place locally. One analyst commented that this research was sometimes superior to that from London based analysts:
Where a company is European and has offices across the community, the best information and the best analysis is done in the local sector, and that springs from the fact that they do understand the accounting standards in full, they do understand the culture, and they understand the language. (Analyst 2) Furthermore, Analyst 1 (a European construction companies analyst based in London) and Analyst 3 (a European telecoms companies analyst based in London) both acknowledged that they occasionally rely on local analysts for certain countries.
to national disclosures (e.g., Barth and Clinch, 1996). However, most prior research assumes that this information is as a result of US GAAP (i.e., an accounting measurement issue), whereas the results of the interviews in the current research indicate that it is also a product of higher disclosure quality. An interesting question is whether this result holds after the account- ing problems surrounding the recent large scale US corporate collapses of Enron and WorldCom.
Information direct from the company either in personal form such as company meetings and presentations, or in published form (particularly the annual report) is highly valued by analysts and fund managers. However, the role and significance of company management in transnational analysis can- not be considered in isolation. Importantly, from a UK perspective, overseas company management as a source of information should be seen alongside locally-based sell-side analysts, who are vitally important in transnational analysis. This is because local analysts represent an interface between UK fund managers and overseas company management. In this capacity, ana- lysts based in the region or country where the subject company is domiciled are able to mitigate or eliminate many of the obstacles faced by foreign investors. They represent a first point of contact for UK fund managers and, in addition to being providers of information, research and analysis them- selves, local analysts perform the important function of providing ongoing access to overseas management. This access may be in the local country or, with the assistance of the analysts’ firm, in the UK. An exception to this is that for European companies, UK-based analysts are most useful. This is perhaps due to the increasing tendency for UK analysts to specialise by sector across the European region, as described in Chapter 7.
The perceived usefulness of overseas analysts would suggest that analyst following of foreign companies is associated with levels of transnational investment. A recent working paper by Aggarwalet al.(2004) offers support for this in an investigation of determinants of investment in overseas firms by US mutual funds. They find that analyst following is a significant firm- level determinant of foreign investment, even after controlling for factors such as accounting and stock-market performance, firm size and accounting quality. That is, the greater the number of analysts following a firm, the more likely US mutual funds are to invest in that firm.
One final point to note on the use of the annual report in transnational analysis is the potential barrier of language differences. Clearly, this barrier is not sufficient to prevent the use of the annual report. This is partly due to the availability of English language versions of the annual report. This raises questions about whether fund managers avoid companies which only provide foreign language annual reports. Further research will be necessary
to examine whether such companies receive less attention than those which publish English translations, and whether there are any economic implica- tions arising from this, such as effects on the cost of capital for these companies.
Interestingly, the balance sheet is ranked as the most useful component of transnational annual reports. Although consideration of balance sheet characteristics is important in domestic analysis, certain reasons for a focus on the balance sheet are more important in transnational analysis. Finan- cing and ownership information was considered particularly relevant by the interviewees. Levels of debt may assume a greater significance given the additional risk introduced by foreign currency volatility. This result is in line with the findings of Kang and Stulz (1997) who found that debt levels are negatively associated with foreign ownership of Japanese shares. De- tails of minority interests are also relevant for gauging attitudes to outside shareholders. Furthermore, cash flow information is either scarce, or not readily available in a suitable format in some foreign companies’ annual re- ports. This finding offers a potential explanation for the relative positions of the cash flow statement and balance sheet in domestic versus transnational analysis in this questionnaire survey. Overall, in domestic analysis, the cash flow statement is the most useful component of the annual report, followed by the balance sheet. In transnational analysis, however, these results are reversed. As such, the balance sheet is fulfilling its role as a primary in- formation source in itself, while simultaneously providing supplementary information for the derivation of an appropriate, reliable cash flow measure.
Increased focus on the balance sheet is also a product of an approach in transnational investment, where company security and stability assume a greater significance than in domestic analysis. Information asymmetries are a likely contributory factor to this result. Gehrig (1993)inter aliastates that, on average, investors are better informed about domestic equities than foreign equities. It is unsurprising then that transnational investors impose high hurdles in terms of the integrity of the investment as a compensatory allowance for the risk that their information set is inadequate. This is not to say that balance sheet security is the only important factor in transnational investment decisions. Rather, as noted in the interviews, the importance of sound balance sheet characteristics is augmented by national boundaries and the associated disparities in information access. Previtset al.(1994) also found that for poorly understood companies, analysts focused more on balance sheet factors. To the extent that UK analysts and investors un- derstand overseas companies less than UK companies, this ties in with the findings of the current research.
In sum, this chapter demonstrates that despite geographical and logist- ical barriers, direct contact with companies and management still forms an integral part of the decision-making information set to analysts and fund managers. Moreover, reliance on accounting information, especially the annual report, is apparently not materially affected by the presence of national boundaries; both analysts and fund managers find such information very useful in the analysis of domestic and overseas equities. Finally, such sources are not used in isolation; locally-based analysts are often viewed as an important interface between UK-based fund managers and overseas companies. However, the limitations of analysts’ advice have not gone un- noticed by the UK investment community.