The limitations of signalling by the choice of accounting methods: the depreciation method case.

This paper discusses the limitations of signalling by income increasing accounting methods, such as linear depreciation. Because legislation only allows the discrete choice between linear and accelerated depreciation, signalling by an income increasing accounting method is only possible in industries where all firms perform well. The industry characteristics would not influence signalling by the depreciation method if legislation allowed all levels of depreciation. Moreover, successful firms would not signal their type by an income increasing accounting method but by an income decreasing accounting method. Finally, the contracting structure, raising the capital by issuing new shares or by the sale of existent shares influences the tax rate environment needed to solve asymmetries in information. This paper shows that the comments on the inventory signalling model of Hughes and Schwartz (1988) are general for all models explaining the signalling function by the choice of an income increasing accounting method.Accounting; Methods;

The efficiency of accounting signals: a comparison between the inventory and the depreciation accounting method.

One of the main comments on the signalling inventory model (Hughes & Schwartz, 1988) was the absence of a comparison between FIFO and other possible signalling devices. In this paper the model of Hughes & Schwartz (1988) is extended by adding a second accounting signal: the depreciation accounting method.If the manager-owner can choose between FIFO and linear depreciation to solve asymmetries in information about the success of the project, he will always choose the signal, which results in the smallest increase in taxes paid. Therefore, the characteristics of the investment and the purchasing policy are very important. In capital intensive industries, where investments in fixed assets are large, FIFO is expected to be the cheapest signal. As the volatility of prices and the inventory level go up, FIFO becomes more expensive as a signalling device.Differences in the cost from using a certain signalling strategy can explain why differences in reporting strategies between industries occur.Efficiency; Accounting;

Corporate governance and performance: Controlling for sample selection bias and endogeneity.

Studies investigating the relation between corporate governance and performance find only weak evidence that corporate governance affects performance. One reason could be that these studies fail to control properly for sample selection bias and endogeneity. Without controlling for these problems, the relation between corporate governance and performance is not inferred correctly. With this study, we provide evidence on the influence of endogeneity and sample selection bias on the coefficient of corporate governance. We use panel data for the FTSE Eurotop 300 companies over 5 years, from 1999 to 2003. We find that using a sample of the 300 largest companies induces selection bias in the results. Furthermore, the results show that an endogeneity problem is present. This endogeneity problem is caused by a negative reverse causality between performance and corporate governance. After controlling for both problems the coefficient on corporate governance increases and becomes highly significant, where it is insignificant when we use OLS. The results also show that controlling for both problems at the same time is important as by controlling for just one of these problems the bias is only partially reduced. Furthermore, we find that both problems have an equally large impact on the bias in the coefficient. Overall, our findings indicate that the lack of significant results in prior studies is due to not controlling properly for sample selection bias and endogeneity.Negotiations; performance; Selection bias; Law; Panel data; Trade liberalization;

Legal and voluntary investor protection and early IFRS-adoption: A study of European companies.

Previous studies (Dumontier and Raffournier, 1998, El-Gazzar et al, 1999; Cuijpers and Buijink, 2004) typically explain the early adoption of IFRS by firm-specific benefits. However, the adoption of IFRS also leads to costs for company insiders, namely less managerial discretion and as a consequence smaller private benefits due to increased disclosure requirements and less accounting method choices. This paper argues that the cost of adopting IFRS depends on characteristics of the institutional environment, more specifically the level of investor protection. Using a sample of European companies, we find that IFRS is more likely adopted in countries with strong laws protecting investors and/or extensive corporate governance recommendations where the loss of private benefits following IFRS-adoption is lower. Furthermore, the results show that corporate governance recommendations are as effective as hard laws in stimulating IFRS-adoption and that their impact increases as laws become weaker. This suggests that by improving corporate governance codes, countries can easily reduce the extraction of private benefits by managers and enhance the quality of the financial information. However, when looking at specific recommendations and laws, we find that shareholder rights with regard to voting rights and the general meeting need to be regulated by law in order to effectively reduce the level of private benefits.Accounting; Characteristics; Choice; Companies; Corporate governance; Cost; Costs; Country; Disclosure; Early adoption of IFRS; Governance; Impact; Information; Law; Legal investor protection; Managers; Order; Private benefits of control; Quality; Recommendations; Requirements; Research; Studies;

A signalling approach to the revaluation of assets: a theoretical and empirical analysis.

