capital mkt consequences of european's firms' mandatory adoption of ifrs

Capital Market Consequences of European Firms’ Mandatory Adoption of IFRS

Jenice Prather-Kinsey Associate Professor of Accountancy

School of Accountancy College of Business

University of Missouri 324 Cornell Hall

Columbia, MO 65211 Phone: 573-882-3671

E-mail: [email protected]

Eva K. Jermakowicz Professor of Accounting

Department of Accounting and Business Law College of Business

Tennessee State University 330 10th Avenue North

Nashville, TN 37203-3401 Phone: 615-963-7052


Thierry Vongphanith Brown Brothers Harriman & CO

Institutional Equities - Strategy Research 140 Broadway

New York, NY 10005-1101 Phone: (212) 493 7949


January 2008


Abstract This paper examines the capital market’s reactions associated with the mandatory adoption of

International Financial Reporting Standards (IFRS) by European firms in 2005. We provide insight on the heterogeneity in capital market consequences from IFRS adoption by investigating the value relevance of book values and information content of earnings announcements of firms before and after IFRS adoption. Additionally, the impact of adopting IFRS on the cost of equity capital is examined. We selected a sample of 157 European firms that implemented IFRS in 2005, used domestic GAAP only for financial reporting in 2004, and reported under IFRS only in 2006. We found that capital market participants consider IFRS adopters’ financial reports more value relevant and informative, and thus resulting in a lower cost of capital after adoption of IFRS. We test whether the heterogeneity in capital market consequences from adopting IFRS can be explained by differences in the legal origin of the country in which firms are domiciled, shareholder rights, and the quality of enforcement. Firms from code law countries experienced more significant market consequences from implementing IFRS than firms from common law countries.

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I. Introduction Globalization of the world’s capital markets has created a need for a single set of accounting

standards that can be applied around the world. Such standards should enhance comparability

and transparency of financial information for investors, resulting in greater willingness of

investors to invest across borders, a lower cost of capital, more efficient allocation of resources

and higher economic growth. These have been the goals of the International Accounting

Standards Board (IASB).

The IASB was created in 2001 with objectives of producing a single set of high-quality,

understandable and enforceable International Financial Reporting Standards (IFRS) and

encouraging global convergence on these standards.1 Today almost every country around the

world is moving toward IFRS in some way. Many countries have either adopted IFRS or based

their local standards on IFRS. World-wide, over 100 nations require IFRS-based financial

reporting for listed companies and it is projected that this number will be over 150 by 2011

(Tweedie 2007). It is clear that near-universal use of IFRS by not only the developing nations

(including China, India and Russia), but also by the most economically advanced ones (Canada,

Japan, USA) is merely a question of time. The existence and influence of the IASB are the result

of market demands for global accounting standards focused on user needs - and not upon

preparer, auditor or regulatory convenience (Stevenson 2007).

1 International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board

(IASB) include the International Accounting Standards (IAS) and their interpretations adopted by the IASB from its

predecessor, the International Accounting Standards Committee (IASC).

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In September 2002, the FASB and the IASB signed the Norwalk Agreement in which

‘each acknowledged their commitment to the development of high quality, compatible

accounting standards that could be used for both domestic and cross-border financial reporting.’

The SEC voted unanimously on November 15, 2007, to eliminate the 20-F requirement for

foreign public issuers to reconcile IFRS financial statements to US GAAP, if the financial

statements are prepared using IFRS as published by the IASB (SEC, 2007a). This decision

signaled the SEC's acknowledgement of the globalization of capital markets and the quality of

the IFRS accounting and reporting framework. In August 2007, the SEC published for comment

a concept release on whether U.S. listed companies should be permitted to report using IFRS

(SEC 2007b). The Commission’s thinking is that if foreign companies have a choice between

IFRS and U.S. GAAP, U.S. companies could be at a competitive disadvantage unless they have

the same option.

All publicly traded companies in the European Union (EU) are required to prepare their

consolidated financial statements in accordance with IFRS from 2005 (EC 2002). Also,

Switzerland, a non-EU member, introduced legislation requiring all multinational companies to

prepare their consolidated financial statements in accordance with IFRS or U.S. GAAP from

2005. The non-EU members of the European Economic Area (EEA), Iceland, Liechtenstein and

Norway, have also agreed to enact the EU Regulation requiring listed companies to report under

IFRS from 2005.

Although EU public companies were required to adopt IFRS from 2005, several

European listed companies switched to IFRS much earlier. In 1998 seven EU nations (Austria,

Belgium, Germany, France, Finland, Italy, and Luxembourg) made provisions allowing

companies under specific prerequisites to use IAS, as well as U.S. GAAP for consolidated

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financial statements to the extent that they comply with the Fourth and Seventh European

Directives. The application decrees, however, have never been adopted in France and Italy

(Delvaille et al. 2005).

Accounting standards differ across countries. A common belief is that these differences

reduce the quality and relevance of accounting information. The vision behind IFRS is that a

single worldwide set of standards would permit investors anywhere around the world to benefit

from a high level of comparability and a consistently high level of quality in financial reporting.

It would eliminate the need for investors and analysts to try to understand financial statements

that are prepared using different accounting standards from many jurisdictions, and it would

eliminate one of the significant barriers to raising capital outside one's borders (Cox 2007).

Our research investigates the impact of mandatory adoption of IFRS on a sample of 157

European IFRS adopters in 2005, the year in which the largest number of European firms

implemented these standards. Although adopting IFRS is more than an accounting issue, with

potential economic, social, political, and cultural outcomes, we examine cross-sectional

differences in the adoption effects by analyzing the stock market reaction associated with

adopting IFRS by European firms.

Following prior research (Barth and Clinch 1996; Ball et al. 2000; Leuz 2003; Barth et al.

2005; Armstrong et al. 2007; Daske et al. 2007a), we analyze whether IFRS adopters’ financial

statements are viewed by investors as more relevant and transparent (informative) than those

before IFRS implementation. Since IFRS is primarily aimed at providing information for the

efficient working of the capital market, we measure value relevance in terms of the ability of

accounting information to explain contemporaneous stock prices. The question of value

relevance is important since it reveals the ability of IFRS to reflect economic information

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incorporated in stock prices.

