The adoption of IFRS, comparability of financial statements and foreign investors’ ownership

Aria Farah Mita (Department of Accounting, Faculty of Economics and Business, Universitas Indonesia, Depok, Indonesia)
Sidharta Utama (Department of Accounting, Faculty of Economics and Business, Universitas Indonesia, Depok, Indonesia)
Fitriany (Department of Accounting, Faculty of Economics and Business, Universitas Indonesia, Depok, Indonesia)
Etty R. Wulandari (Indonesia Financial Services Authority, Jakarta, Indonesia)

Asian Review of Accounting

ISSN: 1321-7348

Publication date: 10 September 2018

Abstract

Purpose

The purpose of this paper is to examine the indirect effect of the International Financial Reporting Standard (IFRS) adoption in increasing the foreign investors’ ownership through the improvement of comparability of financial statements.

Design/methodology/approach

This study employs listed companies in 18 countries across Europe, Asia, Africa, and Australia with an observation period from 2003 to 2012. Unlike previous studies, this study uses a continuous variable to measure the level of IFRS adoption which is measured at the country level. This study includes countries that do not fully adopt the IFRS, partially adopt, make some delays in adoption or some modifications to IFRS.

Findings

The results show that the level of IFRS adoption has a positive effect on the comparability of financial statements. The level of IFRS adoption indirectly increases the foreign investors’ ownership through the comparability of financial statements. These results are consistent with proponents for IFRS adoption which argue that the adoption improves the comparability of financial statements that in turn attracts greater cross-border investment.

Research limitations/implications

The findings of this study need to be interpreted with caution due to limitations. Although this research provides a detail measurement on the IFRS adoption, this study only looks at three general items of difference in adopting the IFRS. “Differences in text” used in this research has not quantified detail differences for each adopted standards. Therefore, future research can use a more in-depth measurement of the IFRS adoption level that considers differences or exceptions of accounting treatment.

Practical implications

The results suggest that the standards setting bodies’ (IASB) strategy on promoting the IFRS and objectives to develop a standard that leads to increase the financial statement comparability have been achieved. This research shows that the IFRS adoption plays a role in ensuring the financial statement quality in terms of its comparability. It implies that the standard-setting bodies in every country, as one of the responsible institutions regulating the business environment, can be entrusted with a greater role in order to ensure better financial information quality.

Originality/value

This study introduces novel measurement that is more detailed in measuring the IFRS adoption level instead of applying the discrete variable approach (“adopt” and “not adopt”) performed by previous studies (DeFond et al., 2011; Tan et al., 2011; Lee and Fargher, 2010). This study does not only cover some EU countries but also covers some countries in Asia, Africa, and Australia, so it can be better at capturing the variation of the IFRS adoption outside the EU. This broader coverage will show the consistency of the benefits of IFRS adoption. This study is most closely related to that of DeFond et al. (2011). This research extends DeFond’s study with some important differences as follows: it uses output-based and firm-specific measurement of the comparability from DeFranco et al. (2011), which is deemed to be more appropriate because it represents the qualitative characteristics of financial statements from a user’s perspective, i.e., investors, who evaluate historical performance and predict future performance in their investment decisions; it uses a broader scope of institutional investors; and it covers IFRS adoption in countries outside the EU for a longer observation period.

Keywords

Citation

Mita, A., Utama, S., Fitriany, F. and Wulandari, E. (2018), "The adoption of IFRS, comparability of financial statements and foreign investors’ ownership", Asian Review of Accounting, Vol. 26 No. 3, pp. 391-411. https://doi.org/10.1108/ARA-04-2017-0064

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Publisher

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Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited


1. Introduction

International portfolio theory suggests that investors should diversify their investment across markets worldwide to maximise risk-adjusted returns (Sharpe, 1964; Stulz, 1981). However, previous literature suggests that investors tend to underweight foreign investment portfolios (Kang, 1997). This phenomenon is called “home country bias”. Home country bias needs to be a concern because it limits the investors’ ability to establish efficient capital allocation through the diversification of investment risk. It has been argued that home country bias is due to additional information processing costs about foreign companies (Ahearne et al., 2004; Yu and Wahid, 2014).

One source of these additional information processing costs are differences in accounting standards. In response to this situation, the International Accounting Standard Board (IASB) aims to develop a single set of accounting standards that yield high-quality, transparent, and comparable information, which will be useful for investors in making investment decisions (Art. 2, IFRS Foundation Constitution, 2013; Tweedie, 2008). Thus, the benefits of IFRS adoption can be obtained through increased transparency and comparability of financial statements. There have been numerous studies focussing on the benefits of the IFRS in improving the transparency of financial statements (Barth et al., 2008; Ashbaugh and Pincus, 2001), while studies that focus on the comparability of financial statements are limited (Yip and Young, 2012; Kim et al., 2016). Since countries are becoming borderless and capital markets are becoming more integrated, studies that focus on the comparability of financial statements are becoming more important.

Previous studies, such as the works of Covrig et al. (2007), Lee and Fargher (2010), Florou and Pope (2012), and Yu and Wahid (2014), have only examined the direct effect of IFRS adoption on foreign investments, while none has examined the indirect effect of IFRS adoption on foreign investments through comparability. The effect may be direct, indirect, or both. Those previous studies have found that IFRS adoption increases foreign ownership. It is still unclear whether the increase in comparability is one of the mechanisms[1] by which the IFRS indirectly increases foreign investments. Prior studies have partially examined the effect of IFRS adoption on comparability (Yip and Young, 2012; Brochet et al., 2013; De Franco et al., 2011) and the effect of comparability on foreign investors’ ownership (DeFond et al., 2011; Bradshaw et al., 2004). This research attempts to fill the gap by proposing and investigating whether improved comparability of financial statements is one of the mechanisms through which the benefits of IFRS adoption can be obtained in terms of increasing foreign ownership.

This study uses the increase in foreign institutional investors’ holdings to proxy the increase in foreign investments, in line with previous studies (i.e. Covrig et al., 2007; Bradshaw et al., 2004; DeFond et al., 2011; Florou and Pope, 2012). The proxy was chosen for two reasons. First, institutional investors are the primary users of financial statements: they rely on these statements and have the expertise to analyse them in depth when making investment decisions. Second, foreign investors should gain more benefit from IFRS adoption than local investors.

This study contributes to the growing literature about IFRS adoption in several ways. First, it attempts to demonstrate the mechanism for obtaining the benefits of IFRS adoption in reducing investors’ home bias, i.e. through the comparability of financial statements. Second, it introduces a novel measurement that is more detailed in measuring the level of IFRS adoption instead of applying the discrete variable approach (“adopt” and “not adopt”) used by previous studies (DeFond et al., 2011; Tan et al., 2011; Lee and Fargher, 2010). Third, it covers not only EU countries but also countries in Asia, Africa, and Australia, so it will be better at capturing the variation of IFRS adoption outside the EU. This broader coverage will show the consistency of the benefits of IFRS adoption. Fourth, this study is most closely related to that of DeFond et al. (2011), although it extends their study with some important differences, as follows: it uses an output-based and firm-specific measurement of comparability, drawn from De Franco et al. (2011), which is deemed to be more appropriate because it represents the qualitative characteristics of financial statements from the perspective of users, namely investors, who evaluate historical performance and predict future performance in their investment decisions; it uses a broader scope of institutional investors; and it covers IFRS adoption in countries outside the EU for a longer observation period.

