The Effects of Accounting Diversity: Evidence from the European Union Peter Joos; Mark Lang Journal of Accounting Research, Vol. 32, Studies on Accounting, Financial Disclosures, and the Law (1994), 141-168. Stable URL hitp://links jstor-org/sicisici=002 1-8456%2819949%2932%3C 141%3ATEOADE%3E2.0,CO%3B2-E, ‘Your use of the ISTOR archive indicates your acceptance of JSTOR’s Terms and Conditions of Use, available at hhup:/www, stor orglabout/terms.html. ISTOR’s Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the sc printed page of such transmission. Journal of Accounting Research is published by The Insitute of Professional Accounting, Graduate School of Business, University of Chicago. Please contact the publisher for further permissions regarding the use of this| ‘work. Publisher contact information may be obtained at hitp:/www jstor.org/journals/grad-uchicago. html Journal of Accounting Research (©1994 The Institute of Professional Accounting, Graduate School of Business, University of Chicago ISTOR and the ISTOR logo are trademarks of JSTOR, and are Registered in the U.S. Patent and Trademark Office For more information on JSTOR contact jstor-info@umich edu, ©2003 JSTOR bupswww jstor.org/ Tue Oct 28 11:51:03 2003Journal of Accounting Research pian ESA The Effects of Accounting Diversity: Evidence from the European Union PETER JOOS* AND MARK LANGt 1. Introduction In this paper, we investigate the financial statement effects of differ- ences in accounting measurement practice in France, Germany, and the United Kingdom (UK.). We find evidence of significant differences in financial ratios and the stock market valuation of accounting data. The differences do not appear to be explained by the composition of the sample or by macroeconomic factors; they are predictable, given cross- country differences in reporting philosophies, and they are present for the components of net income which one would expect based on differ ences in accounting practice. The differences across countries appear largely unaffected by legislation enacted in response to the European Union (EU) directives, which were intended to create an integrated set of reporting standards to serve as a basis for cross-listing and facilitate cross-border investment.! ‘This research provides descriptive evidence, from a capital markets perspective, on how cross-country differences in measurement practices affect the comparability of the resulting accounting data. Europe vides a relevant context to examine this issue for several reasons. F Stanford University and Verick School of Management, Carolina, at; University of Nowth This conclusion is consistent with the contention thatthe effects on measurement practices were minimal (eg, Alexander and Archer [1991]) and with empirical research applying other methodologies (eg, Walton [1092] and Emenyonu and Gray (1992). ua Copyright ©, tite of Profesional Accounting. 1905142 JOURNAL OF ACCOUNTING RESEARCH, SUPPLEMENT 1994 Germany and the UK. are the originators, and arguably the most ex- treme examples, of the two primary accounting philosophies worldwide, the Anglo-Saxon and Continental models.” The Anglo-Saxon model has historically focused on equity holders, permitted discretion in the prep- aration of financial statements as long as the resulting statements pro- vide a “true and fair view” (TFV) of financial condition, and decoupled tax and financial reporting. The Continental model is characterized by a focus on debt holders, codified reporting requirements, and a strong link between financial and tax reporting. France was traditionally closer to Germany but appears to have shifted toward the Anglo-Saxon model. An analysis of Germany, the U.K., and France thus permits a comparison of the effects of two relatively "pure” and one intermediate example of common alternate approaches to accounting measurement; and, if differences in measurement practice are sufficiently large to be detect- able anywhere, they should be here, Further, the underlying economies of the EU countries are fairly similar and barriers to trade are limited, reducing the effects of other factors on financial ratios and the stock market's valuation of accounting data, Because of the influence of the Anglo-Saxon model on accounting in countries colonized by the U:K., and the influence of the Continental model on accounting in much of continental Europe, Japan, and the countries colonized by Germany and France, evidence on their accounting also provides insight into the effects of similar approaches in other countries. This research also provides preliminary evidence on the effects of the EU directives on accounting measurement differences.® The directives were intended to facilitate creation of an integrated European capital market by establishing a basic level of financial transparency and com- parability so that investors in any member country could interpret financial statements from other countries as easily as their own. Their approach was to develop a consensus-based set of accounting directives, to be implemented by member states and to serve as standards for cross- listing in the EU. The directives led to substantial changes in the letter of accounting law in the member countries, but their effect on the re- sulting accounting data is not as clear. While the directives required that financial statements reflect the TFY, their more specific requirements, particularly on measurement issues, left discretion to member states, leading some commentators (e.g., Alexander and Archer [1991] and Walton [1992]) to speculate that the changes may have represented more form than substance. Most of the discussion of the need for, and effects of, the EU's directives on measurement differences across coun- tries has been normative, focusing on the desirability of the changes 2 Fora discussion of accounting models se, for example, Mueller, Gemon, and Meck aan} The directives also addressed issues related to financial statement format, console tion policy, and dsclonire which are not considered sm thin xd‘THE EFFECTS OF ACCOUNTING DIVERSITY 143 (c.g,, Walton (1992]), alternate approaches to i kets (e.g., Wilson [1991]), and potential definitions of abstract concepts, like “rue and fair view" (e.g., the special section of the European Ac counting Review (May 1993}). Recent European research evaluating the effects of measurement differences in the EU includes Simmonds and Aziéres [1989] and Wal- ton [1992] who assess measurement diversity by asking accountants in EU countries to prepare financial statement data for hypothetical trans- actions. Both find evidence of measurement differences within and across countries, but both are based on data prepared during the im- plementation of the directives and neither compares pre- and post- directive differences or conducts statistical tests, Emenyonu and Gray [1992] compare measurement practices as disclosed in the footnotes to 266 firms’ 1989 financial statements and interpret significant differences across countries as evidence of differences in accounting standards. They do not attempt to evaluate the magnitude of the effects of mea- surement practices on the resulting accounting data or to assess the impact of factors, like hidden reserves in Germany, which are not de- tectable from footnote disclosures. Because the effects of such diversity are generally not observable directly,“ a variety of approaches have been used to infer the effective- ness of attempts to reduce accounting diversity, primarily in relation to the efforts of the International Accounting Standards Committee (ASC). Tay and Parker [1990], for example, document and evaluate various approaches to assessing accounting diversity, including surveys of international accounting requirements (¢.g., Nair and Frank [1981]), surveys of national practices (e.g, van der Tas (1988]), and descriptions of accounting principles from footnote disclosure (€.g., Nobes [1987] However, none of these approaches is useful in quantifying the effects of differences in accounting measurement practices on financial state- ments because of the limited detail in publicly available data, We adopt, a capital-markets-based approach which uses comparison of resulting differences in companies’ profitabilities and price multiples across countries to infer the effects of measurement differences, In the next section, we describe differences in accounting between the UK., France, and Germany, and the EU directives. In the third sec~ tion, we discuss the data and the empirical tests and, in the fourth sec~ tion, we provide analyses based on financial ratios and the relation between stock prices and returns and accounting variables. In addition, 4 National requirements allow substantial discretion in practice and accounting policy footnotes provide only limited detail on some of the general measurement practices adopted by the firm thus any effects on the resulting accounting data ae dificult to 38 ‘ernain, For example, while there is general agreement that "hidden” reserves exist in Germany, there is wide divergence in estimates oftheir likely magnitude because of the limited detail in publiely available information144) PETER JOOS AND MARK LANG we consider various explanations for the observed em| cluding differences in macroeconomic factors and sample composition across countries, and focus on specific components of net income which are most likely to be affected by measurement differences. In the fifth section, we present conclusions and potential extensions. 