The Impact of IFRS 8 on Geographical Segment Information

• Author: Arnt Verriest,Edith Leung
• DOI: http://doi.org/10.1111/jbfa.12103
• Published date: 01 April 2015
• Date: 01 April 2015

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(3) & (4), 273–309, April/May 2015, 0306-686X

doi: 10.1111/jbfa.12103

The Impact of IFRS 8 on Geographical

Segment Information

EDITH LEUNG AND ARNT VERRIEST∗

1. INTRODUCTION

This study examines the impact of IFRS 8 on segment reporting of European

firms. Specifically, we investigate (i) the impact of IFRS 8 on geographical segment

disclosures, (ii) cross-sectional differences in the effect of IFRS 8 adoption, and (iii)

whether IFRS 8 has had any economic and informational consequences.

The IASB issued IFRS 8 in November 2006 to replace IAS 14, and it became

effective in 2009.1As part of the ongoing convergence project between the FASB

and IASB, IFRS 8 is aimed at reducing differences between US GAAP and IFRS. This

resulted in IFRS 8 resembling its US counterpart, SFAS 131, which was introduced

in the United States in 1997. Another reason for the introduction of IFRS 8 is the

scope for managerial opportunism present in the industry (business or geographical)

segmentation under IAS 14, which allowed managers to combine several operations

into one, broadly defined, industry segment. A significant difference between IAS 14

and IFRS 8 is the requirement under IFRS 8 to report information for segments as they

are defined for internal reporting purposes. The aim of the “management approach”

to segment reporting is to increase the usefulness of segment reporting to investors

and analysts, because it would allow them to see through the eyes of management

(IASB, 2013).

Although IFRS 8 resembles its US GAAP counterpart to a great extent, it is uncertain

that its effect on segmental reporting will be the same as in the US. Since enforcement

and other relevant institutional designs differ considerably in Europe (and are far from

homogenous within Europe compared to the US), we consider it an open question

what the outcome of IFRS 8 adoption for European firms would be. With the exception

of the UK, European countries have a lower enforcement and shareholders enjoy

∗The first author is from Erasmus School of Economics, Erasmus University Rotterdam, The Netherlands.

The second author is from EDHEC Business School, Roubaix, France. The authors are grateful to Peter

Pope (Editor) and an anonymous referee for detailed and valuable comments. We also greatly appreciate

comments from Daniel Bens, Willem Buijink, Peter Easton, Philip Joos, Maarten Pronk, Jeroen Suijs and Leo

van der Tas and seminar participants at Tilburg University and the 2014 JBFAconference. (Paper received

October 2014, revised version accepted November 2014)

Address for correspondence: Edith Leung, Erasmus School of Economics, Erasmus University Rotterdam,

PO Box 1738, 3000 DR, Netherlands.

e-mail: leung@ese.eur.nl

1 When referring to IAS 14, we actually refer to the revised version of the original IAS 14 standard unless

specified otherwise. The original standard was issued in 1981; the revised one in 1997.

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274 LEUNG AND VERRIEST

fewer rights than in the US. Prior research (for example, Leuz et al., 2003; and Hope,

2003) shows that these differences are partially responsible for managers of European

firms using their discretion to engage in more earnings management and provide

less reliable disclosures and lower overall financial transparency than their American

peers. Given these results from prior work and that the “management approach” under

IFRS 8 still provides managers with discretion to obfuscate segmental information, we

can expect managers to use this discretion more in Europe than in the US. But the

answer to the question of how IFRS 8 affects segmental disclosures in Europe remains

unclear.

To investigate this open issue, we focus on geographical segments and do so for

three reasons. First, and most importantly, IFRS 8 implicitly lowers the disclosure

requirements for geographical segments if firms define operating segments according

to their products and services. For these firms, IFRS 8 does not require the disclosure

of geographical segment information other than minimal entity-wide disclosures. In-

vestors feared this would lead to a significant loss of geographical segment information

and advanced this argument against the European Union’s adoption of IFRS 8 (V´

eron,

2007). We examine whether this is a valid concern.

Second, prior research has mainly focused on the determinants and consequences

of business segment reporting. In comparison, we know much less about the quality of

geographical segment disclosures and whether these matter to investors, particularly

in non-US contexts. It is not straightforward to outline what a geographical segment

should look like in an ideal situation. However, we argue it is reasonable to assume

that investors can make better investment decisions and face less information risk

when, ceteris paribus, firms provide financial statements for more segments and provide

more financial items per segment, especially items relating to segmental income.

For geographical segments, in particular, we deem it reasonable to assume that

investors are better off when disclosed segments are less aggregated and therefore

more detailed in nature. Consequently, our study provides empirical evidence on

the number of segments, the number of items per segment, and the fineness of

geographical segments to assess the quality of segmental disclosures.

