J. Account.

Public Policy 31 (2012) 641657

Contents lists available at SciVerse ScienceDirect

J. Account. Public Policy

journal homepage: www.elsevier.com/locate/jaccpubpol

Does accounting quality change following a switch from U.S.

GAAP to IFRS? Evidence from Germany q
Steve Lin , William Riccardi, Changjiang Wang
School of Accounting, College of Business, Florida International University, Miami, Florida

a b s t r a c t

This study examines whether accounting quality changed follow-

ing a switch from U.S. GAAP to IFRS. Using a sample of German high
tech rms that transitioned to IFRS from U.S. GAAP in 2005, we nd
that accounting numbers under IFRS generally exhibit more earn-
ings management, less timely loss recognition, and less value rele-
vance compared to those under U.S. GAAP. In addition, after
analyzing the accounting quality of rms that applied IFRS
throughout the entire sample period, we nd that, for the metrics
suggesting a decline in accounting quality for both groups of rms,
the change is signicantly more pronounced for rms switching to
IFRS from U.S. GAAP. Overall, our ndings indicate that the applica-
tion of U.S. GAAP generally resulted in higher accounting quality
than application of IFRS, and a transition from U.S. GAAP to IFRS
reduced accounting quality. Our ndings provide the rst evidence
on the potential consequences of a switch from U.S. GAAP to IFRS.
2012 Published by Elsevier Inc.

1. Introduction

Prior research provides some supporting evidence on the improvement in accounting quality fol-
lowing a switch from non-U.S. domestic standards to International Financial Reporting Standards
(IFRS). However, to our knowledge, no study has examined the extent to which accounting quality
changes after a switch from United States Generally Accepted Accounting Principles (U.S. GAAP) to

q
We are grateful for the valuable comments of the referee, Martin Loeb (the Editor), Lawrence Gordon (the Editor), Carol Ann
Frost, Martin Walker, Edward Lee, Inder Khurana and workshop and conference participants at Florida International University,
Manchester Business School, National Cheng Kung University, and AAA 2012 mid year international accounting research
conference.
Corresponding author. Address: School of Accounting, College of Business Administration, Florida International University,
11200 S.W. 8th Street, Miami, FL 33199, United States. Tel.: +1 305 348 3253; fax: +1 305 348 2914.
E-mail address: lins@u.edu (S. Lin).

0278-4254/$ - see front matter 2012 Published by Elsevier Inc.

http://dx.doi.org/10.1016/j.jaccpubpol.2012.10.006
642 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

IFRS. We believe that this is an important research question because there are many current debates
surrounding the costs and benets of switching from U.S. GAAP to IFRS. In this study, we examine
whether accounting quality changed following a switch from U.S. GAAP to IFRS for a sample of German
high tech rms that applied U.S. GAAP and switched to IFRS in 2005.1
Based on various metrics for earnings management and timely loss recognition used in prior re-
search (Basu, 1997; Lang et al., 2003, 2006; Barth et al., 2008), we nd that rms in our sample gen-
erally exhibit more earnings management and less timely loss recognition in the post-adoption period
when using IFRS relative to the pre-adoption period when using U.S. GAAP. In addition, using the re-
turn-earnings model as suggested by Easton and Harris (1991), we nd that accounting numbers un-
der U.S. GAAP appear to provide more value relevant information to investors compared to accounting
numbers reported under IFRS after controlling for rm-specic and time varying factors. Finally, we
perform additional analyses using a sample of similar rms that applied IFRS throughout the entire
sample period in order to compare the detected decline in accounting quality of rms that switched
accounting standards to those that did not. We nd that, for the three metrics suggesting a decline in
accounting quality for both groups of rms, the change is signicantly more pronounced for rms
switching to IFRS from U.S. GAAP. Overall, our ndings indicate that application of U.S. GAAP generally
resulted in higher accounting quality than IFRS, and a transition from U.S. GAAP to IFRS reduced
accounting quality. This study provides the rst evidence on the impact of a switch to IFRS from
U.S. GAAP on accounting quality, which should be of interest to the SEC, the FASB, U.S. rms, and aca-
demics in evaluating the potential benets and disadvantages of a switch from U.S. GAAP to IFRS.
However, the above ndings may not offer direct implications for the U.S. adoption of IFRS and should
be interpreted with caution because the sample rms examined in this study may not be representa-
tive of rms in the U.S.2
This study differs from prior studies in at least three aspects. First, there is a large body of research
regarding how various aspects of nancial reporting are affected by a switch from non-U.S. domestic
accounting standards to IFRS. However, there is no direct evidence as to whether rms using U.S.
GAAP would experience similar benets from adopting IFRS because U.S. GAAP are believed to be
superior to other domestic standards.
Second, some studies compare accounting quality of rms applying U.S. GAAP with those applying
IFRS after matching on certain characteristics (such as size and industry). However, the extent to
which these rms are comparable is unclear given that they operate in different countries and face
various socio-economic and legal environments. Examining the accounting quality effect of a switch
from U.S. GAAP to IFRS uses rms themselves as a control to avoid this issue.
Third, some studies use the reconciled accounting information of foreign rms cross-listed in the
U.S. to compare accounting quality based on U.S. GAAP and IFRS. In these papers, the same rms
provide two sets of nancial information that are used to assess differences in accounting quality.
However, the reconciled information offers limited amounts of data for empirical tests. Further, prior
research has found evidence suggesting that rms will attempt to manage the magnitude of re-
ported accounting differences, which can seriously affect any empirical results drawn from the
use of these reconciled amounts (Tarca, 2002; Landry and Callimaci, 2003; Bradshaw et al., 2004).
Moreover, these rms reconcile to U.S. GAAP from IFRS, whereas we examine an actual switch from
U.S. GAAP to IFRS.
The remainder of this study is organized as follows. The next section reviews prior literature re-
lated to our study. Section 3 discusses our research design. Section 4 describes our sample data. Sec-
tion 5 presents our empirical results. In Section 6, we perform additional tests that we nd relevant to
the setting of our study. In Section 7, we discuss the implications of our results on the potential adop-
tion of IFRS in the United States. We summarize in Section 8.

1
When rms in the European Union cross-listed outside of their country of origin, they were permitted to delay adoption of IFRS
until no later than 2007, including those rms cross-listing in U.S. capital markets. After we imposed the sample selection criteria,
no remaining rms are cross listed in the U.S.
2
This study does not examine the potential consequences of reduced earnings quality following a mandatory switch from U.S.
GAAP to IFRS. A recent study by nds that a switch from local GAAP to IFRS affects direct foreign investments in a switching
country. We believe this is an important issue which should be further investigated in a future study.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 643

