The effect of the adoption of International Financial Reporting Standards on foreign portfolio investment in Africa

Abstract

The goal of achieving a uniform high-quality international accounting standards for financial reporting started in the second half of the 20th Century. This idea became a reality in the year 2001, when the International Accounting Standards Board (IASB) developed the International Financial Reporting Standards (IFRS) as a financial reporting framework for all the listed companies globally. The decision to have a single set of high-quality global accounting standards was accelerated due to the development in the world economy, especially at the end of the Second World War. Besides, the rapid expansion in the globalisation of financial markets and the internationalisation of economic trade across the world demand for unified international accounting standards. Previously, each country made use of its national accounting standards framework for the preparation of financial statements. This development caused much diversity in accounting rules and practices across the nations. It affected the quality, credibility, reliability, and transparency of financial statements, which in turn affected the inflow of foreign investments and hindered economic growth. Consequently, the proponents of IFRS suggest that the adoption of IFRS will improve transparency and enhance the comparability of financial statements in the adopting countries. Hence, foreign investors will be able to compare the financial statements prepared in one IFRS jurisdiction with similar listed companies in other countries to aid the investment decision process. This scenario is assumed to enhance the efficient allocation of resources substantially and diversification of foreign capital, especially in the adopting countries. Given this background and reflecting on the needs of developing countries’ eagerness for foreign capital for economic sustainability, it is believed that adoption of IFRS will influence more inflows of foreign portfolio investment into the adopting countries as suggested by the proponents of IFRS. The European Union took the lead in 2005 when it made it mandatory for all the listed companies in the Union to start using IFRS as an accounting framework for the preparation and presentation of financial statements. Given this, many other developed and developing countries embraced the adoption of IFRS, including certain African countries with the assumption that the adoption of IFRS would enhance more inflows of foreign capital in the adopting countries. This thesis set out to either confirm or refute the initial assumption that IFRS adoption would improve the foreign investment inflow for economic growth purposes in adopting countries. Thus, it examines the effect of the adoption of IFRS on foreign portfolio investment (FPI) in Africa. Annual data from the Balance of Payments and International Investment Positions (BOP/IIP) from 1994 to 2015 on total foreign portfolio investments in liabilities (equity and debt) were collected. Panel data regression analysis incorporating pooled regression, fixed-effects, and random-effects models was estimated. Also, the generalised method of moment estimator was employed to address the problem of endogeneity, usually associated with panel data analysis and as a robustness check for the model. The logit regression model was used to examine the determinant factors of IFRS adoption. Various statistical tests were estimated, such as the diagnostic test, using the histogram and Jarque-Bera statistics, difference-in-difference (DID) test, the unit root test, and the cross-sectional dependence test. The Hausman’s chi-square was estimated to determine the best alternative technique between the fixed-effects and random-effects models. Also the Arellano-Bond estimator autocorrelation 𝐴𝑅⟨1⟩ and 𝐴𝑅⟨2⟩ was used to evaluate the validity of the variable instruments in the model. Besides, the average marginal effect (AME) was estimated for the effect of each covariate on the result. Certain covariates were estimated as control variables in the model. The statistical results show a significant and positive effect of the adoption of IFRS on FPI inflows after the adoption and implementation of IFRS in adopting countries. Equally, the finding further indicates a significant difference in the volume of FPI inflows after the adoption of IFRS than before the adoption, in adopting countries. The statistical estimates also reveal a positive and significant effect of IFRS adoption on FPI in adopting countries, compare with non-adopting IFRS countries where it shows a negative and non-significant relationship. It shows that countries that adopted IFRS experience more inflows in FPI compare with the non-adopting countries in Africa. Furthermore, the logit regression results show that culture, the legal system, political system, investor protection, market capitalisation, and tax were found to be positively significant with the probability of adopting IFRS in the logistic model. This thesis, therefore, suggests that the adoption of IFRS is justified in the selected countries in Africa since the results indicated a positive and significant effect of IFRS adoption on FPI in these countries. Hence, substantiated the assumption of IFRS proponents that adoption will enhance the flow of FPI in adopting countries for economic development. Policies measure to monitor the activities of listed firms and to enforce compliance with IFRS rules and regulations are warranted. These policies would further enable IFRS adopting countries to enhance more flow of FPI.