Market Reaction to the Potential Adoption of

International Accounting Standards in the U.S.

Steve Lin*

Paul Tanyi

Florida International University

August 2010

* Corresponding author

Dr. Steve Lin School of Accounting College of Business Administration Florida International University Miami, Florida 33119 E-mail: lins@fiu.edu

Acknowledgement: We thank the participants in the South Florida Accounting Research Conference and the Accounting Workshops at University of Florida, Syracuse University, Iowa State University, University of South Florida, National Taiwan University, National Chengchi University, National Cheng Kung University, National Central University, and Florida International University for their helpful comments on this paper.

Market Reaction to the Potential Adoption of

International Accounting Standards in the U.S.

Abstract

This study examines the market reaction to 12 major events associated with the

likelihood of adopting International Financial Reporting Standards (IFRS) in the U.S.

Prior research find that investors positively reacted to the adoption of IFRS in the E.U.

member states, but there is no direct empirical evidence on the perception of investors

about the potential adoption of IFRS in the U.S. Using the two-digit SIC industry

classification, we first identify U.S. companies that are included in the largest 20

companies worldwide in each industry, based on their 2007 year-end market

capitalization. We then follow the criteria provided by the SEC roadmap to identify U.S.

companies in industries where IFRS is the most-used accounting standards globally. We

find a positive and significant cumulative abnormal return around 12 major IFRS events

in the U.S. only for the U.S. companies in IFRS industries. This finding indicates that

investors of U.S. companies in IFRS industries perceive the convergence benefit from

IFRS adoption. Further evidence, however, shows that overall investors of U.S.

companies welcomed the convergence projects between Financial Accounting Standards

Board and International Accounting Standards Board but negatively reacted to the

potential adoption of IFRS in the U.S. Our finding could help the SEC decision as to

whether to mandate the use of IFRS for U.S. public companies.

Keywords: IFRS Adoption, SEC Roadmap, Market Reaction Data Availability: All data are publicly available from sources indicated in the text

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I. Introduction

This study examines the stock market reaction to 12 major events1 associated

with the likelihood of adopting International Financial Accounting Standards (IFRS)2 in

the U.S. The widespread adoption of IFRS around the world, especially its mandatory

adoption across European Union (E.U.) member states, is the most significant financial

reporting change in accounting history. The adoption of a single set of globally accepted

accounting standards, such as IFRS, has been controversial among researchers,

practitioners, and government officials because of a lack of theory and inconsistent

empirical evidence on its costs and benefits (e.g. Ball, 2006; Henry et al. 2009; Hail et al.

2009). To our knowledge, there is no direct evidence of investors perception about the

adoption of IFRS around the world, and more importantly, the potential adoption of IFRS

in the U.S. This is because (1) U.S. companies have been exclusively using U.S.

Generally Accepted Accounting Principles (U.S.GAAP) to prepare their financial

statements, and (2) the companies, capital markets, legal and financial reporting systems,

and other environmental characteristics in the U.S. differ substantially from those in other

countries. Hence, conclusions from non-U.S.-based research may not directly apply to the

U.S.

This study provides preliminary empirical evidence as to how investors perceive

the potential adoption of IFRS in the U.S. We believe this is an important research

question because adoption of IFRS is clearly on the agenda of U.S. accounting regulators.

First, the Financial Accounting Standard Board and International Accounting Standard

Board (the Boards hereafter) issued the Norwalk Agreement (September 18 2002) in

which they agreed to make their existing financial reporting standards fully compatible as

soon as practicable, and to coordinate their future work agenda to maintain the

1 This study focuses on 12 events associated with the elimination of IFRS-U.S.GAAP reconciliation disclosure and the SEC Roadmap to allow IFRS reporting in the U.S. (i.e. events after the beginning of 2005) We also include 4 other events associated with the convergence projects and potential adoption of IFRS in the E.U. (i.e. events that occurred before 2005) for all US companies. 2 This study uses the term of IFRS to cover all the international accounting standards issued by International Accounting Standards Committee (IASC) and the International Accounting Standards Board (IASB).

2

comparability between the two sets of standards. The convergence relationship between

the Boards has been developed and strengthened since the Norwalk Agreement (Barth et

al. 2009). For example, most of the agenda projects are now joint projects between the

two standards setters

3

3. The Security Exchange Commission (SEC) also openly welcomed

the convergence plans (February 27 2006). A recent study by Henry et al. (2009)

provides empirical evidence indicating that the average accounting difference between

IFRS and U.S.GAAP declined from 2004 to 2006, consistent with the convergence effect.

Second, to further promote the use of IFRS, the SEC issued its final rule to eliminate the

IFRS-U.S.GAAP reconciliation requirement for foreign companies with their financial

statements prepared in accordance with IFRS (November 15 2007). This ruling clearly

indicates that the SEC accepts IFRS as high-quality accounting standards. Third, the SEC

and Financial Accounting Standard Board (FASB) have consistently supported a single,

globally accepted set of high-quality accounting standards that would benefit both global

capital markets and U.S. investors. The SEC also believes that U.S. investors would be

able to make better-informed investment decisions if they can compare financial

information of U.S. companies with that of non-U.S. companies operating in the same

industry or line of business (SEC Roadmap 2008, paragraph 1, p. 12-13). Fourth,

although more than 110 countries around the world currently require or permit IFRS

reporting for their domestic-listed companies, it is believed that IFRS will be used in

more countries in the near future, including the U.S. The SEC explicitly recognizes that

IFRS has the potential to become the set of accounting standards that best provide a

common platform on which companies can report and investors can compare financial

information. (SEC Roadmap 2008, paragraph 2, p. 3) In fact, the SEC Roadmap for the

use of financial statements prepared in accordance with IFRS by U.S. companies (SEC

November 14, 2008) clearly sets forth seven milestones4 that if achieved could lead to the

3 For example, the Boards new business combinations standards, IFRS 3 (revised) and SFAS No. 141R (IASB 2007; FASB 2007) are the first jointly issued standards that are virtually identical. The Boards have an active agenda for joint projects continuing until the end of 2011. 4 These seven milestones include: (1) Improved accounting standards; (2) accountability and funding for the International Accounting Standards Committee (IASC) Foundation; (3) improved ability to use interactive data for IFRS reporting; (4) education and training; (5) limited early use of IFRS where this would enhance comparability for U.S. investors; (6) anticipated timing of future rule making by the Commission; and (7) implementation of mandatory use of IFRS.

use of IFRS by all U.S. companies beginning in 2014. Under the proposal, the SEC will

decide in 2011 whether adoption of IFRS will benefit U.S. investors and be in the

public interest. Finally, the SEC IFRS work plan announced on February 24, 2010

reaffirms its support of a single set of high-quality global financial reporting standards

and ongoing consideration of the incorporation of IFRS into the U.S. financial reporting

system

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5.

Similar to the potential market reaction to the adoption of IFRS in the E.U.

member states as predicted by Armstrong et al. (2009), investors may react positively

towards the movement of IFRS adoption in the U.S. because they will believe that IFRS

adoption will lower the costs of comparing firms financial information across

jurisdictions. More importantly, the adoption of IFRS in the U.S. would enhance the

global competitiveness of U.S. capital markets and potentially increase stock liquidity for

U.S. firms. However, it is also possible that investors may react negatively towards the

movement of IFRS adoption because investors may believe that IFRS will result in lower

quality financial information than U.S.GAAP, and that IFRS may not be consistently

adopted across different countries (Henry et al. 2009). In fact, many studies have

documented that application of IFRS across countries has reflected the differences in

domestic accounting standards and underlying legal and socio-economic environmental

characteristics. Moreover, potential variation in the implementation and enforcement of

IFRS across countries could increase opportunistic managerial behavior when applying

IFRS. In addition, investors could believe that the implementation and estimated

transition costs associated with IFRS adoption will exceed its benefits. Finally, it is also

possible that investors may not react to the potential adoption of IFRS in the U.S. if they

believe the adoption of IFRS alone is unlikely to change reporting quality and yield

substantial capital market benefits in the U.S. (Hail et al. 2009). Hence, the direction of

the market reaction to the potential adoption of IFRS in the U.S. is an empirical issue.