2. Prior research

To our knowledge, no study has examined the extent to which accounting quality changes after a
switch from U.S. GAAP to IFRS. However, a number of studies examine change in accounting quality
following a switch to IFRS from non-U.S. domestic standards. The ndings of these studies are gener-
ally supportive of the notion that adoption of IFRS improves nancial reporting quality. Most notably,
based on a variety of metrics, Barth et al. (2008) nd that rms exhibit higher accounting quality after
voluntarily switching to IFRS.
There are also a number of papers that examine differences in accounting quality between U.S.
GAAP and IFRS in environments where rms are free to choose between multiple sets of standards.
For example, Bartov et al. (2005) nd no signicant difference in earnings quality, measured by the
price-earnings relationship, for a sample of German New Market rms that were allowed to choose
between IFRS and U.S. GAAP. Similarly, the ndings of Van der Meulen et al., 2007 suggest that there
is no difference in value relevance between application of IFRS and U.S. GAAP using a similar sample of
German rms, though they do nd that application of U.S. GAAP results in more predictable earnings
than application of IFRS. These two studies provide consistent evidence suggesting that investors do
not perceive accounting numbers reported under U.S. GAAP compared to those reported under IFRS
to provide materially different information. This is consistent with Leuz (2003), which nds that mar-
ket liquidity and information asymmetry are similar across IFRS and U.S. GAAP rms.
Finally, some studies focus on the accounting differences reported via the reconciliation disclosure
(Form 20-F) of foreign rms that cross-list on U.S. exchanges. Such studies can be classied into two
groups. First, a number of studies examine the information content of the accounting differences be-
tween IFRS and U.S. GAAP and provide mixed evidence. Harris and Muller (1999) nd that reported
differences in net income and shareholders equity are associated with both market value and stock
returns, but not price. Conversely, Henry et al. (2009) nd that these differences are only associated
with returns. Using an abnormal trading volume approach, Chen and Sami (2009) nd that in the
2-day window surrounding release of reconciliations, abnormal trading volume is positively associ-
ated with the absolute magnitude of differences. Overall, these ndings suggest that reported differ-
ences in net income and shareholders equity have at least some value to investors, implying that the
market may in fact perceive differences in nancial reporting under the two sets of standards.
Using the Form 20-F reconciliation disclosures, Gordon et al. (2010) investigate differences in
accounting quality between U.S. GAAP and IFRS. Based on nine earnings attributes,3 Gordon et al.
(2010) nd similar accounting quality between U.S. GAAP and IFRS except that U.S. GAAP appear to be
more value relevant than IFRS. However, reconciling rms may attempt to reduce the reported differ-
ences between U.S. GAAP and IFRS accounting information4 because large differences between U.S. GAAP
and non-U.S. GAAP income amounts may increase the uncertainty among market participants about the
underlying economic earnings of the rm (Bradshaw et al., 2004; Chen and Sami, 2008). Therefore, infer-
ences regarding the difference in accounting quality between U.S. GAAP and IFRS drawn from this setting
may not truly reect the relative difference in accounting quality between the two sets of standards.
Other studies focus on issues more relevant to the current debates surrounding the relative quality
between IFRS and U.S. GAAP. A recent study by Barth et al. (2011) examines the comparability and the
difference in value relevance between rms domiciled in 27 different countries that adopted IFRS be-
tween 1995 and 2006 to a matched sample of U.S. rms applying U.S. GAAP. The ndings suggest that
comparability has increased between U.S. rms and foreign rms following adoption of IFRS by foreign
issuers and more so for rms whose country of origin shares similar economic, social and legal char-
acteristics with the U.S. (i.e., common-law countries). Barth et al. (2011) also provide evidence that
application of U.S. GAAP results in higher value relevance of accounting information compared to for-
eign rms using IFRS. However, the results of this study do not offer implications regarding how a
switch from U.S. GAAP to IFRS could affect nancial reporting.

3
Specically, their study examines: (1) accrual quality; (2) earnings persistence; (3) earnings predictability; (4) cash
persistence; (5) cash predictability; (6) earnings smoothness; (7) relevance; (8) timeliness; and (9) conservatism.
4
For example, cross-listed foreign rms are more likely to apply accounting practices similar to those used under U.S. GAAP than
other rms from the same country that are not cross-listed (Tarca, 2002; Landry and Callimaci, 2003; Bradshaw et al., 2004).
644 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

To summarize, prior research provides mixed evidence on the relative quality between IFRS and
U.S. GAAP. This study contributes to the literature by investigating the impact on nancial reporting
quality after a switch to IFRS from U.S. GAAP.

3. Research design

3.1. Overview

We make no ex ante predictions regarding how accounting quality should change following the
switch from U.S. GAAP to IFRS. Although many studies attempt to examine the relative quality be-
tween the two, they are generally investigative in nature because there is no clear theory supporting
these predictions. Arguably, the differences in the nature of the standards themselves could be used
to motivate certain predictions with respect to some of our metrics. Still, it is unclear how manage-
rial incentives may play a role in changes in nancial reporting when rms switch standards. There-
fore, the nature of this study is purely investigative in order to better understand the potential
impacts of a switch from U.S. GAAP to IFRS, which has not been examined in prior empirical
research.
We classify all rm-year observations prior to mandatory adoption of IFRS by the European Union
(EU) in 2005 as the pre-adoption period and all rm-year observations after as the post-adoption per-
iod. Following prior research (Lang et al., 2003, 2006; Barth et al., 2008), we infer differences in a vari-
ety of summary statistics (e.g., variances, correlations, R2) relating to our earnings metrics between the
pre- and post-adoption periods as evidence of differences in accounting quality. We also directly
examine regression coefcients where applicable.

3.2. Accounting quality metrics

3.2.1. Earnings management

The rst three proxies for earnings management relate to earnings smoothing5 and the remaining
one refers to managing earnings to achieve positive income (to avoid losses). Beginning with earnings
smoothing, our rst metric is based on the variability of the change in net income6 scaled by total assets,
DNI. If managers take no discretionary action to smooth earnings, then they should be relatively volatile
and uctuate over time. Therefore, we interpret a smaller variance of DNI as suggestive of earnings
smoothing. As the change in net income is at least partially attributable to factors other than those of
the nancial reporting system, we follow prior research to analyze the change in net income on variables
to controls for such factors (Lang et al., 2003, 2006; Barth et al., 2008) using the following regression
model:

DNIit a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it

a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it eit 1

where SIZE = natural logarithm of year-end market value of equity; GROWTH = percent change in
sales; EISSUE = percent change in common stock; DEBT = year-end total liabilities divided by year-
end book value of equity; DISSUE = percent change in total liabilities; TURN = sales divided by year-
end total assets; AUD = an indicator variable equal to 1 for observations where the rms auditor is
PwC, Deloitte, E&Y, PMG, or Arthur Andersen, and zero otherwise; NUMEX = the number of exchanges
on which the rms stock is listed; CLOSE = the percent of closely-held shares of the rms stock;
CF = annual net cash ows from operating activities.

