Can overseas investment improve earnings quality?

Nowadays, globalization of local firms is an important topic for every country. The international firms seem to have a high reputation, but does it really work for investors? Historically, several international firms that had a high reputation among investors have been involved accounting scandals before the exposure of terrible news. These cases raise investors’ suspicion that international firms do not always have high quality accounting information. Investors should focus on some important indexes of earnings quality, helping themselves to decide the quality of companies’ accounting statements which lead to a better decision. This paper tries to answer the following 3 questions: what kind of companies make overseas investment? Can overseas investment improve all types of earnings qualities? Do the legal systems and degree of development of the invested countries effect earnings qualities? In this paper, we hypothesize that firms under greater influence of common law and developed countries have higher earnings qualities. Then we use the propensity score matching model to control for differences in firms’ characteristics between overseas investment Japanese firms and non-overseas investment Japanese firms. After that we examine the correlation between overseas investment and three types of earnings qualities (earnings management, value relevance of accounting information, and reporting conservatism), using two dimensions (quantity and percentage) to represent the extent of influence of common law countries and developed countries. We test out 6 hypotheses with the propensity score matching sample of 6,973 firm-year data for the year 2005 to 2014. Based on the results, we find that Japanese firms with lower advertisement expenditure, lower quick ratio, higher capital ratio, higher R&D expenditure, higher interest expense, higher intangible assets rate, higher ROA, and larger size, have a higher tendency to make overseas investment. In addition, we find that overseas investment can improve earnings quality by reducing earnings management risk. We also find that firms under greater influence of common law countries or developed countries have lower (higher) level of earnings management risk (value relevance). Lastly, we find that overseas investment can damage earning quality by impairing the reporting conservatism, but firms under greater influence of common law countries or developed countries have higher level of reporting conservatism. The findings of this study have implications not only for investors but also for security analysts, auditors, policy makers, and other accounting information users in enhancing their understanding of legal systems and degree of development differences, and their impact on earnings qualities.