The Relation between Income Smoothing, Earnings Persistence and IFRS Adoption/(A Relacao entre Suavizacao, Persistencia e a Adocao dos IFRS).

AutorKolozsvari, Ana Carolina

1. Introduction

This research approaches the influence of income smoothing on persistence of the earnings reported by firms, considering the adoption of International Financial Reporting Standards (IFRS), in Brazilian market. As time series properties, smoothness and persistence capture changes and effects of impacts on earnings differently but relatedly, since they are distinct properties of a same reported earnings stream. Consequently, accounting choices directed to reduce the time series volatility, which denotes an income smoothing behavior, may affect the other property the persistence, representative of earnings usefulness for valuation (Schipper & Vincent, 2003; Dechow & Schrand, 2004; Francis, LaFond, Olsson & Schipper, 2004; Dechow, Ge & Schrand, 2010).

Additionally, during the generation of the earnings time series, through the successive financial reporting process, exogenous factors can change the established temporal properties and their relation, such as the adoption of the IFRS. With it, we study the influence of smoothing behavior on persistence in Brazil, with focus on how IFRS adoption affected this relation.

The persistence of earnings is interesting because this is a time-series property related to the usefulness of this information for valuation, affecting the decision making of investors and external users. Empirical studies in Brazilian market evidence that IFRS adoption increased the relevance of reported earnings (Lima, 2010; Macedo, Araujo & Braga, 2012; Macedo, Machado, Machado & Mendonqa, 2013; Gonsalves, Batista, Macedo & Marques, 2014). Related to this, we seek to clarify whether the reported results, identified as more relevant under IFRS in comparison to former domestic standards, are effectively more informative, from persistence perspective.

A direct approach shows a decrease of persistence by income smoothing, in Brazilian market, for 2004-2013 period as a whole (Kolozsvari and Macedo, 2016). Given that, we intend to clarify this relation, considering the different accounting environments due IFRS, in Brazil. Therefore, we propose the following research question: Which was the impact of IFRS adoption for the influence of income smoothing on earnings persistence, in Brazilian market?

Brazil adopted the international standards lately, initially after 2008 and fully after 2010, while for several other countries, it was mandatory since 2005. With that, most of the empirical researches related to IFRS adoption effects developed so far occurred before the Brazilian convergence process, which gives the opportunity for this study.

Our general objective was to investigate whether the IFRS adoption modified the influence of income smoothing on earnings persistence, in Brazilian market; and specifically, if the differences relate to initial adoption and full adoption, for persistence itself and for the relation smoothing-persistence.

We found evidences of increase in persistence for both steps of IFRS adoption, which complement the increase in relevance from previous studies. For the smoothing-persistence relation, the results show a shift of income smoothing role, regarding the IFRS adoption - in BRGAAP (IFRS) environment, the smoothing increased (decreased) the persistence.

We conclude that the IFRS adoption in Brazilian market increased the quality of reported earnings, in terms of its usefulness for valuation, and the interferences from accounting choices in order to reduce the variability in reported income stream, passed to reduce the capacity of external users in estimate the future performance.

2. Background and Hypotheses Development

2.1 IFRS adoption for the quality of accounting information and the Brazilian market

The adoption of IFRS around the world comes progressively, in different moments. Brazil started to use the international standards after 2008, and the total convergence happened in 2010, with the full adoption (IFRS Foundation, 2015). This process was one of the significant advances of Brazil to strengthen accounting during the last decade (World Bank, 2013).

This process is justified by arguments of improvement in the quality of reported information by companies to external users, since the former Brazilian standards intended for more tax compliance than financial reporting. This change of focus, to a principle-based system leads to new disclosure incentives and accounting practices, an opportunity for managers to improve the informative news of earnings, but also to manipulate earnings with accrual accounting (Cavalier-Rosa and Tiras, 2013).

The reported numbers are of higher quality when they reflect better the economic situation and performance of the firm, because they offer higher basement for investment decisions. Thus, a change of accounting standards that limits the opportunistic discretion of managers and/or allows better adherence of numbers to the economic reality of the firm increases the quality of the information. The voluntary adoption of international accounting standards in several countries, shows lower levels of earnings management and higher value relevance, improving the quality of reported information (Barth, Landsman & Lang, 2008).

