Convergence of Accounting Standards and Corporate Cash Holdings:

A Test Using Mandatory IFRS Adoption

Ru Gao

UQ Business School, The University of Queensland

r.gao@business.edu.au

Peter Clarkson

UQ Business School, The University of Queensland and

Beedie School of Business, Simon Fraser University

p.clarkson@business.edu.au

Kathleen Herbohn

UQ Business School, The University of Queensland

k.herbohn@business.edu.au

ABSTRACT

Using mandatory adoption of International Financial Reporting Standards (IFRS) as a natural

experiment, we investigate whether the changes in disclosure practices in 16 European countries are

associated with the changes in firms’ cash management policies. We find that after the mandated

changes in accounting standards, firms decrease their cash holdings and save less cash from cash

flows. The reduction in cash holdings is greater for firms from countries where the existing legal and

enforcement systems are strong, and for firms which have experienced an improvement in their

accounting quality after mandatory IFRS adoption, which suggests that accounting disclosures can

affect corporate cash management policies. More importantly, we document that such a reduction in

cash is more pronounced for small and young firms, firms which had a low payout ratio, and firms

which held high excess cash in pre-adoption period. These findings are consistent with the premise

that convergence in accounting standards can mitigate market friction, which can then relax financial

constraints and lead to a reduction in agency conflicts existing between shareholders and managers.

Further analyses show that after mandatory IFRS adoption, there is an increase in firms’ performance,

total investment, cash dividend payout, and short and long-term debt.

KEY WORDS: Convergence, Mandatory IFRS Adoption, Corporate Cash Holdings

JEL CODES: M41 M45

(Current Version: 27 October 2016)

mailto:r.gao@business.edu.aumailto:p.clarkson@business.edu.aumailto:k.herbohn@business.edu.au

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I. INTRODUCTION

Given the importance of cash for a firm, little is known for scholars about the determinants of

corporate cash holdings. Building on the stream of research on corporate cash management policies

(e.g., Keynes 1936; Jensen and Meckling 1976; Myers 1984; Opler, Pinkowitz, Stulz and Williamson

1999; Subramaniam, Tang, Yue and Zhou 2011; Kusnadi and Wei 2011; Bigelli and Sánchez-Vidal

2012; Gao, Harford and Li 2013), we examine a previously ignored but important relationship

between the financial reporting and corporate cash holdings. Specifically, using mandatory adoption

of International Financial Reporting Standards (IFRS) as an exogenous shock to firm financial

reporting, we investigate whether the changes in financial reporting practices in 16 European

countries (due to the mandated changes in accounting standards) result in the changes in corporate

cash holdings.

Determinants of cash holdings have long been debated in the finance literature (Bigelli and

Sánchez-Vidal 2012). First, firms could hold cash for reasons that are not bad. Dated back to Keynes

(1936), the trade-off model of cash holdings argues that in the presence of market frictions, raising

external financing is more costly than using internally generate funds. As a result, firms hoard cash to

save transaction costs (Miller and Orr 1966; Myers and Majluf 1984). Firm can also hold cash for a

precautionary motive (Han and Qiu 2007; Ang and Smedema 2011). Under this view, cash is held for

unexpected changes in future, e.g., uncertainty of future cash flows, or unexpected investment

opportunities. However, there is a dark side of corporate cash holdings. Consistent with Jensen’s

(1986) free cash flow theory, a stream of literature finds that entrenched managers have an incentive

to build cash balances and derive private benefits by over-investing in value destroying projects

(Harford 1999; Dittmar, Mahrt-Smith and Servaes 2003; Richardson 2006; Dittmar and Mahrt-Smith

2007).

Although the empirical studies on the determinants of corporate cash holdings have received

much attention in corporate finance in the last decade, little is known about the role of financial

reporting on corporate cash management decisions. Based on prior theories, we argue that financial

reporting can affect corporate cash holdings. First, financial reporting can reduce the cost of external

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finance by mitigating adverse selections caused by information asymmetry (e.g., Healy and Palepu

2001; Verrecchia 2001; Francis, Khurana and Pereira 2005). Thus, financial reporting can reduce

transactional and precautionary motives for cash holdings by lowering the cost of external finance. On

the other hand, it is well established in literature about the disciplinary power of financial reporting

(e.g., Bushman and Smith 2001; Lambert 2001; Beatty and Liao 2010). That is, financial information

is used by investors to monitor managers’ use of corporate resources. Thus, financial reporting can

reduce corporate cash holdings by increasing the marginal costs of holding excess cash.

We investigate the relation between financial reporting and corporate cash holdings in the

context of the mandatory adoption of IFRS. This context offers a powerful treatment effect where the

changes in financial reporting practices of mandatory adoption firms should be significant (and

visible), based on a change of the entire system for preparing and disclosing information (Wang

2014). More importantly, as the adoption decision is made by countries’ policy-makers, it is beyond

the choice of individual firms (De George, Li and Shivakumar 2016). Once the adoption date is set,

the application of IFRS by firms can happen at different points in time depending on their fiscal year-

ends. Some firms in the sample delay their adoption because their fiscal year ends after December

2005. This delay of adoption is largely exogenous (Daske, Hail, Leuz and Verdi 2008), which

provides a benefit to empirically identify the effects of financial reporting on corporate cash holdings.

Using mandatory adoption firms from 16 European countries, we test whether the changes in

financial reporting caused by switching to IFRS are associated with the changes in cash holdings. To

the extent that mandatory IFRS adoption can increase transparency and improve the quality of

financial reporting (EC Regulation No. 1606/2002), we expect that IFRS reporting is associated with

a reduction in cash holdings by increasing firms’ access to the external finance and mitigating the

agency conflicts through increased monitoring. Consistent with our premise, we observe that after

mandatory IFRS adoption, the adoption firms reduce cash holdings by 11%, after controlling for other

factors that can affect firms’ normal cash holdings (such as operational and investing needs). Such

reductions in cash holdings increase over time and we also find that after the mandated changes in

accounting standards, firms save less cash from cash flows, as measured by cash-to-cash flow

sensitivity (Almeida, Campello, and Weisbach 2004).

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One challenge of our analysis is that potential institutional changes around or after the

introduction of IFRS, such as some countries introduce relevant enforcement and compliance

mechanism along with mandatory IFRS adoption, can confound the observed effects of IFRS

adoption (De George et al. 2016). We use three sets of test to address this concern. First, our main

tests employ essentially a difference-in-differences approach which takes into consider the panel

structure of the data (Bertrand and Mullainathan 2003). In this design, we benchmarks the changes in

cash holdings around the introduction of IFRS against the changes in other countries that do not yet

mandate or allow IFRS reporting, as well as the changes in firms which delay their adoption because

their fiscal year ends after December 2005. Both benchmarks help us to control for contemporaneous

changes in cash holdings that unrelated with the introduction of IFRS (Daske et al. 2008). Second, we

examine whether the estimated changes in cash holdings exhibit plausible cross-sectional variation

with respect to country-level enforcement and firm-level improvement in accounting quality. We find

that the observed results are limited to countries with higher enforcement of accounting standards and

only to firms with an improvement in accounting quality after mandatory IFRS adoption, which

provide further assurance of our findings. Third, as a robustness check, we exclude countries which

introduce changes in enforcement along or after mandatory IFRS adoption, as identified Christensen,

Hail and Leuz (2013), and find that the tenor of our results are unchanged. Moreover, we also find

that our results are held when using alternative research designs or samples.

