The Impact of International Financial Reporting

Standards on Comparability:

A Test Using IPO Underpricing

Masako Darrough

Jangwon Suh

Donal Byard

The Tel Aviv International Conference on Accounting

June 21, 2015

1

Motivation • Many countries have adopted IFRS

• The uniform set of accounting standards – decreases information

asymmetry

• The global capital markets have been affected by having the same

accounting standards

• Accounting quality is higher?

Our Main Question: Does IFRS increase comparability?

Does IFRS reduce the IPO underpricing?

• Mandatory adoption

• Voluntary adoption

2

Roadmap

Background

Research Questions

• IFRSIPO

• IPO Underpricing

• Challenges

Hypotheses and Research Design

• Hypotheses

• Tests

• Results

Conclusions

3

Background: Policy Debates

Areas where academic literature follows policy debates

• 1980s – Papers about different GAAPs

• German GAAP is different from UK GAAP

• Late 1990s – Development of IAS

• Germany + more allow voluntary IAS adoption

• IAS become IFRS

• 2005 – Mandatory IFRS adoption (EU etc.)

• More comprehensive standards – increased reporting quality

• Increased comparability

• 2007- Should US adopt IFRS?

• Only increased comparability possible?

4

Academic Debate

Standards vs. Institutions

• Early 2000s

• Importance of reporting incentives

• Institutions shape firms’ reporting incentives

• Ball et al. (JAE 2000, 2003), Burgstahler, Hail & Leuz (TAR 2006),

Leuz et al. (JFE 2003)

• Mandatory IFRS Adoption Experiment

• Uniform set of Accounting Standards

• Higher quality of financial reporting?

• Enhanced comparability?

• # listed firms using IFRS: 9.0% in 2004 → 30% in 2006

• Who benefits?

5

IFRS Mandatory Adoption

Reporting quality

• IFRS > domestic GAAP (Barth et al. 2008)

• IFRS ≈ domestic GAAP (Ahmed et al. 2010)

6

Comparability

• IFRS ≈ domestic GAAP on average (Lang et al. 2010)

• DeFond et al. (JAE 2011), Brochet et al. (CAR 2013),

Wang (JAR 2015), Yip and Young (TAR 2012),

Cascino and Gassen (RAST 2014)

The Effects of IFRS

• Benefits

• Daske et al.(JAR 2008): IFRS increases market liquidity, reduces cost of capital and Tobin’s Q ?

• DeFond et al. (JAE 2011): enhanced comparability increases foreign mutual fund ownership

• Byard, et al. (JAR 2011): improves financial analysts’ information environment: forecast errors, forecast dispersion

• Important: enforcement

• Christensen et al. (JAE 2013)

• Ball (ABR 2006)

• Daske et al. (JAR 2008)

• Byard et al. (JAR 2011)

7

Our Research Questions in IPO

1. Whether investors benefit from enhanced comparability under

IFRS compared to domestic GAAP

2. Whether all of the potentially comparable firms available

under IFRS actually contribute to providing enhanced

comparability.

Potentially comparable firms (peer firms)

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comparability

Comparability and IPO Underpricing

IPO setting – IPO underpricing

Comparability:

• is the “quality of information that enables users to identify

similarities in and differences between two sets of economic

phenomena” (Financial Accounting Standards Board, 1980).

2 Tests

• Mandatory IFRS adoption test (pre vs. post 2005)

• “Voluntary” IFRS adoption test (pre 2005)

9

IPO Underpricing

• First day return

• Worldwide phenomenon

• Money on the table • Asymmetric information

• Rock (JFE 1986),

• Beatty and Ritter (JFE 1986)

• Benveniste and Spindt (JFE 1989)

• Underpricing is less

• Leone and Rock (JAR 2007): “intended use of proceeds”

• Schrand and Verrecchia (2005): greater disclosure frequency in the pre-IPO period

• Boulton et al. (TAR 2011): country-level earnings quality

• Hong et al. (TAR 2014): IFRS

10

IPO Underpricing

Sample size Period Av. Underpricing

Australia 1,562 1976-2011 21.80%

China 2,512 1990-2013 118.40%

France 697 1983-2010 10.50%

Germany 736 1978-2011 24.20%

Greece 373 1976-2013 50.80%

Hong 1,486 1980-2013 15.80%

Italy 312 1985-2013 15.20%

Japan 3,236 1970-2013 41.70%

Norway 209 1984-2013 8.10%

Philippines 155 1987-2013 18.10%

Poland 309 1991-2014 12.70%

Portugal 32 1992-2013 11.90%

Singapore 609 1973-2013 25.80%

Sweden 374 1980-2011 27.20%

UK 4,932 1959-2012 16.00%

US 12,702 1960-2014 16.90%

Source: Loughran, Ritter, and Rydqvist 2015 “Initial Public

Offerings: International Insights”

