Firm characteristics and IFRS 15 disclosure
MSc Accountancy & Controlling
MSc A&C Accountancy track Date: 24/06/2019
Niek Vegter
Student number: S2738953
Kleine Badstraat 25, 9726 CG Groningen Phone: 06-83123858
e-mail: n.c.vegter@student.rug.nl
Supervisors: R. van Duuren MSc, prof. dr. R.L. ter Hoeven Word count: 13,310
Abstract
This study examines the new IFRS 15 disclosure standard, and potential determinants of this standard. Disclosure can be an important tool for managers to convey firm information to outside investors. Voluntary disclosure literature is studied; while IFRS 15 is a mandatory standard, the degree of compliance is for firms to decide. This is particularly interesting since IFRS 15 is a new standard, thus there are no best practices or industry-specific standards available. A disclosure index has been developed in order to be able to judge firms’ disclosure under IFRS 15. Using a sample acquired from the STOXX600, disclosure scores were computed. The extent of disclosure under IFRS 15 was widespread. The EBIT margin, CEO equity compensation, and the debt-to-equity ratio are examined as potential determinants for IFRS 15 disclosure quality. None of these are significantly related to the IFRS 15 disclosure quality. Several factors could have contributed to these insignificant relationships. Firm size is found to be positively related to IFRS 15 disclosure quality, and firms in the utilities industry provide significantly worse disclosures than firms in the technology industry. There are several interesting avenues for future research. The disclosure index that has been used in this paper may prove useful as a guideline for future studies.
1. Introduction 1
2. Literature background 5
2.1 Theory 5
2.1.1 Voluntary and mandatory disclosure, disclosure quality and information asymmetry 6
2.2 Hypothesis development 12
2.2.1 EBIT margin 12
2.2.2 Debt-to-equity ratio 16
3. Research methodology 20
3.1 Dependent variable: IFRS 15 disclosure quality 21
3.2 Independent variables 22
3.2.1 EBIT margin 22
3.2.2 Debt-to-equity ratio 22
3.3 Mediator variable: Analyst following 23
3.4 Control variables: Industry type & firm size 23
3.5 Model 25
3.6 Data modifications and compiling the disclosure index 26
4. Results 27
4.1 Descriptive statistics 27
4.2 Regression analyses 29
5. Discussion and conclusions 35
5.1 Discussion 35 5.1.1 Results discussion 35 5.1.2 Limitations 37 5.1.3 Future research 38 5.2 Conclusion 38 6. Appendix 40
6.1 Disclosure scores for each firm 40
6.2 The five-step model 40
6.3 The different implications per industry 41
6.4 Best practices 44
6.5 The disclosure index 47
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1. Introduction
Revenue recognition is an interesting aspect of accounting. It is one of the biggest issues in accounting. In the period 1998-2007, improper revenue recognition was the most common fraud technique, accounting for more than 60% of all fraud cases (COSO, 2010). The Financial Accounting Standards Board (FASB) stated that, due to restatements commonly resulting from improper revenue recognition, they felt the need to introduce a single standard that ‘would apply to a broad range of industries’ (FASB adds revenue recognition project to its agenda, 2002). The FASB and the International Accounting Standards Board (IASB), through a joint effort, aimed to create a revenue recognition standard. The aim was to clarify the rules regarding revenue recognition. Thus, in 2002, the revenue recognition project was added to the FASB agenda. The FASB ‘establishes financial accounting and reporting standards’ for both public, private, and not-for-profit organizations (FASB, n.d.), and the IASB ‘develops and approves International Financial Reporting Standards (IFRSs)’ (IAS plus, n.d.). In 2005, the IFRS became mandatory for any firm listed on a European stock exchange (European Commission Regulation No 1606/2002). In 2008, the first discussion paper regarding revenue recognition was published (Revenue recognition, n.d.). Finally, on the 28th of May 2014, IFRS 15:’Revenue from contracts with customers’ was published (Aarab, Bissessur & Ter Hoeven, 2015), and on the 1st of January 2018, IFRS 15 came into effect. According to Aarab et al. (2015), IFRS 15 aims to clarify the jurisdiction concerning the recognition of revenues, and to ensure consistency regarding the applicability for different transactions and industries. Additionally, Aarab et al. (2015) state that the standard should supply financial statement users with sufficient information concerning revenue recognition. IFRS 15 was introduced after existing revenue recognition disclosures were criticized, due to being inadequate (EY, 2017/2). Additionally, IAS 11 and IAS 18 were considered difficult to understand and apply (Revenue recognition, n.d.), and one of the aims of IFRS 15 was to remove inconsistencies that existed in the old revenue requirements. IFRS 15 requires firms to expand their disclosure concerning revenue recognition from contracts. Therefore, one of the main goals of the standard is to benefit investors and analysts, by providing them with additional information on revenue recognition policies. In terms of reporting requirements, this standard may have a significant impact for industries where contracts with customers are common, such as Telecommunications, Technology, Construction & Materials, and Utilities (IFRS 15 Revenue from Contracts with
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Customers, n.d.). These industries involve contracts that can be modified by customers, as well as difficulties regarding the identification of performance obligations. The five-step model under IFRS 15 is included in appendix 6.2.
This study examines the impact of firm-specific characteristics on the quality of disclosure under IFRS 15. The main reason for considering these is because they are important to a firm’s stakeholders. Jonas and Blanchet (2000) state that investors and creditors are the main users of financial statements, and Clement and Tse (2003) state that investors follow analysts. Therefore, analysts are an important stakeholder group for firms. Bhushan (1989) finds several significant relationships between firm-specific characteristics and analyst following. Moreover, Demirakos, Strong and Walker (2004) find that analysts frequently use single-period comparative data, demonstrating the value of examining whether there is a relationship between accounting information and disclosure quality to a firm’s stakeholders.
Voluntary disclosure is an important tool for firms and their shareholders (Healy and Palepu, 2001). It could help reduce information asymmetry by providing additional information to the market. Numerous theoretical perspectives have examined voluntary disclosure (e.g., Watson, Shrives and Marston (2002), Berger and Hann (2007), Edelen, Evans and Kadlek (2012), Hooghiemstra, Hermes and Emanuels (2015)). Several studies have examined firm-specific determinants of disclosure quality (e.g. Meek, Roberts and Gray (1995); Ettredge, Johnstone, Stone and Wang (2011); Mouselli, Jaafar and Hussainey (2012)). Healy and Palepu (2001) state that disclosure can provide valuable information, and that voluntary disclosure is credible. Hence, disclosures under IFRS 15 may be valuable to investors. Furthermore, Healy and Palepu (2001) note that investors value regulated financial information, further supporting the potential usefulness of the disclosures under IFRS 15. Therefore, this study examines firm-specific determinants of IFRS 15 disclosure quality. Specifically, this paper studies the relationships between the EBIT (earnings before interest and taxes) margin, the debt-to-equity ratio, and the degree of equity compensation for CEOs on IFRS 15 disclosure quality.
