The Impact of Financial Reporting on Equity versus Debt Markets: Macroeconomic Evidence from Mandatory IFRS Adoption

Abstract

This study investigates whether a shock to financial reporting has a differential impact on debt and equity markets. Using macroeconomic data and a pre-post design centered in 2005, we find that IFRS adoption has a significantly greater effect on foreign debt than on foreign equity investment flows. This result is consistent with the notion that debt investors are greater consumers of financial statement information. Further, consistent with research on the effects of IFRS adoption on individual firms, we find that post-adoption increases in foreign equity investment are limited to countries with high (or improving) governance quality. In contrast, we find increases in foreign debt investment flows are not dependent on governance quality. This is consistent with recent research that concludes that negotiated covenants in bond contracts can offset weak investor protection at the country level. Finally, we find that the increase in foreign equity investment derives primarily from the U.S., whereas the increase in foreign debt investment derives from the U.S. and other non-adopting countries. This evidence that increases in foreign investment originate from non-adopting countries rather than other adopting countries suggests that the benefits from IFRS adoption more likely reflect improved financial reporting quality rather than greater comparability.