Electronic copy available at: http://ssrn.com/abstract=2545938

The impact of IFRS on the relationship between conservatism and

investment efficiency

Paul André Professor

ESSEC Business School Avenue Bernard Hirsch

95021 Cergy-Pontoise, France andre@essec.edu

Andrei Filip

Associate professor ESSEC Business School Avenue Bernard Hirsch

95021 Cergy-Pontoise, France filip@essec.edu

Sophie Marmousez Assistant professor

HEC Montréal 3000, Chemin de la Côte-Sainte-Catherine

Montréal, Québec Canada H3T 2A7

sophie.marmousez@hec.ca

Forthcoming COMPTABILITÉ CONTRÔLE AUDIT

Acknowledgements:

The authors extend very sincere thanks to Hervé Stolowy and Charles Piot, editors of CCA, and two anonymous reviewers for their very constructive comments, criticisms and suggestions. They also wish to thank Rucsandra Moldovan and participants at the 34th annual congress of the AFC (Montréal, 2013). Andrei Filip and Paul André benefited from financial support from the Autorité des Normes Comptables for this project. Paul André also received support from the ESSEC KPMG Financial Reporting Centre.

Electronic copy available at: http://ssrn.com/abstract=2545938

The impact of IFRS on the relationship between conservatism and

investment efficiency Abstract: We test to see whether a higher degree of conservatism is associated with greater investment efficiency (reducing over- and under-investment) for a sample of French firms before and after the mandatory adoption of IFRS in 2005. While a theoretical link between conservatism and investment efficiency is easily established, the question is whether this link still remains after the adoption of IFRS, which are generally considered to reduce conservatism. Empirical tests find a significant decrease in conservatism after IFRS adoption. This result is consistent with the results reported by Piot et al. (2011), Ahmed et al. (2013) and André et al. (2013). Our results show that in the pre-IFRS period, conservatism limited over- and under-investment. For the post-IFRS period, however, conservatism does not seem to play any role in improving investment efficiency. This paper contributes to the academic and regulatory debate over the economic consequences of the qualitative characteristics of useful financial information and the impact of IFRS adoption. The adoption of IFRS has certainly led to a new equilibrium between the various qualitative characteristics of financial information, but the costs and benefits of that equilibrium remain difficult to measure. Keywords: Conservatism; Over- and Under-investment; IFRS; France

1

Introduction

Several studies show that financial reporting quality is positively associated with favorable

economic consequences such as a lower cost of capital (e.g. Francis et al. 2004; Daske 2006;

Li 2010), higher share liquidity (e.g. Daske et al. 2008) and more efficient investment as

indicated by a reduction in over- and under-investment (e.g. Biddle et al. 2009; Garcia Lara et

al. 2013).

This article focuses on this last association, in a very specific context, namely the mandatory

adoption of IFRS. We examine the relationship between conservatism, which can be considered

one of the dimensions of financial reporting quality, and investment efficiency for a sample of

French firms before and after the mandatory adoption of IFRS in 2005.

Financial theory has established that an optimal level of investment exists, and that firms are

likely to deviate from it, into over- or under-investment, largely due to the existence of market

frictions. These frictions or imperfections, particularly the moral hazard and adverse selection

problems, result from the information asymmetry that exists between management and external

capital providers. Any mechanism that mitigates this asymmetry should therefore improve

firms’ investment efficiency. Biddle and Hilary (2006) and Biddle et al. (2009), for example,

show that better quality accounting information, which is supposed to reduce information

asymmetry (e.g. Leuz and Verrecchia 2000; Bushman and Smith 2001), leads to more efficient

investments.

Conservatism1 can be considered a way of responding to the moral hazard issue, caused

notably by the information asymmetry between a firm’s stakeholders (Watts 2003). It can thus

be hypothesized that conservatism – since it is likely to mitigate information asymmetry – is

positively associated with investment efficiency. Garcia Lara et al. (2013) show empirically

that US firms with the highest degree of conservatism are less likely to over- or under-invest.

2

Reducing information asymmetry is considered one positive consequence of the introduction

of IFRS, which supposedly improve the transparency and comparability of accounting

information (Barth et al. 2008; Daske et al. 2008; Li 2010). Using IFRS should therefore have

an ultimately positive effect on investment efficiency. However, this link is not easily

established, because of IFRS’ generally acknowledged effect on conservatism. IFRS are

normally considered to require a lower level of conservatism than local accounting standards,

particularly in comparison to standards in countries (such as France) where the prudence

principle was fundamental. Empirically, many authors show that the move to IFRS led to a

decline in conservatism (Piot et al. 2011; Ahmed et al. 2013; André et al. 2013). In other words,

the introduction of IFRS potentially has a dual effect on investment efficiency; a direct positive

effect, reducing information asymmetry, and an indirect negative effect, reducing

conservatism2.

The objective of this article is to determine whether application of IFRS has changed the

relationship between conservatism and investment efficiency. To put it another way, we

investigate whether the introduction of IFRS has neutralized conservatism’s positive influence

on investment efficiency. Using a sample of listed French firms, we test the hypothesis that the

move to IFRS has an unfavorable impact on the association between conservatism and

investment efficiency. To assess investment efficiency, we first use a measure of abnormal

investment, then, following Biddle et al. (2009), we create a ranked variable to detect

observations with the highest probability of over- or under-investment. To assess conservatism,

we adopt the approach presented by Khan and Watts (2009).

We show that in the pre-IFRS period, conservatism is negatively associated with the absolute

value of abnormal investment, whereas in the post-IFRS period conservatism no longer plays

any role. The results also show that conservatism is negatively linked to the likelihood of over-

3

or under-investment in the pre-IFRS period, but that ceases to be the case in the post-IFRS

period.

Our research contributes to the academic and regulatory debates on the economic

consequences of various features of the accounting information produced by firms, and the

effects of the move to IFRS. To our knowledge, this is the first study to investigate the link

between conservatism and investment efficiency in the context of the mandatory adoption of

IFRS. It also contributes to the debate on conservatism’s role in the IASB’s conceptual

framework, since our results show that the pursuit of neutrality in financial information, which

at least partly explains the absence of conservatism as an identified qualitative characteristic of

financial reporting in the 2010 modified conceptual framework3 , has its benefits but also

involves certain costs. The net effect of what we could call the new equilibrium in the qualitative

characteristics of financial information remains difficult to assess.

