Have IFRS Changed How Stock Prices Associate with Earnings and Book Values?

Evidence from Norway

by

Leif Atle Beisland

University of Agder, 4604 Kristiansand, Norway

Kjell Henry Knivsfl*

NHH Norwegian School of Economics, 5045 Bergen, Norway

August, 2012

* Address correspondence to Kjell Henry Knivsfl, NHH, 5045 Bergen, Norway, or by e-mail to kjell.knivsfla@nhh.no. Thanks to Frystein Gjesdal, John Christian Langli, Peder Fredslund Mller, Ken Peasnell, Frank Thinggaard, and seminar participants at the 33rd EAA Annual Conference and the 1st Nordic Conference on Financial Accounting for their helpful comments on earlier versions of this study.

Electronic copy available at: http://ssrn.com/abstract=1334533

Have IFRS Changed How Stock Prices Associate with Earnings and Book Values? Evidence from Norway
Abstract
Firms listed on European stock exchanges are required to report according to International Financial Reporting Standards (IFRS). We use a Norwegian sample to examine whether the adoption of IFRS in 2005 has changed the value relevance of earnings relative to book values. IFRS are balance sheet-oriented with an emphasis on fair value; Norwegian GAAP are earnings-oriented with a strong focus on transactional (historical) cost. IFRS also differ by recognizing more intangible assets, which further contributes to making IFRS less conservative than NGAAP. We find that more fair value accounting increases the value relevance of book values and decreases the value relevance of earnings. Interestingly, reduced balance sheet conservatism because of more recognition of intangible assets yields associations opposite to those of reduced conservatism due to increased fair value accounting. Fair value revaluations decrease the persistence of earnings, while improved matching of expenditures on intangible assets with future economic benefits increases the persistence of earnings and the value relevance of earnings relative to book values. Keywords: IFRS adoption, accounting conservatism, matching, earnings response coefficients JEL Classification: M41, G15

Electronic copy available at: http://ssrn.com/abstract=1334533

1.

Introduction

The European Union (EU) required all exchange-listed firms within the European Economic Area (EEA) to adopt International Financial Reporting Standards (IFRS) in their consolidated financial statements from January 1st 2005.1 IFRS adoption by the EEA is one of the most significant events in the history of financial accounting, making IFRS the most widely accepted financial reporting model in the world. Surely, it is necessary for financial statement users, standard setters, and regulators to understand the implications of IFRS. We use this mandatory transition to IFRS to study whether the usefulness of accounting information has changed from an investor-oriented perspective. Specifically, we investigate whether the adoption of IFRS has altered the associations between stock market values and summary accounting measures from the balance sheet (the book value of equity) and the income statement (the earnings). The previous empirical evidence on the change in value relevance as a result of IFRS adoption is mixed and depends on the Generally Accepted Accounting Principles (GAAP) used prior to the adoption (Hung and Subramanyam, 2007; Gjerde et al. 2008; Paananen and Parmar, 2008; Devalle et al., 2010; Barth et al., 2011). Most previous IFRS adoption studies are not well connected to the differences between accounting methods when explaining observed value relevance differences; differences are observed but rarely explained by tests. An important contribution of this study is to choose one benchmark GAAP to more clearly being able to identify the main accounting differences between IFRS and the domestic GAAP, and to test the basic research question of whether the main accounting differences contribute to explaining the observed differences in value relevance. As outlined below, our findings demonstrate significant associations between the major accounting differences and the valuation weights of book values and earnings.

The common method of controlling for other effects than differences in accounting methods potentially driving observed value relevance differences is to use matched samples (Gjerde et al., 2008; Barth et al. 2011). But comprehensive matching limits the sample to the year prior to IFRS adoption, for which financial statements according to both accounting regimes can be obtained. When benchmarking on one domestic GAAP to more clearly identify the major accounting differences, matched sampling may be very restrictive to the number of observations and sensitive to short-term implementation effects of the IFRS adoption process, as well as to restatements typically induced by discontinuous operations. Instead, we choose to extend the previous IFRS literature on structural shifts between the pre- and post-adoption periods (Hung and Subramanyam, 2007; Paananen and Parmar, 2008; Devalle et al. 2010) by comprehensively controlling for other factors potentially varying between the IFRS and the domestic GAAP sample, and explaining value relevance differences with differences in the main accounting methods. Our findings are stable and robust for alternative specifications and assumptions. We choose the Norwegian GAAP (NGAAP) as the benchmark for evaluating the mandatory IFRS adoption, a choice that is not random. IFRS are balance sheet-oriented with a strong emphasis on measurement at fair value (Penman, 2007; Dichev, 2008). Consequently, we seek domestic GAAP that are earnings-oriented with a strong focus on transactional (historical) cost measurement as our benchmark.2 This means that we exclude domestic GAAP that have developed toward the balance sheet orientation prior to 2005, e.g., UK GAAP (Paananen and Parmar, 2008), and domestic GAAP with gradual adoptions of IFRS prior to 2005, e.g., Swedish GAAP and Danish GAAP (Hamberg et al., 2011; Thinggaard and Damkier, 2008). Importantly, the application of transactional cost accounting among the remaining domestic GAAP prior to 2005 differs according to whether the prescribed use of accounting estimates, e.g., the remaining life of an asset, is biased or unbiased. Most Continen-

tal and Eastern European countries allow or did allow the use of conservative and, therefore, biased accounting estimates (Alexander and Archer, 2003), e.g., because financial accounting is still closely tied to tax accounting or because it is part of their definition of the prudence principle. To provide the IFRS a challenging benchmark for comparison and an alternative for investors, we exclude all domestic GAAP that allowed the use of biased, often tax-driven, accounting estimates from consideration. The criteria that the benchmark GAAP should be earnings-oriented and based on unbiased accounting estimates and that IFRS adoption should not be gradual leave us with few alternatives. Because Norway represents a stable environment of relatively high investor protection and strict legal enforcement (La Porta et al., 1998), we choose NGAAP as the high quality representative of an earnings-oriented alternative to the more balance sheet-oriented IFRS. High investor protection and strict legal enforcement induce a low and stable level of earnings management and more informative disclosures than in EEA countries with lower investor protection (Leuz et al., 2003; DeFond et al., 2007). According to Leuz et al. (2003), Norway has the sixth lowest earnings management score. NGAAP are based on the transactional costs principle, the matching principle requiring costs to be matched with future revenues, and the requirement of using unbiased accounting estimates in the matching process (Johnsen and Eilifsen, 2003). Measurement at cost secures balance sheet conservatism, and additional prudence is applied only for the purpose of recognizing unrealized losses. The extent of the fair value accounting is the main difference between IFRS and NGAAP (Gjerde et al., 2008). However, after systematically comparing IFRS with NGAAP, we can identify another major difference. In practice, IFRS recognize more intangible assets, by excluding the option of expensing development expenditures as incurred when these expenditures satisfy the definition of an asset and requiring the nonamortization of goodwill with annual testing for impairment. Overall, the two major differences between IFRS and NGAAP, more recognition of intangible assets and more measurement at

fair value, suggest that NGAAP are more conservative than IFRS, according to Feltham and Ohlsons (1995) definition. As outlined in Section 3, theoretical as well as empirical studies suggest that the less conservative accounting exhibited in its increased recognition of intangible assets and more measurements of assets and liabilities at fair value will tend to increase the valuation weight of the book value of equity and decrease the weight of earnings. Accordingly, we hypothesize that the association between market value and book value will increase and that the earnings response coefficients will decrease after the mandatory adoption of IFRS in Norway. Furthermore, we hypothesize that the changes in the response coefficients can be explained by the two major accounting differences between IFRS and NGAAP, i.e., more fair value accounting and more capitalization of intangibles under IFRS than under NGAAP. We find that more measurement at fair value according to IFRS increases the valuation weight of book values. However, more fair value accounting tends to decrease the valuation weight of earnings. More frequent and larger revaluations make reported earnings less persistent and thereby less value relevant (Ohlson, 1995). Conversely, increased recognition of intangible assets is found to decrease the valuation weight of the balance sheet and increase the valuation weight of the income statement. Better matching of investment expenditures with future economic benefits makes earnings more persistent (Dichev and Tang, 2008), which increases the valuation weight of reported earnings. Because the book value effect of more recognition of intangible assets is less significant than the effect of more fair value accounting, the net average effect of the mandatory adoption of IFRS in Norway from 2005 is an increased association between market and book values. Our findings add to the existing research by showing that the value relevance effect of IFRS adoption depends critically on the accounting differences between IFRS and the chosen benchmark GAAP and that the net value

relevance effect of IFRS adoption depends on a complex trade-off between various accounting effects. The remainder of the study is organized as follows. Section 2 provides a short summary of the differences between IFRS and NGAAP. Our hypotheses regarding how investors respond to accounting information under IFRS relative to NGAAP are outlined in Section 3. Section 4 presents the methodology for testing the hypotheses. The data and descriptive statistics are discussed in Section 5. Section 6 performs the statistical tests of the hypotheses and discusses the results. Stability and robustness tests are performed in Sections 7 and 8. Section 9 concludes the study.

