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: * joelson.sampaio@fgv.br; ** humberto.gallucci@unifesp.br; ***: vinicius.brunassi@fecap.br ****

rafael.schiozer@fgv.br

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

2

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

3

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.

4

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

5

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

6

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,

7

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.

8

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.

9

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.

10

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.

11

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.

12

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

13

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;

14

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.

References

Admati, A. and P. Pfleiderer, 1988, "A Theory of Intraday Trading Patterns: Volume and Price

Variability," Review of Financial Studies, 1, 3-40.

17

Almeida, H., Campello, M, Laranjeira, B., and Weisbenner, S. (2011). Corporate Debt Maturity

and the Real Effects of the 2007 Credit Crisis. Critical Financial Review, 1, 3-58.

Angrist, J.D., Pischke, J - S. 2008. Mostly Harmless Econometrics: An Empiricist’s

Companion. Princeton.

Armstrong, C. S., Barth, M. E., & Riedl, E. J. (2010). Market reaction to the adoption of

IFRS in Europe. The Accounting Review, 85 (1), 31-61.

Ayar, S. 2012. From financial crisis to great recession: the role of globalized banks. American

Economic Review: Papers & Proceedings 102, 225–230.

Baiman, S. and R. Verrecchia, 1996, The relation among capital markets, financial disclosure,

production efficiency, and insider trading, Journal of Accounting Research 34, 1-22.

Ball, R.; Kothari, S.P., Robin, A. 2000. The Effect of International Institutional Factors of

Properties of Accounting Earnings. Journal of Accounting & Economics 29, p. 1–51.

Ball, R., Robin, A. & WU, J. 2003. Incentives Versus Standards: Properties of Accounting Income

in Four East Asian Countries. Journal of Accounting & Economics 36, p. 235–70.

Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for

investors. Accounting and Business Research, 36 (1), 5-27.

Barth, M. E., Y. Konchitchki, and W. R. Landsman. 2013. Cost of Capital and Financial Statement

Transparency. Journal of Accounting and Economics 55. 206-224.

Beatty, A., S. Chamberlain, and J. Magliolo. 1996. An Empirical Analysis of the Economic

Implications of Fair Value Accounting for Investment Securities. Journal of Accounting and

Economics 22: 43-77.

Black, B. S., de Carvalho, A. G., & Sampaio, J. O. (2014). The evolution of corporate governance

in Brazil. Emerging Markets Review. DOI: 10.1016/j.ememar.2014.04.004

Botosan, C., Plumlee, M. 2002. A Re-examination of Disclosure Level and the Expected Cost of

Equity Capital. Journal of Accounting Research 40, p. 21–40.

Coffee, J. 1984. Market Failure and the Economic Case for a Mandatory Disclosure System.

Virginia Law Review 70, p. 717–53.

Diamond, D. and R. Verrecchia. 1991. Disclosure, Liquidity, and the Cost of Capital. Journal of

Finance 46, 1325-1360.

Daske, H., Hail, L., Leuz, C. ,Verdi, R. 2008. Mandatory IFRS Reporting around the World: Early

Evidence on the Economic Consequences. Journal of Accounting Research, 46, p. 1085 – 1142.

18

Daske, H., Hail, L., Leuz, C., Verdi, R.S., 2013. Adopting a Label: Heterogeneity in the Economic

Consequences of IFRS Adoptions. Journal of Accounting Research, 53 p. 970 – 1080.

Dye, R. 1990. Mandatory Versus Voluntary Disclosures: The Cases of Financial and Real

Externalities.” The Accounting Review 65, p. 1–24.

IFRS Foundation, 2013. IFRS Application around the World; Jurisdictional Profile: Brazil.

Retrieved from: http://www.ifrs.org/Use-around-the-world/Documents/Jurisdiction-

profiles/Brazil-IFRS-Profile.pdf

Karamanou, I. and G. Nishiotis. 2005. The Valuation Effects of Firm Voluntary Adoption of

International Accounting Standards. Working paper, University of Cyprus.

Kanodia, C. 2006. Accounting Disclosure and Real Effects. Foundations and Trends in

Accounting Vol.1, No.3, 167-258.

KPMG, 2008. Brazil and International Financial Reporting Standards, First-time Adoption of

IFRS: Answers to Frequently Asked Questions. Retrieved from:

http://www.kpmg.com.br/publicacoes/audit/IFRS/Folder_IFRS_Perguntas_Respostas_ingles_25

06.pdf

Jeanjean, T., & Stolowy, H. (2008). Do accounting standards matter? An exploratory analysis of

earnings management before and after IFRS adoption. Journal of Accounting and Public Policy,

27(6), 480-494.

Lambert, R. Leuz, C & Verrecchia, R. 2007. Accounting Information, Disclosure, and the Cost of

Capital. Journal of Accounting Research 45, p. 385–420.

Leuz, C., Verrecchia, R.E. 2001. The Economic Consequences of Increased Disclosure. Journal

of Accounting Research 38, 91-124.

Oliveira, R.F; Schiozer, R.F. & Barros, L.A.B. de C. 2015. Depositor’s Perception of “Too-Big-

to-Fail”. Review of Finance 19, 191-227.

Pelucio-Grecco, M. C., Geron, C. M. S., Grecco, G. B., Lima, J. P. C. 2014. The effect of IFRS

on earnings management in Brazilian non-financial public companies. Emerging Markets

Review 21, 42-66.

Roberts, M., Whited, T.M. 2013. Endogeneity in Empirical Corporate Finance. Handbook of the

Economics of Finance, 493 – 572.

Verrecchia, R. 2001. Essays on Disclosure. Journal of Accounting & Economics 32, p. 91–180.

Verriest, A., Gaereminck, A., & Thornton, D. B. (2012). Corporate governance and properties of

IFRS adoption. Working Paper. Retrieved on

19

http://www.econtrack.nl/uploads/document/coporate%20governance%20and%20properties%20o

f%20IFRS%20Adoption.pdf. [ Links ]

20

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.