11

21.80%

118.40%

10.50%

24.20%

50.80%

15.80%

15.20%

41.70%

8.10%

18.10%

12.70%

11.90%

25.80%

27.20%

16.00%

16.90%

IFRS and IPO Underpricing

• Boulton et al. (TAR 2011): EQ underpricing

• Hong et al. (TAR 2014): AQ underpricing proceeds

• Challenges in research

• Firms go IPO once

• Mandatory IFRS – all IPOs use IFRS

• Institutional differences across countries

• Other concurrent changes (e.g. EU Directives)

12

Hypotheses

H1: Following mandatory IFRS adoption, enhanced overall

comparability under IFRS will reduce IPO underpricing

relative to that under domestic GAAP.

H2: Following mandatory IFRS adoption, only those listed

industry peers domiciled in high quality enforcement

jurisdictions have an effect in reducing IPO underpricing.

13

enhanced overall comparability

enforcement

Overview of Research Questions

Example: Two hypothetical Dutch mining IPOs

• Reporting quality & comparability

• The role of enforcement environment

IPO in 2003

• Reporting quality under

Dutch GAAP

• Comparability

• Few but homogeneous

industry peers using

Dutch GAAP

IPO in 2006

• Reporting quality under

IFRS

• Comparability

• 100+ industry peers

using IFRS

• Heterogeneous industry

peers

14

Mandatory Adoption Sample Selection: Matched Pair Design & DID

2005 Mandatory IFRS

Adoption

Test Sample

Countries

That Mandated

IFRS Adoption in

2005

Control Sample

Countries That

Did Not Mandate

Adoption of

IFRS

2003 - 2004 2006 - 2007

IFRS IPO

Dutch Mining Co.

Domestic GAAP IPO

Dutch Mining Co.

COMPARE

WITH

All Dutch Listed Mining Cos

Using Dutch GAAP

COMPARE

WITH

All Global Listed Mining Cos

Using IFRS

Domestic GAAP IPO

Brazilian Mining Co.

Domestic GAAP IPO

Brazilian Mining Co.

Treatment Benchmark

Change Model

DID

15

TABLE 4

Comparability and IPO Underpricing: Mandatory IFRS Adoption

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H1: (-)

H2: (-)

IniRet = X’β + β1 IFRS + β2 log(1+Comp) + β3 IFRS×log(1+Comp)

+ Controls + υ (1a)

IniRet = X’β + β1 IFRS + β4 log(1+CompWeak) + β5 log(1+CompStrong / (1+CompWeak ))

+ β6 IFRS×log(1+CompWeak) + β7 IFRS×log(1+CompStrong / (1+CompWeak ))

+ Controls + υ (1b)

CompStrong

CompWeak

log(1+Comp) = log(1+CompWeak+CompStrong )

=log(1+CompWeak ) (1+CompStrong /(1+CompWeak))

= log(1+CompWeak )+log (1+CompWeak/ (1+CompWeak))

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Voluntary Adoption

A number of countries allowed early adoption

• Netherlands, Belgium, Denmark, Finland, Austria, Germany

• Additional IPOs that used IFRS as a second set of fin. Statements

Issues

• Self selection

• IPO underpricing

• 34 voluntary IPOs

Reporting Incentives

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TABLE 7

Comparability and IPO Underpricing: Voluntary IFRS Adoption

Prob(IFRS) = Z’γ + ε; (2a)

IniRet = θ1 IFRS + θ2 log(1+Comp) + θ3 IFRS× log(1+Comp) + δ IMR

+ Controls + υ. (2b)

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(-)

Our Sample Countries

Law Enforcement

Strong Weak

IFRSdif

High

Sweden, France,

Japan,

Germany, Italy, France

Greece, Philippines,

Brazil,

China, Poland

Low

Australia, Hong Kong,

New Zealand, Norway, UK,

US, South Korea, Taiwan,

Greece, Singapore,Sweden

India, Indonesia,

Malaysia, Thailand

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Panel A: Mandatory IFRS Adopter Sample

Description # of observations

IPO firms issuing ordinary common shares around the world during 2006-2007 3,380

Various deletions … 2,883

IFRS-reporting IPOs in 2006 and 2007 from Countries that Mandated the Adoption of

