An empirical investigation of multinational firms' compliance with International Accounting Standards

An Empirical Investigation of Multinational Firms'Compliance with International Accounting Standards

Samir M. El-Gazzar, Philip M. Finn and Rudy JacobPace University, New York, NY, USA

Key Words: International Accounting Standards; Cross-border trade; Harmonization; Voluntary

disclosure

Abstract: Over the years, the number of firms acknowledging adherence to International

Accounting Standards (IAS) in the presentation of their financial statements has increased

steadily. Since adherence to IAS is not mandatory, the questions are who are these firms, what are

their characteristics, and why are they voluntarily complying with IAS. This study examines the

underlying motivations and characteristics of firms complying with IAS. This examination is of

special interest to the International Accounting Standards Committee (IASC) for assessing the

merits of mandating IAS by multinational firms. It also helps accounting researchers in

understanding the disclosure behavior of multinationals. Our results indicate that the magnitude

of a firm's foreign operations, its financing policy, membership of certain geographical and trade

blocks in the European Union (EU), and multiple listing on foreign stock exchanges are

significantly associated with multinationals' compliance with IAS.

This paper examines the characteristics of multinational firms complying with Interna-

tional Accounting Standards (IAS). IAS are not mandatory, yet many multinational firms

are voluntarily complying with the standards. The findings of this study should not only

enhance our understanding of why firms are motivated to adhere to IAS, but also provides

us with the merits of mandating IAS instead of allowing discretionary adoption by firms.

The economic forces of international trade and finance made evident a need to

overcome the obstacles created by widely divergent systems of financial reporting and

their nationalistic antecedents. Expanding firm activities into foreign markets increases

the number of users of its financial statements and disclosures. Users in foreign (host)

countries prefer financial statements and disclosures that are comparable to locally

prepared statements in terms of accounting standards and scope of disclosure. Financial

statements prepared in accordance with local GAAP might have to: (i) be restated in

The International Journal of Accounting, Vol. 34, No. 2, pp. 239± 248 ISSN: 0020-7063.

All rights of reproduction in any form reserved. Copyright # 1999 University of Illinois

Direct all correspondence to: Samir M. El-Gazzar, Pace University, Lubin School of Business, One Pace Plaza,

New York, NY 10038, USA; E-mail: [email protected]. Samir El-Gazzar is also associated with Tanta

University in Egypt.

The InternationalJournal ofAccounting

accordance with host country GAAP, as is the case in the United States;1 (ii) provide for

a reconciliation between host country and the local country GAAP; or (iii) adopt a set of

accounting rules that are universally acceptable, such as IAS. For example, when

Daimler Benz of Germany wanted to obtain equity financing and have their shares

traded on the New York Stock Exchange (NYSE), they had to comply with the listing

requirements of the Securities and Exchange Commission (SEC), which require

compliance with United States GAAP.

In the absence of a universally acceptable set of accounting standards and disclosures, a

firm wishing to list its securities on multiple stock exchanges would conceivably produce

multiple financial statements to comply with the securities laws and host country GAAP of

each respective country in which its shares wished to be listed. This could be a very costly

process to the firm and confusing to the financial markets, and may lead to a sub-optimal

resource allocation for both the firm and local markets.

To overcome this and similar type of problems of dealing in an international

environment, the accountancy bodies of nine countries founded and formed the Interna-

tional Accounting Standards Committee (IASC) in 1973. The IASC formulates and

publishes in the public interest accounting standards to be observed in the presentation

of financial statements and to promote their worldwide acceptance and observance. While

not empowered with any enforcement provisions, the members agreed to support the

standards and use their best efforts to ensure that published financial statements comply

with the standards. They further agree to persuade governments, stock exchanges, and

other bodies to support the IASC's standards.