2.

IFRS vs. NGAAP

The International Financial Reporting Standards (IFRS) issued by the IASB in London are based on a balance sheet-oriented conceptual framework.3 This framework defines assets and liabilities; the equity is the residual. IFRS have increasingly indicated fair values as the principle of measurement after the initial recognition of assets and liabilities. However, transactional cost accounting is widely accepted and is often an equal option, e.g., for property, plants and equipment, intangible assets, and when there is no reliable measurement of fair value. Under the balance sheet orientation, revenue is, in principle, an increase in assets or decrease in liabilities; expenses are increases in liabilities or decreases in assets. Thus, comprehensive income, i.e., earnings plus other comprehensive income, is the change in equity that is unrelated to net capital issues or dividends. Although some fair value revaluations are recorded as other comprehensive income, other revaluation gains and losses are reported as earnings, making earnings more nonrecurring or transitory than if they are governed by the matching of transactional (historical) costs with earned revenues in the future (Penman, 2007; Nissim and Penman, 2008).

Norwegian Generally Accepted Accounting Principles (NGAAP) are the accounting regulations in Norway. The most important regulations are the Accounting Act of 1998 and accounting standards issued by the Norwegian Accounting Standards Board (Johnsen and Eilifsen, 2003). NGAAP are based on an earnings-oriented conceptual framework in which investment expenditures are matched with corresponding revenues to calculate a periods earnings based on unbiased accounting estimates, e.g., for the economic lives of assets and their residual values. The matching principle is, nevertheless, combined with prudence: the cost value, net of the accumulated depreciation, is written off to the recoverable amount if there is an impairment loss, and reversed maximum to initial cost if the value increases again. In principle, there is no other revaluation, i.e., there is no write-up to fair value when it is above cost. However, liquid financial instruments are recorded at fair value if they can be measured reliably. The difference between IFRS and NGAAP may appear considerable because their main principles of measuring assets and liabilities in the balance sheet are fair value and past transactional cost, respectively. Still, in practical terms, the two accounting regimes are not very different for important classes of assets, such as most inventories, property, plants and equipment, and some intangible assets. For example, the cost model is usually chosen for PP&E and intangible assets by firms reporting according to IFRS (Christensen and Nikolaev, 2010); although the revaluation model is an equally emphasized option in IAS 16 Property, Plant and Equipment and IAS 38 Intangible assets. Table 1 lists the most important differences between IFRS and NGAAP. The larger degree of fair value accounting under IFRS is related primarily to financial instruments (IAS 39), investment property (IAS 40), and biological assets (IAS 41). - INSERT TABLE 1 ABOUT HERE -

As demonstrated in Table 1, we note another main difference between IFRS and NGAAP; IFRS offer more recognition of assets than NGAAP. Increased recognition is related to intangible assets (IAS 38), especially purchased goodwill, which is not amortized, and capitalization of development expenditures. Overall, the two major accounting differences may lead, on average, to significant deviations in key accounting figures between the two reporting regimes. In general, assets are more often omitted from or understated on the balance sheet under NGAAP, meaning that NGAAP are expected to be more conservative than IFRS.

3.

Hypotheses Development

Based on Ohlson (1995), Penman (1998) develops a valuation model in which the stock price is a linear combination of the book value of equity and the capitalized value of earnings per share (see also Zhang, 2000): PRICE = (1 - w) BVPS + w m EPS, (1)

where PRICE is the stock price of firm i at time t, BVPS is the book value of equity per share, EPS is the periods earnings per share, w is the valuation weight of capitalized earnings, i.e., m EPS, and m is the multiplier that capitalizes the earnings. In this simple model, the choice of accounting methods affects the accounting variables and their weights, but not the stock price; all accounting methods are predicted to have the same overall value relevance. Because the valuation weights amount to one, an increase in the valuation weight of BVPS is always compensated by a decrease in the valuation weight of EPS, and vice versa. Thus, the effect of accounting differences is to change the valuation weights of respectively the balance sheet and the income statement. Conservative accounting is defined in accordance with Feltham and Ohlson (1995) as accounting that understates the book value relative to the price: BVPS < PRICE. Increased book value conservatism and earnings persistence tend to increase the valuation weight of

earnings and residual earnings at the expense of the valuation weight of book values (Ohlson, 1995, 670-672; Feltham and Ohlson, 1996, 223-224; Penman, 1998, Equation (9)). Earnings persistence could be increased, for example, by the better matching of expenses with revenues, as occurs when investment expenditures are capitalized and not expensed as incurred (Dichev and Tang, 2008). In Section 2, we have identified two major accounting differences between IFRS and NGAAP: more recognition of intangible assets and more fair value accounting under IFRS. The overall value relevance between the two accounting regimes is expected to be equal, as pricing according to (1) is unaffected. The analysis of how the two major accounting differences affect valuation weights is less straightforward. First, increased recognition of intangible assets decreases conservatism and increases earnings persistence due to better matching. Thus, the predicted net effects from more recognition of intangibles on the valuation weights are unclear. Lev and Sougiannis (1996) examine the value relevance of capitalizing research and development expenditures relative to expensing them as incurred; see also Aboody and Lev (1998) and Lev and Zarowin (1999). Recognizing R&D expenditures as assets is found to be more value relevant than expensing them as incurred. Impairment testing with no amortization of goodwill under IFRS is also found to be as value relevant as the combined amortization and impairment method consistent with NGAAP because the absence of amortization of purchased goodwill functions as a proxy for capitalizing internally generated goodwill (Stenheim, 2012). However, Hamberg and Beisland (2012) find that the impairment only method deteriorates the value relevance of earnings relative to the combined method, as earnings becomes less recurring. Second, increased fair value accounting has clearer predictions than the increased recognition of intangible assets, as both balance sheet conservatism and earnings persistence are reduced. The latter diminishes due to transitory revaluations in earnings, which means that

the valuation weight of earnings is expected to decrease in favor of the valuation weight of book values. Empirically, Hann et al. (2007) find that fair value accounting contributes to impairing the value relevance of earnings; see also Khurana and Kim (2003), Stunda and Typpo (2004), and Song et al. (2010). Collectively, the two major accounting differences between NGAAP and IFRS, more recognition of intangible assets and more fair value accounting, are expected to increase BVPS relative to PRICE, meaning that the accounting becomes less conservative by Feltham and Ohlsons (1995) definition. Therefore, the expected net effect of more recognition of intangible assets and more measurement at fair values according to IFRS than according to NGAAP is that, ceteris paribus, the weight on BVPS increases toward one and the weight on earnings decreases toward zero. However, we cannot rule out that in particular, the effect of the increased capitalization of intangible assets at costs could work in the opposite direction, as the better matching of investment expenditures with corresponding future revenues increases the persistence of earnings. Overall, empirical studies and insights from simple valuation models suggest that more recognition of intangible assets and more fair value accounting under IFRS can be expected to contribute to explaining the differences in the valuation weights of book values and earnings, and we propose the following hypotheses (specified as alternatives to their nulls and tested two-sided): Hypothesis 1 (H1): The association between book values and market values is higher and the earnings response coefficient is lower for firms reporting according to IFRS than NGAAP. Hypothesis 2 (H2): The changes in the valuation weights of book values and earnings after the IFRS adoption are associated with increased recognition of intangible assets and additional measurement at fair value.

Are these hypotheses also substantiated by previous empirical research on the value relevance effects of the 2005 IFRS adoption? Devalle et al. (2010) examine whether value relevance has changed, using data from five major European countries. The findings are mixed; they find structural breaks in the book value association and earnings response coefficient in several of the investigated countries, but the sign and magnitude vary across the countries. For example, the book value association decreased and the earnings response coefficient increased in Germany after the IFRS adoption. This finding contrasts with an earlier study by Hung and Subramanyam (2007), who study voluntary adoption of IAS/IFRS prior to the mandatory adoption in Germany and report a significantly higher valuation weight for the book value of equity and a significantly lower valuation weight for earnings in the IFRS than in the German GAAP sample. For the UK, Devalle et al. (2010) note an increase in the book value association, a finding consistent with Paananen and Parmar (2008). However, the latter study also documents a decrease in the earnings response coefficient following the adoption of IFRS in the UK. Collectively, these studies have one important feature in common: there is typically, but not always, a trade-off between the valuation weight of book values and earnings, as suggested by H1. Hamberg and Beisland (2012) analyze the changes in value relevance following the introduction of IFRS in Sweden. They report significantly lower earnings response coefficients under IFRS than under Swedish GAAP. Hamberg and Beisland conclude that the approach of only testing goodwill for impairment according to IAS 36 seems to have deteriorated the value relevance of the income statement. Gjerde et al. (2008) examine the value relevance effects of the adoption of IFRS in Norway, focusing on the restated financial statements from NGAAP to IFRS in 2004, the year prior to the mandatory adoption of IFRS on the Oslo Stock Exchange. In 2005, comparable figures for 2004 had to be disclosed. The reconcilement

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adjustment is incrementally value relevant for both the balance sheet and the income statement. Overall, the IFRS adoption literature presents mixed results. Some of the diversity can be attributed to the differences in domestic GAAP, the benchmarks for IFRS evaluation. Moreover, one challenge in many studies is to properly control for the possible changes in other factors in the pre- and post-adoption periods; another is that most studies are unable to isolate the underlying causes of the observed changes in value relevance. Although some studies propose, e.g., fair value accounting and intangible asset recognition as possible explanations for their findings (Hung and Subramanyam, 2007; Gjerde et al., 2008; Paananen and Parmar, 2008), they do not perform formal tests. An exception is Barth et al. (2011). Based on eleven earnings components attributed to individual accounting standards adopted in fifteen European countries, they are able to identify standards with incremental impacts on the value relevance of earnings, simultaneously controlling for other effects by comparing the 2004 financial statements prepared both according to domestic GAAP in 2004 and restated for IFRS in 2005.4

4.

