1
Mandatory IFRS Adoption, Corporate Governance and
Firm Value
ABSTRACT
We study whether financial and accounting disclosure affects firm value, by focusing on the
adoption of the full International Financial Reporting Standards (IFRS) by 2010. We claim that
Brazil is a unique and ideal scenario to investigate this issue, because the country adopted IFRS in
a shorter period compared to other economies, and its firms presented ex-ante cross-sectional
heterogeneity in the quality of accounting. We use diff-in-diff and propensity score matching
techniques to compare firms with ex-ante lower quality of accounting (firms in the Regular and
Level 1 tiers of BM&FBovespa) with otherwise similar firms that already complied with higher
quality accounting standards (firms in the Level 2 and Novo Mercado tiers) before the mandatory
adoption of IFRS. Our results suggest that the adoption of IFRS has a positive impact on Tobin´s
q and Market-to-book ratio. Our inferences stand up to the inclusion of several control variables
and a number of other robustness checks.
Keywords: IFRS, corporate governance, firm value, accounting quality.
Corresponding author.
E-mail: * [email protected]; ** [email protected]; ***: [email protected] ****
Humberto Gallucci acknowledges financial support from the Coordenação de Aperfeiçoamento de Pessoal de Nível
Superior (CAPES), Rafael Schiozer also gratefully acknowledges financial support from CNPq – Conselho Nacional
de Desenvolvimento Científico e Tecnológico (National Council for Scientific and Technological Development) and
GV-Pesquisa.
We thank Heitor Almeida, Roberto Pinheiro, Edilene S. Santos and seminars participants at Fundação Getulio Vargas.
All remaining errors rest with the authors.
Joelson Oliveira Sampaio
Fundação Getulio Vargas - EESP
Fundação Escola de Comércio Alvares Penteado
Humberto Gallucci Netto**
Universidade Federal de São Paulo
Vinícius Augusto Brunassi Silva***
Fundação Escola de Comércio Alvares Penteado
Rafael Schiozer****
Fundação Getulio Vargas - EAESP
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I. Introduction
This paper investigates the effects of the introduction of mandatory International Financial
Reporting Standards (IFRS) reporting on firm value in Brazil, comparing the heterogeneous effects
on firms with ex-ante high and low standards of corporate governance. While a number of studies
have focused on the economic consequences of firms’ increased financial disclosure in general –
and recently, informational outcomes of the European Union’s 2005 adoption of IFRS has
specifically become a popular area of inquiry – the results obtained to date might not adequately
capture the potential benefits of accounting standards convergence because the majority of the
existing literature estimates the effects of IFRS in countries where the information environment
was already considerably rich before its adoption. Therefore, the effects of a marginal change in
accounting quality may be difficult to identify with sufficient statistical significance. In addition,
studies of effects in the European Union should account for the specific terms of Regulation EC
1606/2002, which requires pre-approval by the European Commission for any changes in reporting
standards to become mandatorily enforceable. This has resulted in a somewhat piecemeal adoption
of the IFRS (KPMG, 2008) in the EU; therefore, changes in European firms’ financial disclosure
environment post-2005 capture less precisely the benefits of adopting the IFRS as intended by the
International Accounting Standards Board (IASB) inasmuch as a general convergence in
accounting requirements.
The focus on Brazil aids our identification for a number of reasons. First, IFRS represents
a considerable improvement in accounting standards relative to the pre-existing Brazilian national
generally accepted accounting principles (BRGAAP). Several changes were taken towards the use
of International Financial Reporting Standards (IFRS) brought by Law 11,638 from December
2007. These changes had a material impact on firms’ disclosure due to a significant difference
between these accounting standards. The main changes introduced by IFRS are: i) the IFRS
requires that the value added statement be presented in the financial statements of public
companies. This statement allows a deeper analysis of the nature of the company’s costs and
expenses; ii) the BRGAAP had no specific standard on present value adjustment. In general,
receivables and payables were recorded at nominal value, whereas the IFRS requires that assets
and liabilities be discounted to present value if material; iii) in terms of earnings per share (EPS),
the BRGAAP did not require diluted EPS because the denominator was usually the number of
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shares outstanding, but there was no distinction between ordinary (voting) versus preferred (non-
voting) shares. Under IFRS, the firm needs to calculate the diluted EPS and it requires the
calculation for ordinary shares. The calculation of basic EPS is based on the weighted average
number of ordinary shares outstanding during the period, whereas diluted EPS also includes
dilutive potential ordinary shares (such as options and convertible instruments) if they meet certain
criteria; iv) the BRGAAP defined the tax basis of an asset or liability to be the value assigned for
tax purposes rather than the amount deductible or taxable. Under IFRS, it requires more disclosure
as it relates to gross versus net revenue and various taxes specific to Brazil; v) finally, under BR
GAAP, government grants were usually recorded as a credit in shareholders’ equity rather than
being recorded in the income statement immediately or over time.
In that case, the IFRS includes examples to the Brazilian environment. Government grants
are common in Brazil, for example, the Brazilian Development Bank (BNDES)1 hands out heavily
subsidized credit for some sectors such as infrastructure and industry.
