degree of shareholder protection and the character of the capital market in terms of size of the equity market. Investors are seen as protected by laws to a much higher degree in ‘shareholder-oriented’ countries relative to ‘stakeholder-oriented’ countries. La Porta et al. (1997) find that this distinction shows a strong association with firms’ financing patterns. They find a negative association between the degree of shareholder protection and the concentration of firms’ ownership. The lower the degree of shareholder protection, the higher is the concentration of ownership of firms. These results support their idea that concentrated ownership is an adoption to a lack of shareholder protection (La Porta et al., 1997). La Porta et al. (1997) find that firms in shareholder-oriented countries are mainly financed by public
17 investors, such as shareholders. Therefore, concentration of ownership is low. Firms in stakeholder-oriented countries are mainly financed by private investors like banks, which is why concentration of ownership is high. This means that countries with a higher degree of shareholder protection (e.g. United Kingdom) have a much greater equity market relative to countries with a low degree of shareholder protection (e.g. Germany; La Porta et al., 1997).
The degree to which shareholders are protected has consequences for firms’ incentives to provide credible financial statements (Ball et al., 2003; Soderstrom & Sun, 2007). The first consequence directly results from the relation that La Porta et al. (1997) find. Firms’ ownership is less concentrated in countries with a higher degree shareholder protection (La Porta et al., 1997). Due to this greater dispersion in ownership, investors mainly depend on public communication - as described in section 3.2 - to reduce the information asymmetry between management and investors. As a consequence, there is stronger demand by investors for credible financial statements (Ball et al., 2003; Ali & Hwang, 2000). In countries with a low degree of shareholder protection, firms’ ownership is more concentrated (La Porta et al., 1997). Investors depend mainly on private communication - as described in section 3.2 - to reduce the information asymmetry, and demand for credible financial statements is therefore low (Ball et al., 2003; Ali & Hwang, 2000). The demand for credible financial statements is therefore the first incentive for firms to provide high quality financial statements that is a consequence of the degree of shareholder protection. The second consequence relates directly to the degree of shareholder protection. Firms could face higher expected costs of shareholder litigation in countries with a higher degree of shareholder protection (Ball et al., 2003). These costs derive from increased legal exposure and worse brand name reputation if shareholders exercise their rights in situations of poor financial reporting quality (Soderstrom & Sun, 2007; Francis & Wang, 2008). Firms have incentives to avoid these costs by providing high quality financial statements. Thus, a higher degree of shareholder protection provides incentives to provide high quality financial statements due to stronger investor demand for credible financial statements and higher expected litigation costs for firms.
The degree to which shareholders are protected has consequences for firms’ incentives to provide credible financial statements, and therefore might impact financial reporting outcomes. Ball et al. (2003) examine accounting quality in four East Asian countries and two control groups. The level of shareholder protection in the East Asian countries is low, and the main providers of capital in these countries are banks (Ball et al., 2003). The degree of shareholder protection is high (shareholder-oriented) in the first control group and low (stakeholder-oriented) in the second control group. The quality of the financial reporting
18 standards in the four East Asian countries is considered as strong (Ball et al., 2003). By examining accounting quality, Ball et al. (2003) aim to test whether firms’ incentives are better able to explain financial reporting outcomes relative to high quality of the financial reporting standards. Firms from the East Asian countries do not have strong incentives to provide credible financial reporting information, since the demand for financial reporting information and the expected litigation costs are low due to the low degree of shareholder protection (Ball et al., 2003). Ball et al. (2003) find that the accounting quality in the four East-Asian countries is similar to or even worse than the accounting quality in stakeholder-oriented countries control group; even though the financial reporting standards are strong. Ball et al. (2003) conclude that incentives are better able to explain financial reporting quality than high quality financial reporting standards. The authors suggest that introducing strong accounting standards is not effective in countries in firms’ incentives to provide high quality financial reporting information are weak (Ball et al., 2003).
