The Effect of Various Accounting standrds or Based on Accounting Standrads on Analysts Forecast Accuracy in Germany

The Effect of Various Accounting standrds or Based on Accounting Standrads on Analysts Forecast Accuracy in Germany

1. Introduction

We look at how different accounting principles, as well as a change in accounting standards, affect the accuracy of financial experts' profit forecasts. Our findings show that estimates based on data prepared according to internationally accepted accounting principles (IAAP), such as International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS)1 or United States Generally Accepted Accounting Principles (US GAAP), are more accurate than estimates based on German GAAP (also known as "Handelsgesetzbuch (HGB)") data. Furthermore, projection accuracy is poorer in years when new accounting principles are adopted than in other years for enterprises transitioning from HGB to US GAAP. For two reasons, Germany provides a unique framework for these analyses: To begin with, many publicly traded German corporations have gradually adopted internationally accepted accounting methods (IAAP).,Before 2005, it was IAS/IFRS or US GAAP. As a result, the impact of new accounting rules might be investigated while controlling for macroeconomic and other variables that fluctuate over time. Second, the national German GAAP differs greatly from IAS/IFRS and US GAAP, highlighting the effect of accounting principles on analyst accuracy. The introduction of IFRS throughout Europe is the driving force behind this research. The IAS legislation (1606/2002/EC) has obliged practically all publicly traded European corporations to prepare consolidated statements under IFRS since 2005. 2 We're trying to draw some conclusions from the German adoption process, where many corporations moved to IAS/IFRS or US GAAP before 2005.

Many research have looked into the accuracy of analysts' forecasts and the factors that influence it. The majority of previous research has been done in the United States (e.g., Lys and Soo 1995; Mikhail, Walther, and Willis 1997; Alford and Berger 1999; Clement 1999; Jacob, Lys, and Neale 1999; Duru and Reeb 2002; Irvine 2004; Gu and Wang 2005; Lin and Yang 2006) or the United Kingdom (e.g., Lys and Soo 1995; Mikhail, Walther, and Willis 1997; Alford and Berg (e.g. Acker, Horton, and Tonks 2002). Similar to Capstaff, Paudyal, and Rees (1998), Wallmeier (2005), Daske (2005), and Bessler and Stanzel (2005), we examine the German market (2007). Only Daske's (2005) study, which looked at the years 1993-2002, explicitly accounts for the type of accounting standards used. Similarly, our research addresses the impact of accounting regime variations, but also provides data on analysts' forecast accuracy for a more recent time span, namely 1998-2004.

Our study adds to previous research by using accounting principles and changes in accounting principles as control variables. In contrast to Daske (2005), we can show that the application of an international accounting system (IAS/IFRS and US GAAP) is related with higher financial analyst forecast accuracy. Since 1998, German corporations have been able to select between using national GAAP, IAS/IFRS, or US GAAP to construct their consolidated accounts. As a result, Germany offers a unique foundation for comparative examination inside a uniform institutional setting. This enables us to effectively account for institutional factors (such as regulatory requirements and enforcement systems), which have been shown to be key predictors of analyst forecast quality (Hope 2003a; Hope 2003b; Hope 2004; Barniv, Myring, and Thomas 2005).

The following is the format of our paper: The second section provides a summary of similar past research. The research hypotheses are presented in Section 3. The variables and models utilised in the analyses are explained in Section 4. The sample selection process and data sources are discussed in Section 5. The descriptive and regression results are presented and discussed in sections 6 and 7. Section 8 contains the findings of the sensitivity analysis, while Section 9 is the final section.

2. Literature review

2.1 Drivers of analyst forecast accuracy

There has been an explosion of study into analyst estimates in recent years. Analyst accuracy is driven by interacting analyst-specific and firm-specific factors (see Figure 1). In terms of the individual analyst, it is well known that he or she is optimistic in the sense that his or her estimates are systematically upward skewed (e.g. Easterwood and Nutt 1999) and are changed over time (e.g. Bartov, Givoly, and Hayn 2002). Furthermore, analysts may demonstrate a variety of talents as a result of their experience, workload, or risk tolerance. On the other hand, a firm's features, such as its size, industry or location of operation, or regulatory environment, influence analyst forecast accuracy (e.g. Das and Saudagaran 1998; Higgins 1998). Furthermore, management activities may have a direct or indirect impact on forecast accuracy.On the one hand, multiple studies show that profits management and forecasting guidance toward consensus are important (Bannister and Newman 1996; Degeorge, Patel, and Zeckhauser 1999; Matsumoto 2002; Bartov, Givoly, and Hayn 2002; Abarbanell and Lehavy 2003; Hutton 2005; Burgstahler and Eames 2006; for Germany see Bessler and Stanzel 2007). Management, on the other hand, attempts to influence analysts' expectations by publishing its own estimates (e.g. Williams 1996; Bamber and Cheon 1998; Lennox and Park 2006). As a result, both earnings management and expectations management work together to drive analyst consensus down to beatable analyst projections, which may promote equity issuances or insider trading (e.g. Richardson, Teoh, and Wysocki 2004).