2. Background 2.1. PINANCIAL RERORTING IN EUROPE ‘Three primary factors have historically led to differences in account- ing practice across the EU countries—relative importance of the law, providers of capital, and the link between tax and financial reporting, 2ULL Relative Importance of Law and the TEV. European countries differ in the extent of legal influences on accounting and financial reporting. At the two extremes are the U.K, where the law has historically provided general principles and accounting has been governed by the requirement that the financial statements present a “true and fair view,” and Germany, where there isa Roman Law tradition of highly codified and prescriptive regulations, with France lying historically loser to Germany. Proponents of the TFVapproach argue that the additional flexibility allows firms 10 choose the appropriate course of action to ensure that the accounts accurately reflect the particular circumstances ofthat firm, while opponents argue that it affords managers too much diseretio The likely effects of the TFVon reported profitability and the valuation multiples applied to accounting data are not clear ex ante. The adoption of the TFV as an overriding principle in the EU directives reflects a pre- sumption that it provides more value-relevant accounting data. To the ex- tent this is so, the association between accounting measures prepared under a TFVapproach and stock prices is expected to be higher, ceteris paribus. 21.2 The Providers of Capital Accounting standards develop, in large part, to satisfy the information needs of those who provide capital. In the case of the EU, companies have traditionally varied in their sources of capital. In countries like the U.K., capital is provided by numerous small sharcholders, so the accounting requirements emphasize the accurate reporting of profits. In countries like Germany, firms have relied more heavily on debt financing by a relatively small number of banks, with concentrated equity ownership (often by the same banks).° Here the accounting system has focused on conservative aecounting (“prudence”) and on the balance sheet to ensure maintenance of sulficient resources to repay debt. Further, because capital was provided primarily by a few large sharcholders with whom the firm could communicate directly, public 5 tn addition to direct ownership, banks act as trustes in directing the investments of a large proportion of individual shareholders. Furier, bank representatives are often in ‘cluded on supervisory boards,THE EFFECTS OF ACCOUNTING DIVERSITY 145 reporting of information was not emphasized, France has historically been ‘more similar to Germany, with a strong focus on reporting to creditors, but France has differed from both the U.K. and Germany in its focus on uniform accounting and reporting practices and the provision of detailed information to assist the government in managing the economy.° Differences among the providers of capital could affect the valuation of accounting data in at least three ways. First, more conservative mea- surements, favored by creditors, should result in larger multiples applied to accounting data. Second, a focus on measuring the minimum amounts available to creditors (by, for example, recording unrealized losses but not gains) may reduce the value relevance of the resulting data for equity holders and, hence, their association with share price.’ Third, a balance sheet emphasis may result in a stronger association between sharehold- cers’ equity (relative to net income) and security prices than in countries with more of an equity holder and income statement orientation, 21.3. The Influence of Taxation. In counwies like Germany and France the influence of the tax law on financial statements has traditionally been particularly strong; the required conformity between financial and tax reporting has provided incentives to reduce taxes by reporting lower profits. In other counties like the U.K. the much weaker link between taxation and financial reporting means that financial statement income is. at most a starting point for the calculation of taxable income. ‘There are at least two ways a link between taxation and financial re~ porting can affect the relation between accounting data and stock price. First, the incentive to report lower income should imply conservative measures on the income statement (and the balance shect to the extent that clean surplus holds), resulting in larger valuation multiples. See- ond, the resulting data may have a lower association with share price, both because accounting requirements reflect tax policy (e.g., special depreciation allowed on specific types of assets t0 encourage invest- ment) and because, given a choice, companies may adopt tax-minimiz~ ing measurement techniques that do not reflect economic reality. 2.2 HU inectives ‘The EU directives, which are legally binding instruments adopted by the Council of Ministers and addressed to the member states, specify minimum reporting requirements and allowable options, The member states were required to enact provisions complying with the directives into national law within several years, The most fundamental EU directive ‘on financial reporting is the Fourth (Company Law) Directive, enacted For a discussion, see Muell 12, and Meck (1991), 7 The isue isnot that the “quality” of the resulting data is low, but thatthe data are potentially being prepared fora use (equity valuation) other than the one for which they ‘were designed (assessing credit worthiness), This is also an ive when the accounting data are used asa basis for governmental planning or taxation,146 PETER JOOS AND MARK LANG in 1978. This directive, which is applicable to the accounts of all limited liability companies, was implemented in all member states by 1991; it specifies the TVas an overriding principle, detailed measurement rules, formats for the balance sheet and income statement, and requirements for additional disclosure. “The Seventh Directive, enacted in 1983, focuses on the preparation of consolidated accounts it has been implemented by all member states It applics the requirements of the Fourth Dircctive to group accounts, establishes standards of consolidation, and addresses other issues of special relevance to multinational enterprises, In particular, it defines the concept of the “group” and requires full worldwide consolidation and usc of a “fair value” approach in accounting for asscts purchased through acquisitions and the equity method for associated corporations ‘To. large extent, the Seventh Directive represents a move toward a UK. approach to consolidation forall EU countries; thus it effects should be sreatest for France and Germany and smallest for the UK wen the wording of Article 2 (5) of the Fourth Directive, the TFVis the overriding requirement of financial reporting in the EU. Further, its central importance in the Fourth Directive and the level of contro- versy it created suggest it was viewed as having potentially significant implications for reporting, particularly in France and Germany where it had not traditionally been required. While commentators have ar- sued that the concept of “true and fair” is universal and should result in the same standards being applied in all EU countries (Walton (1992), its impact is difficult to evaluate directly.