7
To address the effects of the economic downturn and other institutional factors
(e.g., enforcement mechanism) on my results, I examine only UK firms that were subject
to the same economic downturn and institutional factors. I find that UK firms that
switched from fair-value accounting under UK GAAP to historical
cost accounting with
impairment testing under
IFRS
exhibit greater reductions in over-investment after
IFRS
adoption relative to
other UK firms
. This finding mitigates the concern that the reduction
in over-investment after
IFRS
adoption is an effect attributed
to the economic downturn
or to other institutional factors.
Prior literature (e.g., LaFond and Roychowdhury 2008; LaFond and Watts 2008;
Ahmed and Duellman 2010) shows that timely loss recognition is a governance
mechanism that mitigates agency conflicts between managers and outside shareholders.
As a supplemental test, I examine the effect on over-investment based on the level of
agency conflicts. If EU firms are indeed using historical cost accounting with strict
impairment rules (i.e., more timely loss recognition) for
PPE
following
IFRS
adoption,
then I predict that as the level of agency conflicts increases, the greater will be the
effect
of timely loss recognition on reducing over-investment. My results are consistent with
this prediction. After
IFRS
mandatory adoption, outside shareholders appear to be
demanding timely loss recognition as a means of addressing agency conflicts with
managers.
This study contributes to the accounting literature in several ways. First, my paper
contributes to the international accounting literature by examining the effect firms’
accounting choices
following mandatory
IFRS
adoption have on firms’ investment
efficiency. My findings suggest that the increase in investment efficiency for
PPE
(i.e.,
lower over-investment) following mandatory
IFRS
adoption is not uniform among firms.
Rather, the investment efficiency benefits are dependent on the accounting choices that
firms followed prior to
IFRS
and the option they chose after the mandatory adoption of
IFRS
. Understanding the effect of
IFRS
accounting choices on
investment efficiency is of
8
potential interest to standard setters and regulators in countries that are considering
IFRS
adoption as well as in countries that have already adopted
IFRS
.
Second, my paper contributes to the literature on the effects of conservative
financial reporting (i.e., timely loss recognition). Prior studies (e.g., Francis and Martin
2010; Srivastava et al. 2010; Ahmed and Duellman 2010)
show that conservative
financial reporting reduces over-investment. These studies examine firms under one set
of domestic standards, U.S. GAAP, where all firms are required to use historical cost
accounting for non-financial assets and are subject to the same impairment rules.
However, in
my study, I exploit a setting where firms have changed their accounting
treatments for
PPE
from fair-value accounting (or historical
cost accounting with loose
impairment rules) to historical cost accounting with strict impairment rules. Therefore, I
investigate in a more direct way the effect of conservative financial reporting on over-
investment in
PPE
. Further, prior studies (e.g., Dietrich et al. 2007; Givoly et al. 2007;
Gow et al. 2010; Tian et al. 2009) show that it is difficult to reliably measure ‘firm-level’
conservatism and that commonly-used conservatism measures, such as the one proposed
by Basu (1997), suffer from measurement errors. In my study, I do not rely on a ‘firm-
level’ measure of conservative reporting. Rather, I exploit a natural sample partitioning
based on whether firms used fair-value accounting or historical cost accounting with
either strict or loose impairment rules for
PPE
to identify which firms are less
conservative in measuring
PPE
than others.
Third, this study provides evidence relevant to
the heated debate among
academics and standard setters regarding whether fair-value accounting for non-financial
assets is beneficial to stakeholders (e.g., Ball 2006; Barth 2006; Schipper 2005; Watts
2006).
9
My findings suggest that the reduction in over-investment in
PPE
after
IFRS
9
Barth (2006, p. 98) states that in almost every standard-setting project of the U.S. Financial Accounting
Standards Board (FASB) and the International Accounting Standards Board (IASB), the boards consider
fair value as a possible measurement attribute. This includes the conceptual framework.
9
mandatory adoption is associated with firms’ election to use historical cost accounting
with strict impairment rules. Hence, my findings imply that any future
IFRS
standards
that mandate fair-value accounting for non-financial assets could produce less firm-
specific investment efficiency benefits than the current
IFRS
standards that allow both
fair-value accounting and historical cost accounting with strict impairment rules.
The remainder of this paper is organized as follows. Chapter II reviews related
literature and develops my hypotheses. Chapter III describes my measures, research
design, and sample. Chapter IV presents my results while chapter V presents my
supplemental test. Chapter VI concludes.
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