78 Managerial Finance

Consequences of Financial Reporting

Requirements on Managerial Decisions: The
Case of U.S. Multinational Corporations and
Foreign Currency Translation
by J. David Spiceland,* Jerry E. Trapnell,** Michael L. Behrens,*** and Abdel Kab-

*Professor at The University of Memphis

**Professor of Accounting and Dean of the College of Business at Clemson University,
***Ph.D. Candidate at The University of Memphis, ****Professor at the University of
Bengazi

I. Introduction

This article reports the results of tests used to detect shifts in the systematic risk of
multinational corporations concurrent with regulations mandating new financial reporting
requirements for foreign currency translations. Results indicate significant beta shifts,
suggesting that management undertook specific suboptimal actions to counteract the
effects of the regulations and that those actions were responded to by the marketplace in
the form of a reassessment of systematic risk. It is further indicated that the market reaction
varies according to both the location and magnitude of firms' foreign investments.

Evaluation of economic consequences should be an integral component of any

regulatory process. A sizable literature examines the consequences of financial reporting
regulation relative to decisions made by investors, creditors, and management. Examina-
tion of the association between specific reporting mandates and management decisions
has attracted a relatively concerted research effort [e.g., reporting for leases, Abdel-khalik
and McKeown (1); research and development costs, Dukes, Dykman, and Elliot (11); and
line of business reporting (SEC 1969, 1970), Horwitz and Kolodny (23)].

In 1975 the Financial Accounting Standards Board (FASB) issued Statement of

Financial Accounting Standards No. 8 (SFAS 8): "Accounting for the Translation of
Foreign Currency Transactions and Foreign Currency Financial Statements". The stand-
ard proved to be controversial, primarily due to the perception that its implementation
would result in volatility in reported quarterly and annual earnings [Cooper, Frazier, and
Richards (9)]. In 1981, after a lengthy deliberative process, the FASB effectively repealed
the controversial requirements of SFAS 8 by issuing SFAS 52, "Foreign Currency
Translation".

The economic consequences of SFAS 8 have been investigated by a number of

researchers. Surveys by Evans, Folks, and Jilling (13) and Shank, Dillard, and Murdock
(33) asked executives of multinational corporations (MNCs) affected by SFAS 8 to
indicate whether the requirement to include translation gains and losses in income
influenced management practices. The findings of these studies, as summarized by Griffin
(21), indicated a number of nontrivial managerial actions in response to the regulation,
Volume 21 Number 9 1995 79

including (1) replacing debt denominated in one currency with debt denominated in
another, (2) adjusting inventory amounts, (3) modifying remittances between foreign
subsidiaries and the U.S. parent, (4) hedging in foreign currency futures markets, and (5)
shifting borrowing, lending, and investment practices. The indicated actions were
prompted by concerns relative to the perceived volatility of reported earnings due to the
pronouncement. However, the actions by MNC executives to reduce exposure to exchange
rate fluctuations, and thus reduce earnings volatility, could represent suboptimal decisions
by the firms in the absence of regulation.

Assuming capital market efficiency, suboptimal decisions on the part of MNC firms
should be reflected by changes in capital market measures. Early research on the effect
of SFAS 8 on security prices by Dukes (10) and Makin (26) failed to identify a significant
effect. However, research by Ziebart and Kim (37) and Salatka (30) found significant
negative excess returns to be associated with the issuance of SFAS 8.

The early, inconclusive, results pertaining to the capital market effects of SFAS 8
may have been the result of a lack of an explicit theory to predict such effects [Foster,
(17)]. More recent research and theory suggests that capital market effects may result from
financial statement effects on contracts written in terms of accounting numbers and from
political lobbying [e.g., Watts and Zimmerman (36); Fama (14); Healy (22)].

Salatka posited that capital market effects due to SFAS 8 were the result of its
financial statement effects via contracts written in terms of accounting numbers and
political costs; consequently, his study included only those firms that experienced trans-
lation gains and losses from the standard. Salatka also theorized that late adopting firms
were most likely to have used accounting methods to offset translation effects prior to
SFAS 8, while early adopting firms would have most likely used production, investment
and financing decisions to offset financial statement effects prior to SFAS 8. His results
were weakly supportive of this conjecture.