Following Armstrong et al. (2009), we use a traditional event study methodology

to investigate investors reaction to 12 major IFRS events associated with the likelihood

of adopting IFRS in the U.S. before the end of 2008. These events are grouped into two

5 The SECs IFRS work plan also suggests that the use of IFRS by all U.S. companies should begin in 2015 or 2016 instead of 2014 because the convergence projects between FASB and IASB will be complete in 2011. Also the SEC may not allow early adoption before 2014.

categories, including events associated with elimination of IFRS-U.S.GAAP

reconciliation disclosure (6 events) and the SECs roadmap to allow IFRS reporting for

U.S. domestic companies (6 events). These events were obtained from the official news

releases from the SEC and the FASB websites. We first identified U.S. companies that

are included in the largest 20 companies worldwide in each industry, based on their 2007

year-end market capitalization. We then follow the criteria provided by the SEC roadmap

to identify U.S. companies in industries where IFRS is the most-used accounting

standards globally. They are the companies that may be allowed to adopt IFRS before

2011. The SEC clearly states that

allowing the limited use of IFRS by U.S. issuers, only in those cases where to do so would enhance the comparability of an industrys financial reporting for the benefit of investors in making comparisons to non U.S. issuers, may help inform the decision whether to mandate the use of IFRS for U.S. public issuers. We also believe that the ability of capital market participants to evaluate and comment on these questions would be enhanced by allowing this limited use of IFRS

(Roadmap 2008 p. 32)

For the comparison purpose, we also identified U.S. companies that are included

in the largest 20 companies worldwide in industries where U.S.GAAP is the most-used

accounting standards globally. Finally, we have other U.S. companies that are not in

IFRS or U.S.GAAP industries.

Using two-digit SIC industry classification, our preliminary analysis finds that 34

(33) out of 67 industries are classified as IFRS (U.S.GAAP) industries where IFRS

(U.S.GAAP) is the most-used accounting standards globally. Australia, Brazil, China,

Germany, Spain, France, UK, Hong Kong, Korea, Netherland, Russia, and Singapore

have more companies in IFRS than U.S.GAAP industries. In contrast, Canada, Japan, and

U.S. have more companies in U.S.GAAP than IFRS industries. We find that the worlds

largest U.S. companies in IFRS industries are mainly concentrated in mining, fabric and

clothing, paper and container, printing, chemical, petroleum and alcoholic, furniture, and

amusement and recreation industries. In contrast, the worlds largest U.S. companies in

U.S.GAAP industries are mainly concentrated in office furniture, machinery and

equipment, medical equipment and supplies, and retails. U.S. companies in IFRS

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industries are larger in size, measured by natural log of the market capitalization at the

end of 2007, and have higher average share price and book value of equity per share.

However, they have poorer operating performance, measured by mean ROA and EPS,

than U.S. companies in U.S.GAAP industries.

Using U.S. companies that are among the largest 20 companies worldwide in each

industry, we find that the cumulative abnormal return around 12 major IFRS events in the

U.S., is significant at the 5% level (t-value = 2.17, p-value = 0.03). Further analysis

shows that this result is driven by U.S. companies in IFRS industries. In fact, we find that

the average cumulative abnormal return for U.S. companies in IFRS industries is 0.49%

(t-value = 4.01, p-value < 0.001), which is much higher (t value = 3.28, p-value = 0.001)

than the zero (0.00%, t-value = 0.02, p-value = 0.981) average cumulative abnormal

return for U.S. companies in U.S.GAAP industries. This indicates that investors of U.S.

companies in IFRS industries perceive convergence benefit from IFRS adoption, and that

U.S. companies in IFRS industries can benefit more from IFRS adoption than U.S.

companies in U.S.GAAP industries. The abnormal cumulative return6 around the events

associated with developing a roadmap to transition U.S. companies to IFRS (1.66%,

February 8, 2008), SEC roundtable on the performance of IFRS and U.S.GAAP during

the sub-prime crisis (1.23%, August 4, 2008), proposed roadmap toward a single-set

global accounting standards (1.22%, August 27, 2008), and SEC and CESR (i.e.

Committee of European Securities Regulators) work plan on the application by

internationally active companies of IFRS and U.S.GAAP in the U.S. and E.U.

respectively (1.07%, August 2, 2006) appear to have the highest magnitude of market

reactions among all events.

Using all the U.S. companies with return data available in CRSP throughout the

period of 2002-2008, we investigate investors overall reaction to the same 12 major

IFRS events. We find consistent negative and significant market reactions to 11 out of 12

major events although investors appear to positively react to the events associated with

the convergence projects between the FASB and IASB (cumulative abnormal return =

6

6 It is calculated as the abnormal cumulative return around the event day (day 0) and the days before (day -1) and after (day +1) the event day.

1.16%, t-value = 12.14, p-value < 0.001). This finding is robust after deleting U.S.

companies in IFRS and U.S.GAAP industries.

Overall, our results support the SEC roadmap that allowing IFRS reporting for the

U.S. domestic companies may enhance the comparability of an industrys financial

reporting for the benefit of investors in making comparisons to non-U.S. companies.

However, our results also indicate that overall investors welcomed the U.S.GAAP-IFRS

convergence events but negatively reacted to the potential adoption of IFRS in the U.S.

The above findings should help the SEC make an informed decision as to whether to

mandate the use of IFRS for U.S. public companies.

The remainder of this study is organized as follows. Section II reviews prior

research and develops research hypotheses. Section III discusses 12 events associated

with the potential adoption of IFRS in the U.S. and 4 events associated with the E.U.

adoption of IFRS and the convergence projects between FASB and IASB. Section IV

describes our data and research design. Section V presents our main empirical results.

Section VI presents sensitivity analyses. Section VII concludes.

II Prior research and hypothesis development This study is built on two streams of accounting research7, i.e. relative quality of

IFRS and U.S.GAAP8 and investors perception about the potential adoption of IFRS.

Some studies have provided mixed results on the relative quality of IFRS versus

U.S.GAAP. For example, Bartov et al. (2005) find no significant difference in earnings

quality, measured by the price-earnings relationship using IFRS and U.S.GAAP

respectively. Using a small sample of foreign companies that are cross-listed in the U.S.,

Harris and Muller (1999) examine whether the differences in earnings and book values of

equity under IFRS and U.S.GAAP can explain the variation of stock prices and returns.

7 Many studies (e.g. Daske et al, 2008; Li, 2009) have examined the economic consequences of IFRS adoptions in the E.U. and around the world. This study, however, focuses on the literature on the relative quality of IFRS versus U.S.GAAP and investors perception about IFRS adoption in the U.S. 8 A review paper by Soderstrom and Sun (2007) provides a comprehensive summary of the literature in this area.

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Their results appear to be mixed depending on the regression model specification

8

9.

Using a larger sample during 2004-2006, Henry et al. (2009) find similar results to Harris

and Muller (1999). Moreover, Van der Meulen et al. (2007) find that IFRS and

U.S.GAAP are not different in terms of value relevance, timeliness, and accrual quality.

Barth et al. (2009) examines whether IFRS as used by non-U.S. firms results in

accounting numbers that are comparable to those resulting from U.S.GAAP as used by

U.S. firms. They find that U.S. firms using U.S.GAAP generally have higher value

relevance of net income and book value of equity than non-U.S. firms using IFRS, and

that value relevance generally became more comparable after non-U.S. firms applied

IFRS than when they applied their domestic standards. Barth et al. (2009) also find that

value relevance and net income comparability are higher after the mandatory adoption of

IFRS in the E.U. in 2005. Overall, the above findings suggest that the application of IFRS

by non-U.S. firms has enhanced financial reporting comparability with U.S. firms, but

significant differences remain.

To our knowledge, no study has examined the investors perception about the

potential adoption of IFRS in the U.S. although some studies examine investors

perception about the mandatory adoption of IFRS in Europe. Comprix et al. (2003)

identify 11 event dates between 2000 and 2002 that signaled the likelihood of IFRS

adoption in the E.U. They find positive stock market reaction to news that increases the

likelihood of IFRS adoption. A recent study by Armstrong at al. (2009) examines the

cumulative abnormal returns around 16 events10 associated with the likelihood of the

adoption of IFRS in E.U member states. They find (1) an incrementally positive reaction

for firms with lower quality pre-adoption information and for firms with higher pre-

adoption information asymmetry; (2) an incrementally negative reaction for firms

domiciled in code law countries; (3) a positive reaction to IFRS adoption events for firms

with high quality pre-adoption information. Their finding suggests that the net benefits

from the mandatory adoption of IFRS in Europe vary between countries depending on

their information quality pre-IFRS adoption, legal system, and investors perception.

9 Both studies find that share price is associated with accounting differences but not share return. 10 They find positive (negative) market reactions to all 13 (3) events associated with increase (decrease) in the likelihood of IFRS adoption in the E.U. In addition, the overall cumulative abnormal return around 16 events is positive and significant.

Landsman et al. (2009) examine the relative information content of annual earnings

announcements, measured by the abnormal return volatility and abnormal trading

volume, pre and post the mandatory adoption of IFRS in 16 countries. Their evidence

suggests that only abnormal return volatility at earnings announcements increased in

countries that mandated IFRS adoption relative to those that maintained domestic

accounting standards. They also find that increases in abnormal return volatility after

mandatory adoption of IFRS are concentrated in countries with Scandinavian, German,

and French legal origin versus English legal origin. Consistent with Armstrong et al.

(2009), the net benefits of adopting IFRS vary between different legal origins.