In 1987, a global body of securities regulatory agencies and security exchanges formed

the International Organization of Securities Commissions and Similar Organizations

(IOSCO) to, among other things, cooperate toward ensuring better regulation of security

markets, and establish standards and an effective surveillance of international security

transactions. In this regard, they joined the IASC consultative group and agreed that they

would enforce compliance with international accounting standards if the number of

allowable options included in acceptable IAS standards were reduced and other standards

were strengthened.2

The IOSCO has promulgated a list of core accounting issues that must be included in

IAS in order for IOSCO to endorse the pronouncements for use by issuers in cross-border

financing. A `̀ work plan'' has been devised by the IASC with scheduled completion of

all projects by 1999. The conclusion of this collaboration could result in statements

prepared in accordance with IAS being acceptable for most foreign stock exchanges,

thereby eliminating the current need to produce multiple financial statements to comply

with each country's individualistic requirements (Nottle, 1993). Not only will this

eventually reduce the cost and confusion associated with different reporting requirements,

it will likely increase substantially the amount of cross-border financing and stock

exchange listings.

The efforts of the institutions mentioned above would hopefully result in a uniform

solution to the problem in the long run. Meanwhile, multinational firms are currently

coping with the problem on a cost-benefits basis. As economies become more and more

inter-dependent, compliance with IAS, as a solution, seems to be growing and, thus,

warrants investigation since IAS are not mandatory. Understanding the characteristics and

240 THE INTERNATIONAL JOURNAL OF ACCOUNTING Vol. 34, No. 2, 1999

motivations of this subset of multinationals would help in assessing the potential outcome

of mandating IAS for multinational firms.

The results of this study help provide some insight into why firms have voluntarily

elected to adopt IAS. It would appear that firms voluntarily complying with IAS are

those wishing to obtain exposure to new markets, obtaining foreign debt and equity

capital, improving customer recognition, or looking to reduce political costs. Their

motivation seems to be driven by a demand for financial information that is prepared in

accordance with a more universally recognized set of accounting standards than those

prepared in accordance with local accounting standards. In an efficient global market, if

the inherent reliability and timeliness of accounting information is questionable, investors

and creditors will impose higher costs of financing on companies providing mis-

information. Mandatory compliance with IAS could lead to more cost effective and

efficient markets through reduced costs of compliance and analysis. It would also

enhance cross border financing and trade as well as provide a means to better

understand foreign firm credit worthiness.

DETERMINANTS OF MULTINATIONAL FIRMS' COMPLIANCE WITH IAS

Although cross-border financing and listing on foreign stock exchanges are significant

reasons for some firms to voluntarily adopt IAS, they are not the only reasons. We

hypothesize that firms are motivated to comply with IAS as a response to their ope-rating

and financing environment. This environment includes among other things: (i) interna-

tional market dependency; and (ii) regional or geographical organization membership.3

International Market Dependency

Multinational firms compete for international resources such as customers for their

products, capital for growth and expansion, and materials and technology. Prior

research (e.g., Zarzeski, 1996) argues and concludes that firms competing for foreign

resources tend to expand their financial and accounting disclosure as bonding for

resource providers. This expanded disclosure is assumed to reduce resource providers'

uncertainty about transactions with the firm and, in turn, enable the firm to obtain

resources at lower costs. Verrecchia (1983), in an analytical description of capital

markets, shows that traders are unable to interpret withheld information of a firm as

good or bad, in comparison to the firm's competitors. Indeed, traders are likely to

discount the value of the firm, thereby encouraging more transparent disclosure

practices.

Compliance with IAS is a form of expanded disclosure aimed at satisfying the needs of

the foreign user of the firm's financial statements. Financial disclosures prepared in

compliance with IAS can facilitate comparison across firms of different nationalities as

well as being indicative of more reliability. Therefore, compliance with IAS reduces the

risks to international users of financial statements. Moreover, reducing the uncertainty of

resource providers through compliance with IAS makes the firm more attractive to

resource providers and, therefore, helps the firm in obtaining international resources at

reasonable costs.