Several researchers have also examined effects associated with the promulgation of
SFAS 52. Ziebart and Kim (37) found significant positive excess returns associated with
events leading up to and including the issuance of SFAS 52. Shalchi and Hosseini (32)
investigated the effect of the standard on foreign exchange contracts. Ndubizu (27)
suggests a relationship between adoption of the standard and earnings volatility. Brown
and Brandi (7) compared the abnormal returns of firms which were either early or late
adopters of SFAS 52, finding that early adopters experienced positive abnormal returns
while late adopters experienced negative returns. Arnold and Holder (3) through an
examination of the annual reports of some of the Fortune 500 Industrials and interviews
with executives and financial analysts concluded that SFAS 52, at least in some cases, led
to more economically rational hedging policies. Studies show the adoption of SFAS 52
resulted in a decrease in hedging activities of multinational corporations [Siegel,
Theerathorn, and Alcerreca-Joaquin (31); Shalchi and Hosseini (32)].

Researchers have also investigated characteristics of firms during the three-year

phase in period of SFAS 52. Benjamin, Grossman, and Wiggins (6) found that early
adoption of SFAS 52 requirements tended to be associated with a favorable impact on
income and earnings per share, although rankings of firms both before and after adoption
80 Managerial Finance

of the standard on these measures were largely unchanged. Gray (20) examined the choice
of accounting method during the transition period for 67 of the largest industrial and
banking firms and concluded that the majority chose the method (SFAS 8 or SFAS 52)
that maximized reported income. However, Ayres (4) questioned Gray's conclusions due
to data limitation problems in determining what the effect on income would have been for
the firms under SFAS 52 for firms that elected to continue under SFAS 8 during the
transition period. Ayres (5) found that early adopters of SFAS 52 had a lower percentage
of stock owned by directors and officers, had smaller percentage earnings increases from
the previous year, were smaller, and were closer to debt and dividend restrictions than
later adopters.

The present study also investigated the effect of foreign currency accounting
regulation on firms. Like other studies, the research utilized security market reactions to
FASB pronouncements. However, unlike most prior research which had used security
prices as the focal point for analysis, the current research utilized shifts in systematic risk
to assess capital market reactions. Specifically, the research investigated whether beta
shifts for MNCs were associated with the implementation of SFAS 8.

The current research is premised on the belief that SFAS 8 increased the volatility
of certain MNCs' earnings and that this volatility was reflected in the market's assessment
of risk related to the ability of the MNC to fund dividends and to cover debt restrictions
and other contractual agreements (e.g., management compensation plans), as well as
incurring political costs. In the event of a shift in the market's assessment of risk, it is
unlikely that the shift would be homogeneous across firms. In fact, making such an
assumption would likely preclude the possibility of observing any SFAS 8 effect due to
the effects being obscured by sampling and aggregation. More likely, the shift vis-a-vis a
particular MNC would be related to the foreign exposure faced by the MNC [Salatka (30);
Theerathorn, Alcerreca-Joaquin, and Siegel (35)]. Exposure is assumed to be related to
the magnitude of foreign investment by the MNC and the foreign exchange rate risk faced
by the MNC. Thus, this research posits a relationship between risk adjustment and the
location and magnitude of foreign investment, controlling for these factors in the research
design. In another departure from prior research design, other extraneous factors were
controlled by using control groups comprised of other MNCs rather than wholly domestic
corporations, as used in prior research, to avoid possible bias.

II. SFAS 8 Effects And Hypotheses

SFAS 8 exposed MNCs' balance sheet accounts to foreign currency exchange rate
fluctuations and enhanced the volatility of reported quarterly and annual net income.
Pakkala (28) reported that, prior to SFAS 8, MNCs used translation methods which tended
to reduce exchange rate fluctuations and tended to defer at least some translation gains
and losses. The promulgation of SFAS 8 eliminated this flexibility.
Volume 21 Number 9 1995 81

The principal balance sheet effects of the standard involved foreign debt and foreign
inventories. MNCs which had formerly translated foreign debt at historical rates were
forced to make the translation at current rates under SFAS 8. Since the dollar had declined
relative to major foreign currencies both prior and subsequent to SFAS 8, the effect of the
standard was to increase the translated value of foreign debt, increasing debt to equity
ratios and resulting in some MNCs facing a net liability rather than a net asset position in
their foreign subsidiaries [Pakkala (28); Aggrawal (2); and Gray (19)]. For inventories
which had been previously translated using current rates, SFAS 8 required translation at
lower historical rates, decreasing the value of inventories. The lowering of the values of
inventories coupled with the increased value of debt also lowered the current ratio for
some firms. Lastly, the translation adjustments resulted in increased translation losses
[Salatka (30)].