This research is conducted on 35,899 firm-year observations from 18 countries across Europe, Asia, Australia, and Africa. The observation period is from 2003 to 2012. The unit analysis of this study is at the firm level, but the measurement of IFRS adoption is carried out at the country level. The results show that the level of IFRS adoption has a positive effect on the comparability of financial statements, and also has an indirect positive effect on foreign institutional investor ownership through the comparability of financial statements. The results also confirm previous studies that have found that the level of IFRS adoption has a direct positive effect on foreign institutional investors’ ownership.

This research has implications for the IASB and the accounting standard setters in each country. The findings of the study are consistent with the aim of the IASB, which is to improve the quality of financial statements to increase cross-border investments. This study provides feedback to the accounting standard setters in each country regarding their decisions as to or not to adopt the IFRS as well as their strategies if they do adopt them.

This paper is divided into five sections. Section 1 explains the motivation, contribution, and objectives of the study. Section 2 provides a literature review and hypothesis development. Section 3 describes data and data sources, as well as the research design. Section 4 provides the empirical results and their analysis. The last section contains the conclusions and limitations.

2. Literature review and hypothesis development

2.1 Measuring IFRS adoption

The need for an integrated capital market to improve the efficiency of capital allocation leads to the necessity for an international level accounting standard such as the IFRS. The IFRS has been adopted around the world, mainly to improve the quality of information for investors’ decision-making. Financial information based on the IFRS is expected to be more transparent and comparable. Nevertheless, every country adopts the IFRS at a different level. Some countries adopt it in full, while some exclude some specific standards within the IFRS or make some modifications, and others delay the adoption of the IFRS.

The variation in IFRS adoption presents a problem for researchers in measuring the IFRS adoption level. The majority of previous research into IFRS adoption has measured the adoption level by taking into consideration IFRS adoption in the EU. This measurement applies a discrete variable that divides adoption into two levels: “adopt” and “not adopt” (DeFond et al., 2011; Tan et al., 2011; Kim and Shi, 2012). Some other researchers have used a time dummy variable: “before” and “after” adoption (Yip and Young, 2012; Wang et al., 2012; Li, 2010). The weakness of these measurements lies in their inability to measure the extent of adoption in each country accurately. This study attempts to overcome this weakness.

2.2 IFRS adoption, comparability, and foreign investors’ holdings

The momentum of IFRS adoption has led to many studies on the benefits of IFRS adoption. Adoption of IFRS is expected to be beneficial to facilitate cross-border investment, improve the transparency of information, lower the cost of information, and reduce information asymmetry, which could lead to increase liquidity, competitiveness, and market efficiency (Ball, 2006). The argument that the IFRS is beneficial is based on the assumption that in comparison with the local accounting standards, IFRS adoption will provide superior information to market participants and will improve the comparability of financial statements across firms and countries in the same industry.

About the benefits of the IFRS in facilitating cross-border investment, previous studies have shown that the adoption of the IFRS increases foreign investments in a company. IFRS adoption will improve the information quality and comparability of financial statements and thus increase investors’ interest in investing in companies outside their home country. Previous studies regarding the direct effect of changes in accounting standards on investors’ home bias have been performed by Kang (1997) and Bradshaw et al. (2004). Meanwhile, Covrig et al. (2007), Yu (2010), Lee and Fargher (2010), Florou and Pope (2012), and Hamberg et al. (2013) focussed on the IFRS and found that IFRS adoption has a direct positive effect on foreign investments. These studies argue that the IFRS is more familiar to foreign investors and increases the quality of information provided to them. It reduces the information acquisition cost, which then attracts greater foreign investment.

Previous studies have not explicitly indicated that the effect of IFRS adoption on foreign investors’ holdings is due to the improvement of financial statement comparability. A direct effect of IFRS adoption on foreign investments has been shown, while an indirect effect through the improved comparability of financial statements has not been demonstrated. In fact, considering that the IASB aims to achieve higher comparability of IFRS-based financial statements (IFRS Foundation, 2013), the effect of IFRS adoption on foreign ownership is potentially achieved through the indirect effect of comparability.

2.3 Hypothesis development

Developing the hypothesis that the level of IFRS adoption has an indirect effect on foreign institutional investors’ ownership through the comparability of financial statements, the study first develops arguments that the level of IFRS adoption has a positive direct effect on the comparability of financial statements.

2.3.1 The level of IFRS adoption and the comparability of financial statements

The application of the same accounting standards, such as the IFRS, can intuitively and has been proven empirically to improve the comparability of financial statements (Taplin, 2010; Krisement, 1997; Van der Tas, 1988). However, improved comparability is not only due to the application of the same accounting standards. Nevertheless, the qualifications of the IFRS, which is a highly reputable set of International Accounting Standards and is known as principle-based accounting, do have an impact on improving the comparability of financial statements. Previous studies have found that IFRS adoption improves the comparability of financial statements (Yip and Young, 2012; Ortega, 2012; Brochet et al., 2013; Petaibanlue et al., 2015).

Principle-based accounting standards like IFRS lead to a better comparability of financial statements compared to other accounting standards, such as rule-based standards. Principle-based standards use recognition and measurement principles that require management judgment in determining the appropriate accounting treatment. In contrast, under rule-based accounting standards, the accounting treatment is determined on the basis of specific criteria or rigid rules, which create the opportunity for management to design legal forms of transactions that support the implementation of accounting treatments which are desirable to the management but may not reflect the economic substance. Therefore, in rule-based accounting standards, different accounting treatments can be applied to transactions that have similar economic substance, or otherwise, similar accounting treatments can be applied to activities that have different economic substance.

Meanwhile, under principle-based accounting standards, the accounting treatment is determined on the basis of the economic substance of the transaction. Management uses professional judgment in determining the accounting treatment that reflects the real economic substance of the transaction. Thus, with principle-based accounting standards, the recognition and measurement of transactions that have similar economic substance will use similar accounting treatments, and the recognition and measurement of transactions that have different economic substance will use different accounting treatments. IFRS adoption will improve the comparability of the financial statement by making things that are alike look alike and making things that are not alike look different. The extensive disclosures that are required by the IFRS will also improve the comparability of the financial statements by making the applied accounting treatment clearer and more understandable for comparison with other firms. Hence, the higher the level of IFRS adoption, the higher the comparability of financial statements. Thus, the first hypothesis is as follows:

H1.

The level of IFRS adoption has a positive effect on the comparability of financial statements.

2.3.2 The level of IFRS adoption, the comparability of financial statements, and foreign investors’ ownership

One of the major obstacles for investors in cross-border investment is the high costs of acquiring and processing information related to investment (Kang, 1997; Bradshaw et al., 2004; Covrig et al., 2007). Likewise, according to the professionals, the main obstacle encountered when looking for investment opportunities abroad with a different accounting standard is the extra time needed to reconcile the financial statements (DeFond et al., 2011).