5
Previous studies show that earnings smoothing may benet capital markets by allowing earnings to be more accurately
forecast and predictable. However, the process of smoothing earnings results in accounting information that may not reect the
underlying economics of the rm, resulting in lower accounting quality.
6
Datastream offers several Net Income denitions for various income line items. We use Net Income before extraordinary and
other non-operating items in all of our analyses.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 645

We denote our rst metric as DNI, the variance of the residuals estimated from the above
regression.7
One concern with the preceding metric of earnings smoothing is that earnings variability may be
due to differences in cash ow activities that are not associated with discretionary accounting choices
(Lang et al., 2003). We attempt to control for these concerns by examining the variability of DNI rel-
ative to change in cash ows, DCF. As the change in cash ows can also be affected by factors other
than those of the nancial reporting system, we control for these factors and estimate the following
regression8:

DCF it a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it

a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it eit 2

From Eq. (2), we take the variance of the residuals as the measure of variability in cash ows, DCF.
Following prior research (Lang et al., 2003, 2006; Barth et al., 2008), the second earnings smoothing
metric is the ratio of variability of DNI to the variability of DCF.
Following prior research (Lang et al., 2003, 2006; Leuz et al., 2003; Barth et al., 2008), we construct
the third earnings smoothing metric as the Spearman correlation between operating cash ows (CF)
and total accruals (ACC), where ACC is measured as net income (NI) minus CF. Managers can use accru-
als to make up for shortcomings in the cash component of income in an attempt to smooth earnings,
increasing accruals as the cash components of income decrease. Thus, a more negative correlation be-
tween ACC and CF is suggestive of greater use of accruals for this purpose. To mitigate the differences
not attributable to the nancial reporting system, we measure the correlations of the residuals from
the following two equations, denoted as CF and ACC, rather than directly comparing correlations be-
tween CF and ACC. In the following regressions, CF and ACC are both regressed on control variables, as
with Eqs. (1) and (2), excluding CF:

CF it a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it

a7 AUDit a8 NUMEX it a9 CLOSEit eit 3

ACC it a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURNit

a7 AUDit a8 NUMEX it a9 CLOSEit eit 4
Prior research documents that a common target of earnings management is to achieve positive in-
come, thereby avoiding the reporting of losses (Burgstahler and Dichev, 1997). Our metric for earnings
management toward positive income is measured as the coefcient on the time period variable, POST,
from the following logistic regression9:

SPOSit a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURNit

a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it a11 POST it eit 5

SPOS is an indicator variable equal to one if net income scaled by total assets is between 0 and 0.01 for
a given observation and zero otherwise, and POST is an indicator variable equal to one for observations
in the post-adoption period and zero otherwise. We base our conclusions on the coefcient of POST
rather than directly comparing frequencies because the coefcient takes into account controls for fac-
tors not attributable to the nancial reporting system. A positive coefcient on POST indicates a higher

7
In each test in which we use the residuals from regression models, we report results based on regressions run by year. For
robustness, we run the same models using a pooled sample with the addition of year indicator variables. Results are similar.
8
To ease exposition, we use the same notation for regression coefcients and error terms where the same variables are used in
multiple regression equations.
9
Based on Burgstahler and Dichev (1997), only an abnormal frequency of small positive income is suggestive of earnings
management. An abnormal frequency occurs when there is a signicantly greater frequency of small positive earnings relative to
small negative earnings (i.e., there is discontinuity in the distribution of earnings around zero). Accordingly, Leuz et al. (2003) test
the frequency of small prots relative to the frequency of small losses. We are precluded from using the latter approach because
the actual frequency of both small positive and small negative earnings for our sample of rms makes it unrealistic to draw
statistical inferences.
646 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

likelihood of small positive earnings in the post-adoption period than in the pre-adoption period (the
opposite holding true for a negative coefcient).10

3.2.2. Timely loss recognition

We measure timely loss recognition metric in two ways. Ball (2001) suggests that rms in different
nancial reporting environments differ in terms of timely loss recognition. Further, other prior re-
search (Ball et al., 2000; Lang et al., 2003) suggests that rms exhibiting more timely loss recognition
should recognize large losses in the period in which they occur rather than deferring them to future
periods. Therefore, we should observe more frequent incidences of extreme negative earnings for
rms applying accounting standards that inherently require a higher degree of conservatism. Consis-
tent with prior research (Lang et al., 2003, 2006; Barth et al., 2008), we estimate the following logistic
regression:

LNEGit a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURNit

a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it a11 POST it eit 6

In Eq. (6), LNEG is an indicator variable equal to one for given observations where net income scaled by
total assets is less than 0.20 and zero otherwise. As with the tests for earnings management to avoid
losses, POST is an indicator variable equal to one in the post-adoption period and zero otherwise. We
base our interpretations on the coefcient of POST after controlling for potential effects other than
those of the nancial reporting system. A negative coefcient on POST indicates that rms are more
likely to recognize large losses in the pre-adoption period than in the post-adoption period.
Our second measure for timely loss recognition is based on Basu (1997), where earnings is re-
gressed on an indicator for bad news (negative returns) in a given period, the actual return, and
an interaction of these two variables. Following prior studies, we include control variables for rm-le-
vel differences that could lead to differences in conservatism among rms in our sample. Ball and Shi-
vakumar (2005), for example, note that larger rms may have more timely recognition of losses than
smaller rms due to increased litigation risk or differences in agency costs. Similarly, rms that have
more debt obligations may also have incentives to recognize losses in a timelier manner (Watts, 2003).
Prior research also nds that the market-to-book ratio can impact accounting conservatism (LaFond
and Roychowdhury, 2008; Khan and Watts, 2009). We include these control variables and interact
them with both the return and negative return indicator variables. Since we are interested in the
accounting quality for the same sample of rms in two periodsthat is, before and after the switch
from U.S. GAAP to IFRSwe further add an indicator variable, POST, and additional two- and three-
way interaction terms, presented in the following equation,

EPSit b0 b1 Rit b2 DRit b3 POST it b4 SIZEit b5 LEV it b6 MBit b7 R  DRit

b8 DR  POSTit b9 DR  SIZEit b10 DR  LEVit b11 DR  MBit b12 R  POSTit
b13 R  SIZEit b14 R  LEVit b15 R  MBit b16 R  DR  POSTit
b17 R  DR  SIZEit b18 R  DR  LEVit b19 R  DR  MBit ei 7

EPS = earnings per share, scaled by beginning of the year price; R = annual return; DR = an indicator
variable equal to 1 if R < 0, and zero otherwise. MB = the market-to-book ratio, measured as the ratio
of market value of equity over book value of equity; POST = an indicator variable equal to 1 for obser-
vations in the post-adoption period, and zero otherwise.
The interaction term R  DR captures the incremental timeliness when the return is negative with
the argument that conservative reporting leads to bad news being impounded in earnings in a timelier
manner relative to good news. Our metric based on the modied Basus conservatism model is the
coefcient on the interaction term R  DR  POST, which captures the magnitude and the direction of
the incremental timely loss recognition of bad news for observations in the post-adoption period

10
Evidence from Beaver et al. (2007) suggests that certain income statement items can complicate the examination and
comparison of the frequency of small positive and small negative income (i.e., effective tax rates and special items). We use Net
Income before extraordinary and other non-operating items, which excludes these items and focuses instead on components of
income over which management has more discretion.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 647

relative to those in the pre-adoption period. A positive coefcient suggests that there is more timely
loss recognition in the post-adoption period while a negative coefcient suggests that there is more
timely loss recognition in the pre-adoption period.