Assuming that firms were optimally contracted and were at optimal production,
investment, and financing positions prior to the imposition of SFAS 8, the effect of the
standard would be expected to result in departures from these optima. Overall, increased
foreign currency exposure should move MNCs closer to contract thresholds (defaults) and
increase the uncertainty of dividend, debt, and bonus payments. Alternatively, MNCs may
have found incentive to offset increased foreign exposure through hedging, refinancing,
etc., resulting in additional risk. Hence, SFAS 8 is expected to result in an increased level
of risk for MNCs adopting the standard.

The extent of risk adjustment is expected to be directly associated with the MNCs
exposure to foreign currency fluctuations and its foreign investment exposure. MNCs with
operations in countries with more volatile currencies relative to the dollar, ceteris paribus,
should experience larger risk shifts than MNCs with operations in countries with more
stable currencies. SFAS 8 effects on restrictive covenants, ceteris paribus, should also
vary with the level of foreign activity. Firms with a relatively larger level of foreign
operations should experience larger effects than those with a relatively smaller level of
foreign operations. In addition, an interaction effect due to location and extent of foreign
operations is also expected. The alternative hypotheses of interest are:

H1: MNCs adopting SFAS 8 that have operations in countries with relatively
unstable currencies will experience larger increases in systematic risk than
MNCs with operations in countries with relatively stable currencies.

H2: MNCs adopting SFAS 8 that have a relatively larger level of foreign opera-
tions will experience larger increases in systematic risk than MNCs with a
relatively smaller level of foreign operations.

H3: MNCs having a relatively larger level of foreign operations and having
operations in countries with relatively unstable currencies are expected to
experience larger increases in systematic risk than those MNCs having a
82 Managerial Finance

relatively smaller level of foreign operations and having operations in coun­

tries with relatively stable currencies.

III. Portfolio Formation and Sample Selection

MNCs were identified from the Value Line database. A firm was classified as an MNC
regardless of its level of foreign investment relative to its total operations or assets. The
following additional selection criteria were also imposed:

1. The firm was classified by the Disclosure Journal [1971-1974) as using either
the (a) current/noncurrent, (b) monetary/nonmonetary, or (c) a hybrid method
of foreign translation, and further classified as following either immediate
recognition or deferral of foreign exchange gains/losses.

2. Any firm changing the method of translation from or to the monetary/non­

monetary method and/or the treatment of foreign exchange gains/losses
during the period 1971-1974 was excluded.

3. Security return data from the Compustat database for the period January 1971
through December 1978 were available.

4. The MNCs foreign investment locations and the percentage of each MNCs
foreign investments to the firmUs total assets were available.

5. Monthly currency value data from the International Monetary Fund for each
country in which the MNCs had subsidiaries were available.

To test the research hypotheses, a total of six, nonindependent, experimental port­

folios were constructed as described below. Furthermore, each MNC included in each
portfolio was pair-matched with another MNC not subject to the effects of SFAS 8,
resulting in six additional control portfolios.

Hypothesis 1 posited that increases in systematic risk would be associated with the
relative level of stability of the foreign currencies of the countries in which foreign
subsidiaries were located. Accordingly, MNCs were classified into one of two groups on
the basis of each host country's exchange rate relative to the dollar. Currencies that were
volatile relative to the dollar were categorized as unstable currencies (UC); otherwise,
the currency was classified as a stable currency (SC).

To measure the volatility of each currency and thus categorize affected MNCs, the
coefficient of variation (CV) for each currency involved was calculated during the period
January, 1971, through December, 1974, using the currency value at the end of each month
expressed in terms of the dollar as follows:

CV(Di) = σDi/ (1)

Volume 21 Number 9 1995 83

CV(Dj) is the coefficient of variation of foreign currency i, D it is the dollar value of

foreign currency i at the end of month t, is the average dollar value of foreign currency
i during the 48 months preceding the event date, and σD is the standard deviation of
foreign currency i during the 48-month pre-announcement period.

