Legal Investor Protection Research Articles

Accounting reforms and conservatism in earnings: Empirical evidence from listed Chinese companies

We examine the effects of the two major accounting reforms of 2001 and 2007 in China on conservatism in earnings using a variety of measures to ascertain the existence of conservatism and to gauge its degree. Our results provide evidence of different levels of conservatism in financial reporting in China during the period under investigation. We suggest that conservatism has generally existed in financial reporting in China since the 1998 accounting reform. However, the effects of the two accounting reforms on conservatism in earnings vary. Specifically, the 2001 accounting reforms significantly improved conservatism in earnings whereas the 2007 reforms reduced the extent of conservatism in earnings. We also note that conservatism in earnings rebounded following the 2007–09 global financial crisis. Furthermore, the 2001 accounting reforms have a greater positive impact on conservatism in earnings in regions with a lower level of legal protection for investors whereas the negative impact of the 2007 accounting reforms on conservatism in earnings is not affected by the level of legal protection for investors. These results suggest that accounting reforms that restrict managers’ abilities to conduct earnings management and improve conservatism in earnings serve as an important substitute mechanism for institutions of investor protection. Our findings provide useful insights into accounting conservatism and have important theoretical and practical implications for accounting regulators, investors, and researchers.

Investor legal protection, capitalized development costs, and audit fees: A cross‐country analysis

AbstractOur study explores the association between capitalized development costs and audit fees. International Accounting Standard No. 38 stipulates the discretion to capitalize the development costs of internally generated intangible assets. We find a positive association between capitalized development costs and audit fees, which reflects auditors’ concern that managers may use the discretion of development cost capitalization to manipulate earnings. Moreover, this positive association is mitigated by stronger investor legal protection because stronger investor legal protection alleviates the earnings management concern from capitalized development costs. These results suggest that country‐level legal regimes affect auditors’ perception on client firms’ accounting choices. Our study contributes to the literature exploring how legal regimes affect auditor behaviors.

Corporate Social Responsibility Strategies of Spanish Listed Firms and Controlling Shareholders’ Representatives

This article aims at analyzing how controlling shareholders’ representatives on boards affect corporate social responsibility (CSR) strategies (disclosing CSR matters) in Spain, a context characterized by high ownership concentration, one-tier boards, little board independence, weak legal protection for investors, and the presence of large shareholders, especially institutional shareholders. Furthermore, among controlling shareholders’ representatives, we can distinguish between those appointed by insurance companies and banks and those appointed by mutual funds, investment funds, and pension funds. The effect of these categories of directors on CSR strategies is, therefore, also analyzed. Our findings suggest that controlling shareholders’ representatives have a positive effect on CSR strategies, as do directors appointed by investment funds, pension funds, and mutual funds, while directors appointed by banks and insurance companies have no impact on CSR strategies. This analysis offers new insights into the role played by certain types of directors on CSR strategies.

Creating Order in the Absence of Formal Regulations and Law: A Historical Perspective on Corporate Governance and the Joint Stock Company

The legal and political explanations that underpin the contemporary literature on corporate governance have focused how the prevailing political or legal system determines how large corporations are governed. They imply that in order to facilitate good corporate practices, emerging economies should converge towards governance systems that offer strong legal protection for investors. Distinguishing itself from this approach, this paper adopts a historical account of the major political economy factors that either impeded or facilitated the evolution of the Anglo American Joint Stock Company (JSC). This illustrates how the JSC did note merge by blueprint or design as is implied in the literature. It also describes the implicit costs associated with the JSC including political rent seeking, the expropriation of small investors, market crises and monopolies. Under these circumstances legal and political developments often enhanced corporate power at the expense of the public interest. This account suggests that the JSC is better viewed as an adaptive and innovative organisational form that has thrived in the absence of formal regulations and law, rather than as a nexus of contracts arising from market failure. The evolution of the JSC and its corporate governance structures are therefore best understood within a political economy framework that accounts for market developments, political and legal interventions and the rise of the regulatory state. For developing economies the main lesson is not that they should replicate either the US or UK, but rather they can draw on the factors that allowed both countries to lessen the costs of mobilising finance, and adapt them to suit local market structures.