Test Methodology

H1 and H2 can be tested by expanding regression models commonly used in value relevance studies to take two different financial reporting regimes, IFRS and NGAAP, into consideration:5 SMT = 0 FIX + 1 ACC + 2 IFRS + 3 ATTR + 4 ACC IFRS + 5 ACC ATTR + 6 ATTR IFRS + 7 ACC ATTR IFRS + , where SMT is the stock market valuation (price) or performance (return) of firm i at time t or over period t. FIX = (INDU, YEAR) is a vector of indicator variables for potential fixed industry and year effects. ACC is a vector of appropriate accounting variables, where
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(2)

the specific variables depend on whether a price or a return regression model is specified (further explained below). IFRS is an indicator variable that equals 1 if firm i reports according to IFRS during period t or 0 if the firm reports according to NGAAP during the same period. ATTR is a vector of other attributes that influence SMT, either directly or through interactions (further explained below). Finally, is the error term and the alphas are vectors of the coefficients. Two SMT - variables are emphasized when examining the value relevance of the accounting measures ACC (Easton and Harris, 1991; Collins et al., 1997; Francis and Schipper, 1999; Lev and Zarowin, 1999). In the price regression model, the stock price (PRICE) is regressed on the book value of equity per share (BVPS) and earnings per share (EPS). Thus, SMT = PRICE and ACC = (BVPS, EPS). In the return regression model, stock market return (RET) is explained by the price-deflated earnings (EARN) and the price-deflated change in earnings (DEARN). Thus, SMT = RET and ACC = (EARN, DEARN).6 We denote the sensitivity of the market valuation or performance to accounting variables, SMT/ ACC, as the accounting association coefficient or simply the AAC. In (2), the AAC equals SMT/ ACC = 1 + 4 IFRS + 5 ATTR + 7 ATTR IFRS. (3)

When ACC = BVPS, the accounting association coefficient AAC can be referred to as the book value association (BVA), measuring the association between market and book values per share. When ACC = EPS, EARN or DEARN, the AAC is commonly referred to as the long-window earnings response coefficient (ERC). In this study, we analyze the degree to which IFRS affects the AAC. The influence of IFRS on the AAC is equal to AAC / IFRS = 4 + 7 ATTR. (4)

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ATTR represents attributes that associate with the stock market (SMT) either directly or through interactions with IFRS and ACC. Three types of variables are represented; test variables (INTAN, FAIR), other value relevance related variables (LOSS, SPEC, MVOL), and risk and scale variables (BETA, SIZE, BTM); the three latter variables convert the return regression model into an abnormal return regression model (see, e.g., Easton and Harris, 1991). INTAN is the extent of intangible assets recognized and capitalized in the balance sheet, and it could be measured by the proportion of intangible assets reported or by an indicator variable for intangible asset-intensive firms. Lev and Zarowin (1999) argue that the lack of intangible asset recognition has been increasingly harmful to the value relevance of financial reporting over time. Financial reporting becomes less informative for investors because valueadding expenditures on intangibles, e.g., R&D, are not treated as investment expenditures and capitalized. Expensing them as they are incurred creates transitory noise in earnings that are not present if these expenditures were capitalized and then amortized (Lev and Sougiannis, 1996; Aboody and Lev, 1998). FAIR is the extent of fair value accounting and can be measured by the proportion of assets valued at fair value in the balance sheet or by an indicator variable for fair valueintensive firms. A proxy could be the proportion of market-based financial instruments in the balance sheet or an indicator variable for a firm with a high proportion of financial assets. Because measurement at fair value leads to revaluation gains and losses in the income statement, the extent of fair value measurement could also be approximated by an indicator variable for firms with a high proportion of financial nonrecurring items, e.g., gains and losses on financial investments. Combining the indicator for financial asset-intensive firms with the indicator for financial nonrecurring item-intensive firms also yields a variable indicating a high degree of fair value measurement.

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To test H1, as specified in the previous section, we restrict 7 to 0 in Model (2) and hence Equation (4). Consequently, (4) is simplified to AAC/ IFRS = 4 and unconditional of ATTR. H1 implies that 4 > 0 for the BVA and 4 < 0 for the ERC. H2 contributes to explaining the unconditional effect of IFRS on the BVA and the ERC by the test variables INTAN and FAIR, respectively. An approach that is conditional on ATTR, which includes INTAN and FAIR, must be employed, making (4) appropriate. H2 implies, e.g., that 71 < 0 and 72 > 0 for the BVA and 71 > 0 and 72 < 0 for the ERC, where the last numbers of the subscripts refer to the variable order in the ATTR - vector. Hence, AAC/ IFRS is expected to be associated with INTAN (the first variable in the ATTR - vector) and FAIR (the second variable). When evaluating the impact of INTAN and FAIR on the value relevance of IFRS versus NGAAP, it is important to control for other variables documented to influence the value relevance and for possible risk and scale differences. Thus, these control variables must be added to ATTR, the vector of attributes beyond ACC and IFRS affecting SMT. LOSS is an indicator variable for negative earnings. Hayn (1995) finds that the response coefficient of negative earnings is lower than for positive earnings (see also Basu, 1997). When earnings relevance deteriorates due to losses, book values become more important. SPEC is the proportion of transitory, nonrecurring or special earnings or an indicator variable for a firm with a high proportion of special earnings. The findings of, e.g., Elliott and Hanna (1996) suggest that nonrecurring earnings, such as large asset impairments, are less value relevant than recurring earnings (see also Francis et al., 1996; Hann et al., 2007). MVOL is market volatility, or an indicator variable of high market volatility. Francis and Schipper (1999) argue that value relevance depends on the variability of SMT. For example; the ERC is expected to fall when the stock market becomes more volatile. BETA is a measure of systematic stock market risk, as in the standard Capital Asset Pricing Model. According to Fama and French (1993), firm size
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(SIZE) and the book-to-market ratio (BTM) are relevant proxy risk factors on the crosssection of firms. These proxy risk factors are lagged variables and are not related to information revealed in the current years accounting variables. To some extent, the control variables may be correlated with INTAN and FAIR.

5.

Data, Descriptive Statistics and Correlations

We have collected market and accounting data for all of the firms listed on the Oslo Stock Exchange (OSE) from 2001 to 2008 that reported according to IFRS and NGAAP. The market data are measured over or at the end of the financial year, or they are delayed by three months to capture delayed disclosure when producing better explanatory power (Aboody et al., 2002). Because the firms are required to report according to IFRS from 2005, IFRS are the dominant accounting regime from 2005 to 2008. To obtain relatively equal sample sizes, we also include four years of NGAAP financial statements: 2001-2004. According to Panel A of Table 2, the total number of firm-year observations with a complete sample of test variables and all control variables equals 1,264. Of these, 623 are IFRS observations and 641 are NGAAP observations. - INSERT TABLE 2 ABOUT HERE In Panel B of Table 2, all of the variables are defined and their computations explained in detail. Alternative proxies are outlined for the test variables; they will all be used in our main tests. Table 3 lists distributional statistics for the total sample and for the IFRS and NGAAP subsamples. The stock price, the book value per share, the earnings per share, the (excess) stock market return, the price-deflated earnings per share and the price-deflated change in earnings per share have been winsorized (so that the 1% lowest and highest values are replaced by, respectively, the 1st and 99th percentile, for the IFRS and NGAAP samples separately).

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- INSERT TABLE 3 ABOUT HERE Panel A shows that the average stock price in the combined sample equals NOK 86.837, while the corresponding equity value per share is 66.304 and the corresponding earnings per share is 6.114. As is usually the case, the stock price and the two key accounting numbers have distributions skewed to the right. The mean price, book value and earnings are in the interval between the median and the third quartile for the total sample and for the two subsamples. Focusing instead on the median, the price/book ratio is 1.536 and the price/earnings ratio is 13.502. The difference in the median price/book ratios between the IFRS and the NGAAP sample is 0.428; it is highly significant. The difference in the median price/earnings ratio is -1.080, which is only weakly significant. The differences between the P/B and P/E ratios are in accordance with H1. Panel B reveals that the average stock market return is 10.0%, measured in excess of the proxy for the risk-free rate. The median is -0.3%. The median excess return is negative in the IFRS sample (-5.5%), mainly because of the financial crisis at the end of 2008. In the NGAAP sample, it is 3.9%. The median earnings yield is 4.9% of the market value, while the median change in the earnings yield over the financial year is 0.5%. Panel C presents the distributional statistics of the accounting attribute variables and control variables. The first variable, IFRS, is an indicator variable, which equals 1 if the observation comes from the IFRS sample and 0 if it belongs to the NGAAP sample; see Panel B of Table 2. The average value of IFRS is 0.492, meaning that the two subsamples are almost balanced. In Section 2, we have documented that the main accounting differences between IFRS and NGAAP are more recognition of intangible assets and more measurement at fair value according to IFRS. To represent these differences, we use several proxies for INTAN and FAIR.