Currencies were then arrayed in descending order by their calculated CV.1 Curren­
cies comprising the upper (lower) half of the array were classified as unstable (stable)
currencies. MNCs with investments in countries with unstable and stable currencies
comprise the UC and SC portfolios, respectively. For MNCs having operations in both
stable and unstable foreign currency locations, judgment was exercised to classify the
MNC.2 In those instances where judgment could not be exercised, the MNC was excluded
from the portfolio.

Hypothesis 2 posited that increases in systematic risk would be associated with the
level of the MNCs foreign investment. The level of foreign investment was proxied by
the percentage of foreign assets to total assets. Two portfolios were formed on the basis
of this measure. MNCs with 20 percent or less of their total assets invested abroad were
included in the "low investment" (LI) portfolio, and those MNCs with investments greater
than 20 percent were included in the "high investment" (HI) portfolio.3

Two additional portfolios were formed to capture any combined effect of exchange
rate volatility and investment level on shifts in systematic risk - Hypothesis 3. A complete
crossing of the two levels of foreign currency stability (UC and SC) and the two levels of
foreign investment magnitude (LI and HI) results in four potential portfolios: UC/LI,
UC/HI, SC/LI, and SC/HI. The UC/HI and SC/LI portfolios represent the two interesting
extremes. The UC/HI portfolio includes firms with subsidiaries located in countries with
relatively unstable currencies and a high level of foreign investment. The SC/LI portfolio
includes firms with subsidiaries located in countries with relatively stable currencies and
a relatively low level of foreign investment. Insufficient sample sizes precluded the
inclusion of the other portfolios (UC/LI and SC/HI) in the analysis.

IV. Control Portfolios

Any observed shift in the systematic risk of a firm in response to the mandated use of the
monetary/nonmonetary translation method, as well as the immediate recognition of
foreign exchange gains/losses is best evaluated in comparison with concurrent systematic
risk measures of similar firms not affected by the mandate. Consequently, each experi­
mental firm in the six portfolios was pair-matched with a control firm. Most previous
studies selected wholly domestic firms as control firms, reasoning that these firms were
unaffected by the new rules. However, the degree of similarity between MNCs and wholly
84 Managerial Finance

domestic firms is suspect, since MNCs operate within an environment characterized by

both domestic and foreign social, political, economic factors. Accordingly, this study
selected as control firms MNCs that were unaffected by the mandate. Prior to the issuance
of SFAS 8, some MNCs voluntarily used the monetary/nonmonetary method of translation
along with the immediate recognition of the foreign exchange gains/losses, (i.e., the SFAS
No. 8 requirements). Consequently, these firms should not have experienced any signifi­
cant effects as a result of the FASB mandate.

Criteria for pair-matching these control firms with MNCs in the six portfolio
groupings were (1) industry membership and (2) pre-pronouncement systematic risk.
Industry membership was determined by reference to the four-digit Standard Industrial
Code (SIC) classifications.5 Sample sizes of the twelve portfolios (six experimental and
six control) formed by applying the five sample selection criteria and two pair-matching
criteria are shown in Table 1.

Table 1. Sample and Portfolio Sizes

Portfolio
Total SC UC HI LI UC/HI SC/LI
Satisfying Criteria:
1,2 1217
1,2,3 651
1, 2, 3, 4, 5 286 204 156 188 73 101
1, 2, 3, 4, 5, and
matching criteria 25 26 24 21 20 24
Control Firms 25 26 24 21 20 24

V. Assessing Risk Shifts

Systematic risk for firm i was measured by the traditional market model beta parameter
β:
Rij = αi + βiRmj + μij (4)

where Rij and R mj were the one-month rates of return during the jth month for firm i and
the Center for Research in Security Prices (CRSP) value-weighted index, respectively.
The returns represented the one-month price relatives adjusted for dividends. The parame­
ters αi and βi were, respectively, the regression intercept term and the systematic risk for
firm i, and μij were the regression error terms.
Volume 21 Number 9 1995 85

