The economic effects of IFRS adoption in Korea^*

* Accepted by Jeong-Bon Kim upon recommendation by Haina Shi

Abstract

This paper examines whether Korea’s mandatory adoption of International Financial Reporting Standards (IFRS) is associated with higher earnings quality. Based on Korean listed companies, we compare earnings quality and market assessment in the pre-IFRS period (2007–2010) with those in the post-IFRS period (2011–2014). We find significant IFRS adoption effects by documenting smaller absolute values in discretionary accruals and real earnings management, higher accrual quality, stronger earnings persistence, and less frequent negative earnings. Thus, we provide evidence of improved earnings quality with Korea’s mandatory IFRS adoption. Additionally, we document an increase in the value relevance of earnings, more accurate analysts’ earnings forecasts, and higher audit fees and hours. These results show that investors and analysts view improvements in the information environment, and auditors’ respond to the complex environment by demanding higher audit fees and making additional efforts after mandatory IFRS adoption.

Keywords:

• IFRS
• economic effects
• principles-based
• earnings quality

Notes

* Accepted by Jeong-Bon Kim upon recommendation by Haina Shi

1. In the 2007 roadmap ceremony for Korea’s IFRS adoption and implementation, Sir David Tweedie, chairman of the International Accounting Standards Board, states, ‘It is an important step for the development of the Korean economy and its place in the world’s increasingly integrated capital markets’.

2. The Organization for Economic Cooperation and Development (OECD) is an international economic organization comprised of 34 countries, including two countries in Asia (Japan and Korea), which was founded in 1961 to stimulate economic progress and world trade.

3. The numerous laws and regulations that require amendments under IFRS adoption include the External Audit Act of Stock Companies, which governs the accounting in Korean companies; the Financial Investment Services and Capital Markets Act, regarding the period for business reports’ submission; and the Corporation Tax Law, reformed in a manner that would neither undermine tax burden equality nor increase entities’ tax burdens.

4. Agenda Paper 4, IFRS adoption and implementation in Korea, and the lessons learned, KASB, December 2012.

5. The Monitoring Board was created in January 2009 to ‘provide a formal link between the Trustees and public authorities’ and enhance the IFRS Foundation’s public accountability.

6. In contrast, Zéghal et al. (2011) find that the IFRS adoption decreases earnings management in French companies.

7. Large Korean firms, such as Samsung, Hyundai, or POSCO, are listed on the KSE, whereas high-tech firms or small- and medium-sized firms are registered on the KOSDAQ.

8. As all public firms in Korea should comply with IFRS (the new accounting standards) after its mandatory adoption in 2011, it is difficult to apply the differences-in-differences design widely used in studies based in other countries. As it is impossible to obtain a control sample of voluntary adopters in our setting, in which all public firms mandatorily use IFRS after 2011, we thus focus on changes in earnings quality between the Pre- and Post-IFRS periods.

9. We use earnings per share of year t + 1, forecasted at the end of year t, in the analyst forecast accuracy analysis, in which the analyst earnings forecast is the median value of consensus analysts’ forecast.

10. Between the residuals’ absolute value and standard deviation, we use the former as a proxy for accrual quality because time series data (normally the past five years’ data) is required to measure the standard deviation.

11. As lag (CFO _t − 1) and lead variables (CFO _t + 1) are required to estimate AQ1 and AQ2, both the Pre-IFRS and Post-IFRS periods are reduced to two years: 2008–2009 and 2012–2013, respectively.

12. As one period ahead variables (E _t + 1, CFO _t + 1 or OI _t + 1) are required in Equations (5–9), both the Pre-IFRS and Post-IFRS periods are reduced to three years: 2007–2009 and 2011–2013, respectively.

13. CFO is not included as a control variable in the regression in which a dependent variable is cash flow (CFO) or accruals (ACC).

14. As change variables (ΔNI and ΔCFO) are required to estimate income smoothing, both the Pre-IFRS and Post-IFRS periods are reduced to three years: 2008–2010 and 2012–2014, respectively.

15. To ensure that all relevant accounting information is publicly available, we use stock prices at the three months after year-end.

16. As the lead variable (ACCR _t+1) is required in Equation (16), both the Pre-IFRS and the Post-IFRS periods are reduced to three years: 2007–2009 and 2011–2013, respectively.

17. Both dependent variables are log-transformed.

18. Since such change variables as Δlog AF and Δlog AH are required in Equations (19) and (20), both the Pre-IFRS and Post-IFRS periods are reduced to three years, respectively (2008–2010 for Pre-IFRS, and 2012–2014 for the Post-IFRS period).

19. The prefix Δ indicates the difference between the values of year t and t − 1 in Equations (19) and (20).