Weak Legal Institutions Research Articles

PCAOB International Inspections and the Market Value of Cash Holdings

ABSTRACT This study examines whether and how Public Company Accounting Oversight Board (PCAOB) international inspections mitigate the market value discount in cash holdings. We find that shareholders value internal cash holdings more highly for the non-U.S.-listed clients of inspected auditors after the public disclosure of the auditors’ inspection reports. We show that the decreased agency frictions and the increased financial reporting credibility are potential mechanisms. Further, we find that the effect of PCAOB international inspections on the market value of cash holdings is stronger in countries with weaker legal institutions and less sound information environment. Since investors’ valuation of cash mirrors how they expect the cash to be used, our results suggest a unique role of PCAOB oversight in mitigating unresolved agency problems and safeguarding corporate resources, thereby lessening investors’ markdowns of cash assets. Our findings help identify the real economic impacts of PCAOB oversight in enhancing global stock market confidence. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G34; M42; M48.

Weak central government, strong legal rights: the origins of divergent legal institutions in 18th-century Chinese and Japanese rice markets

This paper examines the formation of legal institutions in Qing China and Tokugawa Japan with a focus on the rice market. In both countries in the 18th century, rice was the most important commodity. By the end of 18th century, Japan offered strong legal rights to rice market participants, while China managed the rice market with weak legal institutions. We develop a subversive regime game model to explain some of the social and political reasons behind this divergence. Supported by historical evidence from Qing China and Tokugawa Japan, we find that with lower suppression capacity and high risks of domestic threats to power, Edo Japan’s central government (Bakufu) was more likely to enforce legal rights than Qing China’s central government (Imperial Court). Japan’s institutional configuration facilitated the growth of rice markets such as the Doujima market in Osaka, because participants did not need to invest as much in informal protections for their own rights. Moreover, our analysis suggests that a state’s relative strength matters the most in determining its attitude toward legal rights, which further influences the state’s stability and longevity.

Corporate environmental disclosures and financial distress: evidence from an emerging market

This study examines the effect of corporate environmental disclosures on financial distress in Vietnam. From sustainability reports and annual reports of firms listed on the Ho Chi Minh Stock Exchange, we manually collected a dataset on environmental information disclosures about seven management standards, including the utilization of raw materials, energy usage, water consumption, conservation of land and soil, gas emissions, wastewater and solid waste, and compliance with environmental protection laws. We measure the level of environmental information disclosures based on the counts of these standards that a firm has disclosed and employed both Altman’s Z-score and Ohlson’s O-score as proxies for financial distress. The research sample includes 269 firms from 2015 to 2020. The findings indicate that firms with better corporate environmental disclosures tend to have lower financial distress levels. The results are robust with respect to different measures of environmental information disclosures and financial distress, and have implications for investors, creditors, and policymakers. We contribute to the literature by providing evidence from a frontier market with weak legal institutions, where various environmental issues and regulations about disclosing environmental information have just gone into effect.

Political institutions and corporate risk‐taking: International evidence

AbstractTapping into firm‐level accounting data across 90 countries over a 26‐year period, we find that sound political institutions are positively associated with corporate risk‐taking. This result is economically significant, robust to alternative proxies for corporate risk‐taking and political institutions, and continues to hold after mitigating endogeneity concerns of political institutions. We also collect evidence that sound political institutions may compensate for weak legal institutions in inducing corporate risk‐taking. We argue that sound political institutions improve the investment environment for firms and can induce higher levels of corporate risk‐taking, which is ultimately associated with economic growth.