Selection of the critical event date for defining pre- and post-standard periods for
beta measurement is a judgmental task, since no theory exists which specifies the events
which actually result in capital market belief revisions [Ricks (29)]. Nonetheless, the
FASB's approval of the SFAS 8 exposure draft on December 31, 1974, as reported in the
Wall Street Journal on January 2, 1975, was selected as the critical event for the present
study. Salatka (30) found significant negative returns associated with this date, while
Ziebart and Kim (37) identified several later event dates associated with SFAS 8 effects.
Thus, based on prior research, most of the price effects associated with SFAS 8 occurred
on or after December 31, 1974. The pre-SFAS 8 period encompassed the 48 months prior
to and including December 1974. The post-SFAS 8 period included the 48 months
subsequent to December 1974.

To test for the change in systematic risk, pre-announcement (PRE) and post-an­
nouncement (POST) betas were computed for each of the i firms in each of the experi­
mental (E) and control (C) portfolios for each of the k groups (i.e., SC, UC, HI, LI, C/HI,
SC/LI) using equation (4), yielding p ^ , £ , p ^ ' 0 , p™ST>E, and fk0ST'C. Differences
in beta δik for each ith pair-match (i.e., Experimental/Control) in each of the k groups then
were determined for both the pre- and post-announcement periods:

5£F=PrF' £ -p£F C (5a)

8P£ST=pP£ST,E_^ST,C (5b)

The beta shifts for each pair-match δik then were computed as the difference between
the post-announcement pair-matched beta difference and the pre-announcement pair-
matched beta difference:

δi,k = 5£jP5r-5£F (6)

The beta shifts for each pair-match were averaged within each grouping to derive
the test statistic :

i
5*=!>,*/; (7)
/

Since the above statistical procedures are algebraically equivalent to testing differ­
ences between the mean betas of the experimental and control portfolios between the pre-
and post-announcement periods for each group, these means and differences are reported
to facilitate exposition and understanding.

Statistical significance was assessed using a t-test for dependent samples.6 Under
the null hypothesis of no beta shift, the test statistic should not be statistically different
86 Managerial Finance

from zero. The statistical significance of the average beta shift for each firm for each
portfolio (experimental and control) for each grouping was also assessed and reported.

VI. Results and Analysis

The central hypothesis of this study is that MNC executives reacted to SFAS 8 by making
suboptimal decisions intended to reduce the volatility in reported earnings caused by the
statement's requirements. This reaction is posited to be reflected in the market via a
reassessment of the systematic risk of the affected firms, resulting in a higher level of
systematic risk. The significance of the shifts in the firm's systematic risk should vary
from one group to another depending on exchange rate volatility and magnitude of foreign
investment.

A summary of the data analyses appears in Table 2. As can be observed from the
table, the beta pair-matching procedures employed resulted in control and experimental
portfolios that were well matched on pre-announcement betas, the largest average differ-
ence in pre-announcement betas (.07) occurring between the experimental and control
portfolios for the UC/HI grouping. On a firm-by-firm basis, as well as within groupings,
approximately one-half of the control firm beta matches were lower and approximately
one-half of the matches were higher than the experimental firm. Hence, it was not likely
that beta mismatches could account for the beta shifts observed. Furthermore, with the
exception of the UC and SC control portfolios, beta shifts over the pre- and post-an-
nouncement periods for the control portfolios were of small magnitude. In all cases,
computed beta shifts for the control portfolios were not statistically different from zero.
Since the t-test utilized pooled sample variances, any effects on the statistical tests
attributable to differences in variances was mitigated.

Panel A of Table 2 summarizes the findings regarding comparative pre-pronounce-

ment and post-pronouncement changes in the levels of average systematic risk across the
two pairs of portfolios for unstable currencies (UC) and stable currencies (SC).