® ‘The most clear effect of adopting the TVs in relaxing the required conformity between tax and financial reporting for the consolidated financial statements in France and Germany. Although the parent- company financial statements still closely follow tax returns, consolidated cntities are permitted flexibility in adjusting accounting methods to reflect the TFV approach in their consolidated financial statements. The cffect of relaxing of tax/book conformity is seen in the increasing im- portance of deferred taxes in the financial statements of German and French companies. Further, the presence of TFVasan overriding require- ment changes the criteria by which auditors and regulators judge the financial statements and, hence, acceptable measurement techniques.® Estimates and assumptions which are tax-driven but do not reflect eco- nomic reality, for example, are limited by the TEV. Because the directives required the unanimous consent of member countries, they tended to develop slowly and allowed member states 8 The TEV x proba likely to continue to evoie overtime particuirly in countries lke France and Germany UUkimately in cates of conic, i meaning in an EU Jurisdiction willbe decided by the European Court (Ordelheide (1993) 5'Sce, for example, Nobes [1993] fora discussion of these asus. ot best viewed as a staie concept because its interpretation is‘THE EFFECTS OF ACCOUNTING DIVERSITY 147 substantial flexibility in the implementation of the directives into na- tional law. Further, their effets have potentially been limited by the fact that, while the tax-based incentives for accounting method choice in the consolidated financial statements were reduced by the directives, other incentives, such as the desire to reduce union demands for hhigher wages and shareholder demands for higher dividends, may stil influence accounting method choice, particularly in countries like Ge many. As a result, many commentators have questioned the real effects of the directives on measurement practice (e-g., Walton [1992], Alex- ander and Archer [1991], and Emenyonu and Gray [1993}) We consider both across- and within-country diversity in our empirical analysis, but focus on the former since it appears to have been the pre~ dominant focus of the directives and is consistent with their goal of en- hancing comparability across counties. Consistent with the empirical studies cited above and the discussion in the European academic liter ture, to the extent that the directives reduced measurement differences across countries, we expect this reduction to be reflected in the conver- gence of accounting measurement practices subsequent to their adop- tion. Ceteris paribus, if there were differences in reported profitability or in multiples applied to accounting data across countries because of measurement differences prior to the directives, these differences should be reduced by the adoption of the directives. Similarly, any diff ences in the degree of association between stock prices and accounting measures should be reduced by the directives. 3. Empirical Analysis 3.1. ATA AND Save Our analysis is based on annual financial statement data and monthly prices and dividends for 1982-90 from the Global Vantage Industrial Com ‘mercial Data Base. Because we focus on common stock valuation, all other issues are deleted from the sample, To increase sample homogeneity, we limit the sample to companies preparing consolidated accounts, which results in a sample of 172 companies for Germany, 228 for France, and 675 for the UK.'" In addition to comparing results for countries on a year-by-year basis, we also conduct comparisons pooling years before and after the divec- tives were enacted. In Germany, both the Fourth and Seventh Directives were incorporated in the Accounting Directive Law of 1985, effective in 0 For France and the UK. we include only companies preparing full consolidated ae ‘counts, For Germany, we also include companies that apply domestic consoldation, Ger ‘many isthe only country where this group contains a material number of companies and the results in Harris, Lang, and Moller (1994) suggest tha the value relevance of account ing information is similar for both groups. The reults are nt sensitive tothe inclusion of these firms. Because we focus only on firms that prepare consolidated accounts, we ignore the related effects of the Seventh Directive148 PETER JOOS AND MARK LANG 1987. Therefore, we include 1982-86 in the predirective period. France adopted the Fourth and Seventh Directives through Accounting Acts in 1983 and 1985, effective in 1986. Since we focus on consolidated ac: counts, we include 1982-85 in the predirective period. The U.K. adopted the Fourth Directive in 1981 and the Seventh Directive in 1989. Because our sample covers 1982-90, we do not attempt to detect the effect of UK. accounting changes in response to the directives. Rather, because the effects of the directives on the UK. were predominately in the format of financial statements, we treat the U.K. primarily as a benchmark. For comparative purposes, therefore, we include 1982-86 in a predirective period for the U.K., and for all countries, we include 1988-90 in the postdirective period.!! Because our choice of cutoffs is subjective, we emphasize the year-by-year results; as is clear from this analysis, conclusions are not sensitive to the choice of cutoff dates. 3.2 meronoiocy Existing research provides a variety of measures which, ceteris pari- bus, will reflect the effects of accounting differences across countries. We evaluate diversity in measurement practice based on divergence in ng-based measures of profitability, the valuation multiple ap- plied to accounting data, and the degree of association between ac- counting data and stock price. We conduct three primary analyses— univariate ratio analysis, returns regressions, and price regressions—to examine differences in measurement across countries. Our approach assumes that macroeconomic conditions and sample composition (¢.g., expected growth rates, discount rates, and industry composition) are similar across countries, issues which we consider in section 4.3. 321. Univariate Anabsis. Our univariate analysis is based on three ratios: return on equity (ROE)—net income before extraordinary items divided by book value of equity;'® earnings/ price (E/P) ratio—net income before extraordinary items divided by market value of equity at year-end; and book-to-market (B/M) ratio—book value of equity divided by market value of equity at year-end. ROE has the advantage of being purely an accounting-based measure of profitability and is, therefore, not sensitive to stock market fluctuations." £/P and B/M ratios have the advantage of 11987 is potentah ay therefore reflect one-time adjustments {in implementing the stan 7 to inerease comparability in computing carnings changes and to abstract from any effects of the atock market crash of 1987. Re fultgare not sensitive to thi "2 Reauls are similar for net income after extraordinary items and for retuen on sales, A disadvantage of ROE is that both net income and shareholders" equity may be affected by conservative accounting. To the extent that conservatism isa reult of tax! book conformity. it seems likely that the effect on net income will exceed that on share Rolders" equity. However, if both numerator and denominator are affected by conserva tive accouriting, it wll be more difficult to find a difference across countries. Results For ‘ROB ace consistent wth those for E/Pratios, suggesting that the primary effect of conser.‘THE EFFECTS OF ACCOUNTING DIVERSITY 149 comparing accounting:based valuation of net income and shareholders’ equity to a market valuations the former provides insight into valuation on the income statement, while the latter focuses on the balance sheet. Other studies of EU accounting differences provide insight into their likely effect on the measures we considered. Simmonds and Aziéres [1980], for example, suggest that traditional differences in account philosophy across EU countries would result in the highest net profit in the UX., followed by France and Germany. German accounting would produce the lowest reported sharcholders equity; France would be high est, with the UK. lying in between. The difference in ordering for n income relative to shareholders’ equity reflects the fact that goodwill in the UK is typically aken directly to reserves (violating the clean surplus relation), while itis amortized in France and Germany. Asa result, UK. firms are liberal in the measu measuring shareholders’ equity. Based on the preceding discussion, it is possible to formulate hy- potheses about these ratios across countries and over time. Specifically, ceteris paribus, conservative accounting in Germany should result in lower ROE, E/P, and B/M relative to the UK. Predictions for France are tess clear but, based