Why Do Firms Rarely Adopt IFRS Voluntarily?

Academics Find Significant Benefits and the Costs Appear to be Low*

Hans B. Christensen

Booth School of Business

University of Chicago
5807 South Woodlawn Avenue
Chicago, IL 60637

Abstract: Kim and Shi (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.

JEL classification: G14, G15, G30, K22, M41, M47

Key Words: International accounting, International accounting standards (IAS),

International Financial Reporting Standards (IFRS)

*I appreciate helpful discussions with Ryan Ball, Ulf Brggemann, Christian Leuz, Valeri V.
Nikolaev, and Stephen A. Zeff.

Electronic copy available at: http://ssrn.com/abstract=2018337

1. Introduction

Kim and Shi (this issue) find that, on average, voluntary adoption of International

Financial Reporting Standards (IFRS) is associated with a 59% increase in firm-specific

information capitalized in stock prices. The finding that voluntary IFRS adoption is associated

with significant improvements in the information environment is consistent with the majority of

papers published in top accounting journals on the consequences of IFRS adoption. 1 Similar to

Kim and Shi (this issue), many studies in the area implicitly or explicitly attribute

improvements in the information environment around IFRS adoption to the accounting

standards. A review of the literature on the economic consequences of IFRS adoption would

thus likely conclude that IFRS adoption leads to significant capital market benefits. 2 Such a

conclusion would be premature, however, because it ignores empirical evidence to the contrary.

In particular, such a conclusion ignores the fact that the overwhelming majority of managers

decide not to adopt IFRS when given a choice. This raises the question: why do firms choose

not to adopt IFRS voluntarily when the documented benefits are large and the costs appear to be

low? I attempt to answer this question through a discussion of Kim and Shis arguments and

evidence.

Over the past decade, the International Accounting Standards Board (IASB) has had

notable success in promoting the use of IFRS. The handful of firms that employed IFRS in the

mid-1990s has increased to many thousands as of 2011. This remarkable progress was spurred

1
See the literature review in Kim and Shi (this issue, p. 1) for capital market benefits documented upon voluntary
IFRS adoption. Notable exceptions that provide a more nuanced picture include Van Tendeloo and Vanstraelen
(2005), Daske (2006), and Daske et al. (2011). The evidence on mandatory IFRS adoption is also mixed (e.g.,
Daske et al. 2008) but in this discussion I focus on the consequences of voluntary IFRS adoption.
2
See, for instance, the European Commissions evaluation of mandatory IFRS a few years after the mandate (EU
2008, p. 7): Academics have started to analyse the impact of introduction of IFRS on securities markets, but it is
still too early to give conclusive results. However, preliminary studies indicate that there is an overall reduction in
the cost of capital for companies supplying IFRS accounts.[Sic].

Electronic copy available at: http://ssrn.com/abstract=2018337

 by mandatory IFRS adoption in over 90 countries. 3 Mandatory adoption of IFRS is often

justified with reference to academic studies that document capital market benefits around IFRS

adoption. Today, even the United States is considering mandatory IFRS adoption for listed

companies (SEC 2008). Against this backdrop, studies on the economic consequences of IFRS

adoption are highly relevant, and Kim and Shi deserve credit for addressing a question that is

important to academics and policy makers alike. The policy relevance of studies on the

consequences of IFRS adoption warrants a strong emphasis, however, on the caveats to the

conclusions drawn.

Kim and Shi provide evidence based on a sample of firms from 34 countries that adopted

IFRS voluntarily over the seven-year period between 1998 and 2004. They use stock price

synchronicity as a (inverse) measure of firm-specific information in stock prices, and show that

stock prices incorporate more firm-specific information for voluntary IFRS adopters than local

GAAP firms. Kim and Shi also document that IFRS adoption is associated with the greatest

reduction in synchronicity when analyst following is low and institutions are weak. They draw

three conclusions based on their evidence: (i) IFRS improves the information environment by

facilitating the flow of firm-specific information into the market, (ii) the synchronicity-reducing

role of IFRS is more pronounced when there is less competing information from analysts, and

(iii) IFRS adoption can substitute for weak institutions.

I provide an alternative perspective on the evidence and interpretations that Kim and Shi

offer. In Section 2, I evaluate the main arguments and findings that Kim and Shi rely on to

draw their conclusions. I begin by arguing that the low global frequency of voluntary IFRS

adoption is inconsistent with a causal interpretation of the large benefits documented around

IFRS adoption. I then show that variation in the net benefits of IFRS adoption estimated by
3
See iasplus.com.