The mandatory IFRS adoption in Europe and Australia reduced earnings management, including income smoothing, with mixed evidences of decrease / no effects over the value-relevance of reported information and increase in persistence (Zeghal, Chtourou & Fourati, 2012; Jaweuner & Mounira,

2014).

For Brazilian market, the evidences of IFRS adoption show that the earnings management by accruals decreased, but it increased when by operational decisions (Cupertino, 2013), with restrictive effects over discretionary appropriations by full IFRS adoption (Pelucio-Grecco, Geron, Grecco & Lima, 2014). In turn, findings also show no relation between IFRS and the level of discretionary accruals (Joia & Nakao, 2014) and an increase in smoothing practices after the IFRS adoption (Klann & Beuren, 2015). Additionally, the initial IFRS adoption increased the value relevance of earnings and equity (Lima, 2010; Macedo et al., 2012), and the full IFRS adoption increased the relevance of earnings, but not the equity (Macedo et al., 2013; Gonsalves et al., 2014). These findings generally reflect more adequate representations of economic reality in international standards than in former Brazilian domestic standards, with a greater indicative of earnings as useful information.

The evidences of value relevance and earnings management are interesting to this research, as they are strictly related to time-series properties of persistence and smoothness. The value relevance relates to persistence, since it represents the usefulness of earnings stream for valuation purposes. Smoothness, in turn, is frequently associated to earnings management practices - i.e. income smoothing, being also another time-series property, inverse to volatility.

2.2 Persistence

Persistence is a time-series property sensitive to transitory variations --the higher the transience the lower the persistence (Schipper & Vincent, 2003). Similarly, persistence is a synonym of non-randomness in the behavior of reported earnings (Lev, 1983). From an internal perspective of the company, the persistence reflects how much a change in current earnings remains in future earnings (Baginski, Lorek, Willinger & Branson, 1999). From the perspective of external users, especially investors, persistence is a measure of how much current earnings effectively represent future earnings, in order to be useful for valuation (Dechow et al., 2010).

For several countries, there are evidences of no differences in the persistence of earnings reported under international and non-U.S. domestic standards, or for association of earnings and future cash flows (Atwood, Drake, Myers & Myers, 2011). For Greece, the IFRS did not systematically raised the informative content of reported earnings (Doukakis, 2010). For Germany, the voluntary adoption of international standards shows evidences of loss of value relevance. That, associated to a significant decrease of the series autocorrelation, leads to the conclusion for transience, in comparison to persistence in the former standards (Hung & Subramanyam, 2007). But, also, a non-significant difference of value relevance, with a significant increase in persistence, when measured directly (Gassen & Sellhorn, 2006).

Additionally, eliminating the reconciliation of IFRS and U.S. GAAP, to foreign companies in American market, increased the persistence in weaker investor protection countries, and had no effect on stronger countries. This leads to the conclusion that companies from weaker environments had a greater incentive to show information quality by voluntarily improving the disclosure quality (Kang, Krishnan, Wolf & Yi, 2012).

Thus, there is not a consensus about the impacts of IFRS adoption over persistence. However, since previous Brazilian accounting practices focused in tax compliance, while IFRS is more shareholder-oriented (Cavalier-Rosa and Tiras, 2013; Hung and Subramanyam, 2007), from a weak legal system environment, with efforts to strengthen accounting (Kaufmann, Kraay & Mastruzzi, 2009; World Bank, 2013), we expect a more representative reported information about financial position and fundamental performance from the companies. Accordingly, we formulate the following hypothesis related to IFRS adoption impacts over persistence:

H1 The adoption of IFRS increased the persistence of reported earnings, in Brazilian market.

2.3 Influence of income smoothing on persistence

Smoothness, another time-series property of reported earnings, captures variations in a general approach, independently if they are transitory or permanent. It is also defined as lack of variability in the time-series (Schipper & Vincent, 2003; Francis et al., 2004; Dechow et al., 2010).

Another sense to smoothness is as result of earnings management, specified as...

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