Governance tensions in MNCs’ accounting quality

Abstract

This study investigates how the institutional complexity of a multinational corporation (MNC) impacts its accounting quality. Toward that end, we employ a unique sample of MNCs registering subsidiaries in offshore financial centers (OFCs). Our focus is the tension between external governance mechanisms (i.e., US cross-listing, home-country institutional context) and internal governance mechanisms (OFC subsidiaries). Consistent with the corporate governance bonding hypothesis, we show that cross-listed MNCs exhibit higher accounting quality compared to non-cross-listed MNCs. However, the positive association between cross-listing and accounting quality is negatively moderated by an MNC’s choice of OFC subsidiaries, thereby suggesting that the internal governance mechanisms of MNCs interact with external mechanisms to impact its accounting quality. Moreover, an MNC’s OFC choice negatively moderates the relationship between home-country governance and accounting quality, thus lending further support to corporate governance arbitrage hypothesis. Our study underscores, to regulators and investors concerned about opportunistic earnings management, the importance of enhancing monitoring efforts for MNCs with opaque and complex governance that exhibits international mobility.

Résumé

Cette recherche examine comment la complexité institutionnelle d'une entreprise multinationale (Multinational Corporation - MNC) influence sa qualité comptable. Pour ce faire, nous utilisons un échantillon unique de multinationales enregistrant des filiales dans les centres financiers offshore (Offshore Financial Centers - OFCs). Nous nous focalisons sur la tension entre les mécanismes de gouvernance externe (c'est-à-dire la multi-cotation aux États-Unis, le contexte institutionnel du pays d'origine) et les mécanismes de gouvernance interne (filiales enregistrées dans les OFCs). Conformément à l'hypothèse de cautionnement de gouvernance d'entreprise, nous démontrons que les MNCs multi-cotées présentent une qualité comptable supérieure à celle des MNCs non multi-cotées. Néanmoins, l'association positive entre la multi-cotation et la qualité comptable est négativement modérée par le choix d’une MNC d’enregistrer des filiales dans les OFCs, ce qui suggère que les mécanismes de gouvernance interne des MNCs interagissent avec des mécanismes externes pour influer sur leur qualité comptable. De plus, le choix d’enregistrer des filiales dans les OFCs modère négativement la relation entre la gouvernance du pays d'origine et la qualité comptable, ce qui renforce encore l'hypothèse d'arbitrage de gouvernance d'entreprise. Notre recherche souligne, pour les régulateurs et les investisseurs préoccupés par la gestion opportuniste des bénéfices, l'importance de renforcer les efforts de surveillance sur les MNCs avec gouvernance opaque et complexe faisant preuve de mobilité internationale.

Resumen

Este estudio investiga cómo la complejidad institucional de una empresa multinacional (EMN) influye en su calidad contable. Con este fin, empleamos una muestra única de empresas multinacionales que registran filiales en centros financieros extraterritoriales (OFCs por sus iniciales en inglés). Nos enfocamos en la tensión entre los mecanismos de gobernanza externa (es decir, la cotización cruzada en Estados Unidos y el contexto institucional del país de origen) y los mecanismos de gobernanza interna (las filiales en los centros financieros extraterritoriales). Acorde con la hipótesis de la vinculación del gobierno corporativo, demostramos que las empresas multinacionales que cotizan en bolsa presentan una mayor calidad contable en comparación con las que no cotizan. Sin embargo, la asociación positiva entre la cotización cruzada y la calidad contable está moderada negativamente por la elección de las filiales de las empresas multinacionales, lo que sugiere que los mecanismos internos de gobierno de las empresas multinacionales interactúan con los mecanismos externos para afectar a su calidad contable. Así mismo, la elección de una empresa multinacional de una filial en un centro financiero extraterritorial modera negativamente la relación entre la gobernanza en el país de origen y la calidad contable, lo que apoya la hipótesis del arbitraje de la gobernanza corporativa. Nuestro estudio destaca, para los reguladores e inversionistas preocupados por la gestión oportunista de los beneficios, la importancia de mejorar los esfuerzos de supervisión de las empresas multinacionales con un gobierno opaco y complejo que presenta movilidad internacional.

Resumo

Este estudo investiga como a complexidade institucional de uma empresa multinacional (MNC) impacta sua qualidade contábil. Para esse fim, empregamos uma amostra única de MNCs que consignam subsidiárias em centros financeiros offshore (OFCs). Nosso foco é a tensão entre mecanismos de governança externa (ou seja, listagem cruzada nos EUA, contexto institucional do país de origem) e mecanismos internos de governança (subsidiárias em OFC). Consistente com a hipótese de vínculo de governança corporativa, mostramos que MNCs listadas de forma cruzada apresentam qualidade contábil mais alta em comparação com MNCs sem listagem cruzada. No entanto, a associação positiva entre listagem cruzada e qualidade contábil é moderada negativamente por uma escolha de subsidiárias OFC pela MNC, portanto sugerindo que os mecanismos internos de governança de MNCs interagem com mecanismos externos para impactar sua qualidade contábil. Além disso, uma escolha de OFC de uma MNC modera negativamente a relação entre governança do país de origem e qualidade contábil, proporcionando assim suporte adicional à hipótese de arbitragem de governança corporativa. Nosso estudo ressalta para reguladores e investidores preocupados com a gestão oportunista de lucros, a importância de aumentar esforços de monitoramento para MNCs com governança opaca e complexa que apresenta mobilidade internacional.

