Abstract
China Journal of Accounting Studies, 2014 Vol. 2, No. 2, 118–136, http://dx.doi.org/10.1080/21697221.2014.917030 Exploring the determinants of voluntary adoption of IFRS by unlisted firms: A comparative study between the UK and Germany Dan Yang* Business School, Beijing Normal University, Beijing, China This study provides direct evidence on unlisted firms’ adoption of International Financial Reporting Standards (IFRS), differing from previous studies that focused on listed firms. The current literature documents little evidence regarding the deter- minants of voluntary adoption of IFRS by unlisted firms. This study aims to fill in this gap with respect to both firm attributes and country attributes. From examining a sample of unlisted firms in the UK and Germany, I find that firm size, leverage, legal form, profitability and country-level institutional environment contribute to IFRS choices by unlisted firms. I further find that the country-level institutional environment fails to strengthen or weaken the role of firm-level factors affecting IFRS adoption. The evidence in this study offers insights regarding the determinants of unlisted firms’ preferences for adoption of accounting standards, and suggests which types of unlisted firms prefer to use and benefit from IFRS. Keywords: IFRS; International Financial Reporting Standards; unlisted firms; voluntary adoption; comparative accounting 1. Introduction International Financial Reporting Standards (IFRS) have been widely accepted and adopted by listed firms in many countries. Given this, the International Accounting Standards Board (IASB) has taken a number of steps to encourage more countries to consider using IFRS for unlisted firms. In 2009, the IASB published a specific IFRS for SMEs (small and medium-sized entities) which is expected to meet the needs of SMEs. Further progress also includes that the standards (without the related implemen- tation guidance) are free to download and are available in more than a dozen languages in addition to English; an implementation group has been appointed to develop non- mandatory guidance in the form of Q&As; training materials, workshops, newsletter and Board member presentations are provided to support the implementation of IFRS; and the IASB also offers special guidance to help micro-sized entities. Although the standard setters wish the IFRS model to be accepted by unlisted firms, which are estimated to account for over 95% of all firms around the world, it is still unclear whether firms themselves would wish to adopt IFRS and whether they perceive net benefits from adoption. This question leads me to examine unlisted firms’ voluntary choices of IFRS. Because firms are making choices through weighing the cost against the benefit (Drake, Myers, & Yao, 2010; Soderstrom & Sun, 2007), voluntary adopters must believe IFRS to be their preferred reporting strategy and must expect that the *Email: ydabdn@gmail.com Paper accepted by Zhijun Lin. © 2014 Accounting Society of China China Journal of Accounting Studies 119 benefits of adoption will cover the costs of switching. An investigation of the determi- nants of voluntary adoption of IFRS can provide evidence regarding which types of unlisted firms prefer to use and benefit from IFRS. Previous research examining the determinants of voluntary IFRS choices by unlisted firms is scarce, since information about unlisted firms is not often readily avail- able. However, the paper by Francis, Khurana, Martin, and Pereira (2008) and Bassemir’s(2011) working paper are very relevant to this study. Francis et al. (2008), using 3722 small- and medium-sized private firms from 56 countries in 1999 as a research sample, find that choices of adoption of IFRS differ with respect to both firm and country attributes. To be specific, in more developed countries, firm-level incen- tives dominate country-level institutional factors in affecting IFRS decisions, while in less developed countries, country factors seem to be of greater relevance. Bassemir (2011) investigates 3150 German private firms between 1998 and 2009 and provides evidence regarding the specific institutional features of the German setting. The author finds that the likelihood of voluntarily adopting IFRS increases with firm size, interna- tional sales, leverage and growth opportunities. Additionally private firms are more likely to switch to IFRS if they are stock corporations, externally rated, have a Big Five auditor and seek to raise external capital by issuing public bonds or equity. However, the above studies are subject to several limitations. First, Nobes (2010) argues that Francis et al. (2008) may have a bias. The authors gather information from the World Business Environment Survey in which the phrase ‘use international account- ing standards’ is not clear and thus may not mean full adoption but only the application of a subset of IFRS. Moreover, the sample includes countries where private firms are already required to adopt IFRS and countries where private firms are forbidden to adopt IFRS. Second, Francis et al. (2008) and Bassemir (2011) concentrate on private firms, and the results built upon the analysis of private firms may not be generalisable to unlisted firms. My prior working paper (2012), in collaboration with André and Walton, selects a sample of unlisted firms (including independent firms and subsidiary firms) in the UK in 2009 and examines why those firms voluntarily adopt IFRS. We find that interna- tionality, leverage, firm size and auditor reputation help to explain the decisions made by firms. We try to provide evidence regarding unlisted firms in a specific country and do not consider country attributes. This study aims to fill in the gap and extend my prior work, through investigating both firm-level and country-level factors in voluntary adoption of IFRS by unlisted firms. The adoption of a specific set of accounting standards is likely to be influenced by firm-specific incentives as well as country-level institutional factors. First, as exter- nal financing is an important concern for firms, such firms may benefit from providing high quality and transparent accounting information to outsiders, which in turn allows them to raise external financing at a lower cost (Durnev & Kim, 2005). Second, a country’s institutions shape the contracting environment and firm incentives, as firms might be motivated to improve their accounting information quality to facilitate con- tracting. Thus, firm-level factors will be better examined within the broader context of country-level institutional forces (Ball, Kothari, & Robin, 2003; Francis et al., 2008; Leuz, Nanda, & Wysocki, 2003). Using both firm attributes and country attributes, this paper conducts a comparative study on voluntary choices of IFRS by unlisted firms in the UK and Germany. The rea- son that I choose the UK and German unlisted firms is that these two countries differ markedly in their legal systems, accounting and auditing cultures and corporate 120 Yang governance structures, which thus provides different settings of country-level institu- tions. The two countries have large populations of unlisted firms that offer suitable availability