Creating a sovereign wealth fund in a corruption-riddled country: Energizing transparency and sound governance with direct benefit-sharing

Empirical studies suggest two opposing outcomes of natural resource wealth, namely, resource curse and resource blessing. While the former refers to the ill effects of wealth on resource-rich countries, the latter suggests positive outcomes. Resource blessing findings suggest that a sovereign wealth fund (SWF) is an appropriate tool to conserve and distribute revenues from resource-rich countries to benefit citizens. However, scholarship on SWFs also shows that political elites can corrupt the management of SWF so that SWF primarily benefits them and bolsters their authoritarian rule. Can an SWF escape elite capture in corruption-ridden countries with weak legal institutions? How should an SWF be designed in such countries so that it is more likely to have a positive impact for citizens? Exploring these questions using the Philippines as a case study, we underline that proponents of the establishment of an SWF in the Philippines should focus on ensuring effective constraints on executives. In this regard, we argue that transparency and sound governance principles should be supplemented with provision of direct benefit to citizens to incentivize and mobilize citizen participation in the governance of an SWF. Nevertheless, even an optimally designed SWF may not work if there are insufficient pre-existing constraints.

Social trust and firm innovation: Evidence from China

This study investigates the impact of social trust on firm innovation. Using a large sample of A-share listed firms in China from 2002 to 2017, we find that firms headquartered in regions of high social trust tend to have better innovation performance than those in regions with low social trust. In analyzing the mechanisms, we find that the positive impact of trust on innovation is more pronounced in firms where managers face greater career risk, in firms in less financially developed regions, and in firms in regions with weaker legal institutions. In additional analyses, we find that the anti-corruption campaign launched in 2012 reduces the impact of social trust on innovation and that difference in the levels of trust between where the firm locates and where the CEO comes from has an additional effect on innovation, which indicate the roles of institutional quality and cultural difference. Our results are robust to alternative social trust and innovation measures and different estimation methods and after correcting for endogeneity by employing an IV approach.

Do Rating Change Announcements Transfer Effective Information? Test on the Effectiveness and Sustainability of Credit Rating in China

China is commonly viewed as a country with weak legal institutions and disclosure regulations. The validity and effectiveness of credit rating in China are controversial topics. Bond ratings provide information about the quality and marketability of bond issues. This paper studies the effects of rating change announcements on the price of fixed-income enterprise bonds to test the effectiveness and sustainability of credit rating in China. The results show that upgrade and downgrade announcements have an asymmetric effect on bond prices. Downgrade announcements have transferred new information to the market, resulting in statistically significant negative effects, yet upgrade announcements do not have statistically obvious effects on bond prices. That the average cumulative abnormal returns two days before and on the day of the announcement are statistically insignificant implies that the rating information might not be leaked out before the announcement. The results indicate that the pricing function of credit rating has taken effect, and the effectiveness of the market has been improved over the years. The strengthening of regulations and supervision of the Chinese government toward the credit rating industry may help reinforce the sustainability of the industry and the bond market. The cross-sectional results suggest the market responses are more intense to unpredicted changes of ratings, and investors and portfolio managers should pay more attention to the bonds that have been downgraded for several levels from initial ratings.

Do multiple large shareholders matter in financial firms? Evidence from China

We examine whether multiple large shareholders (MLS, henceforth) play a relevant role in financial firms like banks. Different from prior studies that document a significant effect of MLS in non-financial firms, we find that MLS have no effect on bank performance. This finding is robust to the propensity-score matching, the Heckman two-step model, the instrumental variable approach, the bank fixed-effect model, an alternative definition of the large shareholder, alternative outcome variables, banks with a transition of ownership structures, and the subsample of public banks. The insignificant impact of MLS is not driven by blockholder identity. Further analyses show that MLS play a governance role only in state banks and banks headquartered in regions with weak legal institutions. The results suggest that the role of MLS is limited in highly regulated sectors like the banking sector.

The Influence of Institutional Quality towards Foreign Direct Investment (FDI) Inflows in ASEAN’s Developing Countries

This paper discusses the influence of institutional quality on FDI stock inflows towards eight developing countries in Association of Southeast Asian Nations (ASEAN). Institution in this paper is classified in four forms, namely legal, bureaucratic, politics, and economic institutions. This paper utilizes the method of Principal Component Analysis (PCA) and panel data regression. After using PCA method to identify which variables hold the most importance, the authors then constructed an individual index for four institutions as defined before. These indices are then used for panel data regression. The result of this paper indicates that out of four forms of institutions, three institutions are found to be significant determinants. These three institutions are legal, bureaucratic, and economic institutions. Surprisingly, while bureaucratic institution has positive coefficients, the other two forms of institutions have negative coefficients, suggesting that FDI stock inflows towards developing countries in ASEAN are more likely to be motivated by weak legal and economic institutions.

