Timely Loss Recognition and the Value Relevance of the Romanian Listed Companies Considering the IFRS Approach

Dobre, Florin; Brad, Laura; Ciobanu, Radu Article Timely Loss Recognition and the Value Relevance of the Romanian Listed Companies Considering the IFRS Approach Journal of Accounting and Management Information Systems (JAMIS) Provided in Cooperation with: The Bucharest University of Economic Studies Suggested Citation: Dobre, Florin; Brad, Laura; Ciobanu, Radu (2015) : Timely Loss Recognition and the Value Relevance of the Romanian Listed Companies Considering the IFRS Approach, Journal of Accounting and Management Information Systems (JAMIS), ISSN 2559-6004, Bucharest University of Economic Studies, Bucharest, Vol. 14, Iss. 4, pp. 732-747 This Version is available at: https://hdl.handle.net/10419/310608 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/4.0/ Accounting and Management Information Systems Vol. 14, No. 4, pp. 732–747, 2015 Timely loss recognition and the value relevance of the Romanian listed companies considering the IFRS approach Florin Dobre a, Laura Brad a,1 and Radu Ciobanua a Bucharest University of Economic Studies, Romania Abstract: The Romanian listed entities had to report their individual financial statements under International Financial Reporting Standards (IFRS) from 2012. As at international level the adoption of the new regulation created mixed effects, we investigate how the timely loss recognition and the value relevance changed in Romania after their implementation. The present research looks both at timely loss recognition and at value relevance for Romanian entities that are listed on the Bucharest Stock Exchange. The research is conducted on a four year period of time. The research is based on logit and panel data analysis. The results provide evidence that there seems to be more timely loss recognition and more value relevance for Romanian listed entities after the adoption of the IFRS in the individual financial statements. As a consequence, there is more accurate accounting information on the Romanian market which might trigger higher confidence both for the stakeholders of the company and for the foreign investors. Keywords: timely loss recognition, value relevance, Romania, IFRS, listed entities JEL codes: M20, M40, M41 1. Introduction At international level, the adoption of International Financial Reporting Standards (IFRS) as accounting framework created mixed effects. On one hand, the value of earnings management was mitigated; there is more timely loss recognition and 1 Corresponding author: Laura Brad, Bucharest University of Economic Studies, E-mail: [email protected] email addresses: [email protected]; ra[email protected]se.ro Timely loss recognition and the value relevance of the Romanian listed companies considering the IFRS approach Vol. 14, No. 4 733 more value relevance. On the other hand, either an opposite effect was observed, according to which the indicators that measure the performance of the company decreased (for example, the switch from national to international accounting framework implies that higher costs are needed for the recognition of financial elements (Houqe et al., 2012) or the switch from national to international accounting regime did not involve any change. At European level, the entities had to report their consolidated financial statements using the international approach from 2005. The idea on which the implementation of IFRS started to be mandatory was based on the fact that these standards could ensure a higher protection of investors, free movements of capitals and could encourage the competitiveness of European capital market. Further, the regulation extended to the construction of individual financial statements. In Romania, starting with 2012, all entities that are listed in the Bucharest Stock Exchange (main market) have to construct their individual financial statements using the International Financial Reporting Standards. Actually, the adoption of IFRS, as a way of reporting the financial statements, has been previously done. IFRS as adopted by the European Union were required in the consolidated financial statements of listed entities starting with 2007 (when Romania became a member of the EU). However, the influence of IFRS over the Romanian accounting system and practices was older than that. The main reasons for that could be based on the pressure of shareholders, the need to obtain foreign resources and the need to have a more transparent accounting system (Albu & Albu, 2012, King et al., 2001). At international level, Romania seems to be a promoter for the adoption of IFRS (Zeghal & Mhedhbi, 2006) as the first regulations based on IFRS (back in 2001) was required not only from the listed entities, but also from large entities (Larson & Street, 2004). Taking into account the adoption of IFRS and its implications, it is considered that the changes in timely loss recognition and on value relevance should be tested in more than one period of time. As Romania adopted the IFRS from 2012, we wonder how these indicators changed. Consistent with the literature, the data was collected both under the national and the international accounting framework. According to our knowledge, there are no studies that provide evidence about the value of timely loss recognition and the value of value relevance of the companies that are listed on the Bucharest Stock Exchange, in a period of time of more than one year. The research conducted on Romania is important for both the investors and the academic environment. First of all, it fills a gap considering the adoption of IFRS in an emerging market as most of the studies are conducted on developed