ACCOUNTING QUALITY AND THE ADOPTION OF IASB STANDARDS – PORTUGUESE EVIDENCE

Through rule 1606/2002 by the European Commission, Portuguese listed ﬁ rms were required to adopt IASB standards in the preparation and presentation of consolidated accounts for the periods beginning on or after 2005. IASB standards are developed in environments where accounting practices are especially directed at the private sector, reporting rules are largely unaffected by taxation requirements and capital is traditionally raised in public markets. However, in Portugal, ﬁ nancial reporting is closely related to tax reporting and banks play a key role in providing ﬁ nance and inside access to information. We investigate whether adopting IASB standards is associated with higher earnings quality and higher value relevance. We compare the earnings quality and value relevance of accounting data of 34 Portuguese listed ﬁ rms before (1995-2004) and after (2004-2005) the adoption of IASB standards. We ﬁ nd that ﬁ rms, during the period when they adopt IASB standards, report less smooth earnings than those ﬁ rms in periods when they adopted national accounting standards, which seems to suggest an improvement in earnings quality. However, we also ﬁ nd that the value relevance of accounting information decreases with the adoption of IASB standards.


INTRODUCTION
Portuguese listed fi rms are required to adopt International Accounting Standards Board (IASB) standards in the preparation and presentation of consolidated accounts for periods beginning on or after 1 of January 2005 (Rule 1606/2002 of the European Commission).Until 2005, Portuguese listed fi rms were required to apply local standards (Plano Ofi cial de Contabilidade and Directrizes Contabilísticas).
IASB standards are developed in environments where accounting practices are especially directed at the private sector, reporting rules are largely unaffected by taxation requirements and capital is traditionally raised in public markets.IASB standards are clearly infl uenced by common-law countries, like the United States of America (USA) and the United Kingdom (UK).However, Portuguese institutional and legal environments are different and these differences affect the Portuguese accounting system.
Several studies show signifi cant differences in ownership structures between code-law and common-law countries.Faccio and Lang (2002) fi nd that fi rms from common-law countries are more likely to be widely held, while fi rms from code-law countries are family controlled.Faccio and Lang (2002) also fi nd that, in countries like Portugal, the state controls a more signifi cant proportion of fi rms, especially the largest, than in UK or USA.If we consider the state as a single entity, state-owned fi rms have a concentrated ownership.In these countries, agents of stakeholders tend to be informed by private and inside information and the need for timely public disclosure is less important.In a widely-dispersed share ownership, managers and shareholders' interests may diverge in important ways, raising the problem of asymmetric information.This problem is addressed through fi nancial reporting and other forms of timely public disclosure.
The difference in ownership structures can be attributed to weak regulation in code-law countries and strong regulation in common-law countries.La Porta et al. (1997, 1998) show that common law systems, like UK or USA systems, have strong minority investor protection.On the contrary, civil law systems like the Portuguese have weak protection.They argue that the extent to which a country's laws protect investor rights and the extent to which those laws are enforced are the basic determinants of the ways in which corporate governance evolves in that country.Weak legal protections for minority shareholders can create opportunities for managerial abuses.
The design of accounting systems can also be affected by the orientation of a country's fi nancial system.Financial systems can be classifi ed as debt-based (such as Portugal) or market-based (such as UK or USA) (DEMIRGUE-KUNT; LEVINE, 1999).In equity-based fi nancial systems, the preference for equity ownership and the concern with the maximization of shareholder value tend to lead to a greater importance of accounting quality.
Finally, Portuguese fi nancial reporting is closely related to tax reporting, which encourages income smoothing.On the contrary, IASB standards are separate from tax laws.
Previous studies on the quality of accounting standards provide mixed evidence.Barth et al. (2005) and Bartov et al. (2004) fi nd that the adoption of IASB standards increases accounting quality.Based on a large sample of fi rms from different countries, Barth et al. (2005) fi nd that, after IAS adoption, fi rms evidence less earnings management, more timely loss recognition and more value relevance of accounting data than fi rms that do not adopt.Bartov et al. (2004) also fi nd that, for a sample of German fi rms, accounting earnings based on international accounting standards are more value relevant than those based on German accounting standards.However, Eccher and Healey (2003) fi nd that accounting data based on international accounting standards are not more value relevant than those based on Chinese accounting standards.Hung and Subramanyam (2004) identify the sources of reconciling items between German accounting standards and international accounting standards and fi nd that the adjustments to net income are not value relevant.
The objective of this study is to compare the accounting quality (earnings quality and value relevance) of Portuguese listed fi rms before and after the adoption of IASB standards.
First, we investigate if earnings quality increased with the adoption of IASB standards.Similar to Barth et al. (2005), we use fi ve different measures of earnings quality: the variability of the change in net income scaled by total assets; the ratio of the variability of the change in net income to the variability of the change in operating cash fl ows; the Spearman correlation between accruals and cash fl ows; the coeffi cient of small positive income and the coeffi cient of large negative net income.
Second, we investigate the value relevance of accounting data.We regress the market price of shares on earnings and book value of equity in order to estimate R 2 .
Our results seem to suggest that fi rms, during the period when they adopt IASB standards, report less smooth earnings than those fi rms in periods when they adopted national accounting standards, which seems to suggest an improvement in earnings quality.However, we also fi nd that the value relevance of accounting information decreases with the adoption of IASB standards.This contradiction may be due to differences in our samples (we have fewer observations for IFRS/IAS adoption than for Portuguese accounting standards adoption) or because the period of IFRS/IAS adoption is a transition period (the quality of information may be lower than in future periods).
The structure of the paper is as follows.Section 2 defi nes accounting quality and identifi es some measures of accounting quality used in previous studies.Section 2 also defi nes earnings quality and value relevance and revises previous studies.Section 3 provides a description of the sample, hypotheses and variables.Section 4 presents empirical results.Finally, Section 6 summarizes and concludes.