on the Simmonds and Aziéres [1989] case study, fone would expect French ROE and P/E ratios lie between those of Germany and the U.K, while French B/M ratios would exceed those in both countries. If the directives reduced measurement differences across countries, we expect convergence in ratios following their im- ementation, with ratios for Germany and France becoming more Similar to those for the UK 3.22. Returns Ragrssion. In the returns regression, we examine the value relevance of the reported accounting data by evaluating the association between returns and earnings. We compute returns over the 18 months ending 6 months afer fiscal year-end to ensure that the annual report was avilable to investors. The earnings variable is measured on an annual bass. “The regression we estimate is: ment of net income but conservative in B+ d,-P, et eB SS st ang + an co) Be Fra where: fs the price per share of common soc of firm ja ime & ee eee eee eden ee eee fe cenmieed ‘The strength of the associations (as measured by the R2) provides in- sight into the value relevance of the accounting measures. Because part of the decision to move EU accounting methods closer to those for the UK, (particularly with respect to the TPV) was based on the alleged150 PETER JOOS AND MARK LANG superior value relevance of UK. accounting principles, in the prediree- tive period we expect to see a stronger association between the earnings variables and returns for the U:K. than for France and, especially, Ger- many. If the directives reduced differences across countries, we expect convergence in the postdirective period, with Germany and France mov- ing toward the UK. 3.23. Price Regression. We estimate a second regression based on the association between price and earnings and book value:!4 Py = bac Dae Aiea Bit ® where: P's the price per share of common stock of firm jat time t; Ajyis net income before extraordinary items per share for firm j at time Bj is book value of equity per share for firm jat time ¢; and uy is the residual term, If accounting systems in Germany and France have historically pro- vided less value-relevant earnings than in the U.K., ceteris paribus, we would expect the degree of association between price and earnings to be lower than for the UK. in the predirective period. However, given the traditional focus on balance sheet valuation in Germany and France, the association between shareholders’ equity and price may be compa- rable (or even higher) than for the U.K. 4 Results 4.1 pescrirrive starisrics As indicated in table 1, the book value of shareholders’ equity, mar- ket value, net income, and stock returns are similar across countries, ‘The German sample is on average larger than the other two and an- nual stock returns are lower; as discussed later, our results are not sen- sitive to those differences. Average net income is comparable across countries and industry concentration (not reported) is quite similar, with a wide variety of industries represented. Manufacturing is repre- sented somewhat more heavily in Germany than in France and the UK. which are more concentrated in service industries. Results, however, are not sensitive to differences in industry representation. 4.2 UNIVARIATE ANALYSES Table 2 provides summary statisties for ROE, £/P, and B/M ratios and table 3 presents the results of Wilcoxon rank-sum tests of differences in 1p clean surplus holds, equation (1) is equivalent to equation (2) estimated in frst Aiterences. However, clean surpls is unlikely to hold beeause some items (eg. goodwill foreign currency translation adjustments) are charged directly to shareholders equityTHE EFFECTS OF ACCOUNTING DIVERSITY 151 TABLE I Deserve Stasis for Sample Firms int Third Number of Mean Median Quartile Quartile Observations iaseholder milion) Germany eT ee ee) France 4013930 UK a Market Value of Equity ($ millions) Germany 999-365 108TH 1082 France 58718770800, 1392 UK 9119] 4.796 Net Income ($ millions) German 8 3 cy France os 4 8 UK 10 4 36 Anowal Resurn, Germany 019 ont 007 oat France 032 018-010 0.60 uk 025 08-004 0.45 Tatas are from Gil Vonage and are pooled over 1982-B0, Shareholders equity the Book ‘alae of common shareholder” equity in mifions of US, dollars haved on eaten exchange rates Markt value nthe markec sae of omsanding sareholers’ equ i months following fal ear ‘nd in milion of US, dollars bate onthe exchange rates month following fed yearend. Net come x betore extraordinary items and isin milions of US dllar based onthe average exchange te during the fal year Annual recun ithe market return on common shareholders equiy ver re year ending nx month after the Real ear-end. Number of oberatons he Bumbe of com panylyear abuerasions. median ratios across counties. For ROE, the ranking in all years for the three countries is consistent with the predicted effects of conservatism for the predirective period (1982-86). ROE is highest in the U.K., fol- lowed by France and Germany. Further, most differences are significant in the predirective years; the exceptions are the UK. and France (1982) and Germany and France (1984),"5 There is no evidence of conver- gence in the postdirective period (1988-90); differences in ROE across countries are consistent with the predirective ordering and significant in each postdirective year Results for £/P ratios are generally consistent with those for ROE. Ger- ‘man firms have the lowest median E/P ratios in each of the predirective years and the U.K. ratios are the highest in each predirective year except 1982, Further, the pairwise comparisons indicate statistically significant differences in each predirective year, with litle evidence of convergence in the postdlirective period. French /P ratios exceed those in the UK. in 1987 and the gap between Germany and the U.K. appears to narrow 1 Statistica significance is assessed based on 5% cutoff in a one-tailed test unless stated otherwise, There is overlap inthe distribution of ROE (and the other variables which fatlow) a is apparent from the quartile values. However, the frst quartile of ROE for the UK Isgenerallyabove the median for Germany, which suggests shift in the distributions.152 PETER JOOS AND MARK LANG. TABLE 2 Diutriaton of Financial Ratios “PanciARewraonEquity 19H? 1985 1984 1985 1986 19871988 1989 _ 1990 Germany Observations 10 1051151821994 12163168 Mean 04 077 094098040004 10000 Ise Quartile 0201052 058 060.054 1057063 “058 "050 060 074 088.098 005 ‘oR? com L002 “ow? HO 11126 430189199 138135, ‘Observations 125 182 14014150155 208 E207 Mean O83 080.091 LIT 1I3 138160 159.120, Ist Quartile 040050 “049074083 “089105 “103 L072 Median 096.998 097113 4s2 1188150. 150131, Sd Quartile 133 1501491156170, is1 210 ait 15, UK. Observations 481 504526537560 S71 SRT 569 ST Mean O94 125143151165 .186 19518162 Isr Quartle 055 (082093 009111128 198114 “092 Median 103 126136187 “162 Bk 1981179187 Sd Quartile 155 1175 “Is “19821528524 att a20 Panel Bs Earnings/Price Ratio 10521985 198419851986 19871988 1989 1990 Germany Obeervations 75 8897 S10 160 Mean O47 050 071059053089 054048051 IstQuartle (028 029087081 .025 036.083.025.035, Median O47 084 1055 044 041 “060019042 “04s, Sd Quartile 063.065.085.066 (060081070059 O64 France ‘Observations 99 1151913113048 19906198 Mean 132111101 082.070 11.096 086102, IstQuariile 082 060 (060.056.049.076 060 L052 059, Median 119 "089083072 “onl 098 “O79 “069 ose Bd Quartile 175144127098 076182107 088128 UK. Observations 379 43447950543 BRS GOS BT 80 Mean 18 118.110.007.085 086.007 104109 IstQuarile O74 072067 062.060 062-070 O72 _O77 Median 105105097083 “076 080 “01 ‘ons 009 Sd Quartile (M5 1421341108502 Td Be 138 Panel C: Book/Market Ratio 98219881984 1985 1986 1988 1989 1900 Germany Observations 88 9-95-1119 130 14163168 Mean O86 0.71 0.73 0.60 058 075 059 043 0.54 Ise Quartile 053 045 048 039036 0.46 040 0.28 030 Median 073 065 065 052 048 063 O34 039 045 Sd Quartile 08 0.88 O91 069 0.68 094 068 O50 0.65‘THE EFFECTS OF ACCOUNTING DIVERSITY 153 France Observations 108197134 383 20s at Mean Lee Lad 132 065 093 061 053 0.86 TstQuartle 074 060,055 037 034 O41 O34 046 Median 131 1.10 0.91 O51 Ost 058 045 O71 Sd Quartile 226 216 157 069 115 079 067 112 UK. Observations 429 445 499524500592 GOD BRT Mean IS] 105 094 074 0.60 0.54 050 O67 ORR IstQuarile 067 0.54 043 035 030 030 032 035 OAL Median 109 092 0.79 0.60 048 045 O48 O54 0.62 Sd Quarle 169137123 094 074 063 0.69077 _LOL ‘ats are from Glo Venta Retara oa uly net income tore exiraordinay tems ded by ‘he took alu of shareholders equity. Observations with negative shareholders eyo rec 9 ‘yore