It is expected that the EBIT margin is significantly related to the IFRS 15 disclosure quality, however the sign of this relationship is yet to be discovered. This relationship may be mediated by analyst following. IFRS 15 increases the value relevance of annual reports to investors and analysts,
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since they become more comparable, and firms now have to disclose more information under IFRS 15, according to Roozen and Pronk (2018). Furthermore, Clement and Tse (2003) find that investors respond to analyst forecasts, and according to Caylor (2010), analyst benchmarks are the most important benchmarks for managers. Furthermore, the sign of the relationship between the debt-to-equity ratio and IFRS 15 disclosure quality is yet to be discovered. Finally, the relative equity compensation for CEOs is expected to positively influence the IFRS 15 disclosure quality. The hypotheses are elaborated on in section 2, and the IFRS 15 disclosure quality has been determined using a disclosure index, which can be found in appendix 6.5.
Voluntary disclosure literature is considered here since IFRS 15 is a new standard. Therefore, no real industry guidelines exist as of yet, and firms are able to practice some discretion as to how they present the requirements set by IFRS 15. Furthermore, is still uncertainty regarding the presentation of the IFRS 15 mandated disclosures within annual reports. Hence, even though the IFRS 15 standard is mandatory for firms applying IFRS standards, the uncertainty surrounding IFRS 15 disclosures and the discretion of firms regarding the disclosure of their policies under IFRS 15 mean that the disclosures have somewhat of a voluntary nature, since firms have to decide on the extent of disclosure.
In line with the above, it is interesting to examine what determines the quality or extent of disclosure under IFRS 15. Since there are no benchmarks available yet, firms are only able to use the IFRS 15 guidelines itself when deciding on how to satisfy the IFRS 15 requirements. More specifically, the goal of this study is to examine whether and how firm-specific characteristics affect IFRS 15 disclosure quality, and it is interesting to see how firms are implementing the new IFRS 15 guideline disclosure requirements within their annual reports. Therefore, this study will examine the first full application of IFRS 15, not the transition or the disclosures under the transition to IFRS 15. There are transitioning standards within IFRS that guide the transitions to new standards for firms, such as IFRS 1 (First-time Adoption of International Financial Reporting Standards, n.d.). Furthermore, IFRS 15 itself contains transition standards. However, this study focuses on the full application of IFRS 15, since the transition standards are more limited than the IFRS 15 standard itself. Therefore, examining the full application of IFRS 15 has more potential for interesting results. Moreover, this study provides an interesting disclosure index, which could
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help stakeholders in judging the value of the IFRS 15 disclosures for a specific firm. Since disclosure scores have been computed for this study, these can then be used as benchmarks for future scores; furthermore, the disclosure index may provide guidance for future disclosure indices. This research contributes to the existing literature in several ways. First, IFRS 15 is a new standard, thus this study will be one of the first to study the standard, more specifically the determinants of IFRS 15 disclosure quality. This presents a unique setting, since there are no industry best practices nor guidelines as of yet. The only guidance regarding the disclosure is the IFRS 15 standard itself, thus it is interesting to see how firms will approach this new standard. Additionally, an IFRS 15 disclosure index has been developed here. Potential significant relationships could prove useful to standard-setters who wish to increase the general quality of (voluntary) disclosure regarding newly introduced accounting standards. Overall, the economic significance of this study is that it may help stakeholders understand the meaning of extended disclosure under IFRS 15 and accounting policies in general, and how this disclosure is related to the firm-specific characteristics used in this study. Moreover, this research may prove to be useful to investors when assessing analyst forecasts since, according to Clement and Tse (2003), investors follow analyst forecasts and respond based on certain analyst characteristics, and investors are important stakeholders to listed firms. Knowledge regarding a relationship between CEO equity based-compensation and disclosure quality could prove useful to shareholders, who are concerned regarding the disclosure behaviour of their firms. Finally, the firm-specific characteristics discussed in this study may be related to the extent of disclosure under IFRS 15, which would indicate that these characteristics may explain some of the extent of disclosure; moreover, it may impact our view of analyst forecasts and ratings.
Based on the foregoing, since this study looks at listed firms, investors are likely the most important stakeholder group, making firm-specific characteristics an interesting determinant to study when studying IFRS 15 disclosure quality. Under the IFRS 15 guidelines, firms are now expected to have similar disclosures, allowing for easier comparison. No best practices exist as of yet, since IFRS 15 is a new standard. As disclosure is a balancing act, I expect that the extent of voluntary disclosure differs among firms, and for certain firm-specific characteristics, which is in line with prior research (e.g. Meek et al. (1995)). This study focuses on the relationship between firm-specific
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characteristics and IFRS 15 disclosure quality. The main research question guiding this research paper is:
How do firm-specific characteristics influence IFRS 15 disclosure quality?
This study is structured as follows. Section 2 discusses the literature background, theory development, and the hypotheses, section 3 discusses the methodology, section 4 discusses the results, and section 5 contains a discussion and conclusions.
2. Literature background
2.1 Theory
Existing literature addressing disclosure functionality mainly focuses on the impact of firm-specific factors and the usefulness of disclosure. Disclosure can be used as a signalling tool (Skinner, 1994), and according to Healy and Palepu (2001), managers can use disclosure to inform outside investors concerning the performance and governance of the firm. Voluntary disclosure is found to be credible, unless firms suffer from financial distress (Frost, (1997)). Healy and Palepu (2001) argue that information asymmetry and agency conflicts are the major sources of demand for disclosure. Firms can reduce information asymmetry through disclosure of information that investors do not initially possess. From an agency theory perspective, disclosure can reduce agency conflicts (Edelen, et al. (2012)); further, it can both reduce and increase agency costs (e.g. Hooghiemstra et al. (2015), Berger and Hann (2007)). It reduces agency costs since it reduces the likelihood that managers extract large sums of money from the organization, which in turn hurts the shareholders. Conversely, it may increase agency costs if the disclosure reveals agency conflicts, resulting in increased external monitoring. Therefore, disclosure is a delicate cost-benefit balancing act. Furthermore, from a signalling theory perspective, Watson et al. (2002) argue that firms will disclose more information if other firms are doing so, indicating that there may be multiple reasons explaining why firms choose a certain level of disclosure.
Since IFRS 15 is a new standard, it is interesting to see how firms will respond to it. There are no guidelines or best practices as of yet, therefore firms are left to decide on the extent and presentation of the disclosure. This means that there is still a significant degree of uncertainty regarding the application of the standard. This uncertainty has advantages and disadvantages; firms have a certain degree of freedom concerning the application of the standard, however it could lead to
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inconsistencies between firms, leading to low comparability of the disclosures. Therefore, a disclosure index may aid in the comparability of the IFRS 15 disclosures. Furthermore, the argument presented by Watson et al. (2002) may only provide a rationale for the degree of disclosure under IFRS 15 after several years, since industry best practices have yet to emerge. Hence, some firms may disclose their revenue recognition practices to a great degree, while other firms may only meet the minimum requirements that were introduced by IFRS 15.
Furthermore, earlier research found that several firm-specific characteristics impact disclosure (e.g. Meek et al. (1995), Ettredge, et al. (2011), and Mouselli, et al. (2012)). Since IFRS 15 is a new standard, it is worthwhile to extend this research, to examine whether certain firm-specific characteristics can predict disclosure behaviour under the application of IFRS 15. In conclusion, previous studies show that there is an association between firm-specific characteristics and disclosure. Three main theories will be used to support the hypotheses in this study: the agency theory, the signalling theory, and the stakeholder theory.