ACCOUNTING QUALITY
The objective of fi nancial reporting is to provide information about fi nancial position, performance and changes in fi nancial position of an entity that is useful in making economic decisions for a wide range of users, such as investors, employees, lenders, suppliers, customers, government and the public in general.
The quality of fi nancial reporting has been receiving greater attention, especially after recent accounting scandals.Despite the increased attention, the term accounting quality is vague and diffi cult to defi ne.
The objective of IASB is to develop, in the public interest, a single set of high quality accounting standards that require transparent and comparable information in fi nancial statements.However, IASB does not present a defi nition of high quality.Penman (2002) considers that accounting quality should be discussed in terms of shareholders' interests and the fair valuation of those interests.Penman's notion of accounting quality is based on the usefulness of information for the shareholders and the use of the modifi ed shareholder perspective.Under this perspective, accounting should promote shareholders' interest but also consider the public interest.
Despite the inexistence of a clear defi nition of accounting quality, several studies use measures that are considered proxies of accounting quality, for example, earnings management, timely loss recognition and value relevance (BARTH et al., 2005).In this paper, we use earnings quality and value relevance as proxies of accounting quality.Penman (2002) considers that earnings quality is an important feature of fi nancial reporting since investors buy future earnings.

Earnings quality
Despite the importance of earnings for stakeholders, the term earnings quality is also vague and has different interpretations.Some authors relate earnings quality to the accurate representation of underlying economic transactions and events.Another interpretation focuses on persistence of earnings, where earnings of higher quality are sustainable and persist into the future.A more general interpretation of the persistence idea is suggested by tying earnings quality with predictability, claiming that earnings of higher quality are a good indicator of future earnings.Finally, some authors use the term in the context of accounting conservatism.Cohen (2003) defi nes earnings quality as the degree to which accounting fi gures more accurately represent the underlying economic fundamentals of the fi rm and the extent to which they map into operating cash fl ow realizations.Schipper and Vicent (2003) view earnings quality as the extent to which reported earnings faithfully represent Hicksian income (maximum amount that can be consumed consistent with the maintenance of wealth).Chan et al. (2004) consider earnings quality as the degree to which reported income refl ects operating fundamentals.Yee ( 2006) considers that earnings quality has two guises, fi rst as a fundamental attribute and second as a fi nancial reporting attribute.Fundamental earnings are the accounting profi tability measure that gauges a fi rm's ability to make future dividend payments.Reported earnings are the imperfect signal of the fundamental earnings a fi rm announces.Therefore, earnings quality refers to how quickly and precisely reported earnings reveal fundamental earnings.Kirschenheiter and Melumad (2004) consider that high quality earnings are more informative and closer to the long run value of the fi rm.Revsine et al. (1999) consider that earnings are of higher quality when they are sustainable.Also, Penman and Zhang (2002) defi ne high quality earnings as sustainable earnings, that is, earnings that are a good indicator of future earnings.White et al. (2003) defi ne earnings quality as the degree of conservatism in a fi rm's reported earnings.Penman and Zhang (2002) also link earnings quality with conservatism.