The above evidence suggests that the E.U. member states and other countries may

have benefited from IFRS adoption, but little is known about how investors perceive the

potential adoption of IFRS in the U.S. A positive market reaction to IFRS adoption in

Europe does not necessarily guarantee the same reaction would occur in the U.S. because

it is unclear whether IFRS has the same quality as U.S.GAAP or whether IFRS can meet

the information needs of users in the U.S. In fact, prior research suggests that U.S.GAAP

generates more value-relevant accounting information (i.e. earnings and book value of

equity) than does IFRS (Barth et al. 2009). Moreover, although the SEC has estimated the

transition cost11 of IFRS adoption to U.S. companies in the SEC roadmap, the potential

benefit of IFRS adoption to U.S. companies have not been evaluated (Henry et al. 2009).

We believe the net benefit of adopting IFRS in the U.S. can only be observed through

investigating how investors react to the adoption of IFRS worldwide and the potential

adoption of IFRS in the U.S. This study examines this issue.

Both Armstrong et al. (2009) and Hail et al. (2009) argue that the capital-market

effects of IFRS adoption in the U.S. largely depend on whether the quality and

comparability of U.S. firms reporting practices change following the adoption of IFRS.

Together, they provide three different predictions over the directional effects of IFRS

9

11 The SEC estimated that the cost of IFRS transition under Proposal A would be 0.125% of revenue for the U.S. companies that would be eligible to use IFRS accounting, and would be approximately 0.13% of revenue under Proposal B to reflect the additional U.S.GAAP reconciliation disclosure. The SEC also reduced the second-year estimates by 75% as compared to the first-year estimates to eliminate the one-time costs and to account for the fact that eligible companies using IFRS should become more efficient at preparing their financial statements after the first year as the process becomes more routine (SEC Roadmap 2008, p. 116 117).

adoption in the U.S. The convergence effect predicts that IFRS adoption is more likely

to increase the cross-border comparability of U.S. reports because many countries have

already switched to IFRS reporting after 2005. Hail et al. (2009) also argue that the

largest out-of-pocket costs would likely occur during the transition period and not on an

ongoing basis, saving costs in the long run for firms operating internationally and using

IFRS for all their reporting requirements. Hence, the above arguments predict an overall

positive market reaction to events that increase the likelihood of adopting IFRS in the

U.S. In contrast, the lower reporting quality effect predicts that IFRS adoption is likely

to lead to lower reporting quality in the U.S for the following three reasons. First, the

accounting differences between the two standards still remain significant (e.g. Henry et

al. 2009). Second, IFRS allows for more managerial discretion and offers less guidance

than U.S.GAAP. Adoption could therefore lead to more earnings management than under

U.S.GAAP. Finally, IFRS is less comprehensive than U.S.GAAP. Hence, the above

arguments predict an overall negative market response to events that increase the

likelihood of adopting IFRS in the U.S. Finally, the incentive effect predicts that IFRS

adoption alone is unlikely to increase reporting quality and yield substantial capital

market benefits in the U.S. It is argued that IFRS is of similar quality to U.S.GAAP and

the remaining accounting differences between the two sets of accounting standards could

decline after the convergence projects between IASB and FASB. More importantly, both

sets of accounting standards follow capital-market and Anglo-American common law

oriented tradition. Hail et al. (2009) also argue that the reporting incentives in the U.S.

should be the same before and after IFRS adoption. Hence, the above arguments predict

no market reaction to events that increase the likelihood of adopting IFRS in the U.S.

In summary, previous studies provide mixed results on the relative quality of

IFRS and U.S.GAAP although empirical evidence suggests that investors of European

markets positively reacted to IFRS adoption. To our knowledge, there is no empirical

evidence on U.S. investors perception about the potential adoption of IFRS in the U.S.

Finally, we believe that the directional effect of adopting IFRS in the U.S. is an empirical

issue because the net effect of adopting IFRS in the U.S. would be affected by three

competing effects, i.e. the incentive, lower reporting quality, and convergence effects.

Hence, we do not intend to predict the direction of investors reaction to events that

10

increase the likelihood of adopting IFRS in the U.S. Next section discusses the sample

selection criteria and research design.

III. Events associated with the likelihood of IFRS adoption in the U.S.

and IFRS Survey results

Following Armstrong et al. (2009), each author read through all the FASB news

releases archive and the SEC final rules and press release archives during 2005-200812

and independently verified each events timing, content, and likely directional effect on

the likelihood of the adoption of IFRS in the U.S. We then deleted repetitive events and

carefully identified 12 major IFRS events. Surprisingly, all 12 events indicate increases in

the likelihood of adopting IFRS in the U.S. We do not include the official press releases

from the FASB and the IASB that are associated with their joint convergence projects.

This is because they are not directly related to the likelihood of adopting IFRS in the

U.S.13

11

This study focuses on the 12 major IFRS events that occurred after (include) 2005

because IFRS adoption did not become a global phenomenon until after the mandatory

adoption of IFRS in the E.U. member states in 2005.14 These events are also divided into

two categories: elimination of the IFRS-U.S.GAAP reconciliation disclosure and

developing a roadmap to transition U.S. companies to IFRS. For robustness test purposes,

we also examine investors reaction to 4 other events associated with the convergence

12 Several events occurring in 2009 are also related to the potential adoption of IFRS in the U.S. For example, Mary Schapiro, the new Chairman of the SEC, explicitly indicated that she plans to back off on the proposed roadmap for transitioning companies to the international financial reporting standards. She has concerns about the pace of the timeline, the independence of overseas standard-setter, and the quality of the standards themselves. We do not investigate events that occurred after 2008 because the goal to have a single-set of high-quality global accounting standards and allow IFRS reporting for U.S. domestic companies remains the same (see the SECs IFRS work plan, 2010). In fact, The September G-20 meeting further highlighted the commitment of the worlds leaders to one global set of accounting standards and asked regulators to redouble their efforts on the convergence projects to meet the 2011 deadline (IFRS perspective: an executive survey, PWC, December 2009) 13 Future research should investigate the market reaction to the changes and potential changes in U.S.GAAP, such as the extent to which the market reacts to the adoption of fair value accounting for intangible and tangible assets, due to the convergence projects. 14 Unreported results show that U.S.GAAP was the dominant accounting standards among the worlds largest companies before the mandatory adoption of IFRS in the E.U. in 2005.

projects between FASB and IASB and the IFRS adoption in the E.U. member states that

occurred during the period of 2002-2003

12

15. Table 1 therefore lists all 16 events.

-------------------------------

Insert Table 1 here

-------------------------------

The convergence projects between FASB and IASB

The SEC and the FASB have consistently supported a single set of

internationally-accepted, high-quality accounting standards. On September 18, 2002, the

FASB and the International Accounting Standard Board (IASB) jointly expressed their

commitment to converge U.S.GAAP and IFRS. This is known as the Norwalk

Agreement, which set out a number of initiatives, including a move to eliminate major

differences between U.S.GAAP and IFRS, a decision to align the two Boards future

work agenda, and a formal commitment to work together on several joint projects. On

October 29, 2002, the FASB and the IASB issued a memorandum of understanding

making a significant step toward formalizing their commitment to the convergence of

U.S.GAAP and IFRS. We believe that the convergence projects between IASB and

FASB improve the comparability of financial statements prepared in accordance with

IFRS and U.S.GAAP. This may have attracted more foreign investors investing in the

U.S. markets and/or have protected U.S investors investing in other countries

IFRS adoption events in the E.U. and around the world

On March 12 2002, the European Parliament passed a resolution requiring all

European firms listed on E.U. stock exchanges to prepare their financial statements using

IFRS for fiscal years beginning on or after January 1, 2005. On September 29, 2003, the

resolution was endorsed by the European Commission (E.C.). This development

represented a substantial shift in financial reporting not only in Europe but also the rest of

15 This is because the convergence projects between FASB and IASB and the E.U. adoption of IFRS may have certain implication for potential adoption of IFRS in the U.S.

the world. According to the SEC, approximately 85 countries, including Hong Kong,

China, Australia, Russia, South Africa, Singapore and Pakistan etc., require IFRS

reporting for all domestically listed companies. Additionally, other countries are expected

to convert to IFRS in the next few years, including Chile (2009), Korea (2009), Brazil

(2010), India (2011), and Canada (2011). We believe that the adoption of IFRS in the

E.U. member states in 2005 significantly increases the likelihood of worldwide adoption

of IFRS, which in turn has important implication for the U.S. stock markets. For

example, IFRS adoption in the E.U. may have further protected U.S. investors investing

in the E.U. countries and/or have helped U.S. investors make informed investment

decisions. Alternatively, U.S. investors may have anticipated IFRS adoption in the U.S.

after the adoption of IFRS in the E.U.

Elimination of the IFRS-U.S.GAAP reconciliation disclosure

On April 24 2005, the SEC proposed a roadmap to eliminate IFRS-U.S.GAAP

reconciliation requirement16, which was subsequently reaffirmed by both the SEC

Chairman Cox and E.U. Commissioner McGreevy on February 8, 2006 to further

promote IFRS. The convergence projects were also further reaffirmed in the FASB/IASB

memorandum of understanding to achieve greater convergence in the following years

(i.e. 2006-2008). The memorandum clearly notes that achieving convergence between the

two sets of accounting standards would be relevant to removing the reconciliation

requirement.