2.1.1 Voluntary and mandatory disclosure, disclosure quality and information asymmetry
IFRS 15 disclosure consists of both a voluntary and mandatory aspect. The mandatory aspect of disclosure is the part of disclosure which is required by the legislation, while the voluntary aspect of disclosure is the part of disclosure which firms have discretion in choosing. Both aspects are important. First, mandatory disclosure legislation is necessary from a stakeholder, agency, and signalling perspective (more on this below) since otherwise, some firms would choose not to disclose any information at all. Standard setters require firms to participate in disclosure, since disclosure can help reduce information asymmetry, benefiting society (e.g. Watson et al. (2002), An, Davey and Eggleton (2011), Connelly, Certo, Ireland and Russel (2011), Edelen et al. (2012)). Second, voluntary disclosure exists since firms may want to further reduce information asymmetry, or to enhance their credibility (by convincing shareholders that they are acting optimally, (Watson et al., 2002)). Due to IFRS 15 only providing limited guidelines on how to disclose the required information, and no best practices existing as of yet, we may see a wide variety in the extent of disclosure. In other words, the mandatory part is limited, in the form of minimum requirements, whereas there is potential for variation in the voluntary part. This is where firms decide on how they disclose certain items, to what extent they disclose certain items that they deem relevant.
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Firms may voluntarily disclose additional information to reduce information asymmetry. According to Brown and Hillegeist (2007), the annual report disclosure quality is negatively related to the level of information asymmetry, by reducing incentives to gather private information. If an organization experiences large levels of information asymmetry and the implied negative effects of this asymmetry (Leuz and Verrechia (2000)), they may want to increase their disclosure quality. Naturally, this may hold for the IFRS 15 disclosure quality: if firms are experiencing significant levels of information asymmetry surrounding their revenue recognition or contract policies, they may want increase their disclosure under IFRS 15. In the future this may become clear, however, due to the lack of best practices and benchmarks as of yet, this relationship may not yet be clear from the first few financial years. Hence, it is interesting to see whether this will become the case in the future: perhaps firms will alter their disclosure depending on the extent of disclosure provided by peer firms.
2.1.2 Agency theory
The agency theory studies the behaviour of actors within a firm. According to Jensen and Meckling (1976), it examines the relationships between principals (i.e. investors) and agents (i.e. managers). These agency relationships are contracts under which the agents are expected to expend effort and complete tasks on the principal’s behalf. Further, Jensen and Meckling (1976) note, as agents require some decision making authority, assuming that both the principal and the agent seek to maximize their utility, there is a reasonable probability that agents will not act in the principal’s best interests. This poses a source of conflicts, potentially disadvantaging the principal. The agents are able to do this due to information asymmetry, as they possess more information than the principals. Principals experience difficulty in examining whether agents are actually expending effort. Jensen and Meckling (1976) state that in order to mitigate this conflict, principals can engage in monitoring, and agents can provide a credible signal through expending resources (referred to as bonding expenditures). Since, even after all these costs, there exists a divide between agents’ and principals’ welfare-maximizing decisions, there will also be a residual loss. These three costs (monitoring, bonding expenditures, and the residual loss) are agency costs. Thus, the coexistence of agents and principals causes costs.
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Prior research shows conflicting results regarding disclosure from an agency theory perspective. Watson et al. (2002) note that managers may voluntarily disclose information in order to convince shareholders that they are acting in their best interests. According to Leuz and Verrecchia (2000), firms experience a higher cost of capital due to information asymmetry, since this information asymmetry forces firms to issue their capital at discounted prices. This cost can be reduced through increased levels of disclosure, as Sengupta (1998) finds that disclosure leads to lower borrowing costs, since analysts perceive firms with higher disclosure quality to have a lower default risk. Thus, disclosure can alleviate some of the agency costs arising from information asymmetry. Further, Hooghiemstra et al. (2015) and Edelen et al. (2012) find that increased levels of disclosure can reduce agency problems and thus agency costs. Meek et al. (1995) hypothesized from an agency perspective that firms with higher leverage ratios should participate in more disclosure, as increasing leverage increases agency costs. However, Meek et al. (1995) found that leverage was negatively related to disclosure. Meek et al. (1995) thus propose that agency theory may not provide a sufficient explanation for the degree of voluntary disclosure. Zarzeski (1996, p.24) hypothesized that when companies had higher debt ratios, they would ‘share more private information with their creditors’, however Zarzeski (1996) also considers the possibility that firms with lower debt ratios may be subject to more demand for information by stockholders, since they are the primary owners. Overall, Zarzeski (1996) finds that companies with higher debt ratios disclose less public information. Further, Berger and Hann (2007) propose that agency costs may instead lead to less disclosure. They state that when disclosure uncovers agency problems, managers face agency costs in the form of increased external monitoring, leading managers to use their discretion concerning disclosure to withhold segments with low abnormal profits.
From the above, it follows that disclosure could, to some extent, reduce agency problems, however this result is not undisputed. IFRS 15 (IFRS (2014)) requires firms to specifically disclose information relating to contracts with customers. The disclosure has a mandatory and a voluntary part. The mandatory part are the mandated disclosure requirements which are specifically in the guidelines presented by IFRS 15. The voluntary part is how firms decide to present the information that they are required to provide under IFRS 15. The aim of the IFRS is to increase transparency regarding revenue recognition policies. Due to the voluntary aspect, firms have some freedom in
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deciding how much they disclose. Thus, the IFRS 15 disclosure quality and agency costs may differ per firm.
2.1.3 Signalling theory
Another theory which offers an explanation for the extent of voluntary disclosure is the signalling theory. Reasoning from the labour market, Spence (1973) proposed that employees are able to signal their abilities due to a negative correlation between signalling costs and an individual’s productivity. If the signal from employees is credible, it can help employees convince employers of their competency. Connelly et al. (2011) state that reducing information asymmetry is the fundamental concern of signalling theory. They identify a signalling environment consisting of a signaller, the signal, the receiver and the feedback that is sent to the signaller. The signaller sends the signal to the receiver, who then sends feedback to the signaller. This happens in a consecutive fashion. An et al. (2011) develop a framework for voluntary intellectual capital disclosure, and state that signalling theory suggests that excellent organizations should communicate their excellence to society to reduce information asymmetry problems, thus providing an incentive to extend their disclosures. However, poor performance may also induce firms to disclose information, as Skinner (1997) provides some evidence that firms may pre-disclose information in order to reduce the costs of resolving litigation following poor performance. Finally, according to Morris (1987), the signalling theory is consistent with agency theory, since both theories require several of the same conditions. Morris (1987, p.52) further states that ‘the prediction of accounting choices can at least be improved by adding together the predictions from each theory’ when referring to agency and signalling theory. Thus, combining agency theory with signalling theory could lead to interesting conclusions.
Watson et al. (2002) use signalling theory as one explanation of why disclosure may differ between industries. They build on previous literature, and argue that when many firms, or a single large firm, within an industry, disclose information, other firms will follow suit. The reason for this is that when other firms do not participate in this disclosure, this non-participation may be perceived by the market as bad news. Finally, Wang, Sewon and Claiborne (2008) find that profitability is positively related to the extent of disclosure: if firms perform well, managers would like to signal this to the market by increasing the amount of information that they supply. Thus, from signalling
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theory, increased performance may increase disclosure quality; however, in line with Skinner (1997) and Inchausti (1997), poor performance may also motivate increasing disclosure. Thus, the exact relationship between performance and disclosure remains to be tested.
