Do IFRS/UK-GAAP reconciliations convey new information?
Hans B. Christensen, Edward Lee, Martin Walker
Abstract: Following the mandatory adoption of International Financial Reporting
Standards (IFRS) across Europe, all UK listed firms were required to publish IFRS
reconciliations for the final set of accounts they published under UK-GAAP. We
exploit this setting to examine whether the mandatory IFRS reconciliations convey
new information beyond the existing local GAAP and how firms exercise their
discretion in timing the disclosure of this information. We show that early
announcements are associated with significant market reactions and late
announcements tend to contain worse news. Our findings suggest that IFRS
reconciliations contain new information that investors consider relevant for firm
valuation and managers opportunistically delay if unfavourable.
Keywords: international accounting harmonisation, market reaction, disclosure
timing, International Financial Reporting Standards
This version: 24/11/2007
1. Introduction
For financial years commencing on or after January 1st 2005 International
Financial Reporting Standards (IFRS) are mandatory across the European Union (EU)
for all listed firms. As part of the implementation of IFRS all UK firms were required
to disclose IFRS/UK-GAAP reconciliations1 for their 2004 published accounts. We
exploit this unique setting to examine two related research questions. First, whether
the IFRS reconciliations of UK firms published in 2005 provided new information
beyond previously applied local GAAP. Second, whether firms timed the disclosure
of this information opportunistically perhaps to reduce the immediate price impact.
While the existing literature on international accounting harmonisation focuses
largely on voluntary adoption driven by decisions to cross-list, we provide novel
evidence on the impact of accounting standards transition in a mandatory setting.
The purpose for requiring UK firms to provide IFRS reconciliations for the
final set of accounts produced under UK-GAAP is to prepare end-users of financial
statements before the complete switch to the new set of standards. An interesting issue
associated with the IFRS reconciliations is whether they contain new information
beyond the content of the accounts reported earlier under UK-GAAP for the same
fiscal year. There are two reasons why UK IFRS reconciliations may not
systematically surprise the market. First, it is a widely held view that the disclosure
quality under UK-GAAP is already equal to or possibly even better than IFRS (e.g.
Cairns 1999). Second, the adjustments are assumed to be pure accounting translations
without cash flow implications. On the other hand, survey evidence from end-users of
accounting information such as fund managers indicates that IFRS numbers have
affected investment decisions (PwC 2005; PwC 2006). This could occur in two ways.
First, the change in accounting numbers may impact future cash flows associated with
existing contracts based on rolling GAAP. Second, the content of the reconciliations
may convey new implicit performance targets that the firms are committed to under
the new accounting regime.
1
For brevity we will use the term IFRS reconciliation to describe IFRS/UK-GAAP income
reconciliation in the rest of the paper.
1
Although the publication of an IFRS reconciliation was compulsory for all UK
listed firms, they were given significant discretion over the timing of these
disclosures. In effect, they could release these statements any time up to the date when
they published their interim accounts for 2005. Thus, a potentially interesting issue
associated with the UK IFRS reconciliations is how firms exercise their discretion
over the timing of the disclosure. Given that the disclosure is mandatory and that the
information content is unlikely to contain proprietary information, managers should
be in a position to disclose the reconciliation immediately after receiving it. However,
there are various reasons why the announcement may be delayed if firms are given
discretion. First, the lack of external pressure and demand for information may reduce
firms’ incentives to prepare the new set of accounting numbers in a timely fashion,
which could incur higher cost. Second, firms currently experiencing problems in
operations or with other unusual demands on management time might be less
concerned with the timely release of IFRS numbers, which places demands on the
entire accounting system. Finally, if managers believe that the IFRS reconciliations
convey price sensitive information beyond pure accounting translation, it is possible
that some firms might opportunistically delay the disclosure of bad news to smooth
any negative price response perhaps through gradual information leakage or market
inference. Although withholding non-proprietary information may normally be
unsustainable due to the disclosure principle, managers may be able to delay an
unfavourable disclosure if the market is unsure as to when managers are endowed
with the information (Dye 1985; Jung, et al. 1988).
We show that the disclosure of IFRS reconciliations leads to significant
market reactions, which are more pronounced among announcements made early.
This implies that the reconciliations indeed provide investors with new information
beyond what had already been reported under UK-GAAP and that the timing of the
announcement needs to be considered in understanding the market response. Further
analyses reveal that the market reactions are also conditional on dividend payout
policy but not on the level of leverage, pre-vested stock option grants, and tax
expense. Thus, evidence that the market reactions are driven by changes to accounting
numbers used in contracts is weak except through the implicit case of payout policy.
On the other hand, we show that IFRS reconciliations have significant predictive
power for IFRS net income in the subsequent year. Given the aforementioned
2
empirical findings, we posit that the market is more likely to be reacting to
commitments to new performance targets implicit in the IFRS reconciliations.
In terms of timing, we show that the announcement delay is significantly
associated with poorer results reported under IFRS after controlling for other
determinants of disclosure timing. This is consistent with managers being aware that
IFRS reconciliations contain information that would surprise the market, which is
why they have incentives to delay bad news in order to avoid a sudden price response.
The lack of market reactions to late announcements which we observe suggests that
this intention is achieved. Among the determinants of disclosure timing we apply in
our analyses, proxies of external pressure (e.g. foreign listing and analyst demand)
and accounting control environment (e.g. past year’s earnings announcement
reporting delay) are significant. Since the relationship between IFRS reconciliation
delays and poorer results is not subsumed by alternative explanations such as external
pressure or how well firms are managed, we posit that managerial opportunistic
behaviour to reduce the immediate impact of bad news is also a plausible cause.
Our study makes a novel contribution to work on reconciliations of domestic GAAP
accounts to international GAAP. Unlike existing studies on 20F reconciliations, we
find reconciliations from UK-GAAP to IFRS convey new information to investors.
We believe that this difference in finding is due to two main considerations. First our
study involves a mandatory one-off disclosure setting where all firms are forced to
switch to IFRS and to disclose an IFRS reconciliation regardless of whether they
deem IFRS as beneficial. Because all the firms in our study are forced to adopt IFRS
in the same year, there is no potential for self selection bias. Most previous studies of
voluntary reconciliations encounter a selection bias, because firms could choose
whether or not to adopt some form of international accounting, and the year in which
this would be done. Second, unlike 20F reconciliations studies where the firms expect
to continue to produce their main accounts under their own domestic GAAP alongside
US GAAP reconciliations, the reconciliations of this study are the first formal step in
a two part process involving a permanent switch from UK GAAP to IFRS. Thus the
UK IFRS reconciliations provide a potential benchmark for the first year accounts
produced exclusively under IFRS. In particular when UK firms produce their
3
reconciled IFRS earnings for financial year 2004, they know that the earnings they
report for 2005 will be benchmarked against that figure.
The remainder of the paper is organised as follows. Section 2 reviews prior
literature and Section 3 describes the UK institutional background and develops our
testable hypotheses. Section 4 describes the methodology and sample selection.
Section 5 provides descriptive statistics and explains the empirical findings. Section 6
concludes.
2. Literature review
Two streams of literature are relevant to our study. First, studies on the market
reaction to reconciliations between accounting regimes. Second, studies investigating
the disclosure timing of accounting information. Both are key research questions we
investigate using the mandatory IFRS adoption setting in the UK.
2.1 Market reactions to reconciliations between accounting regimes
A number of studies examine the value relevance of reconciliations between
local GAAP (or IFRS) and US-GAAP for firms cross-listed in the US (20F
reconciliations). These studies generally find that reconciliations are correlated with
the value of firms but provide no new information (e.g. Amir, et al. 1993). One
explanation for this finding could be that reconciliations do not change much from
year to year, and thus the market knows from the reconciliations of previous years
what to expect. Rees and Elgers (1997) address the issue by only looking at first time
reconciliations. They find that the market reacts to the news content prior to first time
disclosure, and that the actual disclosure contains no new information, which is
consistent with the market inferring the news content from other sources. The IFRS
reconciliations that we study differ from the 20F setting in that the disclosures were
mandatory and one-off across all firms. Firms could not choose whether they wanted
to reconcile to IFRS, which mitigates self-selection bias. The mandatory setting
implies that all firms must reveal the impact of the accounting change irrespective of
whether the results are in their favor. Since IFRS reconciliations are non-recurring,
investors could not infer information from the previous years. Given these differences
4
together, the market is more likely to be surprised by IFRS as opposed to 20F
reconciliations. In addition, the adoption of IFRS in 2005 involves a change in GAAP
regime, not just a reconciliation from the main accounts prepared under domestic
GAAP and some form of international GAAP. When UK firms produce their 2004
reconciliations it is in the knowledge that their domestic GAAP accounts will be
superseded by accounts prepared exclusively under IFRS. In particular the new
earnings figure produced as a result of the IFRS reconciliation becomes the starting
point for predicting future IFRS earnings.
Two concurrent studies examine IFRS reconciliations similar to this study.
Gordon, Jorgensen and Linthicum (2007) examine the IFRS reconciliations of
European firms cross-listed in the US. These firms were required to disclose their net
income, book value of equity, and cash flows under local GAAP, IFRS, and USGAAP for fiscal year 2004. They find that IFRS reconciliations are value relevant
over and above local GAAP and US-GAAP. Horton and Serafeim (2007) investigate
IFRS reconciliations of UK firms and like Gordon, Jorgensen and Linthicum they also
document evidence that the reconciliations are value relevant. In an attempt to
determine whether the reconciliations contain new information, Horton and Serafeim
find no significant abnormal directional returns around the announcement, which
suggests that the disclosures are neither systematically good nor bad news for all
firms. However, they do find an average negative abnormal return for firms with a net
income that is lower under IFRS than under UK-GAAP and for firms that report an
impairment of goodwill. From this evidence Horton and Serafeim conclude that they
cannot exclude the possibility that the market reacted to the disclosure of
reconciliations where UK-GAAP net income exceeded IFRS net income. We
document that IFRS reconciliations convey new information and that this result is not
limited to a small sub-group of firms. However, in order to understand the market
reactions it is essential to take into account the discretion firms have over the timing
of the disclosure.
2.2 Disclosure timing of accounting information
Studies on the timing of earnings announcements generally document that
good news is reported early and bad news is reported late using either earnings
5
surprise (Kross 1981; Givoly, et al. 1982; Kross, et al. 1984; Begley, et al. 1998;
Bagnoli, et al. 2002; Sengupta 2004) or abnormal returns (Chambers, et al. 1984) to
classify news as either good or bad. Kothari, Shu and Wysocki (2005) investigate
dividend changes, voluntary earnings forecasts and asset write downs rather than
earnings announcements. They use the magnitude of returns to infer managers’
behavior regarding disclosure timing. Their results confirm the conclusions of prior
research that managers delay bad news. On the other hand, studies examining
preemptive disclosures find that managers are more likely to pre-announce bad news
than good news, presumably to avoid stockholder lawsuits (Skinner 1994; Kasznik, et
al. 1995; Skinner 1997; Dutta, et al. 2000). Our study differs from this stream of
research on disclosure timing in two ways. First, since IFRS reconciliations do not
contain information about the activity level or financial structure of the firm that had
not already been reported according to UK-GAAP, it is unlikely to contain proprietary
information. Due to this, our results shed light on whether managers attempt to
withhold non-proprietary information as suggested by Dye (1985) and Jung and
Kwon (1988). Second, unlike earnings announcement timing, where the delay is
rarely more than 7 days (e.g. Bagnoli et al. 2002, Table 1), the scope for opportunistic
disclosure timing is considerable in the case of IFRS reconciliations. For the firms in
our sample, which have identical fiscal year ends, the range of timing choice is more
than 240 days (see Table 2).