Determinants of stock market development: a review of the literature

PurposeThis paper aims to provide a comprehensive review of the literature on the determinants of stock market development.Design/methodology/approachThe paper divides the existing studies into the theoretical and empirical literature. Then, it analyses these studies in turn.FindingsBased on the theoretical literature, the determinants of stock market development can be broadly classified into two groups: macroeconomic factors and institutional factors. The theory and the empirics predict different ways in which macroeconomic factors affect stock market development. The real income and its growth rate foster stock market development, while the banking sector, interest rate and private capital flows can foster or inhibit it. Inflation and exchange rates have adverse effects on stock market development. In terms of the institutional factors, the literature indicates that different legal origins and stock market integration can have a positive or negative impact on stock market development. In addition, factors such as legal protection of investors, corporate governance, financial liberalisation and trade openness contribute positively to the development of the stock market.Research limitations/implicationsFrom the survey, it is imperative that policies which aim at enhancing institutional quality, financial integration, real income growth, macroeconomic stability and capital inflows, among others, will certainly promote stock market development within and across countries. Although the empirical studies have incorporated a large set of variables in their models, the theoretical studies do not contain rich models of stock market development. It is understandable that a theoretical model which contains a large set of the determinants of stock market development may be difficult to solve. However, such a model seems very appealing and will provide a unification of the existing literature.Originality/valueThe originality of the paper lies in the fact that it is the first to undertake a survey of the determinants of stock market development in the literature. It is hoped that this paper will spur further theoretical and empirical research on the determinants of stock market development.

Who Benefits from IFRS Convergence in China?

We study the ex ante stock market reactions to events leading up to China’s convergence to International Financial Reporting Standards (IFRS). The literature consistently shows that the benefits of mandatory IFRS convergence are concentrated in countries with stronger legal enforcement and investor protection. Given that these institutional characteristics are weaker in China relative to more developed Western economies, whether mandating IFRS will benefit the Chinese capital market is an interesting and important, but unanswered question. We find that the Chinese stock market reacts favorably to events leading up to IFRS convergence, and this effect is more pronounced among firms with greater dependence on external capital. This result suggests the market anticipates that such firms will benefit more from IFRS convergence, possibly because of improved financial reporting quality and access to external financing. Additional tests confirm that the value relevance of accounting numbers for these firms is higher following IFRS convergence.

NON-AUDIT SERVICES AND AUDITOR INDEPENDENCE IN AN ENVIRONMENT OF LOW INVESTOR PROTECTION

This paper aims to evaluate whether the provision of non-audit services (NASs) affects external auditor independence in an environment characterised by low legal protection of minority investors and a high concentration of ownership and control. Audit reports and costs of services are analysed over 3 years for 154 Brazilian companies. The binary variable proxy for independence indicates a qualified auditor's report and, as an alternative specification, the issuing of a going concern opinion. Logit models were employed with control variables to identify aspects related to other sources of threats to independence, management influence, and the effort and risk of auditing services. The results indicate that the provision of NASs does not affect auditor independence. This evidence is robust in terms of the alternative specification of the independence proxy and the observation of a subset of companies considered qualifiable. Only when summed to audit fees is there evidence of a negative impact on independence, signalling that the client’s economic dependence might be more relevant than NAS with respect to auditor independence. This result is robust to both independence proxies and the subset of qualifiable companies. In general, other sources of threats do not seem related to independence. This study provides evidence of a market in which auditor independence is expected to be compromised, given controlling shareholders’ influence on company management.

