Does Mandatory Adoption of International Accounting Standards Reduce the Cost of Equity Capital?

This paper examines whether the mandatory adoption of International Accounting Standards (IAS) in the European Union (EU) in 2005 reduces the cost of equity capital. Using a sample of 6,456 firm-year observations of 1,084 EU companies during the period of 1995 to 2006, I find evidence that mandatory introduction of IAS, on average, significantly reduces the cost of equity for mandatory adopters by 48 basis points. I also find that this reduction is present only in countries with strong enforcement systems and that both increased disclosure and enhanced information comparability help explain why IAS reduces the cost of equity. Taken together, these findings suggest that mandatory IAS adoption benefits shareholders, but that the benefits depend critically on the strength of the countries’ enforcement systems. 1 This paper is based on my dissertation at the University of Southern California. I am grateful to my dissertation committee, especially my co-chairs, Mark DeFond and Mingyi Hung, for their invaluable guidance and support. I am also thankful to Robert Trezevant and Biqin Xie for their helpful comments and suggestions. This work is supported in part by U.S. Department of Education Title V1-B funds administered by USC’s Center for International Business, Education, and Research.