In an environment of governance system changes, the authors examine the underlying factors that increase the probability that a firm will voluntarily adopt the International Financial Reporting Standards (IFRS). Moreover, they attempt to examine what features of firms influence the scope of market reaction toward the adoption decision and to what extent.
How Is This Research Useful to Practitioners?
The authors examine the underlying factors behind the decision to voluntarily adopt International Financial Reporting Standards (IFRS) in Japan, the second-largest economy to adopt IFRS (the EU is the first). After the use of IFRS became allowed in Japan, 141 firms decided or planned to adopt it by the end of June 2016. Japan, being a code-law country, features a “stakeholder governance system,” with relative dominance of debt financing—namely, banks. After the collapse of the economic bubble in the 1990s, Japan began its conversion into this system, with self-regulation imposed by shareowners. Such systems typically have weaker legal investor protection and enforcement.
According to the authors, the probability of voluntary IFRS adoption in a transforming governance setting is higher for firms that have a large proportion of foreign shareholders, undertake quality audits, have low levels of leverage, feature a nominating committee, and are included in the new JPX-Nikkei Index 400. Stock prices tend to increase around the announced date of adoption.
The authors identify research opportunities to examine firm behavior and the characteristics that influence the decision whether to adopt the IFRS in an environment of governance system changes. A key difficulty for such research is the coexistence of two effects: the IFRS adoption itself and the impact of regulatory changes happening simultaneously. To overcome this obstacle, the authors use short time periods and both univariate and multivariate analyses.
The outcomes of the study should be of interest to regulators and international investors as well as accounting bodies.
How Did the Authors Conduct This Research?
The authors examine the relationship between corporate governance and the likelihood of IFRS adoption—taking into consideration that both external and internal governance have been changing in Japan during the period studied—by studying the correlation between the adoption and such selected factors as foreign shareholder ratio, audit quality, leverage, the presence of a nominating committee, and inclusion in the JPX-Nikkei Index 400. They then examine the market reaction to IFRS adoption by means of event study methodology.
In order to test their hypotheses, the authors use a probit model with panel data on firms listed on Japanese stock exchanges between 2010 and 2016. They use a dummy variable that has a value of 1 if a firm made an announcement of IFRS adoption by the end of June 2016 and 0 otherwise. As far as the event study methodology is concerned, the authors use the Fama–French three-factor model.
The data are from the Tokyo Stock Exchange (TSE) webpage, where the authors obtained the dates of press releases. According to the TSE, by the end of June 2016, 141 firms had adopted IFRS or planned to do so. Even though this number seems small, these firms represent 29% of market capitalization of the TSE. To estimate the probit model, the authors construct a panel of data on firms listed on the Japanese stock exchanges for 2010–2016. Financial statement data are from the Toyo Keizai Kaisha Shikiho CD-ROM. For the event study analyses, the authors collect data from Yahoo! Japan Finance and the Toyo Keizai Kabuka CD-ROM. The authors exclude all firms whose stock prices could not be obtained because the IFRS adoption took place prior to or shortly after their IPOs.
Abstractor's Viewpoint
The authors essentially investigate three questions:
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How is the corporate governance of firms associated with the likelihood of voluntary IFRS adoption?
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Does IFRS adoption leverage firm value?
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How are market reactions affected by the corporate governance structure?
The authors place their research within a specific regulatory environment undergoing considerable structural change. My assessment is that the authors present several interesting observations and methods whose application to other regulatory settings is yet to be tested and proven. They address the valid issue of the need to separate positive (or negative) effects of IFRS adoption from such other influences as regulatory changes. I would personally appreciate stronger focus on the rationale for the non-early-adoption decision, because of the cost of IFRS adoption or other reasons that prevent firms from making such a decision. Hence, I consider this research to be an interesting foundation for future literature.