Previous studies have shown that accounting standards add value to accounting information in developed economies (Hung and Subramanyam, 2004; Bartov et al., 2004). However, it is unclear whether such benefits also apply to developing or transitional economies. Despite the increasing importance of the earnings management problem in emerging markets, there is relatively little empirical evidence to show whether local accounting standards improve the quality of accounting information provided by firms that have adopted them and whether such adoption reduces the level of earnings management. Recent evidence suggests that accounting information is less useful in emerging markets. For example, Ball et al. (2000) find that there is low transparency of earnings in Hong Kong, Malaysia, Singapore and Thailand. They argue that such low transparency is attributable to weak enforcement of accounting standards in these countries. As this study shows, given the weak legal system and the lack of accounting and capital market infrastructure in transitional economies, emerging economies are particularly likely to face severe problems in monitoring managers' accounting decisions. The introduction of international accounting principles and practices in emerging markets has been shown to increase market liquidity, reduce transaction cost, and improve pricing efficiency (Feldman and Kumar, 1995). It is still an open question as to whether the adoption of IFRS improves the quality of accounting information, thereby reducing the level of earnings management. The emerging market in China provides a unique opportunity to examine these questions. Eccher and Healy (2003) compare the value relevance of accounting information prepared under the IFRS to those under Chinese accounting standards. This study finds that accounting information prepared under the IFRS is not more value relevant than that prepared under the Chinese accounting standards for B-share firms--firms that can be owned by foreign investors. The authors posit that one reason for the modest performance of the IFRS may be the lack of effective controls and infrastructure to monitor reporting under the IFRS, a conclusion similar to that of Ball et al. (2000). An investigation of the changes in the value relevance of earnings between different market segments, following the implementation of new national accounting standards in China, shows that implementation of specific national standards has a positive effective on the perceived value of the accounting information (Zhou et al., 2007). None of these studies, however, examined whether IFRS or local GAAP proves to be more effective in deterring earnings management by managers in public companies. A study by Barth et al. (2005) demonstrates that firms adopting IFRS are less likely to smooth earnings, less likely to manage earnings upwards to avoid reporting losses, and more likely to recognize losses timely than non-adopting firms. Other studies, on the other hand, indicate that the rule-based Chinese accounting system, even before the adoption of any formal standard, provided little opportunities for managers to manipulate earnings through accruals, implying that the effect of implementing IFRS on earnings management, via accounting accruals, could be negative (Chen and Yuan, 2004; Jian and Wong, 2003). In other words, new accounting standards and IFRS could leave the door open for managers to manipulate earnings via accounting accruals. Such contradicting arguments provide a strong basis to empirically examine the impact of new accounting standards on the earnings mangement behavior of firms. Therefore, it is hypothesized (in alternative form) that Hypothesis 1: Firms that adopt IFRS are less likely to smooth earnings than firms that adopt local GAAP. Hypothesis 2: Firms that adopt IFRS are less likely to manage earnings upwards to avoid reporting losses than firms that adopt local GAAP. Hypothesis 3: Firms that adopt IFRS are more likely to recognize losses in a timely manner than firms that adopt local GAAP.
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