In sum, the degree of shareholder protection affects incentives for firms to provide high quality financial reporting information (La Porta et al., 1997; Ali & Hwang, 2000; Ball et al., 2003). First of all, this can be explained by the negative relation of the degree of shareholder protection with firms’ ownership concentration. Firms’ ownership is less concentrated in countries with a higher degree of shareholder protection and more concentrated in countries with a low degree of shareholder protection (La Porta et al., 1997). The extent to which ownership is concentrated influences firms’ incentives to provide credible financial statements. For firms with a high extent of ownership concentration, investors depend mainly on private communication to reduce the information asymmetry, and demand for high quality financial statements is therefore low (Ball et al., 2003; Ali & Hwang, 2000). For firms with a greater dispersion in ownership, investors mainly depend on public communication to reduce the information asymmetry between management and investors. As a consequence, there is stronger demand by investors for high quality financial statements (Ball et al., 2003; Ali & Hwang, 2000). The demand for credible financial statements therefore provides the first incentive to provide high quality financial statements for firms that is affected by the degree of shareholder protection. The second incentive derives from the expected costs of shareholder litigation. Firms could face higher expected costs of shareholder litigation in countries with a higher degree of shareholder protection (Ball et al., 2003). Expected costs of shareholder litigation therefore provide the second incentive to provide high quality financial statements for firms that is affected by the degree of shareholder protection. These incentives might be more
19 important in determining financial reporting outcomes, like value relevance, than the set of financial reporting standards, as shown by Ball et al. (2003).
I expect firms’ incentives to provide credible financial statements to be positively impacted by the degree of shareholder protection in a European setting as well. Incentives might be more important in determining value relevance than only the introduction of the high quality IFRS in the EU. Prior studies find mixed results regarding the impact of IFRS adoption on value relevance of financial reporting information in the EU. These studies did not take into account differences in firms’ reporting incentives resulting from the different degree of shareholder protection. I expect the mixed results on value relevance to be caused by differences in the degree of shareholder protection in the countries in which the studies are conducted. The different incentives following from a different degree of shareholder protection, might explain the mixed results on the impact of IFRS adoption on value relevance. Firms from EU countries have different incentives to provide value relevant financial reporting information, due to the different degree of shareholder protection. I therefore expect the degree of shareholder protection to have a positive influence on the impact of IFRS adoption on value relevance of financial reporting information:
Hypothesis: The impact of IFRS adoption on value relevance of financial reporting information in the EU is positively influenced by the degree of shareholder protection.
20
4. Sample and empirical design
4.1 Sample
I obtain my initial dataset with balance sheet data from Compustat Global – Fundamentals. This dataset includes observations of firms whose headquarters are located in the EU. The data is obtained for the period 1-1-2002 to 31-12-2007, thereby using data of about three years before the adoption of IFRS and about three years after the adoption of IFRS. This results in an initial dataset of 38,532 observations of 6,701 firms. Following prior literature, I drop 8,885 observations with a SIC code between 6000-6999, referring to observations of firms in the business of finance, real estate and insurance (e.g. Liu et al., 2011; Chtourou et al., 2012; Leuz et al., 2003). Subsequently, I obtain share data from the Compustat Global – Security daily database, which is different from the Compustat Global – Fundamentals Annual database. Observations with insufficient share data or data on book value of equity or net income are removed from the sample. The final sample consists of 20,369 observations of 5,333 firms. This sample selection process is outlined in Table 1.
[Insert Table 1 here]
Properties of the full sample are presented in table 2 and 3. Table 2 presents the industry breakdown of observations in the sample. The sample consists of a range of industries, with a great representation (3,852 observations, 18.9%) of firm-years from business services, which comprise the greatest part of the total amount of observations from service industries (SIC 7000-8999, 4,792 observations, 28.44%). This strong representation of observations from service industries is similar to related studies (Barth et al., 2008). Observations of firms in the manufacturing industry (SIC 2000-3999) represent the greatest part of observations (8,720 observations, 42.8%) in the sample, which is similar to related studies as well (Barth et al., 2008; Liu et al., 2011). Table 3 presents the country breakdown of observations in the sample, both for the pre-IFRS and post-IFRS period. The sample consists of observations of firms with headquarters in 16 different European countries. The greatest part of the sample consists of observations from the United Kingdom (38.96% of the total sample), which is similar to related studies (e.g. Leuz et al., 2003; Devalle et al., 2010; Barth et al., 2014). Other countries with a great representation are France (13.5%) and Germany (13.4%), which is similar to related
21 studies as well (e.g. Chtourou et al., 2012; Leuz et al., 2003; Devalle et al., 2010). The properties of the sample used for this study are similar to relevant studies. It is therefore that I can adequately compare results.
