ARTICLES 

Compliance with Flexible Accounting Standards
by Øyvind Bøhren, Jørgen Haug and Dag Michalsen

JEL classification: M41; K42; G38

Key Words: Generally accepted accounting principles; Flexible accounting standards; Compliance; Intercorporate investments; Cost method; Equity method

Abstract:  We examine to what extent firms adhere to the stated intent of noncompulsory accounting standards when reporting for intercorporate investments.  The Generally Accepted Accounting Principles (GAAP) in Norway strongly recommend that a 20-50% intercorporate investment is accounted for by the equity method rather than the cost method, if the investment is long-term, of strategic importance, and involves significant influence.  Even so, we find that the actual use of the equity method is independent of the duration of the investment period, the fraction of equity held, its recent growth, and the investor’s voting power.  This lack of compliance suggests that one cannot use the observed choice between the cost method and the equity to infer the underlying characteristics of the investment as specified by the accounting standard.  Flexible GAAP may therefore not induce firms to disclose the information that the GAAP were designed to produce.

International Managerial Accounting Research:  A Contracting Framework and Opportunities
by Susan F. Haka and Dan L. Heitger

Keywords: International; Managerial; Accounting; Framework; Review; Contracting

Abstract:  The objective of this paper is to provide an international managerial accounting contracting-based framework that organizes a broad sample of published research and (based on that sample) identifies research opportunities.  Organizations that operate in cross-border markets constantly face contracting challenges that arise because of different factor and product market characteristics.  Accounting has a role in defining, implementing, monitoring, and negotiating the implicit and explicit contract firms use in these markets.  Thus, a useful framework for considering international managerial accounting research would incorporate different international market characteristics that impact the contracting role of firms.  Using such a theoretical framework, this paper examines the role of managerial accounting by focusing on operating and strategic decisions that require knowledge transfer, decision-rights assignment, and decision-rights control within international organizations.

An International Investigation of Associations Between Societal Variables and the Amount of Disclosure on Information Technology and Communication Problems:  The Case of Y2K
by S. Mitchell Williams

Keywords:  Information technology and communication problems; Disclosure practices; Societal variables; International accounting

Abstract:  This study examines the association between five societal variables—political and civil system, cultural values, types of legal system, level of economics development, and equity market features—and the amount of corporate disclosure on the Year 2000 (Y2K) technological dilemma.  Data are collected from the 1997/1998 fiscal-year annual reports of 1618 publicly listed firms spanning 17 nations.  Empirical findings indicate the amount of Y2K disclosure varied significantly across national boundaries.  Statistical analysis indicates a strong positive association between the amount of Y2K disclosure and the level of (a) political rights and civil liberties and (b) economic development.  Results also imply publicly listed firms in Common Law nations disclose more Y2K information than counterparts in Roman-German Law nations.  Of Hogstede’s [Hofstede, G. (1980).  CA Sage Publications] four cultural dimensions, only power distance is a significant explanatory factor of variations is the amount of Y2K disclosure.

The Influence of Management Perception of Environmental Variables on the Choice of International Transfer-Pricing Methods
by K. Hung Chan and Agnes W.Y. Lo

Keywords:  Environmental variables; Foreign investors; International transfer-pricing; Major developing economy

Abstract:  In this paper, we provide an empirical study of the association between the management’s perception of the importance of environmental variables and their choice of international transfer-pricing methods in the context of a developing economy.  Given the sizable investment flowing to developing countries and the amount of economic exchange that occurs through foreign investment in these countries, we believe this is a significant issue.  For this study, we collected the data from field interviews with the management of large foreign investment enterprises (FIEs) in China.  These FIEs include mainly investors from the United States, Japan, and Europe.  Our evidence indicates that the more important management perceives the interests of local partners and the maintenance of a good relationship with host government to be, the more likely that the FIE will use a market-based transfer-pricing method.  On the other hand, the more important the management perceives foreign exchange controls in transfer-pricing decisions, the more likely the FIE will choose a cost-based method.  Finally, there is a moderate agreement between U.S. and non-U.S. FIEs on the relative importance of the environmental variables.

Volume 39 Number 2 2004

An Empirical Assessment of Gray’s Accounting Value Constraints
by Shalin Chanchani and Roger Willett

Key Words: International accounting; Culture; Hofstede-Gray theory; Cultural Relevance; Accounting theory; Surveys; Factor analysis 

Abstract:  Gray (1988) proposed a framework for a theory of cultural relevance in accounting.  This renewed an interest in culture-related studies in international accounting.  To date, much of this literature has been theoretical or subjectively descriptive because, the elements constituting Gray’s framework lack an operational foundation.  This paper addresses this shortcoming by presenting research that operationalizes and evaluates the empirical usefulness of Gray’s accounting sub-cultural value constructs of Professionalism, Uniformity, Conservatism, and Secrecy.   