Shareholder protection, income inequality and social health: A proposed research agenda

This paper develops a proposed research agenda in order to highlight how corporate governance, accounting and company law are relevant to the consideration of income inequality and wider social health. To illustrate this proposed research agenda, this paper draws on corporate governance research in the law and finance tradition, as well as macro-level studies in accounting concerned with the wider corporate governance context, in order to consider the association between shareholder protection, income inequality and child mortality. Under 5 child mortality is an objective indication of a country’s ability to nurture its children. In an influential body of work, La Porta et al. (1997a, 1997b, 1998, 2008) concluded that a common law legal system which protected the interests of shareholders gave rise to better economic and social outcomes. However, drawing on corporate governance and accounting literature we contend that such a conclusion is flawed. The findings of this paper suggest that common law countries (i.e. those with the greater legal protection for investors) have worse social outcomes in terms of under-5 child mortality.

An institutional perspective of the socioemotional-financial wealth relationship

Purpose The purpose of this paper is to offer an institutional perspective of the Martin and Gomez-Mejia model. Specifically, this paper offers arguments of how institutions moderate the socioemotional wealth (SEW) and financial performance relationship. Design/methodology/approach This is an individual commentary that explores country-level institutional contingencies that affect the predicted effect of SEW dimensions upon financial performance offered by Martin and Gomez-Mejia. Findings The paper offers arguments of how both formal and informal institutions, such as the legal protection of minority shareholders, labor and investors; freedom of expression and information; and the country’s culture, exacerbate or ameliorate the predicted effect of the five SEW dimensions upon financial performance. Originality/value By exploring an institutional perspective of the socioemotional and financial wealth relationship, this commentary offers additional boundary conditions to those offered by Martin and Gomez-Mejia to further refine their theory.

A potential benefit of increasing book–tax conformity: evidence from the reduction in audit fees

Our study explores a possible benefit of conforming book income to taxable income. We expect that increased book–tax conformity can reduce audit fees by simplifying tax accruals and increasing tax authorities’ monitoring, which reduce audit workload and audit risk, respectively. Consistent with our expectations, we find that a higher country level of required book–tax conformity leads to lower audit fees. Moreover, firm-level book–tax differences are positively associated with audit fees. We also find that the negative association between country level of required book–tax conformity and audit fees is mitigated among firms with larger book–tax differences. Our findings are robust to including country-level legal investor protection or other extra-legal institutions. Overall, our results suggest that one benefit of increasing book–tax conformity is the reduction in audit fees.

Institutional Restrictions on Stock Issuance and Buyback and the Asset Growth Effect

The asset growth effect states that firms with higher asset growth exhibit lower future stock returns. Existing research finds that the effect is stronger in financial markets that are more developed, more transparent and have better legal protection of investors than in markets with less development, transparency and legal protection. We single out equity financing as the dominant driver of asset growth, and provide evidence that institutional regulations on stock issuance and share buyback explain the cross-country differences of the asset growth effect. Institutional restrictions on stock issuances and buyback are negatively associated with the asset growth effect across countries, and supersede variables such as legal system, stock market development, and information transparency in explaining the effect.

The Non-US Premium Discount in Global Takeovers

This paper examines takeover premiums around the world and documents a significant discount in bid offers to target firms outside the US. Controling for deal-level premium determinants, the non-US discount approximates seven percent of the target pre-deal stock price. I investigate whether discount can be explained by country variation in legal investor protection, economic strength, financial market development, and potential competition in the takeover market. I find that the size of the economy in the target country is the most robust premium determinant among these country characteristics. Forty percent of the non-US premium discount can be attributed to the size of economy. Even after controlling for a set of country characteristics, target firms in the US still earn more than in other countries by at least four percent of the target’s trading price before the deal announcement. For the average firm in the sample, a four percent discount equals 31 million dollars.

Executive Compensation and Legal Investor Protection: Evidence from China's Listed Firms

AbstractThis paper seeks to relate the increases in executive compensation observed in China to improvement of the legal environment. We build a simple model and demonstrate that improvement in legal investor protection reduces the manager's private benefits of control; in order to make the managerial incentives compatible, some of the forgone private benefits have to be compensated in the form of increased executive pay. Using a large dataset on Chinese listed corporations, we find strong evidence that improvement of the legal environment is significantly associated with both the rise in executive compensation and the reduction in agency costs, which is consistent with our model predictions.