Daske et al. (2007a) explained heterogeneity in stock market effects by classifying firms into

“label” and “serious” adopters and found that serious adopters experienced stronger positive

effects on the cost of capital and market liquidity than label adopters. Ball (2001) notes that

improvements in accounting standards will amount to little more than “window dressing,” unless

it is accompanied by wholesale revision of the infrastructure that determines the financial

reporting incentives of managers and auditors. We provide insights into heterogeneity in the

capital market consequences by analyzing the legal system of the country in which firms are

domiciled, shareholder rights, and the quality of enforcement.

Easley and O’Hara (2004) model the impact of information attributes on the cost of capital.

They demonstrated that investors demand a higher return to hold stocks with greater private

information (i.e. the stakeholder model in countries with a code-law legal system). An important

implication of this research is that firms can influence their cost of capital by affecting the

precision and quantity of information available to investors. This can be achieved by a firm’s

selection of its accounting standards, as well as through its corporate disclosure practices.

This study will also investigate whether European IFRS adopters experienced a reduction

in the cost of capital following adoption. Decreasing cost of capital as an underlying rationale

for transition to IFRS has been expressed by the IASB regulators around the world and the

European Commission (Levitt 1998; Bolkestein 2000). Francis et al. (2005) found that

alternative legal systems can influence the effectiveness of disclosures. We extend this research

by assessing the impact of legal systems, shareholder rights, and enforcement on the application

of IFRS as measured by market consequences.

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Extant accounting literature distinguishes between two “orientation postulates” (Stewart

1989) under which accounting standards are developed: the shareholders model originating in

countries with a common-law legal system and the stakeholder model originating in countries

with a code-law legal system (Bartov et al. 2005). Traditional accounting systems in code-law

countries such as France, Germany (i.e. most Continental European countries and Japan), have

been driven by an emphasis on financial reporting conformity with tax regulations, conservatism,

and broad-stakeholder orientation. The government, shareholders, debt holders, employees, and

managers are all viewed as stakeholders, relying less on public information because they

typically have access to private information. As a result, the incentives (e.g., minimizing taxes)

and opportunities (e.g., reserve accounting) to reduce earnings volatility are higher in these

countries. We expect that adoption of IFRS would be relatively more beneficial to investors in

these countries and have a more significant impact on capital markets, than for common law

countries where financial reporting has historically been primarily oriented to the private

investor/stockholder. Moreover, book values reported under IFRS should have higher value

relevance than book values determined under national GAAP.

In common-law countries (i.e. U.S., U.K), accounting systems are determined largely by

the disclosure needs of shareholders and potential shareholders (which are primary providers of

capital) and require a high standard of public disclosure. We expect that the adoption of IFRS

would be relatively less beneficial to investors in these countries because their orientation

postulate is similar to that of the IASB.

Our primary contribution is evidence on the likely impact of implementing IFRS on the

value relevance of book values of earnings and equity, information content of earnings

announcements, and cost of capital of a sample of mandatory IFRS adopters in Europe. We are

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looking at the effects of mandatory as opposed to voluntary adoption of IFRS. Most of the prior

research has been conducted on the latter. Our secondary contribution is an investigation of

whether the market responds to the announcement of earnings equally for countries with

different legal systems, shareholder rights, and quality of enforcement. Finally, we test whether

firms adopting IFRS experienced a reduction in cost of capital following adoption of IFRS.

The remainder of our paper is presented as follows. Section II is a discussion of prior

research on the capital market consequences from adopting IFRS. Section III presents the data

and the sample selection process. Section IV describes the research methodology and empirical

design, section V presents our findings. Section VI offers concluding remarks and limitations of

the study.

II. Prior Research

With growing prominence of IFRS, the demand for publications on the effects of

adopting IFRS, country practical experiences in implementing IFRS, as well as future prospects

of global accounting convergence is growing at exponential rates. Several recent studies have

examined the benefits of global accounting convergence and the capital market effects of IFRS

adoptions.

Daske, Hail, Leuz and Verdi (2007a) examined the heterogeneity in economic consequences

of voluntary IFRS adoptions around the world, recognizing that firms have considerable

discretion in how they adopt IFRS. Some firms may simply adopt a label, while others view the

decision as a serious commitment to transparency. They found that the economic consequences

of IFRS adoptions depend on the extent to which firms make material changes to their reporting

policies or have strong reporting incentives. In another paper Daske at al (2007b) analyzed the

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economic consequences of mandatory IFRS reporting around the world using a large sample that

includes over 3,800 first-time adopters. They find that the capital-market benefits from

implementing IFRS exist only in countries with strict enforcement regimes and institutional

environments that provide strong reporting incentives. Also, the effects are weaker when local

GAAP is more comparable to IFRS, in countries with an IFRS convergence strategy and in

industries with higher voluntary adoption rates.

Daske et al. (2007a) defined heterogeneity as the difference in management incentives to

adopt IFRS: “serious” or “label adopters.” We extend Daske et al (2007a) by defining

heterogeneity as common law versus code law countries. We believe that this distinction proxies

for the strength in protection of shareholder rights and the quality of enforcement of those rights

(La Porta et al 1998). Moreover, alternative legal systems, code and common law, have been

found to explain the heterogeneity in financial reporting compliance around the world (Francis et

al. 2005).

Value relevance studies are widely used by researchers to capture the combined attribute of

relevance and reliability of accounting information (Schipper and Vincent 2003). The value

relevance of different GAAP has been explored in the accounting literature using either an

association study or an event study (Holthausen and Watts 2001). We study the association

between book values and the market using a long window (value relevance of 12 months) and a

short window (information content within 6 days of earnings announcements).

Association studies investigate whether financial reporting data explains market

capitalizations and changes over long windows (Barth 1994, Choi et al. 1997, Barth et al. 2005).

The Ohlson model (Ohlson 1991, Ohlson 1995, Feltham and Ohlson 1995) stipulates that the

share price can be written as a linear function of earnings and equity book value, given a

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dividend valuation model and clean surplus accounting, and has been employed in a number of

research studies (Chandra and Balachandran 1992, Harris et al. 1994, Easton and Sommers

2003). We adopt the Ohlson, Juettner-Nauroth (2005) model to study the association between

book value and market values.

Event studies investigate the association of the financial reporting data and abnormal market

capitalization changes over short windows around the date of the financial report publication.

