1. Introduction

2. Prior literature and hypotheses development

3. H₁ Cross-listing in the US stock market is positively associated to accounting quality.

4. Data and research methodology

5. Results

6. Conclusions

References

Abstract

Using 42,808 firm-year observations from 32 countries around the world, we investigate whether cross-listing in the US is associated with better accounting quality, and whether investor protection moderates the effect of cross-listing on accounting quality. Our main results show firms that are cross-listed in the US exhibit more timely reporting of losses, greater tendency to manage earnings downward, and more value relevance of accounting numbers as compared to their domestic counterparts. Cross-listed firms originating from high investor protection jurisdictions, particularly in high anti-director rights and common law countries, exhibit greater tendency to recognise a more timely reporting of losses and to manage earnings downward but exhibit lower value relevance of earnings as compared to cross-listed firms domiciled in low anti-director rights and non-common law countries. These results suggest that the strength of investor protection in home country plays an important role in determining the quality of accounting numbers of cross-listed firms

Introduction

The financial globalization literature highlights that cross-listed firms would benefit in terms of increasing visibility, broadening the shareholder base, gaining access to financial markets, improving relations with the foreign financial community, and increasing demand for the firm’s stock (e.g., Siegel, 2005; He, 2008). Decision of foreign firms to list their shares particularly in the US securities markets (cross-listing hereafter) is driven by the quest for greater access to cheaper capital for funding growth opportunities (Hail and Leuz, 2009). This is due to the fact that cross-listed firms are subjected to the rigorous US Securities and Exchange Commission’s (SEC) requirements including various aspects of corporate governance. However, cross-listing results in an implicit contract between corporate governance of the firm’s home and host environments and raises questions on how much diffusion takes place between these two (Bauer et al., 2004). Evidence of accounting scandals (e.g., Tingting, 2014) brings into question the governance aspects of the cross-listed firms. In particular, despite having strong fundamental characteristics of being listed in the US stock exchanges, unethical issues of the cross-listed firms trigger concerns regarding their accounting quality.

This paper examines the impact of corruption culture on accounting quality (AQ) of listed firms at the municipal level in China. We consider municipalities with (without) corrupt top government officials as having high (low) corruption culture. To isolate the effect of corruption culture, we use the arrest of corrupt officials (the events) to capture the change in local corruption culture, and apply the difference-in-difference method to compare AQ of firms operating in the jurisdictions of corrupt officials pre and post the events, compared to control firms. We find that AQ of firms affiliated with corrupt officials is higher after the events, which is robust to the placebo test, time-trend analysis, and various robustness tests. We complement the literature by showing that the increase in AQ is greater for firms associated with more powerful officials and having stronger connections with corrupt officials. Moreover, the positive effect on accounting quality is stronger in the post-2012 period. Further, we document that firms improving AQ after the events issue more SEOs and have lower cost of capital. Finally, analyses on channels firms used to improve AQ show that firms switch to higher quality auditors, have better internal control, and issue more management forecasts. This study has implications for policymakers in countries that suffer from corruption.

Introduction

Accounting plays an essential role in terms of resource allocation and economic growth (Biddle et al., 2009; Piotroski and Wong, 2012), as it bridges communication between business firms and capital markets, and serves as the foundation for various contracts, e.g., managerial and debt contracting (Watts and Zimmermann, 1986; Rajan and Zingales, 2003). Due to the importance of accounting, it is warranted to examine the impact of various factors on accounting quality. Ball et al. (2003) show that accounting quality is profoundly affected by market and political forces that influence managers’ incentives.1 While acknowledging the contributions of this study, Holthausen (2003) criticises the heterogeneity issues in its setting of four East Asian countries. We follow up Ball et al. (2003) by focusing on the impact of one specific aspect of political forces, i.e., regional corruption culture on accounting quality, and adopting a setting of a single country to mitigate the above concern. This paper examines how local corruption culture could affect accounting quality (AQ) of firms operating in the region using data from China. Corruption culture is measured by whether the top government officials that have the highest power in the region are corrupt.2 Guiso et al. (2006, p. 26) suggest that ‘‘Power is not merely domination but hegemony – that is, the ability to influence society morally and intellectually”. Moreover, Liu (2016) argue that corruption could be affected by political environment. We consider regions with corrupt top officials as having strong corruption culture and regions without corrupt top officials as having weak corruption culture.3 Dass et al. (2017) show that there is significant regional variation in terms of ‘‘corruption culture” in the United States, and public firms in more corrupt regions exhibit a greater propensity for corruption. When a corrupt top official is arrested on charges of corruption, this occurs as a shock to the public including both the corrupt officials themselves and the affiliated firms. This official will be removed from her post and this is very likely to affect the regional corruption culture because the connection between the corrupt official and firms is broken.