Since IFRS 15 was enforced for the financial year starting on January 1st 2018, there is little information explaining differences in IFRS 15 disclosure behaviour between firms. Nevertheless, one might expect that if some of the leading firms within an industry engage in high-quality IFRS 15 disclosures, other firms may follow suit. Watson et al. (2002) find a significant relationship between disclosure and the media and utilities industries. Skinner (1994) reports that disclosure can be used as a signalling tool. He reports that managers engage in voluntary earnings information disclosure for two reasons: (1) if firms are doing well, managers want to engage in voluntary disclosure to differentiate their firm from other firms, and (2) because of legal ability and reputation, managers may engage in pre-emptive bad news disclosures. Therefore, both good and bad performance could lead firms to extend their disclosures. Regarding the incentives for managers to differentiate their firm from other firms, Lev and Penman (1990) state that earnings forecasts can help distinguish firms that perform well from other firms, even within their own industries.
Therefore, from a signalling theory perspective, the industry that a firm is active in may affect the IFRS 15 disclosure quality of a firm. This is especially interesting regarding IFRS 15, as the impact of IFRS 15 differs between industries (EY, 2017/2). In order to mitigate the influence from industry type on IFRS 15 disclosure quality, industry type will be included as a control variable.
2.1.4 Stakeholder theory
Another theory aiming to describe management behaviour is the stakeholder theory. According to Roberts (1992, p.597) ‘stakeholders of the firm include stockholders, creditors, employees, customers, suppliers, public interest groups, and governmental bodies’. He builds on Freeman (1984), who described stakeholders as any person or group who exerts influence over or is influenced by the actions of a firm. Roberts (1992) notes that the stakeholder concept revolves around making strategic decisions that are approved by those groups or individuals whose support is crucial for the going concern of the firm. Extending this to disclosure, when a firm is considering the extent of disclosure in their annual report, they should take into consideration their most
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important stakeholders. As long as the benefits of increasing the disclosure quality exceed the costs, the firm should extend their disclosure.
Ullman (1985) describes a model where higher stakeholder power, which can be seen as the importance of a certain stakeholder to the firm, would lead to more disclosure. Roberts (1992) finds that stakeholder theory provides a valid explanation for corporate social responsibility (CSR) disclosure. For example, Roberts (1992) builds on Cornell & Shapiro (1987) and states that a firm’s implicit claims to its stakeholders (such as continuous service to customers) are inseparable from a firm’s business, thus impacting the total firm risk. Furthermore, for a given amount of stakeholder power, Roberts (1992) finds that economic performance positively influences a firm’s CSR disclosure level. Van der Laan Smith, Adhikari and Tondkar (2005) find that large firms from stakeholder-oriented countries provide more corporate social disclosure than firms from shareholder-oriented countries, since these firms focus more on social issues. Lu and Abeysekera (2014) find that both shareholders and creditors influence corporate disclosures. Thus, the stakeholder theory may provide a valid explanation for the degree of disclosure.
Regarding IFRS 15 disclosure quality, stakeholders may demand more extensive disclosure under IFRS 15 when they consider IFRS 15 more important for a specific firm. For example, firms that deal with many different types of contracts, large complex contracts, contracts that consist of multiple performance obligations, or contracts where there is no clear transaction price that can be allocated to the separate performance obligations. Large firms, such as the firms in the sample of this study, have a significant impact on society. Therefore, they should use some of their resources to ‘aid in meeting social goals’, as stated by Roberts (1992, p.596). Extending this to IFRS 15 disclosure quality, if practicing a high level of IFRS 15 disclosure quality is the social optimal act for firms, firms may have to expend resources even though it may not seem beneficial from an economic cost-benefit analysis; for society as a whole, it may be deemed beneficial.
Since the sample in this study contains stock-listed firms, one of the most important stakeholder groups for the sample is investors. Since investors follow analysts (Clement and Tse (2003)), and both are interested in the annual reports, from a stakeholder theory perspective, firms have an incentive to practice high IFRS 15 disclosure quality. Due to the uncertainty regarding IFRS 15 disclosures, it is interesting to examine the determinants of the disclosure quality.
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Furthermore, Analysts frequently use single-period comparative accounting data (Demirakos et al. (2004)). Additionally, ratio analysis is a useful tool to investors, as found by the very early work of Beaver (1966), who noted that ratio distributions are more stable for non-failed firms than for firms that failed. The IFRS 15 mandated disclosures are useful for investors since, as mentioned before, they are more value-relevant than disclosures under the old standards. Since investors follow analyst forecasts (Clement and Tse (2003)), firm-specific ratios are interesting determinants to explore, both for analysts and investors. Finally, Jonas and Blanchet (2000) state that the most important users of financial statements are assumed to be investors and creditors. Interesting ratios for investors, analysts, and creditors regarding IFRS 15 are those that are either directly or indirectly related to (contract) revenues, or related to revenue recognition. Hence, such ratios form the basis of the analysis. The main ratios I will consider are the EBIT margin, and the debt-to-equity ratio. Additionally, debt-to-equity incentives to CEOs will be considered. These variables and their relevance are substantiated below. Finally, there may be a mediation effect from analyst following, which will be elaborated upon in the next section.
2.2 Hypothesis development 2.2.1 EBIT margin
The EBIT margin is an important ratio for investors. According to Chen and Shimerda (1981), the EBIT margin is a financial ratio that is closely related to profitability, as it exhibits similar characteristics to return on investment. Since this study also examines the debt-to-equity ratio, I will use the EBIT margin to measure profitability, as the EBIT margin is not affected by interest costs. Taking the net profit margin would account for interest costs, which are related to the amount of debt. Taking into account a measure affected by interest costs could influence the relationship. Furthermore, Campanelli and Florio (2018) note that managers may have an incentive to inflate revenue, for example, due to the presence of potential bonus payments. Inflated revenue may affect profitability ratios, reducing the usefulness of financial statements. Therefore, the EBIT margin is one of the characteristics examined.
A firm’s profitability may influence the degree of voluntary disclosure, however the direction of this relationship is subject to debate. For example, Watson et al. (2002) suggest two arguments from an agency theory perspective on how profitability may influence disclosure: (1) managers of
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profitable firms will disclose more detailed information to secure their position and compensation, and (2) in order to avoid external regulation, more profitable companies will practice more voluntary disclosures, as they are subject to greater public scrutiny. Moreover, from signalling theory, Watson et al. (2002) note that when companies perform well, they aim to inform investors of this performance, thus disclose this performance to the market. In terms of profitability, this implies that when firms are more profitable, they have a larger incentive to extend their voluntary disclosure. Regarding the compensation of managers, Watson et al. (2002) build on Inchausti (1997, p.54), who states that from an agency theory perspective, ‘managers of very profitable firms will use external information in order to obtain personal advantages’, meaning that ‘they will disclose detailed information in order to support the continuance of their positions and compensation arrangements’. However, interestingly, Inchausti (1997) finds a negative relationship between disclosure quality and profitability, indicating that firms may use disclosure to explain unfavourable news. Moreover, Skinner (1994, 1997) provides some evidence that the relationship between disclosure quality and profitability could be negative.