To further explore whether the observed effects of IFRS adoption on cash holdings are driven

by increasing access to external finance or lowering agency conflicts between shareholders and

managers, we test whether effects of IFRS adoption vary with the severity of financial constraints and

agency conflicts in pre-adoption period. Our results show that reductions in cash holdings are more

pronounced for financially constrained firms (as measured by firm size, age and payout ratio) and

firms subject to more severe agency conflicts prior to the adoption (as measured by the excess cash in

pre-adoption period). We also find that there is a significant increase in total investment, cash

dividend payout, and debt in the post adoption period. All these results are consistent with the premise

that mandatory IFRS adoption can reduce cash holdings, through both relaxing financial constraints

and lowering the agency conflicts existing between shareholders and managers. Both channels can

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lead to an increase in firms’ performance and we indeed find this evidence in our sample.

Our findings can contribute to a stream of corporate finance literature which examines the

determinants of corporate cash holdings (e.g., Opler et al. 1999; Subramaniam et al. 2011; Tong 2011;

Bigelli and Sánchez-Vidal 2012; Chen et al. 2012; Gao et al. 2013). Specifically, prior studies in this

area find that country-level investor protection (Dittmar et al. 2003; Kusnadi and Wei 2011), and

firm-level corporate governance (Harford, Mansi and Maxwell 2008; Chen, Chen, Schipper, Xu and

Xue 2012) play a role in corporate cash management policy. Although financial reporting is an

important arrangement in corporate governance, little is known how this element can affect cash

management policies. We provide empirical evidence showing that financial reporting can affect

corporate cash holdings policy. Furthermore, recent studies on value of cash holdings provide some

evidence show that accounting information can affect the way investors assign value to cash holdings

(Drobetz, Grüninger and Hirschvogl 2010; Huang and Zhang 2012; Louis, Sun and Urcan 2012).

Distinguish from these studies, we focus on how reporting can directly affect corporate cash

management policy rather than investors’ valuation. From a methodological perspective, as corporate

cash management policy and reporting strategy are usually determined by managers, the use of

mandatory IFRS adoption as an exogenous shock to financial reporting provides a chance to explore

the relations between financial reporting and cash holdings with less subject to endogeneity criticism.

Our paper can also contribute to the stream of accounting literature which investigates the real

effects of mandated discourse policy. Leuz and Wysocki (2016) encourage research to learn about the

real effects of disclosure mandates, such as whether mandated disclosure policy induces disclosing

person or reporting entity changes their behaviour (e.g., investment, use of resource, and

consumption). To respond to this call, we investigate the changes of cash management policy after

mandatory IFRS adoption, a significant regulation change in recent accounting history. In addition,

prior IFRS studies find that mandatory IFRS adoption can affect firm investment decisions (Chen et

al. 2013; Shroff, Verdi and Yu 2014; Gao and Sidhu 2016), merging and acquisition decisions (Louis

and Urcan 2014), dividend payout policies (Hail, Tahoun and Wang 2014), equity issuances (Wang

and Welker 2011), and cross-listing decisions (Chen et al. 2015). In line with these studies, we show

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that cash management policy can be affected by the introduction of IFRS. For this reason, this paper

has policy implications for regulators and policy makers.

The remainder of the paper is organized as follows. Section II reviews the relevant literature

and develops hypothesis. Section III presents research designs and empirical strategy to identify the

effects of mandatory IFRS adoption on cash holdings. Sample selection and sample descriptions are

then presented in Section IV. Section V provides empirical results and Section VI summarizes the

additional analyses. Finally, Section VII concludes.

II. HYPOTHESIS DEVELOPMENT

1. The determinant of corporate cash holdings

Empirical studies on the determinants of corporate cash holdings have received growing

attention from academics over the last decade. Prior literature indicates that there are two main

benefits from holding cash. First, cash provides low cost financing for firms (Ozkan and Ozkan 2004).

Trade-off theory argues that firms trade off the costs and benefits of holding cash to determine

optimal cash levels (Opler et al. 1999). In presence of information asymmetry between investors and

shareholders, market frictions such as adverse selection problem make external financing costly. As a

result, there is a hierarchy in firm financing policies, in which firms prefer internal generated funds

over informationally sensitive external finance (Myers and Majluf 1984). It is also optimal for firms

to hold a certain level of cash to meet the operations and investment needs (Han and Qiu 2007). This

is particularly true for financially constrained firms. Since these firms cannot raise sufficient funds to

finance all future expected investment, they are more likely to hoard cash to react to potential under-

investment problem (Almeida et al. 2004). We refer to this as transaction motive for corporate cash

holdings. Second, cash is a valuable buffer for meeting unexpected contingencies (Bigelli and

Sánchez-Vidal 2012). We refer to this as precautionary motive for cash holdings. Closely related with

the transaction motive for cash holdings, this view argues that cash holdings are used as a

precautionary hedge against the possible cash shortfalls caused by frictions in external capital markets

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(Lins, Servaes and Tufano 2010). As cash provides unconditional liquidity available at any time, firm

increases cash holdings when cash flow volatility is higher and the impact of uncertainty on cash

holdings is more pronounced for financially constrained firms (Han and Qiu 2007).

However, there are also potential adverse effects of cash holdings. The agency cost view of

corporate cash holdings suggests that in presence of information asymmetry, managers have

incentives to misuse funds for value-destroying projects (Myers and Majluf 1984; Jensen 1986). To a

large extent, the magnitude of such behaviour depends on the availability of resources that can be

easily diverted (Fre´sard and Salva 2010). In this case, managers are reluctant to pay out funds, and

they hoard cash to derive private benefits (Harford 1999; Dittmar et al. 2003; Richardson 2006).

Financially unconstrained firms with a high level of agency conflicts (e.g., a low level of managerial

ownership or corporate governance) are more likely to hold a higher level of cash for managers’

private benefits (Dittmar et al. 2003; Drobetz et al. 2010).

In summary, the discussion above emphasizes the role of information asymmetries on cash

holdings. Specifically, market frictions (e.g., adverse selection problem) create the wedge between the

internal and external costs of capital, which leads firms to hold cash for current and future operation

or investment needs. On the other hand, information asymmetry can increase agency conflicts, which

leads entrenched managers to build cash balances for private benefits.

2. Mandatory IFRS adoption and corporate cash holdings

It is well established in the literature that accounting information plays two important roles in

market-based economies (Beyer, Cohen, Lys and Walther 2010). First, ex-ante, financial reporting

can reduce the cost of external finance by mitigating adverse selections caused by information

asymmetry (e.g., Healy and Palepu 2001; Verrecchia 2001; Francis, Khurana and Pereira 2005). Thus,

there is a negative association between transactional and precautionary motives for cash holdings and

financial reporting. Second, ex-post, financial reporting can be used by capital providers to monitor

managers’ use of their capital once committed (e.g., Bushman and Smith 2001; Lambert 2001; Beatty

and Liao 2010). Thus, financial reporting can reduce corporate cash holdings by increasing the

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marginal costs of holding excess cash.

IFRS is generally considered to be a set of high quality, understandable, enforceable and

globally accepted financial reporting standards (IASB 2010). Regulators believe that switching to

IFRS can increase transparency and improve the quality of financial reporting (EC Regulation No.