The perception among users, preparers of financial statements, auditors and regulators is that IFRS adoption will improve the comparability and the quality of financial statements, thereby increasing cross-country investment (European Commission, 2008). Further, Wang (2014) argues that when the underlying measurement processes for accounting earnings are more correlated under the same accounting standard – i.e., when they are more comparable – investors can better harness value-relevant information embedded in the foreign firm’s earnings signal. These perceptions and arguments are supported empirically by previous research showing that: the level of IFRS adoption reduces investors’ home bias (Florou and Pope, 2012; Lee and Fargher, 2010; Yu, 2010); the level of IFRS adoption improves the comparability of financial statements (Yip and Young, 2012; De Franco et al., 2011); and the higher the comparability of financial statements, the lower the investors’ home bias, which is indicated by the increase in foreign mutual fund ownership (DeFond et al., 2011). All of these arguments and empirical evidence show that one of the mechanisms of the effect of the IFRS adoption on the ownership of foreign institutional investors is obtained through the comparability of financial statements.

By adopting the IFRS, the accounting standards used will be more easily understood by foreign investors and the information provided in financial statements will be of high quality. Implementation of the IFRS will result in greater comparability of financial statements. Further, the reconciliation process needed in analysing the comparability between companies can be accomplished more quickly and accurately. Consequently, there will be a decrease in the cost of processing information and lower barriers to comparability analysis in the investment decision-making process. This improvement will increase the foreign institutional investors’ ownership.

Based on the above explanation, it can be argued that the level of IFRS adoption has a positive effect on the comparability of financial statements, and will hence attract foreign institutional investors to increase their ownership. Thus, the second hypothesis is:

H2.

The level of IFRS adoption has an indirect positive effect on the foreign institutional investors’ ownership through improved comparability of financial statements.

3. Research design

3.1 Data and sample

This research is a cross-country study that includes publicly listed companies. The unit of analysis in this research is the company. The level of IFRS adoption is measured at the country level. This study uses an observation period from 2003 to 2012, which aims to capture the variations in adoption levels in European, Asian, and African countries, as well as Australia. Singapore began its adoption of the IFRS in 2003: thus, 2003 is the first observation for this study. Some other countries in Asia began to adopt the IFRS in later years until 2012.

In selecting countries for the research sample, this study considers the availability of data or access to data sources to measure the level of IFRS adoption as well as its local standards during the observation period. The study also ensures that there are diversities in the strategy of IFRS adoption across countries: European Union countries that adopted IFRS at once in 2005; countries outside the EU that adopted IFRS at once; countries that adopted the IFRS gradually; and countries that have not adopted the IFRS. In addition, the selection of countries also considers diversities in terms of size, the legal system, and level of development.

Table I presents a list of 18 countries that meet the selection criteria and are chosen as the research sample.

This study employs companies that are listed on the industrial classification of the Datastream Global Equity Index Hierarchy based on the FTSE’s Industry Classification Benchmark level 4, at the sector level. All sectors are included in the sample except for the financial services, insurance, banking, equity instruments, and other financial services sectors, as well as the “unclassified” sector. The financial services sector is excluded due to the specific characteristics of the industry and because it is highly regulated. Firms in the unclassified sector are excluded because this study needs to calculate the comparability of financial statements using peers in the same industry. The unclassified sector may consist of firms from many sectors, and thus the comparability measurement model is not applicable to this sector.

3.2 Research model

To test H1, that the level of IFRS adoption has a positive effect on the comparability of financial statements, the research model is as follows:

(1) C o m p i t = α 0 + α 1 I F R S j t + α k c o n t r o l k i t + e i t ,
where Compit, the comparability of the financial statement for company i in year t, with reference to De Franco et al. (2011); IFRSjt, the level of IFRS adoption in country j in year t.

H1 predicts that the coefficient α1>0. Based on previous studies by Lang et al. (2010) and Yip and Young (2012), we employ size (Sizeit) and enforcement of accounting standards (Enfojt) as control variables. Enfoit is employed to control for differences of the country-level institutional factors that indicate the reporting incentives. The list of control variables for Model 1 is presented in Table AI in the Appendix.

Model 2 is used to test H2 that the level of IFRS adoption has an indirect positive effect on the foreign institutional investors’ ownership through improved comparability of financial statements:

(2) F I O i t = α 0 + α 1 C o m p i t + α 2 I F R S i t + α j c o n t r o l c o u n t r y j t + α k c o n t r o l f i r m k i t + e i t , C o m p i t = β 0 + β 1 I F R S i t + β k c o n t r o l k i t + e i t ,
FIO is the percentage of foreign institutional investors’ ownership in year t.

In Model 2, Comp is an endogenous variable affected by the level of IFRS adoption. The indirect effect of the level of IFRS adoption on foreign institutional investors’ ownership (H2) may exist when β1>0 and α1>0, which implies that the level of IFRS adoption has a positive effect on foreign institutional investors’ ownership through improved comparability of financial statements. On the other hand, the model also presents a possibility of a direct effect of IFRS adoption on foreign institutional investors’ ownership, which is indicated when α2>0. In conclusion, the test on Model 2 is conducted to reveal whether the adoption of IFRS has a direct effect, an indirect effect, or both effects on foreign institutional investors’ ownership.

In line with Florou and Pope (2012), DeFond et al. (2011), and Kang (1997), we employ the following firm-level control variables in Model 2, i.e., firm size (Size) to control for the difference in size and visibility of the company as an investment destination; ROA, Div, BTM, and leverage to control for the company’s fundamental performance, that affects the investors’ interest; Return variance (Retvar) to control for investors’ risk preferences; audit quality to control for investors’ preferences on the quality of firms’ auditors, and lag FIO.

We follow Florou and Pope (2012) and DeFond et al. (2011) to include the country-level control variables in model 2. The country-level control variables are: GDPgrowth and GDP/cap, to control for variation in economic development across countries; Gov, to control for variation in public governance across countries. A list of control variables for Model 2 is presented in Table AII in the Appendix.

Measurements of the main variables are as follows.

3.2.1 Comparability of financial statements (comp)

Comparability is measured using the output-based measurement of similarity of accounting functions between companies and is from De Franco et al. (2011).

De Franco et al. (2011) use stock return as a proxy for the net effect of economic events on the firm’s financial statements and use earnings as an important summary of the income statement measure. De Franco et al. (2011) focus on the relation between earnings and returns and measure the closeness with which two firms’ accounting functions translate the same economic events to financial statements. The “closeness” of the functions between two firms represents the comparability between the firms. De Franco et al. (2011) argue that if firms have comparable accounting, given a similar set of economic transactions (as reflected in stock returns), firm j should produce similar earnings to firm i. We estimate accounting comparability for each firm i – firm j combination for J firms within the same industry; we then rank all the J values of comparability for each firm i from highest to lowest. The comparability score is the average comparability of four firms’ j with the highest comparability to firm i during period t.

3.2.2 Foreign institutional investors’ ownership (FIOit)

The total percentage of foreign institutional investors’ ownership is measured using the total market value of shares held by foreign institutional investors at the end of the financial reporting period divided by the total market value at the end of the year. Data are obtained from the Thomson Financial Ownership (TFO) database. The coverage of institutional investors used in this study follows Florou and Pope (2012), namely, mutual funds, pension funds, insurance companies, private equity funds, hedge funds, and venture capital funds. This coverage is more extensive than similar research, that has mostly focussed on groups of mutual funds (Covrig et al., 2007; Yu, 2010; DeFond et al., 2011).