3.2.3. Value relevance

To examine changes in value relevance between the pre- and post-adoption periods, we focus on
stock returns rather than price because returns are only affected by information and events in the per-
iod over which they are calculated. We follow Easton and Harris (1991) and construct the following
earnings response coefcient model,

Rit c0 c1 EPSit c2 DEPSit YEAR eit 8

where R = stock return measured 9 months prior to 3 months after scal year-end; EPS = earnings per
share, scaled by beginning of the year stock price; DEPS = annual change in earnings per share, scaled
by beginning of the year stock price; YEAR = year indicator variables.
First, we estimate the regression coefcients on both current period earnings (c1) and annual
change in earnings (c2) in the pre- and post-adoption period. We compute the rst return-based value
relevance metric, the earnings response coefcient, ERC, by summing these two coefcients. We inter-
pret a higher ERC as evidence of higher value relevance. Second, we estimate the total explanatory
power from the regression of return on current period earnings and annual change in earnings. Thus,
we use the adjusted R2 from Eq. (8) in the pre- and post-adoption period as a second metric for value
relevance and test for statistical difference between the two periods. We interpret a higher R2 as evi-
dence of higher value relevance.
Except for the earnings metrics that are measured as regression coefcients, we apply a boot-
strapping procedure to compare the signicance in difference of our earnings metrics. The boot-
strapping procedure requires no assumptions about the distributions of our metrics (Bickel and
Freedman, 1981) and it allows us to test those metrics with unknown distributions, such as the ratio
of variability of change in net income to variability of change in cash ows. It also mitigates the con-
cern that our inferences are a result of sample bias. To illustrate the bootstrapping procedure, we
use the test of differences in variability of change in net income as an example. First, we randomly
select, with replacement from the original sample, the same number of rm-year observations as in
the original sample to obtain a random sample. Second, we run the regression of change in net in-
come on the control variables on this random sample to obtain the residuals that is, the change in
net income unexplained by the reporting environment, managerial incentives, and rm-specic
characteristics. We then calculate the variance of these residuals, which is the metric used in this
test. Third, we repeat this process 500 times to obtain a sample of the metric (i.e., a sample of vari-
ances of change in net income). We perform this procedure separately for the pre- and post-adop-
tion periods. We then apply a t-test for statistical signicance of the differences of the metric in the
pre- and post-adoption periods.

4. Sample and DATA

4.1. Sample rms

A number of rms in Germany applied U.S. GAAP and were required to switch to IFRS in 2005.
These rms voluntarily chose to apply U.S. GAAP in order to (1) add credibility to their nancial state-
ments, (2) report nancial information that is more comparable and of similar quality to their U.S.
counterparts, and (3) attract U.S. investors in a time when use of IFRS was not as widespread as it
is now.11 Further, even after the subsequent failure of the New Market on which many of these rms
had initially listed (2002), they continued to report their nancial statements using U.S. GAAP rather than
switching to German GAAP or IFRS. Despite the similarities between these German rms and their U.S.

11
The German government allowed German rms to prepare their nancial statements in accordance with U.S. GAAP, IFRS, or
German GAAP before 2005. These companies voluntarily adopted U.S. GAAP for reasons stated.
648 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

Table 1
Sample selection.

Firms identied rms from datastream 153

Less: Firms that voluntarily adopted IFRS (30)
Less: Firms that used German GAAP prior to adoption of IFRS (16)
Less: Firms for which we cannot verify missing standards data (11)
Less: Firms that postponed adoption of IFRS (18)
Less: Firms that changed accounting standards multiple times (12)
Less: Firms that are not in high-tech industries (3)
Main sample of rms 63
Less: Firms with missing stockprice and return data (5)
Firms used for Basu conservatism and value relevance tests 58

counterparts, our results may not offer direct evidence on the accounting quality consequences of a
switch from U.S. GAAP to IFRS for rms in the U.S.

4.2. Data

We use Worldscope to identify the accounting standards used by rms during our sample period.
We identify 153 publicly listed German rms that applied U.S. GAAP some time during the pre-adop-
tion period (20002005) and have accounting and market data available from 2000 to 2010. We nd
that only three of these rms are not in the high tech industry. We therefore narrow our focus to the
high tech industry and exclude these three companies from our sample. We also eliminate rms that:
voluntarily adopted IFRS before 2005 (30); used German GAAP in the years immediately preceding
adoption of IFRS (16); have unveriable standards data (11); postponed adoption of IFRS (18)12; or
changed accounting standards multiple times before 2005 (12). Taken together, these criteria impose
the restriction that our sample rms consistently applied the same accounting standards for 5 years in
the pre-adoption period (i.e., U.S. GAAP in 20002004) and in the post-adoption period (i.e., IFRS in
20062010). In addition, this aligns the pre- and post-adoption periods to be consistent between rms
in our sample. Our main sample size therefore comprises 582 rm-year observations representing 63
rms.
For Basus test of conservatism and the value relevance of earnings, we require additional data (e.g.,
monthly stock price and return data). After excluding observations with missing stock price and re-
turns, we are left with 533 rm-year observations representing 58 rms for these tests. Table 1 sum-
marizes the sample selection process.
Table 2 presents descriptive statistics for variables used in our analyses. To mitigate the effects of
outliers, we winsorize all continuous variables used in our analyses at the top and bottom 1% level. On
average, rms in our sample exhibit a greater (less negative) change in earnings (change in cash ows)
in the post-adoption period compared to the pre-adoption period. There is also a higher amount of
both cash ows and absolute accruals in the post-adoption period compared to the pre-adoption per-
iod. In the pre-adoption period, rms tend to have more debt relative to equity, higher growth rates,
and greater issuance of both debt and equity. Stock prices, returns, and earnings are, on average,
higher in the post-adoption period.

5. Empirical results

5.1. Earnings management

Panel A of Table 3 shows the results for our earnings management metrics. The rst nding relating
to earnings smoothing shows that our sample rms exhibits a signicantly higher variability of change

12
That is, among German rms that applied U.S. GAAP prior to 2005, these 18 rms delayed adoption of IFRS until no later than
2007.
Table 2
Descriptive statistics relating to variables used in analyses.

Full sample Pre Post p-Value

N Mean Median Std. dev. N Mean Median Std. dev. N Mean Median Std. dev. t-Test Z-test
Earning management and frequency of large negative income test variables
DNI 582 0.007 0.002 0.277 295 0.015 0.002 0.323 287 0.002 0.005 0.221 0.4649 0.0753
DCF 582 0.006 0.003 0.152 295 0.006 0.008 0.163 287 0.005 0.002 0.140 0.9028 0.2556
ACC 582 0.069 0.049 0.163 295 0.091 0.058 0.185 287 0.047 0.039 0.134 0.0010 0.0059
CF 582 0.024 0.055 0.155 295 0.008 0.037 0.159 287 0.041 0.072 0.149 0.0090 0.0002
SPOS 582 0.052 0.000 0.221 295 0.075 0.000 0.263 287 0.028 0.000 0.165 0.0108 0.0056
LNEG 582 0.144 0.000 0.352 295 0.173 0.000 0.379 287 0.115 0.000 0.320 0.0470 0.0238