Another stream of studies in this area examines the disclosure strategy of firms
that are given multiple years to adopt a new standard (Langer, et al. 1993; Ali, et al.
1994; Amir, et al. 1997a; Amir, et al. 1997b). These studies find that firms delay the
adoption of accounting standards with an adverse effect on income to a later year. The
assumption is that the delay is motivated by the need to re-negotiate existing contracts
based on the accounting numbers in the annual report. In the UK, contracts are often
based on accounting information from the annual report e.g. compensation and debt
contracts. However, UK firms cannot delay the adoption of IFRS to a later year. All
firms in our sample adopt IFRS in 2005. Moreover, although the IFRS accounts
published for financial years 2005 onwards may affect the cash flows associated with
contracts based on rolling GAAP, the IFRS reconciliations for financial year 2004 are
non-recurring and without audit obligation and so are not directly relevant for
contracting purposes. Nevertheless the IFRS reconciliations might be helpful for
6
forecasting the effects of IFRS implementation on existing contracts and/or the ability
of the firm to pay dividends.
3. Hypotheses development
Mandatory IFRS adoption in the UK is an especially interesting case because
it constitutes a change in the entire financial reporting regime of a large stock market
based economy. The mandatory adoption resulted in a large number of changes and
the implications are therefore likely to be more pronounced than in instances where
changes are more limited. Furthermore, for fiscal years beginning after 1st January
2005 firms no longer produce UK-GAAP consolidated statements and investors
consequently have to rely on IFRS numbers. The UK is unique among large European
countries in that there was virtually no early or supplementary adoption of IFRS prior
to 2005. The lack of IFRS application prior to 2005 ensures that all firms, whether
they perceived IFRS as beneficial or not, disclosed IFRS net income for the first time
in the sample period. As such the UK setting provides a relatively clean setting to
study market reactions and the disclosure timing behaviour associated with a systemic
change in GAAP regime.
3.1 Market reactions
Anecdotal evidence suggests that IFRS reconciliations convey new
information to the market. For instance, PwC (2005) asked fund managers in the UK
about the introduction of IFRS. 70% of fund managers responded that they found the
information disclosed by firms fairly useful or very useful. 29% reported that the
disclosure had influenced them to disinvest from a firm, 21% that they had been
influenced to not invest in a firm and 13% had been influenced to invest. To examine
whether the IFRS reconciliations indeed convey new information beyond the existing
UK-GAAP we test Hypothesis 1 (stated in alternative form).
Hypothesis 1: IFRS reconciliation announcements lead to market reactions.
A market reaction could be triggered by IFRS reconciliations in two ways.
First, contracts are often based on accounting information like net income. These
7
contracts tend to rely on rolling GAAP in the UK (Leuz, et al. 1998) and typically
include compensation and debt contracts. IFRS changes the accounting numbers and
therefore potentially also changes the cash flows associated with existing contracts.
To the extent that IFRS reconciliations convey new information about potential future
changes in the accounting numbers this will also reveal potential changes to cash
flows associated with existing accounting based contracts. Second, the IFRS
reconciliations may convey new information that assists investors in predicting future
cash flows. The change from UK-GAAP to IFRS includes a number of mechanical
changes such as the end of goodwill amortisation. However, the principle based
nature of IFRS often relies on the judgement of preparers and therefore leaves
managers with some discretion e.g. on the impairment of some asset groups. Previous
research documents that managers attempt to meet or beat previously realised net
income and that the failure to do so is costly (Degeorge, et al. 1999; Kasznik, et al.
2002; Skinner, et al. 2002; Abarbanell, et al. 2003). Therefore, this year’s realised net
income becomes the target to meet or beat next year. In other words, the way in which
a manager applies the discretion in IFRS could act as a commitment to future
performance. That is to say a manager with good private information is likely to
commit to a higher target than a manager with bad private information other things
being equal. The unique feature of the setting in this regard is that UK-GAAP net
income will not be disclosed for later fiscal years and that the net income disclosed in
the IFRS reconciliations therefore constitutes the only available benchmark for the
future.
3.2 Disclosure timing
The scope for the timing of IFRS reconciliation announcements is governed
by the disclosure rules of the LSE and the interim reporting arrangements that
regulate the timing of UK financial reporting. UK firms provide a full set of accounts
for the entire fiscal year, and a partial set of interim accounts for the first half year of
trading. According to Chapter 9 of the LSE’s listing rules, UK firms are obliged to
comply with IFRS in their interim reports for 2005, and to include comparable
numbers according to IFRS for the fiscal year 2004 in the interim report for 2005. As
illustrated in Figure 1 firms are faced with a discretionary choice as to when to
disclose the impact of IFRS on net income.
8
[insert Figure 1]
Under the LSE’s listing requirements firms should report preliminary earnings
no later than 90 days after the end of the fiscal period. In order to ease the transition to
IFRS this deadline was extended by 30 days for the interim report for 2005.2 The
actual observed disclosure window is wide, with the first and last disclosures released
40 days and 288 days after the financial year 2004 end. This is a much larger variation
than is seen in conventional studies on the timing of earnings announcements. This
factor in combination with the disclosure being non-recurring strengthens the novelty
value of the setting for testing disclosure behaviour. Furthermore, our data on the
timing of IFRS announcements reveals considerable differences in the timing choices
of firms. 12% of the sample report at the same time as their UK-GAAP earnings
announcement for 2004, 23% disclose at the same time as their interim report for
2005 and 65% report in between these two extremes.
In our setting, firms have no discretion over whether or not to disclose the
reconciliations. In addition the IFRS reconciliations are unlikely to contain
proprietary information. Therefore, the disclosure issue essentially involves a choice
about the timing of non-proprietary information. Dye (1985) presents a theoretical
model with assumptions that correspond closely to the decision context surrounding
the timing of IFRS reconciliations. Dye demonstrates the logical possibility of no
disclosure when the market is unsure whether managers are in possession of
information. In this scenario adverse selection does not force disclosure because the
market is unsure whether non-disclosure is due to unfavourable news or the nonexistence of news.3 This raises the possibility that some firms will act
opportunistically to delay the disclosure of bad news. The objective of delaying bad
news may be to reduce the immediate price impact perhaps through gradual
2
The extension is allowed only if the firm announced to the market that it would use this option and
the reasons for using it.
3
Some prior literature interprets empirical evidence on the timing of earnings announcements as
evidence in favour of the Dye model (e.g. Jung and Kwon, 1988). However, Verrecchia (1983) suggest
that earnings announcements may contain proprietary information and Sengupta (2004) provides
empirical evidence to support this. The possibility that earnings announcements could contain
proprietary information is enough for the setting not to be suitable for testing the Dye model.
9
information leakage or perhaps through the market inferring the news from other
sources (e.g. early disclosers). Thus, if investors believe that the likelihood that the
manager is endowed with information increases as time elapses, then favourable
(unfavourable) information will be disclosed earlier (later). Hypothesis 2 tests this
proposition (stated in alternative form).
Hypothesis 2: Firms that delay the IFRS reconciliation announcement on
average report worse news.
An alternative explanation to delayed announcement of unfavourable news in
IFRS reconciliations is that firms may not be able to produce IFRS numbers in a
timely fashion when they are suffering from problems in operations or management.
In other words, the timing of reconciliation disclosure may not be due to managerial
discretion but is a manifestation of the well-being of the firm. We take this possibility
into account in testing Hypothesis 2.
4. Research design
We focus on IFRS reconciliations of net income, which is the most common
first time quantitative disclosure although some also reconcile book value of equity
and cash flows. The net income reconciliations do not come in a set format, but two
formats are very common. Some firms disclose a new income statement; possibly
beside the UK-GAAP income statement reported earlier (see Example 1 in Appendix
A). Other firms disclose a reconciliation between the bottom line UK-GAAP and
IFRS net income numbers (see Example 2 in Appendix A). Most IFRS reconciliations
regardless of format are accompanied by a narrative statement with varying degrees of
detail.
4.1 Market reactions
To test Hypothesis 1, we examine whether abnormal stock price reactions on
the day of disclosure are correlated with the news content.
10
AR = λ 0 + λ1 News i + λ 2 ADRi * News i + λ 3 Surprise i + λ 4 ADRi + ε
i
i
(1)
where:
ARi
= Abnormal returns on day 0 estimated using the market model
Newsi
= Industry adjusted fraction rank of the change in income scaled by total
assets according to UK-GAAP (explained in further details below)
ADRi
= A binary variable that takes the value 1 if the firm is cross-listed in the US
and 0 otherwise
ADR*Newsi
= An interaction term between ADRi and Newsi
Surprisei
= Earnings surprise assuming earnings follow a seasonal random walk
εi
= Random error term
We use abnormal returns (AR) on day 0 to capture the market response to the
disclosure of IFRS reconciliations. Market adjusted returns (MAR) are used as a
robustness test and presented together with the results based on AR. MAR is calculated
as the difference between raw returns and the return on the FT All Shares index, and
AR is calculated as the difference between raw returns and the prediction from the
market model suggested by Sharpe (1963). The model parameters are estimated using
240 trading days (approximately one year) ending 10 days before the disclosure (day
0).
We estimate news content (News) as the difference between the reported
information content and expected information content. We define reported
information content as the scaled change in income (∆π), which is calculated as IFRS
minus UK-GAAP net income for fiscal year 2004 scaled by total assets according to
UK-GAAP at the end of fiscal year 2004.4 The definition of information content
follows the way practitioners initially calculate the level of materiality.5 We focus on
the income statement rather than the balance sheet or cash flow statement because it is
the statement most often included in firms’ first time disclosure of quantitative
information on IFRS impact. Using net income as the basis therefore ensures the
lowest number of missing variables possible. This is especially true for the cash flow
4
As an alternative scaler the absolute IFRS net income is used. No results change as a consequence,
which suggest that our results are not driven by the choice of scaler,
5
See for example Arens and Loebbecke (2000, p. 254). Auditors generally use a percentage of total
assets to estimate the preliminary judgement about materiality regarding a change in net income before
commencing an audit. An issue is material if it could affect users’ decisions and is therefore closely
related to news content.
11
statement because few firms disclose detailed reconciliations of the cash flow
statement. We do not rely on the change in net equity on the day of transition (1st
January 2004) because it is affected by a number of choices that firms are given in
IFRS 1 in order to lower the cost of transition e.g. whether to re-value goodwill
retrospectively at the date of purchase or use the UK-GAAP book value at the 1st of
January 2004 as deemed value. Thus the change in net equity on the day of transition
is not the change from UK-GAAP to IFRS net equity. It constitutes the change from
UK-GAAP to what the IASB view as an acceptable starting point for future IFRS
reporting. Net income is less affected by these choices because it consists of the
change in net equity from 1st January 2004 to 31st December 2004, not the
retrospective change on the day of transition. Furthermore, for net income more is
always better than less. This is not always true for the book value of equity. As the
information content is defined as the firm’s position in the rank of all firms it relies on
the assumption that more is better than less.