Second, Brazil presents a set of firms with heterogeneous ex-ante accounting quality.
Black, De Carvalho and Sampaio (2014) show that firms belonging to the upper corporate
governance tiers at the São Paulo Stock Exchange (Novo Mercado and Level 2) had a recognized
superior level of disclosure compared to firms in the lower tiers before the general adoption of
IFRS in Brazil. Therefore, the adoption of IFRS represents a larger improvement in transparency
and disclosure for lower tier firms than for upper tier firms. Third, the implementation of IFRS
occurred in a relatively short time window compared to other jurisdictions. Law 11,638 was passed
in December 2007, followed by a “hybrid period” (Pelucio-Grecco et al., 2014) in 2008 and 2009,
during which accounting practices partially converged to IFRS, reaching full implementation by
the first quarter of 2010. Finally, following the rationale of Ayar (2012) and Oliveira et al. (2015),
the focus on a single country allows us to refrain from micro and macroeconomic cross-country
differences that might otherwise confound the empirical identification.
The purpose of this paper is to address the efficacy of such uniform standard adoption in
reducing information asymmetry. We analyze efficacy by studying the reduction of value
discrepancy among Brazilian listed companies under different corporate governance requirements
before Brazil’s IFRS adoption. In 2000, the São Paulo Stock Exchange created three governance
1 The BNDES is the main financial support instrument in Brazil for investments in several economic sectors. The Bank allocates special resources,
preferably in the form of long-term funding and shareholdings.
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listings tiers (Level 1, Level 2 and Novo Mercado) to improve governance patterns. Firms listed
in the Novo Mercado present the highest standards of corporate governance. Companies listed in
Level 2 have most of the Novo Mercado requirements, but the main difference is that a firm in
Level 2 is allowed non-voting shares. Importantly, all the firms with Level 2 and Novo Mercado
status were already required to use IAS/IFRS since 2000, whereas firms listed in the Level 1 and
the Regular level had no such mandatory requirement, and could use BRGAAP until 2007.
Because its legal system derives from the code Law tradition, the BRGAAP, adopted by firms in
the Level 1 and regular governance tiers until 2007, favored the form over essence, and the
accounting tradition entailed a more formalistic view, which was strongly influenced by tax
legislation and other regulatory directives.
Therefore, when Regulation 11,638 was voted into law in 2007 and required all publicly
traded firms to adopt IFRS, this only required a change in reporting practices for Level 1 and
Regular level firms. Consequently, the Law improved accounting standards for firms listed in the
Level 1 and regular governance tiers, but not for firms in the Novo Mercado and Level 2 tiers.
Therefore, this Law offers a quasi-natural experiment design, by providing a source of variation
in disclosure that is heterogeneous among firms and almost exogenous.
This paper contributes to the existing literature in at least two directions. First, this is the
first study to investigate the interplay between corporate governance, accounting transparency and
firm valuation in an emerging market context. While several studies have looked into the effect of
accounting on valuation for developed economies, (Daske, Hail, Leuz and Verdi, 2008;
Armstrong, Barth and Riedl, 2010) and the relationship between corporate governance and
accounting quality and transparency (Verrecchia, 2001; Verriest, Gaereminck and Thornton,
2012), this is the first paper to link these three features in a quasi-natural experiment design for an
emerging economy. Second, we claim that the characteristics of the Brazilian market mentioned
above (full adoption of IFRS and ex-ante heterogeneity in accounting quality) allows for a better
empirical identification strategy to evaluate the effects of accounting transparency on firm value
compared to previous papers on the subject.
Using a propensity-score matching, we focus on firm value outcomes for Brazilian firms,
which were required by Law in 2007 to adopt the full IFRS by 2010. We refer to this Law as the
treatment, which, for our identification purposes is as good as an exogenous shock to the
transparency in accounting of Brazilian firms. While the Law required all Brazilian firms to adopt
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IFRS (and therefore all firms could be potentially “treated” by the Law), we argue that a group of
firms with ex-ante superior accounting quality, that were already required to use IFRS because of
their corporate governance listing status were not treated by the Law, whereas firms with ex-ante
lower quality of accounting are more sensitive to the Law. For simplicity, we will henceforth refer
to the latter group of firms simply as treated (i.e., firms with ex-ante low quality of accounting,
more sensitive to treatment) and untreated (firms with ex-ante better quality of accounting, less
sensitive to treatment). Untreated firms in the Level 1 and Regular tiers of the São Paulo Stock
Exchange (BM&FBovespa) are matched to otherwise similar treated firms in the Novo Mercado
and Level 2 tiers to gauge the effects of increased accounting transparency on firm value.
