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Discussion of the effects of the Asian crisis, corporate governance and accounting system on the valuation of book value and earnings
The International Journal of Accounting 41 (2006) 41 – 47
Discussion
Discussion of the effects of the Asian crisis, corporate governance and accounting system on the valuation of book value and earnings Heidi Vander Bauwhede Vlerick Leuven Gent Management School and Katholieke Universiteit Leuven, Naamsestraat 69 B-3000 Leuven, Belgium
The objective of the study on which Davis-Friday, Eng, and Liu (henceforth DFEL) report in their paper bThe Effects of Crisis, Corporate Governance and Accounting System on the Valuation of Book Value and EarningsQ is twofold. The first objective is to examine the impact of the Asian financial crisis on the value relevance of equity book value and net income. The authors expect that the value relevance of book value of equity will increase, while the value relevance of net income will decrease. The second aim is to study the effect of cross-country differences in corporate governance and accounting systems on changes in the value relevance of equity book value and net income caused by the Asian financial crisis. The authors examine the impact of the Asian financial crisis in four countries: Indonesia, Thailand, Malaysia, and South Korea. They use firm-level financial and market data from Datastream, country-level governance data from LaPorta, Lopez-de-Silanes, Schleifer and Vishny (1998) and country-level proxies of reporting and audit quality from Saudagaran and Diga (1997). DFEL use the governance data from LaPorta et al. (1998), and the proxy for audit quality from Saudagaran and Diga (1997) to create a composite governance score. The authors assess the impact of reporting quality separately. The data are from 1996 (the year prior to the financial crisis) and 1997 (the year of the financial crisis).
E-mail address: [email protected]. 0020-7063/$30.00 D 2005 University of Illinois. All rights reserved. doi:10.1016/j.intacc.2005.12.001
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H. Vander Bauwhede / The International Journal of Accounting 41 (2006) 41–47
The authors find some evidence that the value relevance of equity book value and net income has changed during the crisis. However, they find evidence of changes in the value relevance of accounting information in only some countries and the observed changes are not always in the expected direction (see Table 4 in DFEL this issue). As concerns the authors’ second research question, i.e., whether cross-country differences in corporate governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of book value and earnings, the results are, in my opinion, not clear-cut. In the remainder of this discussion, I elaborate on why we should be careful in interpreting the results as evidence that cross-country differences in corporate governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and earnings. The remainder of this discussion is organized as follows. The next section discusses the research hypotheses. In Section 2, I take a critical look at the results. And in Section 3 I provide some potential explanations for the puzzling results regarding the second research question. Section 4 discusses some further issues and Section 5 concludes.
1. A critical look at the research questions and hypotheses 1.1. The first research question: hypothesis 1 Barth, Beaver, and Landsman (1998) examined how the value relevance of equity book value and earnings changes when the financial health of the firm deteriorates. They find that the value relevance of equity book value increases and the value relevance of net income declines. DFEL expand this question to whether a macro-economic shock, like the Asian financial crisis, can cause similar shifts in the value relevance of equity book value and net income. They formulate Hypothesis 1 accordingly. In my opinion, however, an extension of the Barth et al. (1998) hypothesis from a firm-level setting (firm-level financial health) to a macro-economic setting (Asian financial crisis) and from an American context to an Asian cross-country context is not that straightforward. I see two reasons for this. The first reason is that one would expect a shift in the value relevance of equity book value and net income similar to the one observed by Barth et al. (1998) only when the Asian financial crisis has deteriorated the firms’ financial health as defined by Barth et al. (1998). The second reason is that various studies have shown that pre-crisis properties of accounting information (such as, for example, value relevance of accounting figures) already differ across countries (see, for example, Ali & Hwang, 2000). Therefore, it remains to be seen whether any shifts in the value relevance of accounting information in Asian countries will be similar to those observed in the United States. The mixed results reported in Table 4 (see DFEL this issue) are less surprising when viewed from this perspective. 1.2. The second research question: hypotheses 2 and 3 The second objective of the paper is to examine whether cross-country differences in governance and accounting systems can explain the mixed results on the impact of the
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Asian financial crisis on the value relevance of equity book value and net income across countries (see Section 2). Since some prior studies have already investigated hypotheses similar to Hypothesis 1 in some individual countries (see, for example, Graham, King, & Bailes, 2000, for Thailand), the main potential of the paper lies, in my opinion, in this second research question. However, in the hypothesis section, the authors leave the readers in the dark as to how exactly they expect governance and accounting systems to influence shifts in the value relevance of equity book value and earnings caused by the Asian financial crisis. For example, in their Hypothesis 3, the authors only formulate expectations as to how the value relevance of equity book value and net income generated from an IAS-based accounting system compares to the value relevance of accounting info generated from a tax-based accounting system during a crisis. Hypothesis 3 does not indicate how the type of accounting system can impact the expected shifts in the value relevance of equity book value and net income induced by the crisis.
