Network Effects in Countries’ Adoption of IFRS

by Karthik Ramanna & Ewa Sletten

Overview — Between 2003 and 2008, 75 countries adopted, to various degrees, International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board. More countries, including the United States and China, are currently engaged in convergence projects. Researchers Karthik Ramanna (Harvard Business School) and Ewa Sletten (MIT Sloan School of Management) report on the role that perceived network benefits play in convincing some countries to shift from local accounting standards to IFRS. Key concepts include:

  • In a country's decision to adopt IFRS, perceived network benefits from IFRS adoption—that is, lower transaction costs expected to accrue to foreign users of financial statements—come to outweigh institutional differences (e.g., auditing technology) that make IFRS adoption costly.
  • The results suggest IFRS adoption among countries is self-perpetuating.
  • Low GDP countries and countries more dependent on foreign trade have a differentially higher response to these perceived network benefits.
  • Perceived network benefits are unlikely to be realized in low GDP countries since these countries are unlikely to rapidly adapt their corporate governance institutions to IFRS.

Author Abstract

If the differences in accounting standards across countries reflect relatively stable institutional differences (e.g., auditing technology, the rule of law, etc.), why did several countries rapidly, albeit in a staggered manner, adopt IFRS over local standards in the 2003-2008 period? We test the hypothesis that perceived network benefits from the extant worldwide adoption of IFRS can explain part of countries' shift away from local accounting standards. That is, as more jurisdictions with economic ties to a given country adopt IFRS, perceived benefits from lowering transactions costs to foreign financial-statement users increase and contribute significantly toward the country's decision to adopt IFRS. We find that perceived network benefits increase the degree of IFRS harmonization among countries, and that smaller countries have a differentially higher response to these perceived benefits. The results, robust to numerous alternative hypotheses and specifications, suggest IFRS adoption is self-reinforcing, which, in turn, has implications for the consequences of IFRS adoption.

Paper Information