Our results show that the mandatory adoption of IFRS causes a positive impact on Tobin´s
q and Market-to-book ratio for firms with ex-ante lower disclosure quality. As Figures 1 and 2
suggest, the implementation of IFRS almost completely eliminates the pre-existing valuation
(Tobin’s Q and market-to-book ratio) gap between firms in the upper and lower corporate
governance tiers. Our tests confirm that this differential reduction in Tobin’s Q and market-to-
book ratio are not only statistically significant, but also economically very relevant, since the pre-
existing gaps in Tobin’s Q and market-to-book are as large as 33 and 29 percentage points,
respectively. Our matching estimators assure that the comparison is made between treated and
untreated firms that are otherwise similar in terms of observable features such as industry, size and
leverage.
[Figure 1]
[Figure 2]
Our inferences stand up to a number of different robustness checks. A potential concern in
our empirical strategy is that the period of adoption of IFRS (2008 to 2010) partly coincides with
the financial crisis. If the treatment assignment is correlated with macroeconomic variables that
are important to firm valuation and were affected by the crisis (for example, if firms with better
corporate governance are more exposed to negative shocks in the financial sector), the effect on
Tobin’s Q and market-to-book value that we observe would be erroneously attributed to the
adoption of IFRS. To tackle this concern, we check if operational and financial metrics such as
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earnings, income and leverage were differently affected by the crisis for treated and untreated firms
and do not find any significant difference between the two groups of firms. Because the Brazilian
Real suffered a 30% depreciation right after Lehman Brother’s demise, we also check whether
firms in both groups had different exposure to foreign currency. To further address this potential
issue, we run a placebo test, using the 2015 currency shock in Brazil, a period during which no
change in accounting requirements were made, and do not find any similar effects.
Finally, we also control our estimations for a series of variables that were previously found
to affect firm value (measured by Tobin´s Q and Market-to-book) and find results in line with the
previous literature. Firms with higher net income are more likely to have higher Tobin´s Q and
market-to-book as expected. In addition, we find a negative relation between firm value and size,
Ebit-to-sales, sales growth and PPE-to-sales.
The remainder of the paper is as follows. The second section discusses the related literature
and provides information regarding the types of governance listings in Brazil. The third section
shows a description of our data and the fourth section presents our identification strategy. The fifth
section provides our empirical results, whereas the sixth section presents a series of robustness
checks, and the last section concludes.
II. Relevant Literature
This study relates most closely to the ‘association-based’ studies in the financial literature on
disclosure, which generally attempt to document the effects of reduced information asymmetry on
trading volume, cost of capital and firm value (Kanodia, 2006). Both previous theoretical and
empirical work suggest that a negative relationship exists between information asymmetry and
trade volume (Admati and Pfleiderer, 1988). For example, Leuz and Verrecchia (2001) considers
voluntary commitment to increased disclosure levels in Germany and finds that trade volume
increases for firms that switch from German GAAP to IAS or US GAAP, suggesting that
disclosure decreases the information asymmetry component of the cost of capital. Similarly, Beatty
et al. (1996) find that improvements in accounting quality are associated with lower contracting
costs and less managerial rent extraction.
Previous literature illustrates the benefits of higher levels of financial reporting quality. In
a nutshell, these papers relate improvements in accounting quality to lower cost of capital and
positive abnormal returns for firms (e.g., Diamond and Verrecchia, 1991; Baiman and Verrecchia,
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1996, Leuz and Verrecchia, 2001; Karamanou and Nishiotis, 2005, Daske et al., 2013, and Barth
at al., 2013). Botosan and Plumlee (2002) also highlight that the firm implied cost of capital is
negatively related to better governance patterns.
Daske, Hail, Leuz and Verdi (2008) evaluate the economic consequences of mandatory
IFRS adoption in an international setting. They show that market liquidity, equity valuation and
the cost of capital improved after the adoption of IFRS (market liquidity and equity valuation
increased, whereas the cost of capital decreased). According to Coffee (1984), Dye (1990) and
Lambert, Leuz and Verrecchia (2007) investors can better compare companies around the world
due to IFRS reporting. Moreover, Verrecchia (2001) and Lambert, Leuz and Verrecchia (2007)
find that higher quality financial reporting and better disclosure can help to mitigate adverse
selection problems.
In spite of the improvement provided by better governance patterns, Jeanjean and Stolowy
(2008) point out that IFRS provide necessary but no sufficient condition for creating a common
business language. In addition, some papers highlighting reporting incentives, such as Ball,
Kothari and Robin (2000), Ball, Robin and Wu (2003) and Daske et al. (2008), question the
consequences of better reporting policies. However, authors seem to share the positive impact of
higher levels of disclosure.
The effective implementation of IFRS in firm’s reporting also plays an important role (Ball,
2006; Armstrong, Barth, and Riedl, 2010). Dask et al. (2008) show that cost of capital and Tobin’s
Q are affected by the change in accounting rules. Verriest et al. (2012) show that within a
mandatory increased disclosure setting, compliance is associated with previous marks of higher
quality governance.
Our paper stands out from the previous studies in that we examine the effects of improving
accounting quality using a case in which this improvement is mandatory, and uniformly applied
across a well defined set of firms. We use a quasi-natural shock (a law that rendered IFRS
mandatory) and exploit the ex-ante distinction between the tiers’ accounting standard requirements
in Brazil. This setting allows us to identify the effects of mandatory IFRS adoption by a specific
group of firms and compare the effects of improved accounting standards on firm value by
comparing these firms to otherwise similar firms (i.e., matched firms) that already adopted IFRS.