摘要

本研究调查跨国公司 (MNC) 的制度复杂性如何影响其会计质量。为此, 我们采用了在离岸金融中心 (OFC) 注册子公司的MNC的独特样本。我们研究的重点是外部治理机制 (即美国交叉上市、母国制度情境) 与内部治理机制 (OFC 子公司) 之间的紧张关系。与公司治理绑定假说一致, 我们表明与非交叉上市的MNC相比, 交叉上市的MNC表现出更高的会计质量。然而, MNC选择 OFC 子公司时, 交叉上市与会计质量之间的正相关关系受到负向调节, 从而表明MNC的内部 治理机制与外部 机制相互作用以影响其会计质量。 此外, MNC的 OFC 选择负向调节母国治理与会计质量之间的关系, 从而进一步支持公司治理套利假说。 我们的研究向关注机会主义盈余管理的监管机构和投资者强调了加强对具有国际流动性的、不透明的和复杂治理的MNC的监控工作的重要性。

Appendix A

Variables Definition and Data Sources

“DATA” refers to data item number in the OSIRIS database. Δ refers to annual changes.

Variables	Definition	Data sources
Variables used to estimate proxies of financial reporting quality
IBEI	Earnings before extraordinary items and discontinued operations = DATA13037 – DATA13043	OSIRIS
A	Total assets = DATA13077	OSIRIS
Sales	Net sales = DATA13002	OSIRIS
Rev	Total revenues = DATA13004	OSIRIS
ΔRev	Change in total revenues = ΔDATA13004	OSIRIS
Rec	Net accounts receivables = DATA13052	OSIRIS
ΔRec	Change in net accounts receivables = ΔDATA13052	OSIRIS
PPE	Gross value of property, plant, and equipment = DATA20095 + DATA20110 + DATA20125 + DATA20140 + DATA20155 + DATA20170	OSIRIS
MEV	Market capital = DATA21220 – DATA21215	OSIRIS
CFO	Operating cash flows = MEV/DATA31085	OSIRIS
ACCR	Total accruals = IBEI – CFO
Proxies for financial reporting quality
ABS_ACCRUAL	Absolute value of abnormal accruals	OSIRIS
ACCRUAL+	Positive abnormal accruals
ACC_QUALITY	Accruals quality, which is the standard deviation of the firm-level residuals based on the Dechow and Dichev (2002) model for the years t−3 to t multiplied by negative one. The model is a regression of working capital accruals on lagged, current, and future cash flows plus the change in revenue and PPE. All variables are scaled by average total assets. The cross-sectional regression is estimated for each industry with at least 20 observations in a given year based on the Industry Classification Benchmark of the OSIRIS database	OSIRIS
MACC_QUALITY	A modified accruals quality based on Wysocki (2009). It equals the ratio of the standard deviation of the residuals from the model that regresses working capital accruals on current cash flows and the model that regresses working capital accruals on lagged, current, and future cash flows. The standard deviation of the residuals of each model are computed for the years t−3 to t	OSIRIS
EARN_PERS	A measure for earnings persistence, which is equal to negative standard deviation of a firm’s average earnings from year t−3 to t	OSIRIS

Variables	Definition	Data sources
Interest variables
Cross_Listing	An indicator that equals one if a firm is cross-listed in the US stock market and zero otherwise	BNYMellon; websites of NYSE, AMEX and NASDAQ;
SUBindex	The offshore attribute index is from Masciandaro (2008). The index measures attitudes towards OFCs, and it is based on multiple factors such as potential national benefits, political stability, regulations enforcement, the presence of crime, and an inclusion in one of the OFCs’ blacklists: Financial Stability list, FATF list of Non-Cooperative Countries and Territories, and OECD list of tax havens. The index is equal to zero if a country shows a strong onshore attitude; one if a country does not show a strong onshore attitude but it was not listed in one of the blacklists; two, three, and four if a country was present in one, two, or three blacklists, respectively. Finally, one is added to the index if a country or jurisdiction is on the International Financial Centers’ Yearbook (IFCY) dataset from 2006 to 2007 by which a country or jurisdiction is classified as an OFC if the authorities of a country or jurisdiction approved it. The index ranges from zero (low degree of offshore characteristics) to five (high degree of offshore characteristics). We construct SUBindex as a subsidiary-weighted average of the offshore attitude indexes with weights equal to the number of subsidiaries (scaled by the total number of subsidiaries), $SUB{index}_{it}={\sum }_{c}\left(offshoreattributeinde{x}^{c}\times subsidiar{y}_{it}^{c}\right)/{\sum }_{c}subsidiar{y}_{it}^{c}$, where subsidiary is the number of subsidiaries that firm i has in country c in year t	Masciandaro (2008)
Secrecy	The subsidiary-weighted OFC secrecy policy index of an offshore firm. Based on the magnitude of supervision and transparency for international cooperation, the Financial Stability Forum (2000) categorizes OFCs into three groups; those with the highest level of supervision and transparency are listed in Group I, while those with the lowest level placed in Group III. One, two and three are given to OFCs in reference to the index if they are placed in Group I, Group II, or Group III, respectively	International Monetary Fund, 2000. Offshore Financial Centers. IMF Background Paper.
Regulation Arbitrage	The regulation enforcement index of the country of a parent firm minus the subsidiary-weighted regulation enforcement index of its OFC subsidiaries	The Worldwide Governance Indicators (Kaufmann, Kraay, & Mastruzzi, 2011)
TaxDiff	Proxy of the opportunity for tax avoidance, which is the average corporate tax rate of the country where the parent firm is headquartered minus the subsidiary-weighted corporate tax rate of its OFC subsidiaries	Table II.1—Corporate income tax rates: basic/non-targeted. OECD Tax Database: http://www.oecd.org/tax/tax-policy/tax-database.htm. Corporate income tax rates around world, 2014. Tax Foundation website: http://taxfoundation.org/article/corporate-income-tax-rates-around-world-2014

