Capital Gains and the Capital Asset Pricing Model

This paper shows that, in the presence of differential taxation of ordinary income and capital gains, use of the Officer (1994) version of the Capital Asset Pricing Model can result in significant misestimation of the cost of equity capital. In particular, with a high dividend yield, the cost of equity may be underestimated by four percentage points. Underestimation is of particular significance in the context of setting output prices for regulated utility firms

Deprival Value and Fair Value: a Reinterpretation and a Reconciliation

Two alternative measurement bases that have appeared in accounting standards, Deprival Value (sometimes called Value to the Business) and Fair Value, are explained and compared. They are then reconciled by making the following three adjustments to their conventional definitions. (1) In the case of Deprival Value, situations in which net realisable value exceeds replacement cost imply that there is a profitable redevelopment or redeployment opportunity, so that net realisable value is regarded as the appropriate measure of Deprival Value. (2) In the case of Fair Value, transactions costs (including installation and removal costs) are added to acquisition values and deducted from disposal values. (3) In the case of Fair Value, it is assumed that net realisable value represents the “highest and best use”, except when it is exceeded by both replacement cost and value in use. In the latter case, “highest and best use” (and therefore Fair Value) is inferred by assuming profitmaximising behaviour by the owner. It is suggested that the resulting synthesis represents a method of current valuation which is consistent with the objective of measuring the asset in terms of the economic opportunities that are available to its current owner in the condition and location in which it is currently to be found

The Value Relevance of Information about Convertible Financial Instruments

We investigate the value relevance of the financial statement information about convertible financial instruments. Our findings indicate that the classification of convertibles provides incremental information over and above the book value of equity and net income. This finding is not as strong for convertibles that are classified as a form of mezzanine financing between debt and equity as for those classified as debt or equity. We also find that investors make use of information contained in the notes but only with respect to mandatory convertibles and convertibles where the right to make the decision about conversion or redemption rests with the issuer

Effects of audit quality on earnings quality and cost of equity capital: evidence from India

In this paper, using a large sample covering the 10 years from 1998 to 2009, we examine the role of audit quality in earnings quality (discretionary accruals and income smoothing) and cost of equity capital of Indian firms. We find evidence that firms employing high quality auditors experience higher earnings quality and lower cost of equity capital. We find that firms belonging to business groups have higher earnings quality and lower cost of equity capital than their non-business group counterparts. The results do not change after utilising alternative proxies for audit quality, earnings quality and cost of equity. Our findings contribute significantly to the literature on the role of audit quality as an effective monitoring mechanism as reflected in firm level earnings quality and cost of equity capital of listed firms in India which has distinct institutional features in relation to ownership structures and operations

Value Relevance of Environmental, Social, and Governance Disclosure

This paper investigates the impact of Environmental, Social, and Governance (ESG) disclosure by companies around the world on market value. Using a large sample of non financial companies listed in 38 countries during the period 2008–2012, we test for value relevance by employing the modified version of the Ohlson (1995) model developed by Collins, Maydew, and Weiss (1997). We find support for the value relevance of disclosure of ESG both in aggregate form and for its individual components. These findings support the expectation of disclosure theory that disclosure of relevant information (such as ESG) has a positive impact on value. The results are robust to several alternative specifications. Consistent with the finance literature on the impact of legal origin (La Porta, Lopez de Silanes, & Shleifer, 2006; La Porta, Lopez de Silanes, Shleifer, & Vishny, 1998, 2000, 2002), the results for ESG disclosure are stronger in common-law countries. Our results provide new evidence for researchers, investors, and policy makers of the value relevance of ESG disclosure in a broad international setting. The evidence shows that globally investors benefit from the disclosure of both aggregate ESG and the individual factors and this supports regulators in pushing companies to provide additional ESG information

Differentiated regulation: the case of charities

The increasing number and influence of charities in the economy, allegations and evidence of fraud and mismanagement, and the need for information to inform policy, are all reasons for the establishment of charity regulators. Public interest and public choice provide underlying theories explaining charity regulation which aims to increase public trust and confidence in charities (and thus increases philanthropy), and to limit tax benefits to specific organisations and donors. Disclosure-based regulatory regimes are a common model for charities regulation in many jurisdictions. Nevertheless, these can be resource intensive for the regulator and regulated charities, and growing pressure on government budgets requires efficiencies to be found. This paper proposes regulation differentiated according to charities’ main resource providers. This could reduce cost and increase the regulator’s effectiveness through focusing effort. In addition, this differentiation segments charity types according to the theories that explain why these organisations form and operate. We demonstrate the feasibility of such segmentation by use of cluster analysis of data on New Zealand registered charities and show which charities could benefit from differentiated regulation

Auditor Independence and NAS: a Comparative Analysis of Selected Current Regulatory Frameworks

There is a widespread public perception that the provision of NAS undermines auditor independence. In order to protect auditor independence, the regulatory frameworks of many countries include regulations and guidelines which auditors are required to observe. This paper provides a comparative analysis of selected regulatory frameworks. Regulatory frameworks, with respect to independence, make distinctions between independence of mind and in appearance. It is clear from the analysis of the frameworks that the provision of NAS can threaten both independence of mind and in appearance. There are some NAS for which no safeguard seem to be adequate and which are therefore subject to prohibition. On the other hand, for some nonaudit services the threats are not so clearcut, and auditors are then required to apply professional judgment so that the seriousness of the threats is balanced against the effectiveness of specified safeguards

Government Quality, the Adoption of IFRS and Auditor Choice: A Cross Country Analysis

We examine the association between country-level government quality and firms’ choice of external auditors. We use a firm’s choice of a Big 4 auditor as a proxy for the demand for high-quality financial reporting. Using a cross-sectional sample of 142,193 firm-year observations from 46 countries over 1998-2007, we show that government quality of a country has a significant positive effect on the likelihood of choosing Big 4 auditors by firms in that country. We also show that firms in countries with strong governments that have adopted IFRS are more likely to choose Big 4 than non-Big 4 auditors. To our knowledge, this is the first study of its kind to provide direct evidence on the role of government quality in firms’ choice of external auditors. The results provide insights for policy makers on the importance of government quality toward improving financial reporting quality in a country

The Impact of Default Risk on the Basu Measure of Accounting Conservatism

We show, analytically and empirically, that there is a positive correlation between default risk and the Basu measure of conservatism: the higher the default risk, the higher the bias in the Basu measure. We use the insight provided by our analysis to construct an improved version of the Basu measure, the Default-Adjusted-Basu (DAB) measure. The DAB measure adjusts for the effects of default risk on the Basu measure. Using Distance-to-Default as a measure of default risk, we contend that the DAB measure can substantially reduce the bias caused by default risk, and hence is a more robust measure of accounting conservatism than the standard Basu measure. We demonstrate that once one adjusts for the distance-to-default, the Basu conservatism coefficient is no longer positively correlated with leverage

Analysis of Change in Present Value Measurements

In recent years, the leading standard setters for financial reporting have shown an increasing preference for fair value measurement. However, present value is often the only acceptable method of estimating fair value and therefore the actual result of the swing to fair value is likely to be increased use of present value in financial reporting. This paper addresses the issue of interpretation of a change in present value between successive reporting dates and shows that the change can be analyzed by use of the familiar variance analysis framework widely used in management accounting