The rest of the article is organized as follows.Section 1 describes first the association

between financial reporting quality in general and conservatism in particular, and firms’

investment efficiency, then presents a hypothesis concerning the impact of adoption of IFRS

on that association. Section 2 describes the methodology, explaining the measures, models and

sample used. Results are shown and discussed in section 3. The final section summarizes the

results and brings out the limitations and contributions of the study.

4

1. Conservatism, investment efficiency and mandatory adoption of IFRS

Some research establishes a relationship between financial reporting quality and investment

efficiency; and many studies show that the move to IFRS has an impact on financial reporting

quality, conservatism being one of its dimensions. However, the effect of IFRS adoption on the

link between conservatism and investment efficiency has received little attention. The aim of

this section is to explain why it is relevant to consider that there is an association between

conservatism and investment efficiency, and also why application of IFRS may have affected

that association, then to present the hypothesis that will be tested.

1.1 Financial reporting quality, conservatism and investment efficiency

There is a large body of literature on the determinants and economic consequences of firms’

financial reporting. The extensive literature review produced by Dechow et al. (2010) is one

illustration. Among these economic consequences, financial reporting quality supposedly

improves firms’ investment efficiency. Some empirical studies actually demonstrate an

association between financial reporting quality and investment efficiency. Before presenting

these studies, we define what we understand by investment efficiency and explain why

conservatism, which is often considered a desirable attribute of accounting information, is likely

to lead to more efficient investment levels.

Conceptually, a firm can be considered to invest efficiently if it undertakes projects with

positive net present value (NPV). Over-investment is investing in projects with negative NPV,

while under-investment can be defined as not investing in projects with positive NPV. Financial

theory gives market imperfections as the reason why firms may deviate from an optimal level

of investment into over- and under-investment. The principal market frictions, namely the moral

5

hazard and adverse selection issues, are caused by the information asymmetry that exists

between management and capital providers.

Models of moral hazard are founded on the idea that managers, whose aim is to maximize

their personal wealth, sometimes tend to make investments that are not in the shareholders’ best

interests. These models suggest that when the interests of management and shareholders

diverge, managers are likely to invest in projects with negative NPV. When there is surplus

capital, the moral hazard issue may lead to over-investment situations such as consuming

perquisites or expanding the firm beyond its optimal size (“empire-building”) (Jensen 1986).

However, capital providers will probably take these situations into consideration and

consequently ration capital ex-ante, which can lead to under-investment ex-post.

Models of adverse selection suggest that if managers are better informed than investors about

the firm’s prospects, then they will attempt to time capital issues so as to sell overpriced shares.

If they succeed, then they are likely to invest the surplus amounts obtained (over-investment).

But investors may respond rationally to such an event by rationing capital, which could once

again lead to ex-post under-investment.

The information asymmetry between managers and capital providers, which gives rise to

frictions such as the moral hazard or adverse selection issues, thus reduces investment

efficiency (by creating over- or under-investment behaviors). Higher-quality accounting

information, because it should reduce information asymmetry, is therefore likely to improve

investment efficiency.

Conservatism, commonly designated as a dimension of financial reporting quality, appears

to play a particularly important role in investment efficiency. Like Watts (2003), we consider

that conservatism mainly arose in response to the moral hazard caused notably by the existence

of information asymmetry between the firm’s stakeholders, and the problem of managers’

limited horizons. Given the above discussions, it is logical to presume that conservatism can

6

affect investment efficiency. More specifically, conservatism is likely to improve investment

efficiency for at least two reasons: for one thing, it can mitigate the under-investment associated

with capital rationing, and for another, it can limit over-investment by obliging managers to

timely loss recognition.

Use of accounting data in contracts (especially compensation and debt contracts) generally

creates an incentive for managers to bias results. Intuitively, it is easy to understand that

managers have stronger incentives to be optimistic, i.e. reveal “good news” that can have a

favorable effect on the amount of their remuneration or the assessment of compliance with

covenants, rather than “bad news” (such as investment in negative NPV projects). If no

constraints are placed on such potentially opportunistic managerial behavior, the accounting

numbers are likely to be significantly biased and it becomes difficult for capital providers to

monitor managers effectively. Conservatism thus offers capital providers better monitoring

over managers, theoretically mitigating the capital rationing problem and therefore reducing

under-investment, all the more so as certain authors have shown that it facilitates raising debt

capital (Watts 2003; Göx and Wagenhofer 2009) and reduces the cost of debt (Ahmed et al.

2002; Chen et al. 2007; Zhang 2008; Wittenberg-Moerman 2008).

Conservatism, by making recognition of losses mandatory as soon as there is information

indicating those losses are probable, and by countering asymmetric incentives of managers

regarding the revelation of information, compensates for managerial biases, facilitates

monitoring of management and makes contracts more efficient. Conservatism implies timely

recognition of losses. This timeliness is essential as it reflects the effects of management’s

action on the value of the firm in the period when the action is undertaken. Timely recognition

avoids the dysfunctional consequences associated with managers’ limited tenure with the firm,

often referred to as managers’ limited horizons. Ball and Shivakumar (2005) explain that if

7

managers know in advance that losses will be recognized during their time in the post, then they

are less likely to invest in projects with negative NPV.

Admittedly, the response provided by conservatism to information asymmetry between the

firm’s stakeholders is less than perfect. In particular, conservatism obliges managers to

recognize gains only once they are realized, depriving investors of what is presumably good

news and logically leading them to underestimate the value of the firm. In this kind of situation,

unbiased, also called neutral, information may appear to be of higher quality. However, as

conservatism requires a stricter level of verification for income, one of its effects is probably

that it makes “good news” more credible in investors’ eyes4 , giving them the confidence

necessary to prevent capital rationing.

Although the theoretical link between conservatism and investment efficiency is relatively

easily established, there has been little empirical exploration of that link. Given the small body

of literature on the subject, we extend our review to include research into the association

between financial reporting quality, regardless of the dimension under consideration, and

investment efficiency.

Biddle and Hilary (2006) are the first to conduct an empirical study of the link between

financial reporting quality and investment efficiency. They put forward the hypothesis that

better-quality financial reporting, by facilitating preparation and execution of contracts, but also

monitoring of management, and thereby reducing the moral hazard and adverse selection

problems, should make corporate investment more optimal. The results of their inter- and intra-

country analysis support this hypothesis: they show that better-quality financial reporting is

associated with lower investment sensitivity to cash flows (a widely-used measure of

investment efficiency) and that this relationship is stronger in countries where equity financing

is more prevalent than debt financing.

8

Taking as a basis the same theoretical arguments as Biddle and Hilary (2006), Biddle et al.

