Mandatory IFRS adoption and the cost of Equity Capital. Evidence from Spanish Firms

Abstract

Purpose: The main objective of this paper analyses the effects of mandatory International Financial Reporting Standards (IFRS) adoption by Spanish firms in 2005 on the cost of equity capital.

Design/methodology: Using a sample of listed Spanish companies during the 1999 to 2009 period and a country-level focused analysis. To achieve our objective we relied on OLS regression analysis and estimate the dependent variable – the cost of equity – by using the proxy suggested in Easton (2004).

Findings: We find evidence that, unlike previous studies, Spanish listed companies show a significant reduction in their cost of equity capital after the mandatory adoption of IFRS in 2005, after controlling by a set of firm-risk and market variables. According to our results, increased financial disclosure and enhanced information comparability, along with changes in legal and institutional enforcement, seem to have a joint effect on the cost of capital, leading to a large decrease in expected equity returns.

Research limitations: The main limitation of the study is that the sample represents just one country.

Practical implications: The findings of the study may have implications for the firms’ management staff, as they reveal what information determines the cost of equity capital. The systematic risk and the leverage affect positively the cost of stocks and therefore their market value. The results are consistent with the financial principle establishing that the higher risk and the higher leverage, the higher cost of capital.

Originality/value: As a result of the conducted research, one is able to figure out which stock-return variables should be observed to anticipate the change of a company’s cost of capital.