Donor aid allocation and accounting standards of recipients

Abstract

How do donor countries determine foreign aid allocation? The literature seems to agree that institutional quality could be a possible determinant. However, no study has found any decisive variable to represent this factor. Recently, an increasing number of countries, developed as well as developing, have been adopting International Financial Reporting Standards (IFRS) as a single set of high-quality global accounting standards. IFRS aims to generate accurate financial information and to remove information asymmetry, thereby potentially improving corporate governance and performance in firms. We hypothesize that donors allocate more aid to mandatory IFRS-adopting recipients than nonadopting ones, expecting higher aid effectiveness in the recipients. Our bilateral panel data analysis on commitment flows between 28 Development Assistance Committee (DAC) donors and more than 90 recipients shows that, upon mandatory IFRS adoption by a recipient, donors increase the amount of aid by approximately 20%.