The positive relationship has multiple additional perspectives. Berger and Hann (2007) find that managers attempt to conceal low abnormal segment profits due to the existence of agency costs, and Caylor (2010) finds that negative earnings surprises are avoided through managing deferred revenue and accounts receivable. Further, Caylor (2010) noted that managers find analyst benchmarks the most important benchmarks, and firms may manage earnings to meet these specific benchmarks; one method of achieving this is through revenue recognition. Thus, manager discretion regarding revenue recognition can be used for avoiding negative earnings surprises. This implies that any voluntary disclosure regarding revenue recognition (IFRS 15) may be interesting to investors. Through this disclosure, managers can explain and justify their revenue recognition policies, while investors are enabled to disentangle and understand the revenue recognition policies, allowing them to more closely judge the true performance of the firm. Another hypothesis is provided by Brammer and Pavelin (2006), who hypothesized that higher profitability ensures a larger pool of resources for management which allows them to fund the costs of disclosure. Finally, Barako (2007) states that it could be argued that firms that perform poorly may decrease the extent of disclosure, in order to conceal their performance from the shareholders. Thus, from both an
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agency as well as a signalling perspective, profitability may positively influence voluntary disclosure.
Furthermore, if a firm’s profitability is higher, they may have less of an incentive to manage earnings, as a high profitability increases the likelihood that they are meeting analyst benchmarks. According to Lo (2008), highly-managed earnings are of low quality, however low earnings management does not necessarily guarantee high-quality earnings, since earnings management is not the only aspect influencing earnings quality. Nevertheless, low-quality earnings are less conservative than high-quality earnings. Thus, high profitability may increase earnings quality, which in turn could positively influence IFRS 15 disclosure quality, since IFRS 15 deals with revenue recognition. Any disclosures regarding revenue recognition are interesting for investors, since managers can smooth earnings through revenue recognition. Thus, disclosures on revenue recognition could clarify revenue recognition practices of a firm, allowing investors to understand the revenue recognition and earnings smoothing behaviours from managers.
In line with the above, Gamerschlag, Möller and Verbeeten (2010) find that profitability is partially positively associated with environmental CSR disclosure. This may have been caused by historical developments, as consumers in the western world have only recently become concerned with labour practices. Roberts (1992) finds that a firm’s economic performance is positively related to its level of CSR disclosure. Houston, Lev and Tucker (2010) find that firms whose performance deteriorates cease to provide earnings forecasts. Finally, Wang et al. (2008) find that profitability is positively associated with disclosure, since managers have an incentive to signal their good performance to the market, motivating an increase in the extent of disclosure. Thus, a higher profitability may lead to increased disclosure quality, which could therefore lead to higher IFRS 15 disclosure quality.
However, there is some evidence that the relationship between performance and disclosure quality may be negative. Skinner (1994) finds evidence that negative earnings surprises are more often preceded by voluntary disclosure when compared to positive earnings surprises, indicating that managers may participate in more voluntary disclosure under poor earnings performance. Healy and Palepu (2001) report that managers may use voluntary disclosure in order to justify and explain poor earnings performance. Field, Lowry and Shu (2005) report that firms engage in disclosure in
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order to deter litigation, thus negative performance may incentivize managers to participate in extended voluntary disclosure. Finally, Inchausti (1997) finds a negative rather than a positive relationship between disclosure quality and profitability, indicating that firms may use disclosure as a tool to explain unfavourable news.
Thus, it is difficult to predict the direction of the relationship between performance and disclosure quality. In line with this suggestion, Eng and Mak (2003) do not find a significant relationship between profitability and disclosure, as do Barako, Hancock and Izan (2006), Meek et al. (1995), and Brammer and Pavelin (2006). McNichols (1989) finds that firms do not seem to have a preference for disclosing good news regarding performance. Thus, there may be multiple factors underlying the relationship between profitability and disclosure.
Therefore, the EBIT margin will be one of the firm characteristics that is tested for influence on IFRS 15 disclosure quality. Given the previously examined relationships between profitability and disclosure quality, it is difficult to expect which direction the relationship between EBIT margin and IFRS 15 disclosure will take. Existing research has found conflicting results. The positive effect stems from both the agency and the signalling theories, as when profitability decreases, managers are expected to use disclosures and revenue recognition in an attempt to conceal this low profitability. If profitability increases, firms desire to signal their good performance to the market, and the looming danger of agency costs is reduced. Therefore, as profitability increases, managers are more likely to voluntary disclose more information. However, the other potential outcome under decreasing profitability, namely that managers will use their disclosure discretion to explain the bad news, should not be ignored. Managers may extend disclosures under poor performance, in order to justify this poor performance, or to deter litigation. This would present a negative relationship between profitability and disclosure. Whether the negative effect is stronger than the positive effect remains an empirical question. Therefore, the relationship between profitability and IFRS 15 disclosure quality will be tested using a two-sided test. Thus, the first hypothesis is:
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2.2.2 Debt-to-equity ratio
Firms experience information asymmetry. One method of mitigating this is through voluntary disclosure. Watson et al. (2002) stated that managers use voluntary disclosure to convince shareholders of the legitimacy of their actions. Leuz and Verrecchia (2000) found that information asymmetry increased the cost of capital for firms. Voluntary disclosure can reduce this cost, which is confirmed by the findings of Sengupta (1998). Specifically for the debt-to-equity ratio, analysts associate higher disclosure quality with lower default risk. Hence, some agency costs can be alleviated through voluntary disclosure. Thus, firms with higher debt-to-equity ratios could benefit from increasing the level of voluntary disclosure, in order to reduce the cost of capital.
As agency costs can, to some extent, be avoided through extended disclosure (e.g. Edelen et al. (2012), Hooghiemstra et al. (2015)), it is interesting to examine what determines these agency costs, as this could lead to a link between this determinant and IFRS 15 disclosure quality. If agency costs are lower, the incentive for increasing IFRS 15 disclosure quality may also be lower, and firms may feel less pressure to increase IFRS 15 disclosure quality. Therefore, the agency theory perspective provides an interesting avenue for research. Following this reasoning, the debt-to-equity ratio is an interesting determinant of disclosure quality. Jonas and Blanchet (2000) state that creditors are among the primary financial statement users, making it a worthwhile ratio to explore. Jensen (1986) hypothesized that debt could decrease agency costs by limiting the amount of free cash flow available to managers. However, Jensen (1986) notes that increasing leverage also creates agency costs, for example in the form of bankruptcy costs. Thus, Jensen (1986) states that there is an optimal debt-to-equity ratio when considering agency costs.
Hovakimian, Opler and Titman (2001) find that although past profits can be used as a predictor for debt ratios, more often it is the case that firms move towards target ratios which have been determined by static trade-off models, rather than basing their movements on the profits and losses that they achieved. The operating activities that generate revenue are financed by either debt or equity. Furthermore, in return, revenue recognition policies indirectly affect equity through retained earnings. Therefore, the relationship between the debt-to-equity ratio and IFRS 15 disclosure quality, in addition to the first hypothesis, is relevant for investors and creditors, since
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IFRS 15 disclosure helps investors examine and understand the revenue recognition policies, and how these policies affect the income statement and the equity of the firm.