than Oy aurea le ange rao otc te th negative net come o earning pice ats in exces of 5 ae excluded. Bot market at {he book value a shareholders’ equity divided ty the marke alue of outatanding equity tfc year {Oban wi nae Sok a faba o Boke annexes in that year (probably because of the stock market crash, which was more pronounced in France and Germany than in the U.K). For 1988-90, differences in £/P ratios are comparable to those in the predirective period. Average E/P ratios are highest in the U.K., followed by France and Germany in each postdirective year. Results for the B/M ratios for Germany and the U.K. are generally ¢01 sistent with those for the other two ratios in the predirective period, with median B/M ratios in the U.K. exceeding those in Germany for each year except 1986; the differences are significant in each predivective year but 1986. Median B/M ratios in France exceed those in the UK. in each pre- directive year, which suggests less conservative balance sheet valuation in France than in the U.K. in this period, in contrast to the results for ROE and E/Pand consistent with the predicted effects of goodwill write offs in the U.K. There is litle evidence of convergence following the di rectives. B/M ratios for France ate significantly higher than for Germany in each postdirective year except 1988 and for the UK. than for France in each year except 1989, Differences between the U.K. and Germany are less consistent, with B/M ratios for the U:K. exceeding those in Germany for 1989 and 1990 but not for 1987 and 1988. When ROE, £/P, and B/M ratios are pooled across years, as reported in table 8, pairwise comparisoi icant differ ences in both the pre- and postdirective periods for all three ratios, 9 cept for the £/P ratio comparison in the predirective period and the B/Mratio in the postdirective period for the comparison of the U.K. an France. Significance tests comparing the pooled medians in the pre-an postdirective periods across the three countries provide no evidence of convergence afier adoption of the directives. For ROE and the E/P rati154 PETER JOOS AND MARK LANG. TABLE 3 Comparison of Medians Witeoson Rank Sum Test Valet PanelA:Return on Equity Year France-Germany __UK--Germany UK-France oR 7 9 198 1983, aut ost 397 984 Lop 604 558 1985, 24 747 495 1986, 423 os an 1987 307 1136 630 1988 740 8s S64 1989) 18 9.85 281 1990 461 833 429 Panel B: Earnings/Price Ratio Year France-Germany __UK~Germany UK-France 1982 ae 390 =205 1983, 161 1030 179 loss 468 128 24 1985, 353 am 309 86 Sas 974 529 1987 136 on “332 1988 79 iis 292 1989) sas si 630 1900) 898 ap 358 Panel C: Book/Market Ratio Year France-Germany __UK.~Germany UK-France Tor 35 7a Te 1983, 523 a3 38 1984 393 22 30 1985, 337 228 197 1986, oar 030 103 1987 307 “689 9.96 1988, tsi “197 397 1989) 38 624 2s 1990 on, 5m 198 Taine ae sed on Wilcoxon ranisum comparisons of median ratios om ble Band are ssloed o be debated standard norma (Conover [1980], Data are fom lll Vonage Reta on uty et income before exrsordinary ems died by the hook tue of sharers equity. ‘ObscFvacons wth negative shareholder uy or eturn om equlty greater than 0. in about aloe Se excluded. Earings/pice ratios net nears before extrordinay items dvded by market vale ‘St outatanding equity at fal yearend Observation wich meguie earings of earings price ratios {Sh evcest of OS ate exc, Boo/market rato the book value of shareholders equity divided by the markt value of tutanding equity ical yearend. Observations mith negative shareholder! ‘auiy ov book/matke ration in excess 5 ae exthaded median differences increase at least as often as they decrease. For B/M ratios, differences narrow for each pair of countries, but the differences gencrally remain significant in the postdirective period and the changes are generally not statistically significant. In sum, the results of the univariate analyses suggest that substantial differences in ROE, E/P, and B/M ratios existed prior to the EU directivesTHE EFFECTS OF ACCOUNTING DIVERSITY 155 in Germany, France, and the UK. and that the differences were generally predictable based on variation in accounting philosophy across the countries. There is little evidence that the differences were reduced by the EU’s directives.!° 4.3. ALTERNATE EXPLANATIONS Our univariate tests are based on strong ceteris paribus assumptios which may not hold in practice. Fundamental economic differences, just accounting differences, may drive our findings of differences in reported profitabilities and the valuation of accounting data. There are several reasons to believe, however, that differences in fundamental eco- nomic factors do not drive the results. First, the differences in ratios are consistent with those found in studies like Simmonds and Aziéres [1989] which estimate the effect of measurement differences on net income and shareholders’ equity by applying predominant accounting techniques in each country to the same set of transactions.!7 Further, the results for ROE suggest that, assuming no accounting differences, German compa- nies were consistently less profitable than those in France and especially the U.K. over the entire sample period. At the same time, however, they consistently traded at higher multiples of earnings and book value. It seems unlikely that earnings and book value for consistently more profitable companies would be systematically assigned lower valua multiples than those for less profitable companies (unless the differ ences in profitability were transitory, which is inconsistent with the data) Relatedly, itis difficult to imagine how economic differences could per sist over nine years, given the degree of integration and the similarities in the underlying economies of the three countries. ‘The relatively low ROEand E/P ratios in Germany could be due to the German imputational tax system, in which some taxes paid at the cor- porate level are available to individuals as tax credits when dividends are paid, which shields dividend income from taxes and potentially results in lower reported profitability but higher earnings multiples. However, our conclusions are unchanged when the analysis of ROE and E/P ratios is conducted on pretax income, which suggests that taxes do not drive the empirical results. ° Another potential effect of the directives was a reduction in the variability of measure ment practice within counties (sc, for example, Walton (1992) and Emenyon and Gray [1902)) To examine that possibility, we compared measures based on the vartability of ROE, EP, and M/B ratios before and after the directives, following Black [1980] and Blderse, Chet, and Lee (1990). There was lite evidence ofa reduetin in within-county variability for any ofthe measures in the postdirective period "Fthe magnitude of the diferences in £/P and B/M ratios i somewhat larger than could be explained by the types of adjustments to earnings and shareholders equity sade to mitigate the effects of measurement practices in papers lke Speidell and Bavish [1902]. However, their adjustments appear to have been largely limited tothe effects of differences in depreciation poticy since data for other types of adjustments are generally ‘ot publily available156 PETER JOOS AND MARK LANG ‘To investigate potential causes for the differences in E/P and B/M ra- tios more formally, we examine macroeconomic indicators which might be responsible for the divergence we observe. Specifically, French and Poterba [1991], and others, suggest that differences in valuation (but not ROE) across countries are affected by discount rates and expected growth.'