S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

Earning management and frequency of large negative income control variables
DEBT 582 1.495 0.700 3.501 295 1.604 0.741 3.757 287 1.383 0.662 3.219 0.4473 0.4403
GROWTH 582 0.322 0.040 1.754 295 0.583 0.018 2.400 287 0.054 0.066 0.433 0.0003 0.4474
EISSUE 582 0.586 0.026 3.497 295 0.991 0.022 4.664 287 0.169 0.070 1.464 0.0045 0.0031
DISSUE 582 0.476 0.004 2.748 295 0.764 0.012 3.726 287 0.181 0.024 0.946 0.0105 0.0310
TURN 582 1.112 0.999 0.663 295 1.092 0.948 0.696 287 1.132 1.041 0.627 0.4617 0.0346
SIZE 582 516.6 670.9 1573.9 295 457.2 78.9 1207.5 287 577.7 56.0 1877.9 0.3563 0.0232
AUD 582 1.856 2.000 1.021 295 1.895 2.000 1.023 287 1.815 2.000 1.019 0.3477 0.1252
NUMEX 582 0.687 1.000 0.464 295 0.671 1.000 0.471 287 0.704 1.000 0.457 0.3966 0.1983
CLOSE 582 30.843 26.440 28.136 295 32.386 30.490 28.282 287 29.257 21.440 27.946 0.1801 0.1238
RD 582 0.055 0.021 0.077 295 0.051 0.0230. 0.074 287 0.058 0.023 0.080 0.2891 0.2838
Basu test of conservatism and value relevance test variables
P 533 10.103 5.763 12.799 260 9.965 6.493 10.915 273 10.235 5.039 14.385 0.8082 0.0241
R 533 0.141 0.065 0.738 260 0.204 0.144 0.873 273 0.08 0.045 0.576 0.0521 0.0569
EPS 533 0.043 0.024 0.255 260 0.082 0.003 0.255 273 0.007 0.058 0.251 0.0006 0.0000
DEPS 533 0.097 0.012 0.413 260 0.123 0.008 0.472 273 0.073 0.017 0.347 0.1638 0.2286
NI 533 0.082 0.026 0.314 260 0.138 0.003 0.345 273 0.028 0.054 0.271 0.0001 0.0000
SIZE 533 11.362 11.066 1.656 260 11.448 11.192 1.619 273 11.281 10.938 1.689 0.2470 0.1211
LEV 533 0.461 0.415 0.272 260 0.473 0.434 0.290 273 0.449 0.395 0.254 0.3082 0.2158
MB 533 2.522 1.406 3.941 260 2.837 1.486 4.292 273 2.222 1.377 3.557 0.0716 0.1220

DNI is the change in annual earnings, where earnings is scaled by total assets. DCF is the change in annual net cash ow from operations, where cash ow is scaled by total assets. ACC is
dened as earnings (NI) less annual operating cash ows (CF), scaled by total assets. CF is annual operating cash ows, scaled by total assets. SPOS is an indicator variable that equals 1 for
observations with annual earnings scaled by total assets between 0.00 and 0.01, and zero otherwise. LNEG is an indicator variable for observations with annual earnings scaled by total
assets less than 0.20, and zero otherwise. DEBT is total liabilities divided by book value of equity. GROWTH is annual percentage change in sales. EISSUE is annual percentage change in
common stock. DISSUE is annual percentage change in total liabilities. TURN is sales divided by total assets. SIZE is the natural logarithm of market value of equity. AUD is an indicator equal
to 1 for observations where the rms auditor is PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, or Arthur Andersen and zero otherwise. NUMEX is the number of
exchanges the rms security is traded on. CLOSE is the percentage of closely held shares as reported in WorldScope. RD is the research and development expense scaled by total assets. P is
the stock price 6 months after scal year-end. R is annual stock return from 9 months prior to 3 months after the rms scal year-end. EPS is earnings per share, scaled by beginning of the
year stock price. DEPS is the annual change in earnings per share, scaled by beginning of the year stock price. SIZE is the natural logarithm of market value of equity. LEV is total liabilities
divided by total assets. MB is the market-to-book ratio, measured as the ratio of market value of equity over book value of equity.

649
Table 3

650
Earnings management metrics.

Pre Post p-Value

Panel A: Earnings smoothing metrics
Variability of DNI 0.2698 0.1493 <.0001
Variability of DNI over DCF 2.2819 1.5243 <.0001
Correlation of ACC and CF 0.2512 0.3009 <.0001
N 295 287
DNIit a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURNit a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it eit 1
DCF it a0 a2 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it a7 AUDit a8 NUMEX it a9 CLOSEit a10 CF it eit 2
CF it a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it a7 AUDit a8 NUMEX it a9 CLOSEit eit 3
ACC it a0 a1 SIZEit a2 GROWTHit a3 EISSUEit a4 DEBT it a5 DISSUEit a6 TURN it a7 AUDit a8 NUMEX it a9 CLOSEit eit 4

S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

Variable Dependent variable = SPOS
Estimate p-Value
Panel B: Toward positive income
Intercept 1.732 0.2968
SIZE 0.034 0.8277
GROWTH 0.039 0.7833
EISSUE 0.061 0.0759
DEBT 0.048 0.546
DISSUE 0.180 0.3552
TURN 0.072 0.8103
AUD 0.341 0.4451
NUMEX 0.010 0.965
CLOSE 0.004 0.5356
CF 1.917 0.1989
POST 1.098 0.0121
Likelihood ratio 14.5245
Percent concordant 67.70
N 582

Panel A: DNI DCF, CF, and ACC are the residuals from the annual regressions of the above models respectively. DNI is the change in annual earnings, where earnings is scaled by total
assets. DCF is the change in annual net cash ow from operations, where cash ow is scaled by total assets. ACC is dened as earnings (NT) less annual operating cash ows (CF), scaled by
total assets. CF is annual operating cash ows, scaled by total assets. DEBT is total liabilities divided by book value of equity. GROWTH is annual percentage change in sales. EISSUE is annual
percentage change in common stock. DISSUE is annual percentage change in total liabilities. TURN is sales divided by total assets. SIZE is the natural logarithm of market value of equity.
AUD is an indicator equal to 1 for observations where the rms auditor is PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, or Arthur Andersen and zero otherwise.
NUMEX is the number of Exchanges the rms security is traded on. CLOSE is the percentage of closely held shares as reported in WorldScope.
Panel B: SPOS is an indicator variable that equals 1 for observations with annual earnings scaled by total assets between 0.00 and 0.01, and zero otherwise. POST is an indicator variable
equal to one for observations in the post-adoption period, and zero otherwise. DEBT is total liabilities divided by book value of equity. GROWTH is annual percentage change in sales. EISSUE
is annual percentage change in common stock. DISSUE is annual percentage change in total liabilities. TURN is sales divided by total assets. SIZE is the natural logarithm of market value of
equity. AUD is an indicator equal to 1 for observations where the rms auditor is PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, or Arthur Andersen, and zero
otherwise. NUMEX is the number of Exchanges the rms security is traded on. CLOSE is the percentage of closely held shares as reported in WorldScope.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 651

Table 4
Timely loss recognition.

Variable Estimate p-Value

Panel A: Frequency of large negative earnings
Dependent variable = LNEG
Intercept 4.137 0.006
SIZE 0.570 <.0001
GROWTH 0.248 0.3316
EISSUE 0.056 0.3168
DEBT 0.022 0.5328
DISSUE 0.008 0.9591
TURN 0.189 0.4188
AUD 0.662 0.0762
NUMEX 0.072 0.7381
CLOSE 0.007 0.2123
CF 9.604 <.0001
POST 0.734 0.0236
Likelihood ratio 183.0493
Percent concordant 89.30%
N 582
Panel B: Timely loss recognition test based on Basus model
Dependent variable = EPS
Intercept 0.255 0.1199
DR 0.369 0.1315
POST 0.026 0.5943
MB 0.003 0.71
LEV 0.220 0.039
SIZE 0.034 0.0186
POST  DR 0.114 0.0858
MB  DR 0.004 0.647
LEV  DR 0.254 0.0654
SIZE  DR 0.012 0.5607
R 0.078 0.7951
POST  R 0.181 0.0261
MB  R 0.029 0.2478
LEV  R 0.147 0.3655
SIZE  R 0.026 0.3326
R  DR 0.026 0.9433
POST  R  DR 0.177 0.0814
MB  R  DR 0.028 0.2654
LEV  R  DR 0.038 0.8433
SIZE  R  DR 0.022 0.4995
Adj. R-square 0.207
N 533