1606/2002). Many empirical studies support these arguments. They find that mandatory IFRS

adoption can lead to positive stock market reactions (Armstrong, Barth and Riedl 2010), decreases in

analysts’ consensus forecast error (e.g., Horton, Serafeim and Serafeim 2013), higher value relevance

of accounting numbers (e.g., Bartov et al. 2005; Morais and Curto 2009), and improvements in total

accounting quality (e.g., Barth et al. 2008; Chen, Tang, Jiang and Lin. 2010). More importantly,

studies show that mandatory IFRS adoption is associated with an increase in stock market liquidity

(Daske et al. 2008), a decrease in bid–ask spreads (Muller, Riedl and Sellhorn 2011), a reduction in

cost of equity capital (Li 2010), and an increase in cross-border equity investments by mutual funds

(DeFond et al. 2011). These studies argue that mandatory IFRS adoption can reduce the cost of

external finance and increase firms’ access to external capital. In addition, studies also find evidence

that after mandatory IFRS adoption, the suboptimal investment reduces (e.g., Chen, Young and

Zhuang 2013; Gao and Sidhu 2016), suggesting that there is an improvement in the disciplinary

power of financial reporting after the mandatory IFRS adoption.

To the extent that switching to IFRS can enhance transparency (e.g., Ashbaugh and Pincus

2001; Barth, Landsman, and Lang 2008) and/or comparability of financial information (e.g., Yip and

Young 2012), we expect that the adoption of IFRS should reduce the cash reserves. Therefore, we

hypothesize that:

Hypothesis: Firms reduce their cash holdings after the mandatory adoption of IFRS.

III. RESEARCH DESIGN

To investigate the effects of mandatory IFRS adoption on firms’ cash holdings, we employ

essentially a difference-in-differences approach which takes into consider the panel structure of the

data (Bertrand and Mullainathan 2003). Specifically, we estimate the model as follows:

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𝐶𝑎𝑠ℎ𝑖𝑡 = 𝑋𝑖𝑡𝛽 + 𝑃𝑂𝑆𝑇𝑖𝑡∅ + 𝛼𝑖 + 𝜃𝑡 + 𝜖𝑖𝑡 (1)

Where 𝐶𝑎𝑠ℎ𝑖𝑡 represents the cash holdings of firm i at time t, scaled by the total assets. 𝑋𝑖𝑡

is a set of control variables that determine the normal level of cash holdings. POST is an indicator

variable that takes the value of 1 if firms have mandatorily adopted IFRS by the end of year t and 0

otherwise. 𝛼𝑖 and 𝜃𝑡 are dummies for firm and year fixed effects, respectively. The methodology we

used here fully controls for fixed differences between treated (mandatory adopters) and control firms

(non-adopters) via the firm fixed effects (Bertrand and Mullainathan 2003). In addition, year dummies

(𝜃𝑡) are used to control for calendar-year-specific effects. As a robustness check, we replace year

fixed effects with industry-year fixed effects, and all our results are qualitatively similar. 𝜖𝑖𝑡 is an

error term. We cluster all standard errors at the firm level to control for an arbitrary firm-level

correlation structure. The main coefficient of interest is ∅ . Our hypothesis predicts that this

coefficient is negative.

Following prior studies (e.g., Opler et al. 1999; Subramaniam et al. 2011; Bigelli and

Sánchez-Vidal 2012; Gao et al. 2013), we include the following control variables: Size, measured by

the log value of total assets expressed in U.S. dollars; TobinQ, measured by the market to book ratio;

Leverage, measured by total debts over total assets; Cash flows, which is operating cash flows scaled

by total assets; Working capital, which is the net working capital, calculated by the difference

between current non-cash assets and current liabilities scaled by total assets; Cash cycle, which is the

duration of the cash conversion cycle, measured by the sum of inventory conversion cycle, receivable

collection period and the payment period for the account payable. Invest, which is capital expenditure

scaled by total assets; R&D, which is research and development expenditure scaled by sales; Dividend,

an indicator variable taking the value of 1 if the firm paid a dividend during the year and 0 otherwise;

σ(CFO), the standard deviation of cash flows over total assets to proxy for operating risk; Sale PPE,

an indicator variable that takes the value of 1 if the firm sell Property, Plant and Equipment during the

year and 0 otherwise; and Cross-listing, a dummy variable taking on a value of 1 for firms that cross-

list in other countries and 0 otherwise. These variables control for normal cash holdings to meet

operational, investment and financing needs of the firm. In addition, following prior IFRS studies (e.g.,

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Daske et al. 2008; Florou and Kosi 2015), we also control for US GAAP, a dummy variable that takes

a value of 1 for firm-years in which the firm reports in US GAAP to control for implementation of an

alternative set of high quality accounting standards. Unless otherwise noted, all above variables are

measured on a firm-year basis and the subscripts i and t are omitted for notational ease. All

continuous variables are winsorized at the 1% and 99% levels to remove the potential data errors or

influence of outlier observations. The definitions of these variables are also presented in Appendix.

A primary challenge for IFRS studies, as pointed out by Daske et al. (2008), is that IFRS is

mandated for all publicly traded firms in a given country from a certain date on. This makes it

difficult to find a benchmark to control for contemporaneous changes that unrelated with mandatory

adoption of IFRS. Using firm-year panel data from 2002 to 2008, our empirical model allows us to

dynamically compare the treated firms against two types of control firms simultaneously (Bertrand

and Mullainathan 2003). First, this model benchmarks the changes in cash holdings around the

introduction of IFRS against the changes in other countries that do not yet mandate or allow IFRS

reporting. Second, although IFRS is mandated in our sampled countries from a same date, the

application of IFRS by firms can happen at different points in time depending on their fiscal year-ends.

As a result, some firms in our sample delayed their adoption because their fiscal year ends after

December 2005. This delay of adoption is largely exogenous (Daske et al. 2008). Our empirical

model implicitly takes this group of firms as controls at time t, even though they have already adopted

IFRS later on.

The second advantage of this model is that we can investigate the dynamic effects of

mandatory IFRS adoption on cash holdings by simply replacing POST variable with five event-year

dummy variables: Before2, Before1, After0, After1, and After2, where Beforej (Afterj) is a dummy

variable for the jth year before (after) the firm mandatorily adopted IFRS. If the mandatory IFRS

adoption reduces the level of cash holdings, we expect that negative coefficients for After dummy

variables but not for Before variables. The use of Before variable allows us to access whether any

reductions in cash holdings can be found prior to the introduction of mandatory IFRS adoption.

Finding such an effect prior to the introduction of IFRS could be symptomatic of the existence of

confounding factors that are driven the results (Bertrand and Mullainathan 2003). In addition, the use

11

of After variable can assess the average time for firms to adjust cash holdings in light of the

mandatory IFRS adoption (Chen et al. 2012).

IV. SAMPLE SELECTION AND DESCRIPTIVE STATISTICS

Our final sample consists of 7,665 firm-year observations of 1,357 mandatory IFRS adopters

from 16 European countries- Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland,

Italy, Netherlands, Norway, Poland, Portugal, Spain, Sweden and United Kingdom -over the sample

period of 2002 to 2008. Following prior studies (e.g., DeFond, Hu, Hung and Li 2011; Ahmed, Neel

and Wang 2013), we include a benchmark sample of 30,011 firm-year observations in 12 non-IFRS

adoption countries over the sample period. Following Ahmed et al. (2013), we restrict the pre-

adoption period to the three years prior to the IFRS adoption year to reduce the likelihood of other

factors confounding our results (e.g., the Internet Bubble in 2001). As cash holdings can be affected

by the ex-ante expectation of recession (Ang and Smedema 2011), we end our sample by 2008 to

exclude the influence of the Global Financial Crisis1.

Table 1 summarizes the detailed sample selection process. Following prior studies on IFRS

(e.g., Ahmed et al. 2013; DeFond, Hung, Li, and Li 2015), we obtain financial data from Compustat

Global and identify mandatory IFRS adopters as firms with accounting standards (Compustat item:

ACCTSTD) designated as DS prior to 2005 and DI after 2004. Firms that adopt IFRS before the

mandatory IFRS adoption in their countries are deleted from the sample. We also exclude financial

firms from our sample (SIC code between 6000 and 6999) and restrict our sample to firms at least

having a year before and after mandatory IFRS adoption to facility our empirical analyses2.