Similar to Barth et al. (2005), we use several measures of earnings management.
First, we use the variability of the change in net income scaled by total assets (LEUZ et al., 2003;BARTH et al., 2005).
Where: NI is net income and year-end TA total assets.A higher variance is associated with a lower level of earnings smoothing.
Second, we use the ratio of the variability of the change in net income to the variability of the change in operating cash fl ows.
Where: NI is net income and OCF cash fl ows from operations.If fi rms use accruals to manage earnings, the variability of the change in net income should be lower than that of operating cash fl ows.
Third, we use the Spearman correlation between accruals (hereafter ACC) and cash fl ows from operations.We expect that accruals and cash fl ows from operations are negatively correlated.
Fourth, we test if fi rms manage earnings towards small positive earnings (BURGSTAHLER; DICHEV, 1997; LEUZ et al., 2003;BARTH et al., 2005).The measure is the coeffi cient on small positive net income (SPOS) in the following regression: Where: POST assumes the value 1 if the fi rm adopt IASB standards and 0 otherwise; SIZE is the natural logarithm of the market value at the year end; GROWTH is percentage change in sales; EISSUE is percentage change in common stock; LEV is total liabilities at the year end divided by the book value of equity at the year end; DISSUE is percentage change in total liabilities; TURN is sales scaled by total assets at the year end; OCF is cash fl ows from operations and SPOS is an indicator variable that equals 1 if net income scaled by total assets is between 0 and 0,01.
Finally, we test timely loss recognition.Following Lang et al. (2003Lang et al. ( , 2005) ) and Barth et al. (2005), we measure timely loss recognition as the coeffi cient on the percentage of large negative net income (LNEG) in the following regression: Where: POST equals 1 if the fi rm adopts IASB standards and 0 otherwise; SIZE is the natural logarithm of the market value at year end; GROWTH is percentage change in sales; EISSUE is percentage change in common stock; LEV is total liabilities at year end divided by the book value of equity at year end; DISSUE is percentage change in total liabilities; TURN is sales scaled by total assets at year end; OCF is cash fl ows from operations and LNEG is an indicator variable that equals 1 if net income scaled by total assets is less than -0.20.Ball and Brown (1968) were the fi rst to report that stock prices react to the information disclosed in fi nancial statements.Amir et al. (1993) were the fi rst to use the term value relevance with the meaning of how well accounting data refl ect information used by equity investors.Since then, several studies have investigated the price-earnings relation by using different variables.

Value relevance
Following Lang et al. (2003Lang et al. ( , 2005)), we regress the market price of shares, as of six months after year end (hereafter PRICE), on book value of equity per share (hereafter BVEPS) and net income per share (hereafter NIPS) in order to estimate R 2 for the period that fi rms adopt international accounting standards and for the period that fi rms adopted Portuguese accounting standards: As the cross-sectional correlation in our sample is not very strong, we decided not to consider Barth's portfolio methodology (BARTH et al., 2005(BARTH et al., , 2008)).

RESEARCH DESIGN
In this section, we describe the sample selection and research design.

Sample
Our sample consists of 34 Portuguese listed fi rms that prepared and presented consolidated accounts under IASB's standards in 2005.We consider the period between 1995 and 2004 (Portuguese GAAP adoption) and 2004-2005 (IFRS/IAS adoption).Since our sample includes only one country and due to small sample size, we did not use a matching sample procedure like Barth et al. (2005).

