Weak Legal Enforcement Research Articles

Practice and effectiveness of internal corporate governance mechanisms in Saudi Arabia Stock Market: A review of empirical evidence

The aim of this paper is to shed light on the Saudi corporate governance code, its practices and effectiveness. To do so, the paper conducted a detailed review of the articles of the code related to internal corporate governance mechanisms and the previous studies regarding its effectiveness in Saudi stock market context. The main finding is that the provisions of Saudi corporate governance code are adequate. Annual reports (2009-2014) show an increase in the level of the compliance by listed companies, indicating that the code is achieving its aims. However, the empirical evidence seems to suggest that the code has an insignificant impact on company's performance and mitigating earnings management. The main reasons behind that are the following: the code is still in its early stages, there is weak legal enforcement, and there are also some social, cultural, and economic factors. Therefore, the code needs more time for good practice and improvement to achieve its purposes.

Board Independence, Audit Quality and Earnings Management: Evidence from Egypt

Using a unique dataset for Egyptian firms, we investigate the relationship between board independence, audit quality and earnings management. We test whether firm-level corporate governance provisions matter in an emerging market setting characterised by weak legal enforcement and inadequate external discipline by the market for corporate control. Our results cast doubt on the notion that a higher ratio of non-executive members is associated with lower earnings management. We find that the effect of board independence on earnings management practices is contingent on the levels of ownership held by executive directors and large shareholders, as well as the composition of audit committee. In addition, the results are consistent with the view that high-quality auditors are effective in reducing earnings management. JEL Classification: M41, M48

Behaviour of Informed and Uninformed Investors: Ex-Ante Uncertainty vs. Signalling Theory

In this paper, we investigate the stock price behaviour of newly listed companies on the stock exchange market with an extremely high level of information asymmetry. We show a unique mechanism of how informed investors influence the stock prices before entering the market to consume abnormal returns. We point out that weak entry regulation and low disclosure requirements, which are implemented by regulators to meet the needs of small and young companies in gaining capital, together with weak legal enforcement, in reality, encourage market participants to overvalue stock prices in the short-term before debut and squeeze out aftermarket uninformed investors.

Financing Durable Assets

This paper studies the effect of durability on the financing of durable assets. We show that more durable assets require larger down payments of internal funds per unit of capital making them harder to finance, because durability affects the price of an asset and hence the overall financing need more than its collateral value. This insight has implications for the choice between new and used capital, technology adoption, and the rent versus buy decision. Constrained borrowers purchase used assets which are less durable than new assets and adopt less durable, low quality assets, that are otherwise dominated technologies. More durable assets are more likely to be rented given their larger financing need. Legal enforcement affects trade and technology adoption; weak legal enforcement economies are net importers of used assets and invest a larger fraction in less durable, low quality assets. There is a critical distinction between the pledgeability and durability of assets: pledgeability facilitates financing whereas the net effect of durability is to impede financing.

Internal Control Quality, Egyptian Standards on Auditing and External Audit Delays: Evidence from the Egyptian Stock Exchange

This paper examines the impact of internal control quality (ICQ) on external audit delays as proxied by the auditor component of audit report lag (A‐ARL) and the effect of the adoption of the Egyptian Standards on Auditing (ESA) on this relationship in the Egyptian context. Using a balanced panel data of 344 firm‐year observations spanning from 2007 to 2010, we hypothesise and empirically find the following. First, ICQ represents a key determinant of timely disclosure, as it contributes significantly to the reduction of A‐ARL. Second, the adoption of the ESA has significantly contributed to the improvement of audit practices by reducing A‐ARL. Third, the adoption of ESA has also strengthened the relationship between A‐ARL and ICQ for the post‐adoption period of these standards. Additional analysis is conducted to examine the impact of industry characteristics on the relationship between ICQ and A‐ARL and the association remains significant regardless of the sector considered. In order to make a more informative analysis, we examine the effect of ICQ on the management component of audit report lag (M‐ARL) and we document a positive association between both variables. The results contribute to the literature dealing with the relation between A‐ARL and ICQ by shedding light on the importance of ICQ in audit practices in an emerging country characterised by weak legal enforcement and a high level of secrecy. Findings also have policy implications for Egyptian standard‐setters with respect to the development of internal auditing standards.

Executive integrity, audit opinion, and fraud in Chinese listed firms

We examine the influence of auditors on mitigating corporate fraud in China, which is known to have weak legal enforcement, weak investor protection along with tight control of the media and labour unions. We find that firms with executives that have lower integrity, indicated by a greater degree of earnings manipulation, are associated with higher propensity of regulatory enforcement actions against corporate fraud in the subsequent year. We show that this effect is moderated by the issuance of a modified audit opinion report by the auditors. This finding implies that auditors can serve as external governance mechanism to discourage executives with lower integrity in committing fraud. Our results have policy implications for further strengthening auditor independence in emerging countries like China.

