Hans Bonde Christensen

Incentives or Standards: What Determines Accounting Quality Changes around IFRS Adoption?

Abstract We examine the impact of managerial financial reporting incentives on accounting quality changes around International Financial Reporting Standards (IFRS) adoption. A novel feature of our single-country setting based on Germany is that voluntary IFRS adoption was allowed and common before IFRS became mandatory. We exploit the revealed preferences in the choice to (not) adopt IFRS voluntarily to determine whether the management of individual firms had incentives to adopt IFRS. For comparability with previous studies, we assess accounting quality through multiple constructs such as earnings management, timely loss recognition, and value relevance. While most existing literature documents accounting quality improvements following IFRS adoption, we find that improvements are confined to firms with incentives to adopt, that is, voluntary adopters. We also find that firms that resist IFRS adoption have closer connections with banks and inside shareholders, consistent with lower incentives for more comprehensive accounting standards. The overall results indicate that reporting incentives dominate accounting standards in determining accounting quality. We conclude that it is unwarranted to infer from evidence on accounting quality changes around voluntary adoption that IFRS per se improves accounting quality.

Accounting Information in Financial Contracting: The Incomplete Contract Theory Perspective

This paper reviews theoretical and empirical work on financial contracting that is relevant to accounting researchers. Its primary objective is to discuss how the use of accounting information in contracts enhances contracting efficiency and to suggest avenues for future research. We argue that incomplete contract theory broadens our understanding of both the role accounting information plays in contracting and the mechanisms through which efficiency gains are achieved. By discussing its rich theoretical implications, we expect incomplete contract theory to prove useful in motivating future research and in offering directions to advance our knowledge of how accounting information affects contract efficiency.

Capital-Market Effects of Securities Regulation: Prior Conditions, Implementation, and Enforcement

We examine the capital-market effects of changes in securities regulation in the European Union (EU) aimed at reducing market abuse and increasing transparency. To estimate causal effects for the population of EU firms, we exploit that for plausibly exogenous reasons, like national legislative procedures, EU countries adopted these directives at different times. We find significant increases in market liquidity, but the effects are stronger in countries with stricter implementation and traditionally more stringent securities regulation. The findings suggest that countries with initially weaker regulation do not catch up with stronger countries, and that countries diverge more upon harmonizing regulation.

Why Do Firms Rarely Adopt IFRS Voluntarily? Academics Find Significant Benefits and the Costs Appear to be Low

Kim and Shi (Rev Account Stud, doi:10.1007/s11142-012-9190-y, this issue) document that voluntary IFRS adoption is associated with significant benefits and argue that the effect is causal—a conclusion that is similar to many published papers on IFRS adoption. Yet voluntary IFRS adopters constitute only a small percentage of the global population of firms, which implies that either practitioners behave irrationally or the benefits are incorrectly estimated by academics. In this discussion I argue that the error is on the part of academics, not practitioners, and that it is mainly due to the lack of exogenous variation in accounting standards. This conclusion is based on inconsistencies between the estimated benefits and costs of IFRS adoption, as well as the accounting standards choices of presumed rational managers. I also propose a contracting explanation for the capital market benefits around IFRS adoption in which managers behave rationally, but IFRS per se is not the cause.

The Effects of Charge-Price Transparency Regulation on Prices in the Healthcare Industry

Using micro data on actual healthcare purchases, we provide evidence on the causal effects of charge-price transparency regulation (PTR). We find that PTR causes providers to reduce charges by approximately 6%. However, despite the strong cross-hospital correlation between charge and actual prices, these reductions do not lead to lower actual payments. Cross-sectional variation in the estimated treatment effect suggests that the reputational costs of perceived overcharging rather than increased consumer search explain the reduction in charges. Our results show that reputational concerns affect hospitals’ charge setting strategies and illustrate how the healthcare industry’s complex, heterogeneous pricing structure makes it difficult to increase consumer welfare by increasing transparency.

The Real Effects of Mandated Information on Social Responsibility in Financial Reports: Evidence from Mine-Safety Records

We examine the real effects of mandatory social-responsibility disclosures, which require SEC-registered mine owners to include their mine-safety records in their financial reports. These safety records are already publicly available elsewhere, which allows us to isolate and estimate the incremental real effects of including this information in financial reports. Comparing mines owned by SEC-registered issuers with mines that are not, we document that including safety records in financial reports decreases mining-related citations and injuries, and reduces labor productivity. Evidence from stock-market reactions and mutualfund holdings suggests that increased awareness of safety issues is a likely explanation for the observed real effects.

