Table Of ContentInformation Asymmetry, Accounting Standards,
and Accounting Conservatism
A thesis submitted to The University of Manchester for the degree of
Doctor of Philosophy
in the Faculty of Humanities.
2017
Mostafa Harakeh
Alliance Manchester Business School
Table of Contents
ABSTRACT .......................................................................................................................... 5
DECLARATION .................................................................................................................. 6
COPYRIGHT STATEMENT ............................................................................................. 6
DEDICATION ...................................................................................................................... 7
ACKNOWLEDGMENTS ................................................................................................... 8
CHAPTER 1. INTRODUCTION ....................................................................................... 9
CHAPTER 2. DOES CHANGING ACCOUNTING STANDARDS AFFECT
DIVIDEND POLICY? ....................................................................................................... 14
2.1. Introduction ............................................................................................................. 15
2.2. Motivation & Literature Review ........................................................................... 18
2.2.1. IFRS, Legal Systems and Accounting Quality .................................................. 18
2.2.2. Dividend Payout Policy and the Information Environment ............................... 21
2.2.3. Dividend Value Relevance and the Information Environment .......................... 22
2.3. Hypothesis Development ........................................................................................ 23
2.4. Research Methodology............................................................................................ 27
2.4.1. Dividend Payout Regression Model .................................................................. 27
2.4.2. Dividend Payout Regressions among Code-law Firms ...................................... 29
2.4.3. Dividend Value Relevance Regression Model .................................................. 31
2.5. Data & Descriptive Statistics.................................................................................. 32
2.5.1. Sample Construction .......................................................................................... 32
2.5.2. Descriptive Statistics .......................................................................................... 33
2.6. Empirical Results .................................................................................................... 36
2.6.1. Dividend Payout following IFRS ....................................................................... 36
2.6.2. Dividend Payout among Code-Law Firms ......................................................... 40
2.6.3. Dividend Value Relevance following IFRS ....................................................... 43
2.7. Conclusion ................................................................................................................ 44
References: ...................................................................................................................... 46
Appendix A: Variable Definitions (sorted alphabetically) ......................................... 50
Appendix B: Accounting Quality Metrics ................................................................... 52
CHAPTER 3. DOES CHANGING ACCOUNTING STANDARDS AFFECT
EQUITY FINANCING? .................................................................................................... 80
3.1. Introduction ............................................................................................................. 81
3.2. Motivation & Literature Review ........................................................................... 84
3.2.1. IFRS and Information Asymmetry in the SEO Setting ...................................... 84
3.2.2. Earnings Management around SEOs ................................................................. 85
3.2.3. The Market Reaction and the Propensity to Issue SEOs.................................... 86
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3.3. Hypothesis Development ........................................................................................ 88
3.4. Research Methodology............................................................................................ 91
3.4.1. Test of Earnings Management ........................................................................... 91
3.4.2. Test of SEO Market Reaction ............................................................................ 94
3.4.3. Test of Propensity to Issue Equity ..................................................................... 96
3.5. Data & Descriptive Statistics.................................................................................. 97
3.5.1. Sample Construction .......................................................................................... 97
3.5.2. Descriptive Statistics .......................................................................................... 98
3.6. Empirical Results .................................................................................................. 102
3.6.1. Earnings Management around SEOs ............................................................... 102
3.6.2. Market Reaction to SEOs ................................................................................. 104
3.6.3. Propensity to Issue New Equity ....................................................................... 107
3.6.4. Robustness Checks ........................................................................................... 108
3.7. Conclusion .............................................................................................................. 110
