I am grateful to the many people who gave me much appreciated help and support during the writing of this book. John took a keen interest in the progress of the manuscript from the very beginning and without him this book would not have been written.
AIMS AND SCOPE OF THE BOOK
At first glance, users of accounting information such as investment analysts and fund managers seem naturally to support a process that improves the international comparability of financial statements. During the investigation, it also emerged that there was great interest in the results from the analysts and fund managers involved.
OUTLINE OF THE BOOK
It is therefore hoped that the book will be of interest, among other things, to investment professionals involved in the field of transnational equity analysis. The book may also be of interest to advanced undergraduate and postgraduate students of international financial statement analysis.
INTRODUCTION
THE GROWTH IN TRADE OF FOREIGN SECURITIES
As shown in Table 2.2, with the exception of the Tokyo Stock Exchange, each of the world's largest stock markets hosts a significant number of foreign companies. The data in Table 2.2 also indicate the continued international dominance of the London Stock Exchange in raising capital abroad, where foreign companies represent more than a fifth of the total number of companies listed on the stock exchange.
DETERMINANTS OF THE
Capital demand-side factors
For example, in 1992 activity in the shares of Daimler Benz (now Daimler Chrysler) accounted for 11.5% of the total turnover on all German stock exchanges (Radebaughet al., 1995). The effect of this may be to increase the supply of the securities from the foreign stock exchange, resulting in a depressed domestic share price - a phenomenon observed with British Telecom shares in the 1980s (Tondkaret al., 1989).
Capital supply-side factors
Levy and Sarnat's findings show the high importance of the covariance between securities relative to the variance of the individual variances, especially as the portfolio grows. Similarly, the economies of the European Common Market at the time were excluded mainly because of the relatively high positive correlation with the United States.
THE GROWTH IN INSTITUTIONAL INVESTMENT .1 The importance of institutional investment
The role of fund managers and investment analysts
Sell-side analysts cover fewer companies because, unlike fund managers, they don't have to spend time building and monitoring portfolios. Investment banks and brokerage firms (ie, employers of sell-side analysts) have three sources of income.
SUMMARY
Lin and McNichols (1998) also provide evidence that the recommendations and growth forecasts of analysts affiliated with the company being analyzed are significantly more favorable than those of unaffiliated analysts. Therefore, the view of analysts as disinterested intermediaries is increasingly under increasing pressure, even though most of the research is done in the US; However, it should be noted that UK financial regulators seem to be concerned about this issue following lawsuits against US financial institutions where the independence of analysts has been compromised (FSA, 2002).
Foreign Stock Exchange Listings: A Case Study of Daimler-Benz.' Journal of International Financial Management and Accounting. Japanese management views on foreign stock market listings: survey results.' Journal of International Financial Management and Accounting.
INTRODUCTION
CAUSES OF INTERNATIONAL ACCOUNTING DIFFERENCES
- Business ownership and financing
- Legal systems
- Taxation
- The accounting profession
- Consolidation of determinants of international accounting differences
- The classification of accounting systems
In addition to the size of the accounting profession, differences in the influence of the accounting profession were also considered a factor in the differences in accounting reporting systems. In a recent synthesis of the comparative international accounting literature, Nobes (1998) proposes a "general model" of differences in international financial reporting.
THE EFFECTS OF INTERNATIONAL ACCOUNTING DIVERSITY ON REPORTED FIGURES
Example of US/German GAAP differences: BASF
The reversal of goodwill of €167.3 million is due to the fact that under German GAAP depreciation must be made over the useful life, and under US GAAP only depreciation must be made in accordance with impairment testing. The adjustment for deferred taxes is due to differences between U.S. and German GAAP in the asset values included in the consolidated balance sheet for financial reporting and those used for tax purposes.
THE EFFECTS OF INTERNATIONAL ACCOUNTING DIFFERENCES ON STOCK MARKETS
Despite expectations of a stronger relationship between accounting data and stock prices in Britain relative to France and Germany, they found that the value relevance of British accounting data is comparable to the value relevance of French and German accounting data. More recently, however, Ali and Hwang (2000) found that externally reported accounting data is less value relevant in countries where bank-oriented financial systems dominate, such as Germany.