Contracting on GAAP Changes: Large Sample Evidence

We use incomplete contracts theory to explain the inclusion or exclusion of changes to GAAP based on which debt covenants are written. We posit that GAAP is often incomplete with respect to unanticipated future developments (innovations), which can lead to post contractual opportunism and thus destroy ex ante incentives. We argue that the choice to include GAAP changes depends on the effectiveness of accounting standard setters to act as an arbiter who ‘completes’ GAAP ex post. Our evidence indicates that the accounting standard setters achieve mixed success. The GAAP changes we study appear to address inefficiencies associated with opportunism by lenders but not by borrowers. Further, we find that the frequency of credit agreements that rely on standard setters to complete GAAP has decreased by more than fifty percent from 1996 to 2005. This trend is at least partly explained by the actions of standard setters and is consistent with reduced regulatory responsiveness to contracting needs.We explore revealed preferences for the contractual treatment of changes to GAAP in a large sample of private credit agreements issued by publicly held U.S. firms. We document a significant time‐trend toward excluding GAAP changes from the determination of covenant compliance over the period from 1994 to 2012. This trend is positively associated with proxies for standard setters’ shift in focus toward relevance and international accounting harmonization. At the firm level, borrowers facing higher uncertainty are more likely to write contracts that include GAAP changes, but these firms also show a more pronounced time‐trend toward excluding GAAP changes. While this evidence is broadly consistent with an efficiency role for GAAP changes in debt contracting, it is also consistent with a shift in standard setters’ focus offering a partial explanation of why fewer contracts rely on GAAP changes in 2012 than in 1994.

Proper Inferences or a Market for Excuses? The Capital-Market Effects of Mandatory IFRS Adoption

Barth and Israeli (2013) raise five serious concerns regarding the research design and interpretation of Christensen, Hail, and Leuz (2013). They claim: (i) the evidence stands in stark contrast to Daske, Hail, Leuz, and Verdi (2008) and fails to replicate its prior findings; (ii) the research design using fixed effects leaves out main effects and two-way interactions which likely biases the estimated liquidity effects around IFRS adoption and changes in enforcement; (iii) the vast majority of sample observations do not contribute to the identification which is misleading in terms of the scope and the conclusions that can be drawn from the study; (iv) the timing of IFRS adoption and enforcement changes is measured imprecisely leading to low power tests; and (v) the evidence from Japan is irrelevant to the study. In this note, we show that all five claims are incorrect or misleading. Our discussion also more broadly describes how to properly interpret the fixed-effect specifications in Christensen, Hail, and Leuz (2013). Since studies in accounting, finance, and economics make extensive use of fixed-effect models, a correct understanding of this research design is important to avoid interpretational mistakes. More generally, we discuss that proper empirical identification and inferences are important to international accounting and IFRS studies so that this area of research does not become a market for excuses.

The Effect of Regulatory Harmonization on Cross-Border Labor Migration: Evidence from the Accounting Profession

The paper examines whether international regulatory harmonization increases cross-border labor migration. To study this question, we analyze European Union (EU) initiatives that harmonized accounting and auditing standards. Regulatory harmonization should reduce economic mobility barriers, essentially making it easier for accounting professionals to move across countries. Our research design compares the cross-border migration of accounting professionals relative to tightly-matched other professionals before and after regulatory harmonization. We find that international labor migration in the accounting profession increases significantly relative to other professions. We provide evidence that this effect is due to harmonization, rather than increases in the demand for accounting services during the implementation of the rule changes. The findings illustrate that diversity in rules constitutes an economic barrier to cross-border labor mobility and, more specifically, that accounting harmonization can have a meaningful effect on cross-border migration.

Financial Sector Shocks and Corporate Investment Activity: The Role of Financial Covenants

We examine whether shocks to credit institutions affect the choice among accountingbased covenants in private debt contracts and whether this effect represents a channel through which shocks to lenders affect corporate investment. We exploit plausibly exogenous variation in the payment defaults experienced by lenders outside the borrower’s region and industry. We find that financial institutions respond to payment default shocks by shifting the composition of financial covenants towards performance-based covenants (away from capital-based covenants) in newly signed credit agreements. In turn, the increased reliance on performance covenants constrains borrowers’ future investments, particularly among relationship-based borrowers. We also find that lender-specific shocks after a contract is in place affect investments, and that this effect varies depending on the composition of the covenants in place. Overall, our results are consistent with financial covenants being a channel through which idiosyncratic shocks to lenders propagate to the real sector.We show that financial shocks to lenders affect the composition of covenants in new debt contracts in a way that cannot be explained by borrower fundamentals. Using two distinct measures of lender-specific shocks—defaults in a lender’s corporate loan portfolio that occur outside the borrower’s region and industry, and non-corporate loan delinquencies—we show that lenders respond to financial shocks by increasing the use and strictness of performance-based and negative covenants, while reducing the use of capital covenants. We investigate two possible channels for these effects, specifically, the capital channel (lenders are concerned about capital depletion) and the learning channel (defaults carry information about lenders’ screening ability), and find evidence in support of both. Our results indicate that lenders’ preferences influence the use of accounting information in debt contracts.