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The International Journal of Accounting 45 (2010) 169–172

Discussion

Discussion of “IFRS adoption in Europe andinvestment-cash flow sensitivity: Outsider versus

insider economies”

Jenice Prather-Kinsey

School of Accountancy, University of Missouri-Columbia, Columbia, MO 65211, United States

1. Introduction

Schleicher, Tahoun, and Walker (2009) investigate whether investment efficiency (thedegree that managers under- or over-invest) as proxied by cash flow investment, is affectedby mandatory IFRS adoption differently between insider and outsider economies; andbetween large, and small firms. This study presents interesting questions about theconsequences of mandatory IFRS adoption. Moreover, this is a timely analysis as the SECdeliberates about whether to allow domestic private issuers to file using IFRS compliantfinancial reporting. STW find that the investment-cash flow sensitivity of insider economiesis higher than that of outsider economies pre-IFRS adoption, and it is no longer higher afterIFRS adoption.

STW have made improvements to this paper since presenting and my discussing it at theInternational Journal of Accounting Research Conference in Poland. Therefore, mydiscussion is brief as it focuses on my comments made in Poland, much of which has beenaddressed in the final paper.

2. Contribution to the literature

I concur with the conclusion that STW make a contribution to extent literature on theusefulness of IFRS adoption. There are numerous studies on the consequences of IFRS

DOI of original article: 10.1016/j.intacc.2010.04.007.E-mail addresses: Prather@missouri.edu, PratherKinsey@uab.edu.

0020-7063/$ - see front matter © 2010 University of Illinois. All rights reserved.doi:10.1016/j.intacc.2010.04.006

170 J. Prather-Kinsey / The International Journal of Accounting 45 (2010) 169–172

adoption, but none have focused on investment-cash flow sensitivity. However, relative tothe size of the European Union market, this paper uses data from six European countriesonly — UK, Norway, Italy, Greece, Portugal and Spain. Also, there is not a matching onfirm size or industry in the pre- and post-IFRS adoption period. This limited sampleselection and mix-matching of pre- and post samples may mask a competitive explanationfor their findings.

I therefore suggest that their contribution to the literature on finance and economic growth islimited. STWdo not include a comprehensive measure of economic growth; anti-director rightsand legal origin are probably supplanted by variables endogenous to the economy of a country.STW do not sufficiently control for differences in the economies of countries studied whenproxied as outsider and insider. They do little to add to the literature of differences in countryeconomic constraints on investment-cash flow sensitivity as their measure of economicconstraints is no different from prior studies and limited in representing a country's economy.

3. Competing hypotheses

The first hypothesis tested is whether IFRS adoption improves investment efficiency ofinsider economies significantly more than outsider economies. Economies are clusteredsimilar to Leuz, Nanda and Wysocki (2003) as;

“(1) outsider economies with large stock markets, dispersed ownership, strong investorrights, and strong legal enforcement (e.g., United Kingdom and United States); (2)insider economies with less-developed stock markets, concentrated ownership, weakinvestor rights, but strong legal enforcement (e.g. Germany and Sweden); and, (3)insider economies with weak legal enforcement (e.g., Italy and India) “(p 507)””.

Leuz and Nanda et al. (2003) contend that these country clusters are based on legal andinstitutional characteristics as developed by La Porta, Lopez-de-Silanes, Shleifer andVishny(1997). La Porta and Lopez-de-Silanes et al. admit that variables other than institutionalfactors may affect or complement their results. Even after conducting additional diagnostictests, they conclude that other endogenous interactions may exist and thus explain theirresults.

Prather-Kinsey (forthcoming) argues that legal and institutional clusters do not proxy forendogenous variables related to the economies of a country. Schleicher, Tahoun and Walker(2009) have lumped together data from six countries without considering that these countriesmay differ relative to the role and use of accounting. Choi andMeek (2008) state that accountingissues relevant to some countries, for example stock-based executive compensation plans, maynot be relevant to other countries. Similarly, accounting for intangibles may be more importantand significant in countries dominated by service industries than in other countries.Moreover, insome countries the government continues to have a strong influence on government and politics(Uddin & Hopper, 2001; Chalos & O'Connor, 2004; Lee, 2001).

