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Review of Accounting Studies

Erschienen in:

19.03.2021

Re-examining the impact of mandatory IFRS adoption on IPO underpricing

verfasst von: Donal Byard, Masako Darrough, Jangwon Suh

Erschienen in: Review of Accounting Studies | Ausgabe 4/2021

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Abstract

In the mid-2000s, the European Union adopted a number of regulatory reforms intended to increase transparency and disclosure for IPO firms, including mandating the use of International Financial Reporting Standards (IFRS). The reforms also included (1) adoption of the Prospectus Directive, which mandated increased IPO prospectus disclosures and (2) increased accounting enforcement. These new regulations apply only to IPOs listing on “EU-regulated” markets; firms admitted to trading on “exchange-regulated” markets are exempt. We examine the impact of these regulations on IPO firms. For firms listing on EU-regulated markets, we find no association between IFRS and IPO underpricing; however, we find a significant decrease in IPO underpricing associated with adoption of the Prospectus Directive in countries that also increased accounting enforcement. Further, we confirm that, after 2005, most IPOs on exchange-regulated markets went public using domestic accounting standards, not IFRS. Our findings suggest that mandatory IFRS adoption did not play a major role in reducing IPO underpricing and contrast sharply with prior results, which failed to account for IPOs on exchange-regulated markets. Our evidence highlights the importance of controlling for contemporaneous changes in regulations and details of the institutional setting before attributing major economic consequences to a switch from domestic accounting standards to IFRS.

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There are two main legislative instruments for creating EU law: EU directives and EU regulations. After a directive is adopted by the EU, to come into force in an EU member state, it must first be transposed into national law via the member state’s own legislative process. The EU will specify a relatively short period (typically two to three years) over which each EU member state must transpose the provisions of the directive into national law. As a result, a directive comes into force on different dates in different EU member states. On the other hand, EU regulations, such as the IFRS Regulation (IFRSR), automatically become law in all EU member states at the same time.

Specifically, an exchange-regulated market can decide to adopt IFRS, the disclosures requirements of the PD, or both as listing requirements for that market. Exchange-regulated markets are also exempt from other important EU capital markets directives adopted in the mid-2000s (see Section 2).

The benchmark firms are IPOs over the same period by firms based in countries that had not, as of the end of 2007, mandated IFRS adoption for domestic listed firms (e.g., Canada, Japan, South Korea, and the United States).

For example, before 2005, a German firm going public could list on a number of domestic stock markets, all of which were under the same regulatory framework. After 2005, however, a German IPO firm seeking a domestic listing could choose (1) to list on a domestic EU-regulated market and be subject to the provisions of EU capital markets directives and regulation or (2) to be admitted to trading on a new, less regulated, domestic exchange-regulated market (the Entry Standard, founded in 2005) and not be subject to the provisions of EU capital markets directives and regulations, including the IFRSR and PD. The newly developed exchange-regulated markets, such as the Entry Standard in Germany, were designed to encourage the admission of smaller firms to trading in public capital markets.

One possibility is that policymakers believe that smaller growth firms stand to benefit less from IFRS adoption than larger listed firms. Consistent with this belief, Fiechter et al. (2018) show that, in Switzerland, listed firms that switch back from reporting in IFRS to reporting in domestic accounting standards tend to be smaller, have higher inside ownership, and have fewer foreign investor holdings, suggesting that these firms benefit less from using IFRS. Because Switzerland is not a member of the EU or the European Economic Area, the IFRSR does not apply, and the use of IFRS is voluntary in Switzerland (Zeff 2016).

This expectation follows from the observation that firms’ reporting incentives are shaped by country-level institutional variables (Ball et al. 2003; Leuz et al. 2003; Holthausen 2009); as a result, a country-level increase in accounting enforcement can be expected to strengthen the reporting incentives of firms based in that country, which consequently increases reporting quality.

The implementation dates of the PD across the member states of the EU range between March 15, 2005, and March 29, 2007. To proxy for the timing of the increase in accounting enforcement in some EU member states over the period 2005–2007, we follow Christensen et al. (2013) and use the dates on which these member states initiated proactive reviews of firms’ financial reports.

This analysis only applies to exchange-regulated markets that allowed firms to report in either domestic accounting standards or IFRS. Three exchange-regulated markets adopted IFRS as a listing requirement (see Section 2 and Table 6 for details); firms admitted to trading on these markets are required to use IFRS, so we treat these firms as mandatory IFRS adopters and exclude them from our analysis.