IFRS in 2005 with available Benchmark Domestic GAAP Reporting IPO firms 493

Matched (Benchmark) Domestic GAAP-reporting IPOs in 2003 and 2004 in the Same

Industries and the Same Countries 493

Mandatory Adoption Test Sample: 493 IFRS reporting IPOs from 2006-2007, with 493

domestic GAAP-reporting IPOs from 2003-2004, matched by country and industry 986

Control Sample: 628 IPOs from the period 2003-2004 with 628 matched IPOs from the

period 2006-2007, matched by country and industry. These IPOs are from countries that

did not mandate IFRS over our sample period, so all 1,256 IPOs report in domestic GAAP 1,256

Panel B: Voluntary IFRS Adoption Sample

IPO firms issuing ordinary common shares around the world in 2003-2004 2,316

(First trading-day return data are unavailable) (376)

(Accounting standards data are unavailable) (132)

(Other control variables are unavailable) (148)

(Listings in countries that did not mandate IFRS in 2005) (1,089)

Listings in countries that allowed multiple accounting standards over this period 244

(Listings in countries that have no IPO firms that report in IFRS) (224)

Voluntary Adoption Sample 591

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Sample Selection Procedures

TABLE 2: Composition of Samples by Country

Panel A: Mandatory IFRS Adoption Test and Control Samples

IniRet

Test/Control Sample # of observations Domestic GAAP-reporting IPO

firms

IFRS-reporting

IPO firms

Australia Test 672 21.1% 27.3%

France Test 32 6.8% 3.4%

Greece Test 2 42.5% 23.5%

Hong Kong Test 44 10.9% 33.0%

New Zealand Test 6 5.9% 9.2%

Norway Test 24 10.5% 5.0%

Philippines Test 8 1.9% 9.2%

Sweden Test 2 -24.8% 13.7%

United Kingdom Test 196 23.6% 17.3%

Brazil Control 2 0.5% -6.7%

India Control 2 24.0% 88.4%

Indonesia Control 4 12.9% 56.8%

Japan Control 392 52.4% 35.3%

Malaysia Control 74 42.0% 17.9%

South Korea Control 162 34.0% 42.8%

Taiwan Control 122 3.4% 55.2%

Thailand Control 22 26.6% 16.1%

United States Control 476 11.7% 10.8%

Total 2,242

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TABLE 2: Composition of Sample by Country (Cont’d)

Voluntary IFRS adoption

Panel B

# Domestic

GAAP IPOs

#IFRS

IPOs

Domestic GAAP-reporting

IPO firms

IFRS-reporting

IPO firms

China 150 2 14.6% 15.4%

France 20 1 4.3% 0.8%

Germany 1 3 3.6% 5.8%

Greece 6 2 6.9% 0.8%

Hong Kong 65 2 5.3% 11.4%

Italy 1 4 0.8% 5.8%

Poland 3 2 12.8% 14.9%

Singapore 79 9 10.0% 10.6%

Sweden 2 1 0.8% 7.2%

UK 230 8 9.0% 11.6%

Total 557 34 10.0% 9.5%

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TABLE 3: Descriptive Statistics

Panel A: IFRS-Reporting IPOs (N=493)

Mean Min. Q1 Median Q3 Max.

IniRet 23.9% -26.7% 1.1% 12.1% 31.8% 207.3%

Comp 182.8 2 52 142 263 564

CompStrong 146.8 0 25 116 225 522

CompWeak 36.6 0 17 29 45 112

Proceeds 54.0 1.2 2.7 5.6 31.1 56.1

Partial Adjustment 0.2% -3.8% 0 0 0 5.4%

Cross Listing 13.2% 0 0 0 0 1

Market Return 9.0% -31.3% -1.9% 9.0% 21.5% 56.4%

Market Volatility 85.6% 36.1% 64.0% 78.3% 104.8% 188.6%

#IPO 12.5 0 8 12 17 30

Secondary Market 15.4% 0 0 0 0 1

Panel B: Domestic GAAP-Reporting IPOs (N=493)

IniRet 20.1% -26.7% -2.0% 5.0% 22.8% 207.3%

Comp 32.3 0 1 6 62 159

CompStrong 32.0 0 1 6 62 159

CompWeak 0.2 0 0 0 0 32

Proceeds 36.5 1.2 2.6 5.3 31.9 656.1

Partial Adjustment 0.0% -3.8% 0 0 0 5.4%

Cross Listing 1.0% 0 0 0 0 1

Market Return 11.7% -31.3% 3.4% 12.6% 20.7% 56.4%

Market Volatility 57.3% 26.5% 37.3% 47.1% 65.0% 188.6%

#IPO 8.5 0 4 8 11 30

Secondary Market 1.6% 0 0 0 0 1

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T4 Comparability and IPO Underpricing: Mandatory IFRS Adoption

Panel A: Regression Results

Equation (1a) Equation (1b)

Predict Coeff. z-stat. Predict Coeff. z-stat.