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INTAN1 is an indicator variable for highly intangible asset-intensive firms, represented by firms with a ratio of intangible assets relative to their total assets that is above the 75th percentile. By construction, the mean value is 0.250 (32.9% in the IFRS sample and 17.3% in the NGAAP sample). INTAN2 is an indicator variable for firms belonging to industries with an a priori high intensity of intangible assets, defined as biotechnology, information technology or communications. The percentage of new economy observations in the total sample is 23.2 (26.8% in the IFRS sample and 19.7% in the NGAAP sample). As shown in Panel D, the correlation between INTAN1 and INTAN2 is 0.454 (highly significant). Because the two measures are not perfectly correlated, they capture somewhat different aspects of the firms intangible asset intensities. The industry-based measure (INTAN2) may be more related to the capitalization of development expenditures than the balance sheet measure (INTAN1) because development is more common in high-tech industries, and to nonrecognized internally generated goodwill, as the market-to-book value is typically higher in high-tech than in lowtech industries. FAIR1 is an indicator variable for firms whose financial assets (cash excluded) divided by total assets are above the 75th percentile. By construction, the percentage of financial assetintensive firms in the total sample becomes 25% (21.3% in the IFRS sample and 28.8% in the NGAAP sample). FAIR2 is an indicator variable for firms with (scaled) financial nonrecurring items above the 75th percentile, where financial nonrecurring items include revaluations of financial assets due to fair value measurement.7 The mean is 25% (22.8% and 27.1%). FIN3 = FAIR1 FAIR2; the mean is 7.7% (7.5% and 7.8%). FIN4 is an indicator variable for banks and other financial institutions. The mean is 17.3%. There are relatively fewer financial institutions in the IFRS sample than in the NGAAP sample (13.2% and 21.4%, respectively), as several minor savings banks continued to report according to NGAAP some years after 2004. The correlation between the fair value proxies is highest for FAIR1 and FAIR4 and

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equals 0.735; see Panel D. The difference in correlation between the FAIR measures suggests that some measures could be noisier than others; those based on revaluations are likely to be the noisiest measures. The next three variables in Panel C of Table 3 are related to the properties of earnings and book values and function as control variables for changes in the accounting association coefficients (Hayn, 1995; Elliott and Hanna, 1996; Francis and Schipper, 1999). LOSS is an indicator variable for negative earnings. In our sample, 30.3% of the observations are losses. SPEC, the indicator variable for special earnings intensity, is equal to 1 if the absolute value of the sum of operating nonrecurring items scaled by the ingoing market value of equity is above the 75th percentile, i.e., the most extreme observations, and zero otherwise.8 Thus, the proportion of observations related to extensive transitory earnings is constructed as 25.0%. MVOL is an indicator variable for yearly market volatility above the 75th percentile, meaning that two years are considered high-volatility years (2002 and 2008). 27.5% of the observations are from these two years. The final three variables are risk factors or proxy risk factors expected to influence expected returns. BETA is the beta from the Capital Asset Pricing Model, and it is estimated by the market model from the time series of monthly stock market returns. The average beta is 0.964, after winsorizing 1% in each tail. SIZE is the logarithm of the stock market value of the firm at the beginning of the year and is a measure of firm size. After being winsorized, the average value of the SIZE variable is 6.859. The average market value of equity is NOK 6.120 billion, equally weighted. BTM is the adjusted book-to-market ratio; the winsorized average is 0.796. According to Fama and French (1993), both SIZE and BTM are proxy risk factors.

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6.

Main Tests of Hypotheses

To test H1 and H2, we begin by estimating Model (2) as a price regression model.9 Panel A of Table 4 reports the coefficient estimates for the restricted model used to test H1 and then for the unrestricted model used to test H2 (with the exception of the coefficients for fixed industry and year effects). - INSERT TABLE 4 ABOUT HERE The effect of IFRS on the accounting association coefficients (AAC = (BVA, ERC)) is estimated by Model (2) with 7 restricted to zero. Consequently, Equation (4) is reduced to AAC/ IFRS = 4. The impact of IFRS on the AAC is represented by the 4 - vector alone, with one coefficient for book values and one for earnings. According to the first regression of Panel A, the effect of IFRS on book values, i.e., on BVA/ IFRS, is estimated to be 0.472 and is found to be highly significant (with a p-value less than 0.010). The book value association (BVA) is clearly higher in the IFRS sample than in the NGAAP sample. The effect of IFRS on the long-window earnings response coefficient (ERC) is estimated to be -0.150; it is negative, as predicted, but statistically insignificant (with a p-value above 0.100). Consequently, we can only reject the null hypothesis in favor of our alternative, H1, for book values, and not for earnings. There is little reason to believe that the specific influence of the IFRS adoption on the balance sheet and the income statement is uniform across the different characteristics expected to vary between the pre- and post-IFRS samples. Thus, we estimate the unrestricted model in accordance with Model (2). By letting 7 be estimated freely, we are, as suggested by Equation (4), able to test for factors contributing to an explanation of the average effects of IFRS on the AAC. From the second regression model of Panel A, we observe that the INTAN1, our first measure of INTAN or intangible asset recognition, is associated with a decrease in BVA/
19

IFRS, estimated to be -0.420. Therefore, even if the average effect of IFRS on the BVA is positive and equal to 0.472, a separate negative impact of -0.420 on the BVA is included in the average effect for firms with high intangible assets intensity. The impact of INTAN1 is, however, insignificant. If we focus instead on the change in the ERC following IFRS, we note that the partial effect of INTAN1 on ERC/ IFRS is 2.908 and significant (with a p-value below 0.050). The influence of FAIR1, our first measure of FAIR or fair value accounting, on the association between the BVA and IFRS is 0.587. This is a highly significant impact; it is, of course, also highly significantly different from the intangible assets effect (-0.420). The effect of FAIR1 on the association between ERC and IFRS is -2.223, but it is only weakly significant (with a p-value between 0.050 and 0.100). However, it is highly significantly different from the intangible assets effect (2.908). Our findings are consistent with H2; the lack of significance for two of the four coefficients means that we can only claim partial, not general, support of H2. Consequently, we may conclude that thus far, IFRS contributes to increasing the value relevance of the balance sheet, i.e., the book value of equity, mainly because of increased fair value accounting. The effect of increased intangible asset recognition is negative on the value relevance of the balance sheet; therefore, it works in the opposite direction of the main effect of fair value accounting. Although there are traces of reduced value relevance of earnings according to IFRS and some evidence of the origin of this effect, we are unable to fully reject the null hypotheses in favor of H1 and H2.

7.

Robustness Tests

Price regression models have been criticized for potential scale effects (Barth and Kallapur, 1996; Brown et al., 1999; Easton and Sommers, 2003). Although we have cleaned for fixed industry and year effects, we cannot exclude the possibility that the results thus far have been driven by an omitted scale factor differing between the IFRS and NGAAP samples. To reduce

20

the likelihood of scale differences, we employ two remedies. First, we use firm size and other potential scale factors as additional control variables. Next, we expand the analysis with return regressions, which are deflated by the lagged price as a potential scale factor. We also employ scale factors associated with expected returns, i.e., risk variables, as further control variables. The model then becomes a model of abnormal returns with presumably negligible scale effects. Panel B of Table 4 reports the results of the price regression models with ATTR extended by BETA, SIZE and BTM to reduce potential scale effects and account for any risk differences.10 We report only the main coefficients in relation to the impact of IFRS in line with Equation (3) to limit the length of Panel B, and observe that the unconditional BVA/ IFRS decreases from 0.472 in Panel A to 0.449 in Panel B; both coefficients are highly significant. Similarly, the unconditional ERC/ IFRS decreases from -0.150 to -0.425; neither is significant.11 The impact of INTAN1 on the BVAs relationship with IFRS, i.e., on BVA/ IFRS, increases in magnitude as the coefficient decreases from -0.420 in Panel A to -0.576 in Panel B. The latter coefficient is significant. Similarly, the effect of INTAN1 on the ERCs association with IFRS, i.e., on ERC/ IFRS, increases from 2.908 to 3.183; both coefficients are significant. The influence of FAIR1 on the BVAs relationship with IFRS is reduced from 0.587 to 0.428; both are significant. Finally, the impact of FAIR1 on the ERCs association with IFRS increases from -2.223 to -1.415; neither is significant. These findings indicate that the predictions in H2 regarding intangible assets are strengthened by our extended control for scale effects, while the predictions regarding fair value are slightly weakened, as the impact of fair value on the earnings response coefficient moves from being weakly significant to becoming insignificant.