[Insert Table 2 and Table 3 here]
4.2 Empirical design
4.2.1 Shareholder protection
A proxy for the degree of shareholder protection is used for all models in this study. I proxy the degree of shareholder protection with the revised ‘anti-director rights index’ (Djankov et al., 2008), thereby following related research in which this proxy is used as well (e.g. Leuz et al., 2003; Burgstahler et al., 2006; Hope et al., 2006). The anti-director rights index summarizes the protection of minority shareholders by measuring whether shareholders are favoured in a voting process against managers (La Porta et al., 1997). The index is made up based on a questionnaire-based study with answers from attorneys worldwide. La Porta et al. (1997) developed the index in 1997 for 49 different countries, based on the laws in force from 1993 onwards. The revised index of 2008 is an improved and extended (72 countries) version, based on laws and regulations for publicly traded firms from 2003 onwards (Djankov et al., 2008). The anti-director rights index is used as the proxy for the degree of shareholder protection in related research as well (e.g. Leuz et al., 2003; Leuz et al., 2010; Burgstahler et al., 2006; Hope et al., 2006). The values of the anti-director rights index are measured by the variable AntiDirector, with a range of 1.0 to 5.0.
By using AntiDirector, I construct variable DSP that classifies whether the degree of shareholder protection (DSP) is low (DSP = 1), moderate (DSP = 2) or high (DSP = 3). I follow related literature by making such a classification (Burgstahler et al., 2006). The level of shareholder protection in countries with an AntiDirector score between 1 and 2.5 is classified as low; shareholder protection in countries with a score between 3 and 4 is classified as moderate and protection in countries with an AntiDirector score of 5 is classified as high.
4.2.2 First value relevance model: 1st and 2nd metric
The first and second value relevance metric result from the so-called Ohlson model (Ohlson, 1996) that is based on the explanatory power from a regression of share price on book value of
22
1For example: Share data from 24-6 to 7-7 is used to compute the value for SharePrice for observations with fiscal year end
on 31-12. Share data from 24-12 to 7-1 is used to compute the value for SharePrice for observations with fiscal year end on 31-6.
equity and earnings (Barth et al., 2008). This model is used to test the association between accounting information (book value of equity and earnings) and share price. Accounting information is more value relevant to investors if a greater association with share price is found (Chtourou et al., 2012). In line with relevant literature, I regress the following equations, which represent my first model (e.g., Barth et al., 2008; Liu et al., 2011; Eng et al., 2014):
𝑆ℎ𝑎𝑟𝑒𝑃𝑟𝑖𝑐𝑒 = 𝛽0+ 𝛽1𝐶𝑜𝑢𝑛𝑡𝑟𝑦 + 𝛽2𝑆𝐼𝐶 + 𝛽3𝑆𝐸𝐶 + 𝜀 (1)
𝑆ℎ𝑎𝑟𝑒𝑃𝑟𝑖𝑐𝑒∗ = 𝛽0+ 𝛽1𝐵𝑉𝐸𝑃𝑆 + 𝛽2𝑁𝐼𝑃𝑆 + 𝜀 (2)
SharePrice is regressed on country and industry fixed effects in equation 1 in order to obtain a measure of share price that is unaffected by characteristics of industries and countries for each period. SharePrice is a measure of share price six months after fiscal year end. The share price is measured six months after fiscal year end because all accounting information disclosed in the annual report should be processed by investors and reflected in the share price at that moment (e.g. Barth et al., 2008; Lang et al., 2006). I measure SharePrice as the average share price over a time interval of 14 calendar days. I expect this method to give a more reliable and representative view of the share price around six months after fiscal year end relative to just picking share data from one date. SharePrice is therefore measured as the average share price from share data of the seven days before and the seven days after the date six months after fiscal year end1. SharePrice is winsorized at the 1% and the 99% level to control for outliers (e.g., Chtourou et al., 2012; Lang et al., 2006). Country is a measure of the country in which the firm’s headquarters are located. SIC is the two-digit SIC code of the industry into which the firm is active (e.g. Eng & Sun, 2014; Barth et al., 2008; Devalle et al., 2010). SEC is a variable which measures the security exchange code of the major exchange on which the firm’s shares are traded (e.g. Eng & Sun, 2014; Barth et al., 2008; Devalle et al., 2010).