On August 2, 2006, the SEC and the Committee of European Securities

Regulators (CESR) launched a joint work plan, focusing on the application by

internationally-active companies of IFRS and U.S.GAAP in the U.S. and E.U.

respectively. On February 13, 2007, the SEC announced a staff roundtable discussion on

a roadmap to eliminate the IFRS-U.S.GAAP reconciliation requirement. On July 3,

2007, the SEC finally proposed to allow foreign companies to issue financial statements

13

16 Before December 2007 Foreign companies that were cross-listed in U.S. stock markets were required either to use U.S.GAAP to prepare their financial statements, or to reconcile their net income and shareholders equity using foreign GAAP, including IFRS, to U.S.GAAP and disclose this reconciliation in the Form 20-F.

prepared in accordance with IFRS without reconciliation to U.S.GAAP. The SEC

Chairman Cox claimed that a complete convergence of IFRS and U.S.GAAP is not a

prerequisite to eliminating the reconciliation requirement, though an active process for

achieving convergence is a prerequisite. On November 15, 2007, the SEC voted

unanimously on this proposal and approved related rule amendments. This signals that

the SEC accepts IFRS as high-quality' accounting standards. We believe that the

elimination of the IFRS-U.S.GAAP reconciliation requirement reduces preparation cost

for foreign cross-listing companies and promotes IFRS adoption in the U.S.

SEC roadmap to migrate U.S. companies to IFRS

To further promote the adoption of IFRS in the U.S., on August 7, 2007 the SEC

issued a concept release soliciting input on whether U.S. companies should be permitted

to prepare their financial statements using IFRS as published by the IASB. On December

12, 2007, the SEC also called for two more roundtable discussions on the potential

impacts of the adoption of IFRS in the U.S. On February 8, 2008, the SEC Chairman

Cox directed the Commission to develop a roadmap, including a series of rulemaking

efforts, to migrate U.S. companies to IFRS. The roadmap provides all interest parties,

including the SEC, the Public Company Accounting Oversight Board (PCAOB), the

FASB, and other stakeholders, with an outline of the key conditions and steps to follow

in order to transition U.S. companies to IFRS during the transition period. The proposed

roadmap aims to increase integration of U.S. and international financial markets. On

August 4, 2008, the SEC held a staff roundtable discussion on the performance of IFRS

and U.S.GAAP during the sub-prime crisis. On August 27, 2008, the SEC officially

proposed a roadmap that would allow U.S. companies to prepare their financial

statements in accordance with IFRS beginning in 2014. On November 14, 2008, the SEC

finally published a roadmap on its implementation of IFRS in the U.S. With this

roadmap, some selected U.S. companies would be allowed to prepare their first IFRS

14

financial statements before 2011.

15

17 We believe that the SEC Roadmap significantly

increases the likelihood of IFRS adoption in the U.S.

IFRS survey results

Major accounting firms have conducted several surveys to gather the views of

corporate executives regarding the transition to IFRS in the U.S. These surveys were all

conducted after the release of the SECs roadmap. Their findings indicate that corporate

executives surveyed are positive about the ultimate impact of the SECs roadmap on the

conversion process and have already anticipated the mandatory adoption of IFRS in the

U.S. The survey conducted by Deloitte in July 2009 finds that almost 90% of 245

respondents viewed IFRS conversion to be highly or somewhat likely to become

mandatory in the U.S. In fact, 59% viewed mandatory conversion in the U.S. as highly

likely. U.S. companies also appear to have been preparing themselves for the mandatory

adoption of IFRS. For example, 80% of respondents indicated that their companies are

either performing or have performed an IFRS impact assessment. Another survey

conducted by Deloitte in September 2009 finds that 70% of 150 respondents believed that

the SEC should approve its proposed roadmap or a modified version of it. However, 51%

of respondents indicated that the SEC should approve the proposed roadmap, but

consider pushing back the deadline of mandatory adoption of IFRS by a year because the

convergence projects between FASB and IASB would be complete in 2011.

According to the survey conducted by PriceWaterhouseCoopers in September

2009, 41% of respondents (over 100 CFOs and managing directors) believed that the

pace of conversion to IFRS in the U.S. is adequate although 18% of respondents believed

that the SEC and standard setters should be moving more quickly to accomplish the

conversion process. 43% of respondents favored either a mandatory adoption date to

change to IFRS as soon as possible or partial convergence followed by a mandatory

change to IFRS. Nearly a quarter of respondents prefer full convergence between the two

17Based on the comments received, from the roundtable discussions and political pressure on the U.S. market regulators, the SEC has inevitably moved to the direction of requiring U.S. firms to issue financial statements using IFRS with an option for early adoption for selected U.S. companies. The recent SECs IFRS work plan, however, suggests reconsidering this option.

sets of standards. Over half of all respondents placed IFRS conversion as a moderate or

higher priority. Regarding whether companies are ready for the adoption of IFRS in the

U.S., 15% of respondents admitted that their companies are already using IFRS for some

entities; 14% of respondents indicated that their companies have done an impact

assessment and are ready to move forward. 58% of respondents also indicated that their

companies are either planning to do an impact assessment or are doing some learning fact

gathering. Regarding what factors may contribute to the success for IFRS conversion,

75% of respondents believed that a well thought-out training strategy is vital to

successfully making the transition to IFRS in the U.S.

KPMG also conducted an IFRS survey in February 2009, which indicates that

investors, analysts and corporate executives involved in preparation of financial

statements were positive about the ultimate impact of the IFRS roadmap. For example,

65% of analysts and investment executives expected IFRS to make the U.S. capital

markets more attractive to foreign investors; 68 % of investors and analysts expected

more transparency. Moreover, 57% of investors and analysts surveyed believed the

timeline proposal announced by the SEC in November 2008 to be about right; 55% of

corporate executives also agreed with the timeline. 77% of analysts and investors said

they wanted companies to begin explaining their IFRS conversion plans at least one-to-

three years prior to the change. Another survey conducted by KPMG two days after the

SEC work plan was announced on February 24, 2010 indicates that 49% of more than

2,500 respondents (corporate executives) would like the ability to adopt IFRS earlier than

the anticipated 2015 or 2016 implementation date targeted by the SEC work plan.

However, 59% of respondents indicated that the potential IFRS implementation in 2015-

2016 would give their companies enough time to prepare for the change.

In summary, U.S.GAAP has been converging with IFRS since 2002 and the

differences between U.S.GAAP and IFRS are believed to be declined. The messages

from the SEC are clear that they will eventually mandate publicly-listed U.S. companies

to prepare financial statements in accordance with IFRS if certain conditions are met and

if IFRS adoption will be in the public interest. More importantly, there is some evidence

indicating that corporate executives have anticipated the mandatory adoption of IFRS in

the U.S. and support early adoption of IFRS. Although the SEC has estimated the

16

transition costs of IFRS adoption to U.S. companies in its 2008 roadmap, it is essential

to address the overall costs as well as the potential benefits in order to evaluate the

economic desirability of those costs (Henry et al. 2009). Since the costs and benefits of

the adoption of IFRS are not observable, previous studies have investigated the net effect

of the adoption of IFRS in the E.U. member states using the event study methodology

(e.g. Comprix et al. 2003, Armstrong et al., 2009; Landsman et al. 2009). More

importantly, it is unclear how investors react to the potential adoption of IFRS in the U.S.

given the fact that many countries in the world have either required or permitted IFRS.

This study contributes to the literature by examining the perception of investors about the

potential adoption of IFRS in the U.S. More specifically, we investigate how U.S.

investors react to 12 major events associated with the likelihood of adopting IFRS in the

U.S.

IV Data, Sample, and Methodology Data and Sample Selection

All the data items used in this study were obtained from Global Vantage and

CRSP under the WRDS database. Abnormal return is derived from the market-adjusted

model; CRSP value-weighted market index is used to construct market return. We follow

the SEC to identify U.S. companies that are included in the worlds largest 20 companies,

based on their market capitalization as of December 31, 2007. The SEC also limits the

option of early adoption to the worlds largest U.S. companies in industries where IFRS

is the most-used set of standards globally. The SEC provides two major reasons for this

exception (SEC Roadmap, 2008, p.30-32). First, it would allow the financial information

of certain large U.S. companies to be more comparable to the financial information of

their non-U.S. counterparts in the same industry. Second, allowing certain large U.S.

companies to file IFRS financial statements would attract the awareness and attention to

IFRS as a single set of high-quality internationally accepted accounting standards. The

SEC believes this is a prudent approach because the decision to mandate the use of IFRS

by all U.S. companies still depends on whether the seven milestones in the proposed

17

Roadmap are achieved. The SEC provides the following steps to identify the largest

U.S. companies worldwide and the eligible early adopters:

a. Using a certain industry classification system to identify a companys

industry group. The SEC allows several different industrial

classification codes to be used for this purpose18;

b. Identifying the largest 20 companies worldwide in each industry by

market capitalization as of December 31, 2007;

c. Ascertaining which accounting standards each of the largest 20

companies use for financial reporting purposes;

d. Determining whether IFRS is used as the basis of financial reporting

more than any other systems of financial reporting by the largest 20

companies worldwide in each industry. The SEC provides some specific

examples for identification purposes19.

