Mandatory IFRS Adoption and the Contractual Usefulness of Accounting Information in Executive Compensation

Abstract

We examine how the mandatory adoption of IFRS in Continental Europe affects the contractual usefulness of accounting information in executive compensation, as reflected in pay-performance sensitivity (PPS) and relative performance evaluation (RPE). The empirical evidence indicates a weak increase in accounting-based PPS in the post-adoption period, primarily driven by countries with large differences between IFRS and their previously adopted local accounting standards. We also document a significant increase in accounting-based RPE using foreign peers after the adoption. Additional analysis shows that the increase in RPE is greater for firms with more foreign sales, and for those with lower availability of domestic peers of comparable size. The overall results are consistent with the compensation committees in those countries perceiving earnings after IFRS adoption to be of higher quality and comparability. Our paper highlights an important benefit of IFRS largely ignored by the literature, i.e., the higher earnings quality and comparability brought by the adoption of IFRS facilitate executive compensation contracting.

Keywords: IFRS adoption, pay-performance sensitivity, relative performance evaluation, comparability of financial statements

JEL Classification: D8, J33, M41, M48