of data. This paper seeks to answer two questions: how do firm-level incen- tives and country-level institutions influence the voluntary selection of IFRS by unlisted firms in the UK and Germany; and is there interplay between firm-level and country- level factors in determining the IFRS choices of unlisted firms? The research sample of this study is selected from the Orbis database. The Orbis database, providing information on all firms in the World, is operated by Bureau van Dijk Company which also operates the Amadeus database used in many prior studies on private firms, such as Coppens and Peek (2005) and Peek et al. (2010). In this paper, only large- and medium-sized unlisted firms in 2010 are selected. Specifically, the selection criteria are according to the Fourth European Union (EU) Directive in meeting the following requirements: (1) total assets are greater than €2.5 million; (2) operating revenues are greater than €5 million; and (3) the number of employees is greater than 50. Differing from my prior working paper (2012), I also exclude subsidiaries, as subsidiaries may not be free to independently choose a specific set of accounting standards but rather may be influenced by their parent companies for consolidation purposes. Thus, I apply criterion (4), namely when a firm’s ownership by another firm exceeds 50%, the firm is excluded. In this study, I find that larger-sized and more leveraged UK unlisted firms are more likely to choose IFRS, suggesting the impact of size effect and creditor monitoring on UK unlisted firms’ IFRS adoption. German unlisted firms that are larger-sized, public limited companies or private limited companies demonstrate a higher probability of adopting IFRS, suggesting the influence of size effect and owner monitoring on German unlisted firms’ choices of accounting standards. I also find that firms domiciled in Germany are more inclined to use IFRS for their financial reporting; and the coun- try-level institutional environment, as an adjusting factor, has little effect on the role of firm-level factors in affecting IFRS adoption. This study contributes in the following ways. First, previous research on firms’ selection of accounting standards concentrates on listed firms, while this paper contrib- utes to the literature by studying unlisted firms. Second, this paper investigates both firm-level and country-level factors in voluntary adoption of IFRS by unlisted firms, and offers insights regarding the role of firm attributes and country attributes in affect- ing unlisted firms’ IFRS selection. Third, the results of this paper may shed light on how IFRS is promoted in the next step, because this paper indicates European unlisted firms’ preferences with respect to accounting standards selection, and European countries hold a leading position in worldwide adoption of IFRS by listed firms. The remainder of the study is organised as follows. Section 2 reviews the institu- tional background. Section 3 provides the theoretical analysis and proposes research hypotheses. Section 4 outlines the research design and data issues. Section 5 presents the empirical results and analysis, and section 6 provides a conclusion. 2. Institutional background 2.1. Voluntary choice of IFRS by unlisted firms in Europe Table 1 provides a general description of the voluntary choices of IFRS by unlisted firms in Europe in 2010. This study differentiates unlisted firms from unlisted compa- nies, private firms and SMEs. Unlisted firms include unlisted companies and business China Journal of Accounting Studies 121 Table 1. Statistical description for European large- and medium-sized unlisted firms (2010). Firms voluntarily using IFRS European Without Firms in the Percentage countries Financials Financials Total country (%) UK 31 20 51 6287 0.81 Italy 35 106 141 5457 2.58 Spain 2922 183 3105 3107 99.94 Germany 48 30 78 2746 2.84 France 0 32 32 1566 2.04 Portugal 0 3 3 767 0.39 Greece 64 9 73 629 11.61 Belgium 0 2 2 480 0.42 Finland 0 2 2 356 0.56 Sweden 1 2 3 145 2.07 Austria 1 3 4 84 4.76 Netherlands 0 1 1 62 1.61 Luxembourg 0 2 2 19 10.53 When a country has no unlisted firms voluntarily using IFRS, it is not listed in the table. The selection criteria of firms in the table are: (1) total assets are greater than €2.5 million; (2) operating revenues are greater than €5 million; (3) the number of employees is greater than 50, and (4) when more than 50% of a firm’s ownership is controlled by another firm, the firm is excluded. Almost all the unlisted firms in Spain use IFRS to prepare and report their financial statements, and according to interview with staff from the Spanish regulation body, this is likely because the Spanish local GAAP that the unlisted firms use differs little from IFRS, and the Spanish firms consider that they have already adopted IFRS. organisations in other forms. In Europe, unlisted firms refer to private firms and public firms that are not listed (Nobes, 2010). Additionally, unlisted firms include not only SMEs but also large firms. Therefore, unlisted firms are a much larger group than unlisted companies, private firms and SMEs. The statistical data in Table 1 are derived from the Orbis database. Only large- and medium-sized unlisted firms according to the Fourth EU Directive are selected, and subsidiaries are excluded. Table 1 supports the choice of the UK and Germany as the countries for the research sample. First, the UK and Germany have relatively large populations of unlisted firms and voluntary adopters of IFRS, and those offer the basis for the data. Second, the UK and Germany are typical countries from different traditions, and in turn differ markedly with respect to accounting regulations and enforcement. The UK, which may be classified as one of the Anglo-American countries, has a common law legal system, while Germany (as well as Italy, Spain, France, etc.) has the code law system typical of Continental Europe. The traditions shape the two countries’ different accounting regulations and enforcement (Ball et al., 2000; Schipper, 2005; Zeff, 2007). More details are described in Section 2.2. 2.2. Accounting regulations and enforcement in the UK and Germany Table 2 displays the UK and German financial reporting and disclosure regulations for unlisted firms. In the UK, listed companies have been required to use IFRS since 2005. In contrast, UK unlisted firms have a choice between using local accounting principles or IFRS, when preparing their accounts. Unlisted companies are permitted to use IFRS, or follow the Accounting Standards Board (ASB) standards, which encompass 122 Yang Table 2. The UK and German financial reporting and disclosure regulations for unlisted firms. Country Regulation sources UK Before 1/1/2015: Unlisted companies: choice between IFRS and the ASB standards Small unlisted firms: choice between IFRS or the ASB standards or FRSSE After 1/1/2015: Entities not small and not required to apply EU-adopted IFRS: choice from IFRS or FRS 102 or FRS 101 (if the financial statements are the individual financial statements of a qualifying entity) Entities eligible for small companies regime: choice from FRSSE or IFRS or FRS 102 or FRS 101 Germany Individual financial