Does Adoption of IAS/IFRS Deter Earnings Management?

In this study we re-examine whether the transition to IAS/IFRS deters or facilitates greater earnings management (earnings smoothing). Prior research is inconclusive. Barth et al. (2008) find a decrease in earnings management for early voluntary adopters, while Ahmed et al. (2010) find an increase in earnings management for mandatory adopters. Christensen et al. (2008) and Ahmed et al. (2010) attribute these conflicting results to self selection -- i.e. early adopters had incentives to voluntarily adopt while those firms that waited until IFRS adoption became mandatory in EU countries did not. In this paper, we argue that IAS/IFRS standards changed dramatically from the early voluntary adoption period to the mandatory adoption year (2005), particularly during the period from 2003 to 2005 when the IASB was making compromises to win endorsement of IAS/IFRS standards from EU member countries. Compared to earlier IAS standards, revisions of old IAS standards and new IFRS standards issued during the transition period allow greater flexibility in choosing among alternative accounting treatments, which was an often-expressed concern among IASB board members that issued dissenting opinions when more recent IAS/IFRS standards were adopted. We posit that this greater flexibility in IAS/IFRS standards has lead to greater earnings management (smoothing) under the current IFRS reporting regime. Consistent with this conjecture, we find an increase in earnings management from pre-2005 to post-2005 for Early Voluntary Adopters and Late Adopters in countries that allowed early IAS/IFRS adoption, and for Mandatory Adopters in countries that did not allow early IFRS adoption.