3.2.3 The level of adoption of the IFRS (IFRS)

IFRS is the level of IFRS adoption by the country in year t and is calculated from the percentage of the IFRS/IAS that has been adopted by a country and become effective in year t to the total number of IFRS/IAS prevailing at year t. Also, we recognise variations in the implementation of IFRS adoption, and we account for these variations as deductions from the level of adoption score. We follow the Hong Kong ICPA, which defines the following three types of difference[2]: differences in the transitional provisions, in effective date, and in the text. Differences in transitional provision indicate different treatments to adjust the difference of items under new/revised standards and the previous standard that may result in different figures or different presentations of financial statements. Differences in effective date are indicated when a standard is applied on a different date from the effective date set by the IASB. The differences in effective date may result in different figures on the financial statement. Differences in the text are defined as those that are due to differences in accounting treatment due to the exclusion of certain treatments that are not adopted or due to different treatments. For example, for statement of cash flows, a country does not adopt the method of preparing cash flows using the indirect method.

For each country, each IFRS/IAS standard adopted is given a score of 1, else 0. For the standard adopted, if there is one type of difference in adopting the standard, 0.25 is deducted from the adoption score. We assign 0.25[3] for each difference because there is no sufficient justification for assigning different weights of deduction to the three possible differences in IFRS adoption, which are adoption with difference in transitional provisions, adoption with the difference in effective date, or adoption with the difference in text. As an illustration, assume that a country has adopted the IAS 7 Cash Flow Statement. This country excludes an alternate treatment of indirect method in preparing the cash flow statement, so the cash flow statement can only be prepared using the direct method. Therefore, the score given for the adoption of IAS 7 is 0.75, that is obtained from (1–(0.25×1)). Each score for each IFRS/IAS standard adopted in a given year is then summed and divided by the total number of IFRS/IAS standards prevailing in that year according to IASB pronouncements.

The formula is as follows:

I F R S t = i = 1 n [ ( S A i t ) 0.25 × ( S T i t + S D i t + S K i t ) ] i = 1 n S I F R S i t
where IFRSt, IFRS score in year t for each country; SAit, ith standard adopted in year t; STit, ith standard adopted in year t with different transitional provisions; SDit, ith standard adopted in year t with different effective date; SKit: ith standards adopted in year t with different text; n, number of standards; and SIFRSit, number of IFRS/IAS standards prevailing in year t.

The adoption of the IFRS is considered to have been enacted when the local standards have adopted the IFRS mandatorily, and the IFRS have been implemented effectively, as announced by the relevant authorities in each country. This study considers the announcement in the period after the occurrence of two important events related to IFRS convergence. The first event was in 2002 when the EU expressed its plan to adopt the IFRS at the beginning of 2005. The second event was in 2003 when the International Federation of Accountants (IFAC) was reformed and issued the Statement of Membership Obligation (SMO). The SMO requires IFAC members to make the best effort to realise the implementation of a single set of International Accounting Standards. The momentum of IFRS adoption in the EU and the issuance of the SMO are important landmarks that occurred after the harmonisation of accounting standards at the international level. The harmonisation of the accounting standards began with the comparability project undertaken by the IASC, followed by the IASB in 2001.

This research focusses on the investors’ response to the adoption of IFRS. The starting year for IFRS adoption in each country is determined based on a declaration or an announcement from the relevant authorities in each country as to when the adoption of IFRS is effectively applied. The announcement from relevant authorities is seen as the appropriate basis for the argument that foreign investors will use public information from regulators that are considered to have a significant impact on the financial statements. Country years before the effective implementation of the IFRS adoption is coded as 0, as the scores attempt to measure expected benefits from the adoption of the IFRS[4].

Sources of information used as a basis for determining the year of IFRS adoption are obtained from: jurisdiction profiles issued by the IFRS Foundation on the site www.ifrs.org; “IFRS Adoption by Country”, published by PricewaterhouseCoopers, that can be accessed at www.pwc.com; an official statement from standard-setting bodies/authorities; the site: www.iasplus.com, that publishes the adoption of the IFRS in 138 countries and other jurisdictions around the world; the official websites of capital markets; and e-mail correspondence with the relevant personnel in standard setting bodies in each country. Furthermore, all of the information is cross-checked to ensure accuracy and consistency. A list of IFRS or IAS prevailing in year t is obtained from the IFRS book, published annually by the IASB and based on the IASplus website (www.iasplus.com/en/standards accessed 22 April 2014). IFRS standards adopted by countries in year t were obtained from various sources, such as the official websites of standard setting bodies, a publication from the Big Four audit firms, and the accounting standards of each country.

4. Results and discussion

4.1 Selected samples and descriptive statistics

Table II presents selected samples and the percentage specified by each country. Table II shows that the total number of observations of firm-year observations during 2003–2012 is 35,899.

The number of observations reflects the unbalanced panel data, which means that there are some newly listed companies between 2003 and 2012 and that some observations are excluded because of missing data during 2003–2012[5]. Outliers with criteria of 1 per cent upper limit and 1 per cent lower limit percentile are winsorized.

Table III presents the level of IFRS adoption in each country during the observation period from 2003 to 2012.

All EU countries in this sample announced their plans to adopt the IFRS in 2002 and mandated the IFRS for fiscal years 2005 and afterwards. South Africa, the Philippines, Australia, and Hong Kong announced their plans after the EU announcement, but like the EU, they mandated the IFRS from 2005. New Zealand announced the IFRS adoption in 2002 and mandated the IFRS from 2007. Singapore announced adoption in 2000 and mandated the IFRS from 2003 onwards. Around 90 Singaporean firms had adopted the IFRS as of 31 December 2003 (Worldscope database). Malaysia, Indonesia, and Pakistan announced and gradually adjusted their national standards in the period after the mandatory adoption in the EU. Korea announced a roadmap for IFRS adoption in 2007 and mandated it from 2011 onwards. To 2012, countries that had not adopted the IFRS included Taiwan and India. Taiwan announced that IFRS adoption would become effective in 2013 (www.ifrs.org jurisdiction profile, 2013). India made revisions of most of its local standards to the IFRS but has not yet announced when these standards will be effectively applied (www.ifrs.org.jurisdiction profile, 2013).

Some countries have adopted the IFRS all at once, using a big bang approach. This approach was carried out by several EU countries, namely, Austria, Denmark, France, Germany, the Netherlands, and the UK. Outside the European Union, immediate adoption was conducted by Australia, Hong Kong, the Philippines, Korea, South Africa, and New Zealand. Some other countries have adopted the IFRS using a gradual approach, such as Indonesia, Malaysia, Pakistan, and Singapore.

Referring to Table III, the maximum score of EU countries is 0.99, which means that EU countries do not fully adopt the IFRS. The European Union has adopted all applicable IFRS standards but has made a few modifications. The relevant authorities in the European Union set these modifications, namely, the European Financial Reporting Advisory Group, that makes modifications or exceptions (carve out) to the application of IAS 39 (www.ifrs.org. jurisdiction profile, 2013).