We focus on the summary measure of net income rather than any specific
reconciliation item because the format of reconciliations varies greatly among firms.
In particular comparison is complicated by the treatment of taxes. Some firms report
the individual reconciliation items net of tax whereas other firms report the joint
effect of taxes on all reconciliation items as a separate item. Furthermore, to obtain an
objective criteria for collecting the data when firms make several partial IFRS
disclosures we apply the date when firms first disclosed income under IFRS. For
consistency we use the abnormal return on the day a firm disclosed net income to
proxy the market reaction and net income as the basis for measuring the information
content this day. Finally the reconciled Net Income figure, potentially represents a
benchmark for Net Income reported in the first full set of IFRS accounts.
Thus, net income is the basis for the proxy for information content in this
study. We rank firms in ascending order by ∆π (1 being lowest in value) and scale the
rank value by the total number of observations to obtain the fraction rank. The
fraction rank is used to avoid assuming any specific distribution of the ∆π and reduce
12
the influence of outliers.6 In order to identify the news in IFRS reconciliations it is
necessary to construct a proxy for the market’s expected information content. We
assume that these expectations are based on industry membership. Industries are
correlated with growth expectations, profitability, accounting principles applicable
and many other factors expected to influence accounting numbers.7 The news content
is equal to the reported information content minus expected information content, and
is calculated as the error term of a regression of the fraction rank on 22 industry
dummies (without an intercept).
Rank =
i
K
∑ θ k Dk + ε i
k =1
(2)
where:
Rank
= The fraction rank of the scaled change in income
Θ
= The coefficient on the dummy for industry k
D
= A dummy variable for industry k
ε
= The error term for firm i and the principal proxy for news content in this
study.
The error term in Equation 2 measures the information content that is not explained
by industry membership and therefore the news if one assumes that expectations are
formed based on industry membership.
We evaluate the incremental effect of cross-listing in the US (ADR) on the
relationship between market reactions and News in Equations 1. Based on the
empirical findings in Pae, Thornton and Welker (2006) and Christensen, Lee and
Walker (2007) the capital market impact of IFRS is expected to be lower for firms
cross-listed in the US. Firms that are cross-listed in the US generally reconcile their
net income and book value of equity to US-GAAP, and therefore already comply with
an international accounting regime (Leuz 2003 shows that there is no significant
capital market differences between firms adopting IFRS and US-GAAP in Germany's
Neuer Markt). If the IFRS reconciliations contain no new information beyond what is
6
This measurement method does not affect the conclusions. Robustness tests regarding the
measurement of news content is presented in Section 5.4.
7
Besides having intuitive appeal the assumption that expectation follows industries is supported by an
article aimed at financial analysts produced by JCF group that estimate the impact of IFRS for specific
industries prior to mandatory IFRS adoption in Europe (JCF Outlook 2004).
13
included in US-GAAP reconciliations and SEC disclosures for US cross-listed firms
(λ1 + λ2) will be insignificant in Equation 1.
We also control for earnings surprise (Surprise) in our tests because some
disclosures are made simultaneously with earnings announcements as described in
Section 3. If the earnings surprise is correlated with the difference between IFRS and
UK-GAAP income this could result in a biased coefficient on news. To mitigate this
concern a proxy for earnings surprise is included as a control variable (Surprise).8 The
earnings surprise proxy assumes that earnings follow a seasonal random walk. The
surprise is calculated as the difference between EPS reported simultaneously with the
IFRS reconciliation minus EPS of the same period one year earlier scaled by the share
price at 31st December 2004. If the IFRS reconciliation is not disclosed
simultaneously with earnings, the earnings surprise variable is equal to zero.
4.2 Disclosure timing
To test Hypothesis 2 we first predict the disclosure timing of firms based on
the determinants applied in Equation 3 (i.e. the fitted value of DELAY). We then
classify firms into two groups depending on whether they disclose before (negative
error) or after (positive error) the model’s prediction, and compare the news content
between these two groups. Hypothesis 2 is supported if firms that disclose after the
model’s prediction on average report worse news than firms that disclose before.
DELAYi = α 0 + α1 ANAi + α 2 LOSS i + α 3 SGi + α 4 FLADRi + α 5 SIZE
i
+ α 6 FSi + α 7UK 03i + α 8UK 0304 i + α 9QUARi + α10 BIG 4i + ε i
(3)
where:
DELAY = The number of days between the financial year end and the disclosure of IFRS net
income
ANA
= The natural logarithm of the number of analysts following the firm
LOSS
= Consistent loss maker (binary variable)
SG
= Sales growth
8
Simply excluding disclosures made simultaneously with earnings announcement would result in the
exclusion of the 35% most interesting cases, i.e. firms reporting either as early as possible or as late as
possible (as well as 3% reporting with quarterly earnings).
14
FLADR = Foreign listing, which includes ADR listings in the US and any other foreign
listings (binary variable)
SIZE
= The natural logarithm of market value
FS
=Foreign sales to total sales
UK03
= Reporting lag for UK-GAAP earnings for fiscal year 2003
UK0304 = Reporting lag for UK-GAAP earnings for fiscal year 2004 minus UK03
QUAR = Quarterly reporting (binary variable)
BIG4
= Audited by either PricewaterhouseCoopers, KPMG, Deloitte. or Ernest & Young
(binary variable)
The dependent variable in Equation 3 is the announcement delay (DELAY). It
is measured in the same way as studies on the discretionary timing of earnings
announcements define lag, i.e. the number of days between the 31st December 2004
and the date of disclosure of (reconciled) IFRS net income for the fiscal year 2004.
We identify several determinants of disclosure quality from existing literature (Lang,
et al. 1993; Sengupta 2004) falling under two broad categories. One group is
generally associated with an external demand for information, which includes analyst
demand, foreign listing, foreign exposure, and firm size. Another group broadly
addresses the well-being of the firm, which includes profitability, growth, and
accounting control environment proxied by reporting delays of past years, frequency
of reporting, and auditing by Big 4.
The demand from analysts (ANA) is defined as the natural logarithm of the
median number of analysts that provided IBES with an earnings forecast from January
to August 2005. Walker and Tsalta (2001) document that higher levels of analyst
following drive higher levels of disclosure in the UK. We therefore expect a negative
correlation between DELAY and ANA. For foreign listing we define the binary
variable FLADR as 1 if the firm is cross listed on a non-UK stock exchange and 0
otherwise. The expected sign on its coefficient is negative because external pressure is
likely to result in timelier disclosure. Foreign exposure is proxied by the proportion of
foreign sales to total sales (FS) as reported by Worldscope for 2004. It is unclear ex
ante what the sign on FS will be. A firm with a high level of foreign exposure may
benefit more from IFRS than a firm with a low level of foreign exposure. This
suggests a negative correlation. On the other hand FS captures the level of foreign
activity and may be correlated with the number and size of foreign subsidiaries. As
15
the disclosure of IFRS reconciliations requires accounting information to be received
from each subsidiary the task is expected to be greater for a firm with more and larger
foreign subsidiaries which suggest a positive correlation. Firm size (SIZE) is
measured as the natural logarithm of market capitalisation. Size has generally been
found to have a positive impact on reporting quality. Thus a negative relationship
between SIZE and DELAY is expected.
To proxy profitability we define the binary variable LOSS as 1 if the firm has
made a loss according to UK-GAAP for the fiscal years 2002, 2003 and 2004 and 0
otherwise. We expect unprofitable firms to disclose later. The sign on the coefficient
on LOSS is therefore expected to be positive.9 Growth (SG) is proxied by the median
annual sales growth for 2002, 2003 and 2004. Growth firms generally have a greater
need to raise capital externally. Empirical and theoretical evidence suggests that
higher disclosure quality makes obtaining capital cheaper (e.g. Botosan 1997). Based
on this argument a negative coefficient is expected on SG.10 How well a firm is
managed is also associated with its accounting control environment. We define UK03
as the reporting lag of UK-GAAP earnings for 2003. A firm that reports earnings
quickly is likely to have effective controls that decrease the cost of compliance. The
reporting lag of 2003 is most unlikely to have been affected by the implementation of
IFRS. DELAY could, however, be affected by issues that are specific to the reporting
of 2004 earnings. For example, the accounting department itself could have been
under pressure from the change to IFRS. These issues specific to 2004 are proxied for
by the change in reporting lag between fiscal year 2003 and 2004 (UK0304). The
association between DELAY and both UK03 and UK0304 is expected to be positive.
That is to say, firms with a tradition of reporting late (possibly due to a weaker control
environment) and high pressure on the accounting department in 2004 are expected to
report IFRS reconciliations later than other firms. Firms that report quarterly earnings
should generally also use IFRS in these statements. This effect is controlled for by
including a binary variable that takes the value 1 if the firm reported quarterly
earnings according to IFRS for the first quarter of 2005 and 0 otherwise (QUAR).
Clearly, the expected sign on this variable is negative. Finally firms audited by a Big
9
As an alternative proxy for profitability ROA (return on assets) has been used. This does not affect
the results.
10
As an alternative proxy for growth market value to total assets has been used. This does not affect the
results.
16
4 auditor could have the advantage of easier access to IFRS experts than firms that are
not. This effect is controlled for by including a binary variable that takes the value 1 if
the firm is audited by a Big 4 auditor and 0 otherwise (BIG4).
4.3. Sample selection
Data are collected for the largest 752 firms on the LSE. Firms in financial or
asset management industries are excluded because their financial reporting rules
deviate significantly from other firms’ and they are subject to special regulation.11
The 3 firms that disclose their first IFRS figures in 2004 (for fiscal year 2003) are also
excluded because they are special cases and do not fit into the proposed model.
Information is not available for 16 firms typically because they listed in 2004 or the
first half of 2005 and therefore do not have historical data. We also require
information to be available in Hemscott Company Guru, Thomson One Banker and
IBES for a firm to be included in the sample, which further decreases the sample by 6
firms. To ensure that market reactions are not driven by disclosures made
simultaneously with the IFRS reconciliations we search for disclosures on the same
day as the IFRS reconciliations. The only significant simultaneous disclosures we
allow in the sample are earnings announcements. The final sample consists of 137
firms. See Table 1 for the sample selection procedure.
[insert Table 1]
The date of disclosure is identified by searching Regulatory News in Hemscott
Company Guru. Sometimes firms discuss IFRS in several announcements. The date
applied is the first time the firm discloses income under IFRS. The net income
number under IFRS is also collected from Regulatory News. The UK-GAAP numbers
from the announcement in the Regulatory News is compared to the annual report for
2004 to ensure consistency. Annual reports are obtained from Thomson One Banker.
11
In particular these firms are likely to be more affected by IAS 39 on financial instruments than other
firms. This standard was highly debated during the data collection period and subject to exceptions for
EU firms. In order to limit any bias that could be the result of an uneven playing field these firms are
excluded.
17
We deliberately exclude non-December year end firms. It is likely that the
inclusion of non-December year end firms would introduce bias in an unknown
direction as the disclosure choice of those firms would be different from December
year end firms. Non-December year end firms had longer time to prepare for
mandatory adoption and they could observe the disclosure choices of December end
firms before making their decisions.
