Short-Term and Long-Term Effects of IFRS Adoption on Disclosure Quality and Earnings Management

Abstract

This study investigates the effect of IFRS adoption on the transparency of financial reporting in Germany. Using a sample of listed companies ranging from 1995 to 2012, we separately analyze the effect of IFRS adoption on disclosure quality and the degree of earnings management. We use disclosure quality scores of an annual report ‘beauty contest’ published by the German business journal manager magazin to proxy for disclosure quality and discretionary accruals from the Kothari et al. (2005) model to proxy for the degree of earnings management. We hypothesize and find that IFRS adoption is associated with an increase in disclosure quality and with an increase in the extent of earnings management. Although these results seem confounding in the light of the assumed superiority of IFRS over German GAAP, we argue that low compliance, lack of experience and weak enforcement in the early years of IFRS adoption drive the latter result. Based on this notion, we show that the degree of earnings management decreases significantly from the early to the mature phase of IFRS reporting. Finally, we show that disclosures have the potential to constrain earnings management.