An Empirical Investigation of Multinational Firms' Compliance with IAS 241

Distribution Markets

Firms that derive a significant part of their revenues (or manufacturing operations)

from foreign markets tend to develop international policies with respect to investing,

marketing, financing, and disclosure. To serve their trading partners in multiple foreign

markets while minimizing service costs, multinational firms may find adherence to IAS

a more appro-priate disclosure policy that may help reduce chances for misunderstand-

ing and misinter-pretations, thereby strengthening confidence (Wyatt, 1997). In addi-

tion, there have been suggestions that indirect benefits accrue from foreign stock

listings that include increasing publicity about the firm and a reduction of possible

political costs (Gray and Roberts, 1994). For example, increased publicity that results

from foreign listing might change per-ceptions that a firm is more serious about its

commitment to a country thereby encouraging sales to customers who cherish the

stability of local and long-term relationships.

H1: Firms with higher percentage of total revenue derived from foreign sales (FS)

are more motivated to adhere to IAS in their financial statements. This implies

a positive correlation between the percentage of FS and the likelihood of a

firm's adherence to IAS.

Access to Foreign Capital Markets

Multinational firms invest in different foreign countries. Parallel to their multinational

investment policy, is the tendency to raise capital from different foreign markets. Raising

capital from foreign markets helps multinational firms in two areas: (i) raising capital at

lower costs; and (ii) achieving hedges against fluctuations in foreign currencies.

However, capital suppliers in host countries generally demand more reliable and

comparable financial information to assess the foreign investee's worthiness. In fact,

many stock exchanges require foreign firms wishing to list their securities to conform

financial statements to local accounting principles and financial disclosure or to comply

with IAS. Faced with additional risks and uncertainties in procuring competitive

resources, it is likely that multinational enterprises adhere to IAS to satisfy foreign

capital market information needs.

In this study, we use two measures of multinational firms' desire to access foreign

capital markets: the number of firm foreign stock exchanges that the firm is listed on and

the debt to equity ratio (DE). We anticipate that firms with listings on multiple foreign

stock exchanges are more motivated to adhere to IAS as a common disclosure

requirement to satisfy the information needs of multiple foreign capital-suppliers.

H2: Firms with listings on multiple foreign stock exchanges are more motivated to

adhere to IAS. This suggests a positive correlation between the number of

foreign stock exchanges (EX) a firm is listed on and its likelihood of

adherence to IAS.


Prior research suggests that capital structure of multinational companies is dependent

on both local and international economic forces (Sekely and Collins, 1988). For instance,

Zarzeski (1996) argues that companies with high debt ratios tend to share more private

information with their creditors because of well developed banking relationships and

interlocking corporate ownerships. In contrast, companies with low levels of debt

financing tend to depend heavily on equity financing, which could encourage investor

demand for information. Since adherence to IAS can be considered as a form of

expanded disclosure, we hypothesize the following:

H3: Firms with lower debt ratios tend to adhere to IAS. This suggests a negative

correlation between debt financing and adherence to IAS.

Geographical and Trade Blocks Membership

Recently, the European Union (EU) has decided to investigate the use of IAS for

consolidated financial statements of members seeking cross-border financing and listings

rather than develop these standards through its Directive process. In addition, some

countries (i.e., Italy) have adopted IAS in cases where their own accounting standards

are silent. Therefore, we anticipate that firms in countries that are members of EU are

more likely to comply with IAS.

H4: Firms of EU countries (EU) are more likely to adhere to IAS. This suggests

a positive correlation between EU membership and adherence to IAS.

RESEARCH DESIGN

Sample and Data

We relied on two sources for identifying the sample and obtaining the data for

tests: (i) the IASC Secretariat, who provided their list of `̀ Companies Disclosing

that Their Financial Statements Conform with International Accounting Standards'';

and (ii) the Worldscope4 database for obtaining the variables of interest in this

study. The IASC Secretariat's list revealed 221 firms as complying with IAS. This

sample was then screened against the Worldscope database for data availability. Of

the original 221 firms, only 153 were found on the Worldscope database. Of these,

only 87 firms had sufficient information of the above-mentioned variables to be

included in the experimental sample. For inferential purposes, a control sample of

87 matched firms were selected from non-IASC conforming firms appearing in the

Worldscope database. Matching was done on the basis of a firm's similar market

capitalization and similar two digit SIC code to the firms identified in the

experimental sample.