Third, despite concerns about the impact of IFRS 8 on geographical segment dis-

closures that arose leading up to its adoption and remained after its implementation,

no research has examined the actual impact of IFRS 8 on geographical disclosures in

detail.2This study is the first.

To provide empirical evidence on the actual impact of IFRS 8, we hand-collect

segment reporting data for a sample of 737 firms with geographical segment disclo-

sures from 18 European countries.3,4 We deliberately select a sample of firms with

a high proportion of foreign sales. As such, demand for geographical information is

likely to be high, making any changes to geographical segment reporting economically

relevant. Similar to Berger and Hann (2003, 2007), we examine data in the year before

adoption of IFRS 8, as firms are required to restate data for the year preceding the

2 See, for example, http://www.taxresearch.org.uk/Blog/2010/01/08/ifrs-8-in-trouble-country-by-country-

reporting-is-the-answer/.

3 We also briefly analyze the impact of IFRS 8 on business segments. Wehave 632 firms for which these data

could be collected.

4 We hand-collect segment data to enhance the reliability of the data. Thomson Datastream also reports

segment data, but we noticed there are some coding errors, omissions and absences of data that are available

in the annual reports, at least for the years around the adoption of IFRS 8.

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THE IMPACT OF IFRS 8 ON GEOGRAPHICAL SEGMENT INFORMATION 275

adoption year for comparative purposes. This means we can compare historical IAS

14 data originally reported in 2008 to restated IFRS 8 data reported in 2009, thus

holding other changes that could influence segment reporting constant. This makes

it more likely that any observed changes in segment reporting are due to the change

in standards rather than changes in a firm’s economic circumstances.

We find that, on average, firms report more disaggregated segments under IFRS

8, which implies more geographical segments are disclosed. However, the amount of

geographical information (that is, the number of reported items and the frequency of

reporting geographical income) declines significantly. More importantly, we provide

evidence that segment disaggregation does not increase uniformly for all firms. First,

we find no significant improvements for firms that already reported poorly under

IAS 14. This result indicates that improvements do not materialize for the firms with

more room for increased disclosure, resulting in greater cross-sectional divergence

in geographical segment reporting. Second, we find that corporate transparency

affects the impact of IFRS 8. In general, our results show that IFRS 8 led to larger

improvements as transparency increases. Finally, we do not find strong evidence that

firms with improved segment reporting have significantly greater forecast accuracy or

lower forecast dispersion, bid–ask spreads, and cost of equity capital in the year after

IFRS 8 adoption. Collectively, these results cast doubt on whether IFRS 8 achieved its

goal of improving the usefulness of segment information to users, since there appear

to be little to no economic and informational consequences even for improved firms.

We contribute to the literature in the following ways. First, prior studies typically

provide small-sample or single-country evidence or both on the impact of IFRS 8,

whereas we focus on a large cross-country sample of European listed firms. Examining

a large cross-country sample enhances the generalizability of our findings and provides

comprehensive evidence on the impact of IFRS 8. Second, in contrast to most prior

studies on segment reporting, our focus is on the impact of IFRS 8 on geographical

segment reporting. For instance, Nichols et al. (2012) investigate the effect of IFRS

8 on business segments for European blue chip firms, while Bugeja et al. (2015)

comprehensively study the impact of adopting the equivalent of IFRS 8, AASB 8,

for business segments in Australia, but none focus on geographical segments in

particular. Geographical segment disclosures are particularly interesting given our

setting: European firms are much more geographically diversified than US firms,

making geographical disclosures more important to investors and analysts.5Yet IF RS

8 implicitly lowers many of the disclosure requirements for geographical segments,

which was also highlighted as an argument against the adoption of IFRS 8 by the

European Union (V´

eron, 2007). We are the first to examine this issue in detail and

find evidence consistent with these concerns. Third, we investigate heterogeneity in

adoption of IFRS 8 across firms, an important aspect that has been mostly overlooked

in prior research on IFRS 8. As Daske et al. (2013) show, firm-level heterogeneity

should be accounted for when examining economic consequences of regulation. In

particular, we examine whether firms that provide little segment information under

the previous standard improve their segment disclosures as these are the firms for

which improvements are most essential. However, we find that these are not the firms

5 For instance, we find that the average (median) US company in the Compustat database has a ratio

of foreign-to-total sales of 31% (15%), while the average (and median) European firm has foreign sales

reaching 47% of total sales. Moreover, the 100 largest US (European) firms in terms of sales revenues have

a foreign-to-total sales ratio of 43% (64%).

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