References: .................................................................................................................... 112
Appendix A: Variable Definitions (sorted alphabetically) ....................................... 116
Appendix B: Calculation of DACC and REM ........................................................... 118
Appendix C: Sample Construction ............................................................................. 120
CHAPTER 4. THE BIAS IN MEASURING CONDITIONAL CONSERVATISM . 151
4.1. Introduction ........................................................................................................... 152
4.2. Motivation & Literature Review ......................................................................... 155
4.2.1. Accounting Conservatism ................................................................................ 155
4.2.2. Asymmetric Timeliness Measures of Conditional Conservatism .................... 156
4.2.3. The Source of Bias in the AT Measure ............................................................ 158
4.2.4. An Alternative Measure of Conditional Conservatism .................................... 162
4.3. Hypothesis Development ...................................................................................... 164
4.3.1. The Bias in the AT Measure ............................................................................ 164
4.3.2. Assessing the Potential Bias in the C_Score Measure ..................................... 165
4.3.3. The AT Measure in an Interrupted Time-series Research Design ................... 166
4.3.4. The AT Measure in a Cross-sectional Research Design .................................. 167
4.4. Data & Descriptive Statistics................................................................................ 168
4.5. Research Designs and Results .............................................................................. 170
4.5.1. The Unconditional Relation between AT and VR ........................................... 170
4.5.2. Test Statistics for Comparing AT and VR Measures ....................................... 171
4.5.3. Examination of Conservatism Measures .......................................................... 172
4.5.3.1. Comparing the Scale Effect in AT and VR – (H1) ................................... 172
4.5.3.2. Comparing AT and VR across the Constituents of CSCORE – (H2-H5) 173
4.5.4. Comparing AT and VR in Interrupted Time-series Settings – (H6) ................ 177
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4.5.4.1. André, Filip and Paugam (2015) – (H6) ................................................... 177
4.5.4.2. Lobo & Zhou (2006) – (H6)...................................................................... 179
4.5.5. Comparing AT and VR in Cross-sectional Settings – (H7a & H7b) ............... 181
4.5.5.1. Ball, Sadka and Robin (2008) – (H7a) ...................................................... 181
4.5.5.2. Gassen, Fulbier and Sellhorn (2006) – (H7a & H7b) ............................... 184
4.6. Conclusion .............................................................................................................. 188
References: .................................................................................................................... 189
Appendix A: Variable Definitions (sorted alphabetically by section) ..................... 192
CHAPTER 5. SUMMARY AND SUGGESTIONS FOR FUTURE RESEARCH .... 217
This thesis contains 53,040 including title page, tables, and footnotes.
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Abstract
The University of Manchester
Mostafa Harakeh
Doctor of Philosophy (PhD)
Information Asymmetry, Accounting Standards, and Accounting Conservatism
2 April 2017
This thesis consists of three self-contained essays, each assessing the interaction between
financial accounting and information asymmetry from a different aspect. In the first two
essays, I examine how a change in the information environment affects the behavior of
market participants. In the third essay, I evaluate the empirical measurement of conditional
conservatism in accounting data. Together, these studies contribute to the understanding of
the role of financial reporting in mitigating the information gap between stakeholders.
In the first essay, I explore the impact of the mandatory adoption of the International
Financial Reporting Standards (IFRS) on dividend payout policy and the value relevance
of dividends in two Western European economies. I select the UK as a major common-law
country (control group) and France as a code-law country (treatment group) in order to
implement a difference-in-differences methodology. My findings suggest that IFRS
adoption is a major contributor in increasing dividend payouts among code-law firms,
compared to common-law firms, due to a greater reduction in information asymmetry
following the IFRS mandate. This makes investors in code-law firms more willing to rely
on accounting measures of firm performance, thereby causing a significant and material
decrease in dividend value relevance among code-law firms relative to common-law firms.
In the second essay, I examine the potential for IFRS to influence the market for SEOs. I
utilize a difference-in-differences methodology, where the UK (i.e. common-law firms) is
the control group and France (i.e. code-law firms) is the treatment group. I argue that IFRS
adoption serves to mitigate information asymmetry and improve accounting quality.
Accordingly, I find that, following IFRS adoption, earnings management activities
decrease among code-law firms prior to issuing SEOs. As a result of the lower levels of
earnings management and information asymmetry, I predict and find that the market
reaction to issuing SEOs improves significantly for code-law firms following IFRS. Given
that equity financing becomes less costly, I find that the propensity to issue new SEOs
increases among code-law firms after IFRS adoption.