THE INTERNATIONAL HARMONISATION OF ACCOUNTING
The rationale for international accounting harmonisation While multinational corporations and international accounting and auditing
International accounting differences are often seen as barriers to investment, and investors and analysts are generally assumed to provide unqualified support for the harmonization process. Furthermore, Taylor argues that Anglo-American accounting firms promote international accounting standards to reduce global training costs.
Analysts’ and investors’ participation in international accounting standard setting
In a similar context, Sutton (1984) examined participation in the domestic standard setting process in the USA and the UK. He found that producers of financial statements were more likely to engage in lobbying activities than users of financial statements, and like the international standard-setting arena, users were poorly represented in the UK lobbying process.
SUMMARY
It may be the case that the financial community considers the costs of participation or lobbying prohibitive in relation to the benefits. Sutton provided a framework for analyzing the lobbying decision, where individuals lobby when their perceived benefits exceed the costs, expressing the benefits of lobbying as a product of two variables: first, the difference in utility toward a desired outcome in the election/decision;.
Business Lobby for the International Accounting Standards Committee.'Journal of International Financial Management and Accounting. Accounting harmonization within the EU: issues, perspectives and strategies.' The European Accounting Review.
INTRODUCTION
THE THEORY OF EQUITY VALUATION In theory, the value of any financial asset is expressed as a function of its
Despite its apparent simplicity, the dividend discount model is deceptively difficult to apply in practice. Given these limitations, it is not surprising that real-world research clearly shows that investors and analysts use a range of analytical techniques in addition to and separate from the dividend discount model.
EQUITY ANALYSIS TECHNIQUES USED BY ANALYSTS AND FUND MANAGERS
- Fundamental analysis
- Technical analysis
- Beta analysis
- Economic Value Added
- Top-down analysis
Pikeet al.(1993) concluded that the applicability of the assessment methods changed little in the decade. They also found that the use of fundamental analysis was positively related to the seniority and experience of the analysts and the size of the brokerage or fund management firm.
THE EFFICIENT MARKETS HYPOTHESIS AND EQUITY ANALYSIS TECHNIQUES
If analysts do not believe that the market is ill-formed efficient, then (regardless of whether the market is real or not) they are likely to view technical analysis as useful because they do not believe that all past information is reflected in current security prices. . Similarly, if analysts do not believe that the market is semi-strongly efficient, they are likely to view fundamental analysis as useful since they do not believe that all current publicly available information is reflected in current security prices.
EXISTING EMPIRICAL EVIDENCE ON TRANSNATIONAL EQUITY ANALYSIS
Marton found that fundamental analysis was the most popular analysis technique - all analysts interviewed used this approach. Marton also found that analysts are influenced by their national context, as there were some differences between German analytical methods on the one hand and American and British methods on the other.
SUMMARY
The most recent study on this issue is by Marton (1998), who focuses on Swedish firms as providers of accounting information, but examines non-Swedish analysts and investors (based in London, New York and Frankfurt) as recipients and users of this information. Information. In particular, he found that German analysts tended to focus on the longer term, while UK analysts and fund managers were more focused on corporate governance issues than US and German analysts.
The role of dividends in valuation models used by analysts and fund managers.' The European Accounting Review. The use and perceived importance of annual reports by investment analysts in the Netherlands.'The European Accounting Review,2, 219–244.
INTRODUCTION
THE USEFULNESS OF ANNUAL REPORTS AND ACCOUNTING INFORMATION
Empirical evidence on the use of accounting information in domestic equity analysis
In their UK study, Lee and Tweedie (1981) found that, along with interim statements, the annual report was the most important source of information for fund managers. Fund managers paid more attention to the annual report than analysts, ranking it only after formal meetings with company management.
Annual reports and the Efficient Markets Hypothesis Although prior research demonstrates that the annual report and financial
In the most recent and detailed examination of this issue, Barker (1998) found that interim results and the annual report differed in importance for analysts, finance directors and fund managers. Despite the predictions of the EMH, previous research clearly shows that the annual report and financial statements represent a primary source of information.