statements: For dividend and tax purposes: must follow German GAAP For information purposes: choice between IFRS and German GAAP Consolidated financial statements: Choice between IFRS and German GAAP Information is from: http://www.iasplus.com/en/jurisdictions/europe/uk; The FRSSE should be taken as being likely to have general application also to unincorporated entities (FRSSE 2013, Para 6a); Information is from: http://www.icaew.com/en/technical/financial-reporting/other-reporting-issues/other-uk- regulation/frs-100-application-of-financial-reporting-requirements. Financial Reporting Standards (FRS), Statements of Standard Accounting Practice (SSAPs) and Urgent Issues Task Force (UITF) Abstracts. Small unlisted firms may report under IFRS, follow the ASB standards, or follow the Financial Reporting Standard for Smaller Entities (FRSSE) which gives exemptions from applying all other accounting standards. However, major changes regarding regulation bodies and finan- cial reporting standards are being implemented in the UK. In July 2012, the Financial Reporting Council (FRC) assumed responsibility for accounting standards, which were formerly developed by the Accounting Standards Board (ASB) as a constituent of the FRC. The ASB was replaced by the Accounting Council, which reports to the Codes and Standards Committee. In 2012, the FRC revised the financial reporting standards by replacing almost all of the extant standards with three Financial Reporting Stan- dards: FRS 100 Application of Financial Reporting Requirements; FRS 101 Reduced Disclosure Framework; and FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. In such a new setting, unlisted companies can prepare their financial statements in accordance with IFRS, or FRS 102, or, if the financial statements are the individual financial statements of a qualifying entity, FRS 101, while small unlisted firms can still apply the FRSSE, or choose to use IFRS or FRS 102, or FRS 101. The FRSSE notes that some older accounting standards are drafted in terms of application to companies, and they should be taken to apply also to unincorporated entities (FRSSE, 2013, p. 4). The revisions are effective from1 January 2015. German financial reporting and disclosure regulations stem from the Commercial Code (HGB) and the Public Disclosure Act (PublG). These rules of accounting requirements are regardless of a firm’s listing status but rather consider its legal form and firm size. Incorporated entities are required to electronically file their financial statements with the German corporate registering body and disclose to the public. The firm must make an announcement immediately after it files the statements. Large non-incorporated entities face the same regulations and requirements as incorporated entities, and particularly are required to file and publicly report their financial China Journal of Accounting Studies 123 statements. In Germany, all individual financial statements must be prepared in accor- dance with HGB, for dividend determination and tax purposes. For information pur- poses only, firms can choose to prepare individual financial statements following IFRS. If firms choose to comply with IFRS, the full set of standards must be applied. Because consolidated financial statements are reported mainly for informational pur- poses, unlisted firms are free to prepare their consolidated financial statements either following IFRS or German GAAP. 3. Theoretical analysis and research hypotheses 3.1. Cost/benefit analysis of IFRS adoption by unlisted firms Advocates of IFRS claim that IFRS improve accounting comparability and the quality of financial information (IASB, 2010; Tweedie, 2010), and these benefits are also expected to suit unlisted firms. Although unlisted firms do not face the same agency problems as listed firms, they need to maintain contractual relationships with external parties, especially creditors. For example, firms need to provide financial information to creditors when they have financing needs. There is information asymmetry between firms and creditors. In such case, unlisted firms are also likely to need higher quality and more comparable financial reporting to reduce information asymmetry. The sample in this paper is large- and medium-sized unlisted firms, they may have more financing needs and have the potential to go public in the future, thus these may bring them ben- efits from providing higher quality financial information to reduce information asymme- try between firms and external parties. To be specific, the benefits for unlisted firms adopting IFRS can include easier access to international capital, increased financing opportunities, reduced cost of capital and the potential to go public in the foreign capital market. However, IFRS adopters also face switching costs. Such costs include training and familiarising staff with IFRS, changing accounting systems, employing accounting firms that are eligible to review IFRS statements and other invisible costs that result from increased disclosure of accounting information. Therefore, I expect that firms weigh the benefits and costs when making their decisions and that voluntary IFRS adopters perceive that the adoption benefits offset the switching costs. 3.2. Research hypotheses Based on the above benefits and costs of IFRS adoption, I examine the factors that may affect the cost/benefit issues and in turn the motivations surrounding IFRS adop- tion by unlisted firms. Because of the scarcity of prior research on unlisted firms, the firm characteristics in this study are drawn from the current literature on listed firms. I investigate how firm size, leverage, legal form, probability and country-level institu- tional environment affect unlisted firms’ decisions. 3.2.1. Firm size Larger firms are expected to receive more benefits from using IFRS with fewer costs. First, the number of stakeholders, who rely on financial reporting for their decision-making process, increases with corporate size. Larger firms are more likely to engage in contracting with a large number of parties (such as creditors, suppliers 124 Yang and employees), and thus they have stronger motivation to provide a high level of information disclosure and adopt IFRS. Second, it is less costly for larger firms to pro- duce more accounting information and make more disclosures, as they will produce these for internal purposes (Dumontier & Raffournier, 1998). Additionally, adequate financial and human resources result in larger firms bearing proportionately fewer costs when implementing a new set of accounting standards. Not surprisingly, previous research on listed firms and private firms indicates that larger firms are likely to make more disclo- sures, and thus have a higher propensity to adopt IFRS (Bassemir, 2011; Cuijpers & Buijink, 2005; Dumontier & Raffournier, 1998; Francis et al., 2008; Gassen & Sellhorn, 2006; Murphy, 1999; Tarca, 2004; Wu & Zhang, 2009). Hence, this study proposes: H1: The propensity for voluntary adoption of IFRS increases with the size of unlisted firms. 