[Insert Table 1]

1 The tenor of our results is unchanged if we eliminate 2005 to avoid the potentially confounding

effects in the transition year, or use an alternative sample period (2002-2007). 2 As point out by De George et al. (2016), mandatory IFRS adoption may cause sample attrition or

enlargement, which results in the biased estimates in difference-in-differences model. To address this

concern, we use constant sample. However, requiring firms to present in both pre- and post-adoption

period may introduce survivorship bias. Thus, we further confirm that results are qualitatively

identical when excluding this data selection criterion.

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Table 2 presents the sample distributions of our treatment sample of EU mandatory adopters

and the control sample of non-adoption firms for the sample period 2002 to 2008. Panel A reports the

frequency distributions of the mandatory IFRS adopters by country and Panel B reports the

distributions of non-adoption firms. Consistent with prior studies (e.g., Tan, Wang, and Welker 2011;

DeFond et al. 2015), the number of observations vary widely across the mandatory adoption sample

and non-adoption sample. The United Kingdom is more heavily weighted and provides approximately

58 percent of the main sample; and Japan provides about 54 percent of the benchmark sample3.

[Insert Table 2]

Table 3 presents a univariate comparison of means and median for the principal variables of

interest between pre- and post- adoption period for mandatory adoption firms. All continuous

variables are winsorized at the 1 and 99 percent levels to limit the influence of outliers or potential

data errors. We note that after mandatory IFRS adoption, on average, cash holdings of adoption firms

decrease by -0.010 (6.452%) in post-adoption period and the decline is statistically significant at 5%

level. Given that other factors (e.g., changes in firm’s characteristics and general economic trends)

might affect cash holdings of a firm, we do not draw any conclusions from this comparison, relying

instead on multivariate analyses to control for these factors. In terms of control variables, we find a

larger value in firm size (Size), growth opportunity (TobinQ), cash flow from operations (Cash

flows), and capital investment (Invest) in post adoption period, but a smaller value in net working

capital (Working capital), cash conversion cycle (Cash cycle), R&D expenditure (R&D), and the

standard deviation of the cash flow from operations (σ(CFO)) in post-adoption period. We do not find

any statistically significant difference in total leverage (Leverage) and dividend payout (Dividend) in

prior- and post-adoption period.

[Insert Table 3]

Table 4 presents the correlations between the principal variables of interest. Descriptive

statistics are pool over the mandatory adoption sample over the period of 2002 to 2008. There are no

strong correlations (>0.50) between independent variables (Cohen 1988) and the data do not suggest

3 Because we use Compustat Global to obtain data, the United States and Canada do not include in our

control sample. Further robustness checks show that our results are hold when we exclude China and

Japan from the control sample, or include the United States and Canada in the control sample.

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any unusual behaviour.

[Insert Table 4]

V. RESULTS

In this section we discuss the main empirical findings. We first report the results from our

difference-in-differences analyses. Second, to test the robustness of the baseline empirical findings,

we then performance a number of sensitivity tests, including: (1) employing an alternative difference-

in-differences research design; (2) using alternative groups as the control sample; and (3) controlling

for the concurrent institutional changes to the enforcement of financial reporting along with or after

the introduction of the mandatory IFRS in some countries.

1. Main results

To test whether cash holdings of the adoption firms decrease after mandatory IFRS adoption,

we use difference-in-differences research designs taking into consideration of the panel structure of

the data. Table 5 presents the estimated coefficients from a set of difference-in-differences analyses.

Column I presents the results from our base model where we use firm fixed effects to control for the

unobservable differences between treated (mandatory adopters) and control firms (non-adopters), and

employ year fixed effects to control for calendar-year-specific effects. Results for the base model in

column I show that the estimated coefficient on POST is negative and significant at 1% level (-0.017,

t-Stat=-5.65, two tailed). This suggests that when controlling for other factors that can affect firms’

cash management decisions (such as operational and investing needs), adoption firms reduce their

cash holdings after mandatory IFRS adoption, even when comparing with the changes in cash

holdings of non-adoption firms. That is, mandatory IFRS adoption reduces firms’ cash holdings. Our

hypothesis is supported. The magnitude of this effect is not only statistically but also economically

significant. On average, cash holdings decreases by 11% (-0.017/0.155, where 0.155 is the mean

value of cash holdings in the pre-adoption period) in the post-adoption period, holding other factors

constant. The coefficient estimates of the control variables are generally consistent with prior studies

14

(e.g., Opler et al. 1999; Subramaniam et al. 2011; Chen et al. 2012). Column III reports the results of

the difference-in-differences analysis where we replace year fixed effects with industry-year fixed

effects. Consistent with the prior results, the estimated coefficient on POST is negative and significant

at the 1% level (-0.016, t-Stat= -5.49, two tailed).

To investigate the dynamic effects of mandatory IFRS adoption on cash holdings, we then

replace POST variable with five event-year dummy variables: Before2, Before1, After0, After1, and

After2, where Beforej (Afterj) is a dummy variable for the jth year before (after) the firm mandatorily

adopted IFRS. The results are reported in Column II and V. If mandatory IFRS adoption reduces

firms’ cash holdings, we should observe negative coefficients on After variables but not on Before

variables. From Column II, we can see that the coefficients on Before1 and Before2 are very small

and statistically indifferent from zero. In contrast, the coefficients on After0, After1 and After2 are all

negative and statistically significant at the 1% level. These results support the interpretation that the

mandatory IFRS adoption results in the reduction of cash holdings in adoption firms. More

importantly, we note that the coefficient on After variables increase by year, with the smallest value in

the year when firms first adopted IFRS (-0.013, t-Stat=-2.84, two tailed), and largest vale in the

second year after adoption of IFRS (-0.027, t-Stat=-5.32, two tailed). Similarly, from column V, when

replacing year-fixed effects with industry-year fixed effects in estimating the model the estimated

coefficient on After0, After1 and After2 are all negative and significant at less than the 5% level,

while the coefficients on Before1 and Before2 are not significant at conventional level. These findings

suggest that the effects of mandatory IFRS adoption on cash holdings increase over time, which might

because market participants gain more experience with IFRS, or changes in some countries’

enforcement regimes after the IFRS adoption reinforce the faithful adoption of IFRS.

In summary, the baseline analyses suggest that mandatory IFRS adoption results in a

significant reduction in the cash holdings of adoption firms, after controlling for other factors that can

affect firms’ cash management decisions (such as operational and investing needs), and the effect of

such adoption persists for at least two years after mandatory IFRS adoption.

[Insert Table 5]

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2. Robustness tests

To corroborate our main results, we perform a set of sensitivity tests, including using

alternative research design, considering alterative samples and addressing the concerns about the

confounding effects of mandatory IFRS adoption.

Alternative research design

To corroborate our main results, we use an alternative difference-in-differences research

design employed by prior studies (e.g., DeFond et al. 2011; Brown 2016) to re-exam our main

findings. Specifically, we use non-adoption firms from countries that do not allow or require IFRS

adoption during our sample period (2002 to 2008) as a control group and estimate the two-period

difference-in-differences model as follows:

𝐶𝑎𝑠ℎ𝑖𝑡 = 𝛼 + 𝛽1𝑁𝑃𝑂𝑆𝑇𝑖𝑡 + 𝛽2𝐼𝐹𝑅𝑆 + 𝛽3𝐼𝐹𝑅𝑆 ∗ 𝑁𝑃𝑂𝑆𝑇 + 𝑋𝑖𝑡𝛾 + 𝐶𝑖 + 𝐼𝑖 + 𝜃𝑡 + 𝜖𝑖𝑡 (2)

Where 𝐶𝑎𝑠ℎ𝑖𝑡 represents the cash holdings of firm i at time t, scaled by the total assets.