DIRECT COMPANY CONTACT AS AN INFORMATION SOURCE
It is possible that the research showing that the annual report is declining in importance in relation to company contact is attributable to analysts and investors becoming less reserved in accepting the importance of disclosure by company personnel over time, rather than a current increase in import- of these meetings. Additionally, the number of sell-side analysts and fund managers kept on company mailing lists for meeting invitations increased by 66% and 58%, respectively.
INTERNATIONAL EVIDENCE ON INFORMATION SOURCES USED IN DOMESTIC EQUITY ANALYSIS
The most important individual parts of the annual report were the annual accounts, with the income statement and balance sheet coming before the footnotes. Gniewosz (1990) concluded that the receipt of the annual report was the most important routine information event of the fiscal year.
EXISTING EMPIRICAL EVIDENCE ON TRANSNATIONAL INFORMATION SOURCES
Survey-based research
Consistent with Choi and Levich (1991), approximately half of the respondents in Miles and Nobes experienced being affected by international accounting differences. Miles and Nobes found that only six of the 17 respondents adjusted the accounts; one of whom substantially re-compiled the accounts.
Market-based evidence on transnational equity analysis Research into the usefulness of foreign accounting data to investors shares
In the first study of the value of foreign accounting data, Amir et al. 1993) compared US and non-US GAAP accounting measures for 20 countries. In terms of individual reconciliation items, Barth and Clinch found that US GAAP adjustments for goodwill and intangible assets were beneficial for investors in UK and Australian companies.
SUMMARY
They argue that analysts forecast earnings prior to the release of the reconciliation data, thereby anticipating the information in the reconciliations. When the sample was divided into three groups (UK influence, Continental European influence and Other Country) they found that analysts appeared to be ahead of the information for the UK influence group, but the reconciliation appeared to be useful for analysts of European companies (the results of the 'other' group were not significant).
Enhanced functional fixation and safety returns around earnings announcements: a response to the ball and the hoop.'The Accounting Review. The use and perceived importance of annual reports by investment analysts in the Netherlands.'The European Accounting Review.
INTRODUCTION
DATA COLLECTION .1 The questionnaire survey
Semi-structured interviews
Although subjectivity in interpreting the data may conflict with the benefits of interviews (e.g. Barker, 1998 p. 6), steps can be taken to reduce such biases. A structure is therefore imposed on the data analysis that reduces the room for subjectivity in the interpretation of answers.
ANALYSIS OF THE DATA .1 Questionnaire data
Analysis of the interview data
The first approach is case-oriented, where cases are taken as the unit of analysis, i.e., the specific characteristics of the individual or group under study are preserved throughout the analysis. Miles and Huberman (1994) therefore advocate a combination of the two strategies rather than strict adherence to one.
SUMMARY
The analysis of the interview data was based on the approach advocated by Miles and Huberman (1994), which relies on matrices as a framework for distilling, analyzing and summarizing qualitative data. The variable-oriented approach is better able to identify themes and patterns, but is less able to address the complexity of causality.
INTRODUCTION
BACKGROUND OF RESPONDENTS .1 Sample composition
Number of companies analysed
A two-tailed T-test showed that the difference between the average number of companies analyzed by fund managers and analysts is significant at the 0.01 level (t = 8.08; . p=0.000). The distribution of the number of companies analyzed by investment analysts is also skewed towards fewer companies, at 77.7%.
Countries analysed
Another interesting point from Table 7.5 is that, with the exception of the US, the countries covered by investment analysts are concentrated around Europe and Britain. On this evidence, UK fund managers are less parochial than UK analysts.
Analyst and fund manager specialisation
Although these changes are happening globally, UK-based analysts and fund managers are particularly affected. However, a significant number of analysts and fund managers (11 out of 30) deal with shares in the London market.6.
EQUITY ANALYSIS TECHNIQUES USED This section examines the techniques used to analyse equities by investment
Overall usefulness of analysis techniques
Fund manager comments also show that liquidity can vary considerably between equity markets. Technical analysis is more useful for fund managers than analysts, which reflects fund managers.
COMPARISON OF DOMESTIC AND TRANSNATIONAL ANALYSIS TECHNIQUES
International variation in transnational analysis techniques
As mentioned above, the interviews revealed a common pattern in the geographical organization of the financial institutions. Overall, Table 7.10 indicates that there is a high degree of agreement in the usefulness of all the techniques.