3.2.2. Leverage The benefits of IFRS adoption by unlisted firms are expected to increase as leverage increases. As discussed earlier, there is information asymmetry between unlisted firms and external parties, especially creditors. A higher level of leverage suggests that firms have an increased likelihood to satisfy creditors by voluntarily disclosing more informa- tion and reducing information asymmetry between them. The adoption of IFRS is always related to increased voluntary disclosure, thus it is one means of doing so. Because unlisted firms are more dependent on debt financing than listed firms, the argu- ment on leverage in this study differs from that in prior studies on listed firms (e.g., Cuijpers & Buijink, 2005; El-Gazzar, Finn, & Jacob, 1999; Gassen & Sellhorn, 2006; Murphy 1999; Tarca, 2004). Those studies argue that for listed firms, shareholders have stronger monitoring incentives than creditors, as creditors gather private information from loan contracts and communicate more on a private basis with firms. Lower lever- age suggests that firms are more dependent on equity financing. Hence, this study pro- poses a different hypothesis for unlisted firms due to their different financing patterns. H2: The propensity for voluntary adoption of IFRS increases with the level of lever- age of unlisted firms. 3.2.3. Legal form Previous research on private firms (Francis et al., 2008) proposes that the legal form of organisation might influence a firm’s voluntary adoption of IFRS, based on Ang, Cole, and Lin’s(2000) argument. However, Ang et al. (2000) argue that agency costs of a firm increase with a reduction in managerial ownership, but do not suggest that agency costs are related to a firm’s legal form. In Bassemir’s(2011) working paper, the author proposes that because German business law essentially distinguishes between incorpo- rated and non-incorporated entities, a firm’s legal form might affect its voluntary choice of IFRS. However, the reasoning for this proposition would benefit from further explanation. In this study, I also examine the legal form as a firm-level factor, but do not predict the impact of legal form on firms’ voluntary IFRS adoption, for the following reasons. First, based on the current literature, there are few supportive theories or evidence that an unlisted firm’s legal form might be related to its voluntary IFRS adoption. Second, China Journal of Accounting Studies 125 the features among different types of the research sample in this study are not obvious. Based on the information on legal form taken from the Orbis database, the research sample includes public limited companies, private limited companies, limited liability partnerships (LLPs) and partnerships in Germany; and public limited companies, private limited companies, LLPs, companies limited by guarantee (‘Guarantee’) and incorporated mutual societies (‘Society’) in the UK. In Germany, public limited com- panies and private limited companies are incorporated entities, and other types of firms, including LLPs and partnerships, are unincorporated entities. In the UK, the boundary is not quite obvious: some types of firms have mixed features regarding their legal form. For example, LLPs in the UK have features of both partnership and corporation: a UK LLP is similar to an incorporated body because it has a continuing legal exis- tence independent of its members; while in relation to tax, a UK LLP is similar to a partnership, and it pays no UK corporation tax or capital gains tax (the partners pay income tax). In the UK, companies limited by guarantee have a kind of ownership that differs from private limited companies, but they are incorporated entities. Organisations such as Building Societies in the UK are mutual organisations, run for the benefitof their members, but they are incorporated as well. Therefore, I propose the impact of legal form on firms’ voluntary IFRS adoption in the null form: H3: The likelihood of voluntary IFRS adoption is not affected by legal form. 3.2.4. Profitability Based on the current literature on listed firms and private firms, the role of the firm’s profitability affecting IFRS adoption is not obvious. First, adherence to IFRS is often expected to be related to a higher level of financial reporting and a form of expanded disclosure, and it might be less costly for well-performing firms to do so. Secondly, as previously discussed, unlisted firms expect benefits from using IFRS, such as easier access to international capital, increased financing opportunities and reduced cost of capital, and as these benefits may become more important for poorly-performing firms, the likelihood of choosing IFRS may decrease with firm profitability. Further, the choice of a specific set of accounting standards is considered as a long-term policy, and as such, it may not be affected by firm profitability during a short period. Previous research on listed firms and private firms (Bassemir, 2011; Dumontier & Raffournier, 1998; Wu & Zhang, 2009) also evidences no significant association between firm profitability and voluntary adoption of IFRS. Hence, I do not predict the impact of profitability on firms’ voluntary IFRS adoption and propose (in the null form): H4: The likelihood of voluntary IFRS adoption is not affected by firm profitability. 3.2.5. Country-level institutional environment The country-level institutional environment of a firm is expected to determine the net benefits of using IFRS. El-Gazzar et al. (1999) find that firms domiciled in EU coun- tries have a greater probability of choosing IFRS. However, Street and Gray (2002) note a lower level of IFRS compliance related to firms based in EU countries. Cuijpers and Buijink (2005) argue that firms domiciled in countries where domestic GAAPs are less stringent may prefer to adopt IFRS. The net benefits to firms from countries with high quality accounting standards are expected to be much lower, because compliance 126 Yang with their local GAAP have already provided their accounting information greater credibility. Thus, for firms in these countries, the benefits of adopting IFRS would not outweigh the costs. In this paper, I conduct a comparative study on voluntary choices of IFRS by unlisted firms in the UK and Germany. The legal systems of the UK and Germany are common law and code law, respectively. In addition to the legal system, the two countries differ markedly in their accounting and auditing cultures, capital mar- ket development and corporate governance structures. These factors shape the quality of financial reporting and accounting standards in a specific country (Ball et al., 2000; Hail, Leuz, & Wysocki, 2010a, 2010b; Schipper, 2005; Zeff, 2007). Compared with Germany and other continental European countries, the local accounting standards of the UK enjoy little difference from IFRS and tend to pro- tect investors considerably better (Cuijpers & Buijink, 2005; Haller, 2002). Thus, this paper predicts that German unlisted firms have stronger incentives to adopt IFRS than UK unlisted firms and, given their different country-level institutional environment, the firm-level factors of voluntary IFRS adoption also differ. Hence, this paper proposes: H5: Compared with unlisted firms in the UK, German unlisted firms have a greater propensity to voluntarily adopt IFRS; H6: The country-level institutional environment affects the association between firm-level factors and voluntary IFRS adoption. I do not predict whether the country-level institutional environment might strengthen or weaken the role of firm-level factors. 