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III. Data
We start by collecting data from 444 Brazilian publicly listed firms from 2004 to 2016. In our main
tests, we use data around the adoption of IFRS (between 2007 and 2010), but we use the other
periods for our robustness checks and placebo tests, ranging from 2004 to 2015. We capture
financial statements and company information from Economatica2. Table 1 provides a description
of our variables.
[Table 1]
Table 2 presents our sample selection procedure. We exclude observations according to the
following filters: i) firms that changed their corporate governance tiers during the sample period;
ii) over-the-counter, foreign firms listed as BDRs (Brazilian Depositary Receipts) and “Bovespa
Mais”3 listed companies; iii) firms in the Regular or Level 1 tiers with American Depositary
Receipts (ADRs) and firms with any changes in their ADR status, because these firms could
arguably be submitted to more strict disclosure requirements because of cross listing; iv) firms
facing financial reorganization; v) firms in NAICS sectors 522, 524, 525 and 551 and (finance,
insurance and management companies); vi) companies without available information in 2007 or
2010. Our final sample has 132 companies, 56 of them from the untreated group (Novo Mercado
and Level 2) and 76 from the treated group (Level 1 and Regular tiers).
[Table 2]
We pair up firms in the treated and untreated groups on the basis of their 3-digit industry
classification, size and leverage (we explain the pairing procedure in detail in the next section).
After this procedure, our main sample contains quarterly information starting in the first quarter
2 www.economatica.com 3 Similar to Novo Mercado, for smaller firms and with some restrictions, e.g., there is no need for 25% free float.
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of 2007 and ending in the fourth quarter of 2010. We have 76 treated and 76 control companies.4
The mandatory adoption of full IFRS in Brazil, after a transition starting in 2008, was fully
effective starting in the first quarter of 2010. In most of our empirical examinations, we use data
from 2007 (prior to the mandatory adoption of IFRS) and 2010 (after full implementation of IFRS).
The transition period, comprising 2008 and 2009 is used in robustness checks. We also do a series
of placebo checks using the periods from 2004 to 2006 and 2011 to 2016.
Table 3 – panel A - shows the descriptive statistics for the main variables of interest,
splitting the sample into treated firms (i.e., firms from Level 1 and regular tier of corporate
governance, that were forced to adopt IFRS after 2007) and control firms (firms in Level 1 and
Novo Mercado, that already adopted IFRS before 2007). We do not observe any striking
differences between treated and control firms regarding these variables. Treated firms are only
slightly smaller than control firms, and they have similar levels of leverage, net income/assets and
EBIT/assets on average. Control firms have slightly larger levels of PPE/sales and EBIT/sales on
average. Table 3 – panel B – shows the correlation matrix for the same variables.
[Table 3]
Table 4 provides median comparison tests for our main covariates, following Almeida et
al. (2011). We compare treated and untreated firms regarding the within-firm changes in the
matching variables (size and leverage), as well as the net income over assets, EBIT over assets,
EBIT over sales and PPE over sales as of the last quarter of 2007. These tests allow us to capture
time-invariant heterogeneity by comparing within-firm changes in these variables. We do not find
significant differences between treated and control groups in the median of these variables,
suggesting that the matching procedure is able to pair up treated and control firms that are similar
along these observable dimensions prior to the Law.
[Table 4]
4 Our pairing/matching procedure is made with replacement, following Roberts and Whited (2013). Therefore, it is
possible for an untreated firm to be a match for more than one treated firm.
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IV. Identification Strategy and matching procedure
We exploit the specific distinction between the listing tiers’ accounting standard
requirements. Firms in Level 2 and Novo Mercado tiers were required to use IAS/IFRS since 2000,
while Level 1 and Regular firms used Brazilian GAAP until 2007. Regulation 11.638/07 was voted
into law and required all publicly traded firms to adopt IFRS, but this only required a practical
change in reporting practices for Level 1 and Regular firms.
We separate all firms in the sample following each corporate governance tier. This
procedure allows us to identify a treated (Regular and Level 1 firms) and a non-treated (Level 2
and Novo Mercado) group. Selection into tiers was originally chosen by the firms themselves,
meaning that group assignment is not random. However, the self-assignment of firms into the
different tiers of corporate governance seems to be unrelated to the passing of the Law that
rendered IFRS mandatory for all Brazilian firms, because for most firms this assignment was made
seven years before the passing of the Law. The long period between group assignment and the
passing of the Law makes it implausible to assume that firms decided to comply to the
requirements of higher governance tiers because they anticipated the mandatory adoption of IFRS
in the future.