(2009) hypothesize that better quality financial reporting is associated not with lower sensitivity

to cash flows which may reflect a shortfall or excess of liquidities, but rather with a lower

degree of under-investment or over-investment, or both at once. Their results show that better-

quality financial reporting is associated not only with lower under-investment, but also with

lower over-investment.

McNichols and Stubben (2008) examine whether firms managing earnings, which is broadly

considered to indicate low quality in accounting information, make suboptimal investment

decisions. Their findings show that firms that appear to have managed their earnings tend to

over-invest.

Chen et al. (2011) study the association between financial reporting quality and investment

efficiency of unlisted firms in emerging countries. Although the role of financial reporting is

less obvious for these firms than for listed firms, Chen et al. (2011) show empirically that even

for unlisted firms, financial reporting quality has a positive impact on investment efficiency.

To our knowledge, Garcia Lara et al. (2013) are the only researchers who have looked at the

association between conservatism and over- and under-investment. Their findings show that for

a sample of US firms, when conservatism – as defined by Basu (1997) – is higher, there is a

lower likelihood of over- or under-investing.

1.2. Adoption of IFRS and association between conservatism and investment efficiency

The literature suggests a positive association between conservatism and investment efficiency.

But the question arises of whether this association remains after application of IFRS, which are

believed to lead to a lower level of conservatism. Before developing our hypothesis, it is

important to present the few studies that have examined the impact, direct or indirect, that

adoption of IFRS has on investment efficiency.

9

The expected influence of the move to IFRS on investment efficiency has a first logical

explanation: IFRS’ presumed impact on information asymmetry. IFRS are supposed to reduce

information asymmetry by increasing the transparency and comparability of accounting

information compared to the accounting standards they replace (e.g. Barth et al. 2008; Daske et

al. 2008; Li 2010). As explained earlier, a reduction in information asymmetry should lead to

an improvement in investment efficiency. In other words, by increasing financial reporting

quality, adoption of IFRS makes corporate investment more optimal.

Few researchers have explicitly examined the question of the link between adoption of IFRS

and firms’ investment efficiency. Schleicher et al. (2010) focus on the association between

mandatory adoption of IFRS in European Union countries and investment sensitivity to cash

flows. Their results show that before application of IFRS, investment sensitivity to cash flows

is stronger in what Leuz et al. (2003) call insider economies (i.e. economies with less-developed

stock markets, concentrated ownership, low investor rights and weak law enforcement) than in

outsider economies (i.e. economies with well-developed stock markets, dispersed ownership,

high investor rights, high disclosure and strict law enforcement). These results support the idea

that IFRS reduce frictions by improving financial reporting quality.

Biddle et al. (2013) assess whether the move to IFRS, voluntary or mandatory, is associated

with an improvement in firms’ investment efficiency. Their findings show that only mandatory

adoption of IFRS is significantly associated with more efficient investment, especially in

countries with less restrictive legal systems, more concentrated ownership and local accounting

standards with higher distances from IFRS.

Chen et al. (2013) take a slightly different approach to examine the link between IFRS and

investment efficiency. They study the impact of IFRS adoption on accounting externalities, i.e.

the “spillover effect” of this information published by one firm on the performance of other

firms. More specifically, they examine whether mandatory adoption of IFRS in Europe

10

encourages this spillover effect of comparable foreign firms’ accounting information on

investment efficiency, since past literature suggested that comparable information can improve

a firm’s investment efficiency (Hayes and Lundholm 1996; Mitchell and Mulherin 1996;

Durnev and Mangen 2009; Beatty et al. 2013). Based on this argument, Chen et al. (2013)

hypothesize that surplus profits reported by comparable foreign firms (measured as the

difference in ROA between the firm and its foreign peers) can have a positive spillover effect

and reduce under- or over-investment. Their findings notably show that these effects of

information are greater in the post-adoption period, supporting the idea that the move to IFRS,

because it leads to production of a greater volume of more comparable information, has a

positive effect on investment efficiency.

In sum, a few recent studies suggest that adoption of IFRS, in improving financial reporting

quality, has a favorable impact on investment efficiency. This impact may vary in significance,

depending on the mandatory or voluntary nature of IFRS adoption, and the institutional and

legal characteristics of the country in which the phenomenon is studied. However, past research

says nothing about the positive influence of conservatism on investment efficiency in the

context of a move to IFRS. We consider this an interesting question, since conservatism tends

to decline with the application of IFRS. In our opinion it is possible that introduction of IFRS

has had more than one effect, possibly contradictory effects, on investment efficiency. On one

hand, IFRS are presumed to reduce information asymmetry and therefore have a direct positive

effect on investment efficiency. On the other hand, IFRS are presumed to reduce conservatism

and therefore have an indirect negative effect on investment efficiency. In our opinion, the

positive association between conservatism and investment efficiency is likely to be affected by

the move to IFRS. This leads us to formulate the following hypothesis:

H1: IFRS adoption has a negative impact on the association between conservatism and

firms’ investment efficiency.

11

This hypothesis is tested on a sample of listed French companies, with the main objective of

contributing to the academic and regulatory debates on the effects of the mandatory adoption

of IFRS and the role of conservatism in the IASB’s conceptual framework.

2. Methodology

This section presents our principal methodological choices. We describe the measures for

investment efficiency (2.1) and conservatism (2.2), the models (2.3), and the sample used (2.4).

2.1. Measure of investment efficiency

Several measures for investment efficiency have been used in previous research (investment

sensitivity to cash flows in Biddle and Hilary (2006), Schleicher et al. (2010) and Biddle et al.

(2013), the difference between actual and expected investment in McNichols and Stubben

(2008), Biddle et al. (2009), Chen et al. (2011) and Chen et al. (2013), the likelihood of over-

or under-investment in Biddle et al. (2009) and Chen et al. (2013)). Given the definition of

investment efficiency developed earlier, we first propose to use the difference between actual

and expected investment as our measure of over- or under-investment: we call this measure

abnormal investment. Next, we construct a ranked variable to bring out the observations with

the greatest likelihood of over- or under-investment.

12

2.1.1. ABNORMAL INVESTMENT

To measure abnormal investment, we use a regression relating total investment by firm i in year

t+1, INVit+1, to factors generally acknowledged to explain a firm’s level of investment, such as

its growth opportunities, size or cash flows. Richardson (2006), McNichols and Stubben (2008),

Biddle et al. (2009), Chen et al. (2011) and Chen et al. (2013) adopt comparable approaches.

