Financial Reporting and Disclosure Quality, and Emerging Market Companies' Access to Capital in Global Markets

Abstract

This study examines how five financial reporting and disclosure quality proxies are related to emerging markets (EM) firms' cross-listing choices and their access to the global capital market. Our five financial reporting and disclosure quality proxies are transparency of the annual report, global vs. local auditor, global vs. local GAAP, translation of the annual report into English, and voluntary dissemination of information through websites. We first ask whether this set of proxies reflects a single (or two) underlying financial reporting quality constructs using a principal components factor analysis. We find that the proxies are sufficiently distinct to escape parsimonious description as a single construct. This result suggests that EM firms pick and choose from among alternatives to enhance their financial reporting and disclosure quality, rather than moving from low quality to high quality on all dimensions simultaneously. We next document the relations among our reporting and disclosure proxies and EM firms' decisions to be listed or traded in U.S. and U.K. capital markets, after controlling for factors we expected to be associated with firms' cross-listing decisions. Evidence in prior research leaves open the question of the endogeneity of cross-listing and financial reporting and disclosure quality. We find evidence of a strong association between each of our five proxies and EM firms' participation in U.S. and U.K. capital markets, but the variation in the five proxies (plus the controls) explains only about 40% of the variation in firms' cross-listing patterns. This result is important because it suggests that EM firms view being listed or traded in the U.S. or the U.K. as a substitute rather than a complement to enhanced financial reporting and disclosure quality. Finally, we find the reporting and disclosure proxies are not significantly correlated with the amount of debt and equity capital raised in global markets, after controlling for the effects of cross-listing in the U.S. and the U.K. and other control variables. In contrast, firms' cross-listing choices are strongly correlated with amount of capital raised. From this evidence we conclude that, consistent with the bonding hypothesis, EM firms' presence in U.S. and U.K. capital markets is a more important factor in their ability to raise capital than are their financial reporting and disclosure quality choices.