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Study compares financial reporting quality between foreign issuers registered with the SEC and exempt firms. Exempt firms have consistently lower financial reporting quality in comparison with disclosing firms. The triangulation among firm disclosure, financial reporting quality and external monitoring is a fundamental issue in accounting research.
Study compares financial reporting quality between foreign issuers registered with the SEC and exempt firms. Exempt firms have consistently lower financial reporting quality in comparison with disclosing firms. The triangulation among firm disclosure, financial reporting quality and external monitoring is a fundamental issue in accounting research.
Study compares financial reporting quality between foreign issuers registered with the SEC and exempt firms. Exempt firms have consistently lower financial reporting quality in comparison with disclosing firms. The triangulation among firm disclosure, financial reporting quality and external monitoring is a fundamental issue in accounting research.
quality of an exemption from the SEC reporting requirements for foreign private issuers Yuan Ding China Europe International Business School (CEIBS), 699 Hongfeng Road, 201206 Shanghai, PR China Received 2 August 2010 1. Introduction According to U.S. regulation, foreign companies listed in United States are subject to registration under Section 12(g) of the 1934 Securities Exchange Act and are required to fulfill certain filings with SEC (including the annual document 20-F). However, foreign firms can request an exemption from filing 20-F with SEC if they prove that they have only a marginal presence in the U.S. market 1 . They may maintain this exemption afterward regardless the change of their size and presence in U.S. market, if they keep submitting the required non-U.S. disclosure documents. In this article, Gotti and Mastrolia explore this unique institutional setting and compare the financial reporting quality between foreign issuers registered with the SEC (hereafter named disclosing firms) and foreign issuers exempt from filing (hereafter named exempt firms). Using three different proxies of quality (conservatism, abnormal accruals and predictability of earnings), the article finds that exempt firms have consistently lower financial reporting quality in comparison with disclosing firms. Authors believe that this study is particularly timely as the SEC is considering expanding availability of the exemption, and our results indicate that a Rule 12g3-2(b) exemption is associated with lower financial reporting quality (p. 4). E-mail address: dyuan@ceibs.edu. 1 If they have total assets of less than $10 million, more than 500 owners worldwide and less than 300 owners in the United States. 0020-7063/$ - see front matter 2011 University of Illinois. All rights reserved. doi:10.1016/j.intacc.2011.12.003 Available online at www.sciencedirect.com The International Journal of Accounting 47 (2012) 7275 The triangulation among firm disclosure, financial reporting quality and external monitoring is a fundamental issue in accounting research. The current study contributes significantly to the literature on this issue, despite the reservations and comments I have formulate. My discussion will start with the theory contribution and hypothesis development in the paper (Section 2) followed by an analysis on the sample selection and measurement issues (Section 3). It then covers some minor issues (Section 4) before the conclusion (Section 5). 2. Theory contribution and hypothesis development In the current version, the authors still need to clarify several important issues. The article cites abundantly works from cross-listing literature and argues that it contributes to this literature. However, I do not think this study belongs to the research strand on cross- listing. First, in most studies the authors cite, comparisons are made between cross-listed firms and their counterparts only listed in home market, or between cross-listed firms and their counterparts listed in the target (often more developed) market. This study is about none of these markets; because the whole sample is foreign companies listed in the U.S., it has no possible variations in order to formulate hypotheses based on previous cross-listing literature. Additionally, I am not sure that the foreign firms included in this study are cross- listed or not. Some of them are simultaneously listed in their home market and in the U.S. market and are thus cross-listed. Many others (from ANT, BMU or CYM, for example) are companies listed in U.S. market only (some of them are even U.S. companies registered offshore for fiscal reasons, like WorldComin Bermuda). Therefore, the article has the problem of having irrelevance in the literature review and thus having a lack of theoretical supports for the hypothesis development. Using the current research design, the authors are interested in the triangulation of relationship among firm disclosure, financial reporting quality and external monitoring. In order to develop their hypothesis properly, they should find and add the following literature: 1) Why do some firms opt to a lower level of disclosure? 2) Is a poorer disclosure level associated with lower financial reporting quality? 3) Do firms choosing a lower level of disclosure have also lower financial reporting quality? 