INVit+1 corresponds to the sum of investment expenditure (CAPEX) adjusted for assets acquired

through mergers and asset disposals by firm i in year t+1, divided by total assets at the end of

year t5. For each year, the regression we use is therefore as follows:

INVit+1 = α0 + α1INVit + α2ΔSALESit + α3SIZEit + α4MTBit + α5LEVit + (1)

+ α6TANGit + α7CFOSALESit + α8NCTANGit + α9LOSSit + INDit + ςit+1

where INVit = measure of total investment by firm i in year t divided by total assets at the end

of year t;

ΔSALESit = percentage growth in sales for firm i in year t;

SIZEit = firm size measured by logarithm of stock market capitalization of firm i at the

end of year t;

MTBit = market-to-book ratio for firm i at the end of year t;

LEVit = leverage measured by total debt divided by total equity for firm i at the end of

year t;

TANGit = total tangible assets divided by total assets for firm i at the end of year t;

CFOSALESit = operating cash flow divided by total sales for firm i in year t;

NCTANGit = net cash divided by total tangible assets for firm i at the end of year t;

LOSSit = binary variable equal to 1 when net earnings are negative, and zero otherwise;

INDit = series of dichotomous variables for industry (defined by the first figure of the SIC

code).

13

Using equation (1), we calculate for each firm the absolute value of abnormal investment

(ABSINVABNit+1), which is the difference between actual and expected investment, equal to

the absolute value of the residual ςit+1 from equation (1). An observation with a higher

ABSINVABNit+1 is interpreted as an observation with greater likelihood of over- or under-

investment.

2.1.2. LIKELIHOOD OF OVER- OR UNDER-INVESTMENT

We also propose a second approach similar to Biddle et al. (2009) and Chen et al. (2013),

constructing a proxy OVERIit+1, which can identify the observations with the greatest likelihood

of over- or under-investment. To construct this ranked variable, the observations are allocated

into three subgroups of equal size, based on their residual (ςit+1). The first group (OVERIit+1 = 0)

contains the observations with the highest likelihood of under-investment (i.e. strongly negative

residuals), while the last group (OVERIit+1 = 2) contains the observations with the highest

likelihood of over-investment (i.e. strongly positive residuals). By default, the remaining group

(SURIit+1 = 1) comprises the observations considered to show a normal level of investment.

2.2. Measure of conservatism

To measure conservatism at the level of each firm-year, we use the model developed by Khan

and Watts (2009), which is based on Basu (1997). Khan and Watts (2009) argue that the

asymmetry in recognition of gains and losses depends on each firm’s characteristics (size,

market-to-book ratio and leverage). For each year, we use the following regressions to estimate

the λj coefficients:

NIit = β1 + β2Dit + Rit(μ1 + μ2SIZEit + μ3MTBit + μ4LEVit) (2)

+ DitRit(λ1 + λ2SIZEit + λ3MTBit + λ4LEVit)

+ (δ1SIZEit + δ2MTBit + δ3LEVit + δ4DitSIZEit + δ5DitMTBit + δ6DitLEVit) + ζit

14

where NIit = net income of firm i in year t, normalized by stock market capitalization at the start

of the year;

Rit = stock market return for firm i in year t;

Dit = binary variable equal to 1 if Rit < 0 and 0 otherwise;

SIZEit , MTBit and LEVit are as defined above.

In this approach, the λj coefficients are estimated for each year. The level of conservatism

for each firm-year, CONSit (the “C_Score” in Khan and Watts 2009) is calculated using the

following formula:

CONSit = λ1 + λ2SIZEit + λ3MTBit + λ4LEVit (3)

The degree of conservatism thus depends on temporal characteristics (the λj coefficients are

estimated for each year) and variables specific to each firm. We interpret a higher CONSit score

as indicating more conservative accounting information.

2.3. Models

We hypothesize that adoption of IFRS has a negative impact on the association between

conservatism and investment efficiency. To test this hypothesis, we use two models. In the first

model the dependent variable is abnormal investment; this is replaced by the likelihood of over-

or under-investment in the second model.

2.3.1. ABNORMAL INVESTMENT

To check whether more conservative accounting information is associated with higher

investment efficiency, we first use the following model:

ABSINVABNit+1 = θ0 + θ1CONSit + θ2DACCit + INDit + YEARit + εit+1 (4)

15

where ABSINVABNit+1 = absolute value of abnormal investment, determined using equation

(1) for firm i in year t+1;

CONSit = degree of conservatism for firm i in year t (determined by the model in Khan

and Watts (2009), see equation (3));

DACCit = quality of accruals for firm i in year t (absolute value multiplied by -1 of

discretionary accruals determined under the Dechow and Dichev model (2002));

INDit = series of dichotomous variables for industry (defined by the first figure of the SIC

code);

YEARit = series of dichotomous variables for the years.

According to equation (4), if a higher degree of conservatism is associated with lower over-

or under-investment, we should find a negative and significant coefficient for θ1. We include

DACCit as the control variable since previous research shows that financial reporting quality as

captured by accruals has an impact on investment efficiency (Biddle and Hilary 2006; Biddle

et al. 2009; Chen et al. 2011). 6

The impact of IFRS on the relationship between conservatism and investment efficiency is

first captured through separate regressions for observations using French GAAP and IFRS.

Next, to conclude whether there are any differences between the two periods analyzed, we

incorporate a binary variable IFRSit which is equal to 1 if the accounting standards used are

IFRS (period 2005-2007) and 0 otherwise, incorporated in interaction with the other variables

of interest.

2.3.2. LIKELIHOOD OF OVER- OR UNDER-INVESTMENT

In a second approach, we attempt to directly model the association between conservatism and

the likelihood of an observation being in a situation of over- or under-investment. The

dependent variable this time is OVERIit+1, a ranked variable that can detect the observations

16

with the greatest likelihood of over- or under-investment, as discussed in section 2.1.2. Like

Biddle et al. (2009), we use a multinomial logistic regression that addresses the likelihood of

both over- and under-investment:

OVERIit+1 = φ0 + φ1CONSit + φ2DACCit + INDit + YEARit + eit+1 (5)

where OVERIit+1, = ordinal variable equal to 0, 1 or 2, derived from allocation of observations

into three subgroups of equal size based on the ςit+1 residuals from equation (1);

CONSit, DACCit, INDit and YEARit are as defined earlier.

The group of observations for which the level of investment is considered normal

(OVERIit+1 = 1) is used as the benchmark group. If higher conservatism is associated with less

over- or under-investment, we should find a negative and significant coefficient for φ1.