NPOST is an indicator variable that takes the value of 1 if the fiscal year is after the year of mandatory

IFRS adoption, and 0 otherwise. IFRS is a dummy variable equal to 1 if the firm is subject to

mandatory adoption and zero otherwise. This indicator variable is used to control for any fixed

differences between treated (mandatory adopters) and control firms (non-adopters). 𝑋𝑖𝑡 is the set of

control variables that determine the normal level of cash holdings. Similar to the model (1) discussed

earlier, we add the same set of control variables into the model. The regression model also includes

country fixed effects (𝐶𝑖 ), industry fixed effects (𝐼𝑖 ) and year fixed effects (𝜃𝑡 ). The indicator

variables for industry fixed effects are based on the 12-industry classification of Fama and French

(1997). Following prior studies (DeFond et al. 2015; Brown 2016), we suppress the coefficient on the

variable indicating mandatory adopters, IFRS, because this variable is a linear combination of the

country fixed effects in the model. 𝜖𝑖𝑡 is an error term. We cluster all standard errors at the firm level

to control for an arbitrary firm-level correlation structure. Our variable of interest is the coefficient on

the interaction term, 𝛽3 , which captures the incremental changes in cash holdings for mandatory

16

adopters after 2005 relative to the change for the benchmark group. A negative (positive) coefficient

suggests a decrease (increase) in cash holdings for adoption firms after mandatory IFRS adoption.

Panel A of Table 6 presents the results. Column I reports the results where the country and

industry fixed effects are used in the model, while Column II presents the results of full model in

which year fixed effects are also included in the model. From Column I, we observe that the

coefficient on NPOST*IFRS is negative and significant at the 5% level (-0.006, t-Stat=-1.98, two

tailed), indicating that after mandatory IFRS adoption, cash holdings of adoption firms decreases,

compared with that of non-adopters. Similarly, from column II, when the year fixed effects are added

in the model the estimated coefficient on NPOST*IFRS is negative and significant at less than 5%

level (t-Stat=-1.99, two tailed). Consistent with the prior results, our hypothesis is supported.

Alternative control groups

In our main analyses, we use non-adoption firms from countries that do not allow or require

IFRS adoption (non-IFRS adopters) to control for contemporaneous effects that are unrelated to the

introduction of IFRS. However, the differences in characteristics across mandatory adopters and non-

adopters in pre-adoption period present a concern for the inferences drawn from our prior analyses

(De George et al. 2016). To address the concern about the comparability of firms in the treatment and

control groups, we use nearest-neighbor propensity score matching (PSM) to pair each mandatory

adopter to a non-adoption firm from countries that do not allow or require IFRS adoption during our

sample period (2002 to 2008). The PSM non-IFRS adopters typify the treatment group of mandatory

adopters based on observed characteristics. To conduct the matching, first, we estimate a probit model

which predicts the probability of firms to be a mandatory adopter based on firm size (measured by

total assets expressed in U.S. dollars), performance (measured by return on assets), growth

opportunity (measured by market to book ratio), leverage, and the growth rate of GDP in a country

where the firms incorporate. The predicted probabilities from the probit model are the propensity

scores for each firm-year observation. Next, we match without replacement each mandatory adopter

to a non-adoption firm in the same industry. To test our hypothesis, we then re-conduct the previous

17

main tests using PSM non-IFRS adopters as the control sample.

The results are reported in Panel B of Table 6. From Column I, we note that the estimated

coefficient on POST is negative and significant at the 1% level (-0.010, t-Stat=-2.68, two tailed).

Similarly, from Column II, when the industry-year fixed effects are used instead of year fixed effects

the estimated coefficient on POST is negative and significant at the 1% level (t-Stat=-2.84).

Consistent with the prior results, our hypothesis is supported.

Apart from using PSM matched non-adoption firms as controls, we also conduct additional

analyses using other different groups of control firms. First, we conduct additional analyses after

excluding China and Japan from our control group, as these two countries are more heavily

represented than other countries in our sample and more importantly, accounting standards in these

countries have been converging towards IFRS over many years (even though they did not formally

announce adoption of IFRS in our sample period). Second, we include non-adoption firms from the

United States and Canada into control group. Our results (un-tabulated) are qualitatively identical to

reported results in Table 5. In addition, the country-level sample distribution in Table 2 indicates that

the U.K. has the largest number of firms in our treatment sample. In further (un-tabulated) analyses,

we then exclude observations from U.K. and repeat our analyses. Our results are qualitatively

identical to reported results in Table 5.

Addressing the concern of institutional changes around or after mandatory IFRS adoption

As the decision to adopt IFRS is performance at country-level, mandatory adoption of IFRS is

less subject to the endogeneity criticism and naturally a preferred event for researcher (De George et

al. 2016). However, as point out by Christensen et al. (2013), some countries made substantive

changes to their enforcement of financial reporting around or after the time IFRS became mandatory,

this raises contamination concerns that changes in regulation or enforcement may confound the direct

effects of mandatory IFRS adoption. To address this concern, we then conduct our analyses within a

sample without the changes in reporting enforcement either concurrently or after the introduction of

IFRS. Specifically, Christensen et al. (2013) have identified that five countries (Finland, Germany, the

18

Netherlands, Norway, and the U.K.) bundle IFRS introduction with a substantive concurrent change

in enforcement, several other countries (including Sweden and Ireland) made substantive enforcement

changes after IFRS adoption, and Japan changed enforcement before having adopted IFRS. We

therefore exclude observations from these countries from our analyses and re-conduct our difference-

in-differences analyses.

The results are reported in the Panel C of Table 6. Column 1 reports the results from the

model where we include both firm- and year- fixed effects. The coefficient on POST is negative and

significant at the 1% level (-0.013, t-Stat=-2.64, two tailed), indicating that after mandatory IFRS

adoption, cash holdings of adoption firms decreases. The magnitude of this effect is also economically

significant: when holding other factors constant, cash holdings decreases by 10% (-0.013/0.128,

where 0.128 is the mean of cash holdings in pre-adoption period in the sample) after mandatory IFRS

adoption. Consistent with the predictions of our hypothesis, when the industry-year fixed effects is

used in the difference-in-differences analysis, the estimated coefficients on POST are negative and

statistically significant at the 1% level in column II (-0.013, t-Stat=-2.62, two tailed).

[Insert Table 6]

VI. ADDITIONAL ANALYSES

In this section, we expand our empirical analyses by performing three sets of additional

analyses. First, we investigate the cross-sectional variation in the effects of the mandatory IFRS

adoption on cash holdings. This set of analyses can provide further assurance that mandatory IFRS

adoption results in the reduction in cash holdings observed in prior analyses. Second, we investigate

the effect of mandatory IFRS adoption on another aspect of cash management policies, the propensity

to accumulate cash generated by operations, which is measured by cash-to-cash flow sensitivity.

Finally, we investigate the effects of mandatory IFRS adoption on firm financial performance,

investment, cash dividend payout and financing decisions, as the changes in firm cash management

policy will usually affect these aspects of corporate operations.