Institutional framework, corporate ownership structure, and R&D investment: an international analysis

We combine agency theory with the law and finance approach to analyze how the legal protection of investors and the corporate ownership structure affect corporate investment in research and development (R&D). We use information from 956 firms from the five most R&D‐intensive industries in 19 developed countries. Our results show that better protection of investors’ rights by the institutional environment has a positive influence on corporate R&D. We also find that corporate ownership concentration works as a substitute for legal protection. This finding means that R&D investment of the firms in the countries with poor legal protection increases as ownership becomes more concentrated. Our results also show that the identity of shareholders has a relevant effect: Whereas banks and nonfinancial institutions as shareholders result in lower R&D, institutional investors as shareholders increase corporate investment in R&D.

Social capital, investments, and external financing

This study examines the effects of managerial social capital on investment sensitivity to cash flow and Q. Using a large cross-country sample of companies for the period 1999–2012 and a traditional investment-Q framework, we discover that social capital reduces a firm's dependence on internally generated cash. We find that social capital is positively associated with investment sensitivity to Q. We further determine that social capital positively affects the sensitivity of external finance to Q, while inversely influencing the sensitivity of external finance to cash flow. These effects of social capital are stronger in markets characterized by the weak legal protection of investors. Our findings are robust to alternative model specifications, different variable measurements, and tests for endogeneity.

'Take Care of the Crowd!' Legal Protection of Retail Investors in Crowdfunding is Long Overdue

When looking for a little more yield in times of low interest rates, retail investors as well as institutional investors turn increasingly towards crowdfunding. But the crowdfunding business offers “no free lunch”, meaning investors don’t get higher yields for free. In return for a yield pick-up they have to accept higher risks and some of those risks are different and new because they are specific to crowdfunding. Investors might not be aware of those risks.Crowdfunding connects the investor directly with the investee without having a middleman standing in-between. Thus, crowd funders are immediately confronted by the prevalent information asymmetry between both parties. The investee holds all the information while the investor has only limited chances to verify the truth and relevance of the given platform information. Investors need a good portion of trust to believe that investees don’t make an unfair use of their information advantage. But how could investors build up interpersonal trust on a web-based capital mediation platform without knowing each other? This seems to be difficult. Maybe the platform can play the role of a trust broker? No, the platform’s own business model depends on transaction fees, which makes the situation for crowd investors even worse. Are there any minimum information standards for crowdfunding platforms set by European or national law? Only a few European countries have so far defined minimum information standards for crowdinvesting by law. A unified European regulation doesn’t exist. Are platforms accountable for publishing incorrect or false information about investment opportunities? No, platforms deny taking any accountability for the information published. Are there central public authorities as in the banking sector, which control and monitor the crowdfunding industry and its platforms? No! Retail investors are the weakest part of the crowdfunding business. Small investors and institutional ones not only differ by the depth of their pockets. Institutional investors also have more financial expertise and experience. Hence retail investors need a much higher degree of legal protection against crowdfunding risks, because one cannot presuppose the same professionalism as with institutional investors. The aim of this article is to create awareness among European law makers about the substantial risks that face retail investors when investing in crowdfunding. The rest of the article documents the main risks and highlights where legal protection and regulation are urgently needed.