Electronic copy available at: http://ssrn.com/abstract=2018337

 Kim and Shi does not predict which firms voluntarily adopt IFRS adoption. This implies that

either managers are irrational or the benefits are incorrectly estimated. I argue that the latter is

more likely than the former. In Section 3, I provide an alternative explanation for Kim and

Shis results whereby managers behave rationally but IFRS per se has little to no direct effect

on firms information environment. Essentially, a large proportion of voluntary IFRS adopters

implemented the standards in order to list on new stock market segments that contractually

required IFRS compliance. The benefits of listing on the new segments coincided with

fundamental firm changes that improved the information environment, but IFRS was not the

cause. This alternative explanation is closely related to discussions in Christensen et al. (2008)

and Daske et al. (2011).

2. Main Arguments and Findings

Kim and Shis main finding is a reduction in stock price synchronicity around IFRS

adoption the estimated reduction is 59% for a firm with no analyst following. The decrease in

synchronicity suggests that IFRS adoption facilitates the flow of firm-specific information into

stock prices. As the most common argument for IFRS adoption is increased disclosure quality,

the results suggest significant benefits from adopting IFRS. In this section, I evaluate this

finding and discuss its implications.

Kim and Shi argue that the lower stock price synchronicity for voluntary IFRS adopters is

consistent with an improved information environment due to IFRS adoption. Proponents of

IFRS would find this evidence compelling since they argue that a comprehensive capital-market

oriented set of accounting standards improves transparency over national accounting standards

that are often less extensive. However, there is also the argument that accounting standards give

3
significant discretion to managers and hence it is not clear that IFRS per se improves disclosure

quality (e.g., Ball et al. 2000, 2003, Burgstahler et al. 2006).

Although the significant benefits around IFRS adoption that Kim and Shi document are

consistent with most prior studies on the economic consequences of IFRS adoption, they are

inconsistent with the actions of practitioners. Consider the frequencies of global IFRS adoption

that Kim and Shi report in Table 1. The descriptive statistics in Panel B indicate that very few

firms voluntarily adopted IFRS before 2000, and almost all of the voluntary adopters are

headquartered in member states of the European Union (EU). The European Commission

outlined its strategy to mandate IFRS (as of 2005) in June 2000, formally proposed it in February

2001, and legally adopted the regulation in June 2002. Hence, in the EU only IFRS adoption

prior to 2000 can be considered truly voluntary; adoption after 2000 may represent early

adoption of mandatory rules. The descriptive evidence shows that in 2000 only 5% of the

sample firms had adopted IFRS, and by 2004, the year before mandatory IFRS adoption in the

EU, this frequency had grown to only 9%. 4 Thus, truly voluntary IFRS adoption was rare and

even early adoption of mandatory IFRS appears somewhat uncommon in Kim and Shis sample.

Interpreted in an economic framework based on rationality, the large benefits appear inconsistent

with these low IFRS adoption frequencies.

One way to maintain the rationality assumption and justify the large benefits is to argue

that the costs of IFRS adoption offset the estimated benefits. Like most prior papers, Kim and

Shi only estimate the benefits of IFRS adoption, so the costs could plausibly explain why firms

rarely adopt IFRS voluntarily. However, while it is hard to estimate the costs of IFRS adoption,

4
The IFRS adoption frequencies reported by Kim and Shi in Table 1 are most likely biased upward compared to the
adoption frequencies in the population of firms. The upward bias occurs because large firms are more likely to
voluntarily adopt IFRS (see Table 4) and more likely to be covered by the databases that Kim and Shi use. Hence,
Worldscope data (which is also biased towards large firms and therefore IFRS adopters) on the accounting standards
used suggest that less than 3% of the Worldscope universe of firms adopted IFRS voluntarily by 2000.

4
several arguments suggest that they are limited during the period that Kim and Shi consider.