19

1. Cross-sectional variation in the effect of the mandatory IFRS adoption on cash holdings

To further explore the effects of mandatory IFRS adoption on cash holdings, we perform a set

of cross-sectional analyses. First, prior studies (e.g., Daske et al. 2008; Armstrong et al. 2010; Li

2010; Byard, Li, and Yu 2011) find that the country-level enforcement framework is an important

factor in determining the effect of mandatory IFRS adoption. As pointed out by Ball (2006), in the

absence of suitable enforcement mechanisms, the implementation of IFRS is largely subject to a

country's own legal and enforcement level. If mandatory IFRS adoption produced the observed effects

on cash holdings, we should observe these effects are larger in countries where the enforcement of

mandatory IFRS adoption is strong. Following prior literature (e.g., André, Filip, and Paugam 2015;

Cascino and Gassen 2015), we measure the quality of enforcement using a country-level measure

developed by Brown, Preiato and Tarca (2014). Specifically, we sort all firms according to the “Total

score” from Brown et al. (2014) at year t-1, a year before the mandatory adoption of IFRS, and

partition our sample into two groups based on the median value: high vs. low enforcement group. We

then define an indicator variable, Enforcement, which takes the value of 1 if the firm is belongs to the

“high enforcement group” and 0 otherwise. Following Chen et al. (2012), we modify model (1) as

follows to conduct the cross-sectional analyses:

𝐶𝑎𝑠ℎ𝑖𝑡 = 𝑋𝑖𝑡𝛽 + 𝑃𝑂𝑆𝑇𝑖𝑡∅ + (𝑃𝑂𝑆𝑇𝑖𝑡 ∗ 𝑍𝑖)𝛾 + 𝛼𝑖 + 𝜃𝑡 + 𝜖𝑖𝑡 (3)

Where 𝑍𝑖 refers to the dummy variable, Enforcement, that captures the differences in country-

level enforcement frameworks in prior adoption period. Following Chen et al. (2012), because 𝑍𝑖 is

measured in the prior adoption period and it vary with firm but not time, we do not include 𝑍𝑖 on its

own in the presence of the firm fixed effects. We expect that the coefficient on 𝑃𝑂𝑆𝑇𝑖𝑡 ∗ 𝑍𝑖 is negative

when the effects of mandatory IFRS adoption are more pronounced for firms from countries where

the enforcement of mandatory IFRS adoption is strong. The results are presented in Column I of Table

7. As expected, the coefficient on the interaction term, POST*Enforcement, is negative and

significant at 1% level (-0.028, t-Stat=-3.92, two tailed).

To further support the role of mandatory IFRS in reducing cash holdings, we next

20

investigate whether the reduction in cash holdings is greater for firms which have experienced an

improvement in their accounting quality after mandatory IFRS adoption. Based on the findings from

prior studies (e.g., Chen et al. 2013; DeFond et al. 2011), an argument we have made is that the

mandatory adoption of IFRS leads to the reduction of cash holdings through the more transparent

reporting. If that is case, we should observe that the effects are more pronounced for firms which have

experienced an improvement in their reporting quality after mandatory IFRS adoption. We therefore

create an indicator variable, ΔAccounting quality, taking the value of 1 if accounting quality is

improved in the post adoption period as comparing to prior adoption period, and 0 otherwise.

Accounting quality is calculated using modified Jones model (Dechow, Sloan, and Sweeney 1995).

To conduct the analyses, we then replace variable 𝑍𝑖 in model (3) with the dummy variable,

ΔAccounting quality. Column II of Table 7 reports the results. We note that the coefficient on

interaction term, POST* ΔAccounting quality, is negative and significant at 1% level (-0.009, t-Stat=-

2.12, two tailed). Meanwhile, the coefficient on POST is negative but not significant at conventional

level (-0.002, t-Stat=-0.43, two tailed). These findings indicate that the reduction of cash holdings is

restricted only to the firms which have experienced the improvement in accounting quality after

mandatory IFRS adoption.

In the third set of cross-sectional analyses, we further explore the channels through which

mandatory IFRS adoption reduces firms’ cash holdings. As we have discussed earlier, mandatory

IFRS adoption can reduce cash holdings through two potential channels: mitigating financial

constraints, or reducing agency conflicts between shareholders and managers. We further explore

which channels can explain the observed reduction of cash holdings in adoption firms after mandatory

IFRS adoption. First, we investigate whether the reduction is more pronounced for firms with more

severe financial constraints in pre-adoption period. Following prior studies (e.g., Almedia, Campello

and Weisbach 2004; Tong 2011; Chen et al. 2012), we proxy for financial constraints using firm size,

age and payout ratio. The intuition is that larger and older firms have more assets suitable for use as

collateral and face less information uncertainty; therefore they are less likely to subject to financial

constraints (Chen et al. 2012). In addition, financially constrained firms usually have lower payout

21

ratios (Fazzari, Hubbard and Petersen 1988; Tong 2011). To create the dummy variable for financial

constraints, we then sort firm according to their size (measured by total assets expressed in U.S.

dollars), age (measured using the number of years since the firms exist in Compustat Global) and

payout ratio (calculated by the sum of dividends and stock repurchases to total assets) at year t-1, a

year before the mandatory adoption of IFRS, respectively. We then assign a firm to the financially

constrained (unconstrained) group if the relevant variables are below (above) the median of the

variables in the sample. If mandatory IFRS adoption reduced cash holdings through mitigating

financial constraints, we expect that the coefficient on interaction term of POST and the measures of

financial constraints should be negative. Column III, IV and V of Table 7 reports the results. We note

that the interaction terms are all negative and significant at least 10% level (two tailed tests). To the

extent that small firms, younger firms and firms with lower payout ratio in pre-adoption period are

subject to a higher level of financial constraints, the negative coefficients on interaction terms suggest

that financially constrained firms have a greater reduction in cash holdings after adoption of IFRS.

As the final set of cross-sectional analyses, we further test whether mandatory IFRS adoption

can reduce cash holdings through reducing agency conflicts between shareholders and managers. If

mandatory IFRS adoption reduced cash holdings through this channel, we should observe there is a

greater reduction in cash holdings for firms with severe agency conflicts prior to the mandatory

adoption of IFRS. We capture agency problems using the level of excess cash held by a firm in prior

adoption period. Jensen and Meckling (1976) argue that self-interested managers have incentives to

exploit firms’ resources to derive private benefits, and to a large extent, the magnitude of such

behaviour depends on the availability of resources that can be easily diverted (Fre´sard and Salva

2010). The excess cash which is not committed to operational and investment needs can be easily

turned into private benefits (Myers and Rajan 1998). Therefore, we use the excess cash in pre-

adoption period as a proxy for the severity of agency conflicts. Specifically, we follow Fre´sard and

Salva (2010) to measure excess cash as the cash above the predicted level of normal cash level. To

estimate the normal cash level, we regress the cash variable (Cash) on firm size (measured by the log

value of total assets expressed in U.S. dollars), TobinQ (measured by the market to book ratio),

22

Leverage (measured by total debts over total asset), Cash flows (which is operating cash flows scaled

by total assets), Working capital (which is the net working capital), Invest (which is capital

expenditure scaled by total assets), R&D (which is research and development expenditure scaled by

sales) and Dividend (an indicator variable taking the value of 1 if the firm paid a dividend during the

year). We estimate the regression separately for each country and define the residuals from the

regression as excess cash. We then sort all firms according to the excess cash at year t-1, a year

before the mandatory adoption of IFRS. We create an indicator variable, Excess cash, taking the value

of 1 if excess cash of a firm in pre-adoption period is above the median value, and 0 otherwise. To

conduct the analyses, we replace variable 𝑍𝑖 in model (3) with the dummy variable, Excess cash. If

mandatory IFRS adoption reduced cash holdings through mitigating agency conflicts between

shareholders and managers, we expect the coefficient on interaction term, POST*Excess cash, is

negative. From the Column VI of Table 7, we note that the interaction term is negative and significant

at 1% level (-0.068, t-Stat=-12.42, two tailed tests), suggesting that firms which have more severe

agency conflicts in pre-adoption period have a greater reduction in their cash holdings after

mandatory IFRS adoption.