Using two-digit Standard Industrial Classification (SIC) codes as assigned by

COMPUSTAT, the SEC estimates that approximately 110 U.S. companies in the 34

IFRS industries would be eligible for early adoption of IFRS using the above criteria.

These companies have a total market capitalization of $2.5 trillion as of December 2007,

which represented approximately 12% of the total U.S. market capitalization, with a

mean of $23 billion and a median of $8.3 billion. The SEC also admits the potential

18

18 The SEC Roadmap (2008, p. 54) allow several industry classification systems including North American Industry Classification System (NAICS) code at the three-digit level, Standard Industrial Classification (SIC) codes at the two-digit level, or the International Standard Industrial Classification (ISIC) codes at the Division level. Other systems could be allowed if the issuer could use a privately provided, published, and widely accepted industry classification system at a similar level of detail. 19 The SEC made the following examples. If among the top 20 companies there are 4 using IFRS, 3 using U.S.GAAP and 13 using other bases of financial reporting with no single other basis accounted for more then 3, then the industry is regarded as an IFRS industry. If there are 8 companies using U.S.GAAP, 7 using IFRS and 5 using other systems of financial reporting, then the industry also would not be an IFRS industry and the U.S. companies are not eligible to use IFRS.

problems for the above selection process due to certain underlying assumptions and data

availability

19

20.

Consistent with the above process, we follow the steps below to identify the

worlds largest U.S. companies and the most-used accounting standards for financial

reporting purposes in their industries.

a. We find 73 industries using two-digit SIC codes. Industries with 2-digit

SIC codes greater than 90 (miscellaneous industries) were deleted;

b. Companies covered by Global Vantage must have market values

available as of December 31 2007;

c. The worlds largest U.S. companies are the U.S. companies that are

included in the worlds largest 20 companies in each industry, based on

their market values as of December 31, 2007. We deleted industries

with less than 20 companies worldwide;

d. IFRS or U.S.GAAP is used as the basis of financial reporting more than

any other systems of financial reporting by the largest 20 companies

worldwide in each industry.21 We then classified the worlds largest

U.S. companies into those in IFRS or U.S.GAAP industries.

IFRS versus U.S.GAAP companies

We obtained a sample of 67 industries, including 34 IFRS and 33 US GAAP

industries respectively, and 405 U.S. companies (107 U.S. companies in IFRS industries

and 298 U.S. companies in U.S.GAAP industries). However, only 303 companies (i.e.

100 U.S. companies in IFRS industries and 203 companies in U.S.GAAP industries) have

the data available for further analyses. Table 2A provides the distribution of the worlds

20 Footnote 104 of the SEC Roadmap clearly states that the number of eligible companies could be different when using different industry classification systems to determine eligibility.

21 There are 13 different accounting standards codes in Global Vantage database. We follow previous studies to classify firms with DI (i.e. domestic standards generally in accordance with or fully complaint with IFRS) as IFRS companies, DU as US standards, and DS as domestic standards.

largest U.S. firms by industries based on their market capitalization as of December 31,

2007. We find that all industries are classified as either IFRS or U.S.GAAP industries

using the criteria from the SEC roadmap, indicating that both sets of standards are

dominating and competing in global markets. Table 2B shows that 459 of the worlds

largest companies used IFRS to prepare their 2007 financial statements with a majority of

these companies from UK (103), Australia (45), Germany (40), France (65), and

Netherlands (22). However, although 441 top companies used U.S.GAAP to prepare their

2007 financial statements a majority of them are U.S. companies (405). Some companies

from Japan (11), Singapore (10), and Canada (6) used U.S.GAAP for their 2007 financial

statements. Further analysis shows that most of these companies are cross-listed in U.S.

capital markets. Table 2B also shows that many countries have more companies in IFRS

industries than in U.S.GAAP industries. For example, Australia, Brazil, China, German,

Spain, France, the UK, Hong Kong, Malaysia, Netherlands, Russia, and Singapore have

much more companies in IFRS industries than in U.S.GAAP industries. In contrast,

Canada, India, Israel, Japan, Taiwan, and USA have much more companies in U.S.GAAP

industries than in IFRS industries. Table 2C provides the distribution of the worlds

largest U.S. companies in each industry. We find that U.S. companies appear in all 67

industries. U.S. companies in U.S.GAAP industries are mainly concentrated in office

furniture, machinery and equipment, medical equipment and supplies, and retail

industries etc. On the other hand, U.S. companies in IFRS industries are concentrated in

mining, fabric and clothing, paper and containers, printing, chemical, petroleum and

plastic, furniture, and amusement and recreation industries.

-------------------------------

Insert Table 2 here

-------------------------------

Firm Characteristics

We provide descriptive statistics for U.S. companies in U.S.GAAP (203 firms)

and in IFRS (100 firms) industries and examine the differences in their firm

20

characteristics. Table 3 shows that U.S. companies in both groups are significantly

different in terms of accounting performance (ROA), earnings per share (EPS), share

price (PRICE), book value of equity per share (BKVL), and the average firm size,

measured by the natural log of the market value at the end of 2007. U.S. companies in

IFRS industries are generally larger but less profitable than U.S. companies in U.S.GAAP

industries. Table 3 also shows that our 100 U.S. companies in IFRS industries have the

mean market capitalization of $36 billion compared to $23 billion for the 110 U.S.

companies as selected by the SEC. However, the median market capitalization of $9

billion for our 100 U.S. companies in IFRS industries is very close to that of $8.3 billion

for the 110 U.S. companies as selected by the SEC. On the other hand, the total capital

capitalization of the largest U.S. companies in IFRS industries is $3.6 trillion compared

to $2.5 trillion from the U.S. companies as selected by the SEC according to the SEC

criteria.

-------------------------------

Insert Table 3 here

-------------------------------

V. Main Results

We report several different sets of results. First, we report investors reactions to

individual 12 major events. We also follow Armstrong et al. (2009) to report the

cumulative abnormal return around these events because the likelihood of the adoption of

IFRS in the U.S. could evolve over a number of years. Second, we classified U.S.

companies into two groups: the largest U.S. companies in IFRS and U.S.GAAP industries

respectively. Finally, for each set of the empirical results, we report two test statistics.

The first statistic based on a standard t-test examines whether the abnormal return around

each event differs from zero. The second statistic based on a standard t-test examines

whether the mean abnormal return for U.S. companies in IFRS industries differs from

that for U.S. companies in U.S.GAAP industries. The purpose of the second test is to

examine whether the SEC Roadmap is correct that U.S. companies in IFRS industries can

21

benefit more from IFRS adoption than U.S. companies in U.S.GAAP industries. We

report the empirical results in the next section.

The worlds largest U.S. companies in IFRS and U.S.GAAP industries

Panel A of Table 4 reports the market reactions around individual 12 major

events. We find positive (negative) and significant market reactions to 5 (2) out of 12

events. Among them, the event associated with the SEC roundtable on the performance

of IFRS and US GAAP during the sub-prime crisis appears to have the highest mean

abnormal return (1.59% on August 4, 2008), following by the events associated with

developing a roadmap to migrate U.S. companies to IFRS (1.30%, February 8, 2008), the

SEC and CESR work plan on the application by internationally active companies of IFRS

and U.S.GAAP in the U.S. and the E.U. respectively (0.54%, August 2, 2006), proposed

a roadmap towards global accounting standards (0.38%, August 27, 2008), and the SEC

staff roundtable on the roadmap to eliminate the need for non-U.S. companies to disclose

IFRS-U.S.GAAP reconciliation disclosure (0.27%, February 13, 2007). The cumulative

abnormal return around all 12 major events, however, is positive (0.15%) and significant

at the 5% level (t value = 2.17, p-value = 0.03).

Panel B shows that U.S. companies in IFRS industries have positive mean

abnormal return for 10 events with 3 out 10 events having statistically significant

abnormal returns. They are events associated with developing a roadmap to transition

U.S. companies to IFRS (1.66%, February 8, 2008), a proposed roadmap toward global

accounting standards (1.22%, August 27, 2008), and the SEC and CESR work plan on the

application by internationally active companies of IFRS and U.S.GAAP in the U.S. and

the E.U. respectively (1.07%, August 2, 2006). The mean (median) cumulative abnormal

return is 0.49% (0.34%), significant at less than 1% level (t-value = 4.01, p-value =

0.001). Panel B also shows that U.S. companies in U.S.GAAP industries have positive

mean abnormal return only in 5 events with 2 out of 5 events having statistically

significant abnormal returns. Events associated with developing a roadmap to migrate

U.S. companies to IFRS (1.10%, February 8, 2008) and the SEC roundtable on the

performance of IFRS and US GAAP during the sub-prime crisis appear to have the

22

highest mean abnormal return (1.81% on August 4, 2008). In contrast, the SEC concept

release soliciting input on whether U.S. companies should be permitted to use IFRS (-

1.14%, August 7, 2007) and the proposed roadmap towards global accounting standards

(-1.60%, November 14, 2008) have negative and significant abnormal returns. This

indicates that investors of U.S. companies in U.S.GAAP industries did not perceive the

potential adoption of IFRS in the U.S. as good news.