Data was collected for each variable of each experimental and control firm for the most

recent three years as reported in the Worldscope database. Three years of data rather than 1

year were selected to be more representative of a firm's longitudinal characteristics


and to eschew inferences that might occur from any unusual or abnormal data of a single

year.

Model

Two statistical procedures are used: (i) the non-parametric Wilcoxon test is used to

analyze the characteristics of IAS firms in comparison to those of non-IAS firms; and (ii)

the Logit regression model to test the relationship between a firm's compliance with IAS

and the hypothesized explanatory variables. Under the Logit model, the odds of a firm's

compliance with IAS is described by the conditional ratio of: P(Gj /Xj)/(1ÿP(Gj /Xj)),

where P(Gj /Xj) is the probability of being a member of G given Xj. The log±linear

function of this probability can be expressed as follows (see Mensah, 1984; Maddala,

1991):

Log�Pj=1ÿ Pj� � A0 � A1�Log Xj1� � . . .� AK�Log Xjk�;

where:

Pj=probability of firm j adherence to IAS,

Xjk=the explanatory variables of firm j.

The empirical variables used in this model are defined as follows:

Pj=the compliance status of firm j to IAS, and it takes one if firm j adhered to IAS

and zero, otherwise;

X1=the percentage of foreign sales to total sales of firm j (FSj);

X 2=the number of foreign stock exchanges where firm j is listed (EXj);

X 3=the debt to equity ratio of firm j (DEj);

X4=a dummy variable representing membership in the European Union (EUj). EUj

takes one if the firm belongs to EU and zero, otherwise;

A0 and Ak=the intercept and coefficients estimates, respectively.

In order to assure that the results of Logit regression were not affected by outlying

observations, a regression by ranks is also performed.

ANALYSIS OF RESULTS

Summary Statistics

Table 1 presents summary statistics about the characteristics for both the experimental

and control samples. Table 1 reveals that the experimental sample (firms complying with

IAS) has higher FS, lower DE, higher percentage of firms belonging to the EU, and is

listed on more exchanges (EX). Table 1 also shows that the experimental sample has lower

return on equity (ROE). At first glance, the comparative direction of ROE seems contrary

to expectations. However, this variable reflects both underlying economic phenomenon


and differences in accounting practices. For example, complying firms have, on average,

lower debt financing, which suggests lower financial risk and thus, ceteris paribus, lower

cost of equity capital. In addition, compliance with IAS might produce more conservative

measures of earnings, since uniformity embedded in IAS practices reduces managerial

discretion in income measurement.

It should be noted that some of the variables have outlying observations as evidenced

by the values in the minimum and maximum columns of Table 1. To minimize the effect of

these outliers on the regression results, a regression on ranks technique (Cheng et al.,

1992) is also employed.

Nonparametric Wilcoxon Tests

Table 2 presents the Wilcoxon non-parametric tests of differences between the two

samples, IAS firms and non-IAS firms. The results confirm that IAS firms are statistically

different from the non-IAS firms in terms of FS, belonging to the EU, multiple exchange

listings (EX), the ROE, and debt financing (DE). While FS, membership of EU, and ROE

are significant at the 0.01 level or less, exchange listings, DE, and total assets are still

significant at 0.028, 0.10, and 0.08 level, respectively.

These results are consistent with our expectations. That is, IAS sample have more

foreign markets, are listed on more exchanges, and have more firms belonging to EU. The

results also suggest that complying firms employ more equity financing, relative to non-

IAS firms.

