International Financial Reporting Standards, Institutional Infrastructures and Costs of Equity Capital around the World

Abstract

We construct a large sample of 21,608 firm-years with International Financial Reporting Standards (IFRS) adopters and non-adopters from 34 countries over the 1998-2004 period, and evaluate differences in the implied cost of capital between the IFRS adopters and the non-adopters. We also investigate whether and how the cost-of-capital effect of IFRS adoptions is differentially influenced by the efficacy of institutional infrastructures determining a country's corporate governance and enforcement mechanisms. Our results reveal the following. First, we find that the cost of equity capital is significantly lower for the full IFRS adopters than for the non-adopters, suggesting that the IFRS adopters benefit from greater and better disclosures via IFRS by having a lower cost of raising capital from equity markets. Moreover this result holds, irrespective of a country's institutional infrastructure. Second, we find that the cost of capital decreases with the efficacy of institutional infrastructure. Finally and more importantly, we find that the cost of capital-reducing effect of IFRS adoption is greater when the IFRS adopters are from countries with weak institutional infrastructures than when they are from countries with strong infrastructures. The above results are overall robust to the use of alternative measures of the expected cost of capital and a battery of sensitivity checks.