10.2 SUMMARY OF FINDINGS AND IMPLICATIONS .1 Equity analysis techniques
10.2.2 Transnational information sources
Also in line with the literature on domestic equity analysis, accounting information and the annual report are essential sources of information in transnational equity analysis, particularly to investment analysts. Apart from direct company contact, the annual report is the most influential source of in- formation on foreign companies. UK-based analysts and fund managers are heavily dependent on English translations of the annual report, and make limited use of original foreign language versions. As with UK company
analysis, the annual report serves as an agenda-setting device for manage- ment meetings. It acts as a prompt for further questioning of management and is seen as a reliable, verifiable benchmark information source.
The financial statements form an integral part of transnational analysis, despite international accounting differences. They are the most influential part of the annual report, although narrative information is more useful in the analysis of foreign firms than in UK company analysis. Interestingly, the balance sheet is considered very useful in the analysis of overseas firms – it is used to ensure investment security and liquidity, and to assess debt levels.
Such issues concerning company stability and risk appear to be particu- larly important in transnational analysis. In addition, the balance sheet is sometimes used as a device to supplement transnational cash flow informa- tion, which is not always available, or is often in an unsuitable format. This increased focus on the balance sheet relative to the income statement cor- responds with the position of UK Accounting Standards Board, the IASB, and the US Financial Accounting Standards Board (Davieset al., 1999), although it is inconsistent with recent empirical research into UK equity analysis (Barker, 2001).
Direct personal contact through company visits and meetings with man- agement proved to be the most influential source to both investment analysts and fund managers. Such information is considered vital both for domest- ic, and perhaps more surprisingly, for overseas company analysis. Indeed, most fund managers would not consider investment in overseas companies unless they had had some personal contact with company management.
These meetings are used to acquire financial information for investment decisions, and also to establish personal relationships with company man- agement. Analysts and fund managers also use meetings with management to form impressions of management capabilities, and to gauge attitudes towards outside shareholders.
Because of asymmetries in the accessibility and interpretation of transna- tional accounting information, fund managers are heavily dependent on locally-based investment analysts, who are perceived to have the neces- sary expertise to deal with the relevant accounting and financial reporting systems. When analysing overseas equities, fund managers consider locally- based analysts’ reports to be the most useful information source after direct company contact and accounting information. Furthermore, fund managers rely on these analysts to provide interpretation and analysis of foreign ac- counting information. This finding is important because Miles and Nobes (1998) state that UK fund managers think that analysts adjust accounting information, but the analysts in Miles and Nobes’ study (i.e., analysts based in the UK) generally did not. The results of the current research indicate
that the adjustments are more likely to be conducted by analysts based overseas.
Notwithstanding their use of overseas analysts, fund managers expressed reservations about analysts’ independence due to a reluctance to jeopard- ise the analyst/manager relationship. Many fund managers therefore view analysts’ recommendations with a degree of scepticism in light of a per- ceived reluctance to issue recommendations which reflect negatively on company management. Fund managers therefore face a dilemma in relying on sell-side analysts. They clearly need analysts as a link to management, to interpret foreign accounting information and as a means to overcome information asymmetries. Yet perceptions of bias in recommendations on company shares undermine fund managers’ confidence in analyst independ- ence. It should be noted, however, that the concerns related specifically to analysts’ recommendations, rather than to the integrity of analysts’ research in general. Moreover, as fund managers seem to be aware of potential con- flicts, and if these problems are systematic, fund managers should be able to incorporate such factors into their decision making. Prior research supports this view (Dugar and Nathan, 1995).
The evidence on international variation in the usefulness of overseas information sources is mixed. In line with prior research (Choi and Levich, 1991), Swiss, German and Japanese accounting principles were identified in the interviews as being areas of concern. However, since the current research was conducted, some improvements have been made in these countries, such as requiring consolidated financial statements and better pension liabilities disclosures in Japan (Seki, 2000). Moreover, German companies will shortly be required to comply with IAS, along with other European countries.
Numerous comments in the interviews revealed some difficulties in ob- taining the most basic of information sources such as the annual report, par- ticularly for emerging markets. This reinforces assertions in prior research that information asymmetries between local and foreign investors exist, and may be responsible for impeding international capital flows (e.g., Gehrig, 1993; Kang and Stulz, 1997). Potentially, such information asymmetries have interesting financial implications for overseas equity analysis and they are worthy of future research. A comparison of investment performance in light of these asymmetries may indicate whether overseas investors are at a comparative disadvantage relative to domestic investors. Interestingly, Coval and Moskowitz (2001) find a relationship between geography and investment performance in a domestic context in the US. More specifically, they find that fund managers generate higher returns for local investments (i.e., within 100 kilometres of fund headquarters). They also call for research to investigate whether this phenomenon holds in an international context.
A final point on the use of transnational information is that the pace of change in information technology and the internet is causing changes in financial reporting. Although web-sites are regarded as more useful in for- eign company analysis, they were not considered particularly influential in the questionnaire survey. In the interviews, however, there was a substantial improvement in perceptions of the internet, despite some criticisms being made of reliability of the information released on web-sites. Fund managers predicted a diminishing role for some analysts as a result of this techno- logy. Further research will be necessary to keep track of the usefulness of web-sites and similar technology.
10.2.3 Harmonisation and international accounting differences