Korea and South Africa have fully adopted the IFRS with no modifications, which means that these countries apply the IFRS exactly as enacted by the IASB. The IFRS used by Korea is the official translated Korean language version published by the IFRS Foundation. Meanwhile, South Africa uses the official English version of the IFRS, as English is the official language in the country. The Philippines applies adoption all at once, and its score for adoption level for the most recent measurement date of 2012 is 0.99. The Philippines has adopted all IFRS standards but made slight modifications to IAS 39, similar to the EU. Other countries, such as Indonesia, Malaysia, Pakistan, Singapore, Australia, New Zealand, and Hong Kong, have made modifications and some exceptions in adopting the IFRS. These countries still maintain their local accounting standards that are equivalent to the IFRS. These local accounting standards are the MFRS in Malaysia, SFRS in Singapore, AASB in Australia, NZFRS in New Zealand, HKFRS in Hong Kong, and SAK in Indonesia.

Table IV presents the average of country-level variables, including the percentage of foreign institutional investors’ ownership. Table IV shows that the average ownership of total shares held by institutional investors is in the range of 0.43 per cent (Pakistan) to 20.71 per cent (the UK). Many countries from Asia, including Malaysia, Indonesia, India, and the Philippines, have low average foreign institutional investors’ holdings. On the other hand, high averages of foreign institutional ownership are seen for European countries (i.e. the Netherlands, France, Austria, and Germany).

Developed countries generally have low levels of GDP growth and high GDP per capita, while countries in Asia that are generally developing countries have high levels of growth and low GDP per capita during the study period. A public governance index (Gov) is published in the World Bank data catalogue and is measured based on a survey using a method from Kaufmann et al. (2011). The index ranges from −2.5, indicating the weakest governance, to 2.5, indicating the strongest governance. Most of the sample countries have positive average scores during the period 2003–2012. Countries that have negative averages scores during this period are the Philippines, Pakistan, Indonesia, and India, while countries having relatively high average scores during the period are Denmark and New Zealand. The lowest index is for Pakistan (−1.05), while the highest is for Denmark (1.84).

The level of enforcement of accounting standards is considered important to ensure compliance with the IFRS. As shown in Table IV, this level is in the range of 0.2 to 0.85, with a maximum level of 1.00. Taiwan has the lowest level of 0.2, while the UK and Australia have the highest level of 0.85. Overall, the scores for emerging countries are in the range of 0.3 to 0.4, while most developed countries have scores above 0.5. The scores indicate that developed countries already have adequate regulations requiring compliance with accounting standards.

Table V shows the descriptive statistics for all observations for each variable that is included in the hypothesis testing. We can see that IFRS adoption (IFRS) has a minimum value of 0.00, which indicates that the IFRS has not yet been adopted, and a maximum value of 1.00, which indicates full adoption of the IFRS, as conducted by Korea and South Africa. The average level of IFRS adoption for all sample countries in the period from 2003 to 2012 is 0.59. The value shows that the average adoption status for all countries during this period is at a moderate level compared to the maximum value of 1.00 (full adoption).

The average percentage of foreign institutional investors’ ownership (FIO) for all observations is 4.86 per cent. The percentage is higher than DeFond et al. (2011), who reported an average foreign institutional ownership of 2 per cent. The coverage of institutional investors of DeFond et al. (2011) is narrower than this study since it only covers shares owned by foreign mutual funds. This research has a broader scope since it also includes shares owned by pension funds, insurance companies, private equity funds, hedge funds, and venture capital funds. The percentage of ownership of all observations ranges from 0 to 45.24 per cent.

4.2 Hypothesis testing

Results of hypothesis testing for H1 and H2 can be seen in Tables VI and VII. According to the results of the Chow, LM, and Hausman tests, the fixed effects model is the best choice because the random effects model is inconsistently estimated and fixed effects regressions are the most consistent. Further analysis shows that the models have heteroscedasticity problems, which are solved using robust treatments. After assessing multicollinearity using VIF, in which every variable should have a value less than 10, the model is already free from serious multicollinearity problems. The estimation model, presented in Tables VI and VII, is significant, with Probability F(stat) of 0.0000, indicating that all independent variables in the model have statistically significant effects on the dependent variable.

Table VI presents the regression result of the hypothesis testing for H1, which shows that the level of IFRS adoption has a positive effect on the comparability of financial statements.

As depicted in Table VI, the coefficient on IFRS is positive and significant (α=1 per cent), indicating that the level of IFRS adoption has a positive effect on the comparability of financial statements. As a high-quality globally accepted set of accounting standards, the IFRS may improve the comparability of financial statements. Under a principles-based approach, accounting standards consist of broad principles and rely on management judgment in accordance with the current economic phenomena. Therefore, users of financial statements will be able to compare these statements appropriately, and companies that have similar economic activity will report similar accounting figures, while companies that are involved in different economic activities will report different accounting figures. Furthermore, the extensive disclosure required by the IFRS will improve the accuracy of statements and the ability for users to make comparisons between firms. The test result is in line with studies from Barth et al. (2012), Yip and Young (2012), and Brochet et al. (2013), which suggest that IFRS adoption can improve the comparability of financial statements in the sense that the financial information produced will be of higher quality. Additionally, control variables of firm size (Size) and enforcement of accounting standards (Enfo), as expected, have significantly positive effects (α=1 per cent) on the comparability of financial statements (Comp).

Comparability is measured at the firm level: that is, the average comparability from the four highest firms during the test period. Since there is no specific reason for the choice of how many firms should be included in the set of comparable firms, the test is also performed using the average comparability from the top ten firms. This sensitivity test refers to the work of De Franco et al. (2011). The test results (not presented here) support the result of the main test.

The regression result to test the indirect effect of IFRS adoption on foreign institutional investors’ ownership through comparability of financial statements (H2) is presented in Table VII. Further, to confirm previous studies (Covrig et al., 2007), Table VII will also show whether a direct effect of IFRS adoption on foreign institutional investors’ ownership is also evident. Thus, the regression result in Table VII will show whether the effect of IFRS adoption is direct, indirect, or both.

The indirect effect of the level of IFRS adoption on the ownership of foreign institutional investors (H2) will be interpreted based on the results of testing the IFRS variable in Table VI (H1) and the Comp^ variable in Table VII (H2). As shown in Table VI, the IFRS variable has a significantly positive effect (α=1 per cent) on comparability (Comp). In addition, the results in Table VII for the Comp^ variable also show a positive and significant effect (α=1 per cent) on the FIO variable. These results, therefore, lend support to the second hypothesis on the indirect effect of the level of IFRS adoption on the ownership of foreign institutional investors through the improved comparability of financial statements.

These results support the earlier findings by DeFond et al. (2011) on the effect of comparability of financial statements after IFRS adoption on the foreign institutional investors’ ownership. The high level of IFRS adoption will be reflected in a high level of comparability of financial statements. In short, this feature will improve investors’ decision-making process by reducing their information processing costs, then will increase the incentives for foreign institutional investors to invest. The indirect effect of IFRS adoption on increasing foreign institutional investors’ ownership is facilitated by the increased comparability of the financial statements.