® Our results—higher price—earnings and market-to-book ra- tios for Germany relative to the U.K —suggest we should observe higher expected growth rates andl lower discount rates in Germany than in the U.K!" While we would like to compare firm-specific long-term earnings forecasts and discount rates over the sample period, these data are not available. Instead, consistent with French and Poterba [1991], we use ‘medium-term forecasts of growth in national product and real interest rates for the three countries. The growth rate forecasts are for GNPin the case of the UK. and Germany and for GDPin France, as reported inthe International Monctary Bund World Beonomic Outlook [1982-90).2 Long term real interest rates are from the OBCD Historical Statistics (1992] 2 An analysis of growth forecasts (not reported) shows no pronounced pattern. In particular, expected GNP growth rates were typically lower in Germany than in the U.K., which suggests different growth expecta- tions are not responsible for the differences in E/Pand B/M ratios. An examination of the pattern in realized earnings growth indicates that changes in net income as a percentage of market value over the sample period were not larger in Germany than in the UK. The median in- erease in net income was 0.3% of market value of equity for the Ger- zman firms versus 1.1% for France and 14% for the UK. The ordering is maintained in both the pre- and postdirective periods. Similarly, there is little evidence of lower interest rates in Germany than in the UK. and no particular pattern over time ‘Another potential explanation is that systematic differences in indus- tuy concentration across countries capture economic factors which are ' another possible explanation, that domestic investors simply differ in how they vale shares, would require substantial barriers o cross-border investment. There is, however, ex tensive cross border ownership of securities in the EU, which was part ofthe motivation for the directives Further, the persistence of our results suggests that theyare not due to aspec tulative bubble ike that discussed in the context of Japan by French and Poterba (1991), "W'The predictions for France are more difficult because E/P ratios ted to be low but BM ration high 2 The pattern in realized GNP growth rates is similar to that for forecasted growth rates, An examination of other macroeconomic variables like industrial production, em- ployment, and productivity provides no evidence of underlying economie differences ‘which would explain our results 71 Crott-country variation in sysematicrsk could also explain differences in E/Pratios, lk would not be meaningful to estimate systematic risk relative to local markets because ‘our sample represents sich « substantial proportion of these markets. While differences right exist in systematic risk relative to the world market, we know of no ex ante reason to believe that companies in the U.K. would have consistently higher systemati risk than those in France and Germany‘THE EFFECTS OF ACCOUNTING DIVERSITY 157 responsible for the observed differences in ratios. Given that industry specific differences in profitability and the valuation of accounting data are likely to be most pronounced between manufacturing and nonman- lufacturing firms, we conducted all preceding tests limiting the sample to manufacturing companies (two-digit SIC codes 20-39). Conclusions from the analysis were, in all cases, unaffected by the exclusion of non- manufacturing firms and differences across countries were at least as pronounced, Therefore, it does not appear that the results are driven by the inclusion of nonmanufacturing firms. With the exception of the concentration in manufacturing for the German sample, firms are evenly spread across industries, although there is some variation in industry membership across countries based fon twordigit SIC codes. To ensure that those differences do not drive the empirical results, we estimated pooled ordinary least squares and rank regressions of ROE, F/P, and B/M ratios on dummy variables for cach of 19 two-digit SIC industry groupings and for cach of the three countries, The coefficients on the country dummy variables can be used to test for cross-country differences in average ratios after controlling for industry membership. The underlying assumption is that, while the ratios may differ across industries, any cross-country effects of account ing techniques are the same across industries, To the extent that as- sumption is not met, results will be biased against finding significant differences in ratios across countries. As would be expected, there is evidence of significant differences in ratios across industries. The mag- nitude of differences in ratios across countries is not, however, affected by inclusion of the industry control variables, so it does not appear that lustry differences are responsible for the results. Further, the fact that results are similar when conuolling for industry concentration also suggests that differences in expected growth rates or risk do not drive he observed empirical results to the extent that expected growth and isk are largely industry-based phenomena. ‘To examine the possibility that capital structure differences are driv- ng our results, we estimated rank regressions which included debt/asset ratios as potential explanatory variables. We measured debt both as total debt and long-term debt to test the sensitivity to the type of leverage. ‘The empirical results are insensitive to the inclusion of either measure of leverage. We also estimated multiple regressions of ROE, £/P, and M/B ratios on country dummies, industry dummies, year dummies, market capi tion, and debt/asset ratio to control for potential effects of indust 1¢ period, size, and leverage simultaneously. Results (not reported) liza ® Governance dllferences—for example, banks play a more active role in corporate governance in Germany than in the UK—alo exist in oor sample. Ks not clear how these might affect reported peoiabiity and valuation. We do not have accesso data that woul alow us to measure corporate governance structure direct158 PETER JOOS AND MARK LANG from the regressions were in all cases consistent with those from univai ate analysis and the percentage of variation explained ranged from 65% to 80%. The coefficients from the ROE and E/P ratio regression were highest for the U.K., followed by France and Germany. Similarly, the coefficients from the B/M ratio regression were highest in France, fol- lowed by the UK. and Germany, The differences were significant in all cases except for the B/M ratio results for U.K./German pooled compari son. Further, the magnitude of the differences in coefficients across countries was similar to the difference for average ROE, E/P, and B/M ratios reported earlier. Again, there was little evidence of change asa re- sult of the directives. Finally, we considered the components of net income that would be expected to vary most across countries as a result of measurement di ferences. While sales are likely to be affected by differences in revenue recognition across countries, effects are likely to be more pronounced for expenses, In particular, we examine two mutually exclusive catego- ries of expense—depreciation, depletion, and amortization (DD&A) expense and operating expense—deflated by the market value of equity plus the book value of debt over the sample period.23 German firms and, to a lesser extent French firms, are likely to report higher D&A ex- pense due to tax-based depreciation and shorter goodwill write-offs, as well as higher operating expense, reflecting more conservative inven- tory valuation techniques and the effects of operating reserves. ‘The results in table 4 suggest that DDE*A as a percentage of estimated firm market value (market value of equity plus book value of debt) is highest for Germany, followed by France and the UK." The differences are statistically significant in all cases based on Wilcoxon rank-sum tests of the medians. Results are similar for operating expense except that the differences are not significant between France and the UK. Differences in DD&A across countries could be driven by differences in either cap- ital intensity or asset age. However, if that were the case, the book value of fixed assets as a percentage of total assets should be systematically higher in Germany than in France and the U.K; we find no evidence of systematically higher proportions of fixed assets in Germany than in France and the UK. Further, the ratio of DDG*A asa percentage of fixed assets is highest in Germany, followed by France and the UK. for all years, which confirms that the size of the fixed asset base does not ap- pear to drive the empirical results, Comparing over time for evidence of, We consider broad expense categories since subcomponents (like cost of goods sold) re not consistently ixclowed snd expenses may be categorized differently acros countries Reported results should be interpreted with caution because category definitions may ary, even for DDG*A and aperating expense, We ute market value plus book value of debt as an fextimate of total firm value; results are similar with book value of equity or sales as deflator. Sample sizes are reduced because some firms do not report these components of ex: pense separately. Results are not sensitive to inclusion of industry controls‘THE EFFECTS OF ACCOUNTING DIVERSITY 159 the effects of the directives, we find differences across countries DDE&A and operating expense are relatively constant, which suggests no