Hypothesis
The objective of this study is to compare the accounting quality (earnings quality and value relevance) of Portuguese listed fi rms before and after the adoption of IASB standards.
First, we investigate if earnings quality increased with the adoption of IASB standards.Therefore, our fi rst prediction is related with earnings smoothing.Since Portugal is a code-law country, we expect that earnings smoothing is more pronounced when fi rms adopt national standards than when fi rms adopt IASB standards.Leuz et al. (2003) fi nd that earnings smoothing is more pronounced in noncommon law countries.This leads to our fi rst hypothesis: H1: We expect that earnings smoothing is more pronounced before IASB standard adoption than after IASB standard adoption.
Our second prediction is related to the value relevance of accounting data under national and international accounting standards.Alford et al. (1993) fi nd that the association between earnings and stock returns is stronger in countries where capital is traditionally raised in capital markets and there are weaker links between fi nancial and tax reporting.Additionally, Bartov et al. (2004) fi nd that IAS based earnings are more value relevant than earnings produce under German GAAP, based on a sample of German fi rms traded on German stock exchanges.This leads to our second hypothesis: H2: We expect that earnings produced under IASB standards are more value relevant than earnings produced under national accounting standards.

Descriptive statistics
Descriptive statistics are summarized in Table 1 .Table 1 shows that, on the average, during the period of IASB standard adoption, fi rms have higher amounts of earnings per share, but smaller amounts of earnings scaled by total assets and higher amounts of change of earnings scaled by change of cash fl ows from operations.This seems to suggest that earnings based on IFRS/IAS have a greater variability than earnings based on Portuguese accounting standards.The table also indicates that, on the average, the book value of equity per share is higher during the period that fi rms adopted Portuguese accounting standards than during 2004-2005.

Comparison of PGAAP period and IFRS/IAS period
Our fi rst prediction relates to earnings quality.We predict that earnings smoothing is more pronounced before than after IASB standard adoption.
In order to check our fi rst hypothesis, we fi rst compare the variability of net income before and after IFRS/IAS adoption, using the F-test (Table 2 ).
The results show that fi rms that adopt IFRS exhibit signifi cantly higher variability in the change in net income, 0.035 versus 0.002.This result seems to suggest that fi rms, during the period when they adopt IASB standards, report less smooth earnings than those fi rms in periods when they adopted national accounting standards.However, the variability can be determined by the variability of cash fl ow from operations.In order to test if the variability of net income is driven by the variability of cash fl ows from operations, we compare the ratio of the variability of the change in net income to the variability of the change in operating cash fl ows (Table 3 ).
Table 3 shows that the variance of change in net income to the variance in the change of cash fl ows from operations is higher in the period of IFRS/IAS adoption than in    the period of Portuguese accounting standard adoption.This fi nding is consistent with the fact that the adoption of IASB standards leads to a less smooth net income, since the variability is not only due to the variability in cash fl ows from operations.
In order to analyze the correlation between accruals and cash fl ows from operations, we fi rst test the variables' normality assumption (Table 4 ).As one can see, the normality assumption, based on the Kolmogorov-Smirnov test, is rejected in cases of accruals scaled by total assets for the period that fi rms adopt IFRS/IAS and for cash fl ows from operations scaled by total assets for the period that fi rms adopted Portuguese accounting standards.
As we want to check if the observed correlation is statistically signifi cant, the variables should be normal.As this assumption is violated in some comparison groups, we compute the nonparametric Spearman correlation coeffi cient.The results are shown next (Table 5 ).
Table 6 shows that the correlation between accruals and cash fl ows from operations is -0.755 for the period that fi rms adopt IFRS/IAS and -0.779 for the period that fi rms adopt Portuguese accounting standards.These results show that fi rms report more smooth net income when they adopt Portuguese standards than when they adopt IASB's standards.Finally, we use Eviews 5.0 to estimate the Logit model in order to estimate the coefficients of SPOS and LNEG.The results are shown below (Tables 6 and 7 ).
The coeffi cient of SPOS is positive (0.441) and the coeffi cient of LNEG is negative (-0.883).However, none of the two is statistically signifi cant.
Our second prediction is related to the value relevance of accounting data under national and international ac- counting standards.We predict that earnings produced under IASB standards are more value relevant than earnings produced under national accounting standards.To test this hypothesis, we regress the market price of shares, as of six months after the year end book value of equity per share and net income per share, in order to estimate R 2 for the period that fi rms adopt international accounting standards and for the period that fi rms adopted Portuguese accounting standards.The results are shown in Tables 8 and 9 .
As one can see, the R square value is smaller within the period that fi rms adopt IFRS/IAS (2004)(2005).As the difference is so high, it should be statistically signifi cant.However, we also performed the Vuong test to compare the R square value in both groups of companies.The signifi cance associated with the test is 0.000 and the equality assumption is clearly rejected.These results suggest that value relevance decreases with the adoption of IASB standards.These results are contradictory with previous literature that shows that the adoption of IASB's standards improves value relevance.However, these results can be justifi ed by the fact that most political and economic infl uences on fi nancial reporting practices remain local (BALL, 2006) and different.Capital markets are not perfectly integrated and   , 2006).Therefore, some factors (such as legal systems, fi nancial systems, role of the accounting profession, tax alignment and ownership concentration) that in the past justifi ed differences between accounting systems remain different among European countries.As a result of the infl uence of a country's institutional setting on accounting information, the economic consequences of changing from local accounting standards to international accounting stan-dards may vary across countries.Daske et al. (2007) found that the economic consequences of IFRS adoption depend on the extent to which IFRS adoptions represent a serious commitment to transparency.Daske et al. (2008) also found that capital market effects around mandatory IFRS adoption occur only in countries with relatively strict enforcement regimes and where the institutional environment provides strong incentives for fi rms to be transparent.

