Cost of Equity Effects from Mandatory IFRS Adoption, Legal and Financial Institutions, and Auditor Quality Dimensions: Evidence from the E.U.

Abstract

This study examines if cost of equity can be negatively affected by mandatory IFRS adoption. Also, this paper explores how cost of equity effects differ depending on different national level of governance mechanisms because financial reporting incentives are influenced by both accounting regulation and institutional factors. While I document that mandatory IFRS adoption negatively influences cost of equity beyond the transition period, however, such observed results may also be attributed to the concurrent evolving effects from legal quality and enforcement, stock market development and auditor quality. Given that most cross-country national governance studies only apply a set of dated and static indices; I argue that using, time-varying and cross-sectional institutional indices can provide better measurement of both individual and interactive effects on firm-level cost of equity. While average legal mechanisms are an important factor, the results show that increase (decrease) in regulatory quality (legal enforcement) interacts with post-IFRS period significantly (insignificantly) and associate with lower (higher) ex-ante cost of equity. Moreover, I find that countries with different legal origins systematically associate with different dimensions of stock market development to reduce the cost of equity. Also, auditor quality is effective to reduce information asymmetry, but it highly depends on national legal quality and enforcement. Finally, I document that when cost of equity is lowered, it benefits firms with higher value.