2.2 Analyst forecast accuracy and accounting data

This research focuses on management's actions in relation to the firm's accounting processes and disclosure policy. Our research incorporates two types of studies: effect studies of accounting data and impact studies of IAAP adoption.

Financial analysts are generally viewed as competent financial information processors and as market representatives (Revsine, Collins, and Johnson 2001). Furthermore, evidence suggests that financial statements are a valuable source of data for analysts when making estimates (Acker, Horton, and Tonks 2002; Peek 2005).

There has been a lot of research into the effects of (changes in) accounting standards and disclosures on forecast accuracy. Lang and Lundholm (1996), for example, find that a disclosure score for US companies from 1985 to 1989 is positively associated with the number of analysts following (i.e. coverage) as well as forecast accuracy, and negatively associated with forecast dispersion and variability of forecast revisions. However, important links can be found in the category of investor interactions, but annual financial statements and other publicly available information are rarely noteworthy. Hope's international investigation backs up the conclusions of Lang and Lundholm (1996). (2003a). He finds that companies' disclosure levels (as well as the level of enforcement) are positively associated with analyst forecast accuracy, based on 1,309 firm-year observations from 22 countries. Several other studies (Higgins 1998; Chang, Khanna, and Palepu 2000; Ang and Ciccone 2001; Acker, Horton, and Tonks 2002; Hope 2003b; Vanstraelen, Zarzeski, and Robb 2003; Hope 2004) look at the relationship between disclosure quality and forecast errors and find similar results for different countries.

The predictive value of disclosures, in particular, appears to have a beneficial impact on the characteristics of analyst earnings projections. For example, segment reports, which are designed to assist consumers of financial statements in evaluating a company's current and future performance, have been found to improve analysts' profit projections (Baldwin 1984; Swaminathan 1991; Hussain 1998; Lobo, Kwon, and Ndubizu 1998; Behn, Nichols, and Street 2002). Similarly, Barron, Kile, and O'Keefe (1999) show a link between forecast accuracy and the quality of disclosures in the Management Discussion and Analysis (MD&A), particularly specific forward-looking information.

Aside from disclosures, the impact of various accounting standards on forecast accuracy has been investigated. Basu, Hwang, and Jan (1998) found that forecast accuracy is lower in countries with accounting regimes that have the following characteristics: higher relative use of current value accounting (with revaluations passing through the income statement), less relative use of accruals, and fewer accounting methods to choose from. Hope (2004), on the other hand, finds contradictory results for a sample of 18 nations. He finds that, after controlling for differences in enforcement systems between countries and differences in disclosure levels between firms, the relative extent of choice is negatively associated with forecast accuracy and the relative extent of accrual accounting is positively associated with forecast accuracy. Mensah, Song, and Ho study the impact of conservatism on financial analyst forecast accuracy (2004).TThey looked at three different measures of conservatism and discovered that a higher level of conservatism led to higher financial analyst forecast errors.

According to Ashbaugh and Pincus (2001), different accounting systems are compared using financial analyst forecast accuracy as a baseline, and IAS is used as a benchmark. They show that analyst forecast mistakes are positively associated to variances between various native GAAP and IAS for a cross-country sample of 80 companies that adopted IAS between 1990 and 1993. Furthermore, they discover that after implementing IAS, forecast accuracy improves. In 1999, Cuijpers and Buijink evaluated the factors and repercussions of implementing IAAP for 114 enterprises from 12 European nations (including Germany). They demonstrate that the IAAP application has a good effect on analysts who use it. They do, however, show that organisations that use IAAP have a higher analyst forecast dispersion effect. Daske (2005) did a comparable investigation in Germany between 1993 and 2002.He finds that analysts' profit estimates based on IAS/IFRS or US GAAP have poorer accuracy and dispersion, but no significant difference in volatility when compared to those based on German GAAP. In contrast to our research, he does not account for the complexity of the forecasting problem as evaluated by a company's beta. He also presents evidence that the level of disparities between earnings under IAS/IFRS or US GAAP and earnings under German GAAP, as well as the level of transition guidance supplied by corporations, has an impact on forecast accuracy and forecast dispersion during the transition period. The distinct time period analysed and the varied approach could explain why their results differ from ours.