SUMMARY AND CONCLUSIONS
Portuguese listed fi rms are required to adopt IASB standards in the preparation and presentation of consolidated accounts for periods beginning on or after 1 of January 2005 (Rule 1606/2002 of the European Commission).Until 2005, Portuguese listed fi rms were required to apply local standards (Plano Ofi cial de Contabilidade and Directrizes Contabilísticas).
We investigate whether adopting IASB standards is associated with higher earnings quality and higher value relevance.We compare the earnings quality and value relevance of accounting data of 34 Portuguese listed fi rms before (1995-2004) and after (2004-2005) the adoption of IASB standards.
We fi nd that fi rms, during the period when they adopt IASB standards, report less smooth earnings than those fi rms in periods when they adopted national accounting standards, which seems to suggest an improvement in earnings quality.However, we also fi nd that the value relevance of accounting information decreases with the adoption of IASB standards.This contradiction may be due to differences in our samples (we have 72 observations for IFRS/IAS adoption and 212 for Portuguese accounting standards adoption), or because the period of IFRS/IAS adoption is a transition period (the quality of information may be lower than in future periods).

Table 1
Descriptive statistics of variables total assets; ACC is the difference between net income and cash fl ow from operations; OCF/TA is cash fl ow from operation scaled by total assets at the year end; SPOS is an indicator variable that equals 1 if net income scaled by total assets ranges between 0 and 0.01; LNEG is an indicator variable that equals 1 if net income scaled by total assets is less than -0.20;LEV is total liabilities at year end divided by the book value of equity at year end; GROWTH is percentage change in sales; EISSUE is percentage change in common stock; DISSUE is percentage change in total liabilities; TURN is sales scaled by total assets at year end; SIZE is the natural logarithm of the market value at year end; BVEPS is the book value of equity per share and NIPS is net income per share.

Table 2
Variability of net income(F-test)

Table 3
Variability of net income and cash fl ows from operations

Table 4
Variable normality (One-sampleKolmogorov-Smirnov Test) a. Test distribution is Normal.b. Calculated from data.

Table 5
Spearman Correlation between accruals and cash fl ows from operations ** Correlation is signifi cant at the 0.01 level(2-tailed)

Table 6
Logit model for the dependent variable SPOS

Table 7
Logit model for the dependent variable SPOS POST is a variable that equals 1 if the fi rm adopt IAS/IFRS and 0 if the fi rm adopts Portuguese accounting standards.

Table 8
Least squares for the dependent variable PRICE (Firms that adopt Portuguese accounting standards)

Table 9
Least squares for the dependent variable PRICE (Firms that adopt IFRS/IAS)