Panel A: LNEG is an indicator variable for observations with annual earnings scaled by
total assets less than 0.20, and zero otherwise. POST is an indicator variable equal to one
for observations in the post-adoption period, and zero otherwise. DEBT is total liabilities
divided by book value of equity. GROWTH is annual percentage change in sales. EISSUE is
annual percentage change in common stock. DISSUE is annual percentage change in total
liabilities. TURN is sales divided by total assets. SIZE is the natural logarithm of market
value of equity. AUD is an indicator equal to 1 for observations where the rms auditor is
PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, or Arthur Andersen,
and zero otherwise. NUMEX is the number of Exchanges the rms security is traded on.
CLOSE is the percentage of closely held shares as reported in WorldScope.
Panel B: EPS is earnings per share, scaled by beginning of the year stock price. R is annual
stock return from 9 months prior to 3 months after the rms scal year-end. DR equals 1
if R is negative, and 0 otherwise. MB is the market-to-book ratio, measured as the ratio of
market value of equity over book value of equity LEV is total liabilities divided by total
assets. SIZE is the natural logarithm of market value of equity. POST is an indicator variable
equal to one for observations in the post-adoption period, and zero otherwise.
652 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

in net income, DNI, in the pre-adoption period, 0.2689, than in the post-adoption period, 0.1493
(p < .0001). The ratio of the variance of DNI to the variance of DCF in the pre-adoption period,
2.2819, is also signicantly higher than that in the post-adoption period, 1.5243 (p < .0001). This result
suggests that net income variability is not simply a result of cash ow variability. As we infer more
earnings variability to be indicative of less earnings smoothing, these results suggest that there is
higher accounting quality under U.S. GAAP in the pre-adoption period. Our third nding is also con-
sistent, suggesting less earnings smoothing in the pre-adoption period. Specically, the correlation be-
tween accruals, ACC, and cash ows, CF, is 0.2512 in the pre-adoption period and it is signicantly
less negative than the correlation in the post-adoption period of 0.3009 (p < .0001). To assess the
economic signicance of our ndings, we examine the percentage change of our metrics between
the pre- and post-adoption period. We nd that the variability of change in net income and ratio of
the variance of change in net income to the variance of change in cash ow decrease by 44.7% and
33.2%, respectively.13 Similarly, the correlation between accruals and cash ows increases by 19.8%.
Panel B of Table 3 shows the results of the likelihood of small positive earnings regression. Inter-
estingly, the coefcient on POST, 1.0983, is negative and statistically signicant (p = 0.0121), suggest-
ing that rms in our sample manage toward positive earnings more often in the pre-adoption period
than in the post-adoption period. Limitations in our sample preclude us from statistically testing small
positive earnings relative to small negative earnings. However, without drawing statistical inferences,
the actual frequency of small positive earnings relative to small negative earnings is higher in the
post-adoption period for our sample.
Overall, our results indicate that there is generally less earnings management in the pre-adoption
period than in the post-adoption period.

5.2. Timely loss recognition

Panel A of Table 4 presents the results of our rst measure of timely loss recognition metric based
on the frequency of large negative income. The negative and signicant coefcient on POST, 0.734
(p = 0.0236) is suggestive of more timely loss recognition in the pre-adoption period. We also nd that
the likelihood of reporting large negative earnings in the post-adoption period is 52%14 lower than that
in the pre-adoption period. The results from our second measure of timely loss recognition based on Ba-
sus model are reported in Panel B of Table 4. The coefcient on the interaction term POST  R  DR,
0.177, is negative and marginally signicant (p = 0.0814), which suggests a higher degree of conserva-
tism and higher accounting quality in the pre-adoption period. Consistent with the debt contracting de-
mand for accounting conservatism (Watts, 2003), the coefcient on LEV  R  DR is positive and
signicant, and the coefcient on MB  R  DR is negative, which is consistent with the arguments of
Roychowdhury and Watts (2007).

5.3. Value relevance

Table 5 presents the results of the return value relevance regression. The ERC (the sum of the
regression coefcients c1 and c2) in the pre-adoption period, 1.0424, is signicantly greater than
the ERC in the post-adoption period, 0.4898 (p < .0001). We also compare the explanatory power of
the return regression and nd that the adjusted R2 in the pre-adoption period, 58.35%, is signicantly
higher than the adjusted R2 in the post-adoption period, 53.47% (p < .0001). Based on these results,
earnings appear to have higher value relevance to investors in the pre-adoption period than in the
post-adoption period. We also nd that ERC and the adjusted R2 decrease by 53% and 8.4%, respectively
after adopting IFRS.

13
These percentages are calculated as the change in each earnings management metric divided by the metric in the pre-adoption
period. For example, the percentage of change in variability of change in net income is 44.7% (i.e. [0.2698  0.1493]/0.2698).
14
Holding other independent variables at a xed value, the odds of reporting large negative earnings in the post-adoption period
(POST = 1) over the odds of reporting large negative earnings in the pre-adoption period (POST = 0) is exp(0.734) = 0.48. In terms
of percent change, we can say that the odds for the post-adoption period are 52% (1  0.48) lower than the odds for pre-adoption
period.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 653

Table 5
Value relevance using the return model.

Pre Post
Dependent variable = R
Estimate Estimate p-Value
Intercept 0.02 0.1775 <.0001
EPS 0.6932 0.3763 <.0001
DEPS 0.3492 0.1134 <.0001
ERC 1.0424 0.4898 <.0001
Year indicator Included Included
N 260 273
Return model adjusted R 0.5835 0.5347 <.0001

R is annual stock return from 9 months prior to 3 months after the rms scal year-end. EPS is earnings per share, scaled by
beginning of the year stock price. DEPS is the annual change in earnings per share, scaled by beginning of the year stock price.
ERC is the sum of the two coefcients on EPS and DEPS.

Overall, our results are suggestive of higher accounting quality for our sample rms in the pre-
adoption period while applying U.S. GAAP than in the post-adoption period after adoption of IFRS.
All earnings smoothing metrics suggest higher quality for our sample in the pre-adoption period.
We also nd evidence of increased timely loss recognition in the pre-adoption period. With respect
to value relevance, our results suggest that the value relevance of current period earnings and annual
change in earnings decrease following the switch from U.S. GAAP to IFRS. Since the above ndings are
based on 5 years after the initial adoption of IFRS in 2005, we mitigate the concern that our results are
due to a temporary effect following the transition to the more principles-based accounting allowed
under IFRS.