2. A critical look at the results To test whether the Asian financial crisis increases the value relevance of book value and decreases the value relevance of net income (Hypothesis 1) DFEL estimate a multiple linear-regression model with the market value of equity per share (MVS) as the dependent variable, and as independent variables, the book value per share (BVS), earnings per share (EPS), an indicator variable (I) for whether the data are from 1997 (the year of the crisis) or 1996 (the year prior to the crisis), and two interaction variables, i.e., an interaction of the book value per share with the indicator variable (I * BVS), and an interaction of the earnings per share with the indicator variable (I * EPS). The authors run the regression on the individual-country samples (Malaysia, Indonesia, Thailand, and Korea), and on the pooled sample. Table 4 (see DFEL this issue) shows the results of these estimations. The table shows that DFEL find support for Hypothesis 1 in Indonesia and Thailand. However, in contrast to expectations, they find a decrease in the value relevance of both equity book value and earnings in Malaysia. Their results further indicate that the crisis had no impact on the value relevance of book value of equity and net income in Korea. Malaysia seems to dominate the pooled results. The value relevance of both equity book value and net income decreases. Table 1, panel C, provides information on the strength of the governance system and the properties of the accounting system in the four countries under study. The governance proxy (a composite governance score) takes a value from 1 to 4, with four indicating a weak governance system and one indicating a strong governance system. Table 1 shows that Indonesia and Thailand are the countries with the weaker governance systems. Malaysia and Korea are the countries with the stronger governance systems. The proxy for the accounting system takes a one if the accounting standards are based on IAS, and zero if the accounting standards are based on the tax code. Table 1 indicates that Indonesia, Thailand, and Malaysia are classified as having IAS-based accounting standards.
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Taken together, Table 4 and Table 1, panel C, give a first indication on whether governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and net income. More specifically, Hypothesis 1 is supported in countries with the weakest governance systems (Indonesia and Thailand), while the results are mixed for the two countries with a stronger governance system (Malaysia and Korea). Using the accounting system as a classification variable also gives mixed results. More specifically, the value relevance of equity book value increases in two of the three IAS-based countries (Indonesia and Thailand), but decreases in the third country with IAS-based accounting standards (Malaysia). This already suggests that the two factors which are hypothesized to mediate the effect of the Asian financial crisis on the value relevance of equity book value and net income across countries will only have moderate (if any) explanatory power. Another noteworthy observation is that the Asian financial crisis seems to have a similar effect on the value relevance of equity book value in the countries with the weakest governance systems, i.e., Indonesia and Thailand, as a deteriorating financial health has in the United States, a country known to have a relatively strong governance system (see, for example, the values for the corporate governance measures for the United States as reported in LaPorta et al., 1998). To formally test their Hypotheses 2 and 3, DFEL expand their first model with three-way interactions between (1) the proxy for the strength of the governance system or type of accounting system, the year indicator, and book value per share (CG * I * BVS or AC * I * BVS), and (2) the proxy for the strength of the governance system or type of accounting system, the year indicator, and earnings per share (CG * I * EPS or AC * I * EPS). Table 6, panels A and B, show the results of the estimation of these regressions. The table indicates that the three-way interactions with earnings per share are never significant, which suggests that the effect of the Asian financial crisis on the value relevance of net income is similar across countries. However, the results in Table 4 suggest otherwise. There is a significant negative impact of the crisis on the value relevance of net income in Indonesia, Thailand, and Malaysia, but no significant impact in Korea. Table 6 further shows that the three-way interactions with book value per share are significantly negative. Also, in the regression where DFEL examine the mediating impact of the strength of the governance system, the coefficient on the interaction between the year-indicator and book value per share (I * BVS) is positive. Given these two observations, and given that Indonesia and Thailand have the weakest governance systems (values of 4 and 3 on the composite governance score, respectively), the Asian financial crisis turns out to have a negative impact on the value relevance of equity book value for these two countries. This sharply contrasts the estimation results of the country regressions reported in Table 4. Table 4 reports a significant positive impact of the Asian financial crisis on the value relevance of equity book value in Indonesia and Thailand. Similarly, Panel B of Table 6 shows that the coefficient on I * BVS is negative and not significant. The three-way interaction AC * I * BVS is significantly negative. Since AC takes a one for Malaysia, Indonesia, and Thailand (i.e., the countries with IAS-based accounting
