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    Home Country Investor Protection, Ownership Structure and...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.04 Impact of 404, 01.05 Impact of SOX, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality 
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    Title:
    Home Country Investor Protection, Ownership Structure and Cross-Listed Firms’ Compliance with SOX-Mandated Internal Control Disclosures.
    Practical Implications:

    The results carry important implications for regulators, investors, and researchers. The findings suggest both firm-level corporate governance and home country investor protection still matter in explaining the disclosure behavior of cross-listed firms. Hence, it may be warranted for U.S. securities regulators to devote more resources to monitoring the financial disclosure quality of CONTROL_WEDGE firms from weak investor protection countries. The results suggest that U.S. investors should pay closer attention to the financial disclosure quality of cross-listed firms, especially CONTROL_WEDGE firms from weak investor protection countries. This is important because the recent accounting frauds involving cross-listed firms suggest that U.S. investors might not have paid sufficient attention to the disclosure quality, and as a result suffered significant economic losses after the revelation of the accounting frauds.

    Citation:

    Gong, G., Ke, B., & Yu, Y. 2013. Home Country Investor Protection, Ownership Structure and Cross-Listed Firms' Compliance with SOX-Mandated Internal Control Deficiency Disclosures. Contemporary Accounting Research 30 (4): 1490-1523. 

    Keywords:
    investor protection, Sarbanes-Oxley, internal controls
    Purpose of the Study:

    The objective of this study is to assess the effects of home country investor protection and ownership structure on the Sarbanes-Oxley Act (SOX)mandated internal control deficiency (ICD) disclosures by foreign firms that are listed on the U.S. stock exchanges (hereafter referred to as cross-listed firms). In this study, the authors focus on SOX-mandated internal control disclosure provisions, because internal control systems play a crucial role in ensuring the reliability of financial reporting. It is widely recognized that material internal control weaknesses give management the flexibility to manipulate financial reporting to conceal their expropriation activities. In addition, the SOX-mandated internal control disclosure provisions are regarded as the most costly and controversial provisions of SOX. Therefore, it is important to analyze cross-listed firms’ compliance with SOX-mandated ICD disclosure requirements.

    The authors focus on the ICD disclosures during the Section 302 reporting regime and examine whether cross-listed firms whose management is the controlling shareholder of the firm and holds greater voting rights than cash flow rights (denoted as CONTROL_WEDGE firms) have a higher likelihood of misreporting ICDs than other cross-listed firms, especially for cross-listed firms domiciled in weak investor protection countries where managers’ ICD misreporting faces fewer constraints.

    Design/Method/ Approach:

    The sample is restricted to cross-listed firms that are listed on the three major U.S. stock exchanges as of the end of 2002. The sample includes both American Depository Receipts (ADRs) and foreign firms directly listed on the U.S. stock. Using COMPUSTAT, SEC filings, CRSP, and Audit Analytics, the authors created a sample of 355 unique cross-listed firms, of which 41 firms disclosed at least one material weakness during the Section 302 reporting regime.

    Findings:

    For cross-listed firms domiciled in weak investor protection countries, the authors find the following results: 

    • CONTROL_WEDGE firms have a higher likelihood of ICD misreporting than other firms during the Section 302 reporting regime. In addition, the likelihood of ICD misreporting is negatively associated with earnings quality during the Section 302 reporting regime.
    • The likelihood of ICD misreporting is positively associated with the likelihood of voluntary deregistration from the SEC prior to the Section 404 effective date.
    • For cross-listed firms that chose not to deregister, the likelihood of ICD misreporting is positively associated with the likelihood of reporting previously undisclosed ICDs during the Section 404 reporting regime.

    The authors do not find similar results for cross-listed firms domiciled in strong investor protection countries. Overall, the results are consistent with the hypothesis that management of CONTROL_WEDGE firms domiciled in weak investor protection countries is reluctant to disclose ICDs in order to protect its private control benefits. In addition, the results suggest that Section 404 is effective in weeding out cross-listed firms whose management has an incentive to hide ICDs or forcing cross-listed firms to truthfully reveal their ICDs.

     

    Category:
    Internal Control, Standard Setting
    Sub-category:
    Impact of 404 on Fees and Financial Reporting Quality, Impact of 404, Impact of SOX