CitationDownload as .RIS
Emerald Group Publishing Limited
Copyright © 2011, Emerald Group Publishing Limited
Financial regulation: market and valuation impacts
Article Type: Guest editorial From: Pacific Accounting Review, Volume 23, Issue 3
Debate about the merits or otherwise of financial regulation goes back centuries. Benmelech and Moskowitz (2010) note financial regulation was just as contentious in the USA in the nineteenth century as it is today. What has changed, however, is the complexity of financial instruments, markets, and firms. This makes it more difficult for investors to self-regulate by directing their capital away from suboptimal investments. Therefore, achieving the right regulatory settings is perhaps more important now than ever before. The process involves a delicate balancing act, as too little and too much regulation can both be harmful.
There is widespread evidence that inadequate regulation has negative consequences. La Porta et al. (2002) note countries with weaker investor protection legislation have slower financial market development. They also show that firms tend to have lower valuations in countries with weaker investor protection. Other authors, such as Stiglitz (2001), highlight that many economists attribute the financial crisis of the late 1990s to weak regulation allowing financial institution fragility.
However, increasing financial regulation does not necessarily lead to desired outcomes. Stiglitz (2001) points out that an overregulated financial system can hinder innovation and restrict the flow of credit to businesses. Strengthening regulation can also have unintended consequences. Goodhart (2008) suggests that regulation, through constraining the returns to regulated sectors, creates the incentive for firms to move business to unregulated sectors. He uses the example of banks setting up structured investment vehicles (SIVs) to illustrate his point. Hirshleifer (2008) puts forward the theory that many regulations are driven by psychological biases such as scapegoating (attributing blame to another group) and overconfidence as opposed to having rational foundations.
Finally, regulation itself may not impact on market participants’ behaviour if there is not a credible threat of enforcement. Bhattacharya and Daouk (2002) find that legislating against insider trading has less impact on a country’s cost of equity than the first enforcement of the legislation.
2. Special issue overview
Regulatory change impacting on information disclosures is a common theme of each of the six special issue papers. In particular, they examine different regulatory settings that dictate how, what or when information is disseminated.
The first paper analyses the level of information disclosures by NZX listed companies surrounding the introduction of the continuous disclosure regime in December 2002. Alastair Marsden, Russell Poskitt and Yinjian Wang examine the information disclosure behaviour of good and bad news firms. Prior to the continuous disclosure regime, bad news firms had reduced pre-announcement information flows compared to good firms. The information flow asymmetry in the pre-reform period resulted in greater price reactions and dispersion of analysts’ forecasts for bad compared to good news firms. However, the asymmetry between good and bad news firms with respect to their information flows, abnormal price reaction and analysts’ forecasts dissipated after December 2002. The findings suggest that managers are less likely to withhold bad news and information quality is improved as a result of the continuous disclosure regime.
Carolyn Wirth, Jing Chi and Martin Young examine the value of resource consent information. Under New Zealand’s Resource Management Act (1991), projects that may negatively impact on the environment are required to gain resource consent prior to initiation. The authors show that the predominantly non-financial disclosures surrounding resource consent announcements are impounded into share prices on announcement. The authors suggest that a proxy for expected delays in resource approval could be constructed to help inform investors of the valuation implications relating to new capital projects.
The third paper is centred around significant changes to corporate fund raising, continuous disclosure requirements and level of enforcement in Australia at the turn of the century. The paper extends earlier work by Chapple et al. (2005) by showing that the quality and accuracy of earnings forecasts presented in IPO prospectuses improves following these regulatory changes. A noticeable improvement is also evident in forecast revisions leading up to the actual earnings announcement. The authors, Gerry and Natalie Gallery and Angela Linus, argue the improvement in forecast information accuracy is a direct result of increased regulatory monitoring and enforcement which leads to a higher risk of litigation for issuers. The paper concludes that improved disclosure requirements and enforcement leads to observed improvement in forecasting behaviour by firms.
Hong Nee Ang and Matthew Pinnuck’s paper highlights the potential unintended consequences of regulatory changes. A change to accounting standards requiring employee share options (ESO) to be expensed, potentially provides management with an earnings management mechanism. As the inputs used to determine fair values of ESOs are open to manipulation, the change from ESO disclosure only, to expensed could provide managers with a tool to manipulate earnings. The authors do not find evidence of earnings management through ESO. However, as the sample size in the study is small they suggest further research into the regulatory change is required before ruling out the unintended consequence of earnings management.