To further mitigate any existing concerns about this non-random assignment, we follow
Almeida et al. (2011) and adopt a less parametric and more closely related to the notion of a
“design-based” test. In this framework, we match firms in the treated group to otherwise similar
firms in the control group, so as to ensure that treated and control observations belong to the same
industry and have similar features along several important dimensions. We match treated to
untreated firms using a propensity score technique based on industry (3-digit NAICS), size and
leverage5 as of the last quarter of 2007. Because there are more treated than untreated firms in our
sample, we match every treated firm to a single non-treated firm, following Almeida et al. (2011).
We also follow the recommendation of Roberts and Whited (2013) and use replacement in our
matching procedure. After the matching procedure, we remain with 76 treated firms and 76 control
(untreated matched) firms.
5 We also perform alternative matching procedures using other covariates, such as Net Income/Assets, EBIT/Sales,
PPE/Sales and EBIT/Assets. We follow the recommendation of Angrist and Pischke (2008) and use a parsimonious
model containing only the covariates that actually predict the treatment.
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Inferences about the variables of interest (Tobins’ q and market to Book value) are based
on differences in the post-treatment outcomes of treated and control groups. The matching
procedure allows us to mitigate concerns about the non-random assignment of treatment, allowing
us to compare treated to control firms that are otherwise similar. We use the following
specification:
𝑉𝑎𝑙𝑢𝑒𝑖,𝑡 = 𝜔(𝐼𝐹𝑅𝑆𝑖 × 𝑇𝑡) + 𝜏𝑇𝑡 + 𝜑𝐼𝐹𝑅𝑆𝑖 + 𝛽′𝑋𝑖,𝑡 + 𝜀𝑖,𝑡 (1)
Where:
𝑉𝑎𝑙𝑢𝑒𝑖,𝑡 = 𝑇𝑜𝑏𝑖𝑛𝑠′𝑞𝑖,𝑡 𝑎𝑛𝑑 𝑀𝑎𝑟𝑘𝑒𝑡𝑖,𝑡
𝐵𝑜𝑜𝑘 𝑖,𝑡
𝐼𝐹𝑅𝑆𝑖 is a dummy variable for treated firms;
𝑇𝑡 is a time dummy that assumes 0 for the year 2007 and 1 for 2010. In an alternative specification,
we use data from 2007 and 2008 and, in this case the Tt assumes 1 for the year 2008 and 0 for
2007;
𝑋𝑖,𝑡 is a matrix of control variables (size, leverage, net income over assets, EBIT over assets, EBIT
over sales and PPE over sales, NAICS sector);
ω, τ, φ and β’ are parameters to be estimated.
V. Results
Table 5 – Panel A - presents our estimates of the average effects of treatment on the treated
(ATT) firms, which is given by the coefficient ω in equation 1. According to our estimate, the
ATT effect of the mandatory adoption of IFRS is a 0.335 increase in Tobin´s Q (first row of column
1), statistically significant at the 5% level. This effect is also economically significant, as it
corresponds to an increase of approximately 30% of the pre-shock value of Tobin’s Q for the
median treated firm. We also estimate a positive ATT effect of 0.290 on the Market-to-book ratio
(first row of column 2), equivalent to almost 35% of the median pre-existing levels of market-to-
book ratio. This result is statistically significant at 10%. These are the main results of this paper.
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Because our matching procedure guarantees that our treated and control groups are similar in
several observable features, we claim for a causal interpretation of the effect of improved
accounting disclosure on firm value.
Because some features of the IFRS were adopted as early as in 2008, we also check for the
immediate effect of its adoption by comparing the change in our variables of interest for the treated
and control firms from 2007 to 2008. Our ATT estimates, reported in the second row of Table 5 –
panel A -, are only slightly smaller than our previous estimates. The adoption of IFRS adoption
for low governance firms is associated to increases of 0.313 in their Tobin’s Q and 0.270 in their
market-to-book ratio on average (statistically significant at the 5% and 10% levels respectively).
We perform a number of placebo checks in table 5 – panel B – where we adopt alternative
placebo time windows for our treatment and alternative dates to match treated to control firms. For
example, in the first row of table 5 – panel B – we match treated control firms based on the
observable covariates as of the last quarter of 2010, and then perform the same experiment as in
table A, but comparing the change in our variables of interest between 2010 and 2011. We then
perform analogous placebo experiments using different treatment dates. Our estimates of the ATT
are not statistically significant in any of these placebo tests, which suggests that our results in Table
5 – panel A – are not driven by unobservable features that simultaneously drive both the choice of
corporate governance tiers by the firms and firm valuation. For example, firms in low and high
governance tiers could present different sensitivity to economic cycles (betas) or other risk factors.
Importantly, our placebo treatment dates include both periods of economic downturns as well as
more favorable economic periods, both at the local and global levels, mitigating concerns that
these unobserved firm features drive our results.
VI. Further robustness checks
In this section, we address several other potential concerns about our previous inference on
the effect of improved accounting disclosure on firm valuation.