In the third and final essay, I examine the empirical measurement of conditional
conservatism (CC) in accounting data. Prior studies have raised serious concerns about the
bias in the asymmetric timeliness (AT) measure of CC. This measure, along with the
C_Score measure, underpins a large body of empirical research on CC. Thus I endeavor to
assess the extent to which prior literature may need to be revised because of its reliance on
these measures. In exploring this issue, I replicate prior studies that rely on the AT or the
C_Score measure, and then compare the replicated results with those generated by
applying the variance ratio (VR) measure of CC, proposed by Dutta & Patatoukas (2017). I
show that the AT and the VR measures are associated unconditionally. Furthermore, my
findings suggest that the observed variation in the C_Score measure is driven by variation
in the bias implicit in the AT measure rather than variation in CC. I also provide evidence
showing that the AT measure yields similar conclusions to the VR measure in research
designs that model the change in CC following an exogenous change in accounting policy;
however, I find that using the AT measure to document cross-sectional differences in CC is
highly likely to have given rise to invalid conclusions in a large number of studies.
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Declaration
No portion of the work referred to in the thesis has been submitted in support of an
application for another degree or qualification of this or any other university or other
institute of learning.
Copyright Statement
i. The author of this thesis (including any appendices and/or schedules to this thesis) owns
certain copyright or related rights in it (the “Copyright”) and s/he has given The University
of Manchester certain rights to use such Copyright, including for administrative purposes.
ii. Copies of this thesis, either in full or in extracts and whether in hard or electronic copy,
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iii. The ownership of certain Copyright, patents, designs, trademarks and other intellectual
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and/or Reproductions.
iv. Further information on the conditions under which disclosure, publication and
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restriction declarations deposited in the University Library, The University Library’s
regulations (see http://www.manchester.ac.uk/library/aboutus/regulations) and in The
University’s policy on Presentation of Theses.
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Dedication
I dedicate this work to my wife, who has faithfully loved me and supported me unconditionally,
Ghida
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Acknowledgments
Writing this section was as difficult as writing a full chapter of this thesis. In what follows,
I express my indebtedness to everyone who helped and supported me, directly or
indirectly, to successfully complete my PhD. I love you all from the bottom of my heart.
First and foremost, I shall express my heartfelt gratitude to the holy God, Allah. I know
that you have granted me more than I deserve because you are generous and gracious, not
because I am worthy of your countless blessings. I promise you that I will employ the
graces you have endued me with to serve only righteous deeds.
To my great supervisors, Prof. Martin Walker and Prof. Edward Lee, you are just
awesome. I learned a lot from you, more than you can imagine. You made me believe that
the value of any PhD is derived from its supervisors in the first place. Your wisdom,
guidance, intelligence, and support have made my PhD journey one of the most
overwhelming experiences in my life. On top of that, I admire the humane attitude you
have always shown in several incidents. This only makes me respect you more and
appreciate how lucky I was when you accepted me to pursue my doctoral degree under
your supervision. I must also thank my internal and external examiners, respectively, Prof.
Norman Strong and Prof. Colin Clubb, for agreeing to examine my thesis. Indeed, being
examined by such reputable professors gives my PhD more value and credibility.
To my good friend Nikos, no words can express how grateful I am for your presence in
my life during my stay in the UK. You are a true friend that one can count on. I am proud
to have such a loyal and smart friend, with whom I can share my personal matters and
collaborate throughout my academic career. Also, to my friends in Lebanon, to the best
friends a man can have, our WhatsApp chats and Skype calls have made my journey away
from home much easier. Thank you for your support and prayers; I love you guys.
To my brother Maytham, thank you for being a good friend and a loving brother at
once. I will always be there for you when you need me, just like you have always been to
me. To my nerdy sister, Mira, you are the joy of our family. You will always have my full
support in fulfilling your promising academic ambitions. And to my kind-hearted father,
thank you for shaping my personality and for giving me your bright mind.
The famous poet William Ross Wallace says “The hand that rocks the cradle is the hand
that rules the world”; my mother is indeed one of those mothers who Mr. Wallace was
referring to. To the most caring, affectionate, and loving mother, no words can express
how much I love and admire you. The best years of your life went by while holding my
hand and doing all it takes to make that kid become a man – a man you can be proud of. I
hope that one day I will be able to compensate for a small part of your unlimited sacrifice.