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standards), the results suggest that the Asian financial crisis has a negative impact on the value relevance of equity book value in these three countries. We know from Table 4 that this is indeed the case for Malaysia. However, given the results of the country regressions in Table 4, we would expect a positive impact in Indonesia and Thailand. In summary, some of the results reported in Table 6 seem to conflict with the country results reported in Table 4. This suggests that we should be careful in interpreting the results as evidence that cross-country differences in governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and net income.
3. Potential explanations for the results I see various possible explanations for the puzzling results reported in Tables 4 and 6. A first set of explanations relates to the choice and measurement of the variables according to which we classify countries. It is clear from the discussion in Section 2 that governance and accounting system proxies never partition the countries into the three different groups we expect to see, given the results in Table 4 (i.e., countries whose value relevance of equity book value does not change, (increase or decrease) due to the Asian financial crisis). One possible reason is that there are other properties of accounting and governance systems or other institutional variables that were not considered in this paper, which could better explain the different impact of the Asian financial crisis on the value relevance of equity book value and net income across countries. As mentioned in Section 1, the paper does not explain why crosscountry variation in governance and accounting systems would affect the impact of the Asian financial crisis on the value relevance of equity book value and earnings. There is even less support to expect that the specific governance and accounting system proxies used (i.e., shareholder rights, creditor rights, rule of law, ownership, audit report quality and accounting standards) could explain the cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and earnings. Even assuming that there is a clear theoretical basis for using the governance and accounting proxies, there are still some other problems with using these measures in the study. First, although the measures were used in various prior studies (see, for example, LaPorta et al., 1998) they remain crude proxies of the underlying constructs. This does not help in classifying countries correctly. Also, the variation in the governance and accounting-system proxies is limited. This is not very surprising considering that the governance and accounting-system proxies used are country-level (instead of firm-level) measures, and that there are only four different countries in the sample. Expanding the number of countries in the sample (Saudagaran & Diga, 1997, for example, used data from 47 countries with emerging capital markets, and Johnson, Boone, Breach, & Friedman, 2000 used data from 25 emerging markets), and/or using firm-level corporate governance and accounting-system attributes could help to increase the variation in the governance and accounting-system measures.
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Also a research design issue may to some extent explain the puzzling results in Tables 4 and 6. More specifically, the interaction terms between the corporate governance or accounting-system proxy, on the one hand, and the year-indicator, on the other hand, (i.e., CG * I or AC * I) are missing from the models estimated to test Hypotheses 2 and 3, which clouds the interpretation of the results.
4. Some further issues To examine the impact of the Asian financial crisis, DFEL use a year-indicator variable (I). To investigate whether they can really attribute the effect to the Asian financial crisis, and prove that the effect is not a simple year effect, DFEL also test whether the value relevance of equity book value and net income changes in the years prior to and after the Asian financial crisis. Replacing the year-dummy with another proxy for the Asian financial crisis, e.g., the extent of exchange-rate depreciation or stock market decline (see Johnson et al., 2000) might have been an alternative and more direct test of whether they can attribute the results to the Asian financial crisis.