21

Because INTAN1 and FAIR1 are only proxies for INTAN and FAIR, i.e., intangible asset recognition and fair value accounting, we also use alternative proxies (INTAN2, FAIR2, FAIR3, and FAIR4) to capture possible undetected effects, although the proxies might capture somewhat different aspects of INTAN and FAIR and some proxies may be noisier than others. There are seven more combinations of INTAN and FAIR proxy pairs to study. Regarding the overall effect on the AACs, the new seven pairs produce significantly positive effects of IFRS on the BVA, while the effects on the ERC are insignificantly negative; the results are as before, and these coefficients are, therefore, not tabulated. It should be noted that although the significant levels vary, the prediction from the simple Model (1) that a positive change in the BVA is always associated with a negative change in the ERC, is confirmed in all regression analyses. Thus, all our empirical results support the general notion of a trade-off between the value relevance of the balance sheet and the value relevance of the income statement (Ohlson, 1995; Penman, 1998; Nissim and Penman, 2008). Panel C of Table 4 summarizes the impact of the additional seven pairs of INTAN and FAIR proxies on the IFRS ability to alter the BVA and the ERC. We observe that all of the coefficients have signs consistent with those reported in Panel B and consistent with the predictions in H2. The ability of the INTAN and FAIR proxies to explain the effect of IFRS on the BVA is high (two out of sixteen coefficients are still weakly significant or insignificant), while the effect of IFRS on the ERC is insignificant (six out of sixteen coefficients are still significant or weakly significant). Table 5 presents the corresponding results from return regression models.12 Although they have the disadvantage of not including book values, the return regression models are less affected by scale and are, therefore, used to further evaluate the impact of IFRS on the ERC of the level and the ERC of the change in earnings. We focus the discussion on the combined impact, i.e., the sum of the ERC of both the earnings change and the earnings level.

22

- INSERT TABLE 5 ABOUT HERE According to Panel A, the unconditional impact of IFRS on the ERC is 0.129 and insignificant. The analysis by the return regression models is consistent with that of the price regression models: the impact of IFRS on the ERC is insignificant. Accordingly, we cannot reject the null hypothesis in favor of H1 for earnings, only for book values by the price regression model. Furthermore, the combined impact of INTAN1 on ERC/ IFRS in Panel A of Table 5 is 0.179 and insignificant, while the combined impact of FAIR1 is -2.646 and significant. The signs of the estimated effects are consistent with those previously found by the price regression models: compare with Panel B of Table 4. However, the significance of the effects has changed from INTAN1 to FAIR1, possibly due to the return regression models better ability to eliminate scale effects. According to Panel B of Table 5, the estimated signs of the impacts of the INTAN and FAIR proxies are always consistent with H2, but only eight out of the coefficients have some significance. Nevertheless, the impacts of INTAN2 and FAIR1 are always significant, and the impact of FAIR3 is always at least weakly significant. Thus, the return model has documented that IFRS make earnings more value relevant for firms in industries with high intangible asset intensity, as represented by INTAN2, and less value relevant for firms with a high proportion of financial assets on their balance sheets, as represented by FAIR1. As discussed in Section 2, the main difference between IFRS and NGAAP for firms in industries with presumably high intangible asset intensity (biotechnology, information technology, and telecommunications) is more recognition of development expenditures as assets in the balance sheet. Capitalized development expenditures are the likely source of the increase in the value relevance of IFRS earnings at the expense of the IFRS book value of equity; earnings become less transitory, while book values become softer.

23

The finding that the value relevance of IFRS earnings is reduced for firms with a high proportion of financial assets is consistent with a general fair value effect, as financial assets are those most frequently measured at fair value, according to IFRS (and without an industry effect related to financial institutions, as FAIR4 is never significant). However, using return regression models we are unable to relate the effect directly to a high degree of revaluations in the income statement with two exceptions: two cases in Panel B of Table 5, in which FAIR3 is significant or weakly significant. In the price regression models, however, a high degree of revaluation contributes to reducing the value relevance of IFRS earnings on all occurrences of statistical significance for the fair value proxies; see Panel C of Table 4, in which FAIR2 and FAIR3 have some significance.

8.

Stability and Additional Robustness Tests

We have performed stability tests, in which we have divided the test period 2001-2008 into narrower and narrower periods around January 1st 2005, when IFRS were introduced in Norway. The narrowed periods are 2002-2007 with 927 firm-year observations, 2003-2006 with 592 observations, and 2004-2005 with 294 observations. The impact of IFRS on the BVA is evaluated by price regressions, while the impact on the ERC is evaluated by return regressions. Because none of the stability tests contrasts with the results presented in our main tests, we do not tabulate the results. As in the main tests, the significance of the coefficients varies depending on which INTAN and FAIR proxies are chosen. However, significant coefficients are observed in both long and short windows around the introduction of IFRS. For example, the effect of INTAN2 on the BVA difference between IFRS and NGAAP in 2004-2005 is 2.011 and significant; the effect of FAIR1 on ERC difference is -4.077 and significant. Next, we return to the whole sample and report some additional robustness tests. First we run the most basic test model, PRICE = 0 + 11 BVPS + 12 EPS + 41 BVPS IFRS + 42 EPS IFRS + . The impact of IFRS on BVPS (41) is estimated to be 0.528 and high-

24

ly significant, while the effect of EPS (42) is 0.102 and insignificant. Our conclusions about H1 hold true in this simple model. Then we return to the fully specified model with all the controls. As in the stability tests, no robustness tests produce significant coefficients on the test variables contrary to those presented in Section 6. Therefore, we do not tabulate the results; we only list the major tests performed. We start by limiting the sample to the firms that were present in all eight years so that each firm will have four NGAAP observations and four IFRS observations. This limitation is made to increase the similarity in the underlying operations between the IFRS and NGAAP sample and to limit the possibility that operational differences will drive our findings. Second, we replace the indicator variable for a high proportion of intangible assets with the ratio of intangible assets to total assets, as we consistently replace the indicator for a high proportion of financial assets with the ratio of financial assets to total assets. This broadening of the variable definitions is performed to potentially catch continuous effects related to the variables, not only the high-proportion effects. Third, the stock price is measured three months after the end of the financial year, and the stock return is measured from nine months before until three months after the end of the financial year, contrary to the main tests, which measured at the end of the year or over the year. Fourth, we change how we measure the book value of equity per share by not subtracting the current years earnings per share and how we measure the price-deflated level of earnings by not subtracting the price-deflated change of earnings, as we did in the main tests to avoid double counting and concentrate the change effects in single variables. Finally, several additional robustness checks related to outliers and different statistical techniques are conducted.13 As in the main tests, the significance of the coefficients in the robustness tests varies with the pairs of INTAN and FAIR proxies used. Typically, INTAN2 and FAIR1 are the most significant explanatory factors for the differences in book values and earnings between IFRS

25

and NGAAP. In some more advanced statistical specifications, all the test variables within most test pairs are significant in the direction of our alternative hypothesis H2: for example, when using GLS instead of OLS. Overall, the stability and robustness tests confirm and strengthen our conclusions from the main tests in Section 6. The null hypothesis is rejected and we conclude in favor of H1 when considering whether the book value is more value relevant under IFRS. Furthermore, the null hypothesis is rejected, and we conclude in favor of H2. Recognizing development expenditures as assets under IFRS contributes to making the book values less value relevant and the earnings more value relevant than under NGAAP. Conversely, more fair value accounting under IFRS makes book values more and earnings less value relevant than under NGAAP.

9.

Conclusions

This study compares the association between stock market values and accounting information under IFRS and Norwegian GAAP. IFRS generally allow more measurement at fair value and recognize more intangible assets than NGAAP. Financial reports prepared according to NGAAP are, therefore, expected to be more conservative than those prepared according to IFRS. Consequently, we expect IFRS to exhibit a higher association between market and book values and a lower earnings response coefficient than NGAAP. We find clear evidence supporting our initial expectation regarding the association between market and book values; the book values are more value relevant under IFRS than under GAAP. More surprisingly, earnings response coefficients are not significantly different, meaning that earnings are as value relevant under IFRS as under NGAAP. However, as noted by Penman and Nissim (2008), pure correlations and general response coefficients do not offer standard setters much of a grasp of specific policy questions; for instance, questions related to recognition of intangible assets or the use of fair values.

