Canada. IFRS in Canada: Game Changer or Neutral Mutation?

Abstract

With the advent of International Financial Reporting Standards (IFRS), 2011 was certainly critical for Canadian financial markets on several dimensions. On one hand, Canada’s Accounting Standards Board decision to adopt IFRS for publicly accountable enterprises ended more than 20 years of formal or informal convergence toward U.S. Generally Accepted Accounting Principles (GAAP). On the other hand, for auditors, corporate executives, regulators, analysts and investors, the release of IFRS-based financial statements modified in a fundamental way the informational landscape underlying Canadian financial markets.

In light of these events, this chapter aims to achieve two objectives. First, we will present and discuss the institutional context that led Canada’s accounting standard-setter and regulators to adopt IFRS. Second, we will analyze the implementation of IFRS in 2011 as well as its potential implications for key financial markets’ players. Our analysis will be performed through a corporate governance perspective. Ultimately, the chapter’s goal is to assess if Canada’s transition to IFRS was indeed a game changer for financial markets or if, alternatively, it represented a neutral mutation in the country’s institutional landscape with scant market implications.

Michel Magnan is a member of Canada’s Accounting Standards Board. However, the views expressed in this text are strictly personal and should not be construed in any way to represent the Accounting Standards Board’s viewpoint or to have been approved by the Accounting Standards Board. The Accounting Standard Board’s position on any issue is only made through due process.

Definition of Variables

GOV. Vafeas (2000) finds that earnings are more informative for companies with more effective boards while Dey (2005) reports that earnings credibility increases with board quality. These findings suggest that higher corporate governance quality should be associated with less information asymmetry and improve analyst forecast accuracy. A negative (positive) association is expected between GOV and BAS (FORDIS). Two governance scores are used. The first one is based on Board Games (The Globe and Mail’s annual report on corporate governance),¹ which includes four components: 1) board composition; 2) shareholding and compensation; 3) shareholder rights; and 4) disclosure. The grid is based on a total of 100 marks (Board composition; 31 marks; Shareholding and compensation: 26 marks; Shareholder rights: 31 marks; Disclosure: 12 marks). The second score is based on ISS Governance Quick score. The grid is based on a total of 10 marks, 1 meaning an excellent and 10 meaning a weak score. The score is based on board structure, compensation, shareholder rights, and the audit. To facilitate interpretations, we change the score so that an excellent score is 10 instead of 1 (10 − total score +1).

LnVOLUME and LnVOLATILITY. Prior research document that trading volume and share price volatility are fundamental determinants of bid ask spreads. An inverse relationship between spreads and trading activity is expected (Demsetz 1968). Price volatility is also a determinant of bid ask spreads and as such incorporated in information asymmetry models of the spread (e.g. Copeland and Galai 1983; Aitken and Frino 1996). Hence, we expect a negative (positive) relationship between BAS and LnVOLUME (LnVOLATILITY). The logarithmic transformation of these two variables is used to reduce the skewness and potential heteroscedasticity problems (Aitken and Frino 1996).

BETA. Patton and Verardo (2010) observe that the increase in systematic risk is greater for earnings announcements with larger positive or negative surprises, and with greater analyst forecast dispersion. We expect a positive association between BETA and FORDIS.

ANFOL. Analyst forecasts precision is likely to improve, as more information about a company is processed and disclosed by analysts (Alford and Berger 1999). Hope (2003a) documents a negative relationship between analyst following and forecast error. Thus, a negative association is expected between ANFOL and FORDIS.

NEGEPS. Hope (2003a) documents that negative earnings are associated with more forecast error, suggesting that earnings is more difficult to predict for companies that experience losses. Consistent with Hope (2003a, b), an indicative variable for negative earnings is used. We anticipate a positive relationship between this binary variable and FORDIS.