4. Research design 4.1. Research models and variables Based on the above research hypotheses, firm-level factors determining IFRS choices by UK and German unlisted firms are analysed through research model (1). Subse- quently, the country-level institutional environment is involved to identify its impact on the choice decisions through research model (2). Further, the interplay between firm- level and country-level factors is examined and interaction terms are included in research models (3), (4), (5) and (6). Because voluntary IFRS adoption is a binary variable, I use logistic regression in the empirical analysis. The research models are as follows. IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ Industry þ e (1) 0 1 2 3 4 IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ a COUN þ Industry þ e (2) 0 1 2 3 4 5 IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ a COUN þ a SIZE COUN þ Industry þ e (3) 0 1 2 3 4 5 6 IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ a COUN þ a LEV COUN þ Industry þ e (4) 0 1 2 3 4 5 6 IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ a COUN þ a OWN COUN þ Industry þ e (5) 0 1 2 3 4 5 6 IFRS ¼ a þ a SIZE þ a LEV þ a OWN þ a PRO þ a COUN þ a PRO COUN þ Industry þ e (6) 0 1 2 3 4 5 6 China Journal of Accounting Studies 127 where IFRS measures whether unlisted firms voluntarily adopt IFRS with a value of one for IFRS adopters and a value of zero for non-adopters; SIZE measures firm size using the natural logarithm of a firm’s total assets; LEV measures firm leverage (as unlisted firms are typically financed by bank loans, the use of a liabilities/equity ratio may produce abnormal values; thus, the ratio of total liabilities and total assets is employed); OWN measures the legal form of a firm with a value of one for public lim- ited companies and private limited companies and a value of zero for other types of firms; PRO measures firm profitability using the firm’s profit margin ratio (net income/ operating revenues); COUN measures the country-level institutional environment (as discussed before, when compared with Germany, the UK local accounting standards enjoy little difference from IFRS and tend to protect investors better) with a value of one for UK unlisted firms and a value of zero for German unlisted firms; Industry acts as a control variable (as I use all unlisted firms, including financial and non-financial firms, as the research samples, I separately control for manufacturing firms and finan- cial firms in the empirical analysis). Additionally, the interaction terms SIZE*COUN, LEV*COUN, OWN*COUN and PRO*COUN measure the interplay between firm-level and country-level factors, that is, whether the country-level institutional environment affects the extent to which firm size, leverage, legal form and firm profitability deter- mine firms’ voluntary IFRS choices. The measures of the aforementioned variables rely on the relevant research as well as on data availability, which has been recognised as a major challenge for unlisted firms (Nobes, 2010). 4.2. Research sample and data issues Information about IFRS choices and the financial data of UK and German unlisted firms are gathered from the Orbis database. As the research sample, I select large- and medium-sized unlisted firms in 2010 according to the Fourth EU Directive that meet the following three requirements: (1) total assets are greater than €2.5 million; (2) oper- ating revenues are greater than €5 million; and (3) the number of employees is greater than 50. I also exclude subsidiaries, as subsidiaries may not be free to independently choose a specific set of accounting standards but rather may be influenced by their par- ent companies for consolidation purposes. Thus, (4) when a firm’s ownership by another firm exceeds 50%, the firm is excluded. Further, as this study does not refer to accounting techniques for specific economic transactions, I include financial firms in the research sample. Given the above criteria, 51 UK unlisted firms and 78 German unlisted firms that voluntarily adopted IFRS are selected as the IFRS sample. The control sample (non-IFRS adopters) is selected in a similar way, such that, in accordance with the three requirements, and I exclude subsidiaries. Using these search procedures yields a set of 6236 UK unlisted firms and 2668 German unlisted firms as the control sample for a total sample comprising 6287 UK unlisted firms and 2746 German unlisted firms. The IFRS sample and the control sample constitute all large- and medium- sized, independent unlisted firms in the UK and Germany in 2010. The IFRS sample is relatively small, similar to the study by Cuijpers and Buijink (2005)on EU listed firms; it may suggest that most unlisted firms in the two countries do not expect to benefit from using IFRS or that even if they would benefit, the benefits do not compensate for the transition costs. Matched pairs are not used to select the control sample, because it might be inappropriate to use them in this study. First, this paper investigates not only firm 128 Yang attributes but also country attributes, that is, how country-level institutions influence the voluntary selection of IFRS by unlisted firms and if there is interplay between firm-level and country-level factors in determining the IFRS choices of unlisted firms. That is why the variable COUN, the interaction terms SIZE*COUN, LEV*COUN, OWN*COUN and PRO*COUN (please see details in Section 4.1) are involved in the research model. Matched pairs are meaningless for the above variables and the country attributes cannot be examined. Second, choosing the matched pairs may have a bias. Normally, the matched pair is chosen to correspond to the asset size and industries of the study sample as closely as possible. However, firm size is a characteristic examined in this paper. If matched pairs are used, they can only be chosen corresponding to industry. Furthermore the selection of the matched pairs at random may have a bias in examining firm attributes. To make the empirical results as accurate as possible, potential problems including collinearity and outliers are considered and checked. A 98% winsorisation is performed on all continuous variables in the empirical analysis process. Further, alternative choices of measures of variables are used for a robustness check. 5. Results 5.1. Statistical description of research sample Table 3 provides background information about the UK and German sample firms. As indicated for UK unlisted firms, the mean and median (12.679 and 12.405, Table 3. Statistical description of the research sample. Unit: thousand euros Variables Sample N Mean Median St. D Minimum Maximum UK unlisted firms: SIZE IFRS 51 12.679*** 12.405 2.465 8.315 19.917 Non-IFRS 6236 9.608 9.361 1.203 7.825 16.875 LEV IFRS 51 0.889*** 0.895 0.401 0.198 2.414 Non-IFRS 6233 0.665 0.653 0.391 0.095 10.198 OWN IFRS 51 0.840 1.000 0.367 0 1 Non-IFRS 6236 0.920 1.000 0.277 0 1 PRO IFRS 47 3.735 2.650 18.293 −62.380 56.700 Non-IFRS 6203 2.353 2.260 11.323 −96.340 76.260 German unlisted firms: SIZE IFRS 78 13.415*** 13.209 2.363 8.780 19.835 Non-IFRS 2668 10.319 10.196 1.458 7.825 18.880 LEV IFRS 78 0.721 0.722 0.212 0.132 1.457 Non-IFRS 2641 0.660 0.678 0.263 0.024 6.760 OWN IFRS 78 0.880*** 1.000 0.322 0 1 Non-IFRS 2668 0.660 1.000 0.472 0 1 PRO IFRS 77 1.222** 2.240 10.740 −31.640 28.770 Non-IFRS 2667 3.152 2.450 8.690 −91.950 80.160 *Sig.