A first possible source of concern stems from the fact that the valuation gap between treated
and control firms decreases after the IFRS adoption not because low governance firms increase
their average Tobin’s Q and market to book value, but mainly because these metrics are reduced
for high governance firms after 2008, as previously shown in Figures 1 and 2. Our matching
procedure attempts to guarantee that the change in valuation of control firms represent our
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unobserved counterfactual as close as possible. In other words the drop in valuation observed for
high governance firms in the control group is our estimate of the change in valuation of low
governance firm had they not adopted the IFRS. The drop in valuation metrics (Tobin’s Q and
MTB ratio) for high governance firms observed from early 2008 to mid 2009 is possibly related
to the global financial crisis that started to hit emerging economies in early 2008, and it is quite
plausible that low governance firms would have faced a similar drop in their valuation metrics had
they not adopted IFRS.
However, one could still be concerned that high governance firms are more sensitive to a
financial crisis, due to omitted firm features, for example because they had more operational or
financial exposure to global economic cycles than low governance firms. We claim that this is
implausible, for a number of reasons. First, because treated and control firms are matched on
industry, which make their sensitivity to business cycles similar. Second, because our placebo
checks also cover a period of economic recovery and we do not observe a reversion in the valuation
gap in this period.
Third, if the story that low and high governance firms are differently sensitive to the crisis
we perform a series of differences-in-differences regressions in which we use operational and
financial covariates as the dependent variables. The logic behind these tests is that, if some
unobserved firm feature causes treated and control firms to be heterogeneously affected by the
crisis, we should observe different changes in operational and financial performance metrics
around the crisis period. More specifically, we run the following regressions:
𝑌𝑖,𝑡 = 𝛾(𝐼𝐹𝑅𝑆𝑖 × 𝑇𝑡) + δ0𝑇𝑡 + δ1𝐼𝐹𝑅𝑆𝑖 + 𝛽′𝑋𝑖,𝑡 + 𝜀𝑖,𝑡 (2)
Where:
Yi,t is one of the following variables: size, leverage, net income over assets, EBIT over assets, EBIT
over sales and PPE over sales, NAICS sector
𝐼𝐹𝑅𝑆𝑖 is a dummy variable for treated firms;
𝑇𝑡 is a time dummy that assumes 0 for the year 2007 and 1 for 2010. In an alternative regression,
we use data from 2007 and 2008 and, in this case the Tt assumes 1 for the year 2008 and 0 for
2007;
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𝑋𝑖,𝑡 is a matrix of control variables (size, leverage, net income over assets, EBIT over assets, EBIT
over sales and PPE over sales, NAICS sector), obviously excluding the variable that is used as the
dependent variable;
γ, δ1, δ2 and β are coefficients to be estimated.
Our main parameter of interest in the diff-in-diff coefficient γ. A non-significant γ indicates
that, for that particular dependent variable Y, the effect of the treatment is homogeneous between
treated and control firms. The results displayed in Table 6 report the coefficient γ for the
regressions made with each of the dependent variables. For example, in the first row of Table 6
the dependent variable is the ln(assets), whereas in the second row the dependent variable is the
leverage ratio and so on. The difference between the first and second columns of table 6 is that,
the first column uses data from the four quarters of 2007 and 2010, whereas the second column
uses data from 2007 ad 2008 (and the variable Tt is adjusted accordingly). Not a single one of the
coefficients reported in table 6 is statistically significant, which strongly suggests that treated and
control firms do not have very different sensitivities to the financial crisis on average. These results
helps us in ruling out any alternative explanation for our inferences made on the effect of improved
accounting transparency on firm value.
Another possible confounding effect is that the different changes in valuation of firms in
the treated and control groups stem from their different sensitivities to the exchange rate. Because
the Brazilian real appreciated approximately 25% along 2007 up until the third quarter of 2008,
one could be concerned that high governance firms were more hurt by this appreciation than low
governance firms for some reason. We claim that the results from our diff-in-diff regressions help
in ruling out this story, because any such difference in exchange rate exposure would show up
either the firms’ income or EBIT in those regression. In any case, to further mitigate these types
of concerns, we use the depreciation in the Brazilian Real occurred in 2015 (when no change in
accounting requirements took place) as an experiment. We split our sample into low (below
median) and high (above median) Tobin’s Q as of December 2014, and check if their valuation
was differently affected by the depreciation of the Brazilian Real. Figure 3 shows that the median
Tobin’s Q of the two groups follow roughly parallel trends throughout the entire 2014-2016 period,
indicating that firms with high and low Q are similarly exposed to the exchange rate on average.
15
One could also possibly be concerned that the untreated firms selected to serve as matches
(control) have special features that cause some sort of selection bias, or that the matching procedure
“artificially” attributes too much weight for specific control firms that appear more than once as a
match for treated firms. To mitigate any such concerns, we run a series difference-in-differences
regressions (without any matching). In other words, we re-estimate equation 1, but using a dummy
for untreated firms, instead of control (matched) firms, guaranteeing that each observation is
weighted equally in the estimation. The results from this exercise are reported in Table 7. The
coefficients ω for the 2007-2010 regressions are slightly smaller than the ones reported in table 5,
but remain economically and statistically significant at the 10% level. For the 2007-2008
regressions, the coefficients are even slightly larger than the ones reported in Table 5.
