Does Mandatory Adoption of IFRS Enhance Earnings Quality? Evidence From Closer to Home

Abstract

The global accounting convergence and the often discussed probable adoption of International Financial Reporting Standards (IFRS) by U.S. regulators is a timely topic. We contribute to the literature by examining a more recent mandatory IFRS adoption by Canada. Canadian GAAP (CGAAP) is often considered a close substitute for U.S. GAAP. One key feature of this setting is that two earnings numbers are available for fiscal year 2010 since Canadian firms were required to reconcile earnings under CGAAP with earnings under IFRS. We run a “horse race” of earnings quality between earnings under CGAAP and IFRS. We find that on average, relative to IFRS-earnings, earnings under CGAAP have greater association with next period cash flows and higher degree of persistence. Further, when the difference between earnings under CGAAP and IFRS is large, IFRS-earnings are less value-relevant and less persistent. These results strongly support the notion that higher earnings quality is associated with CGAAP. Finally, the results also indicate that differences between CGAAP and IFRS with regard to accounting for financial instruments and investments significantly impair the quality of IFRS-earnings. Our findings are potentially informative to any revival of policy debates on the possible adoption of IFRS by U.S. firms.