Table 1. Summary Statistics of Variables

Variable Mean Standard deviation Minimum Maximum

IAS Firms

LTA 14.6543 1.6874 10.6439 19.1766

ROE 11.8082 11.7352 0.0100 68.0700

DE 1.0902 1.2769 0.0100 9.9529

FS 49.9838 30.1053 0.0000 97.9300

EX 2.4201 1.1272 1.0000 4.0000

EU 0.4138 0.4954 0.0000 1.0000

Non-IAS Firms

LTA 14.2167 1.7433 9.7457 17.8846

ROE 17.7863 18.2727 0.0100 105.6600

DE 1.5152 2.9687 0.0200 14.0000

FS 28.0512 26.0855 0.0000 93.1000

EX 2.0690 1.2556 1.0000 4.0000

EU 0.2069 0.4074 0.0000 1.0000

LTA = Log of Total Assets; ROE = Return on Equity; DE = Debt to Equity Ratio; FS = Foreign Sales to Total Sales;

EX = Number of Stock Exchanges Listed; EU = Percentage of Sample Firms Members of European Union.


Regression Results

Table 3 presents the results of the Logistic procedure. The overall model indicates a

concordance of 80.3%. All of the hypothesized independent variables are significant and

their parameters are in the predicted direction. The most significant variable is FS, percent

of foreign sales. Other significant variables include DE, number of foreign stock exchange

listings (EX), and membership in the EU. These results support the hypotheses previously

set forth.

To investigate whether the results from the Logistic procedure were influenced by

extreme values of the variables, we performed an OLS regression on ranks. The results of

this regression support those of the Logistic procedure.5

CONCLUSIONS AND RECOMMENDATIONS

This paper provides an analysis of why some international firms voluntarily comply with

IAS. A number of hypotheses were introduced, including the desire to access foreign

capital markets, the scope of international operations, and membership of some world or

regional unions or business treaties. The results support these hypotheses indicating that

firms are motivated to voluntarily adopt IAS in order to enhance their exposure to foreign

markets, to improve customer recognition, to secure foreign capital, and reduce political

costs of doing business abroad.

Table 2. Wilcoxon Non-Parametric Test Results of the Comparison Between IAS-Firms and Non-IASFirms

Variable Mean (IAS Firms) Mean (Non- IAS Firms) Z-Statistic Probability >Z

LTA 14.65 14.22 1.71 0.080

ROE 11.81% 17.79% 2.67 0.007

DE 1.09 1.52 1.63 0.100

FS 49.9% 28.1% 4.82 0.000

EX 2.43 2.07 2.20 0.028

EU 0.41 0.21 2.94 0.003

LTA = Log of Total Assets; ROE = Return on Equity; DE = Debt to Equity Ratio; FS = Foreign Sales to Total Sales;

EX = Number of Stock Exchanges Listed; EU = Percentage of Sample Firms Members of European Union.

Table 3. Logistic Results of the Relationship Between Firms' Compliance with IAS and theHypothesized Variables: Yj=A0+A1(DEj)+A2(FSj)+A3(EXj)+A4(EUj)+ej

Variable Parameter estimate Wald Chi-Square P>Chi-square

Intercept ÿ0.349 0.038 0.844

DE ÿ0.147 2.508 0.056

FS 0.029 16.487 0.000

EX 0.382 3.861 0.025

EU 0.887 4.178 0.020

Concordant = 80.3%. DE = Debt to Equity Ratio; FS = Foreign Sales to Total Sales; EX = Number of Stock Exchanges Listed;

EU = Percentage of Sample Firms Members of European Union.


As more firms voluntarily adopt IAS it will become self-evident that the market will

place significant value on the adoption of a universally accepted set of accounting

standards and thereby decrease the uncertainty previously associated with attempts to

universalize accounting standards. The benefits derived from following universally

accepted IAS would include a reduction in the costs associated with financial analysis

and disclosure thereby resulting in more efficient capital markets. This, in turn, would

enhance cross border financing and trade.

