The impact of IFRS adoption on the value relevance of book value and earnings

Abstract

In this study, we investigate the impact of IFRS adoption in Europe and Australia on the relevance of book value and earnings for equity valuation. Using a sample of 3488 firms that initially adopted International Financial Reporting Standards (IFRS) in 2005, we are able to compare the figures originally reported for the 2004 fiscal years to the IFRS figures that were provided in 2005 as the 2004 IFRS comparative figures. As part of the inquiry, we introduce a cross-product term, equal to the product of EPS and BVPS, into the traditional linear pricing models. The estimated coefficient on the cross-product term is statistically significant and negative, as theory suggests in the presence of important nonlinearities. Further, there is increased non-linearity in the data subsequent to IFRS adoption, with the increase being most pronounced for firms in Common Law countries. With non-linear effects controlled for, there is no observed change in price relevance for firms in either Code Law or Common Law countries, contradicting the results from the linear pricing models. The results also suggest that the distribution of measurement errors becomes more similar across Code Law and Common Law countries after the adoption of IFRS, removing one difference between these groups. Thus, IFRS enhances comparability, an inference that would not be possible had we confined the analysis only to linear pricing models.