5. Summary DFEL investigate the impact of the Asian financial crisis on the value relevance of book value of equity and net income in four Asian countries. In addition, DFEL examine whether cross-country differences in governance and accounting systems can explain the different effects of the crisis across the four countries. These are very interesting research questions. However, some of the results of their investigation are puzzling. I propose that these puzzling results may stem from the choice of the mediating factors and/or some data, measurement, and methodological problems, such as a small number of countries in the sample, crude proxies for the strength of the governance system and the properties of the accounting system, and a lack of variation in these proxies, and a model specification issue. Further exploration of the factors affecting changes in the value relevance of equity book value and net income induced by a macro-economic shock seems an interesting avenue for future research. References Ali, & Hwang. (2000). Country-specific factors related to financial reporting and the value relevance of accounting data. Journal of Accounting Research, 38, 1 – 21. Barth, M. E., Beaver, W. H., & Landsman, W. R. (1998). Relative valuation of roles of equity book value and net income as a function of financial health. Journal of Accounting and Economics, 25, 1 – 34. Davis-Friday, P., Eng, L. L., Liu, & Chao-Shin (2006). The effects of the Asian crisis, corporate governance and accounting system on the valuation of book value and earnings. International Journal of Accounting, 41, 22 – 40. doi:10.1016/j.intacc.2005.12.002 (this issue). Graham, R., King, R., & Bailes, J. (2000). The value relevance of accounting information during a financial crisis: Thailand and the 1997 decline in value of the Baht. Journal of International Financial Management and Accounting, 11(2), 187 – 209.
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Johnson, S., Boone, P., Breach, A., & Friedman, E. (2000). Corporate governance in the Asian financial crisis. Journal of Financial Economics, 58, 141 – 186. LaPorta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (1998). Law and finance. Journal of Political Economy, 106, 1113 – 1155. Saudagaran, & Diga. (1997). The institutional environment of financial reporting regulation in ASEAN. The International Journal of Accounting, 35(1), 1 – 26.
Discussion
Discussion of the effects of the Asian crisis, corporate governance and accounting system on the valuation of book value and earnings Heidi Vander Bauwhede Vlerick Leuven Gent Management School and Katholieke Universiteit Leuven, Naamsestraat 69 B-3000 Leuven, Belgium
The objective of the study on which Davis-Friday, Eng, and Liu (henceforth DFEL) report in their paper bThe Effects of Crisis, Corporate Governance and Accounting System on the Valuation of Book Value and EarningsQ is twofold. The first objective is to examine the impact of the Asian financial crisis on the value relevance of equity book value and net income. The authors expect that the value relevance of book value of equity will increase, while the value relevance of net income will decrease. The second aim is to study the effect of cross-country differences in corporate governance and accounting systems on changes in the value relevance of equity book value and net income caused by the Asian financial crisis. The authors examine the impact of the Asian financial crisis in four countries: Indonesia, Thailand, Malaysia, and South Korea. They use firm-level financial and market data from Datastream, country-level governance data from LaPorta, Lopez-de-Silanes, Schleifer and Vishny (1998) and country-level proxies of reporting and audit quality from Saudagaran and Diga (1997). DFEL use the governance data from LaPorta et al. (1998), and the proxy for audit quality from Saudagaran and Diga (1997) to create a composite governance score. The authors assess the impact of reporting quality separately. The data are from 1996 (the year prior to the financial crisis) and 1997 (the year of the financial crisis).
E-mail address: [email protected]. 0020-7063/$30.00 D 2005 University of Illinois. All rights reserved. doi:10.1016/j.intacc.2005.12.001
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H. Vander Bauwhede / The International Journal of Accounting 41 (2006) 41–47
The authors find some evidence that the value relevance of equity book value and net income has changed during the crisis. However, they find evidence of changes in the value relevance of accounting information in only some countries and the observed changes are not always in the expected direction (see Table 4 in DFEL this issue). As concerns the authors’ second research question, i.e., whether cross-country differences in corporate governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of book value and earnings, the results are, in my opinion, not clear-cut. In the remainder of this discussion, I elaborate on why we should be careful in interpreting the results as evidence that cross-country differences in corporate governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and earnings. The remainder of this discussion is organized as follows. The next section discusses the research hypotheses. In Section 2, I take a critical look at the results. And in Section 3 I provide some potential explanations for the puzzling results regarding the second research question. Section 4 discusses some further issues and Section 5 concludes.