The residuals from equation 1, SharePrice*, are the measure for share price that is unaffected by characteristics of industries and countries for each period. SharePrice* is regressed on book value of equity per share (BVEPS) and net income per share (NIPS) in equation 2 (e.g., Barth et al., 2008; Liu et al., 2011; Eng et al., 2014). Both BVEPS and NIPS are winsorized at the 1% and 99% level to control for outliers (e.g., Chtourou et al., 2012; Lang et al., 2006). Equation 2 is regressed for both pre-IFRS and post-IFRS observations, resulting
2The Z-statistic is computed with the Cramer (1987) procedure (Harris et al., 1994; Gaeremynck et al., 2012).
𝑍 = (𝑅12−𝑅22) √(𝑉𝑎𝑟1(𝑅12)+𝑉𝑎𝑟2(𝑅22))
. In which Vari is the mean square error of regression i.
23 in the first set of two regressions (see regression 1 and 2 in Figure 2). I regress equation 2 separately for observations with respectively a low, moderate and high degree of shareholder protection, both for pre-IFRS observations and post-IFRS observations. This means that I run another three sets of two regressions, meaning another six regressions in total (see regressions 3-8 in Figure 2). I run separate regressions since I use adjusted R2s as my first value relevance metric as described hereafter; a dummy approach is followed with the second value relevance model. Standard errors are robust to heteroskedasticity and observations are clustered on a unique firm identifier.
[Insert Figure 2 here]
Both the first and second value relevance metrics result from the Ohlson model. I follow related studies by using the Cramer procedure for the comparison of adjusted R2s (Harris et al., 1994; Gaeremynck et al., 2012). Although the Cramer procedure is used quite often to compute Z-statistics, it is not known as a very reliable and useful procedure (Hope, 2007). It is found in prior studies that it is very difficult to find significant differences between adjusted R2s of two models (Liu et al., 2011; Eng et al., 2014). It is therefore, that I use coefficients resulting from the Ohlson model as value relevance metric as well. However, testing value relevance by comparisons of coefficients between separate regressions has only been conducted in few related studies (Barth et al., 2014; Devalle et al., 2010). It is therefore, that I do not aim to statistically support my hypothesis with the first two value relevance metrics. Results are only used as indications on whether my hypothesis will be supported by the third metric. These indications are discussed as preliminary analysis in section 5.2.
My first value relevance metric is the adjusted R2 value of the regression of equation 2. Adjusted R2 measures the explanatory power of book value of equity and net income for share price (Barth et al., 2008). In order to compare adjusted R2s, the Cramer procedure (1987) is used. The significance levels for comparisons of the adjusted R2s are measured with Z-statistics resulting from the Cramer procedure2 (Harris et al., 1994; Eng et al., 2014). IFRS adoption has a positive impact on value relevance of financial reporting information if the adjusted R2 of the post-IFRS regression (regression 2) is greater than the adjusted R2 of the pre-IFRS regression (regression 1). When taking into account DSP (see regressions 3-8 in Figure 2), the IFRS impact on value relevance is positively influenced by the degree of shareholder protection if the
24 increase in adjusted R2s is greater in subsequent sets of regressions. In other words, I expect the
increase of adjusted R2 to be greater for the set of regressions for which DSP is moderate,
relative to the set of regressions for which DSP is low; I expect the increase of adjusted R2 to
be greater for the set of regressions for which DSP is high, relative to the sets of regressions for which DSP is low or moderate. The results provide indications that the hypothesis will be supported if the increase in adjusted R2 in a set of regressions is the most significant for the last set of regressions.