<0.1. **Sig.<0.05. ***Sig.<0.01. SIZE measures firm size using the natural logarithm of a firm’s total assets; LEV measures firm leverage (as unlisted firms are typically financed by bank loans, the use of a liabilities/equity ratio may produce abnormal val- ues; thus, the ratio of total liabilities and total assets is employed); OWN measures the legal form of a firm with a value of one for public limited companies and private limited companies and a value of zero for other types of firms; PRO measures firm profitability using the firm’s profit margin ratio (net income/operating revenues). China Journal of Accounting Studies 129 respectively) of firm size (SIZE) for IFRS firms are significantly higher than those for non-IFRS firms (9.608 and 9.361, respectively). Furthermore, the mean and median of leverage (LEV) for the IFRS group (0.889 and 0.895, respectively) present a signifi- cantly higher level than those for the non-IFRS group (0.665 and 0.653, respectively). Little difference is found regarding firms’ legal forms (OWN) between the IFRS and non-IFRS group, while firm profitability (PRO) of IFRS firms appears to be higher than that of non-IFRS firms, although the difference is not significant. Thus, the descriptive results suggest that UK unlisted firms that voluntarily adopt IFRS are much larger and more leveraged, while the legal forms and profitability appear to have no influence on the financial reporting choices of firms. It should however be noted that the Orbis data- base used in this study might have a bias on legal form because it can only take infor- mation that is in the public domain. For the UK, the sample includes only public limited companies, private limited companies, LLPs, companies limited by guarantee and incorporated mutual societies (see details in Section 3.2). It does not provide infor- mation on UK partnerships and sole proprietorships from the database because such entities do not publish accounting information in the public domain. As for German unlisted firms, the mean and median of firm size (SIZE) for IFRS firms are significantly greater than those for non-IFRS firms; the mean and median of leverage (LEV) for the IFRS group are higher than those for the non-IFRS group, but the difference is not significant; firms’ legal forms (OWN) differ markedly between the IFRS and the non-IFRS group, with means of 0.880 and 0.660, respectively, suggesting that in accordance with the hypothesis, public limited companies and private limited companies are more likely to adopt IFRS; and the mean and median of firm profitabil- ity (PRO) for IFRS firms are significantly lower than those for non-IFRS firms. As I predict, because unlisted firms are typically financed by creditors, they expect benefits from adopting IFRS, such as easier access to international creditors, increased financing opportunities and reduced cost of capital. And these benefits are more important for poorly performing firms. Overall, the descriptive results reveal that German unlisted firms that voluntarily choose IFRS are larger, are more likely to be public limited com- panies or private limited companies, and possess a lower level of profitability, while leverage fails to affect the financial reporting choices. 5.2. Empirical analysis results Table 4 indicates the Pearson correlation matrix for the research variables in the regres- sion. The factors that are related to voluntary IFRS adoption vary between UK unlisted firms and German unlisted firms. In the UK group, firm size and leverage are found to be strongly correlated with IFRS choices, while in the German group, firm size and legal form present high correlations with IFRS choices. With respect to the total unlisted firms, firm size and leverage are significantly and positively correlated with IFRS, and country-level institutional environment is significantly and negatively corre- lated, suggesting that German unlisted firms are more likely to comply with IFRS to prepare their financial statements than UK unlisted firms. As the correlations among explanatory variables are also found to be significant, collinearity diagnostics are per- formed in advance of the empirical regression, and I find that VIF values for the explanatory variables are all less than 2, indicating a much low level of collinearity among variables. Table 5 reports the regression results of Model (1) through Model (6). Model (1) involves only firm-level factors that may determine IFRS choices, and I separately 130 Yang Table 4. Pearson correlation matrix. Variables IFRS SIZE LEV OWN PRO UK unlisted firms: SIZE 0.220*** LEV 0.051*** 0.058*** OWN −0.024* −0.124*** 0.055*** PRO 0.010 −0.019 −0.315*** −0.111*** German unlisted firms: SIZE 0.326*** LEV 0.039* −0.024 OWN 0.078*** −0.049** −0.184*** PRO −0.036* 0.086*** −0.218*** −0.008 Total unlisted firms: SIZE 0.279*** LEV 0.041*** 0.032*** OWN 0.009 −0.158*** −0.018* PRO −0.005 0.020* −0.297*** −0.075*** COUN −0.079*** −0.254*** 0.006 0.308*** −0.032*** Sig.<0.1. ** Sig.<0.05. *** Sig.<0.01. IFRS measures whether unlisted firms voluntarily adopt IFRS with a value of one for IFRS adopters and a value of zero for non-adopters; SIZE measures firm size using the natural logarithm of a firm’s total assets; LEV measures firm leverage (the ratio of total liabilities and total assets is employed); OWN measures the legal form of a firm with a value of one for public limited companies and private limited companies and a value of zero for other types of firms; PRO measures firm profitability using the firm’s profit margin ratio (net income/operating revenues); COUN measures the country-level institutional environment with a value of one for UK unlisted firms and a value of zero for German unlisted firms. examine UK unlisted firms and German unlisted firms. As shown, with respect to UK unlisted firms, firm size and leverage display significant positive impacts, at the 0.01 or 0.05 significance level, on a firm’s decision to voluntarily select IFRS. The results are consistent with the statistical description, suggesting that larger and more leveraged firms have a greater likelihood of adopting IFRS. Legal form and firm profitability do not affect firms’ choice decisions, and the industry variable Manufacturing (taking a value of one for manufacturing firms, and a value of zero otherwise) and Financials (taking a value of one for financial firms, and a value of zero otherwise) also present little effect. Thus, with respect to UK unlisted firms, research hypotheses H1 and H2 are validated, while research hypotheses H3 and H4, as expressed in the null form, can- not be rejected. As for German unlisted firms, firm size, legal form, profitability and industry variable exhibit significant impacts, at the 0.01 or 0.1 significance level, on