U.S. companies in IFRS industries appear to have higher mean (median)

abnormal returns than U.S. companies in U.S. industries in 9 (9) out of 12 events. A

standard t test (Wilcoxon test) shows that the differences in mean (median) abnormal

return between these two groups of firms is significant in 4 (6) events. The cumulative

abnormal return of U.S. companies in IFRS industries (0.49%) is much higher than that

of U.S. companies in U.S.GAAP industries (0.00%). A standard t test shows that the

difference in cumulative abnormal return is significant at less than 1% level (t-value =

3.28, p-value = 0.001). Similar result is found when using the Wilcoxon test (t-value =

3.10, p-value = 0.001).

We further divided 12 major events into 2 categories. They are events associated

with elimination of IFRS-U.S.GAAP reconciliation and developing a roadmap to migrate

U.S. companies to IFRS. Unreported results indicate that the cumulative abnormal return

around six events associated with elimination of IFRS-U.S.GAAP reconciliation is

0.23%, significant at the 10% level (t-value = 1.8 p-value = 0.072) for U.S. companies in

IFRS industries. There is no significant cumulative abnormal return around the same

events for U.S. companies in U.S.GAAP industries. The median difference in cumulative

abnormal return between the two groups of firms is significant at the 10% level (t-value =

1.35, p-value = 0.089). On the other hand, the cumulative abnormal return around six

events associated with developing a roadmap to migrate U.S. companies to IFRS is

0.75%, significant at less than 1% level (t-value = 3.60 p-value < 0.001) for U.S.

companies in IFRS industries. Again, there is no significant cumulative abnormal return

around the same events for U.S. companies in U.S.GAAP industries. Both the mean and

median differences in cumulative abnormal return between the two groups of firms are

significant at less than 1% level (t-value = 2.99 and 2.89, p-value = 0.003 and 0.002,

respectively).

23

Overall, Table 4 provides consistent evidence indicating that investors of the

worlds largest U.S. companies in IFRS industries perceive convergence benefit from

adoption of IFRS. Consistent with the SEC Roadmap, large U.S. companies in IFRS

industries can benefit more from IFRS adoption than other large U.S. companies.

-------------------------------

Insert Table 4 here

-------------------------------

All U.S. companies

Using all the U.S. companies (4,191 companies per year) with return data available in the

CRSP throughout the period of 2002-2008, we examine the market reaction to 16 IFRS-

related events including four events associated with the adoption of IFRS in E.U. member

states and the convergence projects between FASB and IASB, 6 events associated with

elimination of IFRS-U.S.GAAP reconciliation disclosure, and 6 events associated with

developing a roadmap to transition U.S. companies to IFRS. Panel A of Table 5 shows

that 12 out of 16 events have negative and significant abnormal return including the event

associated with E.C. endorsement on all extant IFRS. Only 3 out of 16 events have

positive and significant abnormal return including the Norwalk Agreement between

FASB and IASB that aimed to eliminate major differences between U.S.GAAP and IFRS

(0.66%, March 12, 2002), FASB and IASB memorandum of understanding to formalize

their commitment to the convergence of US GAAP and IFRS (0.86%, September 18,

2002), and European Parliaments resolution requiring all EU listed companies to use

IFRS by 2005 (1.45%, October 29, 2002). More importantly, the average cumulative

abnormal return around these 16 events is -0.51%, significant at less than 1% level (t-

value = -16.22 and p-value < 0.001).

Panel B reports the average cumulative abnormal returns around 16 IFRS-related

events by categories. Events associated with E.U. adoption of IFRS have a zero average

cumulative abnormal return; events associated with the convergence projects between

24

FASB and IASB have a positive average cumulative abnormal return (1.16%),

significant at less than 1% level (t-value = 12.14, p-value < 0.001); events associated with

elimination of IFRS-U.S.GAAP reconciliation and developing a roadmap to migrate U.S.

companies to IFRS have consistent negative cumulative abnormal returns (-0.28% and -

0.74%, respectively), significant at less than 1% level (t-value = -8.00 and -16.49, p-value

< 0.001).

In summary, results in Table 5 indicate that overall investors welcomed the

convergence projects between FASB and IASB but negatively reacted to the potential

adoption of IFRS in the U.S. Overall, our finding is consistent with the lower reporting

quality effect that investors may have concerns about quality of IFRS and/or expect the

cost of adopting IFRS in the U.S. to exceed its potential benefit.

-------------------------------

Insert Table 5 here

-------------------------------

To further investigate our findings reported in Tables 4 and 5, we compare the

cumulative abnormal returns around 12 major events between U.S. companies in IFRS

industries, U.S. companies in U.S.GAAP industries, and other U.S. companies. Table 6

shows that U.S. companies in IFRS industries consistently have statistically higher

cumulative abnormal return than U.S. companies in U.S.GAAP industries (t-value =

3.28, p-value = 0.001) and other U.S. companies (t-value = 6.13, p-value < 0.001). In

addition, U.S. companies in U.S.GAAP industries have statistically higher cumulative

abnormal return than other U.S. companies (t-value = 8.27, p-value < 0.001). Similar

results apply to events associated with the elimination of IFRS-U.S.GAAP reconciliation

disclosure and developing a roadmap to transition U.S. companies to IFRS. There is no

difference in cumulative abnormal return around events associated with elimination of

IFRS-U.S.GAAP reconciliation disclosure between U.S. companies in IFRS industries

and U.S. companies in U.S.GAAP industries.

Overall, Table 6 confirms the results reported in Tables 4 and 5 that U.S.

companies in IFRS industries are expected to benefit more from IFRS adoption than U.S.

25

companies in U.S.GAAP industries and other U.S. companies. We also find that overall

investors negatively reacted to the potential adoption of IFRS in the U.S. This is robust

after deleting both U.S. companies in IFRS and U.S.GAAP industries.

-------------------------------

Insert Table 6 here

-------------------------------

VI Robustness Test

Regression analysis

As a robustness test, we perform and report the OLS regression results in Table 7.

The regression model is as follows.

i

iiiidaydayi

DUMMYINDBDUMYYEARIFRSLNMKVLBETABMCAR

+++++++=+

__ 65

4321)1,1(

Where

CARi(day-1,day+1): cumulative abnormal return around individual event dates for firm i; BMi: book value per share divided by market price per share for firm i at the end of the

year before related event dates; BETAi: company beta for firm i the year before related event dates; LNMKVi: natural logarithm of the market value of equity at the end of the year before

related event dates; IFRS: 1 if firm i is in IFRS industry, 0 otherwise YEAR_DUMMY: year dummy variables IND_DUMMY: two-digit SIC code industry dummy variables

26

Panel A of Table 7 shows that IFRS (1 if U.S. companies are in IFRS industries

and 0 if U.S. companies are in U.S.GAAP industries) is positively associated with

cumulative abnormal return around 12 major events (t-value = 2.93, p-value = 0.003) and

the events associated with developing a roadmap to transition U.S. companies to IFRS (t-

value = 2.43, p-value = 0.024) after controlling for market-to-book value ratio, company

size, beta and industries. Panel B of Table 7 shows that IFRS (1 if U.S. companies are in

IFRS industries, 0 if U.S. companies are not in IFRS or U.S.GAAP industries) is also

positively associated with cumulative abnormal return around all 12 major events (t-value

= 4.14, p-value < 0.001) and the events associated with the elimination of IFRS-

U.S.GAAP reconciliation disclosure (t-value = 2.82, p-value < 0.005) and developing a

roadmap to migrate U.S. companies to IFRS (t-value = 3.99, p-value < 0.001) after

controlling for other factors. This again confirms that the worlds largest U.S. companies

in IFRS industries have statistically higher positive market reaction to major IFRS events

in the U.S. than other U.S. companies.

-------------------------------

Insert Table 7 here

-------------------------------

Accounting difference and inventory cost method

We also conduct the following robustness tests to investigate whether the above

reported results are driven by certain companies or industries. First, we investigate

whether firm-specific accounting difference between U.S.GAAP and IFRS may affect

investors perception about the potential adoption of IFRS in the U.S. Unreported result

show that using a sample of 75 companies with IFRS-U.S.GAAP reconciliation data

available in their 2006 Form 20-F22, we find no significant difference in the cumulative

abnormal return between companies with high or low (greater or lower than median

accounting difference, respectively) accounting difference in net income in 2006. We

27

22 These companies are in 22 industries. We also examine and find that our results are not driven by any individual industries.

also investigate whether the inventory cost method used by companies may affect

investors perception about the potential adoption of IFRS in the U.S. This is because

IFRS does not allow LIFO inventory method and many U.S. companies have used LIFO

method for their financial and tax reporting purposes. Unreported result shows no

significant difference in the average cumulative abnormal return between companies

using LIFO and FIFO inventory method.

