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Market revaluations of foreign listings'' reconciliations to U.S. financial reporting.

Article Excerpt
Abstract

The Securities and Exchange Commission requires foreign firms wishing to list their securities on the U.S. exchanges to convert their financial statements to U.S.-based generally accepted accounting principles (GAAP) in a reconciliation filing known as Form 20-F. This paper extends prior research analyzing the importance of the SEC requirement by examining the value relevance to U.S. capital markets of Form 20-F reconciliation information under two additional hypotheses: investors' anticipation of the reconciliation, and investors' perception of foreign countries' enforcement and reliability in applying local accounting rules. it is argued that the information content of the Form 20-F reconciliation data is preempted (at least partially) on the date of foreign earnings announcements because of investor anticipation of these reconciliations. Therefore, only significant unanticipated reconciliations exhibit value relevance on the date of filing. In addition, investor perception of the reliability of the reconci liations and the degrec of confidence in foreign authorities enforcing local GAAP also affect the value relevance of the reconciliation data. This study hypothesizes that reconciliations made by firms from countries with mature and developed capital markets should be more value relevant to U.S. investors. The results show that both unexpected foreign earnings and anticipated reconciliations to U.S. GAAP are significantly associated with unexpected market returns during the week of earnings announcements. The region of the foreign country is also significantly associated with market returns. However, unexpected reconciliations are not significantly associated with unexpected market returns during the week of Form 20-F filing. (JEL M4, F3)

Introduction

Under current market regulations by the Securities and Exchange Commission (SEC), foreign firms listing their securities on the U.S. exchanges must reconcile their financial statements to U.S. generally accepted accounting principles (GAAP), and file these reconciliations with the SEC in Form 20-F. Prior research examining the value-relevance of Form 20-F reconciliations has focused on tests of association between security prices or returns and the reconciliation data. Finding a significant association suggests that converting foreign GAAP accounting numbers to U.S. GAAP-based numbers has value to investors. However, the results of the research thus far are inconsistent and inconclusive. Most studies document significant association between long term security prices or returns and shareholders' equity Form 20-F reconciliations, but infrequently for the income reconciliations [Amir et al., 1993; McQueen, 1993]. These relationships are not supported by short-window returns tests around the filing date of Form 2 0-F. Based on these findings, researchers inferred that the information in the reconciliations might have been impounded in market prices from other sources prior to the filing date [Amir et al., 1993; Pope, 1993]. These authors also argue that reconciliations may exhibit sufficient stability, thereby allowing investors to predict future reconciliations from previous filings. Frost and Kinney [1996] report stronger value-relevance of U.S. GAAP earnings of United Kingdom, Japanese, and Canadian firms, but weaker value-relevance for firms from other countries (for example, Israel). This finding suggests a differential market response to the reconciliation for firms from different regions in the world.

Rees and Elgers [1997] examine whether the information in the Form 20-F reconciliations is available from other sources and impounded into security prices long before the filing date. Using income and shareholders' equity reconciliations in initial registration statements of non-U.S. registrants, they retrospectively tested the value-relevance of the Form 20-F reconciliations by examining the association between contemporaneous security prices or returns and retrospective reconciliations made by foreign firms in their initial listings on U.S. exchanges. Their results document that the market to book ratios are significantly associated with shareholders' equity reconciliations for periods prior to initial filings with the SEC by at least three months. Furthermore, the results did not show significant association between annual market returns and the reconciliations for the year it filed its first Form 20-F. They suggest that most of the value-relevant information in the reconciliation is fully impounded in mar ket prices prior to its Form 20-F filings.

The study extends prior research by identifying and capturing the sources that provide the reconciliation information prior to its disclosure. This study hypothesizes two reasons for not finding value-relevance to reconciliation information when disclosed or filed: investor's anticipation of the reconciliation on the date of the earnings announcements; and the existence of other pre-disclosure (filing) sources such as analysts following the firm. In this study, the anticipatory reconciliation hypothesis is specifically tested.

The study differs from Rees and Elgers [1997] in several ways. First, Rees and Elgers [1997] examine the value-relevance of the Form 20-F reconciliations by testing their association with security prices determined in local markets. One might argue that local markets are indifferent to the reconciliations to U.S. GAAP, since investors are not external to local GAAP, and valuation comparisons between firms is less influenced by acceptable accounting rules. Therefore, the results of Rees and Elgers [1997] are not necessarily the appropriate criteria for establishing the value-relevance of the Form 20-F reconciliations to U.S. markets. Second, the Rees and Elgers' [1997] test results are based on long-window associations. Long window tests tend to dilute the information content of short-term events such as the filing of the Form 20-F reconciliation. Thus, a short window event test can be more inviting in determining the value-relevance of Form 20-F reconciliation metrics.

Background

The New York Stock Exchange (NYSE) has long held the view that the requirement for non-U.S. firms to reconcile their financial information between home country and U.S. GAAP is a deterrent to more non-U.S. firms listing securities for sale in U.S. markets [Freund, 1993; Cochrane, 1994]. The burden of filing a Form 20-F has been seen as forcing many non-U.S. firms to seek financing in other markets, to the detriment of the U.S. marketplace. The SEC, on the other hand, feels that the information contained in the Form 20-F filing is relevant to investors making economic decisions about investments in non-U.S. firms and has continued to voice support for its continuation. Recently, the SEC issued a concept release seeking opinions from interested parties (investors, issuers, auditors, and academicians) concerning the acceptance of foreign financial statements prepared under the International Accounting Standards (IAS). Nevertheless, this...

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