We exclude firms from other EU countries that are also subject to mandatory
IFRS. This is because there are significant differences in the way the EU countries
have chosen to implement IFRS. In Germany (the largest country in the EU) for
example, firms had the option to voluntarily comply with IFRS prior to 2005, and
those that already complied with US-GAAP and were cross-listed in the US could
defer compliance to 2007. Thus, the inclusion of German firms in the sample could
have induced a selection bias because German firms were able to choose the time of
IFRS implementation. It is exactly the lack of this timing option that makes the UK a
unique setting.
5. Results
5.1 Descriptive statistics
Table 2 Panel A reports descriptive statistics for the sample which contains
137 firms. The sample exhibits significant variation in firm size, analyst following
and the timing of the IFRS reconciliation disclosure.
[insert Table 2]
The scaled difference in income between IFRS and UK-GAAP (∆π) is on
average 1.2%. The standard deviation is 2.3% with the largest decrease being –9.1%,
and the largest increase being 9.8%. 28% (72%) of firms disclose a lower (higher) net
income under IFRS than under UK-GAAP. 47%, 27% and 14% of firms experience
an absolute change in net income larger than 1%, 2% and 3% of total assets
respectively.
18
Table 2 Panel B presents the correlation matrix of all variables used in
estimating Equation 3. The effect on net income of IFRS (∆π) is negatively related to
DELAY as predicted in Hypothesis 2. Thus, better news leads to a shorter delay. The
correlation between DELAY and LOSS, SIZE, UK03, UK0403, QUAR, ANA, FLADR
and BIG4 are all in the predicted direction. Thus, large and profitable firms that report
preliminary earnings early in 2003, do not delay their preliminary earnings
announcements in 2004, report quarterly, have a high analyst following, are crosslisted on a foreign exchange and audited by a Big 4 auditor have shorter delays in the
disclosure of their IFRS reconciliations. FS is negatively correlated with DELAY
consistent with the potential greater benefits from IFRS dominating the complexity
implied by foreign exposure although this relationship is not significant. The sign on
growth is contrary to expectations, but, consistent with Sengupta (2004) positively
associated with DELAY.
5.2 Stock market reactions
Table 3 Panel A presents the results for our test of Hypothesis 1 through
regressions based on Equation 1. The columns under the heading All in Table 3
include all firms in the sample. The coefficient on the news proxy (λ1) has the
predicted sign and is significant at the 5% level, the adjusted R2 is 0.0306 using AR
and 0.0321 using MAR. Thus, the news content is associated with market reactions on
disclosure although the explanatory power is low. The coefficient on the interaction
term between the news proxy and an indicator variable for a US cross listing (λ2) has a
negative sign as expected. λ1 and λ2 are jointly insignificant suggesting that the
significant stock price reactions are restricted to firms not cross listed in the US.
[insert Table 3]
As discussed in Section 3.2 UK firms exhibit considerable variations in the
timing of the release of their IFRS reconciliations. We expect market reactions to be
more pronounced in earlier announcements since information leakage as well as
investor inference and learning could reduce the surprise element of later disclosures.
Indeed, among the Early announcers the coefficient on the news proxy (λ1) increases
and a test on this coefficient’s significance returns a p-value of approximately 0.1%.
19
The adjusted R2 is 0.2429 (0.2343) under AR (MAR) suggesting a larger explanatory
power than in the full sample. The coefficients λ1 and λ2 are jointly insignificant
indicating that the reconciliations only contain information relevant to the valuation
when the disclosers are not cross-listed in the US.12 Among Late announcers, the
coefficient on news content has the predicted sign but is insignificant (λ1) as are λ1 and
λ2 jointly. The adjusted R2 is negative. In Panel B we test whether the observed
differences in the coefficients on the news content variables (λ1 and λ2) between the
Early and Late announcers are significant. The difference is significant at the 5%
level using AR and 10% using MAR (β3 and β4) , which is consistent with the findings
in Table 3 Panel A that market reactions are more pronounced for more timely
disclosures. On the whole, the results presented in Table 3 suggest that IFRS
reconciliations indeed supply new information that was relevant to firm valuation,
although it is concentrated among Early disclosers that are not cross-listed in the US.
Therefore, we find evidence in support of Hypotheses 1. Section 5.4 presents further
sensitivity tests on the measurement of news, the proxy for earnings surprise, and the
issue of firms’ self- selection of their disclosure timing.
We conduct further analyses to determine whether or not the observed market
reactions to IFRS reconciliations are due to the impact of changes in accounting
numbers used in contracts based on rolling GAAP. Our empirical analyses are
complicated by the fact that we do not have direct access to firms’ contracts. To
implement our test, we partition firms into high and low sensitivity groups. In the high
(low) sensitivity group we expect the particular type of contracts to have more (less)
significance. If a particular type of contract is driving the price reactions we would
expect the market reactions to be concentrated either in the high or low impact group.
For this examination we restrict our tests to the Early announcements because this is
where we identify significant market reactions. We apply Equation 4.
12
The coefficient on ADR captures the incremental stock market reaction for ADR listed firms on the
day of disclosure. This variable consistently loads positively and the coefficient is marginally
significant. This effect is driven by disclosures made simultaneously with earnings announcements. In
this sample, ADR firms on average experienced a positive earnings surprise for 2004 earnings relative
to non-ADR listed firms. To assess whether this affects the results we include a dummy variable that
takes the value 1 for ADR firms disclosing simultaneously with earnings announcements and 0 for all
other observations. This procedure leads to an insignificant coefficient on ADR but no results changes
i.e. the coefficient on news remain significant at the 1% level for early announcers.
20
AR i = β
0
+ β News + β News * D + β ADR * News + β News * D * ADR
i
i
i
i
i
i
i
i
1
2
3
4
+ β Surprise i + β D i + β ADR i + β D i * ARR i + ε i
5
6
7
8
(4)
where:
Di
= A binary variable that takes the value 1 if the firm in the high
sensitivity group
Newsi*Di
=An interaction term between Newsi and Di
Newsi*Di*ADRi
=An interaction term between Newsi, Di and ADRi
Di*ADRi
=An interaction term between Di and ADRi
All other variables are defined as Equation 1.
Debt contracts with covenants are often based on accounting numbers. If these
contracts are based on rolling GAAP a change in accounting numbers could affect
firms’ future cash flows. We proxy firms’ likelihood to be affected by debt covenants
by leverage, assuming that a highly leveraged firm is more likely to have accounting
based debt contracts that could significantly affect future cash flows. In our tests Di
takes the value 1 for firms with above median leverage in the full sample (137 firms)
and 0 for all other firms. Leverage is calculated as the median of the yearly long term
debt to total assets from 2000 to 2004. Table 4 Panel A reveals against expectations
that market reactions are marginally smaller for firms with above median leverage,
although the difference is not significant. The results do not support the hypothesis
that debt contracts generally drives the market reactions.
Executives in UK firms are often granted stock options that only vest when
EPS reach a predetermined level. The change from UK GAAP to IFRS could
therefore result in changes in executive pay that is not caused by the executives’
performance. Perhaps the observed market reactions are related to future cash flow
changes due to performance based executive pay contracts. We examine this issue by
partitioning firms according to the amount of stock options not yet vested. If
accounting based performance contracts are an important determinant we would
expect market reactions to be strongest among firms that rely heavily on this form of
compensation. We collect data on options issued but not vested on January 1st 2005 in
BoardEx. The total value of not vested options is scaled by total assets at December
31st 2004. Di takes the value 1 for firms with above median stock options among
Early announcers. Table 4 Panel B provides the results of the statistical tests. Firms
with high level of not vested stock options have marginally higher market reactions to
21
the disclosure of IFRS reconciliations, although the difference is not significant. The
results do not support the hypothesis that compensation contracts generally drives the
market reactions.
In the UK taxes are calculated based on the legal entity accounts (not the
consolidated accounts). However, groups can voluntarily adopt IFRS in the legal
entity accounts. If a firm voluntarily adopts at the legal entity level IFRS will form the
basis for taxation.13 If tax implications are driving market reactions we would expect
the impact to be largest when tax expenses are high, because the potential cash flow
impact of adoption is likely to be larger for this group. We test this proposition in
Table 4 Panel C. Di takes the value 1 for firms with above median tax expenses in the
full sample (137 firms) and 0 for all other firms. The tax expense is calculated as the
median of yearly tax expense to total assets from 2000 to 2004. Market reactions are
smaller for firms with above median tax expenses, although the difference is not
significant. The results do not support the hypothesis that tax implications generally
drive the market reactions.
UK company law places few restrictions on dividend payments. The
restrictions that the company law does place are all at the legal entity level (not
related to the consolidated accounts). Thus if dividend policy is a driver of market
reactions these are likely to be associated with private contracts either in the form of
restrictions in debt contracts or implicit commitments to shareholders. Table 4 Panel
D provides the results on the association between dividend policy and market
reactions. We apply three proxies for dividend policy. First, the size of dividend
payments is proxied by the median yearly cash dividend paid from 2000 to 2004
scaled by total assets. Di takes the value 1 for firms with above median dividend
payments in the full sample (137 firms) and 0 for all other firms. The results show
that firms with high dividend payments generally experienced lower market reactions
although this result is only marginally significant. Firms with low dividend payments
may be constrained in their ability to pay cash dividends (compared to firms with high
dividend payments) and a change in the net income may therefore be a signal of
improved ability to pay future dividend without breaking contractual obligations. The
13
Survey evidence in PwC (2007) shows that 18% of firms have decided to use IFRS in domestic
subsidiaries’ legal statements. The survey was conducted in April and May 2007.
22
second proxy for dividend policy is the variability of cash dividend payments as a
proportion of net income from 2000 to 2004. For this specification Di takes the value
1 for firms with above median variance of dividend payments in the full sample (137
firms) and 0 for all other firms. A change in income may be a stronger signal of future
dividend payments when the current dividend policy is sticky (i.e. Di equal 0).
Consistent with this we find larger market reactions for firms with a low variability of
past dividend payments although the difference is not significant. The third proxy
combines the idea behind the two prior proxies on dividend policy. The idea is to
capture firms that consistently pay low dividends, perhaps because contracts restrict
their ability to pay. In this specification Di takes the value 1 for firms with below
median dividend payments and variance of payments in the full sample (137 firms)
and 0 for all other firms. Consistent with prediction firms with consistently low past
dividend payments experience significantly higher market reactions than other firms,
although market reactions are not restricted to this group of firms (β1 remains
significant). The results are consistent with firms’ dividend policy partly determining
market reactions.
[insert Table 4]
Overall the results in Table 4 provide little evidence that accounting based
contracts is the underlying reason behind market reactions to IFRS reconciliations.
Only contracts related to dividend payouts are associated with the observed market
reactions. These contracts could be part of debt agreements but based on the results
for debt levels they are more likely to be implicit contracts with shareholders
embedded in dividend policy. A signal of improved net income from IFRS
reconciliations appears to have stronger impact on value for firms with sticky low
dividends most likely because it signals either an assurance of the firms’ ability to
maintain the current level of dividend or even a possibility of future increases in
payout.
As a more direct test of whether the level of net income in IFRS
reconciliations convey information on future performance we run the regression
expressed in Equation 5.
