The Effect of the Information Content of Earnings after Mandatory IFRS Adoption on Financial Analysts’ Earnings Forecast Accuracy
Asian Tax Journal Vol. 19 No. 3 (2018), pp. 119-163
Abstract
This study empirically examines whether the effect of mandatory IFRS adoption, suggesting a association between the financial impact on earnings of the changes to IFRS from GAAP and financial analysts’ earnings forecast accuracy. In other words, this paper predict that the predictability of earnings in the post－IFRS periods are more informative than those of earnings in the pre－IFRS periods are associated with lower forecast errors and dispersion in analyst forecasts. Because I expect that the accuracy of analyst forecasts is related to the accuracy of financial statement－based forecasts and, therefore, that the improvement in analysts’ forecast accuracy around mandatory IFRS adoption is associated with the improvement in the accuracy of earnings on financial reports with firm－level. This relation reflects a fundamental mechanism that could explain the general change in analysts’ earnings forecast around mandatory IFRS adoption. As the relationship, this study also examines whether the adoption effect likely varies with firm－level incentives for auditor effort, foreign investor ownership, and accruals quality. Furthermore, this study partition the sample into market type and test whether the relationship earlier is different for KOSPI versus KOSDAQ listed firms. On the other hand, prior research examine the effects of mandatory IFRS adoption on the accuracy of analysts’ earnings forecasts (e.g., Nam 2015；Houqe et al. 2014；Miralles and Sanabria 2014；Horton et al. 2013；Cotter et al. 2012；Byard et al. 2011；Tan et al. 2011 etc.) Unlike previous studies, this paper differs in that I focus on the informational power of earnings related to analysts’ earnings forecasts errors between the pre－IFRS and post－IFRS periods. For instance, financial analysts are among the major and most intensive users of firms’ financial reports, as they are required to predict a firm’s fundamental value. Furthermore, analysts use firms’ previous financial reports, particularly earnings information, to predict future earnings. Therefore, intuitively, the accuracy of analysts’ forecasts is directly correlated to the quality of financial reports and the information environment(Horton et al. 2013；Houqe et al. 2014). Therefore, I test that the effects of changes in the informational power of earnings on the accuracy of analysts’ earnings forecasts after the mandatory IFRS adoption. Thus, this paper extend prior studies about properties of analyst forecasts in both the national GAAP and IFRS setting in the period before and after mandatory IFRS adoption. To test the effect of mandatory IFRS adoption, test variable in model to estimate the incremental effect of the informational power of earnings in the post－IFRS period is an interaction of IFRS and earnings (i.e., earnings per share deflated by the price, hereafter EL), where IFRS is an indicator variable that equals one for the post－IFRS period (2011－2015) and zero for the pre－IFRS period (2006－2010). The dependent variable is analysts’ earnings forecast accuracy, in particular, this study capture the properties of analysts’ earnings forecast accuracy using absolute forecast errors, forecast errors (i.e., optimistic or pessimistic bias), and forecast dispersion, where smaller absolute forecast errors, smaller optimistic bias, and smaller forecast dispersion generally indicates a richer information environment. The sample covers KOSPI and KOSDAQ listed firms with available data in non－financial industries with fiscal year－end based on the dependent variable (test variable) from 2007 to 2016 (from 2006 to 2015). The final samples includes 7,116 firm－year observations with available data for analyst’ earnings forecast. The empirical findings of this study are following. First, after controlling for several factors that affect analyst’ forecast errors, I find that the coefficient on interaction term between IFRS and EL (IFRS*EL) is significantly negative, when the dependent variable is absolute forecast errors, forecast errors, and forecast dispersion, respectively. Consistent with hypothesis, which indicating that analysts’ forecast on earnings’ informational power becomes more accurate analyst’ earnings forecasts, less optimistically biased forecasts, and smaller forecast dispersion after mandatory IFRS adoption. Second, when I also divided the full samples into positive abnormal audit hours vs. negative abnormal audit hours subsamples, or high foreign investor ownership vs. low foreign investor ownership subsamples, and high accruals quality vs. low accruals quality subsamples according to the median level, I find that a negative and significant relation between an interaction of IFRS*EL and analysts’ absolute forecast errors and forecast dispersion, regardless of high or low auditor effort samples, or high or low foreign investor ownership samples, and high or low accruals quality subsamples. Thus, the results of this study are not sensitive to auditor additional effort, external corporate governance, accruals quality conditioned on firm－level reporting incentives, I find similar results earlier. Therefore, this results suggest that the impact mandatory IFRS adoption itself rather than firm－level with stronger reporting incentives (i.e., higher－quality audit, a larger proportion of foreign investor ownership, and the level of higher financial reporting) is associated with a change in the quality of analysts’ information environment. Finally, in the additional analysis when I classify sample into KOSPI versus KOSDAQ firms, this study find that a significantly negative relation between analyst’ earnings forecast error and IFRS*EL is more pronounced among KOPSI samples, thus leading to a greater improvement in analysts’ information environment for these firms. Overall, the evidence from this study shows a significant reduction in analysts’ earnings forecast errors and dispersion after mandatory IFRS adoption. Specifically, this study show that the improvement in analyst’s earnings forecast accuracy is associated with the improvement in the Informational power of earnings with financial reports around IFRS adoption and that the association between the improvement in analysts’ forecast accuracy and the effect of mandatory IFRS adoption is more pronounced KOPSI samples. Meanwhile, this study is the first to provide direct evidence on the effect of mandatory IFRS adoption, suggesting a association between reported earnings－based measure of the changes to IFRS from GAAP and financial analysts’ earnings forecast accuracy model. Therefore, the results of this study may be of interest to accounting standard setters, policy makers, regulators and practitioners in evaluating the costs and benefits of mandatory IFRS adoption and to financial statement users who wish to understand the effect of mandatory IFRS adoption. As well as, the findings of this study makes contributions to the existing literature on the impact of mandatory IFRS adoption on analysts’ forecasts accuracy.
Keywords
- Mandatory IFRS adoption
- Analysts’ earnings forecast accuracy
- Forecast bias
- Forecast dispersion
- Informational power of earnings
- Audit effort
- Foreign investor ownership
- Accruals quality
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