4) Does a looser external requirement for disclosure result into a lower financial reporting quality of the firm? Fixing these missing points is also crucial for justifying the implications of the current study for practitioners and policy-makers. On page 28, the authors argue, [T]hese results should be of interest to investors and regulators as they may indicate that a Rule 12g3-2(b) exemption may not be in the best interest of U.S. shareholders. This study is very timely as the SEC is currently considering expanding the availability of the exemption to more foreign private issuers, which this study indicates, may result in lower financial reporting quality. I am not convinced by these arguments for several reasons. First, the nature of the above-mentioned exemption is completely different from the one studied, because 73 Discussion the former is an action the regular takes while the latter is an option the firm picks. In the current study, one question remains unanswered: do the exempt firms have low financial reporting quality because only firms with low financial reporting quality ask for the exemption, or because they enjoy less restrictive disclosure requirements after obtaining the exemption? If the former, then the generalization of disclosure exemption to all non- U.S. issuers will not change their financial reporting quality. Moreover, I am not convinced by the argument that the exemption may not be in the best interest of U.S. shareholders, because from the current study, we cannot tell if the exemption has negative consequences on these firms, like a higher risk of bankruptcy or of delisting, lower market or accounting performance, etc. The descriptive statistics are showing more or less the opposite. We do not know if U.S. investors either see through this accounting opacity or even punish these exempt firms with lower stock prices (the authors mention that they study this issue in another working paper). 3. Sample selection and measurement issues Regarding the sample selection, I also note a couple of debatable issues. By reading the text, we may feel that the exemption is not a free choice for every foreign issuer. On page 7, authors write, The exemption under the rule is not available to companies that are subject to the periodic reporting requirements or have been subject to those requirements in the past 18 months, to companies that have acquired another company (U.S. or non-U.S.) that was subject to the periodic reporting requirements, to companies with securities listed on a U.S. stock exchange or quoted in NASDAQ, or to Canadian companies. Additionally, companies may not meet the three criteria when they are listed in the U.S. market. For all these firms, the exemption is never an option and so should be excluded from the studied sample (at least as a robustness test). Furthermore, on page 56, we read that exempt firms shares are exchanged over-the- counter through the Pink Sheets. If exempt firms and disclosing firms are listed in different markets in the U.S., the difference in financial reporting quality we observe might just be a variation among firms listed in different markets. As I mentioned previously, the firm chooses the exemption. We do not know if these exempt firms choose to be in low financial reporting quality or if they have low financial reporting quality because of the exemption (and so the low regulation pressure on their disclosure). Because some companies are both exempt and file with SEC (see p. 36) over the sample period, it might be a stronger test to study these firms switching from exempt to disclosing (from disclosing to exempt) and to see if their financial reporting quality improves (deteriorates). From the Table 1 on page 36, we see the country distribution between exempt firms and disclosing firms varies significantly. Some countries like Bermuda, Canada, or Japan, might drive the results. The authors should test that as robustness check. I also have some concerns with the three proxies of financial reporting quality. Because exempt firms do not prepare 20F and so do not provide financial numbers based on U.S. GAAP while disclosing firms do. These major differences among accounting standards might impact not only accounting numbers like net income used for measuring 74 Discussion conservatism, but also might change the flexibility regarding different manipulations of accrual items. Moreover, it is problematic to compare the predictability of earnings among different industry and various countries, because the measure is strongly influenced by the industry, the dynamism of the business environment, etc. 4. Minor issues It would be helpful if authors provided a comparative table on the required documents for exempt firms and for disclosing firms. The current explanation in the text is difficult to follow. On page 27, authors write, in this paper, we use a unique sample of foreign private issuers that are exempt from filing with the SEC, in order to test whether reporting to the SEC is associated with improved financial reporting quality. The improved financial reporting quality is an over-stated claim because this paper is only discusses the level test but not the change test. On page 36, authors write, we exclude companies that over the sample period have been both exempt and filing with the SEC. This statement contradicts the statement on the following page: All companies includes not only companies that are exempt or filing with the SEC for at least one year between 2000 and 2006, but also companies that switched at least once from exempt to SEC filing (or vice versa) over the sample period. 5. Conclusion The above-mentioned shortcomings cannot take away the article's quality. It is well written and easy to follow. More importantly, it discusses a germane issue in U.S., that is: 1. How could U.S. capital market improve its attractiveness vis--vis des foreign issuers? 2. Does the ease of disclosure requirement of these foreign issuers reduce the quality of financial reporting? The paper certainly contributes constructively to this debate. 75 Discussion