Accounting Standards and International Portfolio Holdings

Gwen Yu,Aida Sijamic Wahid

doi:10.2308/accr-50801

Abstract

ABSTRACTDo differences in countries' accounting standards affect global investment decisions? We explore this question by examining how accounting distance, the difference in the accounting standards used in the investor's and the investee's countries, affects the asset allocation decisions of global mutual funds. We find that investors tend to underweight investees with greater accounting distance. Using the mandatory adoption of International Financial Reporting Standards (IFRS) as an event that changed the accounting standards of various country-pairs, we examine how two sources of changes in accounting distance—(1) changes due to IFRS adoption of the investee, and (2) changes due to IFRS adoption in the investor's country—affect global portfolio allocation decisions. We find that the tendency to underinvest in investees with greater accounting distance significantly weakens when accounting distance is reduced, either from an investee's IFRS adoption or from IFRS adoption in the investor's country. The latter finding holds despite the fact that IFRS adoption in the investor's country had no impact on the accounting standards under which the investee firms present their financial information; the only change is in the investor's familiarity with these standards. This suggests that differences in accounting standards affect investor demand by imposing greater information-processing costs on those less familiar with the reporting standards.

Highlights

Theory suggests that in a world where financial markets are frictionless and perfectly integrated, all investors would hold a global market portfolio regardless of nationality (Grauer et al 1976)
Because the International Financial Reporting Standards (IFRS) adoption dates of most countries were clustered around one specific year, 2005, many country-pairs were concurrently affected by both adoption events
While capital flows across borders have steadily increased over the past decade, portfolio holdings remain significantly biased toward domestic investments

Summary

INTRODUCTION

Theory suggests that in a world where financial markets are frictionless and perfectly integrated, all investors would hold a global market portfolio regardless of nationality (Grauer et al 1976). While several prior studies examine the changes arising from the investee firm’s IFRS adoption (Daske et al 2008; Shroff et al 2013), the literature has focused less on the effect of IFRS adoption in the investor’s country This is partially due to the fact that only the investee’s adoption leads to changes in the standards under which the firm provides its financial information. We find that when accounting distance changes due to IFRS adoption in the investor’s country, investors increase their investment weights in investees with whom they have reduced accounting distance Note that this particular type of adoption requires no changes in the accounting standards that the investees use to present their information.

PRIOR RESEARCH AND HYPOTHESES

DATA AND EMPIRICAL MEASURES

EMPIRICAL TESTS AND RESULTS

ADDITIONAL AND SENSITIVITY ANALYSES

CONCLUSION