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Financial Reporting under IAS/IFRS

Theoretical Background and Capital Market Evidence – A European Perspective

Vera Palea

This book provides the theoretical background and analyses capital market research related to the IAS/IFRS adoption in Europe, which is one of the most important and controversial events in the history of accounting. It adopts both an investor and a firm perspective and therefore investigates the effects of adopting IAS/IFRS on the decision-usefulness of financial reporting for investors as well as on the firms’ cost of capital. The book also focuses on fair value accounting, which is widely controversial.
All these issues are of considerable interest for standard setters and policy makers, whose primary aims are in fact to provide investors with useful information for their decision-making process and to allow firms to have access to a more efficient and cost-effective capital market.

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Chapter 4: The Effect of Accounting Disclosure on the Firm’s Cost of Capital 97

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97 Chapter 4 The Effect of Accounting Disclosure on the Firm’s Cost of Capital 1. Introduction The link between accounting information and the firm’s cost of capital is one of the most fundamental issues in accounting and standard setters and regulators often refer to it. Art. 1 of Regulation 1606/2002 states that its objective is “the adop- tion of international accounting standards with the view to […] ensure a high degree of transparency and comparability of financial statements and hence an efficient functioning of the […] capital market”. As a re- sult, one of the expected effects of the IAS/IFRS implementation in Europe is a reduction in the firm’s cost of capital. A higher level of trans- parency in financial reporting should lower the estimation risk premium which arises in case of information asymmetries and, therefore, the firm’s cost of capital. As claimed by Neel Foster (2003), former member of the Financial Accounting Standards Board (FASB), “more information always equates to less uncertainty. In the context of financial information, the end result is that better disclosure results in a lower cost of capital”. The IAS/IFRS adoption in the European Union is also expected, through accounting standardization, to reduce possible errors in cross-coun- try comparison of European companies due to different accounting sys- tems. The adoption of the same accounting standard set within the Euro- pean Union should improve comparability and, in this way, eliminate accounting measurement errors in pricing firms. As a result, the IAS/IFRS adoption at the European level is also...

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