economies. In Romanian listed entities the major shareholder has in many cases Accounting and Management Information Systems Vol. 14, No. 4 734 more than 50% of the shares of the entity, the companies that are listed have different liquid characteristics, few of them are international traded and they have different ways of implementing the new regulation. The study provides evidence about the financial quality in Romania, revealing the way on how to implement future policy. The study on Romanian emerging market could be useful for further research in markets with similar characteristics with Romania. The study could also be useful for additional foreign investment because of the possibility of growth and further development of the market. It seems that the adoption of IFRS should increase the relationship with regional partners as the transaction costs are going to be mitigated. Considering this, a detailed perspective on the effect of the adoption of IFRS for Romanian companies regarding the timely loss recognition and the value relevance is important both from the theoretical and practical point of view. It brings further possibilities for development and it creates value added to the existing literature. The rest of the paper is structured as follows: the first part reveals the literature review that is both correlated with timely loss recognition and the value relevance. The second section reports the methodology of research where we provide evidence about the sample selection and about the methods of estimation (logit and panel) that we used. The third section is the section where the results are presented and are discussed. The paper ends with a section of conclusion, where we revealed the problems of the research and where we presented several ways of improving it. 2. Literature review The research done on the adoption of the International Financial Reporting Standards provides mixed evidence, considering that the switch from national to international accounting framework was either voluntary or mandatory. While there are researchers according to whom the implementation of IFRS impacts positively the quality of accounting information and increases the degree of transparency in reporting (Daske, 2006), there are also opinions that reveal the marginally effect of their adoption. Cascino and Gassen (2014) consider that the individual characteristics’ of the entities and of the region where they belong to and the degree of uncertainly that their country has affects the comparability of data. The switch of accounting framework is tested by multiple regression models, logit models or by the analysis of panel data models. The results could focus either on earnings management or on the impact of the earnings on financial performance. According to Lang et al. (2003), the entities that are listed have higher value relevance and lower values of earnings management. Similar results were obtained by Barth et al. (2008) who showed that the entities that have adopted the IFRS have lower values of earnings management, more timely loss recognition and more Timely loss recognition and the value relevance of the Romanian listed companies considering the IFRS approach Vol. 14, No. 4 735 value relevance than the companies that use the national accounting framework for reporting. Other mixed results were provided by Zhou et al.(2009) who revealed that the Chinese entities report less earnings management, but the adoption of international regulation have no effect on the period on which timely loses recognition is done. On the other hand, negative effects of the adoption of the IFRS were obtained by Lin et al. (2012). They reveal that using similar way of reporting of financial statements is not enough to ensure comparability of data due to the flexibility that the new accounting framework implies. Their results are summarize in a research conducted by Ahmed et al. (2013) who provides evidence that, on average, in the countries where the international accounting measures are used higher earnings management and lower timely loss recognition are detected towards the countries that use national accounting measure for financial reporting. Regarding the magnitude of the value relevance before and after the adoption of IFRS, the literature provides evidence of two models on which it can be computed. One is based on price models (the price is regressed on earnings per share). Recent research that was conducted on price models is the one conducted by: Liu et al. (2011), Tsalavoutas et al. (2012), Chandrapala (2013) Chebaane and Othmanb (2014). The second way of testing the value relevance is based on return models. Recent research that was conducted on return models is the one conducted by Callao and Jarne (2010), Houqe et al. (2012), Lin et al. (2012), Cheng et al. (2013.) The use of both models can provide different results. Kothari and Zimmerman (1995) proved that the value of the coefficients that are estimated by price models are less biased, while return models can encounter problems in estimation. On the other hand, Van der Meulen et al. (2007) consider that price models do not take into account the market reaction when positive or negative results are obtained by a company. Similar results are found by Ahmed et al. (2013). In a review on value relevance, they revealed that there is more value relevance when IFRS are used rather than national accounting framework in price models and less value relevance when IFRS are used rather than national accounting framework in return models. There are also some problems on each model. The price models included the scale effect, which impacts the value of R-squared (unreliable increase of its value Brown et al., 