The Brief Illusion of IFRS Effects

A new study analyzes the relation between increased effectiveness of corporate boards in constraining earnings management and the introduction of International Financial Reporting Standards (IFRS). This research finds that the corporate board's effectiveness reaches a peak only around IFRS adoption time, thus highlighting the transitory nature of IFRS effect and implying that the higher effectiveness of corporate boards might have been driven by a temporary higher level of attention devoted to the new standards.
Antonio Marra and Pietro Mazzola (Department of Accounting) have published Is Corporate Board More Effective Under IFRS or "It's Just an Illusion"? in Journal of Accounting, Auditing & Finance (Vol. 29, Issue 1, 2014, DOI: 10.1177/0148558X13512405).

Since 2005, publicly listed companies in Europe are required to prepare financial statements in accordance to IFRS. The aim is to benefit investors and financial markets functioning, by enhancing the comparability of financial statements, improving corporate transparency, and increasing the quality of financial reporting. Some recent studies highlight that a higher effectiveness of boards and audit committees in constraining earnings management follows IFRS mandatory adoption. However, others argue that it is possible that these effects are determined by other factors, and that the strong legal enforcement systems might produce persistent effects. As Marra and Mazzola explain, especially in countries with a weak legal enforcement, the higher effectiveness of corporate boards on earnings management can be attention-based related and thus short lived, showing a peak in the adoption year. The authors analyzed all the Italian non-financial companies consecutively listed from 2003 to 2007 which mandatorily adopted IFRS in 2005.

The attention-based view theory, on which this study focuses, can provide a useful lens to understand whether the higher corporate board's effectiveness has indeed a permanent or short-lived effect. The transition to IFRS, in fact, represents a relevant but temporary contextual and organizational variation in the accounting setting, and its beneficial effect seems to be temporary in the accounting context. In this way, it becomes a salient stimuli that catches board members' allocation of attention. Moreover, this temporary re-allocation of attention may be more important in countries with a weak legal enforcement, such as Italy, where the legal system does not encourage a constantly high level of attention toward financial reporting outcomes. The results provide evidence that the highest level of monitoring effectiveness of directors, both as independent directors or audit committees (ACs), is associated with 2005 (the IFRS transition year). The level of effectiveness, then, decreases after the introduction year.

This peak of attention, the authors explain, is driven by the fact that the directors are concerned by reputation issues, and so their motivation to monitor the quality of corporate accounting process is partially driven by the importance of not being punished for ineffective monitoring during IFRS introduction. Moreover, the study shows a similar pattern for the effectiveness of an additional board and AC meeting, in support of the argument that the board refocused its attention on the new standards exactly during the time of introduction.

To conclude, this study points to the transitory nature of IFRS effects and highlights how contextual factors might prevail on accounting standard regulation per se in improving earnings quality. In this way, the study gives an important contribution to the debate on the longevity of the IFRS effects and provides useful findings to regulators by highlighting a potential asymmetry between the expected benefits of a new regulation and its real effects.