Disentangling the Effects of Changes in Book-Tax Conformity Related to Mandatory IFRS Adoption on Earnings Quality

Abstract

Using variation in book-tax conformity across EU countries, we provide new evidence on whether mandatory IFRS adoption leads to increases in earnings quality. Specifically, we examine if the relation between earnings quality and IFRS adoption differs among firms in countries with and without a concurrent change in book-tax conformity. We offer three main results. First, for countries adopting IFRS without a concurrent change in book-tax conformity, we find decreases in earnings persistence and cash flow predictability following IFRS adoption. Second, for countries experiencing decreases in book-tax conformity concurrent with IFRS adoption, we find increases in earnings persistence and cash flow predictability. Finally, we find no significant difference in the level of earnings quality in the post-IFRS period across firms in the two sets of countries. Our findings highlight the importance of considering concurrent changes in book-tax conformity when examining the costs and benefits of a change in financial reporting regulations.