It is commonly understood that businesses pursue international diversification as part of a strategy to seek potential profit elsewhere. The international diversification may also result in more efficient capital allocation and greater economic growth. The public policy implications of this diversification, however, are less clear cut since diversification may result in capital being allocated to international locales where financial transparency and legal protections for investors are limited. The result of such an allocation may be greater profits for controlling owners and managerial personnel and a diversion of corporate resources from minority owners.
Research by Duru and Reeb (2002) and others has indicated that successful internationalization leads to both greater earnings growth rates and earnings persistence. There has been little work to date that examines whether the market's perception of the value relevance of foreign earnings varies among firms with different international diversification profiles. Previous research has focused on differences in the value relevance of foreign versus domestic earnings ( Bodnar
This paper makes several contributions. First, our study widens the sources of information used in studying perceptions of the relationship between internationalization and the value relevance of earnings by using Taiwanese data. Previous studies ( Bodnar and Weintrop, 1997 ; Bodnar
Our second contribution is to explore and document the effects of control divergence on the value relevance of foreign earnings. Given the opportunity for asset diversion that internationalization provides to management and/or controlling owners, it is important to understand the influence of control-ownership divergence on the value relevance of foreign earnings. Obviously, investing corporate assets overseas raises issues as to the proper jurisdiction within which to pursue legal claims. Therefore, our third contribution is to examine the effects of the legal regime governing investor protection in the investee companies on the value relevance of foreign earnings. Internationalization may threaten the firm with the possibility that domestic influences in foreign markets will impact the corporation's ability to assert control over its own investments. Certain aspects of the foreign legal system may influence the investor's concern about this. A combination of better control-ownership divergences and foreign legal regimes that protect the investor may lead to improved earnings informativeness, and therefore higher value relevance of foreign earnings. The importance of control divergences in impacting the behavior of corporate management can be seen in Young
Further, this study contributes to the literature showing the importance of financial transparency to investor decision making. Given the international scope of the investing – and therefore disclosure – pertinent to this study, our study demonstrates that segment disclosure has great value to investors in that the results help the investors evaluate the impact of foreign investments, and their attendant uncertainties, on the firm's expected future performance.
Our empirical results indicate that the market's perception of the value relevance of foreign earnings does not significantly differ from the value relevance of domestic earnings. We do find that the impact of foreign earnings on stock returns is significantly enhanced as the international diversification profiles of the firms in the sample increase. Diversification profiles were measured by country scope and the number of foreign investees. Furthermore, better quality corporate governance (i.e. a reduced difference between the percentage of board seats influenced by the ultimately controlling shareholders and their cash flow rights) was found to enhance the positive effects of internationalization on the value relevance of foreign earnings. Research by Haw
The rest of this paper is organized as follows. Section 2 discusses the relevant institutional background and reviews relevant literature. Section 3 presents our hypotheses. Section 4 describes the data, sample selection procedures, and research designs employed. Section 5 presents the empirical results and our tests of the robustness of those results, with our conclusions being presented in Section 6.
The increasing role that international operations play in the economics of many firms underlines the importance of understanding how foreign earnings are regarded by investors. Research by Bodnar
Research has pointed out the potential for corporate governance systems to impact the behaviors of firms and hurt minority shareholders ( Jaggi