Finally, we perform a number of unreported robustness checks, such as changing the
matching procedure and covariates, running regressions with and without firm-level and
macroeconomic control variables. Our inferences stand up to all these robustness checks.
VII. Conclusion
This paper investigates whether accounting transparency affects firm valuation. The focus
on Brazil during the mandatory adoption of IFRS between 2008 and 2010 allows us to mitigate
the endogeneity concerns present in cross-country studies, while taking advantage of the ex-ante
heterogeneity in accounting quality and corporate governance of Brazilian firms. The institutional
features of the Brazilian market, such as low enforcement and the formalistic approach of the pre-
existing BRGAAP, makes the adoption of IFRS in Brazil a larger improvement in accounting
transparency compared to developed economies.
We use a matching technique that allows us to compare firm valuation between companies
listed in the lower corporate governance tiers of the BM&FBovespa, that adopted IFRS between
2008 and 2010 to otherwise similar firms listed in the higher corporate governance tiers of the
exchange, which already adopted IFRS before it became mandatory by Law. Our results indicate
that the improved transparency provided by the adoption of IFRS increases Tobin’s Q by as much
as 33 percentage points, virtually eliminating the pre-existing valuation gap between firms listed
16
in the high and low tiers of corporate governance. The effect of improved transparency on the
market-to-book ratio is also economically large, reaching 29 percentage points.
Our results add to the previous findings that increased transparency improves firm value.
While most of the previous studies rely on cross-country heterogeneity in transparency, which
could be subject to criticism, our identification strategy that uses a quasi-natural experiment and
matching techniques allows us to better identify the causal relationship between accounting quality
and firm value. Our inferences shed light on the role of regulation in providing transparency to
protect minority shareholders. While our paper does not directly investigate the reasons driving
the pre-IFRS valuation gap between high and low governance firms, previous research shows that
this pre-existing gap might happen because of expropriation between controlling shareholders and
minority shareholders, or because of manager-owner agency conflicts. Because the decision to not
adopt IFRS until determined by Law was essentially a choice of managers and controlling
shareholders, we speculate that this decision was plausibly driven by these players extracting
private benefits from reduced transparency. Therefore, our findings suggest that improving
accounting quality levels the playing field between controlling and minority shareholders and
reduces the room for managers extracting private benefits from shareholders.
Expropriation of minority shareholders by controlling shareholders and managers is
particularly more relevant in emerging markets, where ownership tend to be more concentrated,
non-voting shares are more common, and investor protection tends to be lower than in developed
markets. To guarantee a healthy investment environment, regulators should focus on the
improvement of accounting quality and enforcing transparency rules.
We suspect that the role of corporate governance and accounting quality in reducing
informational asymmetry and creating firm value will continue to be an active research topic, given
its importance and many aspects.
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Figure 1
Median Tobin’s q
Quarter median for each group. Tobin’s q is winsorized at 5% level. Treated are firms in the Regular and
Level 1 governance tiers; Non-treated are firms in the Level 2 and Novo Mercado governance tiers. We
have 76 treated firms and 76 control firms.
21
Figure 2
Median - Market to book
Quarter median for each group. Market to book is winsorized at 5% level. Treated are firms in the
Regular and Level 1 governance tiers; Non-treated are firms in the Level 2 and Novo Mercado
governance tiers. We have 76 treated firms and 76 control firms.
22
Table 2
This tables summarizes the sample selection that we applied to Economatica data.
Number of firms in 2007 444
Drop firms with: Changed corporate governance listing level between 2007 and 2010 1
BDR and OTC 7
Regular or Level 1 firm with ADR 14
NAICS Sectors 522,524,525 and 551 59
Firms facing corporate reorganization 11
No sales information 14
No data in 2007 and 2010 206
Total 132
Novo Mercado and Level 2 firms (untreated firms) 56
Level 1 and Traditional level firms (treated firms) 76
Table 1
Variables Definition
Tobin’s q (book value of debt + market value of common stock)/ book
value of assets
Market-to-book (market value of equity) / book value of assets
ln (assets) natural logarithm of book value of assets
Leverage (Total debt)/total book value of assets
Net Income/assets (Net income)/total book value of assets
EBIT/sales (Earnings before interest and tax)/total sales
PPE/sales (Ratio of property, plant, and equipment)/Total sales
EBIT/assets (Earnings before interest and tax)/total book value of assets
Industry dummies Three-digit NAICS
23
Table 3 This Table presents the descriptive statistics and correlation matrix for treatment and control groups. Both groups
have 76 observations.