Given that IFRS is a relatively principles-based set of accounting standards, it seems unlikely that there would be very large direct costs of switching from domestic accounting standards to IFRS (Christensen 2012). Also, IFRS are widely used in the member states of the EU in the post-2005 period, which should facilitate firms’ access to any expertise required to effect a switch from domestic accounting standards to IFRS.

This is true for the period 2006–2009, immediately after mandatory IFRS adoption, but it is not true for all aspects of EU capital markets law in later periods. For example, in 2014 the EU replaced the Market Abuse Directive with the Market Abuse Regulation. While the earlier Market Abuse Directive only applied to EU-regulated markets, the 2014 Market Abuse Regulation applies to both EU-regulated and exchange-regulated markets (Moloney 2014).

Article 4 of Regulation 2002, the IFRS Regulation, states: “For each financial year starting on or after 1 January 2005, companies governed by the law of a Member State shall prepare their consolidated accounts in conformity with the international accounting standards adopted in accordance with the procedure laid down in Article 6(2) if, at their balance sheet date, their securities are admitted to trading on a regulated market of any Member State… (emphasis added).” The reference here to a “regulated market” refers to an EU-regulated market. This regulation, therefore, does not automatically apply to multilateral trading facilities, i.e., the exchange-regulated markets. Mandatory IFRS adoption applies to all firms with equity securities listed on an EU-regulated market that report on a consolidated basis and applies to fiscal years ending on or after December 31, 2005 (unless a firm is subject to a specific country-level exemption; see Pownall and Wieczynska 2018).

For example, firms admitted to trading on exchange-regulated markets may not have to appoint independent board members or follow other corporate governance rules mandatory for firms listed on the main EU-regulated market of the same stock exchange. The listing process is usually quite different: most firms that are admitted to trading on exchange-regulated markets do so via placements rather than public offerings. Stocks can be placed with institutional investors and, after a lag of at least six months, can then be admitted to trading on an exchange-regulated market without a public offering. Such new issues are outside the scope of the PD and therefore do not require a prospectus in compliance with the Prospectus Regulation.

For a more comprehensive overview of the Financial Services Action Plan, see Moloney (2004) or Ferran (2004). For a more detailed review of EU capital markets law in the post-Financial Services Action Plan period, see Moloney (2014) or Veil (2017).

To clarify, the PD sets out the procedures a National Competent Authority must follow to approve a prospectus that has been submitted by a firm wishing to be admitted to trading on an EU-regulated market or wishing to raise capital via a public offering of securities. The required disclosures to be included in a prospectus and the required format of a prospectus are specified in the Prospectus Regulation (Regulation 2004), which deals with implementation of the PD (Veil 2017). Taken together, the PD and the Prospectus Regulation introduced a completely new issuer disclosure framework into EU law that increased the required disclosures available for IPO firms listing on EU-regulated markets. This is because, in the terminology of the EU, the PD is a “maximum harmonizing directive” (CRA International 2009; Moloney 2014). That is, to achieve the objectives of harmonizing IPO disclosures across the member states of the EU and to ensure investor protection, the approach taken in the PD is to converge mandatory IPO prospectus disclosure in the EU member states toward a maximum. With adoption of the PD and Prospectus Regulation, therefore, mandated IPO disclosures for firms listing on EU-regulated markets were both increased and harmonized across the member states of the EU (Veil 2017). For a brief overview of the major provisions of the PD, see Boury and Panasar (2004). For more detail, see Moloney (2014) or Veil (2017).

While analogous, the setting of the adoption of the PD in the member states of the EU is not identical to that of the adoption of the 1933 Securities Act in the US. This is because, prior to enactment of the PD, EU member states had domestic legislation mandating prospectus disclosures. This domestic legislation was replaced by the PD. Nevertheless, by construction (see Footnote 14), enactment of the PD increased mandatory IPO prospectus disclosures in the member states of the EU, as did adoption of the 1933 Securities Act in the US.

This is because most firms are admitted to trading on exchange-regulated markets via placements. However, if a firm goes public on an exchange-regulated market via a full public offering, then it is within the scope of the Prospectus Regulation and would be required to issue a prospectus in compliance with the Prospectus Regulation (Moloney 2014).