My second value relevance metric are the coefficients 𝛽1 and 𝛽2 of regressions 1-8 of equation 2, which measure the association of respectively book value of equity and earnings with the share price (Barth et al., 2014; Devalle et al., 2010). I compare coefficients 𝛽1 and 𝛽2 for the first regression in a set (regression 1, 3, 5 and 7) with 𝛽1 and 𝛽2 for the second regression
in a set (regression 2, 4, 6 and 8). Chi-squared statistics (Chi2) are used to estimate significance levels for comparisons of coefficients from different regressions. IFRS adoption has a positive impact on value relevance of financial reporting information if the coefficients 𝛽1 and 𝛽2 of the post-IFRS regression (regression 2) are greater than the coefficients 𝛽1 and 𝛽2 of the pre-IFRS regression (regression 1; Barth et al., 2014). The IFRS impact on value relevance is positively influenced by the degree of shareholder protection if the increase in coefficients is greater in subsequent sets of regressions. When taking into account DSP, I expect an improving IFRS impact on coefficients 𝛽1 and 𝛽2 for each subsequent set of regressions. In other words, I expect
the increase of coefficients 𝛽1 and 𝛽2 to be greater for the set of regressions for which DSP is moderate, relative to the set of regressions for which DSP is low; I expect the increase of coefficients 𝛽1 and 𝛽2 to be greater for the set of regressions for which DSP is high relative to the sets of regressions for which DSP is low or moderate. The results provide indications that the hypothesis will be supported if the increase in coefficients 𝛽1 and 𝛽2 in a set of regressions is the most significant for the last set of regressions.
4.2.3 Second value relevance model, 3rd metric
The third value relevance metric results from a regression model that is an alternative for the Ohlson model. I follow most value relevance studies in using both the Ohlson model and its alternative (e.g. Barth et al., 2014; Chtourou et al., 2012; Liu & Liu, 2007; Gaeremynck et al., 2007). In the alternative model, I use two additional variables to construct three-way interaction test variables. These three-way interaction variables allow me to test for the influence of
25 shareholder protection on the impact of IFRS adoption on value relevance of book value of equity and earnings respectively (Eng et al., 2014):
𝑆ℎ𝑎𝑟𝑒𝑃𝑟𝑖𝑐𝑒∗ = 𝛽 0+ 𝛽1𝐵𝑉𝐸𝑃𝑆 + 𝛽2𝐼𝐹𝑅𝑆 + 𝛽3𝐴𝑛𝑡𝑖𝐷𝑖𝑟𝑒𝑐𝑡𝑜𝑟 + 𝛽4𝐵𝑉𝐸𝑃𝑆𝑥𝐼𝐹𝑅𝑆 + 𝛽5𝐵𝑉𝐸𝑃𝑆𝑥𝐴𝑛𝑡𝑖 + 𝛽6𝐼𝐹𝑅𝑆𝑥𝐴𝑛𝑡𝑖 + 𝛽7𝐵𝑉𝐸𝑃𝑆𝑥𝐼𝐹𝑅𝑆𝑥𝐴𝑛𝑡𝑖 + 𝜀 (3) 𝑆ℎ𝑎𝑟𝑒𝑃𝑟𝑖𝑐𝑒∗ = 𝛽0+ 𝛽1𝑁𝐼𝑃𝑆 + 𝛽2𝐼𝐹𝑅𝑆 + 𝛽3𝐴𝑛𝑡𝑖𝐷𝑖𝑟𝑒𝑐𝑡𝑜𝑟 + 𝛽4𝑁𝐼𝑃𝑆𝑥𝐼𝐹𝑅𝑆 + 𝛽5𝑁𝐼𝑃𝑆𝑥𝐴𝑛𝑡𝑖 + 𝛽6𝐼𝐹𝑅𝑆𝑥𝐴𝑛𝑡𝑖 + 𝛽7𝑁𝐼𝑃𝑆𝑥𝐼𝐹𝑅𝑆𝑥𝐴𝑛𝑡𝑖 + 𝜀 (4)
In which both NIPS and BVEPS are still winsorized at the 1% and 99% level to control for outliers and both variables are centered at their mean. AntiDirector is the value of the anti-director rights index as reported by Djankov et al. (2008). IFRS is a dummy variable which equals 1 if the financial statements are prepared using IFRS and 0 otherwise. Standard errors are robust to heteroskedasticity and observations are clustered on a unique firm identifier.