VII conclusion

This study examines the extent to which investors of U.S. companies reacted to

12 major events associated with the likelihood of adopting IFRS in the U.S. during the

period of 2005-2008. Following the criteria provided by the SEC, we identify a group of

the largest U.S. companies worldwide and classify these companies into companies in

IFRS or U.S.GAAP industries. Using a traditional event study methodology, we find that

investors of the largest U.S. companies in IFRS industries positively reacted to 12 major

events. We also find that these companies experience statistically higher cumulative

abnormal return around these events than the worlds largest U.S. companies in

U.S.GAAP industries and other U.S. companies. This indicates that investors of U.S.

companies in IFRS industries expect convergence benefit from IFRS adoption. This

finding is generally consistent with the SEC roadmap that allowing limited use of IFRS in

the U.S. would enhance the comparability of an industrys financial reporting. This study

also provides consistent evidence indicating that overall investors negatively reacted to

the potential adoption of IFRS in the U.S. This is consistent with the lower reporting

quality effect that investors may have concerns about quality of IFRS and/or expect the

cost of adopting IFRS in the U.S. to exceed its benefit. This study is the first study of this

kind to provide empirical evidence to help the SEC inform the decision as to whether to

mandate the use of IFRS for U.S. public companies.

28

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Li, S. 2010. Does Mandatory Adoption of International Financial Reporting Standards in the

European Union Reduce the Cost of Equity Capital? The Accounting Review 85: 607-636.

Landsman, W. R., E. L. Maydew, J. R. Thornock, and M. C. Building. 2009. The Information

Content of Annual Earnings Announcements and Mandatory Adoption of IFRS. Working Paper,

University of North Carolina-Chapel Hill.

PricewaterhouseCoopers, 2009. IFRS Perspective: An Executive Survey.

Van der Meulen, S, A. Gaeremynck, and M. Willekens. 2007. Attribute differences between

U.S.GAAP and IFRS earnings: An exploratory study. The International Journal of Accounting

42: 123-142.

Securities and Exchange Commission (SEC). 2008. Roadmap for the Potential Use of Financial

Statements Prepared in Accordance with International Financial Reporting Standards by U.S.

Companies. Washington, DC.

30

Soderstrom, N. and K. Sun. 2007. IFRS Adoption and Accounting Quality: A Review.

European Accounting Review 16: 675-702

31

Table 1: IFRS Events

Event Date Description Categories

Events before

2005

These events may be associated with the likelihood of the adoption of IFRS in the U.S.

1) Sept. 18 2002 The Norwalk Agreement between FASB and IASB aimed to eliminate major differences between US GAAP and IFRS, align the two Boards future work agenda, and work together on several joint projects

Convergence project

2) Oct. 29 2002 FASB and IASB issued a memorandum of understanding marking a significant step toward formalizing their commitment to the convergence of US GAAP and IFRS

Convergence project

3) Mar. 12 2002 European Parliament passed resolution requiring all EU listed companies to use IFRS by 2005

EU adoption of IFRS

4) Sept. 29 2003 EC endorses all extant IFRS, except IAS 32 and IAS 39

EU adoption of IFRS

Events after the beginning of 2005

These events are associated with the likelihood of the adoption of IFRS in the U.S.

Categories

5) Apr. 24 2005 SEC proposed a roadmap to eliminate U.S.GAAP Reconciliation disclosure in Form 20-F

Elimination of reconciliation requirement

6) Feb. 8 2006 SEC Chairman Christopher Cox and EU commissioner McCreevy affirmed their commitment to eliminate the need of the reconciliation requirements

Elimination of reconciliation requirement

7) Aug. 2 2006 SEC and CESR launched work plan, focusing on the application by internationally active companies of IFRS and US GAAP in the United States and the European Union, respectively

Elimination of reconciliation requirement

32

Table 1: IFRS Events (continued)

Events after the beginning of 2005

These events are associated with the likelihood of the adoption of IFRS in the U.S.

Categories

8) Feb. 13 2007 SEC staff roundtable on the roadmap that describes the path toward eliminating the need for non-US companies to reconcile to US GAAP financial statements they prepare pursuant to IFRS issued by the IASB in filings with the SEC

Elimination of reconciliation requirement

9) July 3 2007 SEC proposed to accept from foreign private issuers of financial statements prepared in accordance with IFRS without reconciliation to U.S.GAAP

Elimination of reconciliation requirement

10) Aug. 7 2007 SEC issued a concept release soliciting input on whether U.S. issuers should be permitted to prepare their financial statements using IFRS as published by the IASB

Potential adoption of IFRS

11) Nov. 15 2007 SEC voted to eliminate the reconciliation requirement, signaling to many that the SEC accepts IFRS as high-quality accounting standards

Elimination of reconciliation requirement

12) Dec. 12 2007 SEC roundtable on IFRS in the U.S. markets

Potential adoption of IFRS

13) Feb. 8 2008 SEC Chairman Christopher Cox directed the commission to develop a roadmap, including a series of rulemaking efforts, to migrate U.S. issuers to IFRS.

Potential adoption of IFRS

14) Aug. 4 2008 SEC Roundtable on the performance of IFRS and US GAAP during the sub-prime crisis

Potential adoption of IFRS

15) Aug. 27 2008 SEC proposed a roadmap toward global accounting standards to help investors compare financial information more easily. This roadmap could result in requiring U.S. issuers to use IFRS beginning in 2014

Potential adoption of IFRS

16) Nov. 14,

2008

SEC published a roadmap on its implementation of IFRS

Potential adoption of IFRS

33

Table 2: IFRS versus US GAAP Industries

Panel A: Top 20 companies in IFRS or US GAAP industries

2- DIGIT SIC CODE

US GAAP FIRMS

IFRS FIRMS

OTHER GAAP

IFRS (1) versus US GAAP (0) INDUSTRY

01 2 4 14 1 02 1 6 13 1 07 4 3 13 0 08 1 10 9 1 10 3 10 7 1 12 4 5 11 1 13 8 4 18 0 14 5 8 7 1 15 2 6 12 1 16 3 13 4 1 17 4 9 7 1 20 4 13 3 1 21 5 6 9 1 22 4 2 14 0 23 7 11 2 1 24 5 6 9 1 25 12 4 4 0 26 5 9 6 1 27 6 11 3 1 28 5 11 4 1 29 4 13 3 1 30 7 6 7 0 31 7 6 7 0 32 1 10 9 1 33 2 7 11 1 34 8 7 5 0 35 12 3 5 0 36 8 8 4 0 37 7 6 7 0 38 12 4 4 0 39 6 6 8 0 40 7 3 10 0 41 2 5 13 1 42 7 7 6 0 44 2 8 10 1 45 2 12 6 1 46 10 2 8 0 47 3 12 5 1 48 3 12 5 1 49 2 10 9 1 50 4 4 12 0 51 6 8 6 1

34

Panel A: Top 20 companies in IFRS or US GAAP industries (Continued) 2- DIGIT SIC CODE

US GAAP FIRMS

IFRS FIRMS

OTHER GAAP

IFRS (1) versus US GAAP (0) INDUSTRY

52 4 11 5 1 53 7 7 6 0 54 5 11 4 1 55 8 3 9 0 56 11 6 3 0 57 5 9 6 1 58 10 9 1 1 59 11 5 4 0 60 7 11 2 1 61 16 0 4 0 62 16 3 1 0 63 10 4 6 0 64 13 4 3 0 65 8 1 11 0 67 18 2 0 0 70 2 11 7 1 72 9 5 6 0 73 12 5 3 0 75 8 7 5 0 78 8 2 10 0 79 7 9 4 1 80 10 9 1 0 82 11 2 7 0 83 7 6 7 0 87 6 7 7 1 TOTAL 441 459 451 34

