Are analyst stock recommendation revisions more informative in the post‐IFRS period?

• DOI: http://doi.org/10.1111/jbfa.12286
• Author: Andreas Charitou,Irene Karamanou,Anastasia Kopita
• Published date: 01 January 2018
• Date: 01 January 2018

DOI: 10.1111/jbfa.12286

Are analyst stock recommendation revisions more

informative in the post-IFRS period?

Andreas Charitou1Irene Karamanou1Anastasia Kopita2

1Accounting& Finance, University of Cyprus,

P.O.Box 205037, Nicosia, Cyprus

2Accounting,University of Essex, Colchester,

Essex,UK

Correspondence

AndreasCharitou, Department of Accounting &

Finance,School of Economics and Management,

Universityof Cyprus, P.O.Box 20537, Nicosia,

CY1678, Cyprus.

Email:charitou@ucy.ac.cy

Fundinginformation

EuropeanUnion (INTACCT Research Program)

Universityof Cyprus

Instituteof Certified Public Accountants of

Cyprus

Abstract

This paper investigates whether the mandatory IFRS adoption has

affected the informativeness of analyst recommendation revisions

in Europe. Although prior studies document that IFRS adoption

improved analyst forecast attributes, the impact of IFRS cannot be

completely assessed without examining how the market reacts to

information-rich events in an environment with enhanced disclo-

sure. Toexamine this question we utilize a difference-in-differences

design using as main control sample firms that had voluntarily

adopted IFRS before the EU's mandated switch. Overall, our evi-

dence suggests that after the mandatory adoption of IFRS, both ana-

lyst upgrades and downgrades are more informative. These results

hold after controlling for a number of variables that capture analyst,

firm and information environment characteristics and are robust to

a number of sensitivity analyses including the use of a US control

sample. Finally, we examinewhether our results are sensitive to the

level of accounting enforcement. We find that analyst downgrades

are more informative in the post-IFRS period for firms in both high

and low enforcement environments. Analyst upgrades, however,are

more informative only if they are issued for firms in high enforce-

ment countries.

KEYWORDS

disclosure, enforcement, financial analysts, IFRS, informativeness,

recommendations

1INTRODUCTION

The 2005 mandatory adoption of International Financial Reporting Standards (IFRS) aimed to enhance the compara-

bility of financial statements, improve corporate disclosure, and increase the quality of financial reporting (Regulation

(EC) No. 1606/2002). In their 2002 joint white paper,KPMG International and Goldman Sachs asserted that the impact

of IFRS adoption in Europe would enhance transparency by requiring companies to disclose new and different aspects

of their businesses. This expectation is also reflected in a study conducted byKPMG in 2005 which showed that nearly

77% of financial analysts surveyed believed that the introduction of IFRS would have an impact on company valua-

tion. Whether this enhanced transparency will also increase the informativeness of analyst stock recommendations is,

J Bus Fin Acc. 2018;45:115–139. wileyonlinelibrary.com/journal/jbfa c

2017 John Wiley & Sons Ltd 115

116 CHARITOUET AL.

however,not aprioriclear.Even though the literature shows that analyst earnings forecasts exhibit more accuracy after

the mandated IFRS adoption, this result may be more related to IFRS earnings exhibiting greater persistence and pre-

dictability,than providing value-relevant information. Ultimately, how investors react to the release of analyst recom-

mendation revisions in the post-IFRS period depends on whether analysts rely on IFRS financial statements to release

more informative recommendations. However,evidence suggests that analysts rely more on their private communica-

tion with firm management than on the financial statements themselves as an input to their stock recommendations

(Brown, Call, Clement, & Sharp, 2015), in turn suggesting that IFRS may not be that useful to analyst research. Thus,

whether the informativeness of analyst stock recommendation revisionshas been affected by the mandatory adoption

of IFRS is still an open question and an important one to answer in order to more comprehensively assess the impact of

mandatory IFRS adoption in Europe.

Our main dataset consists of 9,992 recommendation revisions for EU firms that mandatorily switched to IFRS, with

5,408 (4,584) revisions issued in the pre- (post-) IFRS period. To mitigate concerns that our results are affected by

events other than those associated with the mandated IFRS switch (Hail & Leuz, 2007), our methodological design

implements a difference-in-differences approach. Specifically, we benchmark the analysis, first on a sample of firms

that had voluntarily adopted IFRS, and second on a sample of US firms. Because firms included in the control samples

either use IFRS both before and after mandatory adoption, or do not use IFRS at all, the informativeness of their stock

recommendations can only be affected by concurrent economic and regulatory changes, enabling us to effectivelycon-

trol for potential confounding events. An important concern in related research is whether documented changes in the

post-IFRS period are indeed due to the adoption of IFRS or instead affected by concurrent changes in the institutional

environment and, more specifically,in the country's enforcement levels (Christensen, Hail, & Leuz, 2013; Soderstrom

& Sun, 2007). The use of a control sample comprising voluntary adopters, in particular, helps alleviatesuch concerns

since, to the extentthat disclosure quality of voluntary adopters is also enhanced in the period following the mandated

IFRS switch, differences between the two samples should be more difficult to document, decreasing, in turn, our ability

to find evidence in support of our expectations.

Our results suggest that the market reaction to recommendation revisions for mandatory adopters is stronger in

the post-IFRS period. Specifically, the three-dayabnormal return around the issuance of the revision is more positive

for upgrades and more negative for downgrades, indicating that the 2005 mandatory adoption of IFRS increased the

informativenessof analyst stock recommendations. When we condition the analysis on the level of accounting enforce-

ment1, we find that the increase in informativenessfor stock upgrades is only observed in strong enforcement environ-

ments, consistent with related research (see, e.g., Landsman, Maydew, & Thornock, 2012). Interestingly,we find that

downgrades are more informative in both strong and weak enforcement environments, but the increase in informa-

tiveness is greater when country enforcement is strong. We explain these results based on research suggesting that

managers face incentives to delay or even conceal poor performance (Kothari,Shu, & Wysocki, 2009; Leuz, Nanda, &

Wysocki, 2003). The existence of these incentives suggests that the disclosure of good news is deemed reliable only

when accounting standards are rigorously enforced. On the other hand, bad news can be reliable even if additional

mandated disclosures are loosely applied.

Our results are robust to an array of sensitivity analyses. For example, we conjecture that if indeed the driving

force behind the increased informativeness of analyst recommendation revisions is related to IFRS, revisions released

shortly after earnings announcements should be more informative than those released further away.Results are con-

sistent with this expectation.We also find that our results are not sensitive to: (a) the exclusion from the control sample

of voluntary adopters from low enforcement environments, (b) the exclusionof UK firms, and (c) the use of an alterna-

tive measure of country legal enforcement based on Kaufmann, Kraay,and Mastuzzi (2007).

Ourevidence makes a number of important contributions to the literature. First, we contribute to the IFRS literature

by examining the effect of the mandatory IFRS switch on one of the most important financial research outputs: stock

recommendations. The literature has shown that analyst stock recommendations elicit significant returns when they

1The country enforcement measure used in this study is the auditing and accounting enforcement measure in Brown, Preiato and Tarca(2014). For brevity,

werefer to this measure as accounting enforcement.