The three way interaction variables are used to test the hypothesis. Significant positive coefficients (𝛽7) for the three way interaction terms are expected to reflect differences in the IFRS impact on value relevance of book value of equity and earnings due to the inclusion of the AntiDirector variable. This is interpreted as a positive influence of the degree of shareholder protection on the IFRS impact on value relevance (Liu et al., 2011). Thus to confirm my hypothesis, I expect a positive and significant coefficient 𝛽7 in both regression 3 and regression
4. The coefficients 𝛽4 for BVEPSxIFRS and NIPSxIFRS indicate whether both accounting amounts have a changed association with share price after IFRS adoption (Liu et al., 2011). The coefficients 𝛽5 for BVEPSxAnti and NIPSxAnti indicate whether both accounting amounts have a different association with share price when the degree of shareholder protection is taken into account for the full test period.
26
5. Results
5.1 Descriptive results
Descriptive results on the distribution of observations based on the degree of shareholder protection as measured by DSP are presented in Table 4. This classification is used for the first model and therefore for the first eight regressions. The group with a high degree of shareholder protection is represented the most (40.51%) relative to the groups with a low (29.62%) and a moderate level of shareholder protection (29.87%) respectively. The share of the group with a high level of shareholder protection is mainly caused by the great representation in pre-IFRS observations (55.65% of all pre-IFRS observations). The group with a moderate level of shareholder protection is represented the most consistent during both the pre-IFRS (29.09%) and the post-IFRS period (30.71%). I cannot compare my descriptive statistics with regard to DSP, since previous studies did not consider the degree of shareholder protection or did not elaborate on these statistics (e.g. Burgstahler et al., 2006; Hope et al., 2006; Leuz et al., 2003).
[Insert Table 4 here]
Descriptive statistics on the key variables used in my analysis, both for the pre-IFRS and the post-IFRS period, are presented in Table 5. The means of all key variables are significantly different (at 0.01 level) in the post-IFRS period relative to the pre-IFRS period. The mean of SharePrice equals 26.33 in the post-IFRS period relative to 15.44 in the pre-IFRS period. The mean of BVEPS equals 11.78 in the post-IFRS period relative to 8.12 in the pre-IFRS period. The mean of NIPS equals 1.41 in the post-IFRS period relative to 0.71 in the pre-IFRS period. These developments are similar in related research that cover the same period (e.g. Devalle et al., 2010; Liu et al., 2011; Eng et al., 2014). The mean of AntiDirector is significantly greater in the pre-IFRS period (4.076) relative to the post-IFRS period (3.263). This development can be explained by the relatively strong representation of observations with a DSP value of high in the pre-IFRS period relative to the post-IFRS period, as presented in Table 4.
[Insert Table 5 here]
Correlations of key variables are presented in a correlation matrix in Table 6. SharePrice* is, as expected, positively correlated with both BVEPS and NIPS. BVEPS and NIPS are
27 significantly correlated as well (0.7447). All variables are significantly correlated with others, which is in line with related studies in which a correlation matrix is presented (Bartov et al., 2005). I perform tests to ensure that my analysis does not suffer from multicollinearity problems. These tests provide untabulated results that show that the greatest variable inflation factor (variable BVEPS) equals 2.3. The variable inflation factors of the remaining variables are less than 2.3. Thus even though all key variables are correlated, there are no multicollinearity problems.