A higher debt-to-equity ratio may present an incentive to extend disclosure. Leuz and Verrechia (2000) reported that information asymmetry leads to a higher cost of capital. Further, Sengupta (1998) focuses on disclosure quality and cost of debt, and finds that firms that issue high quality disclosures enjoy a lower cost of debt. Extending this to IFRS 15 disclosure quality, a higher debt-to-equity ratio may provide an incentive to increase disclosure quality. Modigliani and Miller (1958) proposed that the cost of equity increases with leverage. In order to reduce this cost, highly-leveraged firms may want to increase disclosure quality, which may also hold for IFRS 15 disclosure quality. Thus, due to the existence of information asymmetry, reasoning from the agency theory and signalling theory, there may be an incentive to increase disclosure quality when the debt-to-equity ratio is higher.
However, the relationship between the debt-to-equity ratio and disclosure may be negative. According to Eng and Mak (2003), increased leverage actually reduces voluntary disclosure, as it restricts free cash flow to managers, thus reducing the need for disclosure. Eng and Mak (2003) build on Jensen (1986), who stated that debt can reduce the free cash flow problem, as debt reduces the cash flow available to managers. Since managers can ‘bond their promise’ this way (Jensen (1986), p.324), it is stronger than a promise to pay higher dividend, thus shareholders may demand less voluntary disclosure from managers. Finally, Meek et al. (1995) and Zarzeski (1996) find a negative relationship between leverage and voluntary disclosure levels, resulting in Meek et al. (1995) questioning the validity of agency costs as an explanation for voluntary disclosure. Lu and Abeysekera (2014, p.433) find a negative relationship between leverage and environmental disclosure, as firms with low leverage have an incentive to present themselves as a ‘responsible corporate citizen’, resulting in a more favourable assessed financial risk. Since there is no consensus on whether leverage increases or decreases disclosure quality, in line with these findings I expect that the debt-to-equity ratio is significantly related to IFRS 15 disclosure quality. However the direction of this relationship remains to be discovered. Hence, the second hypothesis is:
18 2.2.3 CEO equity incentives
CEO compensation consists of different factors. One factor is the use of equity incentives, or stock options, to compensate and reward CEOs. Rooted in both agency and signalling theory, one issue surrounding CEOs is information asymmetry, as CEOs act on behalf of the owners of the firm (mostly shareholders). The shareholders cannot monitor every single action of the CEO, thus there is some information asymmetry, which leads to a higher cost of capital (Leuz and Verrecchia (2000)). Balsam, Jiang and Lu (2014) note that a higher cost of capital negatively affects firm value, thus equity incentives provide a reason for managers to reduce the information asymmetry, as their compensation would directly be affected by these changes in firm value. Balsam et al. (2014) found that equity-incentive compensation leads to stronger internal controls, providing some evidence that incentives may influence CEO behaviour.
Lambert, Leuz and Verrecchia (2007) find that mandated disclosures should result in a lower cost of capital, by influencing the real decisions that firms make, and through affecting the assessed covariances with the cash flows of other firms. Sengupta (1998) found that disclosure could decrease borrowing costs. Furthermore, Hermalin and Weisbach (2012) state that reducing information asymmetry allows firms to issue securities more easily, reducing the cost of capital and increasing firm value. Hence, when CEO compensation partially consists of stock options or other equity incentives, they have an incentive to increase disclosure quality. This impacts the value of their compensation, through impacting the cost of capital. According to Nagar, Nanda, and Wysocki (2003), stock price-based incentives can mitigate the agency problem between managers and shareholders, since disclosing good news improves the stock price, while not disclosing bad news is interpreted negatively by shareholders, and could lead to litigation costs (Nagar et al. (2003)). Thus, CEO stock incentives should benefit disclosure, and they indeed find a positive relationship between disclosures and the relative size of stock price-influenced CEO compensation and the total value of shares the CEO holds. Furthermore, Skinner (1994) and Field et al. (2005) find that pre-emptive disclosures could reduce litigation risk. In line with the reasoning presented above, I predict that the relative size of stock option compensation for CEOs is positively related to IFRS 15 disclosure quality. Thus, the third hypothesis is:
19 H3: The relative size of equity-based compensation for CEOs is positively related to IFRS 15
disclosure quality.
2.3.1 Mediator variable: Analyst following
Analysts present an important stakeholder of firms, since investors and creditors are the most important users of financial statements (Jonas and Blanchet (2000)), and Clement and Tse (2003) state that investors follow analysts. Increased disclosure affects analyst following. Existing research has shown that disclosing more information causes more analysts to follow a firm (Lang & Lundholm (1996), Hamrouni, Benkraiem and Karmani (2017)). Furthermore, Jegadeesh, Kim, Krische and Lee (2004) find that firms that achieve higher returns obtain more recommendations from analysts. Furthermore, McNichols and O’Brien (1997) found that analysts start following firms which they view as favourable, and stop following firms which they view as unfavourable, and Lang and Lundholm (1993) find that strong firm performance leads to higher analyst ratings. Analysts seem to prefer firms with strong performance, thus a higher EBIT margin may lead to higher analyst following.
Furthermore, Hamrouni et al. (2017) note that analysts are expected to follow those firms which respond to their expectations, as well as those which provide analysts with more relevant information. Additionally, they note that from agency theory, analysts have the ability to reduce information asymmetry. Thus, increased analyst following may reduce the information asymmetry reducing function of disclosures. Huang, Pereira, and Wang (2017) note that increased analyst coverage leads to more pressure to meet earnings benchmarks. More specifically, increased analyst coverage results in higher price reactions to earnings surprises; this effect is stronger when firms miss earnings forecasts, suggesting that greater analyst coverage results in greater pressure to meet earnings benchmarks. According to Fuertes-Callèn, Cuellar-Fernández, and Pelayo-Velázquez (2014) the main reasons for disclosure are investor and analyst requirements, as well as reducing information asymmetry and agency costs. Since extended disclosure leads to increased analyst following, a lack of disclosure by firms with poor performance may be explained by the degree of analyst following. For example, poor performing firms may be motivated to reduce analyst following, and enjoy the resulting decrease in analyst pressure from the reduced following, instead of the explanation offered by the signalling and agency theories. Since this study contains the
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variable ‘EBIT margin’ as a measure of performance, the degree of analyst following may mediate the relationship between EBIT margin and disclosure, since analyst pressure may be influenced by performance, and it may be the underlying reason as to why firms choose a certain disclosure level, instead of the financial performance itself. Hence, analyst following will be included as a mediator variable, leading to the fourth hypothesis:
H4: The relationship between EBIT margin and IFRS 15 disclosure is mediated by analyst
following.
3. Research methodology
This section discusses the collection and measurement of variables, and the research method employed. A sample of 52 financial statements of EU listed firms across the construction & materials, technology, telecommunications and utilities industries has been collected, and the firm-specific variables (e.g. revenues) required for this study have been manually collected from the financial statements of these firms. The population was relevant for our study, since the population contained firms from many different EU countries, firms from different industries, and the firms within the population are listed on stock-exchanges. Roozen and Pronk (2018) found that the main industries experiencing a material impact from IFRS 15 were the Telecommunications and Utilities industries. Thus, in line with Roozen and Pronk (2018) these were included in our sample. Moreover, we included firms from the construction & materials and technology industries, as these also experienced significant impacts (IFRS 15 Revenue from Contracts with Customers, n.d.). The database used for selecting the firms in the sample is the STOXX600, which is an index that contains 600 firms, from many different supersectors from 17 countries in the EU. This makes it a well-weighted, representative database, suitable for collecting a sample; furthermore, any of the firms in the STOXX600 had to issue a publicly accessible annual report, allowing for smooth data collection.