Other research looks into the impact of accounting method changes on forecast accuracy. Brown, Richardson, and Schwager (1987) show that accounting changes in 1976 had just a minor impact on forecast accuracy in the United States. When further disclosures, such as pro-forma adjustments, are disclosed, the impact is reduced. Between 1976 and 1984, Elliott and Philbrick (1990) looked into accounting adjustments. Their findings indicate that forecast accuracy is poorer in years where accounting changes occur without previous notice. Peek confirms the findings for the Netherlands (2005). After changes in accounting rules influencing earnings before unusual items, projection accuracy has decreased. These changes have different implications depending on the earlier disclosures and the type of modification.

Several studies have looked at the impact of the adoption of IAS/IFRS from various perspectives and approaches. Barth, Landsman, and Lang (2007) report a slight decrease in the cost of capital after the adoption of IAS/IFRS and a higher accounting quality of IAS/IFRS in comparison to domestic GAAP on several measures such as timely loss recognition and value relevance in a cross-country study that includes Germany. Other studies employ net income and/or shareholders' equity reconciliations to assess the differences between IAS/IFRS and other accounting systems, as well as the consequences of these differences (e.g. Harris and Muller 1999; Beckman, Brandes, and Eierle 2007). The majority of research look at the impact of IAS/IFRS implementation in a single country. Switzerland (Auer 1999), Finland (Kinnunen, Niskanen, and Kasanen 2000), and Kuwait (Kinnunen, Niskanen, and Kasanen 2000) have all done studies (El Shamy and Al-Qenae 2005).

2.3 Impacts of the adoption of IAAP

The majority of studies on the impact of IAS/IFRS implementation look at Germany. The capital market effects of IAS/IFRS adoption are examined in one part of the study, while the accounting or disclosure quality of IAS/IFRS in comparison to German GAAP is examined in the other. In terms of capital market effects, Leuz and Verrecchia (2000) and Gassen and Sellhorn (2006) report lower information asymmetry but no decrease in volatility after IAS/IFRS implementation. When Leuz (2003) compares IAS and US GAAP adopters in Germany, he finds no substantial difference in terms of information asymmetry as measured by bid-ask spreads and share turnover. Finally, after the introduction of IAS/IFRS and US GAAP, Daske (2006) was unable to demonstrate that the estimated cost of equity capital had dropped.

In terms of accounting or disclosure quality, Hung and Subramanyam (2007) find only a little amount of evidence for IAS being more value relevant than German GAAP in a sample of 80 companies who adopted IAS between 1998 and 2002. Furthermore, they show that German GAAP is more conservative and less focused on fair value than IAS. Positive results based on IAS and US GAAP have a higher value relevance than those based on German GAAP, according to Bartov, Goldberg, and Kim (2005). However, there is no difference between the three accounting regimes for negative earnings or between IAS and US GAAP results. Furthermore, Gassen and Sellhorn (2006) demonstrate that corporations that use IAS/IFRS have more stable, less predictable, and conditional conservative earnings than companies that use German GAAP. Daske and Gebhardt (2006), focusing on disclosures, show that the quality of disclosures has improved when German corporations adopted IAS/IFRS or US GAAP.

According to a review of the available literature, there is yet to be a large-scale study examining the influence of IAS/IFRS and domestic GAAP on analysts' forecast accuracy within the same institutional environment. The purpose of this study is to fill this knowledge gap and to shed light on the effects of varied IAS/IFRS, US GAAP, and German GAAP attributes on forecast accuracy in Germany.Improved forecast accuracy, according to Gebhardt, Lee, and Swaminathan (2001), could be linked to higher accounting quality and a lower implied cost of capital. As a result, the study method employed is related to both the accounting quality of IAS/IFRS and US GAAP as well as the capital market impact of their adoption. However, high analyst forecast accuracy does not always imply excellent accounting quality, because analyst forecast accuracy is a complicated attribute that is formed by a set of potentially competing incentives as well as the institutional context, as mentioned above.

3. Hypotheses

In this research, we look at how analysts deal with the introduction of IAS/IFRS or US GAAP. As a result, we're interested in the short-term effects of changing accounting principles as well as the long-term ramifications of adopting more investor-oriented accounting standards in a country where accounting rules have traditionally been more stakeholder-oriented.