First, the standards in effect during Kim and Shis sample period were developed by the

International Accounting Standard Committee (IASC). The IASC at its founding in 1973 had

members from nine countries with very different accounting traditions (e.g., France, United

States, Germany, and Japan) and a three-quarter majority was required to approve exposure

drafts and final standards. Since country delegations often defended their national accounting

practices and some preferred the flexibility of having optional accounting treatments, many

standards issued by the IASC are based on free choice (Zeff 2012). For instance, the standard on

property, plant, and equipment (IAS 16) allows discretion over the choice between historical cost

and fair value accounting, which reflects the German tradition of conservative asset valuation

and the UK tradition of revaluing assets. Second, the IASC, and later IASB, has followed what

can be characterized as a principle-based approach to standard settings. As a result, IFRS

include far fewer bright-line rules than US accounting standards. Compare, for instance, the US

standard for leasing from 1976 (FASB 13) to the IFRS standard on leasing issued in 1982 (IAS

17). Whereas the US standard has a number of bright-line thresholds, the IFRS standard

includes only principles and a series of examples to guide the user. The question is how costly is

it to adopt accounting standards that rely heavily on discretion and principles. I argue that the

costs are likely low.

Low costs of adopting IFRS questions whether we can interpret the large benefits

estimated by Kim and Shi as a causal effect of the accounting standards. However, so far I have

merely presented anecdotes and arguments, which are debatable. As empirical evidence, I again

turn to Kim and Shis descriptive statistics in Table 1. Regardless of the average cost of

adopting IFRS, it is straightforward to argue that the costs of IFRS adoption increase in the

5
extent to which compliance with the accounting standards is enforced. It is generally

inexpensive to claim compliance with rules that are not enforcedin particular, if application of

the rules requires substantial judgment as under the early IFRS standards (Ball 2006, Daske et al.

2011). Thus, in Table 1 we should observe that firms located in low enforcement countries adopt

IFRS more frequently than firms located in high enforcement countries. Table 1, Panel A shows

exactly the opposite, however: 69% of all voluntary adopters are located in Germany or

Switzerland, which arguably have stronger enforcement than Thailand, Mexico, Brazil, and

India, where no sample firm adopted IFRS voluntarily (e.g., La Porta et al. 1997).

What makes the lack of voluntary adoption in weak enforcement countries even more

surprising is Kim and Shis finding that the benefits of IFRS adoption are greatest in countries

with weak institutions (including enforcement of accounting standards). The higher benefits and

lower costs jointly predict that firms residing in countries with weak institutions should

voluntarily adopt IFRS more frequently than firms residing in countries with strong institutions.

Since we observe exactly the opposite in Table 1, managers must behave irrationally if the

estimated benefits are correct.

Aside from the inconsistencies between the estimated benefits of IFRS and the observed

frequencies of voluntary IFRS adoption, the finding that IFRS can substitute for institutions

designed to enforce compliance with IFRS is fundamentally different from how scholars have

generally thought about the interaction between rules and enforcement (see Djankov et al. 2003

and Shleifer 2005). The literature generally argues and finds that enforcement is critical to the

effect of regulation. How is the argument for IFRS adoption any different?

Overall, the discussion above suggests that either managers behave irrationally or IFRS

adoption per se does not explain the benefits that Kim and Shi estimate. I consider the latter

6
more likely than the former, and I next present an alternative explanation for Kim and Shis

results.

3. Alternative Explanation for Capital Market Benefits around IFRS Adoption

The discussion in Section 2 implies that the improvements in the information

environment around IFRS adoption that Kim and Shi estimate are unlikely to be caused by IFRS

adoption. Yet, Kim and Shis findings are consistent with most published papers on the

economic consequences of IFRS adoption, so it would be imprudent to dismiss them as spurious.

In this section I offer an alternative explanation for the finding that voluntary IFRS adoption is

associated with capital market benefits where managers make rational accounting standards

choices. For brevity, I only present one alternative explanation but a detailed examination of the

institutional settings in countries where voluntary IFRS adoption occurs would likely reveal

other similar examples. The alternative explanation is based in part on the arguments and

findings in Daske et al. (2011).

Recall that Table 1 shows that 69% of the voluntary adopters are located in Germany or

Switzerland. In 2000, when IFRS adoption in Europe was still truly voluntary, 73% of the

voluntary adopters were headquartered in Germany or Switzerland. 5 The most likely reason for

the relatively high number of voluntary adopters in these countries is the creation of stock market

segments that required the adoption of international accounting standards. 6 The new market

segments focused on growth firms and were particularly strong in Germany and Switzerland due

to regulation that allowed compliance with international accounting standards instead of local

5
I thank the authors for providing me with this statistic.
6
Among the new market segments that required the adoption of international standards (IFRS/US-GAAP) were
Neuer Markt and SWX (see Leuz 2003 for details). In addition to these market segments, a number of European
stock market indices included only firms that complied with IFRS. For simplicity I focus on the stock market
segments in my discussion but the arguments above logically extend to most contracting explanations for adopting
IFRS voluntarily.