Whether accounting information quality affects the cost of capital has been the central theme of a large and growing literature in accounting, economics, and finance. This literature provides considerable empirical evidence of a negative relation between the two constructs (Armstrong et al. 2013). However, the mechanism behind the relation has been a subject of intense debate (Beyer et al. 2010; Tang 2011). We contribute to the debate by investigating empirically whether and how accounting information quality is related to existing systematic risk factors (i.e., firm betas). In neoclassical theory, a firm’s cost of capital depends exclusively on exposure to systematic risk, i.e., systematic risk factors and risk premiums on these factors (Hughes et al. 2007; Armstrong et al. 2013). Thus, accounting information quality can affect the cost of capital in only three possible ways: First, accounting information quality constitutes an additional systematic risk factor that is distinct from other known such factors; second, accounting information quality itself is not a systematic risk factor but affects risk premiums on known such factors; and third, accounting information quality is somehow related to known systematic risk factors. Previous studies have closely examined the first two possibilities, producing completely contradictory insights. For example, Easley and O’hara (2004), Francis et al. (2005), and Bandyopadhyay et al. (2017) suggest that accounting information quality is a priced systematic risk factor. However, Core et al. (2008) show that accounting information quality represents idiosyncratic risk that can be completely diversified away. Hughes et al. (2007) argue that high accounting information quality decreases risk premiums on known systematic factors, but Veronesi (2000) demonstrates the opposite. Despite these deadlock situations involving the first two possibilities, the third one has received relatively little attention in academic research.

A large theoretical and empirical literature examines the role of the accounting information quality (Bushman et al., 2001; Bushman and Smith, 2001; Bagaeva, 2008; Chan et al., 2009; Chan and Lee, 2009; Zhiying et al., 2012; Ran et al., 2015). One line of research (Biddle and Hilary, 2006; McNichols and Stubben, 2008; Biddle et al., 2009; Chen et al., 2011) suggests that higher quality information enables managers to identify better investment opportunities. Several studies also propose that auditor specialization can be used to reduce the information asymmetry problems (Almutairi et al., 2009; DeBoskey et al., 2012; DeBoskey and Jiang, 2012; Yaghoobnezhada et al., 2014): A specialist’s knowledge of the industry can be developed through vast auditing experience, specialized staff training, and large investments in information technology. This industry-specific knowledge allows specialist auditors to provide higher quality audit service by reducing the information asymmetry through their greater ability to detect significant anomalies. Theoretical models (Balsam et al., 2003; Lai, 2011) predict that, despite the limited evidence, a highly acquired audit quality is extremely useful for improving investment efficiencies, especially with respect to overinvestment. Based on these premises, the main purpose of this paper is to combine these two mechanisms and analyze the effect of the accounting information quality (AIQ) and the auditor specialization on investment efficiency.

Understanding the potential impact of IFRS on Banks Accounting process is critical to users (Bankers, Accountants, Auditors, Corporate management, investors, lenders, financial analysts, regulators) connected to Banks financial reporting. However, Accounting has severally been described as the language of business. This is simply because accounting focuses on identifying, classifying, summarizing and interpreting economic and other relevant information about reporting entities such that intended users of such information can make informed judgements. Through financial statements the overall well-being as well as the state of affair of organizations is communicated to stakeholders of all manners and kinds (Edirin & Edesiri 2016). International Financial Reporting Standards (IFRSs) are a set of Accounting Standards developed by International Accounting Standard Board (IASB) for the preparation and presentation of public financial statement. The primary objective of financial reporting based on IFRS is to provide high quality financial reporting information concerning economic entities primarily financial in nature, useful for economic decision making (FASB, IASB 2008.) International Financial Reporting Standards (IFRSs) is the set of accounting standards developed under a rigorous due diligence process and now used in more than 120 countries around the world including Australia, Brazil, Canada, the European states south Africa, Nigeria and many others. Accounting theory argues that the purpose of financial reporting is essentially to reduce information asymmetry between corporate managers and their related parties (Watts, 1977, Ball 2001) and financial reporting reduces information asymmetry by disclosing relevant and timely information (Jaggi & Low 2000) It is important to provide high quality financial reporting information because it will positively influence capital providers and other stakeholder in making investment, credit and similar resources allocation decision enhancing overall market efficiency (IASB, 2008; IASB, 2010). In Nigeria, the banking sector forms one of the pillars of economic development since this sector intermediate between the surplus and deficit sector of the economy thus stimulating and providing investment and economic growth and development (Umoren and Enang 2015) Increase in investment in the banking sector will lead to improved performance of the country, but for any meaningful investment to occur in the banking sector, quality accounting information regarding the performance of the banks are essential.