The enforcement activities of the different national enforcement agencies, the designated National Competent Authority in each EU member state are, however, coordinated at the EU level. This coordination function was first undertaken by the Committee of European Securities Regulators, which was later replaced by the European Securities Markets Authority.

Ernstberger et al. (2012) also provide evidence of a decrease in earnings management and an increase in liquidity for German firms that fall under the scope of the new regulatory regime (i.e., those listed on the EU-regulated markets).

The AIM requires all firms traded on that market to report in IFRS from Jan. 1, 2007 (London Stock Exchange 2006). The Euronext Growth Market and EN.A require IFRS since they were founded in 2005 and 2006, respectively.

For example, the listing requirements for Euronext Access state that firms admitted for trading on Euronext Access have “no obligation to publish accounts in IFRS format.” See https://www.euronext.com/en/listings/free-markets.

The European Securities Markets Authority collects and compiles data from the National Competent Authorities, including data on all firms listed on EU-regulated markets (Pownall and Wieczynska 2018). This data is only available from 2007, however. The data is available through the authority’s registry at: https://www.esma.europa.eu/databases-library/registers-and-data

These markets existed in the UK and France prior to adoption of the Markets in Financial Instruments Directive. With the directive’s adoption, these markets in the UK and France would have had to change their status to become exchange-regulated markets. For example, the AIM of the London Stock Exchange was founded in 1995 and operated as a regulated market until October 12, 2004, when it relinquished its (EU-)regulated market status to become an exchange-regulated market (du Vignaux et al. 2006).

This is perhaps not surprising, as the EU includes among its member states countries with a history of strong rule of law and regulatory enforcement (e.g., Denmark, Germany, and the UK) but also countries that, with the collapse of communism in 1989, developed their rule of law and regulatory environment from scratch in the last 30 years (e.g., Estonia, Poland, and Romania).

Estimates of the coefficients on MAD and TD should be interpreted with caution. Because these variables are merely control variables and not the focus of our analysis, our sample is not balanced between pre- and post- Market Abuse Directive/Transparency Directive periods. As a result, the estimated coefficients on MAD and TD may be biased by sample composition.

As discussed in Section 2, the PD allows for passporting provisions that facilitate firms from one EU member state to cross-list securities on an EU-regulated market in another member state. Firms from outside the EU that list on markets within the EU are referred to as third country listings, which fall under a different regulatory regime (Moloney 2014).

To clarify, a firm that goes public on an exchange-regulated market via a full public offering is within the scope of the Prospectus Regulation and required to produce a prospectus (Moloney 2014). However, a firm that goes public on an exchange-regulated market via a placement is outside the scope of the PD and the Prospectus Regulation. Most new issues on exchange-regulated markets are placements. Additionally, to comply with the Prospectus Regulation, a prospectus must be prepared using IFRS (Moloney 2014, p. 106). It follows therefore that for a firm being admitted to trading on an exchange-regulated market, it is not possible to voluntarily adopt the PD/ Prospectus Regulation disclosures but not IFRS; these choices are not independent.

Because IPO firms do not have a long history of reporting, there is heightened uncertainty. As a result, the disclosures of other similar firms (e.g., industry peers reporting in the same accounting standards) may play a more important role in decreasing investors’ uncertainty for IPO firms than for all listed firms (Shroff et al. 2017).

The three benchmark samples are (1) a one-to-one propensity score matched benchmark sample of IPOs based in all non-IFRS adopting countries; (2) a one-to-one propensity-score-matched benchmark sample of IPOs based in all non-IFRS adopting countries, except the U.S.; and (3) a benchmark sample of all IPOs in three developed countries, specifically, the U.S., Canada, and Japan. Benchmark sample (3) is not propensity-score matched with the treatment sample.

This highlights a limitation of the difference-in-differences design when used in international settings. When treatment and control firms are in different countries, a common practice in international accounting studies, this increases the likelihood that the treatment and control samples are exposed to different concurrent regulatory or macroeconomic shocks. In terms of the difference-in-differences design, since the treatment sample is exposed to concurrent regulatory shocks (here the PD) that do not affect the benchmark samples (which comprise firms from non-IFRS adopting countries), the parallel-trends assumption, critical to drawing causal inferences from the difference-in-differences design, is violated (Kahn-Lang and Lang 2019). Further, Hong et al. report that mandatory IFRS adoption is associated with a 38% reduction in IPO underpricing when the benchmark sample is a one-to-one propensity-score-matched sample of IPOs based in all non-IFRS adopting countries, but an 82% reduction in underpricing when the benchmark sample is a one-to-one propensity-score-matched sample of IPOs based in all non-IFRS adopting countries, except the U.S. That is to say, dropping the U.S. from the benchmark sample changes the magnitude of the average identified effect of IFRS adoption from a 38% to an 82% decrease in underpricing.