23
NI 05 IFRS
TA 04 UK i
i
= γ1
NI 04 UK
TA 04 UK
i
i
+γ 2 Δ π + γ 0
1
TA 04 UK
+ εi
(5)
i
where:
NI05IFRSi
= Net income under IFRS for fiscal year 2005
NI04UKi
= Net income under UK-GAAP for fiscal year 2004
Δπ
= The difference between IFRS and UK-GAAP net income for fiscal year
2004 scaled by total assets according to UK-GAAP at 31st December 2004
(the proxy for information content discussed in Section 4.1)
TA04UKi
= Total assets according to UK-GAAP at 31st December 2004
The coefficient on the difference between IFRS and UK-GAAP net income (γ2) tests
whether the reconciliations contain incremental information over and above UKGAAP net income for 2004 for predicting the IFRS net income for 2005. The results
are presented in Table 5. To avoid the concern that outliers in the scaled accounting
numbers affect our conclusions the results presented are based on NI05IFRS/TA04UK,
NI04UK/TA04UK and Δπ winzorised at the 5% level, yet the results are essentially
similar when no variables are winzorised. Panel A confirms that the reconciliation
have incremental information content for predicting the level of net income for 2005.
If firms have some discretion over the timing of items they recognise in their
IFRS reconciliations, it is possible that they may prefer to recognise large losses in
their IFRS 2004 reconciliation rather than delay this until the first set of full IFRS
accounts. This allows them to account for some bad news items outside the normal set
of accounts i.e. through the IFRS reconciliations. Firms may be less motivated to
recognise large gains in their reconciliations i.e. they might prefer to recognise gains
in their 2005 accounts, or perhaps to gradually smooth the gains over several future
years. If firms are more likely to recognise losses in their IFRS reconciliations than
gains. then the predictive value of negative reconciliations should be very different
from the predictive value of positive reconciliations. In particular one would expect
the value of γ2 to be significantly higher for positive reconciliations compared to
negative reconciliations. Panels B and C partition the sample according to the sign on
the net income reconciliation for 2004. The results show that the predictive content of
the reconciliations is largely driven by the positive reconciliations. Moreover the γ2
parameter is much lower for the negative reconciliations than the positive ones.
24
Indeed this parameter value is negative (although not significant) in the case of
negative reconciliations.
Overall the results presented in Table 5 are consistent with positive IFRS
reconciliations conveying information about the future IFRS earnings of firms, and
negative reconciliations being used, at least in part, to recognise (and hence eliminate)
losses in the year before the switch to full IFRS reporting.
[insert Table 5]
5.3 Disclosure timing
Before directly testing Hypothesis 2, we seek to establish what factors other
than news content affect disclosure timing. We apply the regression of Equation 3 to
identify the key determinants of disclosure timing. In Table 6 Regression 1,
profitability, growth, foreign sales and Big 4 auditor are not significant and are
therefore excluded from Regression 2. Foreign cross-listing and size are also
insignificant at conventional levels but are kept in the regression as they offer some
explanatory power. Notice that Regression 2 has a higher adjusted R2 than Regression
1 but no coefficients change qualitatively. Foreign listing and size are still
insignificant in Regression 2. Regressions 3 and 4 exclude size and foreign listing in
turn. When excluding one of these variables the other variable becomes significant. In
both cases the adjusted R2 is reduced compared to Regression 2. The cause of the two
variables being insignificant in Regression 2 is the high correlation between them
(confirmed by Table 2 Panel B) and not their lack of explanatory power. Excluding
one of these variables would result in a mis-specified model. As a consequence, all
variables in Regression 2 are used as control variables. The sign on all coefficients is
consistent with prediction and the model explains approximately 45% of the variation
in disclosure timing.
[insert Table 6]
Table 6 shows a negative and significant relationship between analyst
following (ANA) and DELAY. Assuming analyst following proxies investors’ interest
25
for information, then this result confirms that firm disclosures are timely when
external pressure is higher. Alternatively, this finding may also suggest that analysts
themselves prefer timely disclosure because they believe that the IFRS reconciliations
convey useful information. If so, it would corroborate with the findings regarding
market reactions in Table 3 that the reconciliations contain new information beyond
pure accounting translation. In Regression 5 we interact US cross-listing with analyst
following. The results show that the negative association between analyst following
and delay is only significant among firms that are not cross-listed in the US. This
observation is again consistent with the evidence on market reactions, although we
caution that the interpretation of analyst following is not unambiguous.
In terms of the effect of firms’ well-being on their IFRS reconciliation
disclosure delay, our analyses in Table 6 yields mixed evidence. While we find no
explanatory power from profitability and growth, we show that past reporting delays
are significantly correlated with delays of IFRS reconciliation announcements. The
reporting delay of 2003 preliminary earnings (UK03) and the change in delay in
preliminary earnings from 2003 to 2004 (UK0304) are both significantly positive
throughout all regressions. Firms with tradition of reporting late could indicate weaker
accounting control environment, which in turn could be associated to poorer
management.
In Table 7 we test Hypothesis 2, which posits that firms that delay disclosure
on average report worse news than other firms. The analyses of the determinants of
disclosure timing above reveal factors other than news content that we could use as
control variables. In order to establish that the difference in news content between
Early and Late disclosers is not driven by these identified determinants we categorize
firms that report prior to the prediction from the regression in column 2 of Table 7 as
abnormally early (AbEarly) and all other firms as abnormally late (AbLate). In other
words, AbEarly firms had a shorter delay than expected based on firm characteristics.
An AbEarly firm is expected on average to report news content that is better than
other firms if Hypothesis 2 is supported in its alternative form.
Table 7 Panel A compares the news content proxy and the scaled change in
income (∆π) between AbEarly and AbLate firms. On average the news content is
26
better among AbEarly than among AbLate firms. The position of an AbEarly firm in
the rank of news is on average 9 firms above an AbLate firm (0.0656/(1/137)).
Consistent with this net income on average increase 1.2% of asset more among
AbEarly firms than among AbLate. The difference in the news proxy is significant at
the 10% level, and the difference in the scaled change in net income is significant at
the 1% level (one-tailed test). If IFRS has no affect on the firm we would not expect
there to be any opportunistic disclosure timing. If such a relationship existed we
would be concerned that the results were driven by some omitted variable. Table 7
Panel B excludes firms where the impact of IFRS is marginal. We define marginal
IFRS impact as a change in income less than 0.1% of total assets. Approximately 10%
of the sample is excluded due to this criterion. After the exclusion of firms with
almost no IFRS impact the results become stronger. The position of an AbEarly firm
in the rank of news is now on average 12.6 firms above an AbLate firm
(0.092/(1/137)) and the difference in the change in net income increases by 19%. The
difference in news content is significant at the 5% level and the difference in the
change in net income is significant at the 1% level. The observation that the
relationship becomes stronger after excluding firms with virtually no IFRS impact on
earnings adds support to the interpretation that managers exercised opportunistic
discretion in disclosure timing.
As additional analyses we also evaluate the association between delay and a
proxy for materiality. It is possible that managers base their disclosure timing decision
on materiality rather than news content. Evidence in favour of this proposition would
work against Hypothesis 2 because it would imply that managers prioritise disclosing
material information in a timely fashion rather than opportunistically delaying bad
news. Like the news content proxy we estimate materiality as the error term from
Equation 2. However, rather than constructing the fraction rank based on the
directional change in income we apply the absolute change (ABS(∆π)). In both Panels
A and B of Table 7 the difference in materiality remains insignificant suggesting that
firms’ disclosure choices are not driven by how significant the information content is.
[insert Table 7]
27
The delay of worse news in the IFRS setting is consistent with the results from
prior studies on earnings announcements. To our knowledge we are the first to
provide evidence of this phenomenon in a setting where the information is nonproprietary and where investors should have realised this prior to disclosure. Besides
providing evidence supporting Dye (1985) and Jung and Kwon (1988) opportunism in
the IFRS setting, the results in Table 7 are consistent with managers viewing the
information content of the reconciliations as price sensitive. It is unlikely that
managers would attempt to manipulate the timing of disclosure to the financial
markets if they expect no impact on the market’s valuation of the firm.
5.4 Sensitivity analyses
There are three main concerns regarding the sensitivity of the conclusions
relating to Hypotheses 1. First, the news proxy might not be well specified. Second,
the proxy for earnings surprise might not capture the true earnings surprise. And
finally, the disclosure time is decided by the firm itself and bias from self selection is
therefore a potential risk. The proxy for news content is not a perfect measure of the
surprise element in the reconciliations and could potentially include a measurement
error. If the variable is indeed not well specified this could lead to random noise and
therefore increase the variance of the coefficients and reduce our chances of finding
evidence in support of our hypotheses. Thus, random noise would suggest that the
market reaction on disclosure is stronger than observed in the tests. In order to test
whether the results are specific to the inclusion of the industry adjusted fraction rank
the scaled change in net income (∆π) is alternatively applied. Table 8 reports the
results. The results are generally weaker than when using the industry adjusted
fraction rank (Table 3). However, the inference regarding Hypotheses 1 remains
unchanged, i.e. the market reactions to IFRS reconciliations are more pronounced in
earlier announcements and less among firms cross-listed in the US.
[insert Table 8]
In Table 3 the earnings surprise proxy is insignificant. Studies that assume a
random walk for earnings generally finds a significant relationship with returns (e.g.
Givoly et al. 1982). There are two potential reasons why this is not the case in this
28
sample. First, the assumption that earnings follow a random walk might not be
realistic. An alternative proxy used in empirical research is the difference between
analyst forecast and actual earnings. The advantage of using analysts’ forecasts to
estimate unexpected earnings is that such data may better capture the market’s
earnings expectations and therefore result in a lower measurement error. The
disadvantage in the UK setting is the greatly reduced sample size because forecasts
for interim earnings are only available for a relatively small number of firms (this
only limits the sample size of Late announcements). To test whether the inference
from the earlier analysis is affected by the assumption that earnings follow a random
walk, earnings surprise is estimated using analyst forecasts. This proxy for earnings
surprise remains insignificant and does not appear to perform better in this sample
than the random walk assumption. More importantly, the inference from the prior
analysis is not affected, suggesting that the results are not significantly affected by
this assumption. Second, the number of observations in our study is much smaller
than studies examining earnings announcements. Only 16 observations among the
Early announcements are disclosed with UK-GAAP earnings announcements for
fiscal year 2004. Our proxies for earnings expectations (seasonal random walk and
analyst forecasts) are crude and rely on a large number of observations to show
statistical significance. To test whether the crude assumption regarding earnings
expectations affect the results we exclude all disclosures made simultaneously with
earnings announcements. This is inconsistent with the basic idea in this study.
Disclosures made simultaneously with earnings constitute the 38% of observations
made either as early or late as possible (or with quarterly earnings), and are therefore
the most interesting cases when we know that market reactions are a function of
disclosure timing. Table 9 reports the results. The conclusion is essentially the same
as reported in the main analysis regarding Hypotheses 1, although the coefficient on
news is insignificant in the full sample and only significant at the 5% (10%) level
among Early disclosers using AR (MAR). The lower levels of significance when
excluding the earliest and latest announcements underlines the importance of
including these observations when evaluating the market reactions to IFRS
reconciliations.