These studies measure information content as an unanticipated change in the returns of a firm’s

capital (Beaver 1968, Ball and Brown 1968, Auer 2003). Armstrong, Barth, Jagolinzer and Riedl

(2007) examined the European stock market reaction to sixteen key events associated with the

adoption of IFRS in Europe. They found significant positive (negative) market reactions to

events that increase (decrease) the likelihood of IFRS adoption, which indicates that European

equity investors perceive net benefits to adoption of IFRS. They also revealed a significantly

more positive market reaction to IFRS adoption for firms with lower quality pre-adoption

information environments. Aubert and Dumontier (2007) found that analysts were not able to

anticipate the consequences of the IFRS adoption on earnings, forecast errors being significantly

associated with differences in earnings resulting from compliance with the new financial

reporting standards. Their study was based on a sample of 1,412 European companies that

complied with IFRS for the first time in 2005.

Various accounting items exhibit high-value relevance in common law countries that have

effective judicial systems, better investor protection, and higher quality of accounting practices

(including more transparent reporting) and auditing systems compared with code law countries.

It is expected that the smaller the deviation of a domestic practice from the IFRS, the higher the

value relevance of that practice. Accordingly, the EU countries with the largest deviation of a

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domestic practice from the IFRS should have the most to gain from transition to IFRS (Leuz and

Verrecchia 2000, Hung 2001, Francis et al. 2003, Dumontier and Maghraoui 2007, Morais and

Curto 2007). We expect that code law countries’ market consequences will be significantly

different in 2006 as compared to 2005 than in common law countries.

Several country-specific studies examine the value relevance of certain accounting items

(Barth and Clinch 1998, Oswald and Zarowin 2004, Hung and Subramanyam 2004). Prior cross-

sectional studies identify and analyze factors such as disclosure policies and investor protection

laws that may cause differences in value relevance levels across countries (Hung, 2001, Zhao

2002). A comprehensive review and critique of the value relevance literature is provided by

Holthausen and Watts (2001), Barth et al. (2001) and Beaver (2002).

Bartov, Goldberg, and Kim (2004) examine the value relevance of earnings by focusing on

the magnitude of its coefficients in regressions of returns on earnings based on U.S. GAAP, IAS

and German GAAP. Jermakowicz, Prather-Kinsey and Wulf (2007) study the value relevance of

the DAX-30 German companies to determine whether voluntary adoption of IFRS resulted in

more value relevant book values after as compared to before adoption of IFRS. These studies

provide evidence that accounting earnings based on IAS are more value relevant than those

based on German GAAP, although they are less relevant than those based under U.S. GAAP.

Financial reporting in accordance with IFRS should lead to higher accounting quality as

compared to national GAAP, which should result in lower levels of information asymmetry and

thus lead to a firm’s lower cost of capital. Many empirical studies have investigated the effect of

IFRS adoption on the cost of equity capital, where the expected cost of capital is calculated using

implied estimation methods or proxies such as bid-ask spreads, trading volume or price

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volatility.

Barth, Landsman and Lang (2005), based on a sample comprising 2,228 firm year

observations for 387 firms adopting IAS over the period 1990 through 2004, investigated

whether applying IAS is associated with less earnings management, more timely loss

recognition, higher value relevance of accounting amounts and a lower cost of capital. They

provide evidence that IAS firms exhibit an improvement in accounting quality and a reduction in

a cost of capital with the application of IAS. However, they do not partition the sample to

explain the heterogeneity in the capital markets between common and code law countries as we

do.

Daske and Günther (2006) assessed the quality of the financial statements of Austrian,

German and Swiss firms which had already adopted internationally recognized standards (IFRS

or U.S. GAAP). They provide evidence that disclosure quality increased significantly under

IFRS in the three European countries and this result holds for firms which voluntarily adopted

IFRS or U.S. GAAP as well as for firms which mandatorily adopted such standards in response

to the requirements of specific stock market segments.

Leuz and Verrecchia (2000) revealed that an international reporting strategy was associated

with lower bid-ask spreads, which they assumed to be appropriate proxies for the information

asymmetry component of the cost of equity capital. Brüggermanan and Homburg (2007) updated

and applied the Leuz and Verrecchia model to a much broader sample. Contrary to their

expectations, they provided no evidence of a significant effect of an international reporting

strategy on bid-ask spreads throughout the whole sample period. Research study conducted by

Daske (2006) found no evidence that adopting internationally recognized reporting standards,

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per se, leads to the economic benefits of lower cost of equity capital for adopting firms. Other

research has provided evidence that rather than by the reporting standards, accounting quality is

predominately determined by a firm’s incentives created by its institutional environment and

market forces (Ball et al. 2003, Leuz et al. 2003). Francis, LaFond, Olsson, and Schipper (2003)

found that firms with certain desirable properties of earnings which increase information quality

exhibit lower cost of equity capital. Leuz and Verrecchia (2004) presented a capital market

model with rational expectations in which better information improves the coordination between

firms and outside investors regarding a firm’s investment decisions and thus reduces

misalignment risk between the two parties. We provide evidence on these contradictory findings

by not only studying the cost of capital before and after IFRS mandatory adoption of IFRS, but

also by studying what might explain the heterogeneity in these findings.

Most studies suggest that equity investors perceive net benefits from adoption of IFRS. Our

research continues work in the area of potential benefits to investors from implementing IFRS

and global accounting convergence. Instead of partitioning our sample based on reporting

incentives, we partition our sample based on shareholder rights and the quality of enforcement of

these rights as defined by La Porta et al. (1998). Francis et al (2005) find that alternative legal

systems can influence the effectiveness of disclosures. We extend prior research by not only

studying the cost of capital but also the value relevance of book values and information content

of earnings announcements of firms before and after adoption of IFRS. We focus on cross-

sectional differences in IFRS adoption effects and test whether heterogeneity in investor rights

and enforcement quality as well as common law versus code law legal origins explain

differences in value relevance, information content and cost of equity capital.

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III. THE DATA AND SAMPLE

The Dow Jones STOXX 600 index was used as our reference universe to select the

population of large publicly traded European firms that only traded on their domestic exchange

in 2004-2006, only reported under domestic GAAP in 2004 and only reported in accordance with

IFRS in 2006. Precautions were taken to have the historical constituents included in the index as

they were originally at the end of years 2004 and 2006. This index was favored over other

market indexes for three reasons that we thought important and advantageous for this study.

• The financial significance of the index - Its market capitalization was about €7.6

trillion as of June 30, 2006 and represented roughly 88% of the free float market capitalization of

the European and Eurozone markets. This index is also favored by finance professionals and

provides them with a broad representation of large European companies.