5.4. Sensitivity tests

We consider two potential factors that may have a confounding effect on the inferences drawn
from our previous results. First, there are inherent differences between U.S. GAAP and IFRS that could
lead to the detected differences in earnings quality after rms switched to IFRS. We identify Research
and Development expense (R&D) as a key difference because our sample rms are high tech rms that
may heavily invest in R&D. Under U.S. GAAP, all R&D is expensed in the period in which it is incurred,
whereas part of R&D (i.e., development costs) may be capitalized under IFRS. This could lead to less
volatile earnings when rms apply IFRS even if managers do not use discretionary actions to smooth
earnings. Therefore, we include R&D scaled by year-end total assets as an additional control variable
and repeat all tests reported in Table 3.15 Untabulated results yield inferences consistent with our main
ndings.
Second, our sample period overlaps with the recent global nancial crisis, which could have a sig-
nicant impact on our results. We eliminate all rm-year observations in 2009 and 2010 from the
post-adoption period in our sample16 and repeat all the tests used in our main analyses. Although most
of our results (untabulated) remain intact, we note two major differences. First, after we eliminate these
years, our timely loss recognition metric based on Basus model is no longer signicant (p = 0.2535),
implying that rms may have adopted more aggressive (i.e., less conservative) accounting practices in
periods of economic distress. Second, we nd the correlation of ACC and CF in the post-adoption period
(0.1848) is signicantly less negative (p < .0001) than that of the pre-adoption period (0.2512). This
nding may imply that rms attempt to smooth earnings more during periods of nancial crisis or that
accruals and cash ows are less perfectly matched during economic downturns due to rms altered
operations and consumer behavior.

15
An ideal method to address this issue would be to restate the income amount used in our analyses to exclude R&D. However,
this would likely result in signicant measurement error since we would need to estimate only the portion of R&D reported under
U.S. GAAP that would be capitalized under IFRS.
16
We deleted all the observations in 2009 and 2010 because the nancial crisis should affect non-U.S. rms after 2008.
654 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

Table 6
Earnings quality metrics for IFRS rms.

Pre Post p-Value

Panel A: Earnings management metrics
Variability of DNI 0.1949 0.1673 <0001
Variability of DNI over DCF 2.1666 2.5227 <0001
Correlation of ACC and CF 0.3005 0.2809 <0001
Small positive income (SPOS) 0.5899 0.2369
N 322 370
Panel B: Timely loss recognition and conservatism
Large negative income (LNEG) 0.1086 0.904
Basus conservatism model 0.142 0.3992
Panel C: Value relevance
Return model adjusted R2 0.5411 0.4406 <0001
Earnings response coefcient (ERC) 0.7052 1.335 <0001
N 267 372

This table presents the results for a set of rms that used the IFRS throughout our sample period. All the variables are dened as
in previous tables.

Overall, the above sensitivity tests show that our main ndings of a decline in accounting quality of
U.S. GAAP rms are generally robust after controlling for R&D expenditure and the effect of the recent
nancial crisis.

6. Additional analyses

In order to conrm that the decrease in the accounting quality of U.S. GAAP rms is mainly caused
by the change from U.S. GAAP to IFRS and not due to other factors, we investigate the accounting qual-
ity change for rms that applied IFRS throughout the entire sample period (IFRS rms). We also
compare the changes in accounting quality of rms that switch from U.S. GAAP to IFRS with any
changes of IFRS rms by applying difference-in-differences tests. We would expect that the nancial
reporting quality of IFRS rms should be either constant or increasing throughout the sample period
for three reasons. First, there is no evidence from prior research suggesting that the accounting quality
of IFRS has reduced during the sample period. Second, the SECs Roadmap clearly states that the ongo-
ing convergence projects between IASB and FASB should have increased the quality of IFRS. Third,
since these rms applied IFRS even before it was mandatory, their reporting incentives should remain
consistent.
We identify 63 high-tech German rms that had applied IFRS during the sample period (2000
2008)17 and have all the accounting and market data available for further analyses. Panel A of Table 6
shows that, like U.S. GAAP rms, DNI is signicantly less negative in the pre-adoption period
(p < .0001), suggesting less smoothing in earlier years. However, the ratio of DNI to DCF is signicantly
greater in the post-adoption period (p < .0001), suggesting an increase in accounting quality for these
rms. We focus on the latter result because this metric adjusts for earnings volatility resulting from cash
ow volatility. Consistent with this supposition, the correlation of ACC and CF is signicantly less neg-
ative in the post-adoption period (p < .0001).18 Taken together, our results suggest that IFRS rms have
less earnings smoothing in more recent years, suggesting higher accounting quality. With respect to
earnings management to avoid losses, the result suggests that there has not been a signicant change
in the frequency of reporting small positive income.

17
To be consistent with the results from our most strict specication, we eliminate the nancial crisis years from tests in our
additional analyses.
18
We also investigated the economic signicance of the changes in these earnings metrics during the pre- and post-adoption
periods and nd that the percentages of changes for rms that used IFRS throughout the sample period are much smaller than
those for the switching rms, except for ERC.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 655

Table 7
Difference-in-differences test.

Pre (20002004) Post (20062008) Change

U.S. IFRS p- U.S. IFRS p- U.S. IFRS p-
GAAP Value GAAP Value GAAP Value
Panel A: Earnings management metrics
Variability of DNI 0.2698 0.1949 <.0001 0.1531 0.1673 <.0001 0.1167 0.0276 <.0001
Variability of DNI over 2.2819 2.1666 <.0001 1.4123 2.5227 <.0001 0.8696 0.3561 <.0001
DCF
Correlation of ACC and 0.2512 0.3005 <.0001 0.1848 0.281 <.0001 0.0665 0.0195 <.0001
CF
N 295 322 183 224 500 500
Panel B: Value relevance
Return model adjusted R 0.5835 0.5411 <.0001 0.3776 0.4406 <.0001 0.206 0.1005 <.0001
Earnings response 1.0424 0.7052 <.0001 0.6054 1.335 <.0001 0.437 0.6298 <.0001
coefcient (ERC)
N 260 267 172 225 500 500

This table presents the difference-in-differences results between the rms that switched from U.S. GAAP to IFRS and rms that
used IFRS throughout our sample period. All the variables are dened as in previous tables. The comparison of the pre- to post-
adoption period changes is based on Boot-strapping method with 500 replications.

Turning to Panel B, the tests for the frequency of large negative income and Basus conservatism
both yield insignicant positive coefcients. Therefore, we do not nd evidence of a change in timely
loss recognition for IFRS rms over the sample period. Lastly, Panel C summarizes the results of our
value relevance tests. The earnings responsive coefcient (ERC) is signicantly greater (p < .0001) in
the post-adoption period (1.335) than in the pre-adoption period (0.7052). However, the return model
adjusted R2 of 44.06% is signicantly lower (p < .0001) in the post-adoption period than the adjusted
R2 of 54.11% in the pre-adoption period.
Since some metrics (DNI; the Correlation of ACC and CF; return model adjusted R2) suggest that
the accounting quality of IFRS rms may have declined in the post-adoption period, we perform a dif-
ference-in-differences19 test to examine whether the decline in accounting quality is more pronounced
for rms that switched from U.S. GAAP to IFRS relative to IFRS rms. In all three cases, the results re-
ported in Table 7 show that the change is signicantly greater for rms that switched from U.S. GAAP
to IFRS.
Our robustness tests conrm an overall decrease in accounting quality when German rms
switched from U.S. GAAP to IFRS. Most metrics show that there was little change in accounting quality
for IFRS rms, suggesting that our results are driven by the switch from U.S. GAAP to IFRS. Further, any
potential decline in the accounting quality of IFRS rms captured by our metrics is signicantly less
than the decline in accounting quality for rms that experienced the switch from U.S. GAAP to IFRS.