DIFFERENCES BETWEEN TRANSNATIONAL ANALYSTS AND FUND MANAGERS
An additional finding common to the aggregate results is that technical analysis is more useful for fund managers than for analysts. Compared to other techniques, however, technical analysis is not considered particularly useful by either analysts or fund managers.
TRANSNATIONAL ANALYSIS TECHNIQUES
Examination of fund managers' decision-making revealed a multi-stage process involving other members of the institution. The EV/EBITDA ratio was particularly referred to by the majority of analysts and fund managers.
DISCUSSION AND CONCLUSIONS
Furthermore, fund managers find technical analysis more useful than analysts, which is consistent with their need to effectively time the investment decision. The following chapter examines how international differences in financial reporting regimes manifest themselves in the different sources of information used by analysts and fund managers.
Fund managers' reliance on a technique that facilitates a more systematic approach is consistent with their responsibility for a significantly larger number of companies than analysts, and a consequent need to reduce this to a manageable number for a more detailed analysis. The market for information: evidence from finance directors, analysts and fund managers.'Accounting and Business Research.
INTRODUCTION
DOMESTIC AND TRANSNATIONAL INFORMATION SOURCES
Domestic equity analysis
Prima facie, three groups emerge in the ranking of the most useful domestic information sources. The distribution of the responses to the usefulness of other analysts' reports is also noteworthy.
Transnational equity analysis
This was due to improvements in the quality of information reported, advances in the technology used and increased adoption of the internet by analysts and fund managers. This is a valuable development for both fund managers and analysts involved in cross-national analysis, as such information was much less readily available before the advent of the Internet.
International variation in transnational information sources
One other notable result from Table 8.2 is that company websites are most useful in the US (significant at the 0.05 level). Indeed, this is an apparent endorsement of the institutional changes, as it suggests that the analysis from a UK base is better than that carried out in the local market.
DIFFERENCES BETWEEN TRANSNATIONAL ANALYSTS AND FUND MANAGERS
This result is likely due to the increased European focus of UK-based analysts discussed in Chapter 7; i.e. UK analysts are now less often involved exclusively in analysis of UK companies - they are increasingly required to follow companies from European countries on a sector basis.
THE ROLE OF ACCOUNTING INFORMATION IN TRANSNATIONAL ANALYSIS
- Number of annual reports analysed
- Versions of the annual report used in foreign company analysis
- The usefulness of components of annual reports
- Usefulness of components of transnational annual reports
Therefore, the questionnaire and interviews included questions on the usefulness of the components of the annual report. The third function of the balance sheet in transnational analysis is as a tool to derive cash flow.
COMPANY CONTACTS: USES AND LIMITATIONS Along with accounting information, and in line with prior research into do-
Overall, however, there are important differences between analysts and fund managers involved in foreign company analysis with respect to most sections of the annual report. Overall, therefore, the meeting with company management and other company personnel, both in the local region and in the UK, represents a crucial source of information for both analysts and fund managers.
THE ROLE OF LOCAL ANALYSTS
Information asymmetries as a cause of reliance on local analysts
Fund managers involved in the analysis of emerging markets also faced additional difficulties because there was a general lack of information. With the exception of extremely large US companies, fund managers engaged in the analysis of US companies find access to management unproblematic.
Regional variation
There is therefore effectively a cost associated with the information provided by analysts to fund managers; certain information communicated to fund managers (especially stock recommendations) is potentially biased, and not necessarily reliable for optimal investment decisions. However, the fact that fund managers are aware of such biases suggests that they treat the information from analysts (especially stock recommendations) with some scepticism.
DISCUSSION AND CONCLUSIONS
One final point to note about using the annual report in cross-national analysis is the potential barrier of language differences. Generally, in domestic analysis, the cash flow statement is the most useful component of the annual report, followed by the balance sheet.
In short, this chapter demonstrates that despite geographical and logistical barriers, direct contact with companies and management still constitutes an integral part of the decision-making information provided to analysts and fund managers. Moreover, reliance on accounting information, especially the annual report, is apparently not significantly affected by the presence of national borders; both analysts and fund managers find such information very useful in analyzing domestic and overseas stocks.