IFRS β1 0.236 (1.53) 0.071 (0.49)

log(1+Comp) β2 -0.025** (-2.01)

IFRS×log(1+Comp) β3 ( - ) -0.009 (-0.25)

log(1+CompWeak) β4 -0.023 (-0.63)

log(1+ CompStrong / (1+CompWeak)) β5 -0.020* (-1.81)

IFRS×log(1+CompWeak) β6 0.078** (2.14)

IFRS×log(1+CompStrong /(1+CompWeak)) β7 ( - ) -0.094*** (-5.06)

Control Variables:

log(1+Proceeds) β8 -0.075 (-1.18) -0.086 (-1.34)

Partial Adjustment β9 -0.016 (-0.01) -0.096 (-0.05)

Cross Listing β10 0.211 (0.87) 0.194 (0.79)

Market Return β11 0.171 (1.16) 0.175 (1.02)

Market Volatility β12 -0.021 (-0.17) 0.003 (0.03)

log(1+#IPO) β13 -0.107 (-1.46) -0.120 (-1.62)

Secondary Market β14 -0.350 (-1.61) -0.390* (-1.92)

R2 50.8% 51.8%

Adjusted Clustered standard errors Yes Yes

# of fixed effects for matched pairs 493 493

# of observations 986 986

Panel B: Linear Combination Tests

Equation (1a) Equation (1b)

Predict Coeff. t-stat. Coeff. t-stat.

β2+ β3 ( - ) -0.035 (-1.24)

β4+ β6 0.055 (1.29)

β5+ β7 ( - ) -0.114*** (-9.38)

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TABLE 5

Comparability and IPO Underpricing: DID Results for Mandatory IFRS Adoption

Test Sample Control Sample Difference

Predict’n Coeff. t-stat. Coeff. t-stat. Predict’n Coeff. t-stat.

IFRS β1 0.236 (1.53) 0.145 (1.04) 0.091 (0.91)

log(1+Comp) β2 -0.025** (-2.01) -0.051* (-1.81) 0.026 (1.63)

IFRS×log(1+Comp)1 β3 (-) -0.009 (-0.25) -0.030 (-0.97) (-) 0.021 (1.25)

R2 50.8% 61.2%

Adjusted standard errors Yes Yes

# of fixed effects for matched pairs 493 628

# of observations 986 1,256

Panel A: Re-Estimation of Equation (1a) using Difference-in-Difference Specification

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Table 5: DID (cont’d)

Panel B: Re-Estimation of Equation (1b) using Difference-in-Difference Specification

Test Sample Control Sample Difference

Predict’n Coeff. t-stat. Coeff. t-stat. Predict’n Coeff. t-stat.

IFRS β1 0.071 (0.49) 0.281*** (3.09) -0.210* (-1.95)

log(1+CompWeak) β4 -0.023 (-0.63) 0.161 (0.52) -0.184*** (-4.36)

log(1+ CompStrong / (1+CompWeak)) β5 -0.020* (-1.81) -0.030 (-0.91) 0.010 (0.56)

IFRS×log(1+CompWeak)1 β6 0.078** (2.14) -0.182*** (-4.69) 0.260*** (6.72)

IFRS×log(1+ CompStrong /

(1+CompWeak))1

β7 (-) -0.094*** (-5.06) -0.057*** (-2.98) (-) -0.037** (-1.82)

R2 51.8% 62.3%

Adjusted standard errors Yes Yes

# of fixed effects for matched pairs 493 628

# of observations 986 1,256

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TABLE 6

Descriptive Statistics: Voluntary IFRS Adoption Sample

Panel A: IFRS-Reporting IPOs (N=34)

Mean Min. Q1 Median Q3 Max.