The first premise of our research is that financial analysts' profits per share forecasting accuracy varies depending on the accounting system. According to studies on the impact of disclosures on forecast accuracy, an increase in the quantity and quality of disclosures following the adoption of IAS/IFRS or US GAAP (Daske and Gebhardt 2006) should c.p. lead to a higher forecast accuracy (Lang and Lundholm 1996; Higgins 1998; Chang, Khanna, and Palepu 2000; Ang and Ciccone 2001; Acker, Horton, and Tonks 2002; Hope 2003a; Hope 2003b; Hope 2004). According to Mensah, Song, and Ho (2004), the more conditional conservative earnings of IAS/IFRS compared to German GAAP found by Gassen and Sellhorn (2006) might reduce forecast accuracy for enterprises migrating from German GAAP to IAS/IFRS.

Furthermore, compared to US GAAP and IAS/IFRS, German GAAP is less fair value-oriented. In contrast to US GAAP and IAS/IFRS, German GAAP does not allow upward revaluations of some categories of financial assets at fair value. Even property, plant, and equipment, as well as investment property, can be assessed at fair value under IAS/IFRS (IAS16.31). 3 Hung and Subramanyam experimentally validate the stronger fair value-orientation of IAS/IFRS in comparison to German GAAP (2007). Because earnings under historical cost accounting are more trustworthy and verifiable (e.g. Ijiri and Noel 1984; Knutson 1992) and less volatile than earnings under current cost accounting, Peek (2005) contends and empirically shows that a stronger fair value-orientation reduces prediction accuracy. However, only a portion of the fair value adjustments, such as those resulting from trading financial assets, has an impact on net income under IAS/IFRS and US GAAP. Revaluations of available-for-sale financial assets according to IAS/IFRS as well as revaluations of property, plant, and equipment according to IAS/IFRS until 2003) or must (e.g. revaluations of available-for-sale financial assets according to US GAAP and according to IFRS since 2004) be recognised directly in equity. As a result, the fair value-orientation might give financial analysts with forward-looking information without affecting reported and anticipated profit measurements.

In addition, the lower level of accrual accounting in German GAAP compared to US GAAP (Nobes and Parker 1998; Basu, Hwang, and Jan 1998; Hope 2004) or IAS/IFRS is said to affect prediction accuracy. Capitalization and amortisation provide useful information about future profitability, and as a result, prediction accuracy should improve (Peek 2005). This would suggest a higher prediction accuracy for IAAP-based financial statements. A higher level of accrual accounting, on the other hand, creates opportunities for earnings management, which may have a negative impact on prediction accuracy.

Earnings volatility is another crucial component in determining the accuracy of financial analysts' forecasts (Ashbaugh and Pincus 2001; Peek 2005). When estimating profits with a higher volatility, basic models to extrapolate prior earnings trends may not be possible. As a result, more earnings volatility is likely to lead to decreased earnings predictability, resulting in worse forecast accuracy and a stronger forecast bias among financial experts (e.g., Lys and Soo 1995; Das, Levine, and Sivaramakrishnan 1998). Because the stronger fair value-orientation of IAS/IFRS and US GAAP in compared to German GAAP may result in higher earnings volatility, organisations using IAAP might expect reduced forecast accuracy.

Finally, the reduced range of options in US GAAP compared to IAS/IFRS or German GAAP (Nobes and Parker 1998) may have an impact on projection accuracy. For starters, more options and less discretion may be associated with improved forecast accuracy, since it may improve companies' ability to manage earnings in line with analysts' earnings forecasts. According to several studies, such earnings management behaviour exists (Bannister and Newman 1996; Degeorge, Patel, and Zeckhauser 1999; Matsumoto 2002; Abarbanell and Lehavy 2003).

Choices, on the other hand, enhance the complexity and uncertainty of analysts (Ashbaugh and Pincus 2001), lowering forecast accuracy (Hope 2004). Furthermore, earnings management may have goals other than meeting analysts' earnings forecasts, such as reporting a positive result (Hayn 1995), increasing share price before a stock transaction (Dechow, Sloan, and Hutton 1996; Teoh, Welch, and Wong 1998), or meeting contractual obligations, such as short-term bonus contracts tied to accounting measures (Holthausen, Larcker, and Sloan 1995). Because these goals are largely unknown to outsiders, they may make earnings less predictable for analysts. In Germany, the degree of earnings management appears to be broadly consistent across accounting principles (Van Tendeloo and Vanstraelen 2005; Goncharov 2005). As a result, the amount to which alternative accounting standards are chosen should not have a substantial impact on forecast accuracy in Germany.

In conclusion, the impact of alternative accounting regimes on financial analysts' forecast accuracy is not clear. Analysts should obtain more (externally validated) information about the company's financial status with the adoption of IAS/IFRS or US GAAP, allowing them to base their predictions on a wider data set. Similarly, more insightful accounting systems are likely to improve analysts' prediction accuracy without significantly skewing the expected net income.