1999). The return models can be affected by lagged effect of accounting elements on the value of stock market returns and by the fact that the earnings per share are not constant. (Easton et al., 2000) The value relevance was tested both on countries that adopted voluntary or mandatory the international regulation. Regardless the type of the research that was conducted, the results are also mixed. Hung and Subramanyam (2007) found that Accounting and Management Information Systems Vol. 14, No. 4 736 there is less evidence that an increase in the value relevance is detected even after the IFRS are used. Contrary to them, Jermakowicz et al. (2007) report that more value relevance is obtained by the countries that adopt the IFRS as voluntary even though they admit that the lack of information, the complex character of IFRS and the costs associated with them can mitigate the positive influence of them. On the other hand, the research conducted on samples that have to adopt the IFRS as mandatory provide negative influence. Taylor (2009) considers that there is less value relevance in Great Britain, Hong Kong and Singapore when the IFRS are used. Contrary to their results, Iatridis (2010) reveals that more value relevance is obtained in Great Britain after the entities adopted the IFRS. Other mixed results were found in the research conducted by Devalle et al. (2010). They provide evidence that there is much more influence of earnings on price level in Germany, France and Great Britain after the IFRS were implemented. The legal environment seems also to be very important. Clarkson et al. (2011) concluded that there is no difference in value relevance between Common Law countries and Civil Law countries when they use a linear model, but an improvement is found in Common Law countries when an un-linear model is used. Similar results were found by Chebaane and Othman (2014). Other researches proved that the impact of adoption of the IFRS is higher when there is significant difference between national and international accounting framework (Cai et al, 2014). Moreover, the way in which the accounting information is reported under IFRS implies more value relevance (Tsalavoutas & Dionysiou, 2014) In Romania, few studies were conducted and the sample dimension is in general small. Brüggemann et al. (2013) argue that that there is not a sample or a group of Romanian entities that has been used in international comparisons. Considering the research conducted on the value relevance, Filip and Raffournier (2010) and Filip (2010) emphasize that there is a correlation between book values and the return of the market. The correlation remains statistically significant even if an adjustment with the level of inflation is done. The authors proved that the Romanian entities that are listed on the second category on the Bucharest Stock Exchange have higher returns which are more correlated with market return. Similar, Pascan and Neag (2012) found that there is no more value relevance in the value of global profit with the value of net profit, no matter what is the accounting framework that the entities use. Based on this, we aim to provide evidence about the accounting quality in Romania, considering the changes that occurred in the timely loses recognition and in the value relevance that the Romanian listed entities have. Timely loss recognition and the value relevance of the Romanian listed companies considering the IFRS approach Vol. 14, No. 4 737 3. Methodology of research The purpose of this research is to provide evidence about the changes that have occurred in the recognition of loses and in the value relevance of the entities that are listed on the Bucharest Stock of Exchange that had to construct their individual financial statements using the IFRS. In order to achieve this objective, we selected the entities that have to comply with this regulation (according to the Romanian Supervision Authority at the end of 2013, 71 entities have to mandatory adopt the IFRS for their financial statements. Initially, only 68 companies have to comply with this regulation. After that, one company was delisted and 4 companies had to construct their individual financial statements using the IFRS from 2013). In order to create a more homogenous sample, we have omitted the entities that had to report their individual financial statements using the international accounting framework starting from 2013. These companies are COTE, SNN, SNG, CNTE (these are the symbols that each entity has). We have also omitted the companies (SRT, UZT) that were in insolvency between 2010 and 2012 (the period of transition to IFRS and the year of adoption them). Finally, we have excluded the companies that have a negative value of their own capital (there were 8 companies from 2010 to 2012 and one company in 2013). In order to confer robustness to the results, we have selected financial information from 2010 to 2013. The methodology of research is divided in two parts. One reveals the computation of timely loss recognition and one looks at the computation of value relevance. Timely loss recognition is a technique according to which we can detect the value of earnings management. Lang et al. (2003) consider that, in international framework, the financial statements should focus on timely loss recognition in the moment when they had appeared, rather than reporting them on several periods of time. This method is correlated with the principal of earnings management. If an entity has higher values of earnings management than timely loss recognition is rarely seen. The timely loss recognition is correlated with the conservative and the prudence principals from accounting. It is considered that