In summary, the cross-sectional analyses show that the effects of mandatory IFRS adoption

on cash holdings vary with the enforcement of adoption and adoption effects are only limited to firms

with an improvement in accounting quality after mandatory IFRS adoption. This is consistent with the

view that mandatory IFRS adoption has a significant impact on corporate cash management policies.

As discussed earlier, such effects can operate via either mitigating agency conflicts between

shareholders and managers, or relaxing the financial constraints. These two channels are not mutually

exclusive and our empirical analyses support both channels.

[Insert Table 7]

2. The effects of the mandatory IFRS adoption on cash-to-cash flow sensitivity

We investigate the effect of mandatory IFRS adoption on another aspect of cash management

23

policies, the propensity to accumulate cash generated by operations, which is measured by cash-to-

cash flow sensitivity. Almeida et al. (2004) argue that if external finance is more costly than internal

finance, firms should have a higher propensity to save cash out of current cash flows. This leads to a

higher cash-to-cash flow sensitivity. If mandatory IFRS adoption can mitigate the market frictions and

relax financial constraints of adoption firms, we predict the propensity to hoard cash, as measured by

cash-to-cash flow sensitivity, should be reduce after mandatory IFRS adoption. Following Almeida et

al. (2004), we then estimate the model as follows:

Δ𝐶𝑎𝑠ℎ𝑖𝑡 = 𝑋𝑖𝑡𝛽 + 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠𝑖𝑡∅ + 𝑃𝑂𝑆𝑇𝑖𝑡µ + (𝑃𝑂𝑆𝑇𝑖𝑡 ∗ 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠𝑖𝑡 )𝛾 + 𝛼𝑖 + 𝜃𝑡 +

ϵit (4)

Where ΔCashit is the changes in cash holdings from year t-1 to t. 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠𝑖𝑡 is the

operating cash flows scaled by total assets. POST is an indicator variable that takes the value of 1 if

firms have mandatorily adopted IFRS by the end of year t and 0 otherwise. 𝑋𝑖𝑡 is the set of control

variables. Following prior studies (Almeida et al. 2004; Chen et al. 2012), we include variables as

follows: Size, measured by the log value of total assets expressed in U.S. dollars; TobinQ, measured

by the market to book ratio; Δ Invest, the changes in capital investment from t-1 to t; Δ Working

capital, the changes in net working capital from t-1 to t; and Δ Leverage, the changes in total leverage

from t-1 to 1. In addition, we also include: Cross-listing, a dummy variable taking on a value of 1 for

firms that cross-list in other countries; and US GAAP, a dummy variable that takes a value of 1 for

firm-years in which the firm reports in US GAAP to control for implementation of an alternative set

of high quality accounting standards. 𝛼𝑖 and 𝜃𝑡 represent firm fixed effects and year fixed effects

respectively. ϵit is an error term. We cluster standard errors at the firm level to control for an arbitrary

firm-level correlation structure. Coefficient on cash flows, ∅ , captures the cash-to-cash flow

sensitivity for non-adoption firms; while ∅ + 𝛾 measured the cash-to-cash flow sensitivity for

adoption firms. The coefficient of interest is 𝛾 . Our hypothesis predicts that this coefficient is

negative, indicating that mandatory IFRS adoption reduces the propensity to accumulate cash from

operating cash flows when comparing with non-adoption firms.

The results of analyses are presented in Table 8. From Column I, we note that coefficient on

24

POST*Cash flows is negative and significant at 1% level (-0.092, t-Stat=-3.15, two tailed), indicating

that the cash-to-cash flow sensitivity of adoption firms reduces after mandatory IFRS adoption.

Similarly, from Column II, when the industry-year fixed effects are used instead of year-fixed effects

the estimated coefficient on POST* Cash flows is negative and significant at 1% level (-0.091, t-

Stat=-3.09). In Column III, we then add three additional controls variables into the regression: Δ

Invest, Δ Working capital and Δ Leverage, which control for the impacts of the sources and uses of

cash on the changes of cash holdings. Again, the coefficient on POST* Cash flows is negative and

significant at 1% level. In Column IV When replacing year-fixed effects with industry fixed effects,

we obtain the similar results. These findings suggest that mandatory IFRS adoption provide some

benefits for adoption firms by inducing firms to hoard less cash from operations.

[Insert Table 8]

3. The effects of the mandatory IFRS adoption on firm decisions and performance

In this section, we further explore the effects of the mandatory IFRS adoption on firm

performance, investment, cash dividend payout and borrowing decisions. As we have argued before,

mandatory IFRS adoption can affect corporate cash management policy through mitigating agency

conflicts or relaxing financial constraints in adoption firms. Under both channels, we should observe

an improvement in the performance of the adoption firms. More importantly, the precautionary

motive for corporate cash holdings implies that firms hold more cash to provide financial flexibility

and enable them to pursue valuable investment opportunity that would otherwise been bypassed (Han

and Qiu 2007; Denis 2011). Under this scenario, when mandatory IFRS adoption mitigates financial

constraints, we should observe an increase in firms’ investment and external financing. In contrast, if

the cash holdings in pre-adoption period are suboptimal, that is, managers hoard cash for their

personal benefit, we should observe there is an increase in dividend payout, but no changes in

investment and external financing, if mandatory IFRS adoption mitigated agency conflicts by

improving monitoring. Therefore, we estimate the model as follows to empirical test the effects of

mandatory IFRS adoption on firm decisions and performance:

25

𝑌𝑖𝑡 = 𝑋𝑖𝑡𝛽 + 𝑃𝑂𝑆𝑇𝑖𝑡µ + 𝛼𝑖 + 𝜃𝑡 + ϵit (5)

Where 𝑌𝑖𝑡 represents the measures of performance, investment, cash dividend payout or

borrowings. Following Chen et al. (2012), we use return on assets (ROA) to measure performance.

Investment is measured as the sum of capital expenditure, research and development, and acquisition

expenditures less the sale of property, plant, and equipment, scaled by total assets, following Cheng,

Dhaliwal and Zhang (2013). Dividend payout is measured using the ratio of cash dividends to

earnings. Financing policy is measured by total debt (the sum of long-term and short-term debt, scaled

by total assets), short-term debt (short-term debt, scaled by total assets), and long-term debt (long-

term debt, scaled by total assets). 𝑋𝑖𝑡 is a set of control variables. Following Chen et al. (2012), we

include: Size, measured by the log value of total assets expressed in U.S. dollars; TobinQ, measured

by the market to book ratio; and Cash flows, the ratio of cash flow from operations to total assets. In

addition, we also control for cross-listing (Cross-listing) and the uses of US GAAP (US GAAP) in the

regression. We include firm fixed effects (𝛼𝑖) and year fixed effects (𝜃𝑡) in the mode and cluster

standard errors at the firm level to control for an arbitrary firm-level correlation structure. The

coefficient of interest is µ. As we have discussed earlier, we expect µ is positive in all analyses.