• The index relevance and the extent of its geographical coverage - All the developed

European markets in Europe are covered by the index: Austria, Belgium, Denmark, Finland,

France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal,

Spain, Sweden, Switzerland, and the United Kingdom.

• The availability of financial statements in English for reconciliation purposes - The

vast majority of firms in the Dow Jones STOXX 600 index had their annual reports published in

English making the reconciliation/reconstitution of numbers possible with documents published

by companies. A broader index would include smaller firms not able to produce financial

statements in English because of the costs involved with producing financial reporting

simultaneously in a foreign language.

To provide complete and clean data, different databases were used in our study. The

historical constituents of the Dow Jones STOXX 600 index at the end of 2004 were provided by

Bloomberg. The Thomson Worldscope database on FactSet was our main source of fundamental

data as it provides stock market data and financial reports that are not restated. Bloomberg and

Capital IQ from S&P were also used for cross checking purposes. Both databases provided

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options in how financial statement numbers are shown--as originally filed and/or restated. When

these databases gave conflicting numbers, we carefully reconciled all of these differences. We

also made sure that the definition of the different items matched the financial statement

disclosures. For example, we looked at the annual reports to check which database had the same

number as the published consolidated financial statements and its accompanying notes. The

availability and the use of different databases also allowed the data to be more complete.

(Insert Table 1 here)

Our objective was to examine the heterogeneity in market consequences of mandatory IFRS

adoption in Europe, where market consequence is defined as value relevance, information

content and cost of equity capital. Thus, we excluded from our sample those European firms that

reported using U.S. GAAP during the data base period in order to mitigate the effect of U.S.

GAAP driving IFRS technical compliance results rather than the home country legal

environment, as prior research found that U.S. GAAP compliant financial reports are of higher

quality than IFRS (Barth et al. 2005, Armstrong et al. 2006). We included in our sample those

European firms that reported using domestic GAAP only prior to 2005 and used IFRS only after

2005. This process resulted in 157 firm-year observations in 2004 and 157 firm year

observations in 2006.

In summary, we believe that the market will find IFRS adopters’ financial reports more value

relevant, informative and thus rewarded with a lower cost of capital for both common law and

code law countries but to a greater extent for code law countries. We believe that our sample is

more robust as compared to that of Daske et al. (2007a) since we excluded the early adoption

effects of year 2005 IFRS adoption and examined the effects in 2006.

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IV. METHODOLOGY AND EMPIRICAL DESIGN

Value Relevance

We used the Ohlson, Juettner-Nauroth (2005) value-relevance model to determine

whether the book values of income and equity increased after the adoption of IFRS and whether

that increase is greater for code law than common law countries between 2004 and 2006.

MVj,t/MVj,t-1 = α0t+ β1t BVj,t/MVj,t-1 + βα2t NIj,t/MVj,t-1 + ej,t (1)

where:

t = 2004 or 2006,

MVj, t = market capitalization (market price per share times the number of shares outstanding) for firm j at the end of period t,

BVj,t = the book value of common equity of firm j at the end of period t,

NIj,t = income statement reported net income for firm j for the time t-1 to t,

ej,t = residuals or error term for firm j at the end of period t.

Information Content

Earnings announcements are timely or have information content if they lead to price

changes different from those expected before the announcement. Studies that document earnings

announcement price adjustments include events studies such as Armstrong et al. (2007), Beaver

(1968) and Ball and Brown (1968). We measured information content as an unexpected change

in a security’s returns. When announcements are good news, then returns are higher than

expected; if the announcements represent bad news, then returns are lower than expected.

We began the test for unexpected change during a 6-day window (-1 to 4) by controlling

for market movements at the time of the earnings-announcement period. For each firm

announcement j, and day t, we estimate αj and ßj for the time period t = -130 to -31 days before

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the announcement date as follows:

tmjjtj RR ,, βα += (5)

where Rj,t is the return for stock j on day t, and Rm,t is the return on the market for day t. We had

firm trading dates without an accompanying index date. We kept the public holiday as a non-

holiday day as long as the European index had a closing price that day. The holiday or missing

day was the average closing price of the day before and after the holiday. Since on average the

markets are fairly efficient, investors usually catch up with the “events or information” or make

up for the day’s difference on the trading day following the holiday. Under this scenario, we

assume that the missing day was an arithmetic mean of the day before and after. This approach

allowed for the event study to have a “window” with the same number of days even when

holidays occur. This was not perfect, but we believe that the advantages outweigh the

disadvantages.

The parameters α and ß were estimated using both Ordinary Least Squares and the

method developed in Scholes and Williams (1977). Scholes and Williams’s (1977) estimates of

the market-model coefficients were used to compensate for nonsynchronous trading problems

associated with infrequently traded securities. The Scholes-Williams beta is estimated as

m

jjjSWj ρ

ββββ

21 +++

=+−

(6)

where is the OLS slope estimate from the linear regression of Rj,t on Rm,t−1; β is the OLS

slope estimate from the linear regression of Rj,t on Rm,t; is the OLS slope estimate from the

linear regression of Rj,t on Rm,t+1; and ρm is the estimated first-order autocorrelation of Rm. As in

OLS, the intercept estimator forced the estimated regression line through the sample mean:

−jβ

+jβ

mSWjjj RßR

____−=α (7)

where is the mean return of stock j over the estimation period and is the mean market jR__

mR__

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return over the estimation period.

The abnormal return (ARj,t) for firm j on each trading day t of the event period -1 to +4

was calculated as

ARj,t = Rj,t – αj - ßj Rm,t. (8)

The mean abnormal return (MARt) on trading day t for a sample of N firms is the sample

mean within each group (sample and control):

∑=

=N

jtjt AR

NMAR

1,

1

. (9)

We aggregate average abnormal returns for all N firms within each group (sample or

control) across event days t = -1 to +4 to calculate a mean Cumulative Abnormal Return (CAR):

∑∑=

+=

−=

=N

j

t

ttjAR

NCAR

1

5

3,

1

. (10)

Cost of Equity Capital

We computed the expected cost of equity capital to determine if it was significantly

different between 2004 and 2006 for the code law and common law European country firms. It

was computed similarly to Easton (2004) and Francis et al. (2005), where CEC is computed as

the square root of the inverse of the price-earnings growth ratio as follows:

t

ttPEG P

epsepsCEC 12 ++ −

=

(3) Where: CECPEG= ex ante cost of equity capital, PEG = price earnings growth model (see Ohlson and Juettner-Nauroth (2005),

2+teps = two year ahead mean analysts’ forecast of earnings per share, 1+teps = one year ahead mean analysts’ forecast of earnings per share,

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tP = the fiscal year-end price per share.