2.4. Sample

Table 1 below presents the sample. The initial sample consisted of all French listed firms for

which data is available in the Thomson Financial database (833 firms). We first eliminated all

financial institutions, since they are governed by specific rules (128 firms), then firms that did

not adopt IFRS in 2005 (250 firms). This left a sample of 455 firms for which we had the

required information for the period 2001-2007 (certain variables for 2002 require information

from the previous year, 2001). To avoid bias in our results due to the financial crisis (Filip and

Raffournier 2012), the testing period ends in 20077. Missing observations and observations with

negative equity were also eliminated from the sample (1,045 and 59 observations respectively).

The final sample thus consists of 1,626 observations: 787 using French GAAP and 839 using

IFRS.

17

– Insert table 1 here –

3. Results

After a description of the main variables, we present and discuss the results of our multivariate

analyses.

3.1. Descriptive statistics

The descriptive statistics for dependent and independent variables, presented before and after

the mandatory application of IFRS (respectively “French GAAP” and “IFRS”) are shown in

part 1 of table 2. To limit the risks of outliers causing bias in the inferences of these empirical

tests, all continuous variables are winsorized at 1%.

Between the pre-IFRS period (2002-2004) and the post-IFRS period (2005-2007), French

companies seem to have increased their mean (median) total investment as a proportion of total

assets from 12% to 20% (8% to 10%). We also note a decline in the mean (median) degree of

conservatism between the pre-IFRS period and the post-IFRS period, as measured by the Khan

and Watts (2009) model, from 0.08 to 0.03 (0.08 to 0.06) (a difference that is statistically

significant at 1%, t-stat = 3.40). These results confirm a decline in conservatism on the French

market with the move to IFRS, as observed by Piot et al. (2011), Ahmed et al. (2013) and André

et al. (2013) using the model developed by Basu (1997).

Regarding the other variables, the quality of accruals appears to be unchanged after

application of IFRS, at an average 4% of assets over the entire study period. Also, sales by

French firms seem to increase (the mean percentage sales growth rises from 7% to 13%), as

does the market-to-book ratio (from 1.91 to 2.45). We also observe a decline in leverage (total

debt divided by total equity), which falls from 91% to 77%.

18

– Insert table 2 here –

Part 2 of table 2 presents the correlation matrix. This matrix shows that no correlation

coefficient is higher than 0.50. Moreover, the two principal independent variables included in

the test models, CONS and DACC, are uncorrelated (correlation coefficient of 0.01). To

confirm the absence of multicollinearity problems, in all our regressions we calculated the

variance inflation factor (VIF) for each explanatory variable, and the average VIF (results not

shown here). These analyses enable us to conclude that there are no serious multicollinearity

problems.

3.2. Regression results

To test our hypothesis, we use two models that differ in their dependent variable: abnormal

investment in one, likelihood of over- or under-investment in the other. The results are

presented and discussed below.

3.2.1. ABNORMAL INVESTMENT

The results of the regressions as presented in equation (4), which takes the absolute value of

abnormal investment as the dependent variable, are shown in table 38. First, separate regressions

are run for observations using French GAAP and IFRS. Next, a regression is run on the whole

sample including a binary variable IFRSit, in interaction with the other variables of interest.

– Insert table 3 here –

19

The degree of conservatism shows a negative association with the absolute value of

abnormal investment for observations under French GAAP, as we have a negative, significant

coefficient for θ1 (θ1 = -0.078, t-stat = -3.80). We can thus conclude that in the pre-IFRS period,

greater conservatism leads to less under- or over-investment. This result is similar to the finding

of Garcia Lara et al. (2013) for a sample of US firms over the period 1990-2007. However, this

link disappears after the adoption of IFRS: for observations using IFRS the degree of

conservatism is no longer associated with the absolute value of abnormal investment

(θ1 = -0.002, t-stat = -0.08). This result suggests that the move to IFRS affected the association

between conservatism and investment efficiency.

The results of the final regression support this idea: the positive, significant interaction

coefficient (0.068, t-stat = 1.80) between the CONS and IFRS variables leads us to conclude

that application of IFRS eliminates conservatism’s mitigating effect on abnormal investment.

In other words, the decline in the degree of conservatism between the pre-IFRS and post-IFRS

period (results presented in table 2) implies that conservatism no longer plays any role in the

investment efficiency for listed French firms that do not belong to the financial industry.

Regarding the control variables, it is interesting to note that the quality of accruals, DACCit

(determined using the Dechow and Dichev (2002) model), is associated with the absolute value

of abnormal investment for observations using French GAAP and IFRS (French GAAP : θ2 =

-0.429, t-stat = -3.55; IFRS: θ2 = -0.889, t-stat = -4.89). The regression coefficients indicate that

in terms of magnitude, the quality of accruals plays a much greater role than conservatism in

disciplining investment, whichever accounting standards are used. These results are consistent

with the findings of Biddle et al. (2009) and Garcia Lara et al. (2013) who show that for samples

of US firms, financial reporting quality reduces over- or under-investment. The coefficient of

the interaction term IFRS * DACC (-0.565, t-stat = -2.62) also indicates that application of

20

IFRS very significantly reinforces the association between the quality of accruals and lower

under- or over-investment.

3.2.2. LIKELIHOOD OF OVER- OR UNDER-INVESTMENT

Table 4 presents the results of multinomial logistic regressions that can more directly test the

link between the likelihood of a firm being in a situation of over- or under-investment and the

degree of conservatism. As explained earlier (section 2.1.2), the group of observations for

which OVERIit+1 takes the value 1, i.e. observations with a level of investment considered

normal, is used as the benchmark group.

– Insert table 4 here –

Part A of table 4 presents the results for under-investment. The coefficient for the CONSit

variable has the expected sign for observations using French GAAP and is statistically

significant (φ1 = -1.072, z-stat = -2.88). The association between conservatism and the

likelihood of under-investment disappears after the adoption of IFRS (φ1 = 0.298, z-stat = 0.74).

These results corroborate the results presented in table 3. Regarding the quality of accruals, the

coefficients for the DACCit variable are negative and significant, not only for observations

using French GAAP, but also for observations using IFRS. The association between the quality

of accruals and the likelihood of under-investment persists after the move to IFRS. These

findings also support the results reported in table 3.

The results for over-investment, which are shown in part B of table 4, also indicate that

conservatism reduces the likelihood of over-investment (φ1 = - 0.613, z-stat = -1.66) in the pre-

IFRS period. This relationship no longer exists in the post-IFRS period (φ1 = 0.147, z-stat =

21

0.36). However, the quality of accruals has no connection with the likelihood of over-

investment in either the pre-IFRS or post-IFRS period.