firms’ voluntary IFRS adoption. These findings reveal that larger public limited compa- nies and private limited companies with a lower level of profitability from the manufac- turing sector are more inclined to choose IFRS. Furthermore, leverage does not affect firms’ decisions to comply with IFRS. Therefore, with respect to German unlisted firms, only research hypothesis H1 is confirmed. These results are distinct from the results for UK unlisted firms. Model (2) determines the impact of the country-level institutional environment on unlisted firms’ financial reporting behaviour. As indicated, the research variable COUN is found to be negatively related at a 0.01 significance level, suggesting that firms domiciled in Germany, where domestic accounting standards differ markedly from IFRS, are more inclined to use IFRS for their financial reporting. As I predict, the net China Journal of Accounting Studies 131 Table 5. Empirical analysis results. Model (1) Variables UK sample German sample Model (2) Model (3) Model (4) Model (5) Model (6) SIZE 0.860 (124.150)*** 0.818 (95.613)*** 0.820 (229.307)*** 0.785 (121.145)*** 0.821 (229.004)*** 0.816 (224.164)*** 0.823 (229.486)*** LEV 0.507 (4.679)** 0.215 (0.151) 0.424 (3.146)* 0.426 (3.104)* 0.350 (0.711) 0.413 (2.938)* 0.467 (3.939)** OWN 0.492 (0.963) 1.288 (9.399)*** 1.272 (17.138)*** 1.277 (17.389)*** 1.272 (17.129)*** 1.558 (16.086)*** 1.286 (17.421)*** PRO 0.003 (0.119) −0.019 (2.851)* −0.006 (0.920) −0.006 (0.909) −0.006 (0.883) −0.007 (1.193) −0.020 (3.845)** COUN −1.458 (31.820)*** −2.389 (3.407)* −1.540 (11.985)*** −0.688 (1.296) −1.500 (33.602)*** SIZE*COUN 0.076 (0.541) LEV*COUN 0.111 (0.051) OWN*COUN −0.860 (1.952) PRO*COUN 0.023 (2.987)* Manufacturing −0.302 (0.165) 1.121 (9.620)*** 0.680 (4.894)** 0.663 (4.674)** 0.675 (4.806)** 0.686 (4.969)** 0.675 (4.808)** Financials 0.591 (2.710) 24.176 (0.000) 2.204 (62.915)*** 2.200 (62.339)*** 2.204 (62.872)*** 2.149 (58.300)*** 2.182 (61.551)*** N 6,247 2,717 8,964 8,964 8,964 8,964 8,964 Chi-square 158.431*** 346.315*** 484.537*** 485.079*** 484.589*** 486.427*** 487.558*** *Sig.<0.1. **Sig.<0.05. ***Sig.<0.01. Wald values are indicated in parenthesis; in collinearity diagnostics, VIF values for the explanatory variables are all less than 2, indicating a much low level of collinearity; IFRS measures whether unlisted firms voluntar- ily adopt IFRS with a value of one for IFRS adopters and a value of zero for non-adopters; SIZE measures firm size using the natural logarithm of a firm’s total assets; LEV mea- sures firm leverage (the ratio of total liabilities and total assets is employed); OWN measures the legal form of a firm with a value of one for public limited companies and private limited companies and a value of zero for other types of firms; PRO measures firm profitability using the firm’s profit margin ratio (net income/operating revenues); COUN mea- sures the country-level institutional environment with a value of one for UK unlisted firms and a value of zero for German unlisted firms; the interaction terms SIZE*COUN, LEV*COUN, OWN*COUN and PRO*COUN measure the interplay between firm-level and country-level factors; Manufacturing and Financials are industry variables: Manufac- turing takes a value of one for manufacturing firms and a value of zero otherwise, Financials takes a value of one for financial firms and a value of zero otherwise. 132 Yang benefits from IFRS adoption to firms from countries with less stringent accounting stan- dards are likely to be greater and thus offset the switching costs. Accordingly, research hypothesis H5 is supported. Additionally, the industry variables Manufacturing and Financials are determined to be significantly and positively related, thus revealing that firms from manufacturing and financial sectors have a higher propensity to voluntarily comply with IFRS. Intense competition deriving from the manufacturing sector and the high risk confronted by financial firms create increased demand for high level financial transparency and information disclosures and, in turn, motivate adherence to IFRS. Models (3), (4), (5) and (6) further include interaction terms to examine the inter- play between firm-level and country-level factors. In the Model (3) column, firm size and country-level institutional environment are significantly related to IFRS choices, but the interaction term SIZE*COUN displays little effect. The findings suggest that country-level institutional environment, as predicted to be an adjusting factor, fails to affect the association between firm size and IFRS selection. Similarly, as seen in the Model (4) and Model (5) analyses, the interaction terms LEV*COUN and OWN*COUN present no impact, thus revealing that country-level institutional environment appears to neither strengthen nor weaken the influence of leverage and legal form on firms’ IFRS adoption. The results from Model (6) indicate that firm profitability and country-level institutional environment are negatively related, and the interaction term PRO*COUN exhibits a significant positive effect, thus suggesting that country-level institutional environment affects the role of firm profitability in determining IFRS choices. Unlisted firms presenting a relatively lower level of profitability are likely to voluntarily adopt IFRS, and the likelihood increases for German firms. To summarise, firm-level factors that shape unlisted firms’ IFRS adoption vary markedly between UK and German firms; however, country-level institutional environment, as an adjusting factor, has little effect on firm-level factors’ shaping functions except for profitability. Thus, the inter- play between firm-level factors (firm size, leverage and legal form) and country-level factors is not observed. 5.3. Robustness tests Alternative choices of measures for firm size and profitability are employed in this section for a robustness check. I use REV (the natural logarithm of a firm’s operating revenues) and ROA (return on assets ratio) rather than SIZE and PRO to repeat the empirical analysis. It is found that the effect of ROA appears to be volatile when differ- ent measures are involved, while the results of other variables remain relatively unchanged. Thus, caution must be applied when using the ROA to interpret the influ- ence of a firm’s profitability. Robustness tests support the results of Model (1) for both UK unlisted firms and German unlisted firms as well as the results of Model (2), Model (3) and Model (4). However, the findings for Model (5) and Model (6) are a bit differ- ent in that the country-level institutional environment weakens the legal form’sinflu- ence on firms’ decisions to comply with IFRS, although it does not affect the role of profitability. The results reveal that the country-level institutional environment’s adjust- ing impact on firm-level factors is not stable, which further confirms that little evidence is found regarding the interplay between firm-level factors and country-level factors. 