Voluntary IAS and U.S. GAAP Adoption by Continental European Firms: The Role of Labor Relations

Abstract

We investigate the decision by a sample of Continental European firms to voluntarily adopt the International Accounting Standards (IAS) or U.S. GAAP. The strong employment protection laws in Continental Europe lead to labor practices that lack responsiveness to firm underlying economic performance. We argue that by switching to IAS/U.S. GAAP, a Continental European company can more credibly communicate with its labor force, and/or a potential third party (e.g. a government labor office, an arbitrator, or a labor court judge in the case of labor disputes), the true economic conditions of the firm and potentially reduce the costs associated with labor force adjustments. We expect the costs of rigid labor practices, thus the potential benefits of switching to IAS/U.S. GAAP, to be particularly high for firms with low labor productivity. Therefore, we predict that 1) firms with low labor productivity are more likely to adopt IAS/U.S. GAAP after controlling for other factors potentially affecting the adoption decision; 2) firms adopting IAS/U.S. GAAP and with low labor productivity report lower earnings than before the adoption and the earnings change is more negative than for similar non-adopting firms; 3) firms adopting IAS/U.S. GAAP and with low labor productivity are more likely to reduce labor forces than before the adoption and the reduction in labor forces is more pronounced than for similar non-adopting firms. Our results are consistent with these predictions.