7. Implications for U.S.

Our ndings suggest that a switch from U.S. GAAP to IFRS could lead to a decline in accounting
quality. However, there are a number of reasons why adoption of IFRS by U.S. rms may have different
consequences. First, the convergence projects between the IASB and FASB should continue to reduce
the accounting differences between IFRS and U.S. GAAP, leading to similar quality between the two
sets of standards. Second, these convergence efforts may lead to a reduction in the amount of mana-
gerial discretion allowed by IFRS. Since it is not certain when the U.S. will adopt IFRS, the passage of
time may allow for further changes to be made to converge the two sets of standards and reduce
accounting quality differences. Third, it is unlikely that the reporting incentives of U.S. managers will

19
Each of these tests relies on the previously described bootstrapping procedure to compare summary statistics. To calculate the
change, we rst match each observation from the pre-adoption period with the equivalent observation in the post-adoption. We
then obtain a distribution of the change in the metric and test for signicant differences between the two samples of rms.
656 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657

change following adoption of IFRS. As argued by Hail et al. (2010), managers of U.S. rms should still
strive to provide accounting information that is of a high enough quality to be useful to users of nan-
cial information in U.S. capital markets. Finally, it is possible that in the absence of further improve-
ments to IFRS, the SEC may take some regulatory action to circumvent a potential decline in the
accounting quality of U.S. rms.
An analytical study by Stecher and Suijs (2012) shows that the increased comparability resulting
from harmonized accounting standards may come at the cost of lower reporting quality when coun-
tries using these standards have signicant institutional differences. The results of our study provide
further evidence to suggest that a mandatory switch to uniform accounting standards (i.e., IFRS) in
Germany in 2005 reduced the nancial reporting quality of rms who previously prepared their nan-
cial statements using U.S. GAAP. Taken together, these results should be of interest to regulators and
standard setters in their continued consideration of IFRS adoption in the U.S.

8. Conclusion

A few studies have provided mixed evidence on the relative quality between IFRS and U.S. GAAP.
This study contributes to the literature by examining the change in accounting quality following a
switch from U.S. GAAP to IFRS for a sample of German high tech rms that applied U.S. GAAP and were
required to switch to IFRS in 2005.
We nd that accounting numbers under IFRS generally exhibit more earnings management, less
timely loss recognition, and less value relevance after controlling for rm-specic and time varying
factors. We also nd that for the three metrics suggesting a decline in accounting quality for both
switching and non-switching rms, the change is signicantly more pronounced for rms switching
to IFRS from U.S. GAAP. Overall, our ndings indicate a switch from U.S. GAAP to IFRS could reduce
accounting quality. Although our ndings may contribute to the debates surrounding the possible
consequences of a switch from U.S. GAAP to IFRS, this study does not attempt to infer potential nan-
cial reporting consequences of a switch to IFRS by U.S. rms.

References

Ball, R., 2001. Infrastructure requirements for an economically efcient system of public nancial reporting and disclosure.
Brookings-Wharton Papers on Financial Services 127169.
Ball, R., Kothari, S.P., Robin, A., 2000. The effect of international institutional factors on properties of accounting earnings. Journal
of Accounting and Economics 29, 151.
Ball, R., Shivakumar, L., 2005. Earnings quality in UK private rms: comparative loss recognition timeliness. Journal of
Accounting and Economics 39, 83128.
Barth, M., Landsman, W., Lang, M., Williams, C., 2011. Are IFRS-based and U.S. GAAP-based Accounting Amounts Comparable?
Working Paper, University of North Carolina.
Barth, M., Landsman, W., Lang, M., 2008. International accounting standards and accounting quality. Journal of Accounting
Research 46, 467498.
Bartov, S., Goldberg, R., Kim, M., 2005. Comparative value relevance among German, U.S. and International Accounting
Standards: a German stock market perspective. Journal of Accounting, Auditing and Finance 20, 95119.
Basu, S., 1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics 24,
337.
Beaver, W., McNichols, M., Nelson, K., 2007. An alternative explanation of the discontinuity in earnings distribution. Review of
Accounting Studies 12, 525556.
Bickel, P., Freedman, D., 1981. Some asymptotic theory for the bootstrap. Annals of Statistics 9, 11961217.
Bradshaw, M., Bushee, B., Miller, G., 2004. Accounting choice, home Bias, and U.S. investment in non-U.S. rms. Journal of
Accounting Research 42, 795841.
Burgstahler, D., Dichev, I., 1997. Earnings management to avoid earnings decreases and losses. Journal of Accounting and
Economics 24, 99126.
Chen, L., Sami, H., 2009. Trading volume reaction to the earnings reconciliation from IAS to U.S. GAAP. Contemporary Accounting
Research 25, 1553.
Easton, P., Harris, T., 1991. Earnings as an explanatory variable for returns. Journal of Accounting Research 29, 1936.
Gordon, E., Jorgensen, B., Lithicum, C., 2010. Could IFRS Replace U.S. GAAP? A Comparison of Earnings Attributes and
Informativeness in the U.S. Market. Working Paper.
Hail, L., Leuz, C., Wysocki, P., 2010. Global accounting convergence and the potential adoption of IFRS by the U.S. (part I):
conceptual underpinnings and economic analysis. Accounting Horizons 24, 355394.
Harris, M., Muller, K., 1999. The market valuation of IAS versus U.S.-GAAP accounting measures using Form 20-F reconciliations.
Journal of Accounting and Economics 26, 285312.
 S. Lin et al. / J. Account. Public Policy 31 (2012) 641657 657

Henry, E., Lin, S., Yang, Y., 2009. The European-U.S. GAAP Gap: IFRS to U.S. GAAP Form 20-F reconciliations. Accounting
Horizons 23, 121150.
Khan, M., Watts, R., 2009. Estimation and empirical properties of a rm-year measure of accounting conservatism. Journal of
Accounting and Economics 48, 132150.
Lafond, R., Roychowdhury, S., 2008. Managerial ownership and accounting conservatism. Journal of Accounting Research 46,
101135.
Landry, S., Callimaci, A., 2003. The effect of management incentives and cross-listing status on the accounting treatment of R&D
spending. Journal of Accounting, Auditing, and Taxation 12, 131152.
Lang, M., Raedy, J., Yetman, M., 2003. How representative are rms that are cross-listed in the United States? An analysis of
accounting quality. Journal of Accounting Research 41, 363386.
Lang, M., Raedy, J., Wilson, W., 2006. Earnings management and cross listing: are reconciled earnings comparable to U.S.
earnings? Journal of Accounting and Economics 42, 255283.
Leuz, C., 2003. IAS versus U.S. GAAP: Information asymmetry-based evidence from Germanys new market. Journal of
Accounting Research 41, 445472.
Leuz, C., Nanda, D., Wysocki, P., 2003. Earnings management and investor protection: an international comparison. Journal of
Financial Economics 69, 505527.
Roychowdhury, S., Watts, R., 2007. Asymmetric timeliness of earnings, market-to-book and conservatism in nancial reporting.
Journal of Accounting and Economics 44, 231.
Stecher, J., Suijs, J., 2012. Hail, Procrustes! Harmonized accounting standards as a Procrustean bed. Journal of Accounting and
Public Policy 31, 341355.
Tarca, A., 2002. Achieving International Harmonization through Accounting Policy Choice. Working Paper.
Van der Meulen, S., Gaeremynck, A., Willekens, A., 2007. Attribute differences between U.S. GAAP and IFRS earnings: an
exploratory study. The International Journal of Accounting 42, 123142.
Watts, R., 2003. Conservatism in accounting part I: explanations and implications. Accounting Horizons 17, 207221.