26

Thus, we analyze the sources of the identified value relevance differences, concentrating on whether the two major accounting differences between IFRS and NGAAP contribute to the changes in value relevance. More fair value accounting is shown to have a positive effect on the value relevance of book values, while the increased recognition of intangible assets has a negative effect. The increased value relevance of earnings compensates for the negative balance sheet effect of recognizing intangible assets under IFRS, while the positive balance sheet effect of fair value measurement under IFRS is associated with a negative income statement effect. Fair value revaluations are transitory in nature, leading to less persistent earnings measurement and, therefore, reduced earnings response coefficients. Increased recognition of intangible assets, by contrast, leads to the better matching of investment expenditures with future revenues and, thus, to more persistent earnings measurements. An important contribution of this study is to document and advance the understanding of how reduced balance sheet conservatism in relation to IFRS adoption affects the valuation weights of book values and earnings. Several theoretical studies (Ohlson, 1995; Penman, 1998) demonstrate that the choice between conservative transactional cost accounting versus fair value accounting is a choice between a value relevant earnings statement versus a value relevant balance sheet. Both fair values and transactional costs provide information about future cash flows, but the methods are competing and mutually exclusive ways of conveying information (unless both values are reported). Consistent with the commonly held assumption that IFRS are more fair value-oriented than most domestic GAAPs, we find that the balance sheets valuation weight increased following the IFRS adoption, and, at least partly, at the expense of the earnings response coefficients. However, because we apply a unique test methodology allowing us to split investors response coefficients to accounting information according to accounting regime as well as several accounting attributes commonly recognized to be important drivers of value relevance, we are able to identify the sources of the net aver-

27

age effects. We instructively show that lower accounting conservatism in terms of more recognition of intangible assets and more measurement at fair value, respectively, may have opposite effects on the valuation weights. Our findings suggest that the value relevance effects of the IFRS adoption may be highly sensitive to firm characteristics and the choice of benchmarks to anchor the evaluation on (Christensen et al., 2007). For instance, this study illustrates that intangible asset-intensive companies with an insignificant use of fair value accounting may actually experience a decrease in the value relevance of their balance sheets and an increase in the value relevance of their earnings after IFRS adoption. The findings also suggest that the effect of IFRS adoption on valuation weights may differ throughout the EEA; e.g., the effect may depend on the relative impact of the changed recognition of intangible assets and measurement at fair value and the effect of the changed bias in accounting estimates. Collectively, our results have implications for standard setting and accounting regulation, contributing to identifying the benefits and costs of IFRS adoption in general and of intangible asset recognition and fair value accounting in particular (Schipper, 2011).

28

Notes
EU Regulation No. 1606/2002. EU regulations also bind Norway, Iceland and Lichtenstein through their memberships in the EEA. 2 A balance sheet-oriented framework starts with the definitions of assets and liabilities and then derives the definitions of revenues and expenses, as in IASBs Conceptual Framework for Financial Reporting. An earningsoriented approach begins with the principles of income determination, usually in terms of the matching principle, and derives the balance sheet as a consequence of the matching. Although the conceptual orientation is in principle independent of the valuation method for assets and liabilities, the balance sheet orientation fits well as the basis for fair value measurement, while the earnings orientation is a better basis for transactional (historical) cost measurement. 3 In 2010, the IASBs Framework for Preparation and Presentation of Financial Statements, published in 1989 and governing our sample period of 2001-2008, was superseded by the Conceptual Framework for Financial Reporting. The balance sheet focus in the 1989 Framework continues in the 2010 Framework; the definitions of assets and liabilities (Paragraph 4.4) are the basis for recognizing revenues and expenses (Paragraph 4.25). For a discussion of the balance sheet orientation of the IASB and the FASB relative to the earnings-oriented alternative, see Dichev (2008). 4 A potential problem with the restated IFRS numbers is, however, that they were produced one year later than the corresponding local GAAP figures. Moreover, companies might have adapted to various temporary IFRS adoption regulations when preparing the restatements, and the numbers may be restated because of discontinuous operations. 5 In regression models with interactions, explanatory variables are multicollinear by construction. The main problem with multicollinearity is that real explanatory variables may become insignificant because of the accompanying variance inflation, typically producing regressions with high R2 without many significant coefficients. When a variable is found to be significant, collinearity has been taken into consideration by the variance inflation and represents no further problems for the statistical inference (Wooldridge, 2009, 95-99). 6 The price model is more exposed to scale problems than the return model (Barth and Kallapur, 1996; Brown et al., 1999; Easton and Sommers, 2003). However, both models are used to evaluate value relevance, as they address different aspects of accounting. 7 Financial nonrecurring items are gains and losses on financial instruments, currency gains and losses, and other transitory items reported among financial income and expenses. 8 Operational nonrecurring items are relatively large impairments and other transitory operating items such as large gains or losses on sale of operational assets, restructuring charges and special income from associated companies. 9 Thus, SMT = PRICE, FIX = (INDU, YEAR), ACC = (BVPS, EPS), and ATTR = (INTAN1, FAIR1; LOSS, SPEC, MVOL). The control variables for risk and scale (BETA, SIZE, BTM) will be added to ATTR in the next step of analyses. 10 The conclusions do not change if, e.g., the log of outstanding shares replaces SIZE, the log of market value, as our scale proxy. 11 Further, the persistence of earnings could be evaluated by EARNt = a FIXt + b1 EARNt-1 + b2 EARNt-1 IFRSt-1 + et. We estimate b2 to be -0.367 (the p-value equals 0.003). A significant drop in earnings persistence is consistent with more nonrecurring items in IFRS earnings due to more fair value revaluations reported through the income statement, but the significance of the drop in persistence does not carry over to a significant drop in the ERC after adequate controls. 12 Model (2) has these specific variables: SMT = RET, FIX = (INDU, YEAR), ACC = (EARN, DEARN), and ATTR = (INTAN, FAIR; LOSS, SPEC, MVOL; BETA, SIZE, BTM). 13 First, we return to the raw data, i.e., the data without winsorizing the 1% most extreme observations in each tail. Second, we truncate 1% instead of winsorizing 1%. Third, we winsorize 1% as in the main tests and then further down-weight the impact of extreme observations. Fourth, because we are dealing with skewed distributions, we focus on median effects through median regressions. Fifth, we replace the heteroskedasticity and autocorrelation - adjusted standard deviations, also referred to as Newey-West standard deviations, using multi-way cluster robust standard deviations, with clustering on, e.g., firms and years or industries, audit firms, firms and years, as suggested by Cameron et al. (2011). Sixth, instead of estimating the coefficients by ordinary least squares, we estimate them by general least squares, taking both panel specific heteroskedasticity and first-order autocorrelation into account. Finally, we apply Model (1) with an error term directly and estimate the difference in the valuation weight of capitalized earnings between IFRS and NGAAP to be -0.416, when taking the fixed effects into consideration and allowing the normal trailing price/earnings ratio to differ between the two samples.
1

29

The firms reporting according to NGAAP have a significantly higher weight on capitalized earnings, which is consistent with NGAAP being more conservative than IFRS.

30

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Zhang, X. J., Conservative Accounting and Equity Valuation, Journal of Accounting and Economics 29 (2000), pp. 125-149.

33

Tables
Table 1: Main differences in practice between IFRS and NGAAP in 2001 - 2008
IFRS
Capitalization as assets when satisfying the asset definition and criteria for recognition. Tested annually for impairment. No amortization. Internally generated goodwill is not recognized.

Main area of difference

Goodwill and other intangible assets with indefinite economic lives:

NGAAP
Capitalization of investment expenditures as assets to be matched with future economic benefits. After recognition, the intangible assets are amortized and tested annually for impairment. Internally generated goodwill is not recognized. Both research and development expenditures could be capitalized as an asset, but there is an option of whether to expense both when incurred. In practice, very few exchange-listed firms capitalized R&D. Capitalized as debt to be matched with corresponding revenues. Periodic maintenance could also be accounted for as investments, as this also results in matching the expenses with their corresponding benefits.

Research and development expenditures:

Research expenditures should be expensed when incurred. Development expenditures should be capitalized as assets if they satisfy the criteria for recognition as assets.

Provisions for future expenditures:

Capitalized as liabilities as long as they satisfy the criteria for being recognized as such. The definition of liabilities is interpreted strictly, not allowing, e.g., future periodic maintenance expenditures to be capitalized as a provision. Maintenance cannot be an obligation. Instead, IFRS treat periodic maintenance as an investment when incurred, i.e., as a component of the maintained asset, which is depreciated over the period until the next periodic maintenance. Should be capitalized as assets and measured according to fair value, if the fair value can be measured reliably. Measurement at fair value, unless fair value cannot be measured reliably.

Biological assets and investment property:

Should be capitalized at cost, depreciated if long-lived and tested for impairment.

Financial instruments:

Measurement at nominal value, unless for short-term financial instruments traded in a liquid market.