The additional data constraints required to compute CEC resulted in a reduced sample

size of 142 code law and 142 common law firm-year observations.

If the t-test of difference in means of CEC between groups is significantly different, then

we seek to determine what explains that difference. We use ordinary least squares regression to

ascertain whether the cost of equity capital is explained by firm size, legal origin, shareholder

rights, debt, or economic factors such as inflation or gross national product as follows.

CECj,t = {SIZE, LAW, SR, DEBT, CPI, GDP} (4)

Where:

CECj,t = cost of equity capital,

SIZE = log of total assets,

LAW = 1 if common law country, 0 otherwise

SR = shareholder rights or antidirector rights as defined by La Porta et al., (1999) with 6 indicating the highest shareholder rights and 0 as having no shareholder rights (see Table 3, pages 1130-1131),

DEBT = total debt including long term and short term debt divided by total assets,

CPI = country specific consumer price index,

GDP = gross domestic product per capita as an indicator of level of development as some emerging countries are approaching the developed stage whereas other are not.

V. FINDINGS

Descriptive data about the sample selected is displayed in Table 1. There were 157 firm-

year observations in 2004 and 157 firm-year observations in 2006. Panel A shows that most of

the observations are in the industrial (31%) and consumer discretionary (26%) industries. About

18% of the observations are from energy (4%), consumer staples (10%), and telecommunication

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services (4%) industries. The sample is evenly distributed between industrial and non-industrial.

Panel B illustrates the country of incorporation of the selected sample. Most of the observations

are from Great Britain (26%), France (18%) and Spain (14%) since firms in these countries were

not allowed to switch to IFRS before 2005 (unless to provide additional disclosure). Only about

1% of the observations are from Austria (0.6%) and Greece (0.6%).

-Table 1-

Table 2 provides the summary descriptive statistics for common and code law

observations both in aggregate (Panel A) and disaggregated between years (Panels B and C).

Difference in mean values for cost of capital, log of assets, GDP per capita, CPI, and market

values were significantly different between 2004 and 2006. Cost of equity capital declined after

mandatory adoption of IFRS in 2006. These univariate results imply that capital market

participants were willing to provide capital at a low cost for firms that provide IFRS disclosures.

Moreover, firm size, total debt, GDP/capita and market values increased significantly from 2004

to 2006.


Panel B and C also support that the cost of equity capital declined significantly after

adoption of IFRS for both common law and code law observations. Additionally, the log of

assets, GDP per capita, CPI, net income, and market values were significantly different between

2004 and 2006 for both code law and common law observations

Table 3 shows Pearson Correlation Coefficients for all of the variables included in this

study with the code and common law samples combined but disaggregated by year. The

correlations are highest between net income and book and market values of equity. Therefore,

the variables used in the regression models are deflated by the market value of common equity to

mitigate heteroscedascity.

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The ordinary least squares (OLS) regression models for value relevance are displayed in

Table 4 Panels A (code law countries) and B (common law countries). For code law countries

the explanatory power of the value relevance model almost doubled between 2004 (R2 =13%)

and 2006 (R2 =22%). However, for the common law countries the value relevance model did not

improve between 2004 (9%) and 2006 (7%). Moreover, the value relevance (R2 ) between 2004

and 2006 significantly increased for code law countries but not common law countries (Vong test

of difference in R2 is significant as p< 0.06).We conclude that the effects of mandatory IFRS

adoption (the value relevance of income and equity) are stronger for companies domiciled in

code law countries than for companies domiciled in common law countries because companies

domiciled in code law countries experienced greater differences between IFRS and local GAAP

before adopting IFRS. Consequently, companies domiciled in code law countries had to make

more significant progress in financial reporting with the adoption of IFRS for their reports to

become more transparent and oriented toward meeting external investors’ needs, as compared to

companies domiciled in common law countries . Our findings are consistent with Daske et al.

(2007), that countries’ legal environments are just as significant as the introduction of the new

standards per se in explaining market consequences from mandatory adoption of IFRS.


Next, we test the information content of earnings announcements within a six day

window (-1 to 4). For code law countries, in 2004, earnings announcements were only

marginally significant for only day 2 using the ordinary least squares and Scholes-Williams

models. However, after adoption of IFRS, earnings announcements became significant on days

0, 1, 2, and 4. Cumulative abnormal returns increased from 2004 (0.52) to 2006 (0.83) in both

the ordinary least squares and Scholes-Williams models.


21

The qualitative information content findings of common law countries were somewhat

similar to that of code law countries. Earnings announcements were only marginally significant

on days 1 and 3 for common law countries. However, cumulative abnormal returns over the 6-

day period were not significant before adoption of IFRS, only after adoption of IFRS. Again

these results reveal that market participants responded significantly to earnings announcements

after adoption of IFRS more so than before adoption. We conclude that market participants find

the announcement of earnings computed in accordance with IFRS as useful information.

Lastly, we examine the effects of the mandatory IFRS adoption on the cost of equity capital

of companies domiciled in common law and code law countries for 2004 and 2006. The sample

size decreased for the cost of equity capital regression models as some variables had missing

values. The cost of equity capital decreased for common law as well as code law countries after

adopting IFRS. Cost of equity capital was explained by legal origin and anti-director rights after

the mandatory adoption of IFRS but only margially before the adoption. This last result should

be interpreted with caution since shareholder rights or antidirector rights were applied as defined

by La Porta et al. (1999) and major changes in corporate governance were observed in recent

years.

Insert Table 6 here)

Summarizing, our results are consistent with our expectations, that adopting IFRS was

beneficial to the EU capital markets since it is associated with higher value relevance of earnings

and equity, increased information content, and lower cost of capital than before IFRS adoption.

22

VI. CONCLUDING REMARKS AND LIMITATIONS

This study investigates capital market consequences of European firms’ mandatory

adoption of IFRS by examining whether the value relevance of earnings and information content

of earnings announcements increased, and cost of equity capital decreased for European firms

after mandatory adoption of IFRS in 2005.

Overall, our results reveal that investors perceive net benefits from adopting IFRS. Cost

of equity capital decreased significantly for European firms after adoption of IFRS. In addition,

there was an increase in value relevance and information content of earnings announcement

(using a 6-day window) after mandatory adoption of IFRS. We also investigate how value

relevance of accounting information is influenced by the legal system, code law versus common

law, of the country in which firms are domiciled.