Table 9 presents the effect of the IFRS adoption on firms’ performance, investment, cash

dividend payout and borrowings. In Column I, with ROA as dependent variable, the coefficient on

POST is positive and significant at the 1% level (0.006, t-Stat=2.76, two tailed), suggesting that after

mandatory IFRS adoption the ROA increases by 18% (0.006/0.033, where 0.033 is the mean value of

ROA in the pre-adoption period). Column II reports results regarding total investment. Again, the

coefficient on POST is positive and significant at the 1% level (t-Stat=5.31, two tailed). Given the

average value of total investment in pre-adoption period is 0.065, this estimate implies that after

mandatory IFRS adoption, the total investment increases by about 29% (0.019/0.065). Similarly, we

find that the cash dividend payout increases by 51% (0.099/0.196), total debt increases by 8%

(0.017/0.225), with short-term debt increases by 8% (0.010/0.119) and long-term debt increases by

7% (0.007/0.105). In further un-tabulated analyses, we replace year fixed effects with industry-year

fixed effects and obtain the qualitatively similar results. Consistent with prior cross-sectional

26

analyses, our findings suggest that the mandatory IFRS adoption can reduce cash holdings through

mitigating both the financial constraints and agency conflicts between shareholders and managers.

[Insert Table 9]

VII. CONCLUSIONS

As far as we are aware, this is the first study to investigate the role of accounting standards

harmonization in determining the level of corporate cash holdings. By using mandatory IFRS

adoption as an exogenous shock, we find evidence to support the view that accounting reporting can

affect corporate cash holdings. Specifically, we find that when firms are forced to switch to a same set

of high quality accounting standards, they reduce their cash holdings and have propensity to save less

cash from operating cash flows. This finding is robust to using alternative research design, employing

alternative sample and addressing for contamination concerns of mandatory IFRS adoption. We also

find that the observed results are limited to countries with high enforcement of accounting standards

and to firms with an improvement in accounting quality after mandatory IFRS adoption. In addition,

we find that such a reduction in cash holdings is more pronounced for financially constrained firms

(as measured by firm size, age and payout ratio) and firms subject to more severe agency conflicts

prior to the adoption (as measured by the excess cash in pre-adoption period). We also find that after

mandatory IFRS adoption, the performance of adoption firms increases and these firms increase their

total investment, cash dividend payout, long-term debt as well as short-term debt. These findings are

consistent with the premise that convergence in accounting standards can mitigate market frictions,

which can then relax financial constraints and lead to a reduction in agency conflicts existing between

shareholders and managers.

Our finding contributes to a stream of finance literature (e.g., Opler et al. 1999; Subramaniam

et al. 2011; Tong 2011; Bigelli and Sánchez-Vidal 2012; Chen et al. 2012; Gao et al. 2013) which

examines the determinants of corporate cash holdings, by putting more emphasis on the role of

accounting standards in corporate cash holdings. We also contribute to the stream of IFRS studies by

evidencing that convergence of financial reporting practices can have real (and measurable) impacts

27

on firm operation decisions. Prior studies in this area find that mandatory IFRS adoption can affect

firm investment decisions (Chen et al. 2013; Shroff et al. 2014; Gao and Sidhu 2016), merging and

acquisition decisions (Louis and Urcan 2014), dividend payout policies (Hail, Tahoun and Wang

2014), equity issuances (Wang and Welker 2011) and cross-listing decisions (Chen et al. 2015). We

focus on corporate cash management policy. That is, corporate cash holdings. For this reason, this

paper has policy implications for regulators and policy makers.

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APPENDIX: Variable definitions

Tests for the level of cash holding:

Cash holdings The cash to assets ratio, measured by Compustat item CHE/AT.

POST An indicator variable that takes the value of 1 if firms have mandatorily adopted

IFRS by the end of year t and 0 otherwise.

Beforej (Afterj) A dummy variable for the jth year before (after) the firm mandatorily adopted

IFRS.

Size The log value of total assets expressed in U.S. dollars.

TobinQ Market value of the firm divided by book value of the assets, measured by (AT +

CSHOI* PRCC_F - CEQ - TXDB)/AT.

Leverage Total debt over total assets, measured by LT/AT.

Cash flows The ratio of cash flow from operations (IB+DP) to total assets (AT).

Working capital Working capital less cash, divided by assets, measured by (WCAP-CHE)/AT.

Cash cycle Cash conversion cycle, measured by (RECT/SALE+INVT/COGS+AP/SALE).

Invest Capital expenditure divided by assets, measured by CAPX/AT.

R&D Research and development expenditure scaled by sales, measured by XRD/SALE.

Dividend An indicator variable that takes the value of 1 if the firm paid a dividend and 0

otherwise.

σ(CFO) The standard deviation of the cash flow from operations deflated by total assets.

Sale PPE An indicator variable that takes the value of 1 if the firm sell Property, Plant and

Equipment during the year and 0 otherwise.

US GAAP A dummy variable that takes a value of 1 for firm-years in which the firm reports

in US GAAP.

Cross listing A dummy variable taking on a value of 1 for firms that cross-list in other countries.

Cross-sectional tests in the effects of mandatory IFRS adoption on cash holdings

Enforcement An indicator variable that takes the value of 1 if the firm is belongs to the “high

enforcement group” and 0 otherwise. We sort all firms according to their country-

level enforcement score as developed by Brown, Preiato and Tarca (2014) at year t-1,

a year before the mandatory adoption of IFRS. If the score is above (below) the

median score in the sample, we assign the firm to high (low) enforcement group.

Δ Accounting

quality An indicator variable that takes the value of 1 if accounting quality is improved in the

post adoption period as comparing to prior adoption period. Accounting quality is

calculated using modified Jones model (1991).

Firm size An indicator variable that takes the value of 1 if it is a small firm and 0 otherwise.

We sort all firms according to their total assets at year t-1, a year before the

mandatory adoption of IFRS. If the score is below (above) the median score in the

sample, we classify the firm as small (large) firm.

Firm age An indicator variable that takes the value of 1 if it is a young firm and 0 otherwise.

We sort all firms according to their age at year t-1, a year before the mandatory

adoption of IFRS. If the score is below (above) the median score in the sample, we

classify the firm as young (old) firm. Age is measured using the number of years

since the firms exist in Compustat Global.

Payout An indicator variable that takes the value of 1 if the firm is belongs to the “low

payout group” and 0 otherwise. We sort all firms according to their payout ratio at

year t-1, a year before the mandatory adoption of IFRS. If the score is below (above)

the median score in the sample, we classify the firm as low (high) payout firm.

Payout ratio is calculated by the sum of dividends and stock repurchases to total

assets following Tong (2011).

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Excess cash An indicator variable that takes the value of 1 the firm is belongs to the “high excess

cash group” and 0 otherwise. We sort all firms according to their excess cash at year

t-1, a year before the mandatory adoption of IFRS. If the score is above (below) the

median score in the sample, we classify the firm as high (low) excess cash firm.

Excess cash is estimated as the cash held above a predicted level of cash following

Fre´sard and Salva (2010).

(Other variables are the same as above.)

Tests for cash-to-cash flow sensitivity:

Δ Cash

holdings The changes in cash holdings from t-1 to t.

Δ Invest The changes in invest from t-1 to t.

Δ Working

capital The changes in working capital from t-1 to t.

Δ Leverage The changes in leverage from t-1 to t.

(Other variables are the same as above.)

Tests on firm decisions and performance:

ROA The return on assets, measured by IB/AT.

Total

investment Following Cheng, Dhaliwal and Zhang (2013), it is measured as the sum of capital

expenditure, research and development, and acquisition expenditures less the sale of

property, plant, and equipment, scaled by total assets.

Dividend

payout The ratio of cash dividends to earnings, measured by DV/(IB+XINT+TXDI+ITCI).

Total debt The sum of long-term and short-term debt ((DLTT+DLC), scaled by total assets.

Short-term

debt Short-term debt, scaled by total assets.

Long-term

debt Long-term debt, scaled by total assets.

(Other variables are the same as above.)

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TABLE 1: Sample selection procedure