In addition, as reported in Table VII, the IFRS variable has a significant and positive direct effect on FIO (α=1 per cent). The direct effect of IFRS confirms previous studies from Covrig et al. (2007), Florou and Pope (2012), and Yu and Wahid (2014). The test result shows that IFRS adoption, directly and indirectly, increases foreign institutional investors’ ownership. This finding suggests that the level of IFRS adoption increase foreign institutional investors’ ownership through comparability of financial statements via two channels: direct and indirect. The Size variable has a significant and positive effect at 10 per cent level on FIO, confirming the prediction of institutional investors’ investment in big companies. This outcome is consistent with Dahlquist and Robertsson (2001), Covrig et al. (2006), and Ferreira and Matos (2008). The Retvar variable also shows a significant and positive coefficient at the 5 per cent level, confirming that foreign institutional investors would be likely to invest in companies with high volatility stock returns to pursue short-term gain from fluctuations in stock prices by utilising their owned information as institutional investors. This finding confirms the previous research by Gompers and Metrick (2001) and Yan and Zhang (2009). The Div variable has the expected positive effect at 1 per cent level, which shows that foreign institutional investors will invest in companies with a high dividend payout. The result is consistent with Bushee et al. (2013). Debt level (Leverage) is a significant predictor of FIO but with a negative coefficient (α=10 per cent), which means that the institutional investors prefer to invest in companies with low risk of default. The Quality of Audits (Aud) variable is also a significant and positive predictor of FIO (α=1 per cent). Not surprisingly, this result indicates that institutional investors prefer to invest in companies with well-reputed external auditors (Chou et al., 2014). The ownership of foreign institutional investors in t−1 (FIOt−1) has a significant and positive effect (α=1 per cent) on foreign institutional investors’ ownership for this year (FIO). This result confirms the current literature, which suggests that the investors’ investment holdings in a given period are influenced by their holdings in prior periods. It is noteworthy that five company-level control variables are significant predictors of foreign institutional investors’ ownership, namely Size, Retvar, Div, Leverage, and Aud. These findings suggest that foreign institutional investors tend to invest in the companies which are big, have a highly volatile stock return, pay a high level of dividend, own low levels of debt, and hire highly qualified accounting firms (audited by the Big Four audit firms).

Moreover, the country-level control variables that have expected significant effects are Gov (positive at 10 per cent level) and GDP/cap (negative at 1 per cent level). This result indicates that foreign institutional investors are more likely to invest in companies located in countries with strong public governance and developing countries with low GDP per capita. These results confirm earlier studies by Aggarwal et al. (2012) and DeFond et al. (2011). Surprisingly, the GDPgrowth variable represents a significant predictor of FIO at 1 per cent level but with a negative coefficient. The result does not support the study of Aggarwal et al. (2012), which tries to find the factors that determine foreign investors’ holdings. Aggarwal et al. (2012) found that a country’s GDP growth positively influences foreign investors’ holdings. These contrasting results may be affected by the possibility that foreign investors do not only consider the return growth potential that is usually obtained from companies in high GDP growth countries but also adjusts the return growth with the country risk factor or risk-adjusted return (De Moor et al., 2010).

Ensuring the robustness of the result, the study conducts a sensitivity test using a different measurement of the level of IFRS adoption that includes all the SIC and IFRIC applicable in year t. We apply the same weight of calculation for the SIC and IFRIC with applicable IFRS and IAS standards, since there is no other justification for determining different weights. The results (not presented here) are consistent with the result of the main test. Another sensitivity test is performed by excluding EU countries from the sample. EU countries, namely, Austria, Denmark, France, Germany, the Netherlands, and the UK, potentially dominate or weaken the results because these countries have adopted IFRS using a big bang approach at the same time since 2005 and have homogeneous characteristics. The results (not presented here) remain consistent with the main test’s result.

This study performs an additional test by using dummy/discrete variables in measuring the adoption level of IFRS. This additional test is conducted to show that the measurements of IFRS adoption level used in previous research (e.g. DeFond et al., 2011; Preiato et al., 2013; Tan et al., 2011) were too simple and might result in measurement error. The dummy variable used equals 1 for countries that have adopted the IFRS and 0 otherwise. This dummy variable is constructed using data collected from IASplus (Use of IFRS by Jurisdiction), which was accessed from: www.iasplus.com on 23 April 2014, and also from the accounting standards used in the Worldscope database.

The result (not presented here) indicates that the dummy variable of IFRS adoption does not affect the comparability of financial statements. In addition, there is no indirect effect of IFRS adoption on the foreign institutional investors’ ownership. These additional findings are not consistent with the main results. It can be concluded that the measurement of IFRS adoption using dummy variables is less able to capture variations in the level of IFRS adoption. The IFRS dummy variable=0 (“not adopt”) also includes some companies operating in countries that adopt the IFRS with some modifications or that have not yet fully adopted the IFRS, such as Indonesia, Malaysia, and Singapore. Furthermore, the IFRS dummy variable=1 (“adopt”) is less precise in measuring the level of IFRS adoption. EU countries are often referred to as applying full adoption of the IFRS, and thus will be categorised as 1, whereas in reality, they have modified the application of IAS 39, and consequently should not be considered as having implemented full adoption.

5. Conclusion

The purpose of this research is to examine the indirect effect of the level of IFRS adoption in increasing foreign investors’ ownership by testing whether IFRS adoption indirectly increases foreign investors’ institutional ownership through the improved comparability of financial statements.

The hypothesis tests reveal that the level of IFRS adoption increases foreign investors’ ownership through improved comparability of financial statements. The findings show that high levels of IFRS adoption will improve the comparability of financial statements and consequently increase the incentive for foreign investors to invest. The results of this study support previous studies by Yip and Young (2012) and DeFond et al. (2011). The results also present that the level of IFRS adoption operates through two channels in increasing foreign investors’ ownership, i.e. a direct channel and an indirect channel through comparability of financial statements. The sensitivity analysis shows consistent results with the main test. Finally, the present study also provides evidence that using a discrete variable (adopt and not adopt) to measure IFRS adoption neglects the substance of the IFRS adoption implemented by countries that may adopt the IFRS gradually or with some modifications.

This research finds that IFRS adoption results in greater comparability of financial statements that can increase foreign institutional investors’ holdings in countries that adopt either a big bang or a gradual approach. Both forms of adoption attract investors and are valued as positive processes in improving the comparability of financial statements that is useful for their decision-making. The results suggest that the standards setting bodies’ (IASB) strategy of promoting the IFRS and objectives to develop standards that lead to increased comparability of financial statements has been successful. This research shows that IFRS adoption plays a role in ensuring the quality of financial statements in terms of comparability. It implies that the standard-setting bodies in every country, as examples of responsible institutions regulating the business environment, can be entrusted with a greater role to ensure better financial information quality.

However, the findings of this study need to be interpreted with caution due to certain limitations. Although this research provides detailed measurements of IFRS adoption, this study only looks at three general items of difference in adopting the IFRS. “Differences in text” used in this research have not quantified detailed differences for each of the adopted standards. Therefore, future research could use a more in-depth measurement of the IFRS adoption level that considers differences or exceptions of accounting treatment.

