Foreign ownership and financial reporting quality in private subsidiaries

ABSTRACT

In a sample of large private Spanish subsidiaries, we find that the magnitude of discretionary accruals is significantly higher when the parent company is foreign than when it is local. Our tests support the thesis of recent research on earnings management strategies within multinational corporations, suggesting that the parent company’s incentives underlie the observed negative relation between foreign ownership and financial reporting quality at the subsidiary level. In particular, we find that (1) the tenure of the controlling shareholder has a negative incremental effect on financial reporting quality in firms under foreign control, as opposed to subsidiaries of local groups and (2) the negative association between foreign ownership and financial reporting quality is mainly driven by the subsample of subsidiaries with parent companies located in countries with higher institutional quality than Spain.

RESUMEN

Propiedad extranjera y calidad de la información financiera en subsidiarias no cotizadas En una muestra de empresas subsidiarias españolas no cotizadas, este trabajo presenta evidencia empírica de que la magnitud de los ajustes por devengo discrecionales es significativamente mayor cuando la matriz es extranjera ue cuando es local. Los resultados son consistentes con la tesis de algunos trabajos recientes sobre las estrategias de manipulación del resultado en las compañías multinacionales, sugiriendo que son los incentivos de la matriz los ue subyacen a la relación negativa observada entre la propiedad extranjera y la calidad de la información contable de las subsidiarias. En particular, se observa que: (1) la experiencia de la matriz como accionista de control tiene un efecto incremental negativo sobre la calidad de la información contable en las subsidiarias controladas por un grupo extranjero con respecto a las que tienen matriz local; y (2) la relación negativa observada entre la propiedad extranjera y la calidad de la información contable se debe fundamentalmente al grupo de subsidiarias cuya matriz está establecida en países con mejor calidad institucional que España.

KEYWORDS:

• Foreign ownership
• private firms
• subsidiaries
• earnings management
• discretionary accruals
• institutional quality

PALABRAS CLAVE:

• propiedad extranjera
• empresas no cotizadas
• subsidiarias
• manipulación del resultado
• ajustes por devengo discrecionales
• calidad institucional

JEL CLASSIFICATION:

• F23
• M41
• M48

Acknowledgements

We appreciate the helpful comments of Flora Muiño (the editor), an anonymous referee, Christina Dargenidou, Beatriz García-Osma, Begoña Giner, and Helena Isidro. We also appreciate suggestions from participants at the 38th European Accounting Association Annual Congress (Glasgow), the 13th Annual International Conference on Accounting (Athens), the 11th Workshop on European Financial Reporting (Paris), the 5th PhD Student Workshop in Industrial and Public Economics (Reus) and doctoral seminars at the Universidad Autónoma de Madrid and Universitat Jaume I. We acknowledge financial contribution from the Spanish Ministry of Science and Innovation (ECO2013-48328), and the research project funding 09I340 P11B2009-05 of the Universitat Jaume I. Simona Rusanescu acknowledges financial support from the Spanish Association of University Accounting Professors (ASEPUC), through the 2014 PhD grant.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Literature on ownership concentration and financial reporting quality is extensive and offers conflicting results (Fan & Wong, 2002; Firth, Fung, & Rui, 2007; Francis, Schipper, & Vincent, 2005; Shleifer & Vishny, 1986, 1997; Yeo, Tan, & Chen, 2002).

2. Indeed, foreign investors typically appoint managers from the parent company’s country because they better serve the group’s interests (e.g. Edström & Galbraith, 1977; Harzing, 2001; Kopp, 1994; Tung, 1982, 1987).

3. Spanish standards require companies to present full financial statements (i.e. detailed formats of both balance sheet and income statement, as well as cash flow and changes in equity statements) when they are large enough. In 2011, full financial statements were compulsory for all firms that had met two out of these criteria during two consecutive years: total assets more than 11,400 thousand Euros; net sales revenue higher than 22,800 thousand Euros; and average number of employees higher than 250. These companies must also have their annual accounts audited.

4. The companies analysed have to prepare their financial statements under the standards established in the General Accounting Plan, which is part of the Spanish corporate law. The Spanish local GAAP were harmonised with the International Financial Reporting Standards (IFRS) by the Royal Decree 1514/2007 (2007). However, there are still differences between the Spanish local GAAP and IFRS (see Deloitte, 2011).

5. The other home countries of foreign parent companies are (ordered by frequency): Portugal, Luxembourg, Ireland, Denmark, Finland, Austria, South Korea, United Arab Emirates, Bermuda, Norway, Canada, South Africa, Israel, Mexico, Australia, China, Kuwait, India, Brazil, Turkey, Hong Kong, Taiwan, Kazakhstan, Russia, New Zealand, Lithuania, Saudi Arabia, Algeria, and Colombia.

6. Working capital accruals are calculated as the annual change in non-cash current assets less the annual change in current liabilities.

7. Results are qualitatively the same when estimating the models in each year and 2-digit SIC combination requiring a minimum of 10 observations per regression as in DeFond and Jiambalvo (1994), although the sample size is considerably reduced.

8. Even though the number of countries is substantially reduced, the number of observations is not since we lose only 835 firm-year observations in this analysis (i.e. less than 5 percent of the initial sample).

9. We use the absolute values of ROA and CFO because the discretionary accruals variables are also unsigned. Results are similar whether we use signed ROA and CFO instead.

10. MNCs’ subsidiaries are frequently funded with the parent company’s loans since ‘MNCs can exploit the tax advantage of debt more aggressively than national companies’ (e.g. Møen, Schindler, Schjelderup, & Tropina, 2011).

11. Our conclusions remain unchanged whether we truncate the sample below percentile 1 and above percentile 99 of the variables |DAC|, |WCDAC|, |DD|, Size, Lev, |Roa|, |CFO|, Salesgrowth, and NBanksA.

12. For the sake of comparability, we provide some references of our sample characteristics with regard to other studies using Spanish data. As expected, our sample firms are smaller and less leveraged than listed Spanish firms included in the sample of Beuselinck, Blanco, et al. (2017). As compared to the private firms with audited financial statements used in Cano-Rodríguez and Sánchez-Alegría (2012), our sample firms are larger, and have higher growth rates, while they are similar in terms of leverage and profitability. Finally, compared to SMEs with audited accounts studied in Huguet and Gandía (2016), the firms included in our sample are larger, more leveraged and profitable, and have higher growth rates.

13. Results (untabulated) are qualitatively the same when the sample is partitioned using each individual measure of institutional quality or considering the two underlying factors obtained from applying a factor analysis procedure.

Additional information

Funding

We acknowledge financial contribution from the Spanish Ministry of Science and Innovation (ECO2013-48328), and the research project funding 09I340 P11B2009-05 of the Universitat Jaume I. Simona Rusanescu acknowledges financial support from the Spanish Association of University Accounting Professors (ASEPUC), through the 2014 PhD grant.