the entities should recognize all loses, and should not provide evidence about any gain (Bliss, 1924: 110). As a fact, there is an asymmetry between loses and gains recognition as the bad news affect quicker the value of net profit than good news do (Basu, 1997). In the literature, by timely loss recognition is understood that the ratio between net profit and the value of total assets is under -0.2. Considering that the companies that are part of our sample have rarely loses and the ratio between the net profit and total is closely to zero, we consider that a timely loss recognition is when the ratio Accounting and Management Information Systems Vol. 14, No. 4 738 between net profit and total assets is lower than -0.05. This adjustment is the contribution of authors at the literature as neither article uses this threshold. In order to reveal how the recognition of loses occurred after the adoption of IFRS, we used an econometric model where the dependent variable is a binary one. The value of timely loss recognition is measured on several individual factors. This model is represented in equation (1). The model is similar with the model provided by Lin et al. (2012). However, the model was adjusted to Romania, considering available information. Thus, from the initial model, the variable EISSUE shows the changes found in the number of stocks, rather than the changes found in common stocks. Moreover, from the initial model the number of exchanges on which the firm’s stock is listed is excluded from the analysis as few companies are international traded and the per cent of closely-held shares of the firm’s stock is also excluded as there is no available information about it. iitit itititit itititit POSTCF AUDDISSUETURNLEV EISSUEGROWTHSIZELNEG εαα αααα αααα +×+×+ +×+×+×+×+ +×+×+×+= 98 7654 3210 (1) Where LNEG is a binary variable that looks at loses recognition, this takes one if the value of net profit divided by total assets is smaller than - 0.05. SIZE is the size of the company, which is measured by the logarithmic value of total assets GROWTH is a variable that measures the percent changed in sales from one year to another EISSUE is an indicator that measures the percent changed in the value of total stocks from one year to another. LEV is the rate of indebtedness that the entities have. The indicator is computed by dividing the value of total debts to the value of own capital. TURN is an indicator that measures the value of turnover that the entity had DISSUE is an indicator that measures the percent changed in the value of total debts from one year to another AUD is a dummy variable that takes value 1 if the financial auditor is among BIG 4 companies. CF is the value of cash flow from operations scaled by the value of total assets POST is a dummy variable that takes value 1 if the accounting framework that the entity uses for reporting its individual financial statements is under IFRS. Otherwise, the variable takes value 0. Timely loss recognition and the value relevance of the Romanian listed companies considering the IFRS approach Vol. 14, No. 4 739 The result look at the interpretation of the coefficient POST . A negative coefficient denotes that the companies are inclined to have more timely loss recognition when they use national accounting framework in order to construct their individual financial statements. A positive value of the coefficient suggests that once that the international accounting measures were implemented, there is a more timely loss recognition at company level. In order to provide robustness to the results, we have also switched the dependent variable LNEG with the independent variable POST . The interpretation is similar. As a fact, if we have a negative coefficient of LNEG than the companies had more timely loss recognition when they use the national accounting regime. Otherwise, if we are going to find a positive coefficient then the entities tent to have more timely loss recognition after the adoption of IFRS. In order to reveal the changes in the value relevance, we have calculated values for earnings per share. We have also computed the difference between the earnings per share. As we wanted to reveal if this information has an impact on value relevance, we use the annual return computed 9 month prior to three months before fiscal year end. Considering this, we used a return model as the results in price model can be biased. The model is revealed in equation 2. The model is similar with the model provided by Lin et al. (2012). The author contribution is based on providing information about the value relevance of Romanian companies. ititititit YEAREPSEPSR ε γ γ γ γ + × + ∆ × + × + = 3210 (2) Where R is the annual return computed 9 month prior to three months before fiscal year end. EPS is the earnings per share that is scaled with the price of share from the first day when it was traded in that year EPS ∆ is the difference between earnings per share. It is scaled with the price of share from the first day when it was traded in initial period of time YEAR is a dummy variable that takes 1 for each year included into the analysis i and t are the elements that look at cross sectional effect and at the time effect Considering this, we based our analysis on two hypotheses of research: H1: There is more timely loss recognition after the adoption of IFRS for Romanian entities Accounting and Management Information Systems Vol. 14, No. 4 746 Cai, L., Rahman, A. & Courtenay, S. (2014) “The effect of IFRS adoption conditional upon the level of pre-adoption divergence”, The International Journal of Accounting, vol. 49, no.2: 147-178 Callao, S. & Jarne, J.I. 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