Sample countries

European Union
Big bang Austria, Denmark, France, Germany, the Netherlands, the UK
Outside the European Union
Big bang Australia, Korea, Hong Kong, New Zealand, Philippines, South Africa
Gradual Indonesia, Malaysia, Singapore, Pakistan
Not adopt India, Taiwan

List of selected samples

Countries Firms % Firm years %
Australia 754 10.4 3,815 10.6
Austria 31 0.4 261 0.7
Denmark 48 0.7 434 1.2
France 338 4.7 2,362 6.6
Germany 378 5.2 2,598 7.2
Hong Kong 593 8.2 2,656 7.4
India 1,326 18.3 3,569 9.9
Indonesia 83 1.1 391 1.1
Korea 877 12.1 4,434 12.4
Malaysia 499 6.9 2,358 6.6
The Netherlands 73 1.0 563 1.6
New Zealand 61 0.8 387 1.1
Pakistan 93 1.3 445 1.2
Philippines 91 1.3 606 1.7
Singapore 365 5.0 1,656 4.6
South Africa 144 2.0 1,111 3.1
Taiwan 895 12.3 4,567 12.7
UK 603 8.3 3,686 10.3
Total 7,252 100 35,899 100

Notes: The total sample firm years is 35,899 from 7,252 total sample firms for an observation period 2003–2012. This study employs an unbalanced data panel because not all firms are listed on the stock exchange in 2003

Source: Datastream

The level of IFRS adoption

Country 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Australia * * 0.84 0.84 0.93 0.93 0.94 0.94 0.95 0.95
Austria * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99
Denmark * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99
France * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99
Germany * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99
Hong Kong * * 0.72 0.73 0.74 0.80 0.80 0.80 0.82 0.83
India * * * * * * * * * *
Indonesia * * * * * 0.04 0.06 0.07 0.30 0.57
Korea * * * * * * * * 1.00 1.00
Malaysia * * 0.79 0.70 0.74 0.74 0.74 0.78 0.81 0.96
The Netherlands * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99
New Zealand * * * * 0.91 0.91 0.91 0.91 0.97 0.97
Pakistan * * 0.78 0.86 0.86 0.91 0.94 0.94 0.94 0.95
Philippines * * 0.94 0.99 0.99 0.99 0.99 0.99 0.99 0.99
Singapore 0.66 0.68 0.75 0.76 0.81 0.81 0.78 0.78 0.86 0.86
South Africa * * 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Taiwan * * * * * * * * * *
UK * * 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99

Notes: *Country has not adopted or implemented the IFRS, thus the level of IFRS adoption=0.00. Each score above shows the level of IFRS adoption per year, which is calculated using the formula:

I F R S t = i = 1 n [ ( S A i t ) 0.25 × ( S T i t + S D i t + S K i t ) ] i = 1 n S I F R S i t ,

where IFRSt, IFRS score in year t for each country; SAit, ith standard adopted in year t; STit, ith standard adopted in year t with different transitional provisions; SDit, ith standard adopted in year t with different effective date; SKit, ith standards adopted in year t with different text; n, number of standards; and SIFRSi, number of IFRS/IAS standards prevailing in year t

The average of country-level variables per country

Country n FIO (%) GDPgrowth (%) Gov Enfo GDP/cap (USD)
Australia 3,815 3.43 3.01 1.61 0.85 40,211
Austria 261 8.89 1.63 1.59 0.40 42,566
Denmark 434 6.03 0.60 1.84 0.75 43,150
France 2,362 7.04 1.07 1.23 0.83 36,742
Germany 2,598 6.65 1.24 1.46 0.66 40,143
Hong Kong 2,656 3.49 4.22 1.45 0.63 44,473
India 3,569 3.82 7.50 −0.24 0.35 3,960
Indonesia 391 4.22 5.66 −0.52 0.38 7,306
Korea 4,434 3.21 3.62 0.74 0.47 27,957
Malaysia 2,358 1.36 5.02 0.35 0.54 19,250
The Netherlands 563 13.24 1.17 1.67 0.56 44,875
New Zealand 387 3.35 2.05 1.77 0.65 31,188
Pakistan 445 0.43 4.09 −1.05 0.38 4,062
Philippines 606 1.45 5.14 −0.48 0.53 5,209
Singapore 1,656 2.22 5.97 1.50 0.46 65,831
South Africa 1,111 5.84 3.49 0.31 0.58 11,213
Taiwan 4,567 3.61 4.10 0.89 0.20 19,011
UK 3,686 20.71 1.13 1.42 0.85 36,719
Min 0.43 0.60 −1.05 0.20 3,960
Max 20.71 7.50 1.84 0.85 65,831
Total n 35,899

Notes: FIO, percentage of foreign institutional investors’ ownership; GDPgrowth, economic growth, real GDP growth; Gov, public governance, worldwide governance index per country; Enfo, level of enforcement of accounting standards (modified from Brown et al., 2014); GDP/cap, real GDP per capita

Descriptive statistics

Variable n Average SD Min. Max.
IFRS 35,899 0.59 0.45 0.00 1.00
FIOt (%) 35,899 4.86 9.73 0.00 45.24
FIOt−1 (%) 35,899 4.95 9.89 0.00 46.10
Size (000 USD) 35,899 1,053,387 6,432,250 1,280 198,851,000
ROA 35,899 0.0036 0.2634 −0.9634 0.4214
Retvar 35,899 0.2142 0.2470 0.0328 1.0540
Div 35,899 0.0235 0.0411 0.0000 0.1475
BTM 35,899 1.0426 1.2717 −0.5815 5.5660
Leverage 35,899 0.2158 0.2725 0.0000 0.8064
GDPGrowth 35,899 3.3941 3.2193 −5.6663 14.7808
Gov 35,899 0.9366 0.6791 −1.1808 1.9120
Enfo 35,899 0.6142 0.2665 0.1591 0.9545
GDP/cap (USD) 35,899 29,104 17,829 3,960 65,831
Comp 35,899 −0.0775 0.2066 −0.8967 −0.0046
Aud=1 Aud=0
Aud 35,899 59.88% 40.12% 0 1

Notes: IFRS, level of the IFRS adoption; FIOt, percentage of foreign institutional investors’ ownership in year t; FIOt−1, percentage of foreign institutional investors’ ownership in year t−1; Size, size of the company, Ln of market value of equity; ROA, profitability, income before extraordinary items/total assets at the beginning of the year; Retvar, volatility of stock returns, standard deviation of monthly stock returns during the year; Div, level of dividend, total dividend/year-end market value of equity; BTM, prospects for growth, book value of equity/market value of equity at the end of the year; Leverage, level of debt, total debt/total assets at the end of the year; GDPgrowth, economic growth, real GDP growth per year; Gov, public governance, worldwide governance index per country per year; Enfo = level of enforcement of accounting standards (modified Brown et al., 2014) per year; GDP/cap: real GDP per capita per year; Comp, level of comparability; Aud, audit quality: 1 for Big Four and 0 otherwise

Regression of effect of the level of IFRS adoption on the comparability of financial statements

C o m p i t = α 0 + α 1 I F R S j t + α k c o n t r o l k i t + e i t
Variable Expected sign Coefficient t-value Prob t-value
IFRS H1: + 0.02*** 7.52 0.00
Size + 0.02*** 17.62 0.00
Enfo + 0.02** 3.80 0.03
Constant −0.34 −24.42 0.00
Model Firm fixed effect
Heteroscedasticity test Robust
R2 3.53%
Prob F(stat) 0.0000
n 35,899

Notes: IFRS: level of IFRS adoption; Comp: level of comparability; Size: size of the company, Ln of the market value of equity; Enfo: level of enforcement of accounting standards (modified from Brown et al., 2014); R2 values for each model shows a relatively low value of between 1 and 3 per cent. Nevertheless, the relatively low value of R2 that this is consistent with the results of various previous research related to the comparability of financial statements ranged between 0.6 and 7.3 per cent (Yip and Young, 2012). Seeing this, the study was relatively acceptable considering this research is research at the company level and between countries. **Significant at α=5 per cent; ***Significant at α=1 per cent