The cost of equity capital decreased for firms domiciled in common law as well as code

law countries after adopting IFRS. Decreasing cost of capital as an underlying rationale has been

expressed by the IASB and regulators around the world to reason the adoption of IFRS. Cost of

equity capital was explained by legal origin and anti-director rights after the mandatory adoption

of IFRS but only marginally before adoption.

We find that market consequences differ for firms in code law legal origin countries than

in common law legal origin countries in 2006, after implementing IFRS. Firms applying code

law-based domestic accounting standards have a more significant reaction to IFRS adoption than

do those applying common law-based domestic standards. The value relevance of earnings and

book value of equity for firms domiciled in common law countries did not significantly change

between 2004 and 2006. We conclude that common law-based domestic standards were more

23

comparable to IFRS while code law-based accounting standards deviated more from IFRS and,

consequently, firms domiciled in code law countries had to make more significant changes in

financial reporting with the adoption of IFRS. Also, the institutional infrastructure required to

support high-quality financial reporting is more developed in common-law countries such as the

UK. Therefore, adopting IFRS resulted in more significant market consequences to firms

domiciled in code law rather than common law countries.

We test the information content of earnings announcements within a six day window.

For code law countries, earnings announcements were more significant after adoption of IFRS.

Cumulative abnormal returns over the 6-day period as well were not significant before adoption

of IFRS, only after adoption of IFRS. Again these results reveal significantly more positive

market reactions to earnings announcements after adoption of IFRS than before adoption,

especially for firms from code law countries, having lower pre-adoption information quality. We

conclude that market participants find the announcement of earnings determined in accordance

with IFRS as useful information. The adoption of IFRS improved the transparency of financial

reporting in European countries, as well as the reliability and the relevance of the reported

numbers, resulting in higher value relevance of accounting information and increased

information content, ultimately leading to a lower cost of equity capital.

Our findings are subject to four limitations. First, there is considerable heterogeneity

between the firms in our sample resulting in cross-sectional variation in the impact of IFRS.

Second, our sample does not include firms representing the banking industry and financial

institutions since those firms are more likely to not report under IFRS, as published by the IASB,

because of their “carve-out” provisions of IAS 39. Third, we have a small sample size because

we included only those firms listed on their domestic stock exchange that reported under local

24

GAAP only in 2004 and reported in accordance with IFRS only in 2006. Consequently, we

excluded from our sample those European firms that reported using U.S. GAAP during the data

base period in order to mitigate the effect of U.S. GAAP driving IFRS technical compliance

results rather than the home country legal environment. Fourth, the role of IFRS alone in

improving the value relevance of accounting information is not clear. For example,

implementing IFRS could be associated with more rigorous audit, reporting incentives or

enforcement scrutiny.

Our findings add to the literature on the benefits of implementing IFRS by providing

evidence that investors perceive benefits from the adoption of IFRS in Europe. Future research

may focus on the economics of changing accounting standards, including the costs of

implementing IFRS, as well as on differences in interpretation and application of IFRS across

firms, industries, countries and time. Further, the U.S. capital market consequences of foreign

private issuers reporting in accordance with IFRS without reconciliation to U.S. GAAP merit

investigations.

25

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32

Table 1 Sample Selected Panel A: Industry Classification Number of Firm Year Observations

2004 (n = 157)

2006 (n = 157)

Frequency Percent Frequency Percent Consumer Discretionary 41 26.11 41 26.11 Consumer Staples 16 10.19 16 10.19 Energy 6 3.82 6 3.82 Health Care 6 3.82 6 3.82 Industrials 48 30.57 48 30.57 Information Technology 7 4.46 7 4.46 Materials 17 10.83 17 10.83 Telecommunication Services 6 3.82 6 3.82 Utilities 10 6.37 10 6.37 Totals 157 100 157 100 Panel B: Country of Incorporation Number of Firm Year Observations

2004 (n = 157)

2006 (n = 157)

Frequency Percent Frequency Percent Austria 1 0.64 1 0.64 Belgium 2 1.27 2 1.27 Denmark 3 1.91 3 1.91 Finland 6 3.82 6 3.82 France 29 18.47 29 18.47 Germany 1 0.64 1 0.64 Gr. Britain 41 26.11 41 26.11 Greece 1 0.64 1 0.64 Ireland 3 1.91 3 1.91 Italy 15 9.55 15 9.55 Netherlands 10 6.37 10 6.37 Norway 3 1.91 3 1.91 Portugal 2 1.27 2 1.27 Spain 22 14.01 22 14.01 Sweden 15 9.55 15 9.55 Switzerland 3 1.91 3 1.91

33

TABLE 2 Descriptive Statistics (Mean Median Standard Deviation and t-tests)

Panel A: Code and Common Law Observations Combined

2004 2006 Total Variable N Mean Median Std Dev N Mean Median Std Dev t-test of

difference Cost of capital 142 0.097 0.089 0.050 143 0.087 0.080 0.035 3.96*** Log of Assets 157 8.564 8.437 1.384 157 8.834 8.657 1.421 3.42*** Total Debt 157 3,914.550 1,246.900 7,088.650 110 3,758.910 1,591.000 5,746.210 0.38 GDP/ capita 157 29,538.460 29,541.000 3,015.140 157 33,564.100 34,800.300 3,405.080 22.18*** Antidir Rights 157 3.344.000 3.000 1.324 157 3.344 3.000 1.324 N/A Code/Common 157 0.720 1.000 0.451 157 0.720 1.000 0.451 N/A CPI 157 1.806 1.375 0.776 157 2.239 2.217 0.656 10.66*** Net income 157 891.296 210.000 2,788.820 157 1,141.780 312.748 2,878.400 1.56 Book value of equity

157 4,970.650 1,466.000 12,220.240 157 6,206.330 1,894.770 13,606.230 1.70

Market value 157 12,523.210 4,209.330 33,251.850 157 18,274.140 6,494.760 43,870.06 2.62*