IniRet 25.5% -20.3% 1.3% 11.4% 43.4% 215.6%

Comp 31.6 2 11 22.5 45 99

Proceeds 124.3 0.2 5.9 16.0 135.6 569.3

Partial Adjustment 0.00 -0.03 0.00 0.00 0.00 0.03

Cross Listing 41.2% 0 0 0 1 1

Market Return 6.8% -58.6% -8.5% 4.1% 21.1% 67.7%

Market Volatility 84.9% 44.1% 58.0% 79.6% 105.0% 191.1%

#IPO 4.91 0 0 3 7 22

Secondary Market 29.4% 0 0 0 1 1

Common 55.9% 0 0 1 1 1

CompDomestic 10.6 0 2 3.5 13 54

IFRSdiff 25.6% 0.0% 0.0% 9.5% 57.1% 57.1%

Leverage 0.340 0.012 0.193 0.305 0.502 0.684

ROA 7.8% -36.6% 0.5% 8.2% 17.6% 30.4%

Multiple Acct Stds 47.1% 0 0 0 1 1

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Table 6 (cont’d)

Panel B: Domestic GAAP-Reporting IPOs (N=557)

IniRet 32.9% -20.3% 3.2% 14.2% 46.3% 215.6%

Comp 25.0 1 6 15 40 99

Proceeds 43.4 0.2 5.0 17.1 38.5 569.3

Partial Adjustment 0.00 -0.03 0.00 0.00 0.00 0.03

Cross Listing 7.7% 0 0 0 0 1

Market Return 5.3% -58.6% -9.9% 4.9% 22.0% 67.7%

Market Volatility 89.0% 40.5% 59.7% 84.9% 113.4% 191.1%

#IPO 8.59 0 3 6 13 27

Secondary Market 45.1% 0 0 0 1 1

Common 67.1% 0 0 1 1 1

CompDomestic 24.9 0 6 15 39 95

IFRSdiff 18.5% 0.0% 4.8% 4.8% 42.9% 57.1%

Leverage 0.317 0.012 0.185 0.308 0.445 0.689

ROA 1.3% -83.4% -1.3% 6.2% 11.3% 30.4%

Multiple Acct Stds 41.8% 0 0 0 1 1

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Table 7: Panel A: Endogenous Treatment Model Results

Equation (2a)

Dep. Var. = Prob(IFRS)

Equation (2b)

Dep. Var. = IniRet

Coeff. z-stat. Predict Coeff. z-stat.

IFRS θ1 0.350 (0.98)

log(1+Comp) θ2 0.010 (0.54)

IFRS×log(1+Comp) θ3 ( - ) -0.143** (-1.69)

Control Variables:

log(1+Proceeds) 0.055 (0.76) -0.064*** (-4.49)

Partial Adjustment 0.557 (0.20)

Cross Listing 1.382*** (5.36) -0.008 (0.10)

Market Return 0.063 (0.90)

Market Volatility 0.254*** (4.45)

log(1+#IPO) 0.094*** (3.47)

IFRSdiff

Secondary Market 0.287 (0.90) -0.179*** (-3.78)

Common -0.281*** (-5.26)

log(1+CompDomestic) -0.377*** (-4.24)

IFRSdiff 1.737*** (2.96)

log(1+Leverage) 0.196 (0.32)

ROA 0.703 (1.07)

Multiple Acct Stds 0.074 (0.30)

Inverse Mills Ratio δ 0.046 (0.34)1

Year fixed-effects Yes Yes

# of observations 591 591

Panel B: Linear Combination Test (Eq. (2b)

(θ2 + θ3) = 0 -0.132* (-1.60)

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Additional Analyses

1. Prospectus Directives

2. Exclusion of Australian IPOs

3. Including IFRSdif

4. US as potential comparable firms

31

Summary of Key Findings

IPO underpricing ↓ • If IPO firms use IFRS instead of domestic GAAP

• As # comparable firms in high enforcement countries ↑

• US firms are not perfect substitutes for IFRS reporting comparable firms.

• Voluntary Adoption

• More likely for firms with fewer domestic comparable firms

• IPO underpricing is reduced by IFRS

32

Current Questions/Issues

• Our result = only comparable firms in high Enforcement jurisdictions matter

• Claims of enhanced comparability under IFRS are over-stated

• Q: What is “enforcement”?

• Q: Develop good measures of comparability • De Franco et al. measure (2011)

• Barth et al. (2012)

• Information Transfer

• Ours: Number of industry peers

• Q: Is there is a limit to comparability? • What about investor attention?

• What about differences across industries?

• Q: Would the US really benefit from enhanced comparability under IFRS?

33

Thank you!

34

IPO Underpricing: US

Mean First Day Return

Year # IPOs EW

Proceeds-

Weighted

Amount left

on the table

Aggregate

proceeds

1980-1989 2,044 7.20% 6.10% $3.27 billion $53.46 billion

1990-1998 3,612 14.80% 13.30% $30.10 billion $226.35 billion

1999-2000 858 64.50% 51.60% $66.94 billion $129.81 billion

2001-2014 1,546 13.60% 12.30% $49.50 billion $805.77 billion

35