7
GAAP (Leuz 2003). The largest new segment, NeuerMarkt at Frankfurt Stock Exchange, was

established in 1997, which coincides with the increase in voluntary IFRS adoption starting in

1998 reported by Kim and Shi (see their footnote 6). Because the adoption of international

accounting standards was one of several contractual requirements to be listed on the new

segments, if the costs of adopting IFRS were sufficiently low, managers considering listing their

firms on the new segments could rationally adopt IFRS absent any capital market benefits of

IFRS per se. Hence, contracting may explain why some firms adopted IFRS voluntarily.

The contracting explanation can also explain the capital market benefits around IFRS

adoption because the decision to contract is not random. Managers have the greatest incentive to

reconsider their listing decisions when their firms require external capital. Consistent with this

argument, voluntary IFRS adoption is associated with reliance on external capital, cross-listings,

and connections to banks (e.g., Leuz and Verrecchia 2000, Ashbaugh 2001, Tarca 2004, Cuijpers

and Buijink 2005, Gassen and Sellhorn 2006, Christensen et al. 2008). In this context, a firm

could experience a fundamental change (e.g., a shock to growth opportunities) that motivates

efforts to obtain external capital. The need for external capital, in turn, increases the benefits to

listing on the new segments. To the extent that the fundamental change also positively affects

the information environment (e.g., reduces stock price synchronicity), the researcher will observe

benefits around IFRS adoption even though these benefits are not caused by IFRS adoption per

se. Thus, in this setting, managers of firms that do not experience a fundamental change

rationally stick to local GAAP even if the costs of IFRS adoption are relative low.

Kim and Shi acknowledge the endogeneity problem and employ two empirical methods

in an effort to overcome it: propensity score matching and a Heckman-type two-stage treatment

effect approach. My first observation is that propensity score matching controls for cross-

8
sectional differences in observed variables and hence does not alleviate the concern that

voluntary IFRS adoption could coincide with fundamental but unobservable changes to the

adopting firm. Second, the Heckman approach ideally relies on at least one valid instrument (see

Francis et al. 2012). Unfortunately, valid instruments are difficult to identify in this setting and

the instruments that Kim and Shi exploit, namely, foreign sales and growth, are unlikely to meet

the exclusion restriction. That is, foreign sales and growth likely correlate with constructs such

as growth opportunities, which could affect stock price synchronicity.

Finally, stock price synchronicity may not be the ideal outcome variable if the objective

is to identify a causal effect of IFRS adoption. Although it is straightforward to argue that IFRS

could affect the quality of annual (and perhaps interim) reports, it is less clear why annual reports

should affect stock price synchronicity. Kim and Shi measure stock price synchronicity weekly

over the year but annual reports are disclosed, by definition, only once a year. It is unclear why

infrequent disclosures should affect information flow throughout the year. Indeed,

improvements in the flow of information into stock prices throughout the year are likely to be

more consistent with a fundamental change to the firm than a causal effect of reports disclosed

annually. 7

4. Summary and Implications

Kim and Shi (this issue) present evidence that voluntary IFRS adoption is associated with

a decrease in stock price synchronicity. They interpret the results as IFRS adoption facilitating

the flow of firm-specific information into stock prices and improving firms information

environment. Their evidence is important from both an academic and a policy perspective.

7
See Ashbaugh-Skaife et al. (2006) for a thorough discussion of the limitations involved with using stock price
synchronicity in international samples.

9
 My central argument is that the large improvements to firms information environment

that Kim and Shi document around voluntary IFRS adoption, although consistent with prior

research, appears inconsistent with the low frequency of voluntary IFRS adoption globally.

Assuming that managers are rational, the benefits of IFRS adoption must be substantially smaller

than what academics generally have estimated them to be. I reason that endogeneity bias likely

explains some of the capital market changes around voluntary IFRS adoption.

Estimating a causal effect of new accounting standards is an ambitious task and it is

inevitable that results and their interpretation will be questioned. However, given the policy

relevance of research in this area, I encourage more evidence on the consequences of IFRS

adoption. One of the central questions that remains largely unanswered is: what are the costs of

adopting IFRS? Most research to date focuses on estimating benefits of IFRS adoption. Given

that firms revealed preferences suggest that most resist IFRS adoption, it follows that the costs

must be significant or that the benefits are small.

10
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