Contracts valuation assessment noise and cross-border listing of equities on U.S. and U.K. stock markets

Abstract

This study develops and tests the hypothesis that firms in the home country have capital market incentives to cross-border list on foreign stock exchanges that have similar financial reporting with local generally accepted accounting principles (GAAP). Non-U.S. firms' contracts and the underlying GAAP are based on the home-country culture and institutional climates. This connection with culture and institution makes the local GAAP's assessment of the contracts less spurious relative to foreign GAAP. Ball et al. [J. Account. Econ. 29 (2000) 1] note that contracting with stakeholders in the home markets is based on local GAAP's numbers, while cross-border listing provides settings in which the value relevance of local GAAP-based contracts is assessed based on foreign GAAP. Therefore, foreign investors' assessment of the contracts using foreign stock exchange GAAP or mindset of foreign GAAP is likely to result in an assessment noise, which is value irrelevant. The level of assessment noise depends on the differences between foreign and local GAAP. Because of the valuation implications of the assessment noise, we expect cross-border listing to diminish as the likelihood of assessment noise increases. As predicted, we find that assessment noise undermines cross-border listing on U.S. stock exchanges. Because U.S. and local GAAPs are based on different cultural and institutional environments, assessment noise arises if U.S. investors use the mindset of U.S. GAAP financial reports to assess local GAAP-based contracts of cross-border firms. The results are robust in the London Stock Exchange in which assessment noise is induced by interpreting local GAAP contracts as if they were based on U.K. GAAP. As expected, the influences of assessment noise on cross-border listings are more robust in the United States than in the United Kingdom. Our results suggest that harmonization of financial reporting is critical in attenuating the influences of assessment noise on global capital market developments.