Some have argued that total accounting harmonization is difficult since accounting

practices appear to be culture-driven. However, the results of this empirical study are

significant because they suggest that firms operating in the international markets are more

likely to voluntary disclose higher levels of investor-oriented information. Indeed, the

evidence in this paper suggests that firms' accounting disclosure policies are influenced by

the harmonizing and encompassing effects of world culture and market forces. Further,

international dependency may force firms to be so transparent in their reporting require-

ments that institutionalized harmonization of accounting principles/practices for multi-

national firms may be totally unnecessary if one believes that accounting principles and

practices can be harmonized on their own by the `̀ invisible hand'' of free market forces.

Compliance with IASC Standards is strictly voluntary. Nevertheless, support for the IASC

and its Standards is increasingly apparent around the world. Indeed, the accounting

profession may not be too far away from a set of acceptable `̀ world class'' accounting

principles. Further analysis is required to impound more demographic, cultural and

environmental factors.

NOTES

1. The reconciliation requirement has been cited as a major factor for discouraging foreign firms to

offer securities in the US market (Cochrane, 1992).

2. Opponents of IAS have argued that adoption of IAS will hurt investors because of their

perceived lowering of standards when compared to many host countries' standards. Harris

(1995), however, shows that reconciliation between revised IAS and US GAAP was quite small.

3. Other environmental factors have been analyzed in Adhikari and Tondkar (1992).

4. Worldscope is a database of information on over 10,000 international corporations published by

Disclosure.

5. In the OLS regression on ranks, FS is positive and significant at the 0.00 level, indicating that the

higher the firm's percentage of FS, the more likely the firm will comply with IAS. Exchange

listing (EX) is also positive and significant at the 0.03 level, supporting the hypothesis that

compliance with IAS is positively correlated with multiple exchange listings. Similar conclusion

can be made for EU membership.

REFERENCES

Adhikari, A. and R. Tondkar. 1992. !Environmental Factors Influencing Accounting Disclosure

Requirements of Global Stock Exchanges." Journal of International Financial Management

and Accounting, 4(2): 76±105.

Cheng, C., W. Hopwood, and J. McKeown. 1992. !Non-linearity and Specification Problems in


Unexpected Earnings Response Regression Model." The Accounting Review, (October): 579±

598.

Cochrane, J. 1992. !Helping to Keep U.S. Capital Markets Competitive: Listing World-Class Non-

U.S. Firms on U.S. Exchanges." Journal of International Financial Management and Ac-

counting, 4(2): 166±170.

Gray, S. and C. Roberts. 1994. VOLVO, International Accounting: A Case Approach. New York:

McGraw-Hill.

Harris, T. 1995. International Accounting Standards versus US GAAP Reporting: An Empirical

Evidence Based on Case Studies. New York: Southern Western College Publishing.

Maddala, G.S. 1991. !A Perspective on the Use of Limited-Dependent and Qualitative Variables in

Accounting Research." The Accounting Review, (October): 788±807.

Mensah, Y.M. 1984. !An Examination of the Stationarity of Multivariate Bankruptcy Prediction

Models: A Methodological Study." Journal of Accounting Research, (Spring): 380±395.

Nottle, R., 1993. Recent Developments in International Securities Regulation: Some Implications for

Accountants, Fifth Annual Conference of Accounting Academics. April, Hong Kong, 1993.

Sekely, W.S. and J.N. Collins. 1988. !Cultural Influences on International Capital Structure." Jour-

nal of International Business Studies, (Spring): 87±100.

Verrecchia, R. 1983. !Discretionary Disclosure." Journal of Accounting and Economics, 5-3: 179±

194.

Wyatt, A. 1997. International Accounting Standards and Organizations: Quo Vadis?, International

Accounting and Finance Handbook. New York: Wiley.

Zarzeski, M. 1996. !Spontaneous Harmonization Effects of Culture and Market Forces on Account-

ing Disclosure Practices." Accounting Horizons, 10(1): 18±37.


Documents

An empirical investigation of multinational firms' compliance with International Accounting Standards