For the UC grouping, the experimental portfolio experienced a statistically signifi-

cant (p=.001) beta shift of .60. While the control portfolio experienced a beta shift of .09,
this shift was not statistically different from zero.7 The pair-matched beta shift for the UC
group was .51 and statistically significant at the .001 level. No significant beta shifts were
observed for the SC grouping. Thus, the comparative difference between beta shifts of
MNCs affected by the pronouncement (experimental portfolio) and MNCs not affected
by the pronouncement (control portfolio) was significant only for the UC firms, lending
support for Hypothesis 1. This result was not surprising. Firms whose foreign operations
were located in countries with unstable currencies were more greatly affected by the
pronouncement than were those operating in environments with stable currencies. The
change in the method of foreign currency translation tended to coincide with a reassess-
ment by the market of systematic risk for the MNCs whose foreign operations were located
in countries with unstable currencies.

It was also hypothesized that the consequences of the pronouncement and therefore
reactions of MNC executives would vary from firm to firm in relation to the level of the
firm's foreign investment. Panel B of Table 2 depicts the test results of this hypothesis.
Volume 21 Number 9 1995 87

Table 2. Summary of Data Analyses

Panel A: Effect of Foreign Exchange Rate Volatility on Systematic Risk
Pre-Announcement Post-Announcement Change (Level of
Portfolio Mean Beta Mean Beta Significance)#
Unstable Currency
(UC):
Experimental 1.37 1.97 .60 (.001)*
Control 1.39 1.48 .09 (.43)
Difference -.02 .49 .51 (.001)*

Stable Currency (SC):

Experimental 1.34 1.41 .07 (.32)
Control 1.31 1.23 -.08 (.36)
Difference .03 .18 .15 (.21)

Panel B: Effect of Foreign Investment Magnitude on Systematic Risk

Pre-Announcement Post-Announcement Change (Level of
Portfolio Mean Beta Mean Beta Significance)
High % Investment
(HI):
Experimental 1.24 1.39 .15 (.10)
Control 1.27 1.25 -.02 (.81)
Difference -.03 .14 .17 (.04)*

Low % Investment
(LI):
Experimental 1.36 1.54 .18 (.04)*
Control 1.39 1.38 -.01 (.91)
Difference -.03 .16 .19 (.10)

P a n e l C: C o m b i n e d Effect of E x c h a n g e R a t e Volatility a n d Foreign I n v e s t m e n t

M a g n i t u d e o n S y s t e m a t i c Risk
Pre-Announcement Post-Announcement Change (Level of
Portfolio Mean Beta Mean Beta Significance)
Unstable Currency/
High % Investment
(UC/HI):
Experimental 1.22 1.44 .22 (.01)*
Control 1.29 1.27 -.02 (.83)
Difference -.07 .17 .24 (.02)*

Stable Currency/
Low % Investment
(SC/LI):
Experimental 1.38 1.40 .02 (.81)
Control 1.39 1.43 .04 (.62)
Difference -.01 -.03 -.02 (.82)

#
t-test for d e p e n d e n t s a m p l e s .
* Null h y p o t h e s i s of n o c h a n g e is rejected.
88 Managerial Finance

An upward shift in the market's assessment of systematic risk was apparent from
these results for both the HI and LI groups. However, consistent with expectations stated
in Hypothesis 2, the pair-matched beta shift of .17 was statistically significant (at the .04
level) only for MNC's with relatively greater foreign investments (HI).

Test results regarding the stability of the host country's currency and the magnitude
of the foreign investment suggested that both factors influence the market's reassessment
of systematic risk. These tests also suggested that currency volatility was the more
influential of the two factors; i.e., even for the portfolio comprised of firms with relatively
low foreign investments, some beta shift was apparent.

The final tests compared two extreme portfolios (1) an unstable currency in combi-
nation with a higher level of foreign investment and (2) a stable currency in combination
with a lower level of foreign investment. That comparison is presented in Panel C of Table
2.

The test results were consistent both with the priors expressed in Hypothesis 3 and
with the results of the earlier tests. The UC/HI grouping was shown to experience a
significant (p=.02) pair-matched beta shift of .24 concurrent with the new regulations, but
no such shift was revealed for the SC/LI portfolio. In fact, the stability of the foreign
currency was apparently sufficient to negate any cause for reassessment of market risk.
Recall that in the previous test the LI portfolio revealed a tendency for beta to shift.
However, that portfolio includes MNCs with relatively low investment in countries with
both stable and unstable currency.