1. A critical look at the research questions and hypotheses 1.1. The first research question: hypothesis 1 Barth, Beaver, and Landsman (1998) examined how the value relevance of equity book value and earnings changes when the financial health of the firm deteriorates. They find that the value relevance of equity book value increases and the value relevance of net income declines. DFEL expand this question to whether a macro-economic shock, like the Asian financial crisis, can cause similar shifts in the value relevance of equity book value and net income. They formulate Hypothesis 1 accordingly. In my opinion, however, an extension of the Barth et al. (1998) hypothesis from a firm-level setting (firm-level financial health) to a macro-economic setting (Asian financial crisis) and from an American context to an Asian cross-country context is not that straightforward. I see two reasons for this. The first reason is that one would expect a shift in the value relevance of equity book value and net income similar to the one observed by Barth et al. (1998) only when the Asian financial crisis has deteriorated the firms’ financial health as defined by Barth et al. (1998). The second reason is that various studies have shown that pre-crisis properties of accounting information (such as, for example, value relevance of accounting figures) already differ across countries (see, for example, Ali & Hwang, 2000). Therefore, it remains to be seen whether any shifts in the value relevance of accounting information in Asian countries will be similar to those observed in the United States. The mixed results reported in Table 4 (see DFEL this issue) are less surprising when viewed from this perspective. 1.2. The second research question: hypotheses 2 and 3 The second objective of the paper is to examine whether cross-country differences in governance and accounting systems can explain the mixed results on the impact of the
H. Vander Bauwhede / The International Journal of Accounting 41 (2006) 41–47
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Asian financial crisis on the value relevance of equity book value and net income across countries (see Section 2). Since some prior studies have already investigated hypotheses similar to Hypothesis 1 in some individual countries (see, for example, Graham, King, & Bailes, 2000, for Thailand), the main potential of the paper lies, in my opinion, in this second research question. However, in the hypothesis section, the authors leave the readers in the dark as to how exactly they expect governance and accounting systems to influence shifts in the value relevance of equity book value and earnings caused by the Asian financial crisis. For example, in their Hypothesis 3, the authors only formulate expectations as to how the value relevance of equity book value and net income generated from an IAS-based accounting system compares to the value relevance of accounting info generated from a tax-based accounting system during a crisis. Hypothesis 3 does not indicate how the type of accounting system can impact the expected shifts in the value relevance of equity book value and net income induced by the crisis.
2. A critical look at the results To test whether the Asian financial crisis increases the value relevance of book value and decreases the value relevance of net income (Hypothesis 1) DFEL estimate a multiple linear-regression model with the market value of equity per share (MVS) as the dependent variable, and as independent variables, the book value per share (BVS), earnings per share (EPS), an indicator variable (I) for whether the data are from 1997 (the year of the crisis) or 1996 (the year prior to the crisis), and two interaction variables, i.e., an interaction of the book value per share with the indicator variable (I * BVS), and an interaction of the earnings per share with the indicator variable (I * EPS). The authors run the regression on the individual-country samples (Malaysia, Indonesia, Thailand, and Korea), and on the pooled sample. Table 4 (see DFEL this issue) shows the results of these estimations. The table shows that DFEL find support for Hypothesis 1 in Indonesia and Thailand. However, in contrast to expectations, they find a decrease in the value relevance of both equity book value and earnings in Malaysia. Their results further indicate that the crisis had no impact on the value relevance of book value of equity and net income in Korea. Malaysia seems to dominate the pooled results. The value relevance of both equity book value and net income decreases. Table 1, panel C, provides information on the strength of the governance system and the properties of the accounting system in the four countries under study. The governance proxy (a composite governance score) takes a value from 1 to 4, with four indicating a weak governance system and one indicating a strong governance system. Table 1 shows that Indonesia and Thailand are the countries with the weaker governance systems. Malaysia and Korea are the countries with the stronger governance systems. The proxy for the accounting system takes a one if the accounting standards are based on IAS, and zero if the accounting standards are based on the tax code. Table 1 indicates that Indonesia, Thailand, and Malaysia are classified as having IAS-based accounting standards.
