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Impact of Accounting Choices on Performance Evaluation

By Harvard Law School Program on Corporate Governance

(Editor?s Note: This post comes from Joanna Shuang Wu of the University of Rochester and Ivy Zhang of the University of Minnesota.)

In our forthcoming The Accounting Review paper entitled ?The Voluntary Adoption of Internationally Recognized Accounting Standards and Firm Internal Performance Evaluation?, we investigate whether the voluntary adoption of international accounting standards is associated with changes a firm?s internal performance evaluation process; in particular, is it associated with increases in the sensitivities of CEO turnover and employee layoffs to accounting earnings.

Our sample consists of firms from Continental Europe that voluntarily adopted IFRS or U.S. GAAP from 1988 to 2004. We require the adopting firms to have both pre- and post-adoption data, and as a result, exclude firms that report under IFRS/U.S. GAAP from the first year they enter into our sample. We classify firms into those following IFRS/U.S. GAAP accounting standards and those following local accounting standards. For the IFRS/U.S. GAAP adopting firms, the adoption year is treated as event year zero. The local standards firms (firms that follow local GAAP throughout our sample period) serve as the control sample in the various tests. Our final sample comprises 200 IFRS/U.S. GAAP adopting firms and 766 local standards firms.

We find that CEO turnover and employee layoffs are more sensitive to accounting earnings after IFRS/U.S. GAAP adoption. These findings support our hypothesis that accounting earnings play a greater role in firm internal performance evaluations after the adoption of international accounting standards. In addition, we investigate firms? decisions to adopt international accounting standards and proxy for the performance evaluation demand with two variables: closely held shares and labor productivity. After controlling for various other factors, we find that greater performance evaluation demand (less closely held shares and lower labor productivity) are associated with a higher likelihood of IFRS/U.S. GAAP adoption.

The above evidence does not necessarily imply that the voluntary adoption of international accounting standards causes the changes in internal performance evaluations in terms of higher earnings performance sensitivities. Firms that voluntarily adopt IFRS/U.S. GAAP likely experience fundamental changes in their operations, financing, and corporate governance; and the adoption of international accounting standards can simply be an instrument for these profound changes. Our findings suggest that the greater reporting transparency through international accounting standards likely plays a role (which may not be strictly causal, but is important nonetheless) in improving firms? internal performance evaluations. We document that IFRS/U.S. GAAP adoption is associated not only with changes in firms? operating and information environment, but also with changes in corporate governance.

Our findings highlight the multitude of implications from the adoption of international accounting standards and add to our understanding of the complex changes experienced by the adopting firms.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on April 17, 2009 (boomark / email).