Mandatory IFRS Adoption and the Usefulness of Accounting Information in Predicting Future Earnings and Cash Flows
47 Pages Posted: 10 Apr 2017
Date Written: April 7, 2017
We examine whether the mandatory adoption of International Financial Reporting Standards (IFRS) has changed the usefulness of accounting information in predicting future earnings and cash flows out-of-sample. Using a sample of firms from European Union countries that mandatorily adopted IFRS in 2005, we find the out-of-sample earnings and cash flows forecasts derived from alternative accounting models become significantly more accurate after IFRS adoption. The accuracy, however, varies with the strength of legal and regulatory enforcement. Firms in strong enforcement countries experience larger improvements in earnings forecast accuracy than firms in weak enforcement countries but the opposite happens for cash flow forecasts. Accruals are useful in the prediction of both earnings and cash flows, but again their usefulness varies with the strength of the legal and regulatory environment. Portfolios of stocks based on the out-of-sample forecasts earn economically significant 12-month ahead hedge returns after IFRS adoption, which corroborates the detected forecast accuracy improvements. Overall, the study contributes to the IFRS literature by providing new evidence that an important dimension of accounting quality, predictive ability, has improved after mandatory IFRS adoption.
Keywords: IFRS, out-of-sample prediction, earnings, cash flows
JEL Classification: M41, G15, G17, G18
Suggested Citation: Suggested Citation