convergence as a result of the EU directives. Subject to the limitations of the analysis, the results of the specifica tion checks discussed in this section do not suggest that differences in ROE, E/P, and B/M ratios are the result of the potential confounding fac tors which we consider. Because there are other potentially confounding factors which we may have overlooked, however, conclusions should be drawn with caution, 4A REGRESSION RESULTS 441, Eaomometric and Statistical Issues. We estimate both yearly re- sgressions and pooled regressions of the returns specification in equation (1) and the price specification in equation (2). Pooled regressions give rise to serial correlation in the residuals because multiple observations are included fora given firm. Overlapping windows will tend to induce residual autocorrelation for the returns regressions, while persistence in prices over time will induce autocorrelation in the price regressions. We use a tho- transformation of the original equation to estimate the regressions when significant autocorrelation is found to exis, based on the Breusch-Godtrey test Further, we adjust the standard errors in the price regression using the White correction for the effects of heteroscedasticity. Finally, we exclude observations which are more than three standard deviations away from the mean?” 422. Returns Regressions. Year-by-year results from the regression in equation (1) are presented in table 5 and results pooled across the pre-and postdirective periods are presented in table 6. Conclusions from both tables are generally consistent. The Rs for the predirective period in table 6 are highest in France, followed by Germany and finally the U.K, providing no evidence that netincome reported in the U.K. was more value relevant than that in France and Germany.2” Results for the postdirective * see Greene (103]foran outline ofthe Brewsch- Code tet for seria cotelaton and description othe rho-vansformaton procedure andthe heteroscedasty adjustment We fo estimated the regressions applying a boowtrapping randomization technique and with Jear/counery intercepts, with very similar rests: However, the effects of croscorelated Tesidual coud ail exis othe pore standard errors forthe coefficient eatimates shoud be viewed with caution 3 Results are not sensitiv tothe incision of these observations. 2 Conclusions about the value relevance of accounting data bared on a comparison of 2% shoud be made wth cation since they asmime thatthe same amount of other infor mation reaches the market across countries. To the extent there were no other sources Gf information available, for example, one might expecta strong association Between Fe ‘urnsanearningscvenif earnings were a poor masire of performance. However tscems Untey chat there fst aly Tess nformation rellecied in price, a, Germany than chewheregien the anserted prevalence of alternate commineation channels, especially to lage shareholders. Jacobson and Saker [1095] provide evidence that cros-oldings Similar to those in Germany atally increase the lof information tothe market the case of Japan160 PETER JOOS AND MARK LANG TABLE 4 Disirition of Depreciation, Depletion, and Amortization Expense and Operating Expense ‘Panel A: DD@A Deflated by Market Value of Equity Plus Book Value of Debt 1982 1985 1984 1985 19851987 19881989 1990, Termay Observations 8192961081203 AT T2168 Mean 089.085 088077073 0910836075, IstQuardle 058050 “0510411037051 087087048 Median 079073079 064.063 “081.073.060.004 Sd Quartile 10107114 097-093 119116085101 France Observations 1071223 6ST] Mean 045048038036 .035 048099097042 Tst Quartile 026 02707028025 027023 021036 Median (041 040036037 “0st 039085034 089 Sd Quarile 058.056 049 048-042 050.086 045.057 UK. Observations 421479513537 571 OR RT «GOT B79 Mean O38 037 035034028026 025.028 034 TstQuariile 022019 O18 “018-913 013-015 O01 Median (083031029 02502021022 028028, Sd Quartile 017045043 040055 081082035 L042 Number of Standard First Thied Observations Mean Deviation Quartile Median Quartile ‘All Years 16080049 os OT 108, Predieectve 402 sz 051 4s 072108 Postdiretive st 075 NG 013067099 France ‘ll Years 87 on 0283 02503709 Predirectve 355 os) 038 028038058, Postdirective 339 09024 280358 uk Al Years 5051 ost 027 ow 05089 Predirecive 2.521 034030 O17 28 ote Posdirective 1928080024, O28 087 Panel B: Operating Expense Deflated by Market Value of Equity Plus Book Value of Debt 1982 19831984 198519851987 1988 1989 1990, Germany Observations 8191S T2030 AT T6168 Mean 177170 82161 14879 Ll LST Lad 122 120 125 105 097 192 104 ORK O.9 182 156 180 149 139171155 1281.36 SdQuanile 228 218 227 203 184 226 205 160 179 France Observations 1G 152 TE THOS TSS 18 Mean 152 142 125115 1071.28 Lod oe 1.10 IstQuartile 0.95 «O83 0.70 075 065 O88 0.69 0.60 067 Median 187 126° 107 103 098 1070.96 083 097 Sd Quartile 185 18S 160 140 151 Led LLIB LAL uk Observations 421479513587 5710260789 Meat Lol 149 140 125 106 095 096 098 1.10‘THE. EFFECTS OF ACCOUNTING DIVERSITY 161 IstQuartle 0850.74 068 0.58 050 046 0.50 0.48 0.58 Median LS8 127 113 101 085 078 081 O82 0.98 Sd Quartile 193 18271155 132119 LS Lat 1.88 Number of Standard First Third Observations Mean Deviation Quartile Median Quart Less 08z 108 © 200 Predictive 492 166 08D 10 6 200) Postdirectve 494 14508002185 L.8T France ‘All Years 1s 070 om 081.498 Predirective 137 07908012875 Postdirective ror 059 0m8 0921.38 UK. Ail Years Lay 100088 ot Lar Predictive rain 0621087 Postdirective Kor__080 050 ost Data are from Cll Vanage The numerator depreciation, depletion, and amortation expense panel A and operating expense in pane! The denominator in bots panes tthe market tale of uy eal one pl he ook vai of Tongtrm debt and cre abies period in table 6 suggest that R?sin the U.K. were higher than in Germany but lower than in France. There is little evidence of convergence or increased R% for Germany or France in the postdirective period in either table 5 of 6, which suggests that the directives did not significantly improve the value relevance of accounting data in Germany or France. Covariance among independent variables in a multiple regression might bias the standard errors of the estimates, so to assess the significance of each independent variable separately, we also estimated univariate re- gressions. The results (not reported) of the univariate analyses are con- ent with those from the multiple regressions. Coefficient estimates for the earnings change variable are significantly higher in the UK. than in Germany or France, both in the predirective and the postdirective period. For earnings levels, there is no significant difference in coefficients in the predirective period, but coefficients for the postdirective period are highest in Germany, followed by France and. the UK. The results suggest that earnings changes are more strongly as- sociated with returns in the U.K. than in France and Germany, while carnings levels are more strongly associated with returns in Germany and, to a lesser extent, France than in the UK. Further, differences are at least as strong, if not stronger, in the postdirective period, incon- sistent with a narrowing of measurement differences as a result of the directives. 43.3. Price Regressions. Year-by-year regression results are presented in table 7 and pooled results are presented in table 8. R's for the U.K. in the predisclosure period are significantly lower than those in Germany, which are in turn significantly lower than those in France. The R°s for162 PETER JOOS AND MARK LANG: TABLE 5 Year by-Yoar Reals forthe Regression of Returns om Earnings Levels and Changer “Panel A: Germany Earnings Barings Number of Year__Intercept__Level Chany HE Observations Toss 033 “0.87 089015 36 (0.03) (0.42) (ost) lost 0410 169) 0550.18 85 (0:05) (068) (036) 1985036 2.68 075038 a8 (007) (1.08) 14s) 1850.2 079 Lok oo %” (005) (080) (076) los? 008 1.05 ~0.08 002 108 (009) 07) om toss 0.49 320 0.09 1 (0.09) 132) too o.72 192 oz my (0.08) i) 1990001 188 0.10 149 (000) 072) Panel Bs France Earnings Earnings Number of Year Intercept Level Change RY Observations TRS 0.55 748 SOR yi (0.06) ey en 1910.88 6086 126 coor) (a8) 1985 0.71 i026 132 coun (7s) 1986047 “38036 135 (007) «an 1987-011 0 020 Mt (0.04) «an 1988 0.46 9 07 130 (013) «an, 199035 oad 192 (0.06) <4) 199 0.16 st oa 200 (007) 33) Panel C: UK. Earnings Earnings Number of Year__Intercept Level Change RE _ Observations Toss 0a 050 Te 50 (003) (038) (0.3) 191 0.40 032 210 old 459 (009) (028) (51) Joss o.88 078 309019 490 (0.06) (02) (075) 1986 0.65, 819 237030 sa (0.06) (0.58) (035)‘THE