[insert Table 9]
29
Self-selection is another potential issue because the decision to disclose early
is likely to be related to firm characteristics, and as hypothesized in Equation 3
characteristics vary systematically depending on disclosure timing. In order to
mitigate concerns of self selection driving the results a Heckman (1979) two stage
estimation approach is applied. Table 10 Panel A presents the results of the first stage
Probit model. The dependent variable is an indicator taking the value 1 if the firm is
an Early disclosers and 0 otherwise, and the independent variables are those identified
in Section 5.3. The second stage results for the regressions for Early and Late
disclosers separately are reported in Table 10 Panel B. All results are consistent with
those reported in the main part of the paper. Thus the control for self selection does
not change the conclusions regarding Hypotheses 1.
[insert Table 10]
The results reported for the first stage are those using the explanatory variables
from Regression 2 of Table 6 plus the proxies for news content and materiality
because this specification has the highest explanatory power measured by pseudo R2.
However, all combinations of variables from Table 6 are tested and none of them
change the results in the second stage. The quarterly reporting dummy (QUAR) is left
out because all firms subject to quarterly reporting according to IFRS report early. To
ensure that this limitation does not affect the results the tests are replicated when
excluding firms that report quarterly according to IFRS and the outcome of this does
not affect the conclusions.
6. Conclusion
We exploit the mandatory IFRS adoption setting of UK firms in 2005 to
evaluate the market reactions and disclosure timing behaviours associated with IFRS
reconciliations in the year before a change in regime from UK to international GAAP.
Our objectives are to determine whether the reconciliations contain new information
beyond the previously applied local GAAP and whether firms choose the timing of
this disclosure in an opportunistic way.
30
We show a significant relationship between market reactions and the news
content that is mainly concentrated among earlier announcers that are not cross-listed
in the US. This confirms that IFRS reconciliations issued by UK firms provide new
information to the market, which rejects the belief that the switch to IFRS is a pure
accounting translation with no impact on expected future cash flows. This is
especially interesting in the UK setting because it is a widely held belief that UKGAAP is close to IFRS. With regard to disclosure timing, we show that later
announcements are associated with relatively poor results. This observation suggests
that managers believe IFRS reconciliations include price sensitive information and
that poorer results are delayed to reduce the immediate negative impact on share
price. It triangulates with the results of the market reaction tests and supports the
inference that IFRS reconciliations contain new information relevant to firm
valuation.
Our findings, which are based on a mandatory disclosure setting, are different
from most studies on voluntary reconciliations between accounting regimes. For
instance studies on 20F reconciliations have generally found no information content
(Rees and Elgers 1997). Firms in our setting are required to disclose reconciliations
regardless of whether they view IFRS as beneficial or not. This implies that
mandatory adoption generates relative winners and losers, at least during the
transition stage. In other words, there will be firms that perceive the adoption as
unfavourable and they will seek to reduce the cost of adoption by exercising
discretion made available to them. In addition the reconciled Net Income figures
arguably constitute a benchmark for the first full set of IFRS income figures published
in the first full financial year of IFRS accounting.
31
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33
Appendix A: Examples of the most common reconciliation formats
This appendix includes two examples of IFRS income reconciliations. IFRS income reconciliations do not come in a set format
but most firms disclosure in a format similar to the two presented in this appendix. In Panel A the reconciliation replicates the UKGAAP income statement disclosed earlier and the IFRS income statement disclosed for the first time. The major reconciliation
items relate to goodwill amortization (+1.2m), share option charges (-0.4m) and deferred taxes (-1.2m including the tax effect of
goodwill amortization and share option charges). In Panel B the net income under UK-GAAP is reconciled to net income under
IFRS. The major reconciliation items are special purpose entities (aircraft financing), pensions, employee share options and
goodwill amortization. The reconciliation itemizes each adjustment and disclose it both including and excluding taxes.
Example 1: Acambis PLC
Reported
Total Restated
effect
Under
under
of
IFRS
UK GAAP transition
to IFRS
£m
85.5
(34.3)
_____
£m
(0.7)
_____
£m
85.5
(35.0)
_____
51.2
(0.7)
50.5
(28.9)
(2.7)
(7.7)
(0.5)
(0.1)
2.1
(29.4)
(2.8)
(5.6)
10.2
-
10.2
_____
_____
_____
22.1
0.8
22.9
0.2
4.8
(0.9)
_____
_____
0.2
4.8
(0.9)
_____
26.2
0.8
27.0
Taxation
(6.4)
_____
(1.2)
_____
(7.6)
_____
Profit on ordinary activities after taxation
19.8
_____
(0.4)
_____
19.4
_____
Revenue
Cost of sales
Gross profit/(loss)
Research and development costs
Sales and marketing costs
Administrative costs (including costs relating to
Canton plant impairment and restructuring costs)
Other operating income: Settlement of Canton
agreement
Operating profit
Non-operating income
Finance income
Finance costs
Profit on ordinary activities before taxation
Example 2: BAE Systems PLC
Ref
Loss - UK GAAP
Reformatted into IFRS format
Loss - UK GAAP in IFRS format
IFRS adjustments:
Regional aircraft financing
Pensions
Business combinations
Goodwill amortisation
Development costs
Share-based payments
Long-term contracts
Reduced depreciation from reversal of
revaluation reserve
Taxation
Profit - IFRS
Before
tax
£m
After
tax
£m
(232)
(95)
(466)
(327)
(466)
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.1
11
38
(13)
457
17
(18)
2
11
8
21
(8)
457
16
(9)
1
8
4.12
178
(25)
3
4.1
34
Figure 1: Discretionary timing of IFRS/UK-GAAP reconciliations
This figure illustrates the discretionary choice as to when to disclose the impact of IFRS on net income that UK firms were faced
with. The earliest time possible is with UK-GAAP earnings for 2004 and the latest time is with the interim report for 2005. 12% of
our sample reported with UK-GAAP earnings announcement for fiscal year 2004 (further 3% with the first quarter results of
2005), 23% with the interim report for 2005 and 65% in between these two extremes.
Dates:
FYE 2004
1st Jan
UK 2004 earnings
before 1st April
IFRS interim earnings
before 1st Oct
Sample:
12%
65%
23%
Table 1: Sample selection
Number of
observations
The largest 752 firms listed on LSE (official list August 2005)
752
Excluded due to IFRS not mandatory in all cases:
-AIM (have to comply from 2007)
-Overseas issuers
-28
-204
-232
Number of UK issuers listed on LSE main market
520
Excluded due to not meeting the sample criteria:
Financial issuers
-168
Not December year end
-190
Disclosure of IFRS reconciliations in 2004
-3
-361
Firms that meet the sample criteria
159
Excluded due to missing data:
Missing in DataStream
-1
Missing in IBES
-5
Listed between 1/1/04-31/12/04
Other
-6
-10
-22
Final sample
137
35
Table 2 Descriptive statistics and correlation analysis
This table provides summary statistics in Panel A and a correlation matrix in Panel B for the key variables. DELAY equals the
number of days between the 31 December 2004 and the IFRS earnings announcement. FS is the percentage of foreign sales as
reported by Worldscope. LOSS equals 1 if the firm had negative net income according to UK-GAAP in 2002, 2003 and 2004. SG
is the median yearly sales growth for 2002, 2003 and 2004. FLADR equals 1 if the firm is cross-listed on a non-UK stock
exchange or listed as ADR on the New York Stock Exchange. ANA is the natural logarithm of the median number of analysts that
provided IBES with an earnings forecasts for the firm monthly from January 2005 to August 2005. SIZE is the natural logarithm of
market capitalisation according to the LSE’s official list August 2005. UK03 equals the number of days between the 31 December
2003 and the earnings announcement for the fiscal year 2003. UK0304 equal the number of days between the 31 December 2004
and the earnings announcement for the fiscal year 2004 minus UK03. QUAR equals 1 if the firm released an earnings
announcement for the 1st quarter of 2005 according to IFRS. BIG4 equals 1 if the firm is audited by a Big 4 auditor. ∆π is net
income according to IFRS minus net income according to UK-GAAP for 2004 scaled by total assets according to UK-GAAP at 31
December 2004. ASB(∆π) is the absolute value of ∆π. In Panel B, *, **, and *** indicate 10%, 5%, and 1% level of significance
in two-tailed test respectively.
Panel A: Descriptive statistics
Variables
Obs
Mean
Median
Max
Min
Standard deviation
DELAY
137
169.7518
177.0000
288.0000
40.0000
66.3109
FS
137
45.7029
48.9100
100.0000
0.0000
33.4680
LOSS
137
0.0438
0.0000
1.0000
0.0000
0.2054
SG
137
0.0941
0.0575
1.1213
-0.1584
0.1721
FLADR
137
0.2920
0.0000
1.0000
0.0000
0.4563
ANA
137
2.1224
2.3026
3.1355
0.0000
0.6680
SIZE
137
6.9210
6.7046
11.8027
5.1279
1.3501
UK03
137
64.8978
64.0000
124.0000
27.0000
14.8865
UK0304
137
0.9416
-1.0000
48.0000
-23.0000
8.2549
QUAR
137
0.1095
0.0000
1.0000
0.0000
0.3134
BIG 4
137
0.9635
1.0000
1.0000
0.0000
0.1882
∆π
137
1.1958%
0.7895%
9.8156%
-9.0628%
2.3055%
ABS(∆π)
137
1.6370%
0.9655%
9.8156%
0.0000%
2.0140%
Panel B: Correlation matrix
DELAY
FS
LOSS
SG
FLADR
ANA
SIZE
UK03
UK0304
QUAR
BIG 4
FS
-0.09
LOSS
0.05
0.12
SG
0.09
-0.17**
FLADR
-0.42***
0.33***
0.10
0.06
ANA
-0.50***
0.06
-0.16*
-0.02
SIZE
-0.56***
0.22***
-0.11
-0.05
0.62***
0.71***
UK03
0.50***
-0.08
0.03
0.18**
-0.25***
-0.44***
0.09
0.04
0.10
-0.03
-0.01
-0.08
0.03
-0.17*
-0.46***
0.23***
0.04
0.02
0.34***
0.24***
0.45***
-0.34***
0.01
BIG 4
-0.15*
0.05
0.04
-0.01
0.13
0.09
0.19**
-0.24***
0.11
∆π
-0.20**
0.01
-0.02
-0.28***
0.08
0.05
0.07
-0.11
0.04
0.02
0.09
ABS(∆π)
-0.15*
-0.07
0.03
-0.08
0.09
0.01
-0.01
-0.11
-0.01
0.04
0.11
UK0304
QUAR
∆π
-0.10
0.42***
-0.50***
0.07
36
0.68***
Table 3: Market reactions to IFRS reconciliations
This table reports the results of the regressions:
ARi = λ 0 + λ1 News i + λ 2 ADR * News i + λ 3 Surprise i + λ 4 ADRi + ε i
AR i = β
0
(Panel A)
+ β News + β ADR * News + β News * Early + β News * Early * ADR
1
2
3
4
i
i
i
i
i
i
i
i
(Panel B)
+ β Surprise i + β Early + β ADR i + β ADR i * Early + ε i
5
6
7
8
i
i
AR (MAR) is the abnormal return (market adjusted return) on the day of disclosure. News is the industry adjusted fraction rank of
news content according to ∆π, where ∆π is net income according to IFRS minus net income according to UK-GAAP for 2004
scaled by total assets according to UK-GAAP at 31 December 2004. ADR is an indicator variable that takes the value 1 if the firm
is cross-listed on a US exchange. SURPRISE is a proxy for earnings surprise calculated as (EPSt – EPSt-1) / Pt. EARLY is an
indicator variable that takes the value 1 if the firm reported prior to the median DELAY. The column All includes all firms in the
sample. The column Early (Late) only include those firms that disclosed prior to (after) the median delay. Coefficients are
followed by t-values in parentheses ( ), using White (1980) heteroskedasticity robust standard errors. *, **, and *** indicate
10%, 5%, and 1% level of significance in two-tailed test respectively. One outlier is excluded because the associated standardized
residual exceeds 3.5.
