Accounting Standards Harmonization and Financial Statement Comparability: Evidence from Transnational Information Transfer

• Author: CLARE WANG
• DOI: http://doi.org/10.1111/1475-679X.12055
• Date: 01 September 2014
• Published date: 01 September 2014

DOI: 10.1111/1475-679X.12055

Journal of Accounting Research

Vol. 52 No. 4 September 2014

Printed in U.S.A.

Accounting Standards

Harmonization and Financial

Statement Comparability:

Evidence from Transnational

Information Transfer

CLARE WANG

∗

Received 19 October 2011; accepted 18 March 2014

ABSTRACT

This paper investigates whether accounting standards harmonization en-

hances the comparability of financial information across countries. I hypoth-

esize that a firm yet to announce earnings reacts more strongly to the earn-

ings announcement of a foreign firm when both report under the same

rather than different accounting standards. My analysis of abnormal price

reactions for a global sample of firms supports the prediction. Next, in an at-

tempt to control for the underlying economic comparability and the effects of

changes in reporting quality, I use a difference-in-differences design around

the mandatory introduction of International Financial Reporting Standards.

∗Kellogg School of Management, Northwestern University.

Accepted by Philip Berger. This paper is based on my dissertation at the Wharton School,

University of Pennsylvania. I am indebted to my dissertation committee members Brian

Bushee, Luzi Hail, Cathy Schrand (Chair), and Ro Verrecchia for their continuous and in-

valuable guidance. I appreciate the helpful comments of an anonymous referee, Gus De

Franco, Wayne Guay, Mirko Heinle, Ray Ke, Jim Naughton, Ira Yeung, and workshop partici-

pants at the University of Pennsylvania, University of Chicago, University of Toronto, Harvard

University, Boston College, University of Michigan, New York University, Northwestern

University, Emory University, Duke University, University of Southern California, and

Washington University in St. Louis. I gratefully acknowledge the financial support from the

Wharton School, the Connie K. Duckworth Endowed Doctoral Fellowship, and the Kellogg

School of Management.

955

Copyright C, University of Chicago on behalf of the Accounting Research Center,2014

956 C.WANG

I find that mandatory adopters experience a significant increase in market

reactions to the release of earnings by voluntary adopters compared to the

period preceding mandatory adoption. This increase is not observed for non-

adopters. Taken together, the results show that accounting standards harmo-

nization facilitates transnational information transfer and suggest financial

statement comparability as a direct mechanism.

1. Introduction

This study seeks to enhance our understanding of financial statement com-

parability’s benefits for market participants, asking whether harmoniza-

tion of accounting standards achieves comparability across countries. In a

transnational intraindustry information transfer context, I predict and find

that a firm’s price reaction to a foreign firm’s earnings announcement is sig-

nificantly higher for firms reporting under the same rather than different

accounting standards. The intuition is that, when the underlying measure-

ment processes for accounting earnings are more correlated, that is, when

they are more comparable, investors can extract additional value-relevant

information embedded in the foreign firm’s earnings signal.

Financial statement comparability has been recognized as an important

characteristic of financial reporting, improving the usefulness of account-

ing information. Broadly, economic decision making compares alterna-

tives, and accounting textbooks emphasize that financial results cannot be

evaluated in isolation. Libby, Libby, and Short [2009, p. 714], for example,

maintain that “[a]nalyzing financial data without a basis for comparison

is impossible.” The importance of financial statement comparability across

firms is further underscored in valuation techniques, such as price multi-

ples, which are used extensively by investment banks and institutional in-

vestors. Consequently, standard setters position comparability as a central

feature of the financial reporting system. Specifically, comparability is one

of the four “enhancing qualitative characteristics” of accounting informa-

tion defined in the first phase of the joint conceptual framework completed

by the IASB and the FASB (FASB [2010], IASB [2010]).

Financial statement comparability, however, is inherently difficult to de-

fine and operationalize. Even theoretically, the effect of comparability on

equity valuation is not definitive. A few empirical studies investigate the role

of comparability in different contexts including a firm’s overall information

environment (e.g., Bradshaw, Miller, and Serafeim [2009], Lang, Maffett,

and Owens [2010], De Franco, Kothari, and Verdi [2011]), mutual fund

holdings (e.g., DeFond et al. [2011], Yu and Wahid [2013]), and use of rel-

ative performance evaluation (RPE; e.g., Ozkan, Singer, and You [2012]).

Yet these studies provide mixed evidence and do not directly address the ef-

fect of comparability in equity valuation. Moreover, in studies that examine

the firm’s own economic consequences to test the effects of comparability,

a first-order reporting quality effect as an alternative explanation for the

results is difficult to rule out.

TRANSNATIONAL INFORMATION TRANSFER 957

I define comparability as the correlation between the measurement

processes of two firms’ accounting earnings. This characterization allows

me to motivate an equity valuation role for comparability in the well-

established information transfer setting. The information transfer context

is useful for identifying the comparability effect empirically as it is a direct,

short-window test of how one firm’s information signal (e.g., an earnings

announcement) affects the other firm’s valuation. I predict that the nonan-

nouncing firm’s market reactions to the announcing firm’s earnings re-

port increase with financial statements comparability, as more correlated

accounting standards allow investors to extract more information from the

announcing firm’s earnings signal when valuing the nonannouncing firm.1

I test the prediction that comparability affects the degree of informa-

tion transfer in two cross-border settings leveraging the ongoing global

convergence toward International Financial Reporting Standards (IFRS).

Harmonization of accounting standards offers a powerful treatment effect

where the increases in financial statements comparability should be signif-

icant and visible based on a change of the entire system for preparing and

disclosing information. In theory, if two firms with the same economic ac-

tivities report under the same standards, then the measurement processes

should be perfectly correlated.2If two firms report under different stan-

dards, then the correlation between measurement processes will depend

on the specific standards. For example, one would expect the correlation

resulting from applications of IFRS and U.S. GAAP to be relatively high

in comparison to the correlation resulting from applications of IFRS and

Greek GAAP.3Consequently, I expect the nonannouncing firms’ price re-

action to an earnings announcement by the foreign firm to be higher

for firms reporting under the same (more correlated) accounting stan-

dards than for firms reporting under different (less correlated) accounting

standards.

However, there are at least two reasons why my predictions may not be

borne out empirically. First, extant literature shows that a mere switch to a

1See Wang [2014] for the corresponding statistical definition of financial statement com-

parability and a two-firm, sequential information release framework that delivers these predic-

tions theoretically.

2In general, any set of accounting standards accommodates accounting method choices.

As a simplification on the conceptual level, I assume that firms make the same accounting

method choices to yield perfect correlation in measurement processes under the same ac-

counting standards. I do not intend to imply that descriptively no difference in accounting

method choices is associated with using the same standards. My empirical tests (1) capture the

extent to which the same accounting standards narrow down the set of available accounting

method choices and (2) employ cross-sectional analyses and difference-in-differences design

to partially account for the heterogeneity in method choices.

3Bae, Tan, and Welker [2008] construct a summary score of how local GAAP differ from

IFRS on 21 accounting dimensions. Greek GAAP differs from IFRS on 17 dimensions, while

U.S. GAAP differs from IFRS on four dimensions only. Greek GAAP, for example, does not

require a cash flow statement, segment reporting, or disclosure of the fair value of financial

assets and liabilities.