Source: Gjerde et al. (2008, 94-95). In addition, there are several minor differences in the application of standards and principles. 34

Table 2:
Panel A:

Sample selection and variable definitions

Sample selection on the Oslo Stock Exchange
Firm-year observations Firm-year observations of PRICE, BVPS and EPS 2001 - 2008 = = = Lacking observations when lagging and calculating changes Firm-year observations of RET, EARN and DEARN Lacking observations of accounting attribute and control variables Sample with complete set of variables NGAAP observations IFRS observations Number of companies involved in the selected sample 1,606 176 1,430 166 1,264 641 623 271

Panel B:
FIX PRICE BVPS

Definition of variables
Fixed effects in terms of industry (INDU) and year (YEAR) effects. Thus, FIX = (INDU, YEAR). The stock price of firm i = 1, 2, , N = 271 at the end of financial year t = 2001, 2002, , 2008. The price three months after the end of the financial year is used as a robustness check. The book value of equity of firm i at the end of year t, including a provision for the proposed dividend and excluding noncontrolling interests, divided by the number of outstanding shares at year end. When BVPS is an explanatory variable together with EPS in the price regression models, EPS is deducted from BVPS to capture EPS in a single variable, except in a robustness test. Firm is reported earnings per share in year t. The excess stock return of firm i in year t, where excess means return in excess of the estimated risk free rate. Return is calculated as arithmetic return, adjusted for dividend payments during the year. The risk-free rate of return is approximated by the three-month Nibor rate, which is an interbank borrowing rate. Nibor is adjusted for 28% tax and an average risk premium of 15% is deducted, which corresponds roughly to an average bank rating of AA. As a robustness check, RET is also measured over the year, running nine months before to three months after the end of the financial year or calculated logarithmic. The reported earnings per share of firm i during year t divided or deflated by the previous years stock price at the years end. Thus, EARN = EPS/PRICEt-1. When EARN is an explanatory variable together with DEARN in the return regression models, DEARN is deducted from EARN to capture DEARN is a single variable. Then, EARN = EPSt-1/ PRICEt-1, except in a robustness test. Price-deflated change in earnings per share. Thus, DEARN = (EPSt - EPSt-1)/PRICEt-1. Indicator or dummy variable that equals 1 if the firm reports according to IFRS or 0 if firm i reports according to NGAAP in year t. Indicator variable for intangible asset intensive firms. INTAN is measured in several ways. INTAN1 is an indicator variable for firms with a high ratio of intangible assets relative to total assets, i.e., above the 75th percentile. Alternatively, INTAN2 is an indicator variable for firms in industries with presumably high intangible asset intensity, defined as the biotechnology, information technology and communications industries. Proxy variable for fair value-intensive firms. FAIR is estimated in several ways. FAIR1 is an indicator variable for firms with a high ratio of financial assets, except cash, relative to total assets, i.e., above the 75th percentile. FAIR2 is an indicator variable for firms with a high absolute value of financial nonrecurring earnings relative to the lagged stock price; see endnote 7 for examples of nonrecurring financial items, including fair value revaluations. FAIR3 = FAIR1 FAIR2. Finally, FAIR4 is an indicator variable for banks and other financial institutions. Indicator variable that equals 1 if EPS and EARN < 0 and 0 if EPS and EARN 0. Indicator variable for firms with a high level of special or nonrecurring operational items. 35

EPS RET

EARN

DEARN IFRS INTAN

FAIR

LOSS SPEC

MVOL

BETA SIZE BTM

A high level is measured by a high absolute value of the ratio of operational nonrecurring earnings per share relative to the previous years lagged stock price, i.e., above the 75th percentile. Endnote 8 lists examples of items classified as nonrecurring or special operational items. Indicator variable for years with high market volatility, i.e., above the 75th percentile. Market volatility is measured as the monthly standard deviation of the equally weighted stock market index, based on monthly excess returns the 12 months before the end of the financial year and scaled by the square root of twelve. Beta is an estimate of systematic risk according to the Sharpe-Lintner-Mossin Capital Asset Pricing Model and is estimated from the time series 12 months before the end of the financial year. Firm size is a proxy risk factor, according to Fama and French (1993). Firm size is lagged and measured as the logarithm of the previous years average market value of equity, where the average is calculated on a monthly basis. Book-to-market ratio is a proxy risk factor, according to Fama and French (1993). The book value of equity is lagged and calculated as the average over the previous years monthly book-to-market ratios.

36

Table 3:
Panel A:
PRICE BVPS EPS P/B P/E IFRS: PRICE BVPS EPS P/B P/E NGAAP: PRICE BVPS EPS P/B P/E

Descriptive statistics
Price regression variables
Obs
1,264 1,264 1,264 1,251 880 623 623 623 623 447 641 641 641 628 433

Mean
86.837 66.304 6.114 2.236 28.374 83.719 52.768 6.391 2.651 32.551 89.868 79.460 5.845 1.824 24.063

St. dev.
136.631 142.018 19.026 2.303 62.372 126.849 87.008 17.527 2.789 77.801 145.544 179.146 20.388 1.586 40.370

Min
0.140 -0.700 -40.939 0.191 1.139 0.533 0.098 -35.193 0.192 1.139 0.140 -0.700 -40.939 0.191 1.702

Q1
9.000 5.299 -0.232 0.986 9.057 9.050 4.624 -0.121 1.097 8.379 8.950 6.612 -0.421 0.935 9.681

Median
39.950 22.823 1.531 1.536 13.502 35.100 20.066 1.404 1.787 12.824 43.500 26.568 1.639 1.358 13.904

Q3
116.000 87.281 8.581 2.591 21.852 105.500 59.401 8.255 3.207 22.022 122.500 104.782 8.786 2.137 21.392

Max
1101.000 1534.263 139.379 17.778 561.734 778.000 529.950 100.362 17.778 561.734 1101.000 1534.263 139.379 9.147 291.682

Panel B:
RET EARN DEARN IFRS: RET EARN DEARN NGAAP: RET EARN DEARN

Return regression variables

Obs
1,264 1,264 1,264 623 623 623 641 641 641

Mean
0.100 0.014 0.058 0.026 0.036 -0.005 0.172 -0.009 0.120

St. dev.
0.789 0.202 0.589 0.685 0.133 0.174 0.873 0.249 0.805

Min
-1.000 -0.853 -2.422 -0.941 -0.281 -0.732 -1.000 -0.853 -2.422

Q1
-0.371 -0.033 -0.048 -0.445 -0.021 -0.048 -0.292 -0.057 -0.048

Median
-0.003 0.049 0.005 -0.055 0.049 0.004 0.039 0.049 0.006

Q3
0.369 0.101 0.064 0.345 0.096 0.046 0.394 0.105 0.095

Max
4.781 0.556 5.481 3.207 0.556 0.652 4.781 0.530 5.481

Panel C:
IFRS INTAN1 INTAN2 FAIR1-2 FAIR3 FAIR4 LOSS SPEC MVOL BETA SIZE BTM

Accounting attributes and control variables

Obs
1,264 1,264 1,264 1,264 1.264 1,264 1,264 1,264 1,264 1,264 1,264 1,264

Mean
0.492 0.250 0.232 0.250 0.077 0.173 0.303 0.250 0.275 0.964 6.859 0.796

St. dev.
0.500 0.433 0.422 0.433 0.266 0.379 0.460 0.433 0.447 0.703 1.684 0.885

Min
0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 -0.347 2.933 -0.001

Q1
0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.409 5.662 0.349

Median
0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.859 6.695 0.581

Q3
1.000 1.000 0.000 1.000 0.000 0.000 1.000 1.000 1.000 1.362 7.921 0.902

Max
1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 3.491 11.649 7.313

P/B is the price/book ratio, i.e., PRICE/BVPS with BVPS > 0. P/E is the price/earnings ratio, i.e., PRICE/ EPS with EPS > 0. Other variables are defined in Panel B of Table 2. Obs is the number of firm-year observations, mean is the sample average, St. dev. is the standard deviation, Min is the minimum, Q1 is first quartile, Median is the second quartile, Q3 is the third quartile, and Max is the maximum observation. PRICE is registered at the end of the financial year, and RET is measured over the financial year. The PRICE, BVPS, EPS, RET, EARN, DEARN, P/B, P/E, BETA, SIZE and BTM are winsorized with cutoffs at the 1st and 99th percentile separately for the IFRS and NGAAP samples.

37

Panel D:
INTAN2 FAIR1 FAIR2 FAIR3 FAIR4

Correlation matrix for INTAN and FAIR proxies

INTAN1
0.454 -0.253 -0.156 -0.125 -0.255

INTAN2
-0.222 -0.192 -0.137 -0.252

FAIR1
0.076 0.499 0.735

FAIR2

FAIR3

0.499 -0.018

0.245

INTAN1 is an indicator variable for firms with a ratio of intangible assets relative to total assets above the 75th percentile. INTAN2 is an indicator variable for firms in industries with high intangible asset intensity. FAIR1 is an indicator variable for firms whose ratio of financial assets, except cash, to total assets is above the 75th percentile. FAIR2 is an indicator variable for firms with a high absolute value of financial nonrecurring earnings relative to the lagged stock price. FAIR3 = FAIR1 FAIR2. FAIR4 is an indicator variable for banks and other financial institutions. The Pearson correlation coefficients are significant at the 1% level, tested two-sided, except -0.018, which is insignificant.