34

Panel B: Code Law Firm Year Observations

2004 2006 Total Variable N Mean Median Std Dev N Mean Median Std Dev t-test of

difference Cost of capital 103 0.097 0.086 0.056 105 0.090 0.083 0.039 2.04* Log of Assets 113 8.949 9.057 1.335 113 9.241 9.361 1.362 3.36** Total Debt 113 5,114.49 2,174.700 8,007.330 79 4,864.190 2,414.74 6,415.180 0.46 GDP/ capita 113 28,826.52 29,300.000 3,039.420 113 32,893.47 33,408.22 3,641.68 18.22*** Antidir Rights 113 2.726 3.000 1.020 113 2.726 3.000 1.020 Code/Common 113 1.000 1.000 0 113 1.000 1.000 0 CPI 113 1.959 2.283 0.856 113 2.198 1.908 0.767 4.21*** Net income 113 1,162.06 269.000 3,243.46 113 1,425.770 452.667 3,297.420 1.22 Book value of equity 113 6,443.19 2,613.35 14,086.55 113 8,010.140 3,378.65 15,517.650 1.58 Market value 113 16,211.61 5,928.27 38,531.45 113 23,574.160 8,966.91 50,589.500 2.46*

Panel C: Common Law Observations 2004 2006 Total Variable N Mean Median Std Dev N Mean Median Std Dev t-test of

difference Cost of capital 39 0.098 0.093 0.030 38 0.078 0.076 0.020 6.54*** Log of Assets 44 7.574 7.300 0.958 44 7.787 7.599 0.966 2.04* Total Debt 44 832.907 361.578 1,339.31 31 942.224 559.300 1,245.690 0.72 GDP/ capita 44 31,366.860 30,821.000 2,041.300 44 35,286.400 34,800.300 1,817.790 19.02*** Antidir Rights 44 4.932 5.000 0.255 44 4.932 5.000 0.255 Code/Common 44 0 0 0 44 0 0 0 CPI 44 1.415 1.350 0.0.242 44 2.343 2.317 0.100 27.02*** Net income 44 195.909 93.341 357.422 44 412.420 143.950 990.580 2.72* Book value of equity 44 1,188.900 521.400 2,143.480 44 1,573.840 660.816 3,732.320 1.18 Market value 44 3,050.74 1,626.580 4,087.32 44 4,662.720 2,344.14 7,261.40 2.56*