Microfinance and business regulations in emerging markets

The rapid expansion of microfinance has been uneven across emerging market countries. Our study examines whether the regulatory and legal environment for small and medium enterprises (SMEs) associated with microfinance institution (MFI) lending in informal markets may be part of the explanation. Our study of 51 emerging market countries for the period 2007–2015 used two measures of MFI lending: 1) the market penetration index (PI) which reflects MFI outreach and 2) gross loan portfolio per capita (GLP) which gauges the volume of MFI lending. Based on our search, this is the first study to incorporate both measures of MFI lending. We find that excessive regulation and weak legal institutions are associated with less MFI lending both in terms of outreach (PI) and loan volume (GLP). Hence, the international differences in MFI expansion may be partially attributable to business-unfriendly regulations and legal structures.

How does Buddhism affect corporate cash holdings?

PurposeThis study explores whether and how Buddhism impacts corporate cash holdings. Buddhist culture affects investors' perception of how cash is deployed and then influences corporate cash holdings. This study first examines the impact of Buddhism on corporate cash holdings and then investigates whether formal governance mechanisms such as legal institutions and institutional ownership influence the relationship between Buddhism and corporate cash holdings.Design/methodology/approachThe authors conduct empirical tests with data on Chinese listed companies between 2006 and 2019. Buddhism is measured with the natural logarithm of the number of Buddhist temples within a radius of a certain distance around a firm's headquarters. The authors adopt the OLS method to regress and take the 2SLS method, Heckman selection model and FEVD approach to address the endogeneity issue.FindingsThe results show a positive relationship between Buddhism and corporate cash holdings. This positive relation is more prominent for firms located in regions with weak legal institutions and for firms with low institutional ownership. Further analysis shows that Buddhism works through the channel of alleviating agency problems and finally improves the value of cash to investors.Research limitations/implicationsThe authors’ findings have important implications. First, this study provides inspiration for incorporating the ethical values of traditional cultures, such as Buddhism, into the corporate governance system. Second, the findings imply that informal institutions can influence corporate financial decisions beyond the effect of formal institutions, suggesting that informal systems should be emphasized when dealing with business affairs in countries where legal institutions are relatively weak. Third, the results suggest the significance of encouraging research on religious culture to explore its active role in corporate governance.Originality/valueThis study illustrates the positive value of religious culture in advancing corporate governance by relating Buddhism to corporate cash holdings based on the explanation of investors' perception. It makes a marginal contribution to the literature that investigates the determinants of cash policies and explores the firm-level consequences of religious culture, adding to the research area of culture and corporate finance.

The Republic as a historical problema

The republic that was born as an ideal form of political regime in Greece with Plato and had its later development with Cicero in Rome, has had a diverse reception in pluralistic world experiences, so in America there were two extreme readings of this concept one in EE.UU. and the other in South America, in our midst the idea is nationalized with autocratic forms from its origin. Peru has not completed a historical evaluation, which goes beyond the versions of political science that associate it in many cases with militarism by creating Cesarist republicicas, lacking democratic practices and weak legal institutions. At the origin of independence there was a doctrinal debate that faced two versions on the desired governance, however, after the establishment of the Republic (1822) there was a long transition that led to crisis, disgovernment and anarchy that the republic could not contain or foresee. Despite its dense Constitutions that reaffirmed themselves republican. In recent years a growing academic interest in the subject shows that this historical assessment has not been completed in Peru.

