Did the switch to IFRS 11 for joint ventures affect the value relevance of corporate consolidated financial statements? Evidence from France and Italy

Abstract

We investigate the effects of the adoption of International Financial Reporting Standard (IFRS) 11, Joint Arrangements. In so doing, we analyze whether the removal of the proportionate consolidation option and the mandatory use of the equity method in reporting for joint ventures influences the value relevance of co-venturers’ total assets and liabilities. In a reverse situation, i.e. the elimination of the equity method, Richardson, Roubi, and Soonawalla (2012) found a decline in the value relevance of the aforementioned amounts for firms forced to change reporting method, partially offset by the value relevance of joint venture data disclosure. We focus on a continental European setting and analyze a sample of 120 Italian and French non-financial listed firms over the period 2008–2015. We find a reduction in the value relevance of co-venturers’ total assets and liabilities for companies obliged to move from proportionate consolidation to the equity method. Conversely, we do not find an increase in the value relevance of joint venture disaggregated data provided in the notes.

Introduction

The provisions of International Financial Reporting Standard (IFRS) 11, Joint Arrangements, revived the debate on reporting for investments in joint ventures. Issued by the International Accounting Standard Board (IASB) in 2011, this standard eliminated the free choice between using proportionate consolidation and the equity method to account for joint ventures by requiring use of the equity method. The IASB’s decision is not supported by the extant accounting literature, which has not reached conclusive results on the conceptual supremacy of the equity method. Furthermore, most respondents to the Exposure Draft ED 9 (International Accounting Standard Board, 2007) did not agree with the abandonment of proportionate consolidation (Alexander, Delvaille, Demerens, Le Manh, & Saccon, 2012).

The two accounting methods ultimately lead to the same total shareholders’ equity and net income, but result in a significantly different qualitative and quantitative representation of the group’s results. Due to these differences, many studies have attempted to demonstrate the supremacy of one method over the other. However, the results are mixed.

Research has addressed this issue from a theoretical point of view, identifying the advantages and disadvantages of each method (Dieter & Wyatt, 1978; Bierman, 1992; Milburn, FASB, and Chant, 1999). Empirical studies have examined the ability of proportionally-consolidated amounts, compared with those using the equity method, to predict the co-venturer’s profitability (Graham, King, & Morrill, 2003; Leitner-Hanetseder, 2010). Some research analyzed the association between several financial statement figures and ratios computed under the two concurrent methods with variables assumed as proxies for market risk, such as share-price volatility (Kothavala, 2003), bond ratings (Bauman, 2007), and bond risk premiums (Stoltzfus & Epps, 2005). Previous research provided evidence that the disclosure of disaggregated data of joint ventures is value relevant (Bauman, 2003; O’Hanlon & Taylor, 2007; Soonawalla, 2006) and can reduce information asymmetry between market participants (Lim, Yeo, & Liu, 2003). Another stream of research deals with the drivers of the corporate choice between proportionate consolidation and the equity method (Catuogno, Allini, & D’Ambrosio, 2015; Lourenço & Curto, 2010).

Richardson et al. (2012) examine the effects on value relevance of the co-venturer’s total assets and liabilities stemming from the decision of the Canadian standards setter to abandon the equity method in reporting for joint ventures. They detected a decrease of value relevance for companies that switched from the equity method to proportionate consolidation, as well as a significant value relevance of joint venture data provided by mandatory disclosure. These authors suggest that their results may be due to the elimination of accounting choice. However, because they could not analyze the reverse situation, they were unable to discern conclusively whether the decline in value relevance was due to the use of the proportionate consolidation method or in some way represented a cost of the reduced choice in reporting methods. Therefore, there is a need for research carried out in the situation of a mandatory change from the free choice of the equity method or proportionate consolidation to the required use of the equity method.

Finally, the effects of adopting IFRS 11 are rather unexplored, and the few studies addressing this issue focused on the impact of the new standard on financial statement amounts and ratios (Demerens, Le Manh, Delvaille, & Parè, 2014; Leitner-Hanetseder & Stockinger, 2014; Lopes & Lopes, 2019). We explore this gap by verifying whether the mandatory use of the equity method, required by IFRS 11, affects the ability of the co-venturer’s total assets and liabilities to explain the equity market value of the reporting firm. Moreover, since the equity method does not allow the co-venturer’s share of joint venture assets and liabilities to be shown on the statement of financial position, we investigate whether the value relevance of the disclosure of such amounts in the notes increases for companies required to change to the equity method.

We view the value-relevance perspective as the ultimate goal of EU Regulation 1606/2002, which adopted IAS/IFRS, because it seeks “to improve the efficient and effective functioning of capital markets”. This is consistent with the value-relevance perspective that focuses on the information needs of equity investors (Palea, 2013). Further, research providing evidence on the value-relevance implications of a change in accounting standards can be of interest to standard setters as it “can be informative to their deliberations on accounting standards” (Barth, Beaver, & Landsman, 2001, p. 89).

To the best of our knowledge, no study has yet analyzed the effects of the adoption of IFRS 11 on the value relevance of the co-venturer’s consolidated financial statements and we contribute by analyzing a continental European setting. We focus on the French and Italian contexts, which are comparable for financial market characteristics, accounting culture, and corporate governance structures (Franks, Mayer, Volpin, & Wagner, 2011; Nobes, 2011; Rizzotti, Frisennsa, & Mazzone, 2017; Gandini, Astori, & Cassano, 2009), and use a sample of 120 non-financial listed firms over the period 2008–2015.

Our findings demonstrate that companies that preferred proportionate consolidation before adopting IFRS 11 and were then required to change to the equity method suffered a decrease in the value relevance of total liabilities and, with lower statistical significance, of total assets Conversely, companies that used the equity method before IFRS 11 came into force do not show any significant effect on the value relevance of their total assets and liabilities. Further, the switch to the equity method does not significantly affect the value relevance of the co-venturer’s share of joint venture assets and liabilities disclosed in the notes.

Our study contributes to the literature on reporting for joint ventures and to the empirical research on the value relevance of accounting information provided under IFRS (Barth, Landsman, & Lang, 2008; Clarkson, Hanna, Richardson, & Thompson, 2011; Fasan, Fiori, & Tiscini, 2014; Hung & Subramanyam, 2007; Morais & Curto, 2009). We add to the scarce literature on the effects of IFRS 11 adoption, presenting evidence on a continental European setting. In so doing, we provide some insights to the IASB in order to assess the effect of the implementation of IFRS 11.

The remainder of the paper is organized as follows: the next section presents prior studies on reporting for joint ventures; Section 3 illustrates the main motivations underlying the IASB’s decision to eliminate proportionate consolidation as an option to account for joint ventures; Section 4 introduces the value-relevance perspective and hypotheses development; Section 5 describes the data and methods; Section 6 provides the results and discusses them; Section 7 presents sensitivity analysis; and Section 8 concludes by noting limitations and suggests avenues for further research.