Conclusion

The objective of our research is to test whether conservatism, an attribute of financial reporting

that is generally considered desirable, is associated with greater investment efficiency, or in

other words with lower over- or under-investment for a sample of French listed firms, before

and after the mandatory application of IFRS in 2005. The theory establishes that conservatism

is likely to improve investment efficiency, since more conservative accounting information

presumably reduces the information asymmetry between the firm and its capital providers, and

should therefore make corporate investment policies more optimal. Garcia Lara et al. (2013)

effectively show for a sample of US companies that firms with the highest conservatism are

less likely to over- or under-invest. Yet to our knowledge, no research has so far examined the

impact of IFRS adoption in terms of conservatism’s influence on investment efficiency. Our

study’s aim is to nourish debate, both academic and regulatory, on the impact of IFRS adoption

on financial reporting quality, and therefore on its favorable economic consequences.

Our results first show that conservatism significantly declines after the move to IFRS.

This result corroborates the findings of Piot et al. (2011), Ahmed et al. (2013) and André et al.

(2013), and can be explained by a reduction in asymmetrical recognition of gains and losses,

resulting from the declared intention to give more emphasis in the international conceptual

framework to neutrality, which is difficult to reconcile with the conservatism principle. Next

and more importantly, we note that in the pre-IFRS period, conservatism limits over- or under-

investment. However, in the post-IFRS period, conservatism no longer appears to be associated

with investment efficiency in non-financial listed French firms. Also noteworthy is that the

quality of accruals, another dimension of financial reporting quality, plays an important role

22

over the whole study period (pre- and post-IFRS) in disciplining investment, and this role grows

with the adoption of IFRS. If the quality of accruals is analyzed in connection with the concept

of neutrality, i.e. as a way to fight bias and subjectivities in accounting choices and estimates,

then from this standpoint adoption of IFRS looks beneficial for investment efficiency.

Like all research, this study has certain limitations. It is of course always complex to

identify a single factor as the sole explanation for a phenomenon. In our study, it is made more

difficult by the fact that the move to IFRS took place at a time when several other changes were

happening in European financial market and audit regulations. Our study is also open to

criticism for omitted variables, or its simultaneous determination of the degree of conservatism

and investment efficiency. We readily acknowledge that our work is probably not free of

endogeneity issues. However, as Larcker and Rusticus (2010) state, solutions to this kind of

problem are difficult to implement and can easily give rise to other kinds of bias. Finally, we

recognize that the INV variable is probably understated for the pre-2005 period (due for

example to the different treatments of leases pre- and post-IFRS). However, we believe that this

understatement works against our result (we should not see any association between the degree

of conservatism and over- or under-investment during the pre-IFRS period).

We believe our results make a particularly timely contribution to the debate on the

economic consequences of the move to IFRS, as the European Commission has launched a

study on the question and the IASB is currently working on a revision of its conceptual

framework. In the current debates, the international standard-setter generally emphasizes its

objective of neutrality. But by encouraging more neutral information, which theoretically has

better predictive value especially as regards cash flows, IFRS limit conservatism. The cost-

benefit analysis of what could be called the new equilibrium in the qualitative characteristics of

financial reporting is still difficult to measure. As things stand, our empirical observations

suggest that if conservatism is losing its regulation power over investment with the introduction

23

of IFRS, the quality of accruals, which reflects the principle of neutrality, is taking over. This

supports the standard-setter’s aim to emphasize neutrality, but will still require further

investigations, if only for a better grasp of the tradeoffs.

24

References

André, P., Filip, A., Paugam, L. (2013). Accounting conservatism in Europe and the impact of

mandatory IFRS adoption: Do country, institutional and legal differences survive? http://dx.doi.org/10.2139/ssrn.1979748: 39 p.

Ahmed, A. S., Billings, B. K., Morton, R. M., Stanford-Harris, M. (2002). The role of accounting conservatism in mitigating bondholder-shareholder conflicts over dividend policy and in reducing debt costs. Accounting Review 77 (4): 867-890.

Ahmed, A. S., Neel, M., Wang, D. (2013). Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research 30 (4): 1344-1372.

Ball, R., Shivakumar, L. (2005). Earnings quality in UK private firms: comparative loss recognition timeliness. Journal of Accounting and Economics 39 (1): 83-128.

Barth, M. E., Landsman, W. R., Lang, M. H. (2008). International accounting standards and accounting quality. Journal of Accounting Research 46 (3): 467-498.

Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings. Journal

of Accounting and Economics 24 (1): 3-37. Beatty, A., Liao, S., Yu, J. J. (2013). The spillover effect of fraudulent financial reporting on

peer firms’ investments. Journal of Accounting and Economics 55 (2/3): 183-205. Bessieux-Ollier, C., Walliser, E. (2014). Sur la contingence du référentiel comptable :

l’exemple des entreprises françaises cotées sur Alternext. Recherches en Sciences de

Gestion 100 : 73-93. Biddle, G. C., Hilary, G. (2006). Accounting quality and firm-level capital investment.

Accounting Review 81 (5): 963-982. Biddle, G. C., Hilary, G., Verdi, R. S. (2009). How does financial reporting quality relate to

investment efficiency? Journal of Accounting and Economics 48 (2/3): 112-131. Biddle, G. C., Callahan, C. M., Hong H. A., Knowles, R. L. (2013). Do adoptions of

international financial reporting standards enhance capital investment efficiency? Working

paper. 45 p. Bushman, R. M., Smith, A. J. (2001). Financial accounting information and corporate

governance. Journal of Accounting and Economics 32 (1-3): 237-333. Chen, Q., Hemmer, T., Zhang, Y. (2007). On the relation between conservatism in accounting

standards and incentives for earnings management. Journal of Accounting Research 45 (3): 541-565.

Chen, F., Hope, O.-K., Li, Q., Wang, X. (2011). Financial reporting quality and investment efficiency of private firms in emerging markets. Accounting Review 86 (4): 1255-1288.

Chen, C., Young, D., Zhuang, Z. (2013). Externalities of mandatory IFRS adoption: Evidence from cross-border spillover effects of financial information on investment efficiency. Accounting Review 88 (3): 881-914.

Daske, H. (2006). Economic benefits of adopting IFRS or US-GAAP – Have the expected cost of equity capital really decreased? Journal of Business Finance & Accounting 33 (3/4): 329-373.

Daske, H., Hail L., Leuz C., Verdi R. (2008). Mandatory IFRS reporting around the world: Early evidence on the economic consequences. Journal of Accounting Research 46 (5): 1085-1142.