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Taken together, Table 4 and Table 1, panel C, give a first indication on whether governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and net income. More specifically, Hypothesis 1 is supported in countries with the weakest governance systems (Indonesia and Thailand), while the results are mixed for the two countries with a stronger governance system (Malaysia and Korea). Using the accounting system as a classification variable also gives mixed results. More specifically, the value relevance of equity book value increases in two of the three IAS-based countries (Indonesia and Thailand), but decreases in the third country with IAS-based accounting standards (Malaysia). This already suggests that the two factors which are hypothesized to mediate the effect of the Asian financial crisis on the value relevance of equity book value and net income across countries will only have moderate (if any) explanatory power. Another noteworthy observation is that the Asian financial crisis seems to have a similar effect on the value relevance of equity book value in the countries with the weakest governance systems, i.e., Indonesia and Thailand, as a deteriorating financial health has in the United States, a country known to have a relatively strong governance system (see, for example, the values for the corporate governance measures for the United States as reported in LaPorta et al., 1998). To formally test their Hypotheses 2 and 3, DFEL expand their first model with three-way interactions between (1) the proxy for the strength of the governance system or type of accounting system, the year indicator, and book value per share (CG * I * BVS or AC * I * BVS), and (2) the proxy for the strength of the governance system or type of accounting system, the year indicator, and earnings per share (CG * I * EPS or AC * I * EPS). Table 6, panels A and B, show the results of the estimation of these regressions. The table indicates that the three-way interactions with earnings per share are never significant, which suggests that the effect of the Asian financial crisis on the value relevance of net income is similar across countries. However, the results in Table 4 suggest otherwise. There is a significant negative impact of the crisis on the value relevance of net income in Indonesia, Thailand, and Malaysia, but no significant impact in Korea. Table 6 further shows that the three-way interactions with book value per share are significantly negative. Also, in the regression where DFEL examine the mediating impact of the strength of the governance system, the coefficient on the interaction between the year-indicator and book value per share (I * BVS) is positive. Given these two observations, and given that Indonesia and Thailand have the weakest governance systems (values of 4 and 3 on the composite governance score, respectively), the Asian financial crisis turns out to have a negative impact on the value relevance of equity book value for these two countries. This sharply contrasts the estimation results of the country regressions reported in Table 4. Table 4 reports a significant positive impact of the Asian financial crisis on the value relevance of equity book value in Indonesia and Thailand. Similarly, Panel B of Table 6 shows that the coefficient on I * BVS is negative and not significant. The three-way interaction AC * I * BVS is significantly negative. Since AC takes a one for Malaysia, Indonesia, and Thailand (i.e., the countries with IAS-based accounting
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standards), the results suggest that the Asian financial crisis has a negative impact on the value relevance of equity book value in these three countries. We know from Table 4 that this is indeed the case for Malaysia. However, given the results of the country regressions in Table 4, we would expect a positive impact in Indonesia and Thailand. In summary, some of the results reported in Table 6 seem to conflict with the country results reported in Table 4. This suggests that we should be careful in interpreting the results as evidence that cross-country differences in governance and accounting systems can explain cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and net income.