Using this index, our research group selected only those firms which devoted additional attention to IFRS 15 in their annual statements, by either mentioning IFRS 15 or revenue recognition explicitly in their key audit matters. Since beforehand it is difficult to estimate whether a firm will experience significant consequences from IFRS 15, these specific firms were selected due to an increased likelihood of their annual reports containing extensive reporting regarding IFRS 15.
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Next, regression analyses were conducted using the gathered data. All firms in the sample are subject to IFRS 15, and experience a significant impact from the application of IFRS 15. The ‘impact’ considered here is the actual presentation under IFRS 15 of the annual report, and not the transition to IFRS 15. The variables that will be used are described in more detail below.
3.1 Dependent variable: IFRS 15 disclosure quality
The IFRS 15 disclosure quality has been determined using the publicly available annual reports from the firms in the sample. Since the standard took effect on the 1st of January 2018, most of the first annual reports affected by IFRS 15 have been published near the end of the first quarter of 2019. Thus, this study concerns the financial year 2018. Data was collected as the reports became available.
The disclosure quality has been determined by judging the readability of the disclosure in terms of qualitative and quantitative aspects, whether it is information useful, and how the IFRS 15 disclosures are presented. To ensure that any effect is caused by the selected variables, control variables have been used. In collaboration with three other students, as a research group, we developed a disclosure index in terms of the aspects that are present in IFRS 15 and how well these are disclosed in the annual reports. The disclosure index consists of 27 separate items. Some items in the disclosure index had a different maximum score, relating to the number of separately identifiable aspects for that item. After computing the total scores, the scores were weighted, e.g. a score of 2 on an item with a maximum score of 2 was just as good as a score of 1 on an item with a maximum score of 1. This ensures that no item is more important than any other item, as it is
difficult to judge items on importance, and hence reducing the impact of subjectivity.
The available annual reports were divided among our research group for judgement. Since the scores will always be subject to some interpretation, several measures were taken in order to increase consistency of judgement. We attended workshops with a supervisor present, and conducted peer reviews among the research group, in order to discuss any issues that were encountered during the judgement process. If any of the items in the disclosure index happened to be not applicable for certain firms, this item was not included in the weight of their total scores. For instance, not every firm applied the practical expedients under FIRS 15.129, thus for those firms this item would not get a score. Finally, after weighing the scores and considering the
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applicable items, each firm achieved a certain percentage-score on the disclosure index; a higher score indicates higher quality, more complete disclosures.
3.2 Independent variables
The independent variables are the EBIT margin, the debt-to-equity ratio, and the industry type. This section describes the collection of those variables.
3.2.1 EBIT margin
The EBIT margin is EBIT divided by total revenues. It is one of the most accurate ratios to indicate the profitability of a firm (Chen and Shimerda (1981)). Campanelli and Florio (2018) highlighted that profitability ratios can be affected by improper revenue recognition, affecting financial statement users, thus it is important to consider profitability. Since the existing literature is two-sided on whether performance increases or decreases voluntary disclosure quality, the hypothesis tested here is two-sided. Furthermore, in Berger and Hann (2007), EBIT is one of the main measures of profitability in their analysis, and they find a significant relationship between profitability and disclosure. Thus, this study measures profitability by taking the EBIT margin, by either measuring EBIT ourselves, or by taking the EBIT readily reported by companies, and it will be collected from the income statements.
3.2.2 Debt-to-equity ratio
As explained in the theoretical framework, I expect that there is a significant relationship between the debt-to-equity ratio and the voluntary IFRS 15 disclosure quality. Due to the availability of data, the book value of the debt-to-equity ratio has been used. Higher debt-to-equity ratios indicate that a larger proportion of the firm is financed with debt. The debt-to-equity formula used in this study is total liabilities divided by total equity. This is in line with Roberts (1992), who finds a significant positive effect between a firm’s average debt-to-equity ratio (over a period of four years) and social responsibility disclosures, providing some evidence that the debt-to-equity ratio is related to voluntary disclosure.
3.2.3 Stock option-based and equity-based compensation
The stock option and equity compensation of CEOs will be retrieved from the annual statements. In order to correct for the importance of stock option-based and equity-based compensation for
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CEOs, the value of the stock option-based and equity-based compensation will be divided by the value of the total compensation for the CEOs, as when the stock option-based compensation is a larger part of the total compensation, the reward for the CEO will be more affected by any fluctuations in the stock price. This is in line with the work of Nagar et al. (2003), who use the proportion affected by stock price of the income of CEOs as a measure of stock-price incentives, and find a significant relationship between this variable and disclosure.
3.3 Mediator variable: Analyst following
In order to estimate the number of analysts following a firm, data has been extracted from the Institutional Brokers’ Estimate System (IBES). This database consists of the individual opinions of analysts, allowing us to see how many analysts follow a firm. Since some analysts issue multiple opinions within one year, duplicates had to be removed. Whenever multiple analysts issue opinions on a firm, this is an indication of the visibility of a firm. If more analysts issue an opinion on a firm, this means that more analysts have followed this firm and analysed their data, thus the number of opinions is a sufficient proxy for analyst following. Therefore, this is how analyst following is measured in this study: by taking the number of analysts who have issued an opinion on each firm. This is in line with Huang et al. (2017) who use the number of analysts issuing forecasts per quarter for each firm, as do Bushee and Miller (2012, p.896), who use the logarithm of 1 + ‘the number of unique analysts issuing earnings forecasts over the four calendar quarters’ prior to the date that they analyse.
3.4 Control variables: Industry type & firm size
3.4.1 Industry type
Industry type will be recorded as the main industry that a firm is active in. IFRS 15 significantly affects several industries (EY, 2017/2). Therefore, the selection of industry types is limited. The selected industries are the technology, telecommunications, construction & materials, and utilities industries, and have been collected from the aforementioned STOXX 600 index. To determine the differences between industry types, dummy variables will be used for each industry type.
From a signalling theory perspective, the specific industry that a firm is active in may affect a firm’s disclosure behaviour. Results on whether or not industry type determines disclosure are
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divided. Meek et al. (1995) find somewhat of a relationship between industry type and voluntary disclosure. They propose that this may be caused by political or social issues, as some industries experience more public scrutiny than others. Raffournier (1995) notes that industry type may affect disclosure due to the differing degree of international activity of firms between industries. He builds on Cooke (1992) for this reasoning. Raffournier (1995) finds a significant relationship between industry type and disclosure. Watson et al. (2002) find an association between the media and utilities industries and disclosure quality, as do Oliveira, Lima Rodrigues and Craig (2006). Regarding CSR disclosure, Holder-Webb, Cohen, Nath and Wood (2009) find a significant relationship between industry type and disclosure. Furthermore, Gamerschlag, et al. (2010) find that CSR disclosure differs among industries.