35

Panel B: Top 20 companies in IFRS and US GAAP industries by country of origin

COUNTRY Firms using

IFRS Firms using US GAAP

OTHER GAAP

US GAAP INDUSTRY

IFRS INDUSTRY

United Arab Emirates 1 0 0 1 0 Australia 45 0 0 28 17 Austria 3 0 0 2 1 Belgium 5 0 0 4 1 Bermuda 1 0 9 4 6 Brazil 0 2 30 21 11 Canada 0 6 58 23 41 Switzerland 20 0 0 10 10 China 15 3 65 46 37 Czech Republic 1 0 0 1 0 Germany 40 0 0 25 15 Denmark 6 0 0 4 2 Egypt 1 0 1 2 0 Spain 21 0 0 18 3 Finland 10 0 0 6 4 France 65 0 -3 46 16 UK 103 0 -3 63 37 Greece 6 0 -1 3 2 Hong Kong 15 1 53 41 28 Ireland 6 0 0 5 1 Iceland 5 0 0 3 2 Israel 2 0 4 2 4 Italy 19 0 0 11 8 Jamaica 1 0 0 1 0 Jordan 1 0 0 1 0 Japan 0 11 137 67 81 Korea 1 0 60 34 27 Kuwait 2 0 0 2 0 Luxembourg 6 0 0 6 0 Latvia 1 0 4 0 5 Netherland 22 0 0 13 9 Norway 7 0 0 5 2 New Zealand 2 0 0 1 1 Poland 4 0 0 2 2 Portugal 3 0 0 3 0 Romania 1 0 0 1 0 Russia 6 3 15 13 11 Singapore 1 10 15 17 9 Slovenia 2 0 0 1 1 Sweden 7 0 0 5 2 USA 0 405 0 107 298 South Africa 9 0 0 6 3 TOTAL 459 441 451 654 697

36

Panel C: Firms used for empirical tests (only US firms with data available to calculate abnormal return in CRSP)

Original set Used for empirical test

2- DIGIT SIC CODE

US firms in US GAAP industry

US firms in IFRS industry

US firms in US GAAP industry

US firms in IFRS

industry

1 0 2 0 2 2 0 1 - - 7 3 0 3 0 8 0 3 - - 10 0 2 0 2 12 0 3 0 3 13 8 0 8 0 14 0 5 0 5 15 0 2 0 2 16 0 3 0 3 17 0 2 0 2 20 0 3 0 3 21 0 3 0 3 22 4 0 4 0 23 0 6 0 6 24 0 3 0 3 25 10 0 10 0 26 0 5 0 5 27 0 6 0 6 28 0 5 0 5 29 0 3 0 3 30 7 0 7 0 31 7 0 7 0 32 0 2 0 2 33 0 1 0 1 34 8 0 8 0 35 10 0 10 0 36 7 0 5 0 37 6 0 5 0 38 11 0 11 0 39 6 0 6 0 40 6 0 5 0 41 0 2 0 2 42 7 0 7 0 44 0 3 0 3 45 0 3 0 3 46 9 0 9 0 47 0 4 0 4 48 0 3 0 3 49 0 2 0 2 50 3 0 3 0

37

Panel C: Firms used for empirical tests (continued)

Original set Used for empirical test

2- DIGIT SIC CODE

US firms in US GAAP industry

US firms in IFRS industry

US firms in US GAAP industry

US firms in IFRS

industry

51 0 6 0 6 52 0 4 0 4 53 6 0 6 0 54 0 4 0 4 55 5 0 5 0 56 10 0 10 0 57 0 6 0 6 58 9 0 8 0 59 9 0 6 0 60 0 2 - - 61 16 0 - - 62 16 0 - - 63 10 0 - - 64 13 0 1 0 65 8 0 1 0 67 18 0 - - 70 0 3 0 2 72 9 0 8 0 73 11 0 9 0 75 8 0 7 0 78 7 0 7 0 79 0 5 0 5 80 8 0 8 0 82 11 0 8 0 83 6 0 5 0 87 6 0 6 0 Total 298 107 203 100

38

Table 3: Differences in firm characteristics

Firms in US GAAP industries Firms in IFRS industries Difference

Variable Mean Median Std Dev Mean Median Std Dev t-TEST (p-value)

WILCOXON (p-value)

ANALYST 11.7 11 6.9 11.23 11 4.88 -0.62(0.55) 0.28(0.39) MKVL(M) 20407.2 4510.08 38954.99 36071.67 9050.45 69416.98 2.51(0.03) 3.45(0.00) PRICE ($) 48.54 37.91 55.7 61.58 44.8 80.78 1.45(0.15) 2.24(0.03)

ROA 0.05 0.06 0.1 0.02 0.05 0.16 -1.98(0.05) -1.18(0.12) LOSS 0.15 0 0.36 0.21 0 0.4 1.16(0.26) 1.13(0.13)

BKVL ($) 13.31 10.01 12.42 17.36 12.58 30.62 1.27(0.27) 2.48(0.01) EPS ($) 1.54 1.71 3.77 0.39 1.85 5.95 -1.77(0.08) 0.77(0.22)

LEV 0.58 0.56 0.24 0.59 0.6 0.17 0.52(0.64) 1.08(0.23) BM 0.34 0.29 0.46 0.31 0.29 0.19 -0.77(0.44) 0.28(0.39)

Notes:

ANALYST: number of analysts following during 2007;

MAKVL: Market value of shareholders equity at end of 2007, measured by million dollars.

PRICE: Share price at the end of 2007, measured by dollars.

ROA: return on total assets for 2007;

LOSS: proportion of firms that recognized net loss for 2007;

BKVL: book value of shareholders equity per share for 2007, measured by dollars;

EPS: earnings per share for 2007, measured by dollars.

LEV: leverage ratio (total debts/total shareholders equity) at the end of 2007;

BM: book value to market value ratio at the end of 2007.

39

Panel A: Three-day (day-1, 0, and 1) cumulative abnormal return

Table 4 Market reaction to IFRS Adoption in the U.S.

303 largest U.S. Firms worldwide

Event dates Mean% Median

% Std

Dev% t-value

(p-value) 5) April 24, 2005 -0.07 -0.28 3.06 -0.38 (0.704) 6) Feb. 08 2006 -0.06 0.36 3.71 -0.29 (0.773) 7) Aug. 2 2006 0.54 0.61 3.26 2.83 (0.005) 8) Feb. 13 2007 0.27 -0.05 2.40 1.94 (0.053) 9) Jul. 03 2007 -0.05 -0.28 2.09 -0.40 (0.689)

10) Aug. 7 2007 -0.53 -0.53 5.19 -1.77 (0.078) 11) Nov. 15 2007 -0.12 0.13 3.51 -0.61 (0.543) 12) Dec. 12 2007 -0.31 0.14 3.52 -1.50 (0.134) 13) Feb. 8 2008 1.30 0.92 3.92 5.74 (

41

U.S. companies in IFRS industries U.S. companies in U.S.GAAP industries Difference

Event dates Obs. Mean %

median %

Std Dev%

t-value (p-value) Obs.

Mean

%

Median %

Std Dev

t-value (p-value)

t (p-value)

Wilcoxon (p-value)

5) April 24 2005 100 0.11 0.22 2.56 0.40 (0.689) 203 -0.16 -0.54 3.29 -0.66 (0.508) 0.74 (0.457) 1.41 (0.080)

6) Feb. 08 2006 100 -0.44 0.17 4.44 -1.00 (0.322) 203 0.11 0.44 3.28 0.46

(0.643) -1.10 (0.274) -0.78

(0.217) 7) Aug. 2 2006 100 1.07 0.70 3.29 3.25 (0.002)

203 0.29 0.61 3.24

-1.26 (0.210) 1.93 (0.055) 1.47 (0.071)

8) Feb. 13 2007 100 0.31 -0.07 1.91 1.60 (0.112) 203 0.22 -0.54 2.62 1.18

(0.241) 0.35 (0.729) 0.22 (0.413)

9)Jul. 03 2007 100 0.03 -0.32 2.59 0.10 (0.918) 203 -0.06 -0.25 1.89 -0.45

(0.654) 0.30 (0.767) -0.64 (0.260)

10) Aug. 7 2007 100 0.84 0.62 5.54 1.50 (0.137) 203 -1.14 -1.37 4.91 -3.31

(

42

Table 5 Market Reaction to all IFRS-related Events

Panel A: Three-day cumulative abnormal return

All 4191 U.S. Firms

Event dates Mean% Median

% Std

Dev% t-value

(p-value) 1) Mar. 12 2002 0.66 0.52 6.05 6.40 (

43

IFRS firms

US GAAP firms Other firms

Mean difference

IFRS vs. US GAAP

Mean difference IFRS vs. Other

Mean difference USGAAP vs. Other

Mean median t-value Mean t-value Mean Median t-value Event dates % % (p-value) %

Median % (p-value) % % (p-value)

t (p-value)

t (p-value)

t (p-value)

Obs=1,200 Obs=2,436 Obs=46,656

All 0.49 0.34 4.01

(

Table 7: Regression Results

Panel A: IFRS versus US GAAP Firms

Model:

FULL

OBS (3,636)

ELIMINATION OF RECONCILIATION

OBS (1,818)

POTENTIAL ADOPTION OF IFRS

OBS (1,818)

Variable Coefficient t-value

(p-value) Coefficient t-value

(p-value) Coefficient t-value

(p-value) Intercept -0.020 -4.14

(

Panel B: IFRS versus other US companies

FULL

OBS (47850)

ELIMINATION OF RECONCILIATION

OBS (23,928)

POTENTIAL ADOPTION OF IFRS

OBS (23,928)

Variable Coefficient t-value

(p-value) Coefficient t-value

(p-value) Coefficient t-value

(p-value) Intercept -0.009 -7.76

(