3. Potential explanations for the results I see various possible explanations for the puzzling results reported in Tables 4 and 6. A first set of explanations relates to the choice and measurement of the variables according to which we classify countries. It is clear from the discussion in Section 2 that governance and accounting system proxies never partition the countries into the three different groups we expect to see, given the results in Table 4 (i.e., countries whose value relevance of equity book value does not change, (increase or decrease) due to the Asian financial crisis). One possible reason is that there are other properties of accounting and governance systems or other institutional variables that were not considered in this paper, which could better explain the different impact of the Asian financial crisis on the value relevance of equity book value and net income across countries. As mentioned in Section 1, the paper does not explain why crosscountry variation in governance and accounting systems would affect the impact of the Asian financial crisis on the value relevance of equity book value and earnings. There is even less support to expect that the specific governance and accounting system proxies used (i.e., shareholder rights, creditor rights, rule of law, ownership, audit report quality and accounting standards) could explain the cross-country differences in the impact of the Asian financial crisis on the value relevance of equity book value and earnings. Even assuming that there is a clear theoretical basis for using the governance and accounting proxies, there are still some other problems with using these measures in the study. First, although the measures were used in various prior studies (see, for example, LaPorta et al., 1998) they remain crude proxies of the underlying constructs. This does not help in classifying countries correctly. Also, the variation in the governance and accounting-system proxies is limited. This is not very surprising considering that the governance and accounting-system proxies used are country-level (instead of firm-level) measures, and that there are only four different countries in the sample. Expanding the number of countries in the sample (Saudagaran & Diga, 1997, for example, used data from 47 countries with emerging capital markets, and Johnson, Boone, Breach, & Friedman, 2000 used data from 25 emerging markets), and/or using firm-level corporate governance and accounting-system attributes could help to increase the variation in the governance and accounting-system measures.
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Also a research design issue may to some extent explain the puzzling results in Tables 4 and 6. More specifically, the interaction terms between the corporate governance or accounting-system proxy, on the one hand, and the year-indicator, on the other hand, (i.e., CG * I or AC * I) are missing from the models estimated to test Hypotheses 2 and 3, which clouds the interpretation of the results.
4. Some further issues To examine the impact of the Asian financial crisis, DFEL use a year-indicator variable (I). To investigate whether they can really attribute the effect to the Asian financial crisis, and prove that the effect is not a simple year effect, DFEL also test whether the value relevance of equity book value and net income changes in the years prior to and after the Asian financial crisis. Replacing the year-dummy with another proxy for the Asian financial crisis, e.g., the extent of exchange-rate depreciation or stock market decline (see Johnson et al., 2000) might have been an alternative and more direct test of whether they can attribute the results to the Asian financial crisis.
5. Summary DFEL investigate the impact of the Asian financial crisis on the value relevance of book value of equity and net income in four Asian countries. In addition, DFEL examine whether cross-country differences in governance and accounting systems can explain the different effects of the crisis across the four countries. These are very interesting research questions. However, some of the results of their investigation are puzzling. I propose that these puzzling results may stem from the choice of the mediating factors and/or some data, measurement, and methodological problems, such as a small number of countries in the sample, crude proxies for the strength of the governance system and the properties of the accounting system, and a lack of variation in these proxies, and a model specification issue. Further exploration of the factors affecting changes in the value relevance of equity book value and net income induced by a macro-economic shock seems an interesting avenue for future research. References Ali, & Hwang. (2000). Country-specific factors related to financial reporting and the value relevance of accounting data. Journal of Accounting Research, 38, 1 – 21. Barth, M. E., Beaver, W. H., & Landsman, W. R. (1998). Relative valuation of roles of equity book value and net income as a function of financial health. Journal of Accounting and Economics, 25, 1 – 34. Davis-Friday, P., Eng, L. L., Liu, & Chao-Shin (2006). The effects of the Asian crisis, corporate governance and accounting system on the valuation of book value and earnings. International Journal of Accounting, 41, 22 – 40. doi:10.1016/j.intacc.2005.12.002 (this issue). Graham, R., King, R., & Bailes, J. (2000). The value relevance of accounting information during a financial crisis: Thailand and the 1997 decline in value of the Baht. Journal of International Financial Management and Accounting, 11(2), 187 – 209.
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Johnson, S., Boone, P., Breach, A., & Friedman, E. (2000). Corporate governance in the Asian financial crisis. Journal of Financial Economics, 58, 141 – 186. LaPorta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (1998). Law and finance. Journal of Political Economy, 106, 1113 – 1155. Saudagaran, & Diga. (1997). The institutional environment of financial reporting regulation in ASEAN. The International Journal of Accounting, 35(1), 1 – 26.