Panel A: Market reaction to news partitioned by disclosure time
All
Early
Late
AR
MAR
AR
MAR
AR
MAR
News
λ1
+
0.0259**
0.0265**
0.0613***
0.0610***
0.0072
0.0084
(2.00)
(2.01)
(3.50)
(3.17)
(0.46)
(0.53)
ADR*News
λ2
–
-0.0254
-0.0241
-0.0703***
-0.0677***
-0.0047
-0.0034
(-1.39)
(-1.30)
(-3.05)
(-2.84)
(-0.18)
(-0.13)
0.0271
0.0262
0.0018
0.0168
0.1999
0.1665
(0.22)
(0.21)
(0.02)
(0.17)
(0.63)
(0.52)
0.0066
0.0106*
0.0102*
-0.0038
-0.0034
Predicted sign
Surprise
λ3
+
ADR
λ4
?
0.0068
(1.52)
(1.48)
(1.97)
(1.90)
(-0.58)
(-0.50)
Intercept
λ0
?
-0.0036
-0.0032
-0.0044
-0.0041
-0.0031
-0.0025
(-1.25)
(-1.11)
(-1.19)
(-1.07)
(-0.80)
(-0.66)
Observations
136
136
68
68
68
68
2
0.0306
0.0321
0.2429
0.2343
-0.0493
-0.0504
λ1 + λ2 = 0
0.00
0.04
0.37
0.24
0.02
0.06
F-stat
1.87
1.91
5.37***
4.97***
0.19
0.19
Adj. R
Panel B: Market reaction to news where slop is allowed the vary with disclosure timing
Predicted sign
+
News
β1
ADR*News
β2
News*Early
β3
News*Early*ADR
β4
–
Surprise
β5
Early
β6
ADR
β7
Early*ADR
β8
Intercept
β0
+
?
?
?
?
Observations
2
AR
MAR
0.0070
(0.44)
0.0083
(0.51)
–
-0.0011
+
0.0557**
(-0.04)
-0.0007
(-0.03)
(2.34)
0.0538**
-0.0718**
(2.14)
(-2.15)
-0.0692**
(-1.97)
0.0747
(0.58)
0.0719
(0.55)
-0.0021
(-0.38)
-0.0022
(-0.38)
(-0.45)
-0.0027
(-0.49)
-0.0026
0.0130*
(1.74)
0.0126
(1.66)
-0.0024
(-0.61)
-0.0021
(-0.51)
136
136
Adj. R
0.0617
0.0587
β1+β3 = 0
12.64***
10.30***
β1+β2 +β3+β4= 0
F-stat
0.51
0.32
2.78***
2.55**
37
Table 4: Determinants of market reactions
This table present descriptive statistics on whether the observed market reactions are driven by existing accounting based
contracts. The analysis is performed by running the following regression:
AR i = β
0
+ β News + β News * D + β ADR * News + β News * D * ADR
i
i
i
i
i
i
i
i
1
2
3
4
+ β Surprise i + β D i + β ADR i + β D i * ARR i + ε i
5
6
7
8
AR (MAR) is the abnormal return (market adjusted return) on the day of disclosure. News is the industry adjusted fraction rank of
news content according to ∆π, where ∆π is net income according to IFRS minus net income according to UK-GAAP for 2004
scaled by total assets according to UK-GAAP at 31 December 2004. ADR is an indicator variable that takes the value 1 if the firm
is cross-listed on a US exchange. SURPRISE is a proxy for earnings surprise calculated as (EPSt – EPSt-1) / Pt. D is an indicator
variable that takes the value 1 if the firm is defined as a high sensitivity firm. A firm is defined as a high sensitivity firm in Panel
A if debt to total assets is larger than the median of all firms’. In Panel B a firm is defined as a high sensitivity firm if the value of
executive options not yet vested is above the median of all firms’. In Panel C a firm is defined as a high sensitivity firm if the tax
expense to total assets is larger than the median of all firms’. In Panel D a firm in turn is defined as a high sensitivity firm if cash
dividend divided by total assets if larger than the median firms’, if the variability of cash dividends to net income is above the
median of all firms’, and if cash dividend to total assets and the variance of cash dividends to net income are below the median of
all firms’. *, **, and *** indicate 10%, 5%, and 1% level of significance in two-tailed test respectively.
Panel A: Debt to total assets (D=1 when above median leverage)
News
News*D
β1
ADR*News
β2
β3
ADR*News*D
β4
N
D=1
D=0
AR
0.07
(2.67)
-0.02
(-0.55)
-0.06
(-1.40)
-0.02
(-0.40)
38
30
MAR
0.07
(2.55)
-0.02
(-0.74)
-0.06
(-1.38)
-0.01
(-0.22)
38
30
Panel B: Performance based executive pay (D=1 when above median net vested options)
News
News*D
β1
ADR*News
β2
β3
ADR*News*D
β4
N
D=1
D=0
AR
0.05**
(2.02)
0.01
(0.39)
-0.07
(-2.34)
0.02
(0.38)
34
34
MAR
0.04*
(1.84)
0.02
(0.61)
-0.06
(-2.27)
0.01
(0.33)
34
34
Panel C: Tax expense (D=1 when above median tax expense)
News
News*D
β1
ADR*News
β2
β3
ADR*News*D
β4
N
D=1
D=0
AR
0.08
(3.11)
-0.04
(-1.15)
-0.10
(-2.92)
0.07
(1.57)
31
37
MAR
0.08
(2.81)
-0.04
(-1.13)
-0.09
(-2.72)
0.07
(1.52)
31
37
Panel D: Dividend policy
News
News*D
β1
ADR*News
β2
β3
ADR*News*D
β4
N
D=1
D=0
Size of dividend (D=1 when above median cash dividend payment)
AR
0.08***
(3.49)
-0.05
(-1.65)
-0.12***
(-4.18)
0.11***
(2.77)
38
30
MAR
0.09***
(3.29)
-0.06*
(-1.79)
-0.12***
(-4.06)
0.12***
(3.02)
38
30
Variability of dividend (D=1 when above median variance of cash dividend payment)
AR
0.07***
(2.40)
-0.02
(-0.66)
-0.10
(-2.78)
0.01
(0.25)
37
31
MAR
0.07**
(2.26)
-0.03
(-0.76)
-0.10
(-2.70)
0.02
(0.48)
37
31
Size and variance (D=1 when below median cash dividend and below median variance of cash dividend)
AR
0.04***
(2.73)
0.07**
(2.14)
-0.04
(-1.33)
-0.10**
(-2.34)
18
50
MAR
0.04**
(2.53)
0.07**
(2.24)
-0.03
(-1.05)
-0.11**
(-2.54)
18
50
38
Table 5: IFRS reconciliations ability to predict future net income
This table presents statistics on the ability of IFRS reconciliations for 2004 to explain net income for 2005. The analysis is
performed by running the following regression:
NI 05 IFRS i
NI 04UK i
1
= γ1
+γ 2 Δπ + γ 0
+ εi
TA04UK i
TA04UK i
TA04UK i
NI05IFRS is net income for 2005 according to IFRS. NI04UK is net income for 2004 according to UK-GAAP. TA04UK is total
assets according to UK-GAAP at 31st December 2004. ∆π is net income according to IFRS minus net income according to UKGAAP for 2004 scaled by total assets according to UK-GAAP at 31 December 2004. The column All includes all firms in the
sample. The column Negative (Positive) reconciliation only include those where ∆π<0 (∆π>0). Coefficients are followed by tvalues in parentheses ( ), using White (1980) heteroskedasticity robust standard errors. *, **, and *** indicate 10%, 5%, and 1%
level of significance in two-tailed test respectively. There are 5 firms less than the sample described in Table 1 because they have
no data available for 2005 in Datastream.
Predicted sign
NI04UK/TA04UK
∆
π
γ1
γ2
Intercept
γ0
+
+
?
All
Negative reconciliation
Positive reconciliation
1.0025***
1.0309***
0.8841***
(13.79)
(11.54)
(8.13)
0.4731**
-0.6558
0.6190***
(2.21)
(-1.65)
(2.78)
1611.21
154.20
3351.79
(1.75)
(0.21)
(3.21)***
Observations
132
39
93
2
0.7509
0.7813
0.7430
88.89***
119.20***
98.19***
Adj. R
F-stat
39
Table 6: Determinants of disclosure delay
This table reports the results of the regression:
DELAYi = α 0 + α 1 LOSS i + α 2 SG i + α 3 FLADR i + α 4 ANAi + α 5 SIZE i
+ α 6 FSi + α 7UK 03i + α 8UK 0304i + α 9 QUARi + α 10 BIG 4 i + ε i
DELAY equals the number of days between the 31 December 2004 and the IFRS reconciliation announcement. LOSS equals 1 if the
firm had negative net income according to UK-GAAP in 2002, 2003 and 2004. SG is the median yearly sales growth for 2002, 2003,
and 2004. FLADR equals 1 if the firm is cross-listed on a non-UK stock exchange including ADR listing on the New York Stock
Exchange. ANA is the natural logarithm of the median number of analysts that provided IBES with an earnings forecasts for the
firm monthly from January 2005 to August 2005. SIZE is the natural logarithm of market capitalisation according to LSE’ official
list August 2005. FS is the percentage of foreign sales as reported by Worldscope. UK03 equals the number of days between the 31
December 2003 and the earnings announcement for the fiscal year 2003. UK0304 equal the number of days between the 31
December 2004 and the earnings announcement for the fiscal year 2004 minus UK03. QUAR equals 1 if the firm released an
earnings announcement for the 1st quarter of 2005 according to IFRS. BIG4 equals 1 if the firm is audited by a Big 4 auditor.
Coefficients are followed by t-values in parentheses ( ), using White (1980) heteroskedasticity robust standard errors. *, **, and ***
indicate 10%, 5%, and 1% level of significance in two-tailed test respectively. † A test of the significance of the coefficient on ANA
+ ADR*ANA returns an f-stat of 0.13 (p-value 0.7159).
Predicted sign
LOSS
Α1
+
SG
α2
–
Regression 1
Regression 2
Regression 3
Regression 4
Regression 5
5.28
(0.43)
25.12
(0.92)
FLADR
α3
–
-21.35
-16.44
-23.08 **
(-1.64)
(-1.33)
(-2.08)
-6.05
(-0.10)
ADR
-39.89
(-0.54)
ANA
α4
ADR*ANA
–
†
-17.05 **
-17.35 **
-23.64 ***
-17.02 **
-18.11
(-2.19)
(-2.22)
(-3.44)
(-2.15)
(-2.35)
+
12.13
**
†
(0.76)
SIZE
FS
α5
α6
–
?