[Insert Table 6 here]
5.2 Preliminary analysis
The full regression output for the eight regressions with the first value relevance model (equation 2) is reported in Table 7, panel A. As expected, the coefficients of both BVEPS (𝛽1) and NIPS (𝛽2) are significantly positive in all eight regressions. This means that both book value of equity and earnings are positively associated with share price. The 𝛽2 coefficient
(NIPS) is greater relative to the 𝛽1coefficient (BVEPS), which is similar to related studies (e.g. Liu et al., 2011).
[Insert Table 7 here]
The results for the first and second value relevance metrics are presented in Table 7, panel B and C. The first lines of panel B and C report results for the set of two regressions with the full sample: a regression for which IFRS equals 0 and a regression for which IFRS equals 1. These regressions are made to examine whether there is an IFRS impact on value relevance. The value relevance model shows less explanatory power in the post-IFRS period (Adjusted R2 = 0.584) relative to the pre-IFRS period (Adjusted R2 = 0.650), although not significantly different (Z-statistic = 0.002). This is an indication that overall value relevance has worsened after the adoption of IFRS. Similar results based on this value relevance metric are found in related studies (e.g. Chtourou et al., 2012). The coefficients for BVEPS and NIPS resulting from the Ohlson model present the second value relevance metric. The BVEPS coefficient is insignificantly (Chi2 = 0.41) smaller in the post-IFRS period (0.881) relative to the pre-IFRS period (0.939). The NIPS coefficient is insignificantly (Chi2 = 2.26) greater in the post-IFRS
28 indicates that the decrease in value relevance of financial reporting information is mainly caused by lower value relevance of book value of equity. These changes in coefficients are similar to changes of coefficients found in related studies (e.g. Eng et al., 2014; Gaeremynck et al., 2007).
The degree of shareholder protection is taken into account for the remaining results in Table 7, panel B and C. These results are not compared with other studies, because the degree of shareholder protection has not been taken into account in other value relevance studies. The second lines of panel B and C report the results for two regressions with observations with a low level of shareholder protection. The value relevance model shows less explanatory power in the post-IFRS period (Adjusted R2 = 0.5122) relative to the pre-IFRS period (Adjusted R2 = 0.5731). Although a decrease in value relevance is witnessed, this decrease is not significantly different (Z-statistic = 0.0019). Still, these results indicate that value relevance decreased after IFRS adoption for countries with a low level of shareholder protection. The BVEPS coefficient is insignificantly (Chi2 = 0.37) smaller in the post-IFRS period (0.816) relative to the pre-IFRS period (0.922). Similar to coefficients of the regressions with the full sample, the NIPS coefficient is insignificantly (Chi2 = 0.20) greater in the post-IFRS period (6.581) relative to the pre-IFRS period (5.540). These changes in coefficients are insignificant, but they indicate that the decrease in value relevance for countries with a low level of shareholder protection is mainly caused by a lower value relevance of book value of equity.
The third lines in panel B and C of Table 7 report results for the first and second value relevance metrics for the two regressions with observations with a moderate level of shareholder protection. As with the previous four regressions, a decrease in value relevance is shown by the lower adjusted R2 in the post-IFRS period (0.586) relative to the pre-IFRS period
(0.643), although this difference is not significant (Z-statistic = 0.001). The changes in coefficients for these regressions show a similar development as the changes of coefficients for the previous four regressions. The BVEPS coefficient is insignificantly (Chi2 = 0.04) smaller in the post-IFRS period (0.877) relative to the pre-IFRS period (0.900), although the decrease is insignificant. The NIPS coefficient is significantly (at 0.1 level, Chi2 = 3.08) greater in the post-IFRS period (6.581) relative to the pre-post-IFRS period (5.540). This indicates that the decreased value relevance for countries with a moderate level of shareholder protection is caused by a lower value relevance of book value of equity.
Finally, regression results for observations with a high level of shareholder protection are presented in the last lines of panel B and C in Table 7. A different development in the adjusted R2 is reported for these regressions. Adjusted R2 increased strongly post-IFRS (0.4078)