6. Conclusions The decision by unlisted firms to adopt IFRS has been a topic of great interest as well as a focus of the standard setters in recent years. As one of few studies to examine unlisted China Journal of Accounting Studies 133 firms’ IFRS adoption, this study uses a sample of UK and German unlisted firms and investigates the type of firm that may prefer to use and benefit from IFRS, by examining both firm and country attributes. The study seeks to answer the following questions: how do firm-level incentives and country-level institutions influence the voluntary selection of IFRS by unlisted firms in the UK and Germany; and is there interplay between firm-level and country-level factors in determining the IFRS choices of unlisted firms? I select large- and medium-sized unlisted firms in 2010, according to the Fourth EU Directive, and exclude subsidiaries. These search procedures yield a set of a total sample that includes 6287 UK unlisted firms and 2746 German unlisted firms, where 51 UK firms and 78 German firms voluntarily adopted IFRS. Accordingly, the percentages of IFRS adopters among both UK and German unlisted firms are quite small. This result suggests that most firms in the two countries do not expect to benefit from using IFRS or that even if they would benefit, the benefits do not compensate for the transition costs. This paper finds that while unlisted firms share some firm incentives with those documented for listed firms, they remain different; and among unlisted firms, the reporting incentives differ markedly. To be specific, the results of the empirical analysis indicate that larger-sized and more leveraged UK unlisted firms are more likely to choose IFRS, which reveals the impact of size effect and creditor monitoring on UK unlisted firms’ IFRS adoption. German unlisted firms that are larger-sized, public lim- ited companies or private limited companies demonstrate a higher probability of adopt- ing IFRS, which suggests the influence of size effect and owner monitoring on German unlisted firms’ choices of accounting standards. This paper also finds the following: German IFRS adopters exhibit a relatively lower level of profitability; firms domiciled in Germany, where domestic accounting standards differ markedly from IFRS, are more inclined to use IFRS for their financial reporting; and the country-level institutional environment, as an adjusting factor, has little effect on the role of firm-level factors in affecting IFRS adoption. This paper concludes that the decision by unlisted firms to adopt IFRS differs based on both firm and country attributes. Although the interplay between firm-level factors and country-level factors is not observed, the country-level institutional environment has been found to determine the motivation surrounding IFRS adoption. The findings in this study help the standard setters understand that convincing unlisted firms of the net benefits of a specific set of accounting standards and promoting its application can be challenging. In appraising the findings of this study, it is important to consider the limitations. First, this study focuses on the voluntary adoption of IFRS by UK and German unlisted firms; further research examining unlisted firms in more countries is warranted. Second, the Orbis database used in this study does not cover all unlisted entities in the UK. The UK sample includes only public limited companies, private limited companies, LLPs, companies limited by guarantee and incorporated mutual societies. Information on UK partnerships and sole proprietorships is not available in the public domain and therefore is not in the database. Further research needs to find a robust dataset for unincorporated businesses such as the World Bank survey data used by Francis et al. (2008). Acknowledgements The author acknowledges Professor Paul André (the Research Director of ESSEC- KPMG Financial Reporting Centre, ESSEC Business School, France) and Professor Peter Walton (the Chair of European Accounting Association Financial Reporting 134 Yang Standards Committee) for their insightful comments in the initial stage of this research project, and thanks ESSEC-KPMG Financial Reporting Centre for the data access. This work was supported by the Fundamental Research Funds for the Central Universities in China [grant number SKZZX2013036]. I also thank two anonymous reviewers, the lan- guage editor and the editors for their helpful and constructive comments. I take full responsibility for this paper. Notes 1. According to the statistical date of IASPlus 2013, nearly 120 countries have required or per- mitted their listed firms to adopt IFRS. 2. IASB is the successor to the International Accounting Standards Committee (IASC). In 2000, the IASC was restructured in order to facilitate the formation of the International Accounting Standards Board. 3. Information is from the IASPlus website: http://www.iasplus.com/en/standards/other/ifrs-for- smes. 4. Unlisted firms include not only SMEs but also large firms. The SMEs account for a large per- centage of unlisted firms. The SME here is defined using firms’ total assets, operating revenues and the number of employees according to the European Union (EU) requirements. 5. Information is based on: http://www.ifrs.org/IFRS-for-SMEs/Pages/IFRS-for-SMEs.aspx. 6. In Europe, unlisted firms refer to private firms and some public firms such as unlisted PLCs in the UK, AGs in Germany and SAs in France (Nobes, 2010). Thus, unlisted firms are a much larger group than private firms in such countries. 7. As for unlisted firms, some use the calendar year as their fiscal year, some start on April 1 and end on March 31, while others use the period from July 1 to June 30. In this study, we collect information ending on June 30 2010; thus, accounting data are taken from the firms’ financial statements on December 31 2009, March 31 2010 and June 30 2010. 8. Information is based on: http://www.iasplus.com/en/jurisdictions/europe/uk. 9. More information is available at FRS 100 page 3–4: https://www.frc.org.uk/getattachment/ a32157a3–499d-4c34–84fb-e2a257b1d7c7/FRS-100-Application-of-Financial-Reporting- Requirements.aspx. 10. Information is based on: http://www.iasplus.com/en/jurisdictions/europe/germany. 11. Kim, Tsui, and Yi (2011) examine the influence of voluntary IFRS adoption on loan con- tracting and loan ownership structure for non-US borrowers between 1997 and 2005. They indicate that firms adopting IFRS benefit from lower loan rates, less restrictive covenants and extended credit through larger loans and longer maturities from the banks. 12. In Bassemir’s(2011, pp. 11–12) working paper, the author argues that “Incorporated entities have a separate legal personality, whilst non-incorporated firms have not. Next, the liability of the owners of incorporated firms is limited, while the owners of a non-incorporated entity are fully liable with their entire personal assets. Also, the owners of incorporated entities are often not actively involved in the management of the company, while in non-incorporated entities the partners are not only the owners, but regularly also the managers of their firm. 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Journal
China Journal of Accounting Studies
– Taylor & Francis
Published: Apr 3, 2014
Keywords: IFRS; International Financial Reporting Standards; unlisted firms; voluntary adoption; comparative accounting
