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The Economics of IFRS
December, 12th 2007

Most accounting experts think the convergence to an international financial standard will have a dramatic effect on markets. A few are not so sure.

The eventual transition to a single, international financial reporting standard will not merely affect companies. Making IFRS mandatory will also affect the markets in every country and many believe the change will be for the better.

Two new studies discuss the optimism about the future of a global standard. A survey by the International Federation of Accountants asked 143 accounting leaders from 91 countries about the significance of converging standards, and 89 percent said it was "very important" or "important." Just 9 percent said it was "somewhat important" and only 1 percent said it was not important at all.

"Convergence is not only desirable, but essential in an economy that is quickly dissolving borders," said Barry Melancon, president and CEO of the American Institute of Certified Public
Accountants.

Accountants are expected to be excited about all of this, but is their enthusiasm justified? A new working paper produced by academics for the University of Chicago's Initiative on Global
Markets could be among the 10 percent minority who are unsure of the economic importance of convergence. A transition to a global, mandatory IFRS will definitely have its benefits, but they will be distributed unevenly, the paper suggests.

Analyzing first-time adopters of IFRS in 26 countries, the authors Holger Daske,of University of Manheim, Luzi Hail of the University of Pennsylvania's Wharton School, Christian Luez of the University of Chicago's Graduate School of Business, and Rodrigo Verdi of MIT's Sloan School of Managment finds that adoption of the international standard will most directly impact market liquidity and the cost of capital.

The study finds that stock market liquidity increases by about 4 percent once IFRS is adopted, as more firms enter the market. Meanwhile the costs associated with trading will decline. Other
results, however, are more mixed. "The effects are weaker when local GAAP (generally accepted accounting principles) are closer to IFRS, in countries with an IFRS convergence strategy, and in industries with higher voluntary adoption rates," the authors write.

The authors conclude that changes in the cost of capital in different countries varies depending on how well they support the introduction of IFRS, and how different the new rules are from their previous ones. Countries that adopt IFRS voluntarily gain more than those that take it up once it becomes mandatory, as they are more likely to already have solid regulations in place. And countries that adopted IFRS earlier also benefit when new countries implement
it, as they then have better friends with whom to deal.

With such a variety of results, can any economic benefits be pinned to IFRS? The authors are not certain. Their findings suggest "modest but economically significant capital market benefits" around the introduction of IFRS. But since they find so much difference across their sample of countries, they say, it may not be the sole factor.

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