An Alternative Paradigm of Managing Sustainability in the Global Supply Chain

Based five year field work (2006-2011) in China, the author interviewed 30 Chinese executives from 20 different foreign multinational enterprises. Only two companies chose to practice more communication with their suppliers despite interests in operational efficiency. Exemplifying an alternative paradigm of managing sustainability based on thorough understandings through change of their organizational culture and relationships with their selected Chinese suppliers. Their commitment to sustainability in the global supply chain is due to the moral consciousness of their leaders and the persistence, compassion, and humbleness of their dedicated corporate social responsibility officers. There are five major barriers for managing sustainability in the global supply chain in China: seeking low cost and production efficiency; lacking internal alignments between commercial and responsible supply chain objectives; lacking incentives to practice procedural justice or develop trusting relationships with their suppliers in China in which there is weak legal enforcement system and civil society; easily bypassing many social and environmental responsibilities in China; and evasive compliance-oriented mechanism (i.e., monitoring, evaluating, reporting and sanctioning) over Chinese suppliers. Pursuing sustainability under the existing low-cost operational efficiency paradigm cannot overcome these five barriers. Managing sustainability in the global supply chain must be driven by the spirit of caring people and environment.

The role of formal contracts with weak legal enforcement: A study in the Chinese context

This article explores in depth the mechanisms through which formal contracts and relational governance complement each other, focusing on the role played by formal contracts in transitional economies characterized by weak legal enforcement and a culture oriented around informal ties. The findings, drawn from case studies conducted at five firms across China, suggest that formal contracts are used even when they are not legally enforceable because by defining the rights and obligations in an exchange, contracts reinforce reciprocity in long-term exchange relationships. Although this role of contracts has not previously been clarified in the literature, it is particularly important in China because its cultural traditions prioritize reciprocity. The findings have implications for developing a theory of inter-firm relationship governance and optimal contracting, particularly in transitional economies.

Auditor Industry Specialization, Political Economy and Earnings Quality: Some Cross‐Country Evidence

AbstractUsing cross‐country data, we evaluate the impact of investor protection on the association between earnings quality and audits by industry specialists. Our findings show that the positive association between industry specialist auditors and earnings quality as documented in the literature is affected by the political electoral system, which reflects investor protection rights in a country. We document that audits by industry specialists are associated with higher earnings quality in countries with the proportional electoral system, reflecting weak investor protection. Our results also confirm Kwon et al.'s findings that overall there is a positive association between earnings quality and audits by industry specialists in countries with weak legal enforcement. Our findings, however, indicate that Kwon et al.'s results are valid only for countries with weak investor protection reflected by the proportional electoral system and not for countries with strong investor protection reflected by the majoritarian electoral system. These findings thus suggest that higher earnings quality of firms audited by industry specialists across countries can especially be expected when investor protection is low and legal enforcement is also weak. In addition, our research suggests that future cross‐country studies could explicitly consider the role of the political electoral system of a country in evaluating corporate governance, management and accounting issues.

Executive Integrity, Audit Opinion, and Fraud in Chinese Listed Firms

We examine the influence of auditors on mitigating corporate fraud in China, which is known to have weak legal enforcement, weak investor protection along with tight control of the media and labour unions. We find that firms with executives that have lower integrity, indicated by a greater degree of earnings manipulation, are associated with higher propensity of regulatory enforcement actions against corporate fraud in the subsequent year. We show that this effect is moderated by the issuance of a modified audit opinion report by the auditors. This finding implies that auditors can serve as external governance mechanism to discourage executives with lower integrity in committing fraud. Our results have policy implications for further strengthening auditor independence in emerging countries like China.

Can foreign firms bond themselves effectively by renting U.S. securities laws?

The study tests the functional convergence hypothesis, which states that foreign firms can leapfrog their countries’ weak legal institutions by listing equities in New York and agreeing to follow U.S. securities law. Evidence shows that the SEC and minority shareholders have not effectively enforced the law against cross-listed foreign firms. Detailed evidence from Mexico further shows that while some insiders exploited this weak legal enforcement with impunity, others that issued a cross-listing and passed through an economic downturn with a clean reputation went on to receive privileged long-term access to outside finance. As compared with legal bonding, reputational bonding better explains the success of cross-listings.

Beyond Legal Compliance: Toward Better Corporate Citizenship of Foreign Multinational Enterprises in China

Many leading multinational enterprises (MNEs) are found to practice fewer corporate social responsible actions in developing countries even though they are legally mandated by their global supply chain partners (Abdul-Gafaru,2009; Murdoch & Gould, 2004; Philipp, 2009; Rondinelli, 2006; Stiglitz, 2006). Will the voluntary corporate social responsibility (CSR) initiatives of foreign multinational enterprises in China be a better alternative than legal regulations in a country where there is a weak legal enforcement system?