In many countries firm can choose whether to report a revaluation in the financial statements. Besides contracting costs, signalling reasons can determine the decision to revalue assets. An analytical model is developed which allows to indicate conditions in which it is more likely that successful firms will not revalue assets as a credible signal to potential investors of their success. These include high variability in success and low equity-to-debt ratios in the industry. The empirical results using Belgian data confirm that besides the classical contracting effects, indeed successful firms are less likely to revalue assets, at least in those industries with a high difference in performance or low equity-to-debt ratios. As firms are closer to covenant default or violate the covenant, and as they are larger, they are more likely to revalue assets. Finally, the results support a dichomotous choice to revalue or not as signalling device but not the amount of revaluation.Assets;

The simultaneous relation between audit report type and business termination : evidence for non-listed companies in a non-litigious audit environment.

This study provides evidence on the relationship between audit report type and subsequent business termination in an environment where firms are closely held and the audit environment is non-litigious. The results show that an endogenous relationship exists between bankruptcy and audit report type, and between voluntary liquidation and audit report type. A non-clean opinion is typically given to firms with financial difficulties, which in turn become more severe after the receipt of a non-clean audit opinion. We find evidence that, even without a litigation deterrent in Belgium, financial performance has a similar impact on audit report type as in litigious environments, that is, the worse the financial condition the higher the likelihood of receiving a non-clean audit report. We also find that the self-fulfilling prophecy holds for bankruptcy, that is that a non-clean audit report triggers bankruptcy. Our paper investigated the relationship between audit report type and business termination for various types of business terminations including bankruptcy, voluntary liquidation and merger. The results reveal significant differences across the forementioned types of business terminations. One difference is that the self-fulfilling prophecy only holds when the audited firm has no decision power as to termination of is operations, that is for bankruptcy. It does not hold for voluntary liquidation nor merger. Another important difference relates to business termination through merger. No significant difference in performance exists between surviving and merging firms and no endogenous relationship exists between mergers and audit report type. For merging firms audit report qualifications are triggered by the weakness of the auditee's internal control system and not by substandard financial performance. Finally, our study provides some evidence on quality differentiation between Big Six and non Big Six auditors in the Belgian audit market. When financial difficulties are obvious, as is the case when a company is about to go bankrupt, both Big Six and non big Six auditors are as competent and/or independent to assess and report going concern problems. However, when financial difficulties are less apparent, as is the case for firms which are about to go into liquidation, our results indicate that Big Six auditors are more likely to issue a qualified audit opinion.Management; Companies;

On the disclosure and capitalization of research and development spending: some empirical observations for Flanders.

In the US, FASB NR2 demands the full expensing of R & D costs because they would not contribute to future earnings. In Europe, however, article 37 of the Fourth European Directive allows companies to capitalize their costs of R & D as an intangible asset or to expense them immediately in their income statement. The paper exploits that difference and tries to analyze empirically which factors determine the reporting choice made by firms in Europe.More specifically, we analyze the capitalization as well as the disclosure decision of 321 Flemish firms, who are actively performing R & D activities. Company information from their financial statements is combined with privately held data on the size and nature of their R & D activities. The disclosure decision is analyzed separately from the capitalization decision. Only 30% of the 321 R & D active firms in the sample disclosed the amount of R & D spent in their financial statements. About 70% of those firms disclosing choose to capitalize.The empirical results show that the disclosure decision is determined by the R & D characteristics as well as by the financial performance of the firm. The probability that a firm discloses its R & D expenses is increasing with its R & D intensity, the existence of an R & D department and cooperation with universities or other firms. The current as well as the long term financial performance are also relevant for the disclosure decision. Once the firm has decided to disclose its R & D expenses, the decision to capitalize these expenses is mainly determined by the financial performance. If firms can not repay part of their debt and if stakeholders do not receive a sufficiently high income, firms are more likely to capitalize their R & D costs. When the group of capitalizing firms is compared to the group of expensing firms, whether disclosing or not, our results suggest that the R & D intensity, at least in highly innovative industries, and the financial performance determine the capitalization of R & D expenses. Our results suggest that the expenses of successful R & D activities are more likely to be capitalized as an asset in the balance sheet.Research and development; Demand; Costs; Companies; Factors; Data; Characteristics; Performance; Probability; Cooperation; Industry;

