IFRS adoption and enforcement and their effects on accounting quality and capital markets: evidence from South Africa
This study addresses a critical gap in the literature on the impact of International Financial Reporting Standards (IFRS) adoption on accounting quality and capital markets by exploiting the unique case of South Africa (SA). Unlike the European union and other countries, where IFRS adoption and enforcement changes occurred simultaneously, SA provides a unique setting where these events can be studied separately. IFRS adoption in SA became mandatory on January 1, 2005, without concurrent enforcement changes, which were only implemented six years later with the introduction of the Companies Act No. 71 of 2008, in 2011. This separation creates two natural experiments' that allow for an isolated analysis of the effects of IFRS adoption and subsequent enforcement changes. SA appears to be the first emerging and developing country to adopt IFRS and introduce enforcement mechanisms in a staggered manner (rather than contemporaneously), thus providing an innovative setting for examining the separate effects of both on accounting quality and capital markets. The study leverages this unique context to assess whether the benefits observed in accounting quality and capital markets literature are attributable solely to IFRS adoption or also to the enforcement changes. The first natural experiment refers to the period from 2005 to 2010, during which SA adopted IFRS without enforcement changes. The second natural experiment refers to the period from 2011 onwards, marked by significant enforcement reforms, including the Companies Act requirement for state-owned and public companies to prepare financial statements compliant with IFRS, thus providing legal backing for their enforcement, the establishment of the Companies and Intellectual Property Commission (which monitors and enforces IFRS compliance), and the Financial Reporting Investigations Panel (FRIP), among other enforcement enhancements. The research employs four earnings management models, one timely loss recognition measure, several value relevance metrics (price and returns models), and a liquidity proxy, bid- ask-spread, to measure accounting quality and capital market effects across three periods: SA GAAP period (2001-2004), IFRS only period (2007-2010), and IFRS with enforcement period (2012-2022). The study uses a balanced sample of 87 firms listed on the Johannesburg Stock Exchange (JSE), broken down into 348 firm-year observations for the SA GAAP period, 348 firm-year observations for IFRS only period, and 957 firm-year observations for the IFRS with enforcement period. The results of the study reveal several key findings. Firstly, IFRS adoption alone only leads to a slight (but insignificant) improvement in accounting quality, with significant improvements observed following enforcement changes. Secondly, the effects on capital markets align with the findings on accounting quality, showing that IFRS adoption only marginally decreases the bid-ask spreads, resulting in a slight (but insignificant) improvement in capital market liquidity. However, post-enforcement measures are associated with a significant reduction in the bid-ask spreads. These results make an important contribution to the literature as they highlight the critical role of enforcement in realizing the full benefits of IFRS adoption, thereby contributing valuable insights for policymakers and governments seeking to enhance accounting quality and capital market efficiency. The findings of this study have important policy implications for all the countries that have adopted IFRS (mostly developing and emerging economies, especially in Africa) without introducing enforcement mechanisms to ensure adherence to or compliance with the standards.
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