The availability of external finance for small- and medium-size enterprises (SMEs) is a topic of significant research interest among academics and a crucial issue for policymakers (Berger and Udell 2006; De la Torre et al. 2010). Especially, a high rate of interest is set on bank debt, as it is the most common source of external finance1 since their size precludes them from accessing capital markets. Even so, SMEs frequently experience problems when trying to access credit (Schiffer and Weder 2001; Beck et al. 2005, 2006, 2008; Hyytinen and Väänänen 2006). The most common argument is the opaqueness generally attributed to SMEs, which accentuates information asymmetries (Berger and Udell 1998; Berger et al. 2001; Mason and Stark 2004; Berger and Frame 2007; Hyytinen and Pajarinen 2008). It can be particularly challenging to collect information about SMEs. It is not unusual for small businesses to have a short history, a lack of formal or public records, or a deficiency of formal control systems (Bruns et al. 2008). This lack of information can put the banks at a disadvantage, by making it difficult to differentiate between high-risk and low-risk borrowers (Stiglitz and Weiss 1981; Berger and Udell 1998). Within this context, relationship lending is particularly relevant (Petersen and Rajan 1994; Boot 2000), as asymmetric information problems tend to be more acute for SMEs than for large firms (Berger et al. 2001). In relationship lending, the bank relies on a range of private information gathered through contact with the firm, their owners and managers and the local community in which they operate (Berger and Udell 2006). Furthermore, banks also use other lending techniques in order to evaluate the firm’s riskiness, such as the evaluation of financial statements or credit-scoring (Berger and Udell 2006). In addition, trying to minimise the probability of error, banks seek to formalise both the information-gathering process and the loan officer’s decision process (Bruns et al. 2008). However, despite all formal procedures to support the decision to grant credit, in many (or even most) cases, credit risk management is not automated, and it is ultimately based on a loan officer’s judgement and perceptions (De la Torre et al. 2010).

Tax non-compliance is a serious concern to governments worldwide.1 Outstanding tax debt payments undermine the ability of governments to provide public services and pose a threat to the perceived fairness of the tax system. According to the latest Internal Revenue Service (IRS) estimates for the years 2008 to 2010, the average annual tax gap in the US amounted to $458 billion – 18.3 percent of the total revenue owed (IRS, 2016). Despite substantial collection efforts of the IRS, a considerable part of this tax liability will never be paid. Even in countries with a relatively small population like Australia, collectable tax debt is $19.5 billion annually (ATO, 2015). The major share of this amount can be attributed to businesses who often owe more than twice as much as individual taxpayers (Ariel, 2012). Businesses and self-employed persons have more opportunities to evade taxes because they are less often subject to tax deducted at the source of their payments and to third party reporting (Thomas, 2013). As a consequence, only about half of business non-compliance is detected (Kamleitner et al., 2012). Business taxpayers have also been found to have a lower tax morale, ie. a lower intrinsic willingness to meet their tax obligations, than individual taxpayers (Torgler, 2007). Other studies find no difference in tax morale between business owners and employees in terms of personal norms regarding tax honesty, but a greater share of business owners admits to have evaded tax payments (Ahmed and Braithwaite, 2005). Consequently, business taxpayers constitute a highly relevant target group for tax collectors trying to increase voluntary tax compliance. Despite the substantial contribution of business taxpayers to government revenue, research on the behavioral foundations of business tax compliance is rather scarce (Hallsworth, 2014; Gangl et al., 2014; Arcos-Holzinger and Biddle, 2016) for three main reasons: First, due to its nature, it is difficult to observe tax non-compliance. In the face of potential punishment, evading taxpayers will try to conceal their actions and are unlikely to respond correctly even in anonymous surveys (Slemrod, 2016). This behavior is even more likely for businesses because there may be more than one person responsible for filing. Second, most tax administrations refrain from engaging in field evaluations testing the effect of alternating policies to improve compliance behavior. Third, most trial research on tax behavior focuses on one intervention only rather than analysing multiple approaches to influence the same decision process. Randomized controlled field experiments have emerged only very recently as a tool to investigate tax compliance (Wenzel and Taylor, 2004; Dwenger et al., 2016). Most of these experiments have focused on individual taxpayers, while business taxpayers remain understudied (Gangl et al., 2014; Hallsworth, 2014; Ariel, 2012).

One of the heated discussions on foreign direct investment (FDI) is the agency problem between managers and stakeholders. Lee and Kwok (1988) argue that legal differences, multicounty financial statements, and multicounty auditors make it difficult to monitor managers in international markets. Choi et al. (2016) report that the extent of institutional dissimilarity between institutions in home and host countries worsens monitor function of stakeholders. In addition, Singhal and Zhu (2013) argue that managers may be willing to make potentially value-destroying diversification decisions to derive and preserve private benefits such as enhanced status, high perquisites, future employment prospects, and reduced employment risk. Weak monitor function in FDI firms provides more opportunities for managers to pursue personal interests, which consequently increases agency costs. Therefore, the present study argues that managers in FDI firms may use accounting maneuvers to mislead stakeholders and lower accounting information quality in the pursuit of personal benefits such as a better compensation contracts (Healy, 1985) or improved job security (DeAngelo, 1988). Using earnings management, which is frequently applied as a measure of information quality (An et al., 2016), this study predicts earnings manipulation increases with foreign investment by FDI firms.