Last but definitely not least, to the only girl I have ever loved, to the girl who has stood
by my side at all times, to the blessing of my life, to my best friend, to Ghida, thank you
for believing in me and for patiently spending four years waiting for me to come back. It is
said that outstanding accomplishments start with a dream. Ghida had this dream for me and
she made all it takes to make this dream come true. Without Ghida’s motivation and
support in getting this PhD, I wouldn’t have been writing these words now.
Mostafa Harakeh
Manchester, April 2017
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Chapter 1
Introduction
In his famous paper “The Market for Lemons”, the Nobel Prize Laureate George
Akerlof started in 1970 a long standing literature on the economic consequences of
information asymmetry (Akerlof, 1970). Since its introduction to the field of financial
economics, the concept of information asymmetry has played a major role in accounting
and finance research (see the surveys of Biais, Glosten, & Spatt, 2005; Healy & Palepu,
2001). Scott (2015, p. 137) states that information asymmetry is undoubtedly the most
important concept of financial accounting theory. Information asymmetry derives its
critical role in financial markets from the fact that severe levels of asymmetric
information might lead to a complete collapse of markets. A recent example is the so-
called subprime crisis in 2008 (Ryan, 2008, p. 1626). Given these tragic consequences,
regulators and accounting standard setters strive to mitigate information asymmetry
through enforcing policies and financial reporting standards which aim to diminish the
information gap between market participants.
As far as the financial accounting research is concerned, financial reporting and
disclosure affect information asymmetry, which in turn influences economic decisions
made by market participants. In general, there are two kinds of market participants in an
information asymmetry setting: insiders and outsiders. I refer to managers and informed
(institutional) investors as insiders and to less informed (individual) investors as
outsiders. In capital markets, information asymmetry exists because of two main
problems: moral hazard and adverse selection. Moral hazard problems arise when
insiders misuse the firm resources to serve personal interests rather than maximizing the
firm value (i.e., hidden action). Such problems are exacerbated when outsiders do not
have enough information to monitor the economic decisions taken by insiders. Adverse
selection problems arise when one side of a potential economic transaction has relevant
information that the other side does not have (i.e., hidden information). Such problems
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negatively affect investment efficiency and capital allocation and, accordingly, increase
the deadweight loss in the society.
A fundamental role of financial reporting is to mitigate moral hazard and adverse
selection problems through diminishing the informational gap between insiders and
outsiders (Mora & Walker, 2015). This brings the existing firm value closer to its
fundamental value (Scott, 2015, p. 141). In the same context, my thesis examines the
interaction between financial accounting and information asymmetry from three
different aspects. This thesis is structured around three self-contained essays in Chapters
2, 3, and 4. These essays examine original and different research questions, have
separate literature reviews, and exploit different datasets. While I recommend reading
each chapter independently, yet the concept of information asymmetry keeps a coherent
theme across all chapters. Chapters 2 and 3 examine how the behavior of market
participants changes following a positive information shock caused by the mandatory
adoption of the International Financial Reporting Standards (IFRS). This exogenous
improvement in the supplied information mitigates information asymmetry and reduces
the frictional costs of financial transactions between insiders and outsiders. In Chapter
4, I assess the measurement of a major feature of financial reporting: conditional
accounting conservatism. Conditional conservatism is a financial reporting attribute that
is meant to mitigate information asymmetry arising from adverse selection and moral
hazard problems. Specifically, investors (i.e. shareholders and bondholders) need to
assess their investment payoffs based on conservative estimations of firms’ net assets
due to their incomplete information (Balakrishnan, Watts, & Zuo, 2016). I re-examine
the empirical measurement of conditional conservatism in accounting data, which was
initially introduced in Basu (1997), in light of a contemporary study by Dutta &
Patatoukas (2017). I briefly discuss the three essays below.
In the first essay, I examine the effect of the mandatory adoption of IFRS on aspects
of dividend policy. Myers & Majluf (1984) theorize that, under information asymmetry,
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Description:DOES CHANGING ACCOUNTING STANDARDS AFFECT. DIVIDEND POLICY adoption of the International Financial Reporting Standards (IFRS).