The fifth paper examines the value relevance of cash flow information provided in annual reports of Australian and New Zealand listed companies. By 1992, the accounting bodies of both countries had required reporting entities to disclose cash flows from operating, financing and investing activities. Christopher Malone, Udomsak Wongchoti and Alan Mitchell provide some support that this type of information is valuable by showing operating cash flow surprises are associated with abnormal price responses. They also find a significant negative reaction to unexpectedly high investing and financing cash flows. In comparing their results to an Australian study covering the pre-cash flow reporting regime (Cotter, 1996), the authors show that the market response now exhibits greater consistency.
The final paper of the special issue examines changes in accounting standards designed to improve the dissemination of information surrounding goodwill impairment testing. Examining 200 goodwill-intensive ASX listed companies, Tyrone Carlin and Nigel Finch find evidence of widespread non-compliance with IFRS goodwill impairment testing regime disclosure requirements. The authors discuss the lack of enforcement action against non-compliers, even though compliance of accounting standards are mandated by law, and argue that the lack of enforcement raises concerns regarding the efficacy of Australia’s financial regulatory framework.
Information disclosure is a common theme in all papers included in this special issue. The typical scenario is that regulation and legislative changes have altered how, what or when information is disseminated. We have also seen in several papers that enforcement plays a critical role in the effectiveness of any regulatory changes. Participant behaviours and the intended outcomes of the regulatory regime change are only evident when there is enforcement.
We received 21 submissions to the special issue. Several papers were desk rejected as they were outside the special issue’s scope. The remaining papers underwent a rigorous editorial and review process. Thankfully, we had a team of dedicated reviewers who provided expert feedback. We would like to extend our sincere thanks to the extensive and thoughtful reviews they each provided.
Hue Hwa Au Yong, Monash University, Australia;Steven Cahan, University of Auckland, New Zealand;Tyrone Carlin, University of Sydney Business School, Australia;Candie Yuk Ying Chang, Massey University, New Zealand;Jing Chi, Massey University, New Zealand;Julie Cotter, University of Southern Queensland, New Zealand;Paul Dunmore, Massey University, New Zealand;David Emanuel, University of Auckland, New Zealand;Aaron Gilbert, Auckland University of Technology, New Zealand;Graeme Guthrie, Victoria University of Wellington, New Zealand;Grace Hsu, The University of Queensland, Australia;Khairil Faizal Khairi, Universiti Sains Islam Malaysia, Malaysia;Alastair Marsden, University of Auckland, New Zealand;Claire Matthews, Massey University, New Zealand;Nick Nguyen, University of Auckland, New Zealand;Nuttawat Visaltanachoti, Massey University, New Zealand;Amelia Pais, Massey University, New Zealand;Andrew Prevost, Ohio University, United States of America;Tālis J. Putninš, Stockholm School of Economics in Riga, Sweden;Asheq Rahman, Massey University, New Zealand;Helen Roberts, University of Otago, New Zealand;Philip Stork, Massey University, New Zealand;David Tripe, Massey University, New Zealand;Jeff Wongchoti, Massey University, New Zealand.
We would also like to thank the editors and administrators of PAR for all their help, and the Schools of Accountancy, and Economics & Finance of Massey University for the assistance they provided. Our final thanks goes to Glenn Boyle for giving us the opportunity to compile this special issue and, in particular, for the guidance and support he provided throughout the experience.
Hamish D. Anderson and Ben R. MarshallGuest Editors
Benmelech, E. and Moskowitz, T.J. (2010), “The political economy of financial regulation: evidence from the US state usary laws in the 19th century”, The Journal of Finance, Vol. 65 No. 3, pp. 1029–73
Bhattacharya, U. and Daouk, H. (2002), “The world price of insider trading”, The Journal of Finance, Vol. 57, pp. 75–108
Chapple, L., Clarkson, P. and Peters, C. (2005), “Impact of the Corporate Law Economic Reform Program Act 1999 on initial public offering prospectus earnings forecasts”, Accounting and Finance, Vol. 45, pp. 67–94
Cotter, J. (1996), “Accrual and cash flow accounting models: a comparison of the value relevance and timeliness of their components”, Accounting and Finance, Vol. 36, pp. 127–50
Goodhart, C. (2008), “The boundary problem in financial regulation”, National Institute Economic Review, No. 206, pp. 48–55
Hirshleifer, D. (2008), “Psychological bias as a driver of financial regulation”, European Financial Management, Vol. 14 No. 5, pp. 856–74
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R. (2002), “Investor protection and corporate valuation”, Journal of Finance, Vol. 57 No. 3, pp. 1147–70
Stiglitz, J. (2001), “Principles of financial regulation: a dynamic portfolio approach”, The World Bank Research Observer, Vol. 16 No. 1, pp. 1–18