Dechow, P. M., Dichev, I. D. (2002). The quality of accruals and earnings: The role of accrual estimation errors. Accounting Review 77 (4): 35-59.

25

Dechow, P. M., Ge, W., Schrand, C. (2010), Understanding earnings quality: A review of the proxies, their determinants and their consequences. Journal of Accounting and Economics 50 (2/3): 344-401.

Durnev, A., Mangen, C. (2009). Corporate investments: Learning from accounting restatements. Journal of Accounting Research 47 (3): 679-720.

Filip, A., Raffournier, B. (2012). The impact of the 2008-2009 financial crisis on earnings management: The European evidence. Working paper. 34 p.

Francis, J., LaFond, R., Olsson, P. M., Schipper, K. (2004). Costs of equity and earnings attributes. Accounting Review 79 (4): 967-1010.

Garcia Lara, J. M., Osma, B. G., Penalva, F. (2013). Accounting conservatism and firm investment efficiency. Working paper. 53 p.

Göx, R., Wagenhofer, A. (2009). Optimal impairment rules. Journal of Accounting and

Economics 48 (1): 2-16. Hayes, R. M., Lundholm, R. (1996). Segment reporting to the capital market in the presence of

a competitor. Journal of Accounting Research 34 (2): 261-279. Jensen, M. (1986). The agency costs of free cash flow: Corporate finance and takeovers.

American Economic Review 76 (2): 323-329. Jones, J. J. (1991). Earnings management during import relief investigations. Journal of

Accounting Research 29 (2) : 193–228. Khan, M., Watts, R. L. (2009). Estimation and empirical properties of a firm-year measure of

accounting conservatism. Journal of Accounting and Economics 48 (2/3): 132-150. Larcker, D. F., Rusticus, T. O. (2010). On the use of instrumental variables in accounting

research. Journal of Accounting and Economics 49 (3): 186-205. Leuz, C., Verrecchia, R. E. (2000). The economic consequences of increased disclosure.

Journal of Accounting Research 38 (3): 91-124. Leuz, C., Nanda, D., Wysocki, P. D. (2003). Earnings management and investor protection: an

international comparison. Journal of Financial Economics 69 (3): 505-527. Li, S. (2010). Does mandatory adoption of international financial reporting standards in the

European Union reduce the cost of equity capital? Accounting Review 85 (2): 607-636. McNichols, M. F., Stubben, S. R. (2008). Does earnings management affect firms’ investment

decisions? Accounting Review 83 (6): 1571-1603. Mitchell, M., Mulherin, J. (1996). The impact of industry shocks on takeover and restructuring

activity. Journal of Financial Economics 41 (2): 193-229. Piot, C., Dumontier, P., Janin, R. (2011). IFRS consequences on accounting conservatism

within Europe: The role of Big 4 auditors. Working paper http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1754504 : 54 p.

Richardson, S. (2006). Over-investment of free cash flow. Review of Accounting Studies 11 (2/3); 159-189.

Schleicher, T., Tahoun, A., Walker, M. (2010). IFRS adoption in Europe and investment-cash flow sensitivity: Outsider versus insider economies. International Journal of Accounting

45 (2): 143-168. Watts, R. L. (2003). Conservatism in accounting Part I: Explanations and implications,

Accounting Horizons 17 (3): 207-221. Wittenberg-Moerman, R. (2008). The role of information asymmetry and financial reporting

quality in debt trading: Evidence from the secondary loan market. Journal of Accounting

and Economics 46 (2/3): 240-260. Zhang, J. (2008). The contracting benefits of accounting conservatism to lenders and borrowers.

Journal of Accounting and Economics 45 (1): 27-54.

26

Table 1 : Sample

Number of French listed firms in Thomson Financial 833

(–) Financial firms -128

(–) Firms that did not adopt IFRS in 2005 a -250

(=) Number of available firms = 455

*6 = Number of potential observations (2002-2007) = 2 730

(–) Unavailable observations b -1 045

(–) Observations with negative equity -59

(=) Observations in the sample = 1 626

French GAAP (2002-2004) 787

IFRS (2005-2007) 839 a This category includes firms for which information on accounting standards was missing and firms that had not adopted IFRS or adopted them after 2005 (firms listed on the unregulated Alternext market had the choice – see Bessieux-Ollier and Walliser 2014). b Estimation of our models requires data to be available for at least three years in order for a firm to be retained in the sample.

27

Table 2: Descriptive statistics and correlation matrix Part 1: Descriptive statistics

Variables Standards N Mean Standard deviation

25% Median 75%

INVit+1 French GAAP 787 0.12 0.23 0.04 0.08 0.13 IFRS 839 0.20 0.34 0.06 0.10 0.21

CONSit French GAAP 787 0.08 0.28 -0.04 0.08 0.21 IFRS 839 0.03 0.24 -0.06 0.06 0.19

DACCit French GAAP 787 -0.04 0.04 -0.05 -0.03 -0.01 IFRS 839 -0.04 0.04 -0.05 -0.02 -0.01

ΔSALESit French GAAP 787 0.07 0.25 -0.04 0.03 0.10 IFRS 839 0.13 0.26 0.01 0.08 0.18

SIZEit French GAAP 787 5.09 2.06 3.54 4.90 6.41 IFRS 839 5.56 1.97 4.04 5.42 6.87

MTBit French GAAP 787 1.91 1.36 1.01 1.54 2.38 IFRS 839 2.45 1.61 1.27 2.07 3.12

LEVit French GAAP 787 0.91 1.06 0.22 0.65 1.16 IFRS 839 0.77 0.90 0.19 0.51 1.02

TANGit French GAAP 787 0.44 0.32 0.16 0.37 0.65 IFRS 839 0.42 0.32 0.14 0.33 0.64

CFOSALESit French GAAP 787 0.06 0.11 0.03 0.07 0.11 IFRS 839 0.07 0.11 0.03 0.07 0.12

NCTANGit French GAAP 787 0.39 0.69 0.05 0.14 0.38 IFRS 839 0.45 0.76 0.06 0.14 0.50