The recognition of an accounting practice and its timing as signalling tools.

This paper extends the literature on the signalling function of accounting and financial information by investigating the information content of the adoption of a certain accounting practice, namely the recognition of deferred taxes in the financial statements. Specifically, we examine whether (1) the decision to recognise a certain accounting practice, and (2) the timing of the recognition supplement one another as signalling devices. The new accounting law on deferred taxes (Royal Decree of December 30, 1991) requires all Belgian firms to recognise deferred taxes for all grants on the balance sheet as of 30/12/91. The results show that the recognition and the timing of the recognition supplement one another as signalling tools. The immediate recognition of positive deferred taxes signals good news: firms that report positive deferred taxes typically perform better at the time of adoption and in the near future thereafter. Within the class of recognisers, early recognisers perform better than late recognisers. However, this second signal, the timing of the recognition is only used as a second signal for the class of tax-paying firms. Our findings also indicate that the impact on the balance sheet is a significant determinant of the decision to report deferred taxes. Firms where the adoption of deferred taxes would lead to a high increase in the debt/equity ratio are less likely to adopt, or, if they do report deferred taxes, do so later. These results suggest that firms decide not to recognise positive deferred taxes in order to limit the decrease in their solvency position. Indeed, firms that have already experienced a decline in their solvency position are more likely to postpone the recognition of deferred taxes.Accounting; Law; Solvency;

Differences in audit quality between audit firms: The impact of audit-firm portfolio characteristics.

Companies generate financial statements that are used for decision making by various stakeholders and the quality of those financial statements depends on the quality of the external auditor. There exists empirical evidence of quality differentiation between audit firms, but the audit-quality proxy that is typically used, auditor size (big 6 / non-big 6 firm), is very rough. The major purpose and contribution of this paper is to further investigate audit-quality determinants empirically. To that end we test the impact on financial statement and audit quality of audit-firm portfolio characteristics, that we selected based on a well-perceived theory by DeAngelo (1981). We indeed find that audit-firm portfolio characteristics better explain variations in financial statement and audit quality. In particular: 1) the short-term leverage of an audit firm's portfolio is negatively, and 2) the number of clients in an audit firm's portfolio is positively associated with financial statement and audit quality.Image; Characteristics; Companies; Decision making; Theory;

Attribute differences between USGAAP and IFRS earnings: An exploratory study.

With the successful completion of the IASC's standards, IFRS and US GAAP were placed as the two pre-eminent world financial reporting frameworks. For years, however, US GAAP was accepted widely as the international set of standards to ensure high quality financial statements. Especially in the US, but also elsewhere, the introduction of IFRS has lead to a discussion on the (relative) quality of both regimes. However, relatively little research has been devoted to the subject. In this study, we address that void and further compare the quality of the two standard regimes using a sample of German New Market firms. Financial statement quality is measured applying multiple earnings attributes traditionally used in accounting research. Consistently throughout our measures, we find that the quality of US GAAP prepared financial statements and IFRS information is overall very comparable. Only with regard to predictive ability of accounting information do we find US GAAP superiority.Accounting; Accounting regime; Earnings attributes; Earnings quality; Selection bias; Studies;