EFFECTS OF ACCOUNTING DIVERSITY 168 ios os 15, 209 oat is (004 (oa 73) 1988 0.06 1.60 T9908 ors (0.03) (033) @60) 1959-09 Ma 283 oa 336 (008) 042) @63) 1990 -9.10 187 037 O38 345 (008) 03) @35) Data ate fom Gla Yana fy tthe sock return estimated over the IB-month window ending 6 ‘monte after heal year-end 4y met income before extraordinary ems per share. Fy sare pice ‘the Begining ofthe Heal ear Standard eos ave ned in parentheses. TABLE 6 arnings Earnings Number of Imercept___Level” Change? __Obervations Germany Predirectve 0.25 082 0570s 369 (oo 027) (038) Postdiretive 0.15 6.14 026 0.19 420 (0.06) (096) (1.08), France Predirectve ost om om ou an (005) 023) 017) Postdirective 001 336 030038 a7 (0.06) 0.58) (085), UK Preditectve 0.66 107 145 oat 1894 (004 0.27) (028), Postdirective “0.09 217 133 034 1,680 (003) 24) (027), “Te xnav veqreion fe By aut Og + Data are from Glia! Lange fy the sock return entimated over the 18.month window ening 6 ‘monche after fal yearend 4y net Income before extraordinary ems pr ahare fy bare pce tthe beginning of the fuel year Standard errors ae noted in parentheses. The preirecve period {81982286 for Germany andthe UR and 82-88 for France The pentdiretive period 188.00 fr alvenree eounires. France are higher than those for the U-K. and Germany for each year of the sample period. Further, the R2% for Germany are generally comparable to those for the U.K. There is no evidence of significant convergence in the postdirective period, although 2% for France appear to decrease slightly Results in tables 7 and 8 suggest that the coefficients on sharehold- ers" equity tend to be larger in Germany and France than in the UK,164 PETER JOOS AND MARK LANG TABLE 7 Year Yor Regression of Pree on Net Income and Shareholder” Epil Panel Ai Germany Book Year Intercept ___Barnings Value ioe 9287 3a 68 0.58 36 2158) (085) .19) 1983 95.65 3.13 075080 88 ey) (089) (021) 1984, 78 3.96 om 035 9%, (30.73) an) (037) 1985 128.76 4.88 ool 020 wor (3488) 22) 030) 1986 105.07 438 Tos 03s rt (40383) «198 (0380) m9g7 12.24 631 065020 1 (3231) (165) (0328) 198s 162.75 2.05 120082 mM (26.25) «6s (034) too 241-70 335. 130037 138 (33:79) «183 (039) 199098748 sal 093 oe 187 41.32) (1.99) (038) Panel Bs France Book Number of Year___Intercept__ Earnings __Value___R®_ Observations 198 Tat 438 aT 0a 17 (720) (095) (0.12) 1983 108.56 502 0480.50 17 G47) 108) (015) 1984 50.68 5.20 0960.85 1s (5.58) 09) (013) 19857767 524 Li om 135, (36.80) 2) (0222) 1985 179.59, 648 Los 07 a wasn i) a7) a7 80.48 532 075078 135, (3135) ay 18) 1988 7R.68 538 107075 197 (35:98) (098) (012) 1989 350.09 1g 131056 20 a7) (097) (015) 1990 331.80 1.36 om 049 197 (3762) 9 (012) Panel C: UK. Book Number of Year __Intercept___Earmings Value? __—_—_ Observations Taz 78 ‘017 035 3s (0:06) (0.09) 1983, ost 00707 a8 (0.6) (oor) 1984 107 010045 (0.06) (0.09)‘THE EFFECTS OF ACCOUNTING DIVERSITY — 165 1985 146 025 0g 0a 287 (0:08) (0.48) (007) 1986, 1.80 3.16 022 020 368 (0.15) (189) (028) 1987 1.69 062 035 OAL 598 (0.13) (162) 19) 1988, 168 7 033042 606 (0.14) 3) (oat) 1989 152 196 015020 580 (0.15) (168) 18) 1990 170 182 015 Ost 556 (0.15) om conn, “The ented epreion Data are from Glbl Vintage Pi the stock price six month fer fal year-end yi net income before exranrdnnyiems per doar Bye the book ae of sharcholers equity per thoes and ys ‘ered trm Standard errors are noted in parentheses TABLE 8 Pooled Regression of Price on Net Income and arnings Earnings nber of Intercept___Level” Change _R?__ Observations Germany Predirectve 176.61 164 119 ot 491 2800) (058) @.14) Postdirectve = MBI2 458 089 ot am 4013) (084) (0.8) France Preditectve eusT 35 078035. sis (40.09) (049) 1), Postdirectve 21346 2.00 iy os ou (780) (053) (oan) UK. Predictive 308 ong 02501280 (0.15) 0.19) (0.08 Postdirective 2.96 176 016030 1.854 (021) 059) cons), Py = Bt bgt a Be a ‘Data ate fom Gla Vee Py the stock price sk months ater fea yearend, Ay is net income before eataosnny items per char, By book value of shareholder equ pot thves and ‘he residual term, Sandard errors are hated in parcrihesee. The prdiretve period i 1982-65 for {Germany andthe UR: and 1982-48 for France. The posiitecive period i 1984-00 forall three consistent with a balance sheet focus and conservatism.** Coefficient estimates for earnings are also generally larger in France and Germany than in the UK., again consistent with conservatism. As before, there is little evidence of convergence after implementation of the directives. 5 Conclusions on coefficient magnitudes should be drawn with caution because of the potential for scale bias (Barth and Kallapur (1994).166 PETER JOOS AND MARK LANG 5 jummary and Conclusions In this paper, we have examined differences in profitability ratios and the multiples applied to accounting data in Germany, the UK., and France for evidence on the effects of diversity in accounting mea- surement practices. Our analysis was based on univariate analyses of financial ratios, returns regressions, and price regressions. Overall, the results suggest that significant differences in reported profitability and the multiples applied to accounting data did exist prior to the direc- tives and were consistent with differences in accounting measurement practice across countries. Specifically, there is evidence that measure- ment practices in Germany were more conservative than those in the UK. (and France in the case of net income). We find no evidence that measurement practices in the UK. resulted in accounting data with a higher association with share price, inconsistent with the arguments underlying the decision to move EU accounting requirements toward those in the UK. Although the evidence suggests that country-specific measurement practices had significant effects on accounting-based performance ‘measures prior to the directives, we find no evidence that the differ- ences were reduced following implementation of the directives. How- ever, there is substantial disagreement among European academies and practitioners on the effectiveness of the directives in reducing measure- ment differences and some (e.g., Nobes [1993]} have suggested that the effects may have been more of form than of substance. ‘Our findings are consistent with either of two conclusions: that sub- stantial accounting differences existed, but the directives did litle to reduce them; or that fundamental (i.e., nonaccounting) differences in the sample companies across countries led to the observed differences. ‘The second conclusion seems unlikely, given the similarity of the three economies we study and the fact that the observed differences are gen- erally predictable based on cross-country differences in accounting philosophy and practice. Further, the results are robust to controls for cross-country economic differences. Finally, even if other factors could explain differences in the levels of our measures prior to the directives, the absence of evidence of a change over time suggests that the effects, of the directives have been limited or even nonexistent so far. There- fore, subject to the limitations imposed by data availability, we conclude that important differences in the three measures we consider existed historically and the directives have done little to reduce them. ‘The results have two implications for policymakers. First, itappears that, consistent with crities’ arguments, the flexibility allowed by the directives and the incentives which remained to adopt differing approaches left sub- stantial differences in accounting among Germany, France, and the UK. langely unaffected. To the extent that comparable measurement of net in- come and shareholders’ equity is perceived as important, additional at-piversiry 167 ‘THE EFFECTS OF ACCOUNT! tempts at integration may be merited.®” More generally, the results suggest caution in applying a similar approach to developing integrated standards as a basis for cross-listing globally. It appears that, unless care is taken to limit the number of options and reduce the effects of tax-based and other incentives, the resulting changes may be limited, Second, the analysis indicates a role for empirical research in assessing the need for and effectiveness of efforts to reduce accounting measure- ment differences. While empirical research cannot be used to address the issue of the optimal level of integration (without data on cost/benefit trade-offs), it may be useful in assessing the extent to which accounting measurement differences affect the reported data, REFERENCES Aursasoen, DoS. 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