Panel A – Descriptive Statistics
Treated Mean Median Standard
Deviation Minimum Maximum
ln (assets) 14.04 13.88 1.99 10.46 17.78
Leverage 0.25 0.23 0.14 0.00 0.61
Net Income/assets 0.04 0.04 0.09 -0.32 0.20
EBIT/sales 0.15 0.11 0.23 -0.42 0.94
PPE/sales 1.44 0.81 2.31 0.12 11.23
EBIT/assets 0.09 0.08 0.09 -0.16 0.27
Control ln (assets) 14.60 14.53 0.99 12.60 16.74
Leverage 0.25 0.23 0.14 0.00 0.45
Net Income/assets 0.05 0.05 0.04 -0.03 0.20
EBIT/sales 0.21 0.12 0.30 -0.48 0.74
PPE/sales 2.24 0.81 2.89 0.12 11.23
EBIT/assets 0.08 0.07 0.06 -0.05 0.27
Panel B – Correlation Matrix
ln
(assets) Leverage
Net Income/
assets
EBIT/
sales PPE/sales
Leverage 0.15* 1.00
Net Income/assets 0.35*** -0.01 1.00
EBIT/sales 0.27*** 0.45*** 0.33*** 1.00
PPE/sales 0.01 -0.05 -0.14 0.11 1.00
EBIT/assets 0.29*** 0.15* 0.71*** 0.62*** -0.21**
24
Table 4
Medians for Treated and Control Firms in 2007. The treated firms are defined as firms in the
Regular and Level 1 segments at BMF&Bovespa. Control firms are defined as firms in the Level
2 and Novo Mercado segments. We have 76 treated and 76 non-treated firms. The test for a
difference in the medians of a firm characteristic across two groups is conducted by calculating
the Pearson’s X2 statistic, with the p-values of this test reported at the bottom row of each panel.
ln
(assets) Leverage
Net
Income
/Assets
EBIT/
Sales
PPE/
sales EBIT/Assets
Treated 13.88 0.23 0.04 0.11 0.81 0.08
Control 14.53 0.23 0.05 0.12 0.81 0.07
Difference -0.65 0.00 -0.01 -0.01 0.00 0.01
Median test
p-value 0.42 0.87 0.63 0.87 0.87 0.63
25
Table 5
This table presents the Difference-in-differences of firm Tobin’s Q
and Market-to-book before and after the mandatory IFRS adoption
in Brazilian firms. We have 76 control firms and 76 treated firms for
each quarter in 2007 and 2010 (or 2008). The control variables are:
ln(Assets), Leverage, Income to assets, EBIT to sales, PPE to sales
and EBIT to assets.
Panel A Tobin's Q Market to book
2007-2010 0.335** 0.290*
(0.151) (0.149)
observations 1,216 1,216
Adj-R2 0.49 0.52
2007-2008 0.313** 0.270*
(0.151) (0.150)
observations 1,216 1,216
R2 0.46 0.49
Panel B
Placebo Test
2010-2011 0.023 0.033
(0.084) (0.083)
observations 1,384 1,384
R2 0.57 0.60
2011-2012 0.008 0.006
(0.096) (0.092)
observations 1,306 1,306
R2 0.66 0.67
2012-2013 -0.001 -0.010
(0.127) (0.127)
observations 1,282 1,282
R2 0.72 0.76
2013-2014 0.122 0.129
(0.107) (0.102)
observations 1,200 1,200
R2 0.58 0.62
2014-2015 0.097 0.077
(0.088) (0.078)
observations 1,152 1,152
R2 0.62 0.67
26
Table 6 – Robustness Checks – change in covariates This table presents the Difference-in-differences of covariates before
and after the mandatory IFRS adoption in Brazilian firms. We have
76 control firms and 76 treated firms for each quarter in 2007 and
2010 (or 2008).
2007 x 2010 2007 x 2008
ln(Assets) -0.200 -0.171
(0.271) (0.247)
observations 1,216 1,216
R2 0.69 0.71
Leverage -0.044 -0.005
(0.033) (0.032)
observations 1,216 1,216
R2 0.45 0.52
Income/assets 0.005 -0.003
(0.010) (0.011)
observations 1,216 1,216
R2 0.66 0.65
EBIT/sales 0.024 -0.021
(0.055) (0.039)
observations 1,216 1,216
R2 0.72 0.76
PPE/sales -0.040 0.218
(0.368) (0.409)
observations 1,216 1,216
R2 0.72 0.68
EBIT/assets -0.015 0.003
(0.011) (0.009)
observations 1,216 1,216
R2 0.80 0.80
27
Table 7 – Robustness check – diff-in-diff regressions
(without matching)
This table presents the Difference-in-differences of firm Tobin’s Q
and Market-to-book before and after the mandatory IFRS adoption
in Brazilian firms. We have 56 untreated firms and 76 treated firms
for each quarter in 2007 and 2010 (or 2008). The control variables
are: ln(Assets), Leverage, Income to assets, EBIT to sales, PPE to
sales and EBIT to assets.
Panel A Tobin's Q Market to book
2007-2010 0.268* 0.250*
(0.146) (0.143)
observations 1,056 1,056
Adj-R2 0.55 0.59
2007-2008 0.370*** 0.352***
(0.136) (0.133)
observations 1,056 1,056
R2 0.54 0.54
Figure 3 – Robustness Check
Median Tobin’s q and exchange rate shock
This graphic presents the result of sample split in High Tobin’s Q and Low Tobin’s Q
firms during the 2015 Brazilian exchange rate depreciation.
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