VII. Summary and Conclusions

The research described in this article extends the prior research of those studies which
surveyed corporate managements relative to their reactions to SFAS 8 as well as those
which investigated the market price reaction to the pronouncement. The study differs from
those earlier studies in several important respects. First, the investigation focuses on the
potential shift in systematic risk rather than market prices. Second, the research design
allows for and assesses differential reaction due to the location and magnitude of the
foreign investment. Finally, the selection of a control group from MNCs not affected by
the pronouncement offers advantages over prior research which selected wholly domestic
firms as control groups.

The study's findings are consistent with the survey research which found that MNC
executives did take specific actions in response to SFAS 8 to reduce the volatility of
reported earnings. Our findings suggest that the market responded to managements'
actions with an upward reassessment of systematic risk. The findings further suggest that
both the volatility of the host countries' currencies and the proportionate size ofthe foreign
investment affect the degree to which risk perception changes as reflected in the extent of
the shift in beta. Currency volatility is shown to be the more influential determinant of the
two factors affecting the shift in systematic risk.

This research also illustrates the difficulties faced by regulatory bodies (both in the
U.S. and in other countries) in assessing the impact of proposed changes in accounting
Volume 21 Number 9 1995 89

standards. As previously cited, earlier research failed to detect any capital market effects
associated with SFAS 8. It may be argued that this could be due to a faulty assumption
that any effects of regulation will be observable across a large cross-section of firms. The
current study investigated a sample of MNC firms operating in environments conducive
to enhancing effects as a result of the mandated standard with positive results. Further-
more, more recent research and theory suggests that capital market effects may occur for
even cosmetic accounting changes. The results of this study, as well as those cited
previously, indicate that accounting standards regulation may have imposed nontrivial
costs upon some MNCs.

VIII. Limitations

Several limitations were inherent in the research. Lacking an explicit theory for identifying
significant events, the periods selected for assessing beta shifts were judgmental and
arbitrary, as was the chosen length of time for measuring beta. While the research
attempted to control for the effects of some extraneous variables on beta, other extraneous
variables were not controlled, e.g., growth rates. To the extent that growth rate or other
omitted variables were proxied by included variables in the regression models, interpret-
ing the significance of the included variables becomes confounded. The OLS regressions
assumed the absence of cross-sectional correlations in the error terms and equal variances.
To the extent that these conditions were not met, tests of significance will be invalid or
made more difficult. The use of weighted least squares regression or other procedures may
be appropriate. The variables selected to proxy for the firm-specific variables expected to
be associated with risk shifts, although based on prior research, were crude; consequently,
lack of significant findings may not be due to the falsity of the construct, but to
measurement error.
90 Managerial Finance

Footnotes

1. Since some countries index their currencies with the dollar, the CV formula yields a
value of 0 for these currencies. These currencies were classified as stable currencies.

2. For example, if an MNC had 80 percent of its foreign operations in a unstable currency
and 20 percent of its foreign operations in a stable currency, the MNC would be classified
as belonging to the UC porfolio.

3. A preliminary investigation of the Value Line database revealed that approximately 50

percent of the MNCs had foreign investments equal to or less than 20 percent of total
assets.

4. This has been empirically verified by Ziebart and Kim (1987).

5. In order to achieve an acceptable sample size, it was necessary to match some firms in
the UC/HI and SC/LI portfolios using three-digit or two-digit SIC codes.

6. Separate analyses were performed due to the fact that portfolios were not independent,
i.e., the same firm could be a member of more than one experimental or control portfolio,
depending on the classification variable of interest.

7. The increase in beta for the control portfolio, although not significant reduced the
probability of rejection of the null hypothesis of no beta shift under pair-matching. The
fact that the null hypothesis was still rejected under these conditions adds strength to the
results.
Volume 21 Number 9 1995 91

References

(1) Abdel-khalik, A.R. and J.C. McKeown, (1978) "Understanding Accounting Changes
an an Efficient Market: Evidence of Differential Reaction", The Accounting Review, Vol.
53,pp.851-868.

(2) Aggrawal, R., (1978) "FASB No. 8 and Reported Results of Multinational Operations:
Hazard for Managers and Investors", Journal of Accounting, Auditing & Finance, Spring,
pp.197-216.

(3) Arnold, J.L. and W.W. Holder, (1986) Impact of Statement 52 on Decisions, Financial
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