The paper presents the results from an “Accounting Values Survey” administered to a sample of users and preparers of financial statements in New Zealand and India.  The data is subjected to multi-variate analysis and the results provide some support for the usefulness of Gray’s accounting values as empirically based classificatory constructs, though they may require some adaptation and re-interpretation.  Professionalism appears as the most clearly defined construct and the elements of the Uniformity construct also hold together well, although appearing to attract elements of the construct of Secrecy.  The part of the Secrecy construct concerned with the level of detail in financial statements appears to be reasonably well defined by respondents to the survey and Conservatism seems to fragment into two sub-dimensions, perhaps representing measurement and the disclosure aspects of that construct.  A question arises as to the possible existence of other, as yet unrecognized, accounting-value constructs.  The findings suggest the importance of further quantitative, survey research of this type to investigate the relevance of cultural factors in understanding international accounting practices.

The Value Relevance of R&D and Advertising Expenditures: Evidence from Korea
by Bong H. Han and David Manry

Key Words:  R&D Expenditures, Advertising Expenditures, Value-Relevance

Abstract:  This study examines the value-relevance of R&D and advertising expenditures of Korean firms, using a regression model based on the Ohlson (1995) equity-valuation framework.  Results indicate that R&D expenditures are positively associated with stock price, suggesting that capitalizing R&D expenditures is appropriate.  The association is stronger for the portion of R&D expenditures that is capitalized, rather than expensed, suggesting that investors agree with management that the capitalized expenditures represent greater future economic benefits.  Investors also appear to interpret fully-expensed R&D expenditures as positive net present value investments, however, suggesting that these expenditures should also be capitalized.  Additional results indicate that advertising expenditures are negatively associated with stock price, and the magnitude of this negative association is similar to the association between other expenses and stock price.  These findings suggest that investors believe the economic benefits of advertising expenditures expire in the current period, similar to other expenses.

Big Six Auditors and Audit Quality:  The Korean Evidence
by Seok Woo Jeong and Joonhwa Rho

Key Words:  Audit Quality, Big Six Auditor, Discretionary Accruals

Abstract:  This study investigates the association between discretionary accruals and Big Six and non-Big Six auditors, and the direction of auditor change. We hypothesize that there is no significant difference in discretionary accruals between Big Six and non Big Six clients when there is low incentive for auditors to provide high-quality audits, as in Korea.

Upon examination of the discretionary accruals of firms listed on the Korean Stock Exchange from 1994-1998, we find there is no significant difference between the discretionary accruals of firms with Big Six and non-Big Six auditors.  This holds true for firms that switch from non-Big Six to Big Six auditors and vice versa.  These resources imply that there may be no difference in audit quality between Big Six and non-Big Six auditors in Korea. This is consistent with other studies in Korea, while inconsistent with the findings of previous studies on audit quality in other countries.

The Decision Relevance and Timeliness of Accounting Earnings in Saudi Arabia
by Mohammed Al-Sehali and Nasser Spear

Abstract:  This study examines the decision relevance and timeliness of accounting earnings in Saudi Arabia during the 1995-1999 sample period.  The empirical results suggest that the publication of accounting earnings does not cause significant revision to the market assessment of future cash flows of Saudi firms.  On the other hand, it appears that the publication of accounting earnings leads individual investors to revise their security holdings.  However, this evidence is limited to cases where firms reported profit.  The empirical results further suggest that earnings are timely in terms of their association with security returns and that increasing the measurement interval significantly improves this association. The tests also show that positive and negative earnings have differential implications for the timeliness of accounting earnings.  Further tests show that this evidence is not consistent with the loss liquidation argument (Hayn 1995) and potentially may reflect the lack of tax incentives to liquidate investments in loss firms.  Finally, the results show that Saudi managers do not incorporate economic losses into accounting earnings on a timely basis which may reflect reduced market demand for accounting information, low levels of public debt, low expected litigation costs, and weak monitoring by analysts and other stakeholders. 
 

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Volume 39 Number 3 2004

Evidence on the Efficacy of Interest Rate Risk Disclosures by Commercial Banks
by Anwer S. Ahmed, Anne Beatty and Bruce Bettinghaus

Abstract: This paper documents evidence on the efficacy of maturity-gap disclosures of commercial banks in indicating their net interest income that is exposed to interest rate risk.  For the large sample of banks that filed call reports from 1990-1997, a period that includes a wide range of interest rate movements, we find that (i) one-year maturity gap measures are significantly related to the one-year and three-years-ahead change in net interest income, (ii) fixed-rate and variable-rate instruments differ in explanatory ability, and (iii) the one-to-five-year aggregate gap measures also have some power in explaining three-year ahead changes in net interest income.  These findings hold after controlling for the ex post growth in assets as well as the amount of rate-sensitive assets and liabilities (a competing set of explanatory variables).  Because of SEC’s (1997) Tabular disclosures are finer than maturity-gap data, our findings mitigate concerns about the usefulness of the SEC’s market-risk disclosure requirements.  Furthermore, they suggest contrary to the claims of certain banks that the omission of prepayment and early withdrawal risk from gap measures does not totally compromise the ability of gap data to indicate interest-risk exposures.