28

Part 2: Correlation matrix

INVit+1 CONSit DACCit ΔSALESit SIZEit MTBit LEVit TANGit CFOSALESit

INVit+1 1,00

CONSit -0.04 1.00

DACCit -0.14 *** 0.01 1.00

ΔSALESit 0.20 *** -0.11 *** -0.13 *** 1.00

SIZEit -0.01 -0.42 *** 0.22 *** 0.06 ** 1.00

MTBit 0.22 *** -0.43 *** -0.16 *** 0.23 *** 0.19 *** 1.00

LEVit -0.11 *** -0.18 *** 0.01 -0.01 0.09 *** 0.02 1.00

TANGit -0.29 *** 0.10 *** 0.21 *** -0.14 *** 0.02 -0.27 *** 0.12 *** 1,00

CFOSALESit 0.06 ** -0.13 *** 0.13 *** -0.03 0.27 *** 0.09 *** -0.01 0,13 *** 1,00

NCTANGit 0.31 *** -0.02 -0.18 *** 0.07 *** -0.12 *** 0.19 *** -0.14 *** -0,49 *** 0,00 Correlation coefficients are Pearson’s coefficents. 1,626 firm-year observations over the period 2002-2007 for a sample of non-financial listed French firms that adopted IFRS in 2005 with data available in Thomson Financial database. All variables are winsorized at 1%. INVit+1 = investment expenditure (CAPEX + assets acquired through mergers) by firm i in year t+1 divided by total assets at the end of year t; CONSit = degree of conservatism for firm i in year t (determined by the model in Khan and Watts (2009); DACCit = quality of accruals for firm i in year t (absolute value multiplied by -1 of discretionary accruals determined under the Dechow and Dichev model (2002)); ΔSALES it = percentage growth in sales for firm i in year t; SIZEit = logarithm of stock market capitalization of firm i at the end of year t; MTBit = market-to-book ratio for firm i at the end of year t; LEV it = total debt divided by total equity for firm i at the end of year t; TANGit = total tangible assets divided by total assets for firm i at the end of year t; CFOSALESit = operating cash flow divided by total sales for firm i in year t; NCTANGit = net cash divided by total tangible assets for firm i at the end of year t. *, **, *** : significant at 10%, 5% and 1%.

29

Table 3: Results of linear regressions – abnormal investment

Standards French GAAP IFRS French GAAP + IFRS Variables

CONS it -0.078 *** -0.002 -0.068 *** (-3.80) (-0.08) (-2.69)

IFRS it *CONS it 0.068 * (1.80)

DACC it -0.429 *** -0.889 *** -0.374 ** (-3.55) (-4.89) (-2.52)

IFRS it *DACC it -0.565 *** (-2.62)

IFRS it 0.028 (1.57)

Industry Included Included Included

Year Included Included Included

Constant 0.079 *** 0.163 *** 0.110 *** (3.08) (4.69) (4.59)

N 787 839 1 626 F 6.08 *** 12.33 *** 15.07 *** Adjusted R2 0.066 0.130 0.122

1,626 firm-year observations over the period 2002-2007 for a sample of non-financial listed French firms that adopted IFRS in 2005 with data available in Thomson Financial database. All variables are winsorized at 1%. The dependent variable ABSINVABNit+1 (absolute value of abnormal investment), is the absolute value of the residual from the annual regression of investment expenditure for year t+1 on a series of control variables - see equation (1). CONSit = degree of conservatism for firm i in year t (determined by the model in Khan and Watts (2009); DACCit = quality of accruals for firm i in year t (absolute value multiplied by -1 of discretionary accruals

determined under the Dechow and Dichev model (2002)); IFRSit = binary variable equal to 1 if the accounting standards used are IFRS (in the period 2005-2007) and 0 otherwise); fixed industry and year effects included in the regression. *, **, *** : significant at 10%, 5% and 1%.

30

Table 4: Results of multinomial logistic regressions – likelihood of over- or under-investment

Standards French GAAP IFRS

Part A : under-investment versus normal investment

CONS it -1.072 *** 0.298 (-2.88) (0.74)

DACC it -5.627 *** -6.062 ** (-2.65) (-2.34)

Industry Included Included

Year Included Included

Constant -0.769 0.817 * (-1.63) (1.93)

Partie B : over-investment versus normal investment

CONS it -0.613 * 0.147 (-1.66) (0.36)

DACC it -1.539 -3.213 (-0.71) (-1.21)

Industry Included Included

Years Included Included

Constant -0.171 -0.011 (-0.42) (-0.02)

N 787 839 Pseudo R2 0.038 0.050

1,626 firm-year observations over the period 2002-2007 for a sample of non-financial listed French firms that adopted IFRS in 2005 with data available in Thomson Financial database. All variables are winsorized at 1%. The dependent variable OVERI it+1 is a ranked variable taking the values 0, 1 and 2: observations are classified intro three subgroups of equal size based on the residual from the annual regression of investment expenditure for year t+1 on a series of control variables – see equation (1). The group of observations for which OVERIit+1 = 1 is used as the benchmark group. CONSit = degree of conservatism for firm i in year t (determined by the model in Khan and Watts (2009); DACCit = quality of accruals for firm i in year t (absolute value multiplied by -1 of discretionary accruals determined under the Dechow and Dichev model (2002)); fixed industry and year effects included in the regression. *, **, *** : significant at 10%, 5% and 1%.

31

1 As defined by Basu (1997). Basu’s definition emphasizes timely recognition of losses and the requirement of having information suggesting the loss is probable in order to record a reduction in the accounting profit. In comparison the “prudence” principle that existed in France and Germany did not necessarily include a requirement that the loss should be probable. It could be reflected in systematic selection of the lowest value from a range of possible values, or early recognition of expenses. 2 The authors thank one of the referees for his suggestions regarding clarification of the theoretical relationships. 3 In the Basis for Conclusions accompanying the new version of the conceptual framework in September 2010, the IASB states that the qualitative characteristics of useful financial information (chapter 3 of the conceptual framework) includes neither conservatism nor “prudence” as aspects of “faithful representation” because including either would be incompatible with neutrality (BC3.27). 4 The authors thank the editor and one of the referees for their suggestions regarding clarification of theoretical relationships. 5 In the definition of the INV variable, the only difference from Biddle et al. (2009) is our decision not to include research and development expenses (R&D). Including R&D is problematic because of the accounting method (French GAAP and IFRS differ, but also it is impossible to measure total R&D expenses in the IFRS period as only the non-capitalized portion is available). Consequently, we decided to concentrate on investment expenditure on tangible assets. 6 Replacing DACCit by a measure taken from Jones’ (1991) model gives similar results (not reported here). 7 We also conduct this analysis after elimination of 2005, the year IFRS adoption became mandatory. The results (not reported here) are similar. 8 As a robustness check of the results reported in tables 3 and 4, rather than total investment we used investment expenditure or only CAPEX (like Biddle et al. 2009, for example). The results of these analyses (not reported here) are similar.