Variables	Definition		Data sources
Interest variables
RuleofLaw	Country-level rule of law that reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence		Kaufmann et al. (2011)
HRuleofLaw	HRuleofLaw is equal to one if a multinational firm has its headquarters registered in the countries with the RuleofLaw higher than the median of our sample and zero otherwise		Kaufmann et al. (2011)
Control variables
LGDP	Measure of economic development defined as the natural logarithm of GDP of the country of a parent firm in US dollars (billion)	IMF and CIA (2013) World Factbook
Tax	Average corporate tax rates of countries where firms have headquarters registered	Tax Foundation website: http://taxfoundation.org/article/corporate-income-tax-rates-around-world-2014
Eng	Eng is equal to one if the official language of a country or jurisdiction where a firm has headquarters registered is English, zero otherwise	The Centre d’Etudes Prospectives et d’Informations Internationales (CEPII) dataset
Mcap	The market capitalization of countries where firms registered headquarters	World Bank website: http://databank.worldbank.org/data/views/reports/tableview.aspx
Big5	Big5 is equal to one if an offshore firm is audited by one of the Big 5 auditors and zero otherwise	OSIRIS and firms’ annual reports
Litigate	Litigate is equal to one for firms in high-litigation risk industries: biotechnology (ICB 4533-4577), computers (ICB 9533-9578), electronics (ICB 2733-2737), and retail (ICB 5333-5379) industries and zero otherwise	OSIRIS and firms’ annual reports
Inde	The Inde variable ranges from zero through 10, and it represents the degree of independence of minority shareholders from controlling shareholders, with 10 indicating the highest degree of independence	OSIRIS
Ifrs	Ifrs is equal to one if a firm follows International Financial Reporting Standards (IFRS), zero otherwise	OSIRIS
Size	Log of the net sales of the fiscal period = Log (DATA13002)	OSIRIS
Mtb	Market-to-book ratio = MEV / total shareholder equity (DATA14041)	OSIRIS
Lev	The ratio of total liabilities to total assets = DATA14022 / DATA13077	OSIRIS
Neti	Current period net profits scaled by total assets = DATA13045 / Ait	OSIRIS

Variables	Definition	Data sources
Control variables
σ_CFO	The volatility of cash flow from operations, which is the standard deviation of the cash flow from operations	OSIRIS
σ_Rev	Revenue volatility, which is the standard deviation of total revenues (DATA13004)	OSIRIS
CFO/Sales	A ratio of cash flow from operations to net sales	OSIRIS
Analyst Following	Log of the number of financial analysts following a firm	IBES
Heckman first-stage variables
Legal Origin	An indicator of common law to civil law	La Porta et al. (1998)
RegulationQuality	A country-level governance index of a firm’s home country, which is the regulatory quality index of Kaufmann et al. (2011)	Kaufmann, et al. (2011)
GovermentEff	Reflects perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies	Kaufmann, et al. (2011)
LnGNP	Log of GNP per capita in US dollars	World Bank website: https://data.worldbank.org/indicator/NY.GDP.PCAP.KD
ave_Disclosure	The average of the World Bank business disclosure index, which measures the country-level extent of business transparency	World Bank website: https://data.worldbank.org/indicator/IC.BUS.DISC.XQ
Market Turnover	Country-level stock trade turnover, which is a proxy of market liquidity. Market turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is calculated as the average of the end-of-period values for the current period and the previous period	World Bank website: https://data.worldbank.org/indicator/CM.MKT.TRNR
ave_LnBM	Log of book-to-market ratio	OSIRIS
Roe	Return on equity (DATA 31065)	OSIRIS
Industry	Industry dummies variables. Industries defined in the OSIRIS are: Energy, Materials, Industrial, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecommunication Services, and Utilities	OSIRIS