Prather-Kinsey (forthcoming) shows that there is almost no correlation between legal andinstitutional measures of La Porta and Lopez-de-Silanes et al.'s (1997, 1998, 1999, and 2000)and culture as defined byHofstede (1980) or the economic development of a country. La Portaand Lopez-de Silanes et al. (1998) find almost no correlation between anti-director rightsscores and per capita income. Culture and accounting values may interact with management's

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incentives in one country differently than another. Amodel that captures only legal and capitalmarket institutional measures perhaps is biased and limited in capturing management'sincentives for financial reporting. A more appropriate, comprehensive and complimentarymeasure of a country's economy is Kaufmann, Kraay and Mastruzzi's (2008) aggregate andindividual governance indicators. They provide a more refined and continuous measure ofdifferences in country economies than La Porta and Lopez-de-Silanes et al.'s (1997, 1998,1999, and 2000) legal origin, shareholder rights and institutional measures.

Kaufmann et al. (2008) governance measures include six dimensions—voice andaccountability, political stability and absence of violence, government effectiveness,regulatory quality, rule of law and control of corruption. Kaufmann et al. (2008), rely onsurveys of individuals and firms, commercial risk ratings, non-governmental organizationsand the public sector to name a few. They use 310 individual variables to measuregovernance for 33 different sources of 30 different organizations. They provide indicatorsfor 212 countries whereas Leuz and Nanda et al. (2003) classify only 31 countries. Given thebreadth of Kaufmann et al. (2008) sources and the number of variables studied, their measureof economies is a more comprehensive, more current and refined proxy of differences incountry economies than those of La Porta and Lopez-de-Silanes et al.'s (1997, 1998, 1999,and 2000). These governancemeasures may better capture the endogenous factors that affectmanagement incentives and thus investment policies.

STW do include diagnostics comparing Kaufmann et al. (2008) to Leuz and Nanda et al.(2003). STW diagnostic test includes a country ranking based on Kaufmann scores, which ineffect takes a refined measure and waters it down to a ranking that assumes equal variationbetween rankings. I support that the STW primary regression analyses should be conductedusing the Kaufmann score, not ranking of the score, to capture the refined and comprehensivemeasure of an economy in addition to that of Leuz and Nanda et al. (2003). Moreover, STWcould include more European countries in their study if they use the Kaufmann et al. (2008)governance indicators rather than the Leuz and Nanda et al. (2003) classifications.

Another competing variable for which STW did not control for that may explain theirresults is whether the firm had an auditor switch to a global or Big 4 audit firm. Additionally,STW's pre-IFRS period is 2000–2003 and post-IFRS period is 2005–2006. This is a fouryear versus two year pre and post analysis. Results may be biased toward showing moresignificance because of the heavy weighting of observations in the pre-IFRS years.

The pre and post-IFRS mandatory adoption years selected are questionable. Some(Prather-Kinsey, Jermakowicz and Vongphanith, 2008) support that 2005 is a noisy IFRSreporting year as it is the first time of mandatory application of IFRS in the EU and thusrepresents a learning year. In 2002, the EU announced the mandatory adoption of IFRS andmany investors and companies had reacted to this IFRS announcement prior to 2005 (seeCuijpers & Buijink, 2004; Daske 2006). I believe that matching and comparing a pre-2002with a post-2005 year would provide a more robust test of the sensitivity of cash flows tomandatory IFRS adoption.

4. Conclusions

This is a timely study that examines an issue of great importance to accounting regulatorswho are grappling with whether to adopt IFRS. The U.S. and some non-European countries

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are trying to understand the advantages of adopting IFRS. STW show that one of the benefitsis investment efficiency. This study and discussion should motivate future research on thebenefits that accrue from mandatory adoption of IFRS and using the Kaufmann et al (2008)indicator as a measure of economic governance.

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