Earnings Management Motives and Firm Value Following Mandatory IFRS Adoption Evidence from Canadian Companies

When Canada already has a set of well- established legal enforcement and investor protection mechanism to control earnings management; and the quality of Canadian GAAP is high, I examine if the accounting quality for Canada can still be improved since its adoption of IFRS mandatorily in 2011. The extant literature argues that IFRS adoption benefits firms domiciled in countries with strong legal and financial institutions. However, when the quality of IFRS is as good as the local standards for many Anglo-Saxon countries such as Canada, it is questionable if these countries can still receive substantial economic consequences. Following the literature, I estimate a set of comprehensive measurements of earnings management as the proxies of accounting quality. Empirically, I document evidence that the results are mixed: while discretionary accruals have been improved, but not for Manage Earnings Towards Target (METT) and Timely Loss Recognition. Besides accounting standards, I also find that firms issuing more equities are motivated to associate with lower earnings quality. In addition, firms engaging in two distinct strategic directions (prospector vs. defender) have systemically dissimilar effects on earnings quality in IFRS adoption. Finally, I document evidence that firm value following IFRS adoption has been increased, but at the expense of lower accounting quality. Overall, my study shed some lights into the literature that accounting standards per se implemented in strong institutional setting is not sufficient to ensure a higher level of accounting quality; and firm-level earnings management motives are important factors too.

Corporate Governance and the Information Content of Earnings Announcements: A Cross‐Country Analysis

AbstractUsing firm‐level data from 23 developed markets, we document a positive association between overall firm‐level governance quality and the informativeness of earnings announcements measured by abnormal stock return variance. This finding is robust after controlling for the potential endogeneity of firm‐level corporate governance. Further analyses reveal that firms with strong governance show little evidence of earnings management, appoint Big 4 auditing firms, and attract analyst following, implying a positive link between strong corporate governance and the information quality of earnings announcements. Finally, there is some evidence that the relation between firm‐level governance and market reactions around the announcements exists only in countries characterized by a transparent information environment and strong legal investor protection.

KEWENANGAN OTORITAS JASA KEUANGAN MENGENAI PERLINDUNGAN HUKUM BAGI INVESTOR TERHADAP TINDAKAN TIPPEE YANG MELAKUKAN INSIDER TRADING DALAM PERDAGANGAN SAHAM

One type of a criminal in the capital market is the practice of insider trading. Insider trading is an act that involves a group of insider in the capital market who deliberately exploit information that has not been released to investors with the advantages. In insider trading there are two actors such as party directly as an insider who works in the company or indirect as tippee party who obtain confidential information from an insider. Tippee is the party who receives confidential information from an insider either passively or actively against the law or not against the law for personal gain in the stock trading. This is very detrimental to the investors in the stock trading. Because of that if needs the protection for investors against the actions of the Tippee. This study discusses two (2) problem first about the subject matter of the action form Tippee in insider trading to the stock at Indonesia and the second about OJK authority on legal protection for investors in case of insider trading by the Tippee in capital market activities. This research is a normative law. The Method approach is the approach of legislation, conceptual approach and comparative approach. Legal materials used are primary and secondary legal materials. Mechanical collection of legal materials is through the study of literature that further uses analysis techniques that description techniques and interpretation. The results shows that this form of action Tippee can be done actively and passively. Actively to perform an unlawful act such as stealing information. In is not trying to fight the law, but to obtain inside information and legal safeguards for investors to act with regard to insider trading Tippee do give legal certainty through legislation and legal certainty by the OJK through law enforcement

Law and Project Finance

We investigate Project Finance as a private response to inefficiencies created by weak legal protection of outside investors. We offer a new illustration that law matters by demonstrating that for large investment projects, Project Finance provides a contractual and organizational substitute for investor protection laws. Project Finance accomplishes this by making cash flows verifiable through two mechanisms: (i) contractual arrangements made possible by structuring the project within a single, discrete entity legally separate from the sponsor; and (ii) private enforcement of these contracts through a network of project accounts that ensures lender control of project cash flows. Comparing bank loans for Project Finance with regular corporate loans for large investments, we show that Project Finance is more likely in countries with weaker laws against insider stealing and weaker creditor rights in bankruptcy. We identify the predicted effects using difference-in-difference and triple-difference tests that exploit exogenous country-level legal changes and inter-industry differences in free cash flow and tangibility of assets.