Regression of the indirect effect of the level of IFRS adoption on the foreign institutional investors’ ownership

F I O i t = α 0 + α 1 C o m p i t + α 2 I F R S i t + α j c o n t r o l c o u n t r y j t + α k c o n t r o l f i r m k i t + e i t   C o m p i t = β 0 + β 1 I F R S i t + β k c o n t r o l k i t + e i t
Variable Expected sign Coefficient t-value Prob t-value
IFRS + 0.41*** 4.70 0.01
Comp H2: + 14.95*** 8.04 0.00
FIOt−1 + 0.26*** 30.28 0.00
Size + 0.14* 2.70 0.09
ROA + −0.14 −1.94 0.17
Retvar + 0.64** 3.26 0.05
Div + 3.54*** 7.78 0.00
BTM −0.05 −2.22 0.13
Leverage −0.27* −3.10 0.06
Aud + 0.34*** 4.74 0.01
GDPgrowth + −0.02*** −5.04 0.00
Gov + 0.79* 2.94 0.07
GDP/cap −3.84*** −15.48 0.00
Constant 5.57 25.26 0.00
Model Firm fixed effect
Heteroscedasticity test Robust
R2 44.55%
Prob F(stat) 0.0000
n 35,899

Notes: FIO, percentage of foreign institutional investors’ ownership in year t; FIOt−1: percentage of foreign institutional investors’ ownership in year t−1; IFRS, level of IFRS adoption; Comp, level of comparability that is influenced by the level of IFRS adoption (fitted value); Size, size of the company, Ln of the market value of equity; ROA, profitability, income before extraordinary items/total assets at the beginning of the year; Retvar, volatility of stock returns, standard deviation of monthly stock returns for 1 year; Div, level of dividend, total dividend/year-end market value of equity; BTM, prospects for growth, book value of equity/market value of equity at the end of the year; Leverage, level of debt, total debt/total assets at the end of the year; Aud, audit quality, 1 for Big Four and 0 otherwise; GDPgrowth, economic growth, real GDP growth; Gov, public governance, worldwide governance index per country; GDP/cap, real GDP per capita. *Significant at α=10 per cent; **Significant at α=5 per cent; ***Significant at α=1 per cent

The operational definitions of variable controls used in Model 1

Sizeit Firm size, measured by the natural logarithm of the total market value of equity at the end of the year t
Enfojt The index of the enforcement of accounting standards of each country j in year t, measured by modified version index from Brown et al. (2014)a

Notes: aThis study has modified Brown et al.’s (2014) index by excluding AUDIT (point h) and ENFORCE (point f) due to data limitation. Although the index modification generates a different value to Brown et al.’s (2014) index, yet it does not affect the data testing and analysis, as the data measurement is equally treated for all sample country. AUDIT (point h) is the level of audit fee and ENFORCE (point f) is the number of employees of the supervisory bodies who perform enforcement functions

The operational definitions of variable controls used in Model 2

Firm level
Sizeit Firm size, measured by the natural logarithm of the market value of equity at the end of year t
Retvarit The volatility of stock returns, measured by the standard deviation of monthly stock return of firm i during year t
ROAit Return on assets, calculated as income before extraordinary items divided by total assets of the firm i at the beginning of year t
Divit Dividend paid divided by the total market value of equity of firm i at the end of the year t
BTMit Book to market ratio, calculated as the book value of equity divided by market value of equity at the end of the year t
Leverageit Debt level, which is measured by total debt divided by total assets at the end of the year t
Audit Audit quality, q for Big Four audit firms and 0 otherwise
FIOt−1 Percentage of foreign institutional investors’ ownership in year t−1
Country level
GDPgrowth Economic growth, measured by real GDPgrowth
GDP/cap GDP per capita, measured by the natural logarithm of real GDP per capita
Gov Public governance, measured using a country’s worldwide governance index from World Bank. Worldwide Governance Indicators capture six key dimensions of governance, namely, voice and accountability, political stability and lack of violence, government effectiveness, regulatory quality, rule of law, and control of corruption

Notes

1.

Other mechanisms have been studied, namely, representational faithfulness (Ortega, 2012), information quality (Horton et al., 2013) and transnational information transfer (Wang, 2014).

2.

These three types of difference refer to the comparison report of the HKFRS and IFRS in Hong Kong, published every six months by the HKICPA on www.hkicpa.org.hk/.

3.

There will be four possible conditions of adoption, which are assigned with the same weight. Weight=1/4=0.25; therefore, the range of values for each standard adopted is between 0.25 and 1. Meanwhile, standards that are not adopted are scored 0.

4.

This approach is similar to previous studies by Lee and Fargher (2010), Tan et al. (2011), Yu (2010), and Yu and Wahid (2014). Their studies have limitations, since they use restricted measurement, as the IFRS adoption is measured by a discrete variable (i.e., adopt or not adopt) and they do not consider countries that have gradually converged and shifted their local standards to the IFRS, such as Malaysia, Indonesia, and Pakistan. Countries that have adopted the IFRS gradually are excluded in their research or classified as non-adopters (denoted by 0). Another limitation is they assign a value of 1 to adopters that may actually not fully adopt the IFRS, such as Australia, New Zealand and Hong Kong. Those countries adjust their national standards in line with the IFRS with some exceptions or modifications.

5.

This research employs Stata 12. If there is any missing data for any variable from one observation, then Stata 12 will automatically exclude the observation. Thus, observations processed by Stata already reflect the unbalanced panel data structure.

Appendix

Table AI

Table AII

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Further reading

Beneish, M.D. and Yohn, T.L. (2008), “Information friction and investor home bias: a perspective on the effect of global IFRS adoption on the extent of equity home bias”, Journal of Accounting and Public Policy, Vol. 27 No. 6, pp. 433-443.

Daske, H., Hail, L., Leuz, C. and Verdi, R. (2008), “Mandatory IFRS reporting around the world: early evidence on the economic consequences”, Journal of Accounting Research, Vol. 46 No. 5, pp. 1085-1142.

Doidge, C., Karolyi, G.A. and Stulz, R.M. (2004), “Why are foreign firms listed in the US worth more?”, Journal of Financial Economics, Vol. 71 No. 2, pp. 205-238.

Financial Accounting Standards Board (FASB) (2008), Exposure Draft of Conceptual Framework for Financial Reporting, FASB, Norwalk, CT.

Foerster, S.R. and Karolyi, G.A. (1999), “The effects of market segmentation and investor recognition on asset prices: evidence from foreign stocks listing in the United States”, The Journal of Finance, Vol. 54 No. 3, pp. 981-1013.

Framework, IASB (1989), Framework for the Preparation and Presentation of Financial Statements, International Accounting Standards Committee, London.

International Accounting Standards Board (2008), “Exposure draft of an improved conceptual framework for financial reporting”, International Accounting Standards Board, London.

Tweedie, D. and Seidenstein, T.R. (2004), “Setting a global standard: the case for accounting convergence”, Northwestern Journal of International Law & Business, Vol. 25 No. 3, pp. 589-608.

Web references

Corresponding author

Aria Farah Mita can be contacted at: aria.farahmita@ui.ac.id