38

Table 4:
Panel A:

Tests of hypothesis 1 and 2 by price regression models

Full specifications
Coefficient Yes 0.439 4.940 -26.041 -12.915 20.985 -15.348 -5.042 10.951 0.472 0.628 0.059 0.253 -0.065 -0.003 -0.150 -0.055 -2.153 -2.302 -1.526 -0.222 -3.684 -20.748 3.838 2.036 7.292 t-value *** *** ** *** *** *** 3.48 5.93 -2.05 -2.57 2.74 -2.93 -0.98 0.92 4.50 4.79 0.48 1.85 -0.59 -0.05 -0.28 -0.11 -3.04 -3.44 -2.33 -0.44 -0.60 -2.12 0.56 0.33 0.49 Coefficient Yes 0.613 4.032 -25.808 -12.745 26.341 -14.126 -7.166 4.397 0.193 0.867 -0.146 0.204 -0.179 0.022 1.441 -1.748 -1.140 -3.238 0.034 -0.112 -6.260 -39.965 3.561 8.334 28.993 -0.420 0.587 0.249 0.217 -0.299 2.908 -2.223 4.009 -2.584 -1.546 0.915 1,264 t-value *** *** ** ** *** *** 5.76 4.77 -2.24 -2.34 3.42 -3.01 -1.36 0.35 0.82 3.69 -1.36 1.32 -1.72 0.32 1.00 -1.46 -1.44 -3.32 0.04 -0.17 -0.94 -3.51 0.56 1.20 1.99 -1.44 2.57 1.00 1.03 -2.24 2.10 -1.79 2.91 -2.11 -1.54 F = 203.02

Variable FIX BVPS EPS IFRS INTAN1 FAIR1 LOSS SPEC MVOL BVPS IFRS BVPS INTAN1 BVPS FAIR1 BVPS LOSS BVPS SPEC BVPS MVOL EPS IFRS EPS INTAN1 EPS FAIR1 EPS LOSS EPS SPEC EPS MVOL INTAN1 IFRS FAIR1 IFRS LOSS IFRS SPEC IFRS MVOL IFRS BVPS INTAN1 IFRS BVPS FAIR1 IFRS BVPS LOSS IFRS BVPS SPEC IFRS BVPS MVOL IFRS EPS INTAN1 IFRS EPS FAIR1 IFRS EPS LOSS IFRS EPS SPEC IFRS EPS MVOL IFRS Adjusted R2 Number of observations

*** *** *

***

*** *** **

***

**

***

** ***

** ** * *** ** ***

0.910 1,264

***

F = 211.32

Complete model: PRICE = 0 FIX + 1 ACC + 2 IFRS + 3 ATTR + 4 ACC IFRS + 5 ACC ATTR + 6 ATTR IFRS + 7 ACC ATTR IFRS + , where FIX = (INDU, YEAR), ACC = (BVPS, EPS), ATTR = (INTAN1, FAIR1; LOSS, SPEC, MVOL), all variables are defined in Panel B of Table 2, the alphas are the coefficients, and is the error term. In the nested model, 7 = 0. The coefficients are estimated by OLS, and the standard deviations and, hence, the statistical inferences are adjusted for heteroskedasticity and autocorrelation (HAC: White, 1980; Newey and West, 1987). One, two or three asterisks indicate significance at the 10%, 5% or 1% level, tested two-sided. The net effect of IFRS on the AAC and the marginal impact of INTAN and FAIR are shaded in grey. 39

Panel B:

Impact of IFRS on the BVA and ERC with extended set of control variables
BVA/ IFRS Coefficient t-value 0.50 ** ** -2.06 2.05 0.90 1.12 -2.29 0.47 0.49 -1.78 4.63 ERC/ IFRS Coefficient -0.546 3.183 -1.415 3.784 -2.208 -2.101 -0.461 0.078 1.291 -0.425 ** *** * ** t-value -0.25 2.42 -1.31 2.83 -1.85 -2.04 -0.59 0.31 1.46 -0.87

Fixed effect INTAN1 FAIR1 LOSS SPEC MVOL BETA SIZE BTM AAC/ IFRS

0.198 -0.576 0.428 0.226 0.228 -0.334 0.075 0.028 -0.282 0.449

**

* ***

The coefficients are estimated using regression models identical to those used in Panel A, except that ATTR is extended to (INTAN1, FAIR1; LOSS, SPEC, MVOL; BETA, SIZE, BTM). Only AAC/ IFRS = 4 + 7 ATTR, where AAC = (BVA, ERC), is reported. The net effect on AAC and the marginal impact of INTAN and FAIR are shaded in grey, as they represent tests of H1 and H2. One, two or three asterisks indicate significance at the 10%, 5% or 1% level, tested two-sided after employing HAC robust standard deviations. The adjusted R2 is 92.9%.

Panel C:

Impact of IFRS on the BVA and ERC for different INTAN and FAIR proxies
BVA/ IFRS Coefficient -0.531 0.389 -0.467 0.614 -0.706 0.443 -1.382 0.411 -1.051 0.364 -1.204 0.593 -1.177 0.438 * *** *** *** ** *** ** ** ** ** *** ** ** t-value -1.79 2.78 -1.57 3.33 -2.65 2.15 -2.70 2.01 -2.08 2.55 -2.31 3.26 -2.37 2.14 ERC/ IFRS Coefficient 1.754 -2.052 2.912 -1.989 2.516 -0.809 2.336 -1.288 2.268 -1.825 2.156 -1.737 2.414 -0.822 t-value 1.29 -2.04 2.08 -1.84 1.94 -0.80 1.56 -1.20 0.84 -1.82 1.33 -1.62 1.70 -0.82

Test pairs 1) INTAN1 FAIR2 2) INTAN1 FAIR3 3) INTAN1 FAIR4 4) INTAN2 FAIR1 5) INTAN2 FAIR2 6) INTAN2 FAIR3 7) INTAN2 FAIR4

** ** * *

INTAN1 is an indicator variable for firms with a ratio of intangible assets relative to total assets above the 75th percentile. INTAN2 is an indicator variable for firms in industries with presumably high intangible asset intensity, defined as biotechnology, information technology and communications industries. FAIR1 is an indicator variable for firms whose ratio of financial assets, except cash, to total assets is above the 75th percentile. FAIR2 is an indicator variable for firms with a high absolute value of financial nonrecurring earnings relative to the lagged stock price. FAIR3 = FAIR1 FAIR2. FAIR4 is an indicator variable for banks and other financial institutions. 40

Table 5:
Panel A:
Fixed effect INTAN1 FAIR1 LOSS SPEC MVOL BETA SIZE BTM ERC/ IFRS

Tests of hypothesis 1 and 2 by return regression models

Impact of IFRS on the ERC of the level and change in earnings
Level 1.983 0.065 -1.670 0.452 -0.206 -0.018 -0.812 -0.046 -0.320 0.173 Change 1.178 0.114 -0.976 0.396 0.068 0.001 -0.076 -0.098 -0.699 -0.044 Sum 3.161 0.179 -2.646 0.848 -0.138 -0.017 -0.888 -0.144 -1.019 0.129 F-value 2.47 0.03 6.25 0.25 0.02 0.00 0.92 0.32 1.66 0.04

***

**

Model: RET = 0 FIX + 1 ACC + 2 IFRS + 3 ATTR + 4 ACC IFRS + 5 ACC ATTR + 6 ATTR IFRS + 7 ACC ATTR IFRS + , where FIX = (INDU, YEAR), ACC = (EARN, DEARN), ATTR = (INTAN1, FAIR1; LOSS, SPEC, MVOL; BETA, SIZE, BTM), all variables are defined in Panel B of Table 2, the alphas are coefficients, and is the error term. We report only the impact of IFRS on the ERC of both the level and change of earnings: ERC/ IFRS = 4 + 7 ATTR. The net effect of IFRS on the ERC and the marginal impacts of INTAN and FAIR are shaded in grey. One, two or three asterisks indicate significance at the 10%, 5% or 1% level, tested two-sided after employing HAC robust standard deviations. The adjusted R2 is 62.2%.

Panel B:
Test pairs 1) INTAN1 FAIR2 2) INTAN1 FAIR3 3) INTAN1 FAIR4 4) INTAN2 FAIR1 5) INTAN2 FAIR2 6) INTAN2 FAIR3 7) INTAN2 FAIR4

Impact of IFRS on the ERC of the level and change in earnings for different INTAN and FAIR proxies
Level 0.109 -0.497 0.099 -1.833 0.100 -0.573 1.203 -1.521 1.224 -0.287 1.338 -1.630 1.081 -0.427 Change 0.246 -0.295 0.135 -1.086 0.109 -0.774 2.190 -0.897 2.119 -0.022 2.260 -0.940 2.001 -0.617 Sum 0.355 -0.792 0.234 -2.896 0.209 -1.347 3.393 -2.418 3.343 -0.309 3.598 -2.570 3.082 -1.044 F-value 0.10 0.66 0.04 4.26 0.03 1.00 8.08 5.19 7.74 0.12 9.11 3.66 6.74 0.59

**

**

* ** * ** **

*** * *** *** ***

*** ** *** *** * ***

INTAN1 is an indicator variable for firms with a ratio of intangible assets relative to total assets above the 75th percentile. INTAN2 is an indicator variable for firms in industries with high intangible asset intensity. FAIR1 is an indicator variable for firms with a ratio of financial assets, except cash, relative to total assets above the 75th percentile. FAIR2 is an indicator variable for firms with a high absolute value of financial nonrecurring earnings relative to the lagged stock price. FAIR3 = FAIR1 FAIR2. FAIR4 is an indicator variable for banks and other financial institutions. 41