Accounting harmonization plays an important role in global capital markets. A single set of financial reporting standards around the world potentially can facilitate cross-border comparisons of financial data and make it easier for analysts to cover foreign firms by lowering information acquisition costs. It can also improve forecast accuracy by helping analysts better understand the economic performance and positions of foreign firms. So do these things in fact happen?
The International Financial Reporting Standards (IFRS) provides a unique setting for investigating these issues. It has been adopted mandatorily by a number of countries, providing an ideal laboratory to test the effects of accounting harmonization on analysts, as Hongping Tan, Shiheng Wang and Michael Welker have done.
“Analysts are among the most important and sophisticated users of financial statements, but the potential effects of mandatory IFRS adoption on analyst following and forecast accuracy aren’t obvious,” they said.
“On the one hand it can reduce information acquisition and processing costs for analysts so that learning a new set of accounting standards is not an impediment to following foreign firms. This would allow foreign analyst to cover more firms. They should also be more accurate in earnings forecasts if accounting harmonization eliminates forecast errors caused by different accounting standards.”
“On the other hand, opponents of harmonization have argued that the unique accounting issues, history, cultural and institutional frameworks in each country determine the optimal accounting standards. They also criticize IFRS for allowing too much judgment in fair value measures. Increased subjectivity of accounting estimates could decrease transparency and comparability.”
The authors test the alternative hypothesis of effects of IFRS adoption for 3,280 firms from 25 IFRS mandating countries and 1,865 analysts from 34 countries who follow foreign firms in above 25 IFRS adoption countries. They also compared the impacts on both foreign and local analysts.
They find, first, a pronounced increased in foreign analyst following and forecast accuracy with mandatory IFRS adopters compared to voluntary and non-adopters. This was especially so for foreign analysts located in countries that were adopting IFRS at the same time as the target firm’s country – foreign analyst following from this group increased by about 20 per cent increase following IFRS adoption. Coverage also increased substantially among analysts with prior IFRS experience, by more than 30 per cent.
Moreover, foreign analyst forecast accuracy increased by 16 per cent after adoption. While the authors cautioned this could be due to greater management guidance in the post-adoption period, a similar improvement was not seen among local analysts. “This suggests IFRS adoption reduces or eliminates the forecasting advantage of local analysts and it also suggests management guidance isn’t likely to be causing the increase in foreign analyst forecast accuracy,” they said.
Finally, the authors found that where there was a larger difference between local accounting standards and IFRS prior to adoption, the reductions in these differences were associated with greater foreign analyst following.
“Overall, the results are consistent with the argument that accounting harmonization in the form of widespread IFRS adoption enhances the usefulness of accounting data to financial analysts. The results also suggest that enhanced comparability of accounting data plays a major role in this,” they said, adding the results should be of interest to academics and to regulators and practitioners in countries that have adopted IFRS or are considering doing so.