Mandatory financial reporting regulations and firms' capital investment efficiency: evidence from mandatory adoption of International Financial Reporting Standards

Abstract

This thesis investigates the relationship between mandatory financial reporting regulations and the efficiency of capital investment by a firm. Using mandatory adoption of International Financial Reporting Standards (IFRS) as an exogenous event, this thesis addresses two main research questions with respect to the effect of mandatory IFRS adoption on the investment efficiency of two types of firms: the mandatorily adopting firms and firms voluntarily adopting in the pre-mandatory adoption period.

First, the thesis goes beyond investigating the average impacts of mandatory IFRS adoption on the investment efficiency of mandatorily adopting firms previously documented (Lenger et al., 2012; Biddle et al., 2013) to explore the heterogeneity in these real economic consequences at the country level and the firm level. More specifically, it examines the interactions between the country-level enforcement of the mandatory financial reporting regulations and firm-level reporting incentives and their effects on firms' capital investment efficiency. Results based on a sample from 26 countries are consistent with the predictions from "cheap talk game" theory (e.g., Stocken 2000) and prior studies on accounting discretion and reporting incentives (e.g, Leuz et al. 2003, Daske et al. 2013). Improvements in investment efficiency are observed only for firms with strong incentives for transparent reporting, and then, only if they are situated in countries with strong enforcement mechanisms.

Second, the thesis further examines how the changes in publicly available information of peer firms (mandatorily adopting firms) impacts on the investment efficiency of firms voluntarily adopting in the pre-mandatory period. Tests reveal that the probability of inefficient investment (over- and under-investment) by voluntary adopters declines after IFRS is mandated. This documents positive externalities (spillover effects) of mandatory financial reporting regulations on capital allocation decisions by firms. However, heterogeneity in these effects is observed both at the firm and country level. Both sources of heterogeneity suggest that the externalities increase with improvements in the comparability of accounting information.

Overall, and in line with prior literature (e.g., Biddle and Hilary 2006, Biddle et al. 2009, Chen et al. 2013), the thesis presents additional evidence showing accounting information can impact on capital allocation decisions of firms.