EARNINGS QUALITY

Prepared by: Nazzatul Afiqah Binti Shuhaimi

Earnings Quality In Privatized Firms:
The Role Of
State And Foreign
Introduction:

To investigate the relationship between:

• Shareholder identity and earnings quality

• Foreign ownership affect earnings quality

Research Issues/ Statement Problems:

• Privatization, provide a natural laboratory in which can isolate the determinants of

accounting transparency

• Political interference in the state is likely to report lower earnings quality

• Foreign ownership is associated with:

(i) smaller abnormal accruals,
(ii) higher earnings informativeness, and
(iii) more persistent earnings
Literature Reviews:

• The state generally pursues political objectives

• The government has more incentives
to tunnel corporate resources and expropriate other shareholders for
political benefits.
• To hide this expropriation, the government may lead managers to manipulate earnings,
which results in a lower
quality of accounting information.
• Furthermore, because they have access preferential financing through political connections
Literature Reviews:

• Ownership structure, particularly shareholders’ identity, influences the quality of released

financial information.

• Financial accounting information is typically used to identify investment opportunities,

improve resource allocation toward positive net present value projects, and reduce the
informational asymmetries between insiders and outsiders.

• Privatization, defined as the sale of state-owned enterprises to private investors, leads to a

change in the nature of ownership and the incentive structures of the firm, which in turn
creates differences in the reporting incentives for financial information.
Significance/Implications

• Impact of state ownership on earnings quality

The results show that state ownership varies systematically with Ball and Shiva Kumar's
(2005) unsigned abnormal accruals. Specifically, they find that the coefficient for STATE is
positive and significant at the 1% level, implying that greater state ownership is associated
with greater abnormal accruals. More specifically, a one standard deviation increase in state
ownership is associated with a 13.4% increase in abnormal accruals.

This evidence is consistent with their prediction, suggesting that state owners have fewer
incentives to report higher quality earnings
Significance/Implications

• Impact of foreign ownership on earnings quality

The results of Model 1, using the same model, shows that the coefficient for FOR is negative
and significant at the 1% level, suggesting that greater foreign ownership is associated with
smaller abnormal accruals.

More specifically, an increase by one standard deviation in foreign ownership is associated

with a 12.1% (0.186 ⁄ (0.037)/0.057 = 0.121) decrease in abnormal accruals.

This evidence is consistent their prediction, the conjecture that foreign investors require higher
transparency to prevent insiders from expropriating their wealth.
Conclusion

• The achievement of privatization objectives may not materialize when the

government maintains the control of the privatized firm. In fact, the study shows that
government control is associated with lower earnings quality.

• Foreign ownership is associated with higher earnings quality in the following ways:
(i) smaller abnormal accruals,
(ii) higher earnings informativeness, and
(iii) more persistent earnings.

• This finding supports the conjecture that foreign owners require higher earnings
quality to prevent the expropriation of corporate resources by insiders
 ON THE ASSOCIATION BETWEEN
STRATEGIC INSTITUTIONAL OWNERSHIP
AND
EARNINGS QUALITY: DOES INVESTOR
PROTECTION STRENGTH MATTER?
Introduction

To investigate the relationship between:

• Whether strategic institutional ownership is positively associated with earnings

quality at the international level

• Whether this relationship varies with the strength of investor protection at the
country level
• Research Issues/ Statement Problems:

• Earnings are significantly more timely in common law countries than in code law countries,
and Leuz et al. (2003) document a negative association between earnings management and
the degree of investor protection at the country level.

• The authors argue that managers of firms located in strong investor protection countries have
less ability to acquire private control benefits, which lowers their incentive to manage
earnings.
Literature Reviews:
Investors pressure managers to achieve short-term profit goals at the expense of long-term
value (e.g., Coffee, 1991; Jacobs, 1991),

Leading to more earnings management in firms with higher institutional ownership. Guthrie
and Sokolowsky (2010) find evidence that firms tend to manipulate their earnings around
seasoned equity offering in the presence of large outside block holdings.

On the other hand, institutional investors are often viewed as better informed than individual
investors. They can look beyond current earnings, thus creating less incentive for firms to
manipulate earnings. Also, due to their superior access to databases and analytical tools, it is
less costly for institutions to engage in in-depth firm analysis (Hope, 2013). Moreover,
because of their large stakes in the firm, institutional investors are likely to monitor managers.
Literature Reviews:

• Several studies show that the association between earnings quality and institutional investors
varies with institutional investors categories.

• Collins et al. (2003) indicate that stock prices reflect the persistence of accruals more
accurately in firms with a high level of institutional ownership and a minimum threshold
level of active institutional traders, and Burns et al. (2010) find that only short term oriented
institutional investors are associated with more discretionary accruals management.

• Overall, there is evidence supporting the notion that, in the U.S. context, long-term
institutional investors are associated with higher earnings quality.
Significance/Implications

• Summary statistics at the country level. All nations were included and have at least one firm
having strategic institutional investors. The sample includes 28 code law countries and 13
common law countries. Code law countries have dramatically fewer observations than
common law countries. Tabulated

• On the other hand, there are countries where institutional investors have large stakes in
companies, such as Finland, Ireland, Japan, Netherlands, and the U.K. In an un-tabulated
result, a t-test of the difference in mean in institutional ownership shows that common law
countries have significantly higher institutional investor holdings (11.0%) than code law
countries (2.0%). This result suggests that, in better investor protection markets, institutional
investors are more attracted by equities.
Significance/Implications

• Correlations between institutional ownership and our proxies for investor protection. It
confirms that institutional investors have more ownership stakes in countries with stronger
investor protection.
• It also shows that common law markets:
(i) have a higher anti-self-dealing rights index,
(ii) have a higher disclosure requirements index,
(iii) are more stringent on liability index, and
(iv) have stronger public enforcement index.

All the correlations among investor protection variables are significant

at the 5% level, or lower.
Conclusion:

The study indicates that higher institutional ownership is associated with better
earnings quality, and evidence is mostly confined to the U.S.

The study also explore this relationship in a broader sample. They documented a
positive association between strategic institutional ownership and earnings quality
across 41 countries.

More importantly, we find that this association is stronger

in countries with strong investor protection