35

Table 3, Pearson Correlations, 2004 Parameter, p-value, n

Cost of Equity

Log of Assets Total Debt

GDP/ Capita

Anti-Director Rights

Code/ Common

Consumer Price Index

Net Income

Book Value of Equity

Market Value


1.000 142

0.04019 0.6349 142

0.03105 0.7137 142

0.14746 0.0799 142

0.02968 0.7258 142

-0.00615 0.9421 142

-0.16238 0.0535 142

-0.110520.1904 142

-0.01169 0.8901 142

-0.06672 0.4302 142

Log of Assets

0.04019 0.6349 142

1.00000 157

0.72917 <.0001 157

-0.03367 0.6755 157

-0.30816 <.0001 157

0.44739 <.0001 157

-0.00458 0.9546 157

0.49075 <.0001 157

0.59057 <.0001 157

0.51645 <.0001 157

Total Debt 0.03105 0.7137 142

0.72917 <.0001 157

1.00000 157

0.00215 0.9787 157

-0.19354 0.0152 157

0.27214 0.0006 157

-0.04091 0.6110 157

0.58115 <.0001 157

0.74349 <.0001 157

0.61753 <.0001 157

GDP/Capita 0.14746 0.0799 142

-0.03367 0.6755 157

0.00215 0.9787 157

1.00000 157

0.09328 0.2452 157

-0.37961 <.0001 157

-0.63629 <.0001 157

0.12900 0.1073 157

0.08858 0.2699 157

0.03785 0.6379 157


0.02968 0.7258 142

-0.30816 <.0001 157

-0.19354 0.0152 157

0.09328 0.2452 157

1.00000 157

-0.75081 <.0001 157

-0.11441 0.1536 157

-0.080990.3133 157

-0.12920 0.1068 157

-0.11192 0.1628 157

Code/ Common Law Dummy

-0.00615 0.9421 142

0.44739 <.0001 157

0.27214 0.0006 157

-0.37961 <.0001 157

-0.75081 <.0001 157

1.00000 157

0.31580 <.0001 157

0.15609 0.0509 157

0.19373 0.0151 157

0.17833 0.0254 157

Mean Consumer Price Index

-0.16238 0.0535 142

-0.00458 0.9546 157

-0.04091 0.6110 157

-0.63629 <.0001 157

-0.11441 0.1536 157

0.31580 <.0001 157

1.00000 157

-0.196440.0137 157

-0.19771 0.0131 157

-0.16353 0.0407 157

Net Income

-0.11052 0.1904 142

0.49075 <.0001 157

0.58115 <.0001 157

0.12900 0.1073 157

-0.08099 0.3133 157

0.15609 0.0509 157

-0.19644 0.0137 157

1.00000 157

0.91908 <.0001 157

0.86222 <.0001 157


-0.01169 0.8901 142

0.59057 <.0001 157

0.74349 <.0001 157

0.08858 0.2699 157

-0.12920 0.1068 157

0.19373 0.0151 157

-0.19771 0.0131 157

0.91908 <.0001 157

1.00000 157

0.87499 <.0001 157

Market Value

-0.06672 0.4302 142

0.51645 <.0001 157

0.61753 <.0001 157

0.03785 0.6379 157

-0.11192 0.1628 157

0.17833 0.0254 157

-0.16353 0.0407 157

0.86222 <.0001 157

0.87499 <.0001 157

1.00000 157

36

Panel B Pearson Correlations, 2006 Parameter, p-value, n

Cost of Equity

Log of Assets Total Debt

GDP/ Capita


Code/ Common

Consumer Price Index

Net Income


Market Value


1.00000 143

0.09730 0.2476 143

0.03576 0.7253 99

0.06276 0.4565 143

-0.03230 0.7017 143

0.15003 0.0737 143

-0.12020 0.1527 143

-0.121860.1471 143

0.04255 0.6138 143

-0.04735 0.5744 143

Log of Assets

0.09730 0.2476 143

1.00000 157

0.69027 <.0001 110

0.01488 0.8532 157

-0.31047 <.0001 157

0.46100 <.0001 157

-0.23373 0.0032 157

0.52964 <.0001 157

0.61334 <.0001 157

0.52276 <.0001 157

Total Debt 0.03576 0.7253 99

0.69027 <.0001 110

1.00000 110

0.06765 0.4825 110

-0.21460 0.0244 110

0.30847 0.0010 110

-0.16881 0.0779 110

0.30874 0.0010 110

0.48793 <.0001 110

0.34905 0.0002 110

GDP/Capita 0.06276 0.4565 143

0.01488 0.8532 157

0.06765 0.4825 110

1.00000 157

0.12621 0.1152 157

-0.31663 <.0001 157

-0.59854 <.0001 157

0.12488 0.1192 157

0.17092 0.0323 157

0.12570 0.1167 157


-0.03230 0.7017 143

-0.31047 <.0001 157

-0.21460 0.0244 110

0.12621 0.1152 157

1.00000 157

-0.75081 <.0001 157

0.35712 <.0001 157

-0.066560.4075 157

-0.12829 0.1093 157

-0.11093 0.1666 157

Code/ Common Law Dummy

0.15003 0.0737 143

0.46100 <.0001 157

0.30847 0.0010 110

-0.31663 <.0001 157

-0.75081 <.0001 157

1.00000 157

-0.10001 0.2127 157

0.15862 0.0472 157

0.21313 0.0074 157

0.19423 0.0148 157

Mean Consumer Price Index

-0.12020 0.1527 143

-0.23373 0.0032 157

-0.16881 0.0779 110

-0.59854 <.0001 157

0.35712 <.0001 157

-0.10001 0.2127 157

1.00000 157

-0.181190.0231 157

-0.22102 0.0054 157

-0.20590 0.0097 157

Net Income

-0.12186 0.1471 143

0.52964 <.0001 157

0.30874 0.0010 110

0.12488 0.1192 157

-0.06656 0.4075 157

0.15862 0.0472 157

-0.18119 0.0231 157

1.00000 157

0.88914 <.0001 157

0.92613 <.0001 157

Book Value

0.04255 0.6138 143

0.61334 <.0001 157

0.48793 <.0001 110

0.17092 0.0323 157

-0.12829 0.1093 157

0.21313 0.0074 157

-0.22102 0.0054 157

0.88914 <.0001 157

1.00000 157

0.93253 <.0001 157

Market Value

-0.04735 0.5744 143

0.52276 <.0001 157

0.34905 0.0002 110

0.12570 0.1167 157

-0.11093 0.1666 157

0.19423 0.0148 157

-0.20590 0.0097 157

0.92613 <.0001 157

0.93253 <.0001 157

1.00000 157

TABLE 4 Regression Tests of Value Relevance

Ordinary Least Squares Regression Model

Panel A: Code Law where n = 113 firm year observations Dependent Variable is MVj, t/MVj, t-1

2004 2006 Parameter Estimate

t-Value

Parameter Estimate

t-Value

Intercept 10.9 27.3*** 1.01 19.37***BV j,t/MV j,t-1 1.23 3.72*** 1.60 4.25*** NI j,t/MV j,t-1 0.04 0.65 .030 3.55***

F-Value 9.07 *** 16.43 Adj R2 0.13 .22

Vong test of difference in Adj R2, p < 0.06 Panel B: Common Law where n-113 Dependent Variable is MVj, t/MVj, t-1

2004 2006 Parameter Estimate

t-Value

Parameter Estimate

t-Value

Intercept 1.18 9.01*** 1.09 18.52*** NIj,t/MVj,t-1 -1.50 -1.49 -0.82 -1.75 BVj,t/MVj,t-1 0.53 2.37* 0.37 2.18* F-Value 3.25 0.05* 2.59 0.09* Adj R2 0.09 0.07

Vong test of difference in Adj R2, p < 0.70

37

TABLE 5 Information Content of Earnings Announcement

Mean and Cumulative Abnormal Returns

Panel A = Code Law Countries Code Law Group (n = 113)

Abnormal Returns Common Law Group (n = 227)

Abnormal Returns

Ordinary Least Squares

Scholes-Williams

Ordinary least squares

Scholes-Williams

2004

2006

2004

2006

2004

2006

2004 2006

Day

MAR

MAR

MAR

MAR

MAR

MAR

MAR

MAR

-1 0.03 0.07 0.05 0.05 0.32 -0.10 0.29 -0.15

0 0.35 -0.39* 0.35 -0.39 0.18 1.29*** 0.19 1.30**

1 0.09 0.62*** 0.01 0.62*** -0.42** 0.14 -0.48** 0.16

2 0.20* 0.34*** 0.21** 34** -0.02 0.29 0.02 0.31

3 -0.07 -0.06 -0.08 -0.06 0.26* 0.49** 0.23 0.52**

4 -0.08 0.24** -0.06 0.22** -0.14 0.16 -0.13 0.16

CAR CAR CAR CAR CAR CAR CAR CAR -1 to +4

0.52*

0.83***

0.56*

0.78***

0.17

2.26***

0.11

2.30***

Legend: MAR = daily mean abnormal returns for a sample of N firms. CAR = mean cumulative abnormal return from day -1 to 1 days within the announcement

period.

38

39

TABLE 6 Cost of Equity Capital

For years 2004 and 2006

Legal Origin Code Law Common Law Year 2004 2006 2004 2006 Number of Observations 103 105 103 105 Mean value of Cost of Equity Capital 0.097 0.090 0.098 0.078***

Panel B CECj,t = {SIZE, LAW, SR, DEBT, CPI, GDP}

2004 N=142

2006 n = 142

Variable Parameter Estimate

t-Value Parameter Estimate

t-Value

Intercept 0.02 0.50 -0.05 01.12 Log (assets) 0.00 0.30 0.00 0.57 Code/ Common dummy 0.02 2.18* 0.04 5.04*** AntiDir Rights 0.01 2.00* 0.01 3.70**** Mean CPI -0.01 -2.24* -0.01 -0.90 GDP/Capita 0.00 1.86 0.00 2.64* Total Debt -0.00 -0.08 -0.00 -11.22 F-Value 0.96 1.95 Adj R-squared .00 .04

Where: N = number of firm year observations ,

CECj,t = cost of equity capital, SIZE = log of total assets, LAW = 1 if common law country, 0 otherwise

SR = shareholder rights or antidirector rights as defined by La Porta et al., (1999) with 6 indicating the highest shareholder rights and 0 as having no shareholder rights (see Table 3, pages 1130-1131),

DEBT = total debt including long term and short term debt divided by total assets, CPI = country specific consumer price index,

GDP = gross domestic product as an indicator of level of development as some emerging countries are approaching the developed stage (like South Africa) whereas other are not.

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