-6.13
-6.70
(-1.14)
(-1.36)
-10.32 **
-7.41
(-2.31)
(-1.47)
0.15
(1.09)
UK03
α7
+
1.08 ***
(3.15)
UK0304
α8
+
1.03 **
(2.28)
QUAR
BIG4
α9
α 10
–
–
1.18 ***
(3.59)
1.05 **
(2.35)
1.27 ***
(4.18)
1.01 **
(2.26)
1.14 ***
1.25 ***
(3.59)
(3.65)
1.06 **
1.01 **
(2.32)
(2.22)
-52.11 ***
-47.98 ***
-53.05 ***
-49.95 ***
-46.05 ***
(-4.41)
(-4.44)
(-4.56)
(-4.67)
(-4.08)
185.11 ***
148.95 ***
207.81 ***
186.51 ***
-13.44
(-1.01)
Intercept
α0
+
192.79 ***
(3.85)
(4.06)
(4.88)
(5.03)
(4.04)
R2
0.4678
0.4593
0.4536
0.4517
0.4609
Adj. R2
0.4255
0.4344
0.4328
0.4307
0.4272
137
137
137
137
137
n (sample size)
F-test
27.65 ***
39.72 ***
48.92 ***
43.90 ***
31.04 ***
40
Table 7: Differences in news content between firms disclosing before and after the predicted
announcement date
This table compare the news content of firms disclosing before and after the prediction from the model in column 2 of Table 4. A
firm that reports prior to (after) the model’s prediction is defined as abnormally early (late). In Panel A all firms in the sample are
included. In Panel B firms with an impact of IFRS on net income less than 0.1% of total assets are excluded. News is the industry
adjusted fraction rank of news content according to ∆π, where ∆π is net income according to IFRS minus net income according to
UK-GAAP for 2004 scaled by total assets according to UK-GAAP at 31 December 2004. Material is the industry adjusted rank of
news content according to the absolute value of ∆π. Panels C reports results on News only. *, **, and *** indicate 10%, 5%, and
1% level of significance in one-tailed test respectively.
Panel A: All firms
AbEarly
News
∆π
Mean
0.03
Median
Observations
AbLate
AbEarly – AbLate
Material
News
∆π
Material
News
∆π
Material
0.02
-0.01
-0.03
0.01
0.01
0.0656*
0.012***
-0.020
0.05
0.01
-0.01
-0.01
0.01
0.00
0.0551*
0.003***
-0.012
64
64
73
73
73
137
137
137
64
Panel B: Firm where IFRS had an impact on earnings
AbEarly
News
∆π
Mean
0.07
Median
Observations
AbLate
AbEarly – AbLate
Material
News
∆π
Material
News
∆π
Material
0.02
0.05
-0.02
0.01
0.03
0.092**
0.014***
0.013
0.07
0.01
0.05
0.00
0.01
0.00
0.071**
0.005***
0.051
56
56
69
69
69
125
125
125
56
41
Table 8: Market reactions to IFRS reconciliations using scaled change in income as news proxy (∆π )
This table reports the results of the regression:
ARi = λ 0 + λ1 Δπ i + λ 2 ADR * Δπ i + λ 3 Surprise i + λ 4 ADRi + ε i
AR (MAR) is the abnormal return (market adjusted return) on the day of disclosure. ∆π is net income according to IFRS minus net
income according to UK-GAAP for 2004 scaled by total assets according to UK-GAAP at 31 December 2004. ADR is an indicator
variable that takes the value 1 if the firm is cross-listed on a US exchange. SURPRISE is a proxy for earnings surprise calculated as
(EPSt – EPSt-1) / Pt. The column All includes all firms in the sample. Early (Late) only include those firms that disclosed prior to
(after) the median delay. Coefficients are followed by t-values in parentheses ( ), using White (1980) heteroskedasticity robust
standard errors. *, **, and *** indicate 10%, 5%, and 1% level of significance in two-tailed test respectively. One outlier is
excluded because the associated standardized residual exceeds 3.5.
All
Predicted sign
Early
Late
AR
MAR
AR
MAR
AR
MAR
0.0514
0.4887
0.4694
-0.1074
-0.1024
∆π
λ1
+
0.0542
(0.21)
(0.20)
(2.28)**
(2.17)**
(-0.36)
(-0.34)
ADR*∆π
λ2
–
-0.0121
0.0116
-0.5078
-0.4633
-0.1183
-0.1333
(-0.04)
(0.04)
(-2.05)**
(-1.90)*
(-0.28)
(-0.30)
-0.0056
-0.0106
0.0155
0.0198
0.1993
0.1689
(-0.04)
(-0.07)
(0.13)
(0.16)
(0.60)
(0.50)
0.0066
0.0185
0.0176
-0.0056
-0.0054
Surprise
λ3
+
ADR
λ4
?
0.0071
(1.22)
(1.14)
(2.95)***
(2.85)***
(-0.71)
(-0.66)
Intercept
λ0
?
-0.0042
-0.0038
-0.0125
-0.0120
-0.0020
-0.0015
(-0.89)
(-0.81)
(-2.71)
(-2.59)
(-0.37)
(-0.28)
Observations
136
136
68
68
68
68
2
Adj. R
-0.0146
-0.0145
0.0920
0.0823
-0.0454
-0.0486
F-stat
0.85
0.99
2.98**
3.01**
0.28
0.27
Table 9: Market reactions to IFRS reconciliations excluding earnings announcements
This table reports the results of the regression excluding firms disclosing simultaneously with earnings announcements:
ARi = λ 0 + λ1 News i + λ 2 ADR * News i + λ 3 ADRi + ε i
AR (MAR) is the abnormal return (market adjusted return) on the day of disclosure. News is the industry adjusted fraction rank of
news content according to ∆π, where ∆π is net income according to IFRS minus net income according to UK-GAAP for 2004 scaled
by total assets according to UK-GAAP at 31 December 2004. ADR is an indicator variable that takes the value 1 if the firm is crosslisted on a US exchange. The column All includes all firms in the sample. Early (Late) only include those firms that disclosed prior
to (after) the median delay. Coefficients are followed by t-values in parentheses ( ), using White (1980) heteroskedasticity robust
standard errors. *, **, and *** indicate 10%, 5%, and 1% level of significance in two-tailed test respectively.
All
Predicted sign
News
λ1
+
Early
Late
AR
MAR
AR
MAR
AR
MAR
0.0062
0.0062
0.0226**
0.0187*
-0.0025
-0.0010
(0.81)
(0.84)
(2.22)
(1.79)
(-0.25)
(-0.10)
-0.0185
-0.0395**
-0.0344**
-0.0133
-0.0135
ADR*News
λ2
–
-0.0186
(-1.70)
(-1.66)
(-2.51)
(-2.08)
(-1.09)
(-1.07)
ADR
λ3
?
0.0013
0.0016
0.0044
0.0048
-0.0053
-0.0041
(0.44)
(0.52)
(1.14)
(1.18)
(-1.31)
(-1.05)
Intercept
λ0
?
0.0002
0.0005
-0.0013
-0.0016
0.0022
0.0029
(0.09)
(0.21)
(-0.47)
(-0.56)
(0.66)
(-0.86)
Observations
84
84
48
48
36
36
2
Adj. R
-0.0191
-0.0186
0.0374
0.0163
-0.0759
-0.0811
λ1 + λ2 = 0
2.52
2.20
2.00
1.50
5.11**
3.64*
F-stat
1.14
1.02
2.71*
1.94
2.33*
2.14
42
Table 10: Market reactions controlling for self selection (two stage Heckman)
Panel A presents the results of the first stage Probit regression:
EARLYi = δ 0 + δ1 Newsi + δ 2 Materiali + δ 3 FLADRi + δ 4 ANAi + δ 5 LMCAPi + δ 6UK 03 i + δ 7UK 0304 i + ε i
The dependent variable EARLY is assigned the value of 1 if firm i disclosed IFRS net income before the median delay and the value
0 otherwise. News is the industry adjusted fraction rank of news content according to ∆π, where ∆π is net income according to IFRS
minus net income according to UK-GAAP for 2004 scaled by total assets according to UK-GAAP at 31 December 2004. Material is
the industry adjusted fraction rank of the absolute value of ∆π. FLADR equals 1 if the firm is cross-listed on a non-UK stock
exchange or listed as ADR on the New York Stock Exchange. ANA is the natural logarithm of the median number of analysts that
provided IBES with an earnings forecasts for the firm monthly from January 2005 to August 2005. LMCAP is the natural logarithm
of market capitalisation according to the LSE’s official list August 2005. UK03 equals the number of days between the 31
December 2003 and the earnings announcement for the fiscal year 2003. UK0304 equal the number of days between the 31
December 2004 and the earnings announcement for the fiscal year 2004 minus UK03.
Panel B presents the results of the second stage regression:
ARi = λ 0 + λ1 News i + λ 2 ADR * News i + λ 3 Surprise i + λ 4 ADRi + λ 5 MILLi + ε i
AR (MAR) is the abnormal return (market adjusted return) on the day of disclosure. News (∆π) is the industry adjusted fraction rank
of news content according to ∆π, where ∆π is net income according to IFRS minus net income according to UK-GAAP for 2004
scaled by total assets according to UK-GAAP at 31 December 2004. ADR is a variable that takes the value 1 if the firm is crosslisted on a US exchange. Surprise is a proxy for earnings surprise calculated as (EPSt – EPSt-1) / Pt. MILL is the inverse Mill ratio.
The column Early (Late) only includes those firms that disclosed prior to (after) the median delay. Coefficients are followed by tvalues in parentheses ( ). *, **, and *** indicate 10%, 5%, and 1% level of significance in two-tailed test respectively. One outlier
is excluded because the associated standardized residual exceeds 3.5.
Panel A: First stage probit model
Panel B: Second stage results
Early
Predicted sign
δ1
News
+
Predicted sign
2.15**
News
λ1
+
(2.25)
Material
δ2
?
FLADR
δ3
+
ANA
δ4
+
LMCAP
δ5
+
UK03
δ6
–
-0.04***
UK0304
δ7
–
-0.04**
Intercept
δ0
?
-2.40**
MAR
0.0595***
0.0597***
0.0071
0.0085
(4.21)
(4.20)
(0.50)
(0.60)
-0.0659***
-0.0045
-0.0034
–
-0.0676***
(-2.99)
(-2.89)
(-0.10)
(-0.08)
Surprise
λ3
+
-0.0004
0.0153
0.2037
0.1648
(-0.00)
(0.11)
(0.76)
(0.61)
ADR
λ4
?
0.0123*
0.0114*
-0.0040
-0.0033
(1.95)
(1.80)
(-0.32)
(-0.26)
Intercept
λ0
?
-0.0069
-0.0058
-0.0035
-0.0024
(-1.06)
(-0.88)
(-0.53)
(-0.36)
(1.14)
0.28
AR
λ2
(1.41)
0.35
MAR
ADR*News
(-2.46)
0.51
Late
AR
(1.48)
(-2.97)
(-2.09)
-0.54
(-0.38)
Observations
136
Observations
136
136
136
136
Correctly predicted
74%
Censored
68
68
68
68
2
Pseudo R
LR chi2
0.3203
Uncensored
68
68
68
68
60.38***
Mills lambda
0.0033
0.0023
0.0007
-0.0003
(0.45)
(0.31)
(0.07)
(-0.03)
Wald chi2
32.76***
31.59***
5.98
5.89
43