The Adoption of IFRS 3: The Effects of Managerial Discretion and Stock Market Reactions

Abstract

In recent years several accounting standards issued by the IASB substitute measures of fair value for historical cost, and give managers the discretion to determine the fair value without an actual market for the asset. We document the accounting consequences of the adoption of IFRS 3 and the stock market’s reaction using data from Sweden. After the adoption of IFRS 3 in January 2005 the amount of capitalized goodwill has increased substantially. Goodwill impairments under IFRS are considerably lower than goodwill amortizations and impairments made under Swedish GAAP. An analysis of economic incentives influencing the impairment decision at the initial adoption of IFRS 3 show some evidence that tenured management is negatively associated with the impairment decision. However, most firms did not reclassify goodwill or make additional impairments. Firms with substantial amounts of goodwill yielded abnormally high returns despite that they earned abnormally low earnings. Investors seem to, correctly or incorrectly, have viewed the IFRS 3 related boost in earnings as an indication of higher future cash flows.