This belief is supported by evidence that, in Switzerland, firms that switch back from reporting in IFRS to using domestic accounting standards tend to be smaller firms with higher inside ownership and less foreign investor holdings (Fiechter et al. 2018).

This third benchmark sample is not one-to-one propensity-score matched with the treatment sample.

Establishing parallel trends in the pre-treatment period does not negate this criticism. Parallel trends in the pre-treatment period only suggest counterfactual parallel trends; establishing parallel trends in the pre-treatment period is not sufficient to establish that the parallel counterfactual trends condition holds (Kahn-Lang and Lang 2019). A priori, the fact that we know that the treatment and benchmark samples are exposed to different concurrent shocks (adoption of the PD in the treatment sample) suggests that the parallel counterfactual trends condition does not hold here.

The sampling error is clear from Hong et al.’s description of their treatment sample (see Hong et al., Table 1). For example, their Table 1 states that there are 124 French IPO firms in the period 2006–2007 in their treatment sample subject to mandatory IFRS adoption. Using the same data sources, we identify 113 French IPOs in the same time period (see Table 7 of this paper). To identify firms’ listing markets, we hand-collect data from firms’ IPO prospectuses. Using this data, we find that 83 of these firms are admitted to trading on exchange-regulated markets that do not require IFRS (specifically, Alternext and Marché Libre). We also confirm that these 83 firms went public using French accounting standards, not IFRS.

While we follow Hong et al. and refer to these firms as “IPO firms,” most of the firms that are excluded from our corrected treatment sample because they were admitted to trading on exchange-regulated markets would have raised capital via placements, not public offerings.

This results in the re-classification of a small number of IPOs. These are cases in which a firm is domiciled in one country, but its stock is only listed/trading on a stock exchange in another. For example, Smartrac is a firm domiciled in the Netherlands that went public on the Frankfurt stock exchange in 2006.

We use the following procedures to identify firms’ listing market. For European listing countries with both an EU-regulated market and an exchange-regulated market in this period (i.e., Austria, Belgium, Denmark, Finland, France, Greece, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Sweden, and the United Kingdom), we use data from stock exchange websites and IPO prospectuses, or newswires if not available from these two sources, to hand-collect listing market data for each firm. For countries that did not have an exchange-regulated market in the period 2006–2007 (Spain, Australia, Hong Kong, the Philippines, and South Africa), we follow Hong et al. and assume that all firms are main market listings subject to mandatory IFRS adoption.

Switzerland is not a member of either the EU or the European Economic Area (non-EU member countries that follow EU regulations; specifically, Norway and Iceland). EU capital markets regulations and directives, such as the IFRSR, therefore do not apply to Switzerland. Many Swiss listed firms have voluntarily adopted IFRS (Zeff 2016; IFRS Foundation 2017). Because the use of IFRS by listed firms in Switzerland is voluntary, there are cases where Swiss firms switch back from IFRS to domestic accounting standards (Fiechter et al. 2018).

For firms admitted to trading on exchange-regulated markets, we use data from Thomson One to hand-check the IPO prospectus of each firm to verify whether the firm went public using IFRS or domestic accounting standards.

Specifically, for the test using the third non-propensity-score-matched benchmark sample, Table 4 of Hong et al. reports a sample of 2901 firm observations. As their treatment sample includes 1540 observations, this implies that their third benchmark sample includes 1361 observations. Our third benchmark sample is very similar (1290 observations). As (our) Table 5 shows, our analysis focusing on the third benchmark sample includes 2714 firm observations, consisting of 1424 observations for the treatment sample and 1290 observations for the benchmark sample.

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Titel: Re-examining the impact of mandatory IFRS adoption on IPO underpricing
verfasst von: Donal Byard
Masako Darrough
Jangwon Suh
Publikationsdatum: 19.03.2021
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 4/2021
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-020-09576-3

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