A Framework for the Analysis of Firm Risk Communication
by Sergio Beretta and Saverio Bozzolan

Abstract: In this paper we propose a framework for the analysis of risk communication and an index to measure the quality of risk disclosure.  Mainstream literature on voluntary disclosure has emphasized that quantity can be used a sound proxy for quality.  We content that, in the analysis of the disclosure of risks made by public companies, attention has to be paid not only to how much is disclosed but also to what is disclosed and how.

We apply the framework to a sample of non-financial companies listed in the ordinary market on the Italian Stock Exchange.  To verify that the framework and synthetic index are not influenced by the two factors recognized in the literature as the most powerful drivers of disclosure behavior for listed companies, we use an OLS model.  The regression shows that the index of disclosure quantity is not influenced either by size or industry.  Thus the synthetic measure can be used to rank the quality of the disclosure of risks.

Referral as a Determining Factor for Changing Auditors in the Belgium Auditing Market: An Empirical Study
by Joël Branson and Diane Breesch

Key Words: Audit switching, referral, subsidiaries

Abstract:  Traditional research on auditor choice and auditor switching focuses on company and audit (or) characteristics such as size and reputation, level of fees, or audit  opinion. These studies seek causal relationship between changes in these characteristics and changes in auditor. This article claims that the conclusions of existing research have limited application to smaller companies in a small open economy like Belgium. We see a need to supplement the research model to reflect the fact that the decision to choose or switch auditors in subsidiary companies often occurs at the parent level and is determined by group characteristics rather than local characteristics of the subsidiary. In this article, we show that “referral” the situation whereby the subsidiary – encouraged by the parent company – appoints the same auditor as the parent company, must be considered as an explanatory variable to understand audit-switching behavior in Belgium.

Volume 39 Number 4 2004

Evidence from China on the Value Relevance of Operating Income vs. Below-the-Line Items
by Shimin Chen and Yuetang Wang

Key Words:  Value relevance of recurring vs. non-recurring earnings, special items, below-the-line items, earnings-response coefficients, persistence of earnings

Abstract:  This study investigates the value relevance of operating income vs. below-the-line items in the Chinese stock market.  The motivations for this study are twofold.  First, there is a need for empirical evidence of the value relevance of earnings components given that previous findings of value relevance in China at the aggregate level have often been questioned in the literature.  Second, the reporting environment for earnings components in China provides an interesting opportunity to present additional evidence on the pricing of persistent vs. less persistent earnings.  Chinese GAAP is more specific in defining the scope and specifying the format of reporting earnings components with different levels of persistence.  In addition, differing from the U.S. evidence in the extant literature, below-the-line items in China is overwhelmingly income- increasing and frequently account for a large percentage of a firm’s reported net income.  By linking valuation analysis with earnings time-series properties, we present additional evidence to support value relevance in China:  An earnings component is impounded in stock prices as long as it is persistent and non-persistent below-the-line items are value irrelevant.  However, the time-series properties of earnings components are not fully priced by the market.  The earnings- response coefficients are larger for below-the-line items than for operating income, even though below-the-line items are less persistent and have lower predictive power.  In discussing this pricing anomaly, we identify some unique institutional factors that may be responsible for the results.  

Option-based Compensation: A Survey
by Rutger Muurling and Thorsten Lehnert
 

Abstract: Despite empirical research and theoretical validity, there is mixed evidence on whether employee stock options align interests between management and shareholders by turning managers into owners.  What used to be a functional tool introduced in the 1950’s, has gotten out of hand, as perceived by the press and popular literature.  The main catalyst is the accounting treatment stock options receive.  This paper provides an overview of the empirical research in the field and discusses the current accounting treatment of employee stock options and impending changes.  We conclude by proposing alternative compensation tools.

A Comparison of Value Relevance of Accounting Information in Different Segments of the Chinese Stock Market

by Heibatollah Sami and Haiyan Zhou

Keywords:  Value relevance; Accounting information; Market segmentation; IAS; Chinese GAAP; Emerging markets 

Abstract:  This paper investigates the difference in the value relevance between the accounting information prepared and audited under the Chinese GAAP for A-share investors and under the international accounting standards (IAS) for B-share investors in the Chinese stock market.  The study reports three primary findings.  First, accounting information influences the pricing process in both the A-share market and the B-share market.  Second, the accounting information in the B-share market is more value relevant than that in the A-share market, as expected.  Finally, the value relevance level of accounting information in the A-share market was low in earlier years, peaked in 1996, and then decreased due to changes in the disclosure environment.  However, the value- relevance level of accounting information in the B-share market had no substantial changes.  Using a constant sample, control variables on firm features, and measures of traders’ behavior, we obtain robust results.  These findings have implications for policy makers on recent moves toward replacing local GAAP with the IAS.