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

2.2 Hypotheses Development 
The primary objective of this paper is to examine the effect of accounting choices 
that firms can make under 
IFRS
on over-investment in 
PPE
. Several studies (e.g., Ball 
2001; Watts 2003; Ball and Shivakumar 2005; Francis and Martin 2010; Ahmed and 
Duellman 2010) suggest that timely loss recognition, one important characteristic of 
high-quality financial reporting, is part of a firm’s governance structure that leads 
managers to make more efficient investment decisions. Further, 
IFRS
, under IAS 36, 
arguably has more informative, more transparent, and more comparable impairment rules 
(i.e., strict impairment rules) for 
PPE
relative to EU countries’ domestic GAAP that had 
less informative, less transparent, and less comparable impairment rules (i.e., loose 
impairment rules) for 
PPE
. Consequently, more timely loss recognition for 
PPE
is 
expected following 
IFRS
adoption among EU firms that used historical cost accounting 
with strict impairment rules under 
IFRS
. Hence, managers are likely to be more 
disciplined in making investment decisions that increase shareholder value because 
timely loss recognition reduces managers’ wealth via bonuses, reappointment, and 
reputation. In addition, managers knowing, ex-ante, that future losses will be recognized 
in earnings in a more timely manner under the new 
IFRS
impairment rules, will find it 
unattractive to undertake negative NPV projects. Therefore, I test the following 
hypothesis (stated in alternative form):
16
H1.
EU firms that used historical cost accounting with strict impairment rules 
under IFRS will exhibit lower over-investment in PPE following IFRS adoption