Accounting choices under ifrs and their effect on over-investment in capital expenditures

IFRS
adoption. My purpose in conducting 
this analysis is to directly investigate the extent to which the accounting choices under 
IFRS
promote more efficient real investment decisions.
Prior studies document that timely loss recognition is an important property of 
accounting that improves the efficiency of contracts. Timely loss recognition, through 
which expected future cash losses are charged against current earnings, is considered part 
of a corporate governance structure that constrains opportunistic behavior by managers, 
particularly their investment decisions (e.g., Ball 2001; Watts 2003; Ball and Shivakumar 
2005; Francis and Martin 2010). Timely loss recognition allows outside suppliers of 
capital to monitor managerial performance and discipline managers’ tendency to over-
invest in a more timely manner (Francis and Martin 2010). If managers know, ex-ante, 
that economic losses will be recognized in a timely manner, they are less likely to engage 

---

2 
in value-destroying activities, such as empire building.
1
Further, timely loss recognition 
increases the incentives of managers to quickly abandon losing investments. Economic 
losses from losing investments will have negative earnings consequences and, thus, will 
reduce managers’ earnings-based compensations and, consequently, their job security.
2
Francis and Martin (2010) show that firms with more timely loss recognition 
pursue more profitable acquisitions and make better ex-post divestiture decisions. In a 
related study, Srivastava et al. (2010) find that timely loss recognition increases the 
likelihood of timely closures of unprofitable projects. Using data from twenty-five 
countries, Bushman et al. (2011) find that timely loss recognition disciplines managers 
who are confronted with declining investment opportunities (i.e., investments in ex-ante 
value-destroying projects). Furthermore, other studies show that timely loss recognition 
reduces agency conflicts between managers and outside shareholders (e.g., LaFond and 
Roychowdhury 2008; LaFond and Watts 2008; Ahmed and Duellman 2010). These 
studies provide evidence consistent with timely loss recognition being part of a firm’s 
governance structure that results in better managerial investment decisions.
A number of prior studies examine whether adoption of 
IFRS
leads to more 
timely loss recognition. The findings are mixed and inconclusive. For example, Barth et 
al. (2008) find an increase in timely loss recognition following firms’ voluntary adoption 
of 
IAS/IFRS
over the 1994-2003 period.
3
However, Barth et al. (2008) do not account for 
managers’ incentives and prior research (e.g., Christensen et al. 2008) shows that benefits 
from 
IAS/IFRS
adoption are highly dependent on managers’ incentives to voluntarily 
1
Jensen (1986) argues that managers have incentives to expand the firm beyond its optimal size because 
(1) this increases the resources under managerial control and (2) executive compensation is positively 
related to firm size. 
2
Warner et al. (1988) show that managers’ bonuses and job tenure are a function of reported earnings. 
3
International Accounting Standards (
IAS
) were issued by the International Accounting Standards 
Committee (IASC). The International Accounting Standards Board (IASB), the successor body to the 
IASC, issues 
IFRS
that include standards issued by the IASC. 

---

3 
adopt 
IAS/IFRS
. Further, Barth et al.’s (2008) findings may not apply to mandatory 
adopters of