Effect of Mandatory IFRS Adoption on Accounting-Based Prediction Models for CDS Spreads

Posted by Wayne Landsman - Jun 24, 2020

In a recent study, published in the European Accounting Review (EAR), Pepa Kraft, Zilu Shan, and I, examine the effects of mandatory IFRS adoption on accounting-based predictionmodels for credit default swap (CDS) spreads for a sample of 292 firms in 16 IFRS-adopting countries.

Mandatory adoption of IFRS in 2005 substantially affected financial reporting for firms around the world. There is a large literature examining the effects of mandatory adoption of IFRS on accounting quality, equity capital markets benefits, and effects on comparability of accounting amounts—as reflected in equity prices—between firms in countries adopting IFRS mandatorily and US firms. However, to date there is little research examining the effects of IFRS adoption on the informativeness of accounting amounts for debt markets. Accounting amounts are particularly important to debt market participants because, unlike equity, only a small percentage of corporate debt is publicly traded.  Providing evidence on the effects of accounting information on debt market participants as evidenced by CDS spreads is important to obtaining a fuller picture of the economic impact of IFRS in light of the fact that the amount of debt financing far exceeds the amount of equity financing throughout the world

We conduct our analysis by estimating a credit risk model that relates CDS spreads to the accounting-based measures of firm size, leverage, profitability, and interest coverage separately for financial and nonfinancial IFRS firms before and after mandatory IFRS adoption.  Because application of IFRS is not the only reason for potential changes in predictability of CDS spreads after IFRS adoption, we also estimate accounting-based prediction models for CDS spreads for financial and non-financial US firms before and after mandatory IFRS adoption to obtain prediction errors that serve as a benchmark. We then estimate regressions employing a change-in-difference research design to assess whether changes in predictability for IFRS firms before and after IFRS adoption differ from those for the benchmark US sample. We find that mean and median absolute percentage prediction errors are larger for both financial and non-financial firms after mandatory IFRS adoption. Although US firms also exhibit an increase in mean and median absolute percentage prediction errors over the same period, findings from the regression analysis indicate that the increase is significantly larger for firms in countries that adopted IFRS mandatorily. The findings suggest that accounting amounts based on IFRS are less informative to debt market participants than are those based on domestic accounting standards.

Prior studies in the equity markets suggest that capital market benefits following mandatory IFRS adoption are more likely to accrue to firms in countries with strong legal and regulatory enforcement, as well as for firms in countries with well developed capital markets.  Consistent with these studies in the equity markets, we find that changes in prediction errors are smaller following IFRS adoption for firms in countries with stronger auditing and reporting standards and stronger investor property rights, and in countries where firms have relatively easy access to credit. Taken together, these findings suggest that the extent to which capital market benefits accrue to firms following mandatory IFRS adoption depends on the strength of the legal and regulatory enforcement and the extent of debt market development in the country in which a firm is domiciled.

To cite this article:

Pepa Kraft, Wayne R. Landsman & Zilu Shan (2020) Effect of Mandatory IFRS Adoption on Accounting-Based Prediction Models for CDS Spreads, European Accounting Review, DOI: 10.1080/09638180.2020.1760116