Due to numerous underlying reasons, industry type has been found to be significantly related to disclosure quality several times. The industries selected for the sample experience a significant impact from the introduction of IFRS 15, which differs per industry. In order to increase comparability, the aim was to include firms from a single industry. However, it proved difficult to amass a sample of sufficient size, since not all firms deemed IFRS 15 or revenue recognition an important issue, or due to publication dates of annual reports. The final sample contains firms from the construction & materials, technology, telecommunications, and utilities industries. In order to include the industry type variable in the regression, dummy variables have been created for each industry, in line with the methodology used in Meek et al. (1995) and Watson et al. (2002). The technology industry was used as the reference group for the regressions, since it had the highest representation, and since it has the highest correlation with the other industries. To illustrate the differences, the main implications for the industries have been outlined in appendix 6.3. What industry type proxies is not certain, thus it will be used as a control variable in the regression, as the differences between industries may be significantly influencing the relationship.
3.4.2 Firm size
Hail, Leuz and Wysocki (2010) showed that financial disclosure costs are more significant for smaller companies. Using different measures for size, it is not clear-cut whether firm size influences disclosure (e.g. Chow and Wong-Boren (1987), Meek et al. (1995), Eng and Mak (2003), Ettredge et al. (2011)). Furthermore, Ball and Foster (1982) state that firm size has been
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used as a proxy for many firm attributes. This indicates that the true meaning of an effect of firm size on disclosure cannot (yet) be understood. To control for the unknown effect of firm size on disclosure quality, firm size will be included as a control variable. Since IFRS 15 concerns revenue recognition, firm size will be measured by using the logarithm of total revenues; using total revenues as a proxy for size was previously done by Meek et al. (1995), who found a significant relationship between firm size and disclosure.
3.5 Model
In order to estimate the relationships in the sample, the ordinary least squares method is used. The independent variables from the hypotheses (the EBIT Margin, debt-to-equity ratio, and CEO equity compensation), the mediator variable (analyst following) and the control variables (industry type and firm size) have been included. As mentioned before, each industry type has been transformed to a dummy variable. The general model which has been used is IFRS15 = 𝛼𝛼0+ 𝛽𝛽0∗ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 + 𝛽𝛽1∗ 𝐷𝐷𝐸𝐸𝐸𝐸𝐸𝐸 + 𝛽𝛽2∗ 𝐶𝐶𝐸𝐸𝐶𝐶 + 𝛽𝛽3∗ 𝐴𝐴𝐴𝐴 + 𝛽𝛽4∗ 𝑈𝑈𝐸𝐸𝐸𝐸𝑈𝑈 + 𝛽𝛽5∗ 𝐶𝐶𝐶𝐶 + 𝛽𝛽6∗ 𝐸𝐸𝐸𝐸𝑈𝑈𝐸𝐸 + 𝛽𝛽7∗ 𝐸𝐸𝐸𝐸𝐶𝐶𝑇𝑇 + 𝛽𝛽8∗ 𝑆𝑆𝐸𝐸𝑆𝑆𝐸𝐸 The meaning of the abbreviations in the model can be found in table 1:
Abbreviation Variable
EBIT EBIT margin
DEBT The debt-to-equity ratio
CEO Stock option-based and equity-based CEO compensation;
AF Analyst following
UTIL Dummy variable for the utilities industry
CM Dummy variable for the construction & materials industry TELE Dummy variable for the telecommunications industry
TECH Dummy variable for the technology industry
SIZE The natural logarithm of total revenues
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The statistical software used to conduct the regression is SPSS.
3.6 Data modifications and compiling the disclosure index
Several data modifications were necessary to allow for a smooth analysis. First, The outliers for each independent variable have been winsorized using a cut-off z-score of 2.576, meaning that only the most extreme percentile has been excluded. This was done in order to ensure that these outliers were not able to skew the results. The winsorizing meant that all the outliers were changed to the most extreme value that was within the suitable z-score range. Furthermore, a scatter plot was made of total revenues. This indicated that the total revenues were heteroskedastic when plotted against the IFRS 15 disclosure scores. Thus, total revenues were transformed using the natural logarithm, reducing the heteroskedasticity. Finally, one observation was missing for the analyst following variable. In order to mitigate this, the missing observation was replaced by the average value for analyst following.
When compiling the disclosure index, several choices had to be made. For instance, certain items, such as IFRS 15.114, could have been explained both quantitatively (in the form of a table) or qualitatively (in the form of a textual explanation). Therefore, these items could score two points: one for the quantitative and one for the qualitative aspect. Next, some standards, such as 15.119, contained several significant items. Thus, these standards could score as many points as there were significant items; in the case of 15.119, the maximum achievable score was 5. Furthermore there are some practical expedients in IFRS 15, such as 15.121. When firms applied such a practical expedient, if it was disclosed, the standards that would no longer be relevant due to this application (in the case of 15.121, this would be 15.120) this standard would be scored ‘not applicable’. If the practical expedient would not be applied, instead the practical expedient (i.e. 15.121) would be scored ‘not applicable’.
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4. Results
4.1 Descriptive statistics
First, descriptive statistics of the final sample were computed, in order to identify the outliers which were dealt with as described in section 3.6. The descriptive statistics of the dependent variable, the IFRS 15 disclosure quality score, and of the independent variables, including the main control variable, have been displayed in table 2. The disclosure score for each firm has been included in appendix 6.1.
Variable N Mean Std. Dev. Min Max
IFRS 15 disclosure score 52 48.15% 15.20% 13.30% 75.50% EBIT Margin 52 0.126 0.103 -0.156 0.345 D/E Ratio 52 2.015 1.221 0.126 4.860 Equity compensation 52 0.191 0.205 0 0.696 Log of total revenues 52 22.798 1.372 19.760 24.960
Table 2: Descriptive statistics for the variables
Finally, table 3 contains the descriptive variables for the industries; more specifically, the number of firms present in each industry from our sample.
Industry Telecommunications Technology Utilities Construction & materials
No. of firms 15 18 11 8
% of total 28.85% 34.62% 21.15% 15.38%
Table 3: Number of firms in each industry.
In order to detect possible relationships existing in the data, a correlation matrix has been computed. This has been displayed in table 4.
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IFRS 15
Score D/E Ratio EBIT Margin Equity compensation Log of revenues Analyst following Utilities Tech Telecom
D/E Ratio -0.107 (0.452) EBIT Margin -0.157 (0.265) -0.076 (0.595) Equity compensation 0.102 (0.471) 0.134 (0.343) -0.077 (0.587) Log of revenues 0.186 (0.187) 0.361*** (0.009) -0.414*** (0.002) -0.183 (0.195) Analyst following 0.074 (0.602) 0.049 (0.729) 0.062 (0.663) -0.343** (0.013) 0.526*** (0.000) Utilities -0.276** (0.048) 0.426* (0.002) 0.158 (0.262) -0.074 (0.604) 0.331** (0.016) 0.165 (0.243) Tech 0.080 (0.571) -0.427*** (0.002) 0.146 (0.303) 0.084 (0.555) -0.377*** (0.006) -0.286** (0.040) -0.377*** (0.006) Telecom 0.147 (0.298) -0.045 (0.751) 0.020 (0.891) -0.092 (0.517) -0.028 (0.845) 0.348** (0.011) -0.330** (0.017) -0.463*** (0.001) Construction & materials 0.022 (0.880) 0.137 (0.332) -0.396*** (0.004) 0.088 (0.533) 0.157 (0.267) -0.247* (0.077) -0.221 (0.116) -0.310** (0.025) -0.271 (0.052) Table 4: correlation matrix
*=significant at the 10% level **=significant at the 5% level ***=significant at the 1% level
