Descripción del proceso

This section reports the hypotheses of the thesis. It is structured into two sub-sections; section 3.1.1 develops the hypothesis for the effects of IP on SPS and section 3.1.2 develops hypotheses for the association between FFI and SPS and the complementing effect of IP on the association between FFI and SPS.

3.1.1 IP and SPS Stage

Global capital markets and economies have experienced developments and institutional changes, which have brought many new investors and traders into the capital markets. Such changes and improvements in IP have been made with the aim of improving financial markets and restoring the confidence of local and international investors. Implementation of credible accounting practices through IFRS adoption adds to these positive changes in the capital markets.

MYY find that countries with strong IP show low SPS, while countries with weak IP result in high SPS. Similarly, Jin and Myers (2004) observe that countries with less transparency tend to have high SPS, while economies with more transparent information environments show low SPS. Li et al. (2004) and Jin and Myers (2004) also document a negative relation between SPS and IP variables proxied by efficient legal systems and less corrupt

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economies. All these studies suggest that these mechanisms allow investors to gather and rely upon firm-specific information. Therefore, the question is whether the continuing improvements in these IP mechanisms have continued to beneficially affect SPS in capital markets. In other words, my first research question is whether the MYY hypothesis that IP is negatively associated across countries is valid for a longer period of time is my first research question. Likewise, I hypothesize that:

H1: There is a negative association between IP and SPS.

3.1.2 FFI and SPS Stage

MYY do not find a direct support for their contention that SPS represents FFI across countries. Their study suggests that improvements in IP allow investors to gather and rely upon firm-specific information. As discussed in Chapter 2, the inconsistent results of earlier studies of the relation between FFI and SPS lead to a further investigation for a larger sample of countries over a longer period of time.9A larger sample of countries with a variety of IP arrangements would be better to ascertain whether and under what circumstances FFI matters.

As identified in Chapter 2, stock prices reflect both market-wide information and the different levels of FFI of individual firms. Thus, investors rely on firm-specific information for investment decisions. MYY and others argue that SPS is a function of firm-specific information. Based on this notion, Ashbaugh et al. (2006) posit that if investors rely on FFI rather than market-wide movements in making investment decisions, better quality FFI would reduce SPS.

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However, Ashbaugh et al. (2006) report that SPS does not reflect FFI and variation in stock returns occur due to noise or factors unrelated to FFI.10 The Ashbaugh et al. (2006) FFI variables only reflect the income smoothing and risk measures related to firm’s past performance and do not account for institutional arrangements, which could be the reasons for the inconclusive results. Ashbaugh et al. (2006) also use only a small set of countries, which allowed them to conduct only intra-country tests of association between FFI and SPS.

Accrual accounting information is often used to provide information to outsiders that reflect a firm’s current and future performance (Dechow, 1994). Accrual accounting recognizes the expected future financial benefits and obligations accruing to an enterprise over a period. Accrual accounting matches revenue and expense better than cash flow accounting and makes accounting information more value-relevant (Hung, 2000). The investors' demand for and reliance on reliable publicly disclosed information may drive insiders to provide information that truly and accurately reflect a firm’s economic performance (Healey & Wahlen, 1998). If investors perceive accruals as information signals, then this is likely to reduce SPS.

Theoretically, MYY’s argument that SPS is a function of firm-specific information is logical because SPS is based on firm specific returns. Therefore, regardless of the proxy of SPS (Ashbaugh or accruals), I hypothesize:

H2: There is a negative association between FFI and SPS.

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However, the literature review also highlights that managers can use accrual accounting opportunistically to manage earnings. Insiders and controlling owners may have incentives to manage earnings either to mask firm performance and/or to hide their private control benefits from outsiders (Leuz et al., 2003). They do so by using their financial reporting discretion. In essence, insiders, in order to avoid outsiders’ intervention, manage the level and variability of reported earnings. If investors perceive accruals to be an earnings management tool then higher accruals will increase SPS.

MYY argue that countries differ in the use of FFI because of different levels of IP across countries. They contend that the incorporation of FFI depends on the IP arrangements of the respective capital markets. For an efficient capital market not only FFI is important but also IP is a fundamental factor for reducing information asymmetry, and adequately capitalizing FFI in share price returns. Legal rules and their strict enforcement effectively protect outside investors (Leuz et al., 2003). MYY also argue that the level of IP arrangements endogenously regulates the quality of firm-specific information reported to outsiders. Thus, a strong IP system is likely to increase the use of FFI in capital markets and reduce SPS. I expect IP to have a complementing influence, with the strength of IP arrangements enhancing the effects of FFI. Therefore, I hypothesize:

H3: The negative association between FFI and SPS is enhanced by IP.

Figure 2 provides the framework for the thesis. It identified the main associations explained in the motivation to the hypotheses, that is, the association of IP and FFI with SPS and the complementing effects of IP on the association between FFI and SPS. In short, the figure

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depicts that while both FFI and IP have direct effects on SPS, the most effective impact is when both FFI and IP are of higher quality.

Fig 2 Framework of the Thesis