On the Effects of Capital Markets’ Regulation on Price Informativeness: an Assessment of EU Market Abuse Directive

This study assesses the impact on price informativeness of the market abuse directive adopted by European economic area member-states. Price informativeness is measured by the future earnings response coefficient that captures the ability of stock prices to reflect firms’ fundamentals and future profitability. A difference-in-differences analysis is performed to compare the evolution of this coefficient in countries that adopted the directive with that of countries from a control group. The preliminary findings suggest a decline in information content of stock prices about firms’ future profitability in the aftermath of the directive’s entry-into-force. Further exploration suggests however that the detrimental impact is concentrated on countries that neither improved the quality of enforcement regimes nor reinforced the supervisory powers and resources available to national financial authorities following the Directive’s adoption. The pre-existing state of the legal framework has also influenced the obtained results. The impact was particularly detrimental in countries with weaker legal institutions that did not undertake a shift in enforcement with respect to the new law, suggesting that the negative influence of inefficient bureaucracy and weak legal institutions on price informativeness was exacerbated by the adoption of the new rules.

Singapore as International Debt Restructuring Center: Aspiration and Challenges

According to some economists, the deglobalization of the world has commenced. While that is true of trade and of ideas, it may not reflect the experience of existing companies undergoing restructuring which have in a sense been locked into a previous matrix where its assets and stakeholders were widely dispersed throughout the globe. This has created anomalies in the handling of worldwide insolvency cases which comes up against both protectionism, including judicial competition for such cases leading to less universalism in some situations, as well as the realignment of interests between the various corporate constituencies due to Covid-19, which may have further strengthened the hands of shareholders at the expense of other stakeholders as companies are kept afloat. In Singapore the government decided to develop Singapore into an international center for debt restructuring as part of its strategy to export its services and for this purpose embarked on an ambitious project to reform both its domestic and crossborder insolvency laws. The hybrid scheme was created by injecting some US bankruptcy law elements into the ‘English’ scheme of arrangement. The UNCITRAL Model Law on Cross-border Insolvency, in the form of the Third Sch of the Insolvency, Restructuring and Dissolution Act 2018 (IRDA 2018), was also adopted. Providing a forum for distressed companies in the region to restructure their debts without having to travel to London or New York is a positive development for Singapore and the region. The hybrid scheme is a path-breaking innovation so challenges to its design and operation are unavoidable. But its structure is flexible enough to allow for judicial creativity to fill gaps and to prevent its abuse. The courts face less challenges in interpreting the Third Sch, and has achieved some success in fostering cooperation and communication in cross-border insolvency matters between courts, but the domination of family companies, fragmentation of credit and weak legal institutions in the region may be more difficult challenges to Singapore’s aspiration to serve as the regional restructuring hub.

Business Friendliness: A Double-Edged Sword

In this paper, we test the hypothesis that business-friendly local-government policies combined with weak legal institutions lead to lower economic welfare in the form of greater fraud activity. Using data of almost 3000 failed peer-to-peer (P2P) lending platforms in China, labeled as “runaways”, we find that they are more prevalent in provinces with business-friendly policies with weak law-enforcement regimes.

Fear of commitment: Weak institutions, volatile economy, and the prevalence of short-term International capital

This paper shows that weak legal and political institutions and high macroeconomic volatility shorten the maturity of cross-border bank lending. Although these results are confirmed in the previous literature, this paper uses a broader panel data set of 135 countries from 1983 to 2012. Data also suggest new finding that the maturity of international bank credit and per capita GDP are positively correlated. The share of debt incurred by banks shortens the maturity, while the share of debt incurred by governments lengthen the maturity of cross-border credit. Our results are robust after we control for potential endogeneity.

