Do firms’ earnings reported under IFRS 3R reveal more about future earnings and cash flows? Evidence from the European Union

Motivated by recent studies documenting inconsistent results regarding the benefits of adopting International Financial Reporting Standards (IFRS), the objective of this thesis is to examine the information value of firms’ earning reported focusing on IFRS 3 (Business Combination). IFRS 3 aims at providing systematic guidelines for acquirers of a business combination transaction to properly report identifiable assets and liabilities, to fairly measure goodwill and to disclose relevant information for investors’ evaluation. IFRS 3 was revised and became effective in July 2009. Opponents of the revised IFRS 3 (IFRS 3R) criticized the guidelines to have broadened the disconnection between current earnings and future cash flows and they argued against the widened implementation of fair value measurement by IFRS 3. This thesis covers European Union’s mandatory adoption of IFRS in 2005 along with the revision of IFRS 3 in 2009. The examination period is split into two time periods: Period 1 is from the mandatory adoption of IFRS to the eve of policy change, and Period 2 is from the policy change to the end of 2013. Sample in this study comprises of 374 firms involved in merger and acquisition (M&A) transactions in both time periods which results in 13,464 firm-quarterly observations drawn from 20 out of 28 European Union member countries. This study finds the association between current earnings and future earnings as well as future cash flows has been weakened since the adoption of IFRS 3R which implies the information value of current earnings has receded. In addition, quarterly earnings reported under IFRS 3 appear to be more volatile after controlling for factors influencing earnings volatility such as size, economic shocks and managers’ income smoothing behavior. Moreover, this study suggests that earnings volatility has a negative effect on earnings persistence over the whole testing period. In addition, such effect has amplified since the introduction of IFRS 3R. Following Mishkin’s (1983) method of testing market efficiency, this study supports that capital market impounds attenuated degree of earnings volatility effect on earnings predictability since the application of IFRS 3R. These results should draw the attention of both standard setters and public users as the convergence to IFRS from domestic GAAP has been a globally debating topic. Thus, standard setters should balance the benefits such as improved relevance, reliability and comparability of financial reports and costs such as the information loss of earnings when making IFRS adoption decisions. Meanwhile, public users should use the financial statements with caution, especially when M&A transaction involves