INTRODUCTION
THE EFFECTS OF INTERNATIONAL ACCOUNTING DIFFERENCES ON
Differences between analysts and fund managers
For a number of reasons, international accounting differences can be expected to be more problematic for fund managers than for analysts. Furthermore, and as shown in Table 9.2, while only one analyst (2%) indicated that international accounting differences significantly influenced his decisions, eight fund managers (8%) felt highly influenced by international accounting differences.
International variation in the effects of international accounting differences
Somewhat surprisingly, fund managers responsible for portfolios of emerging market companies had the most problems with accounting standards. Despite concerns in this regard, most analysts and fund managers stated that the quality of disclosure generally improves over time.
Accounting standards and the cost of capital
Interestingly, some of the responsibility for this was attributed to the reluctance of US investors to invest in companies with accounting standards with which they were unfamiliar. The next section examines the related issue of the extent to which analysts and fund managers support the harmonization of international accounting standards.
VIEWS ON THE INTERNATIONAL HARMONISATION OF ACCOUNTING
Differences between analysts and fund managers
Further support for the notion that investment analysts are in favor of harmonization is provided by the analysis of the frequency of responses to the harmonization question in Table 9.5: 60% of analysts were 'a lot'. There is therefore no evidence that fund managers are more supportive of harmonization than investment analysts.
Reasons for support for harmonisation
If you look at an investor investing or thinking about investing in, say, Africa, if they have to learn about the accounting standards of that country for about 2 weeks, they're probably never going to get their money back. But because he knows the standards, he can look and say "Okay, these are the reported numbers according to the standards I know", the investment decision can be made much faster and the investor feels much safer.
DISCUSSION AND CONCLUSIONS
The limited implementation capabilities of IASC's predecessor, the IASC, have often been seen as an obstacle to the widespread adoption of IAS. The next chapter concludes the book with a summary of the research and a discussion of the limitations and implications of the findings.
IAS versus US GAAP: information-asymmetry-based evidence from Germany's emerging market.'Journal of Accounting Research. The main findings are then discussed along with the implications and limitations of the empirical study.
MOTIVATION FOR THE BOOK
The final section provides some concluding remarks. analysis techniques and information sources may vary between different countries. As noted in the introduction, the broad objectives of the study were: i) to examine the relative usefulness of the different analytical techniques used in transnational equity investment decisions; (ii) examine the usefulness of accounting information and other information sources in transnational stock analysis; iii) assessing the impact of international accounting differences on the decision-making of fund managers and analysts; And. iv) exploring the views of analysts and fund managers engaged in transnational equity analysis on the international harmonization of accounting standards.
SUMMARY OF FINDINGS AND IMPLICATIONS .1 Equity analysis techniques
Transnational information sources
Analysts and fund managers based in the UK rely heavily on English translations of the annual report and make limited use of the original foreign language versions. Direct personal contact through company visits and management meetings proved to be the most influential source for both investment analysts and fund managers.
Harmonisation and international accounting differences The results of the study do not support the idea that fund managers and
Given the strong support for harmonization in the current research, it seems reasonable to conclude that analysts and fund managers are reassured by the use of IAS/US GAAP. Indeed, analysts and fund managers who compare financial statements internationally are significantly more supportive of harmonization.
Limitations of the empirical study
Some comments from fund managers suggested that the adoption of globally recognizable accounting standards also serves as a signal to analysts and fund managers that companies are attuned to the needs of equity investors. Therefore, it is possible that analysts and fund managers based outside the UK take different approaches to the analysis of overseas shares and have different attitudes to harmonization than UK-based fund managers and analysts.
CONCLUDING REMARKS
The book also provides evidence of analyst and fund manager support for international accounting harmonization and mechanisms for addressing diversity in national financial reporting systems. The findings suggest that where international accounting differences cannot be directly overcome by relying on local expertise or firm personnel, fund managers and analysts allow for greater uncertainty by incorporating a risk premium into their decisions.
The use of foreign accounting data in UK financial institutions. 'Journal of Business Finance and Accounting,25(3 en. Stock valuation methods of financial analysts in a thin stock market in Sweden, with comparisons with the United Kingdom and the United States.’ International Journal of Accounting.
31 financial statements