Mandatory Corporate Social Responsibility? Legislative Innovation and Judicial Application in China

Abstract Corporate social responsibility (CSR) is often understood as voluntary corporate behavior beyond legal compliance. The recent emergence of CSR legislation is challenging this typical understanding. A number of countries including China, Indonesia, and India have expressly stated in legislation that companies shall undertake CSR. However, the CSR law is controversial. Critics of CSR see the law as an unwise effort to challenge profit maximization as the only social responsibility of the corporation. Even CSR advocates welcome the CSR law with great caution. Given the vague statutory language of CSR, the practical application of the law places high demands on the judiciary. However, as the countries that have adopted the CSR law are mainly developing countries with rather weak legal institutions, it raises a common concern that the law is simply an innovation without implementation. This Article conducts an empirical study of China, an early adopter of CSR legislation. The empirical analysis of Chinese court cases reveals what the CSR law means in judicial practice, whether CSR is in fact mandatory, and in what types of disputes CSR is relevant or outcome determinative. Among various findings, this Article shows that the CSR law is by no means as useless as commonly expected. The meaningful application of the law is attributable to the law’s compatibility with China’s legal infrastructure and sociopolitical institutions. Chinese courts have innovatively applied CSR in various contexts far beyond the traditionally Western-led focus on directors’ fiduciary duties. The Chinese experience suggests that the CSR law is more of a judicial review standard than a corporate behavior standard, which further confirms the importance of judicial capacity in implementing the vague law. This Article concludes with insights for the corporate purpose debate from a comparative perspective and with policy suggestions for adopting CSR legislation.

Auditor gender and stock price crash risk: evidence from China

ABSTRACT Stock price crash risk is attributed to agency problems and information asymmetry. Auditors generally play a more important governance function in countries with weak legal institutions. Previous studies document that audit judgements and information processing differ by auditor gender, which ultimately impacts the quality of audited financial reporting and the governance role. This study examines the relationship between auditor gender and stock price crash risk, particularly whether female auditors may reduce stock price crash risk because of their risk aversion and ethics. Using a large sample in China with weak legal institutions, this study finds that female auditors play a governance role in curbing stock price crash risk, and the effect is dominant in the firms with high agency costs. Also, these findings are robust to a battery of tests. Finally, this study conducts two sets of cross-sectional analyses, indicating that the effect of auditor gender mostly concentrates on non-state-owned enterprises with high agency costs, and on firms with non-busy auditors that are deemed to have sufficient time to properly engage their audits. This study extends the literature on determinants of crash risk and has implications for firms, stakeholders and monitors over reducing crash risk to keep sustainable growth.

Investment as Bargaining Chip

Institutional environments are often considered exogenous in firms’ investment decisions. While the non-market strategy literature has discussed various approaches that firms may adopt to influence their interactions with institutions, such discussion is mostly absent in the analysis of market strategies. In this paper, we argue that in countries with significant government discretion, firms may obtain better treatment from the local institutions by locating R&D or manufacturing—the types of investments usually welcomed by the local governments—in the host countries. Using a sample of global patenting and litigation records of the Fortune Global 500 companies from 2007 to 2014, we find that firms tend to have a better chance at obtaining patents, or reversing unfavorable patenting decisions at patent authorities, after their increased local R&D or manufacturing presence. The results are only significant in countries with weak legal institutions, and in countries with relatively weak domestic industries. The effect of investment on firm-specific experience with local institutions thus offers an alternative explanation for location decisions that may seem suboptimal when environments are treated as exogenous.

STANDAR AKUNTANSI KEUANGAN DAN PRAKTIK MANAJEMEN LABA DI INDONESIA

Financial reporting in Indonesia is based on accrual-based Financial Accounting Standards (SAK), where according to Watts and Zimmerman (1986) accounting recorded on an accrual basis is subject to managerial discretion, due to the flexibility given by the General Accepting Accounting Principle (GAAP), which gives managers encouragement to modify financial statements (earnings management). This study aims to map earnings management practices in Indonesia after convergent Financial Accounting Standards on IFRS. The data analysis technique used in this study is the two different test average with the t-test (independent sample t-test). The results of data analysis found that there were no significant differences. This is caused by the same earnings management pattern. The highest level of earnings management implementation exists in countries with weaker legal institutions and higher levels of pre-transition earnings management, which are partially and fully associated with market value and returns, which means that earnings management practices continue to be carried out because market demands for high rates of return on investment.