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The impact of corporate
governance and IFRS on the
relationship between financial
reporting quality and investment
efficiency in a continental
accounting system
Impact of FRQ
corporate
governance
and IFRS
Received 12 June 2020
Revised 17 January 2021
20 February 2021
10 April 2021
Accepted 14 April 2021
Asma Houcine
GEF2A-Lab, Higher Institute of Management of Tunis (ISGT), University of Tunis,
Tunis, Tunisia and
Accounting and Finance Department, Emirates College of Technology,
Abu Dhabi, United Arab Emirates
Mouna Zitouni
VPNC Lab, Faculty of Law, Economics and Management of Jendouba,
University of Jendouba, Jendouba, Tunisia, and
Samir Srairi
RIM-RAF Lab, ESCT, University of Manouba, Tunis, Tunisia
Abstract
Purpose – The purpose of this paper is to investigate whether Financial Reporting Quality (FRQ), Corporate
Governance and IFRS affect investment efficiency of French listed companies.
Design/methodology/approach – Based on a sample of 125 French firms listed on the CAC All Tradable
index between 2008 and 2017, the study uses Feasible Generalized Least Squares (FGLS) regressions to
examine the relationship between FRQ and firms’ investment efficiency.
Findings – The findings show that FRQ plays a role in reducing overinvestment and does not affect
underinvestment, suggesting that in a code-law country, informal and personal relationships tend to replace
the role of financial reports in mitigating information asymmetry. The results also reveal that the relationship
between FRQ and investment efficiency increases with better corporate governance and with the
implementation of IFRS. However, the results provide no evidence between incentives to minimize profits
for tax purposes and firms’ underinvestment and continues to be negative for overinvesting companies that
have more incentives to manage their earnings for tax purposes.
Research limitations/implications – Our study has some limitations. First, we only examine listed firms,
so the results cannot be generalized to unlisted companies that represent the vast majority of French economic
activity. Second, this research does not distinguish between government companies and private companies.
The two types of companies have different governance mechanisms, financial reporting, disclosure
environment and concentration of ownership.
Practical implications – This study suggests that in a code-law country with weak investor protection, FRQ
acts as a governance mechanism by mitigating asymmetric information and improving firms’ investment
decisions.
Originality/value – The relationship between FRQ and investment efficiency has been widely examined for
companies in “common law” countries. This study extends the scarce evidence of this relation to companies in a
JEL Classification — G 31, M 41
The authors greatly acknowledge the thoughtful comments and suggestions of anonymous referees
to improve the quality of the manuscript.
EuroMed Journal of Business
© Emerald Publishing Limited
1450-2194
DOI 10.1108/EMJB-06-2020-0063
EMJB
code-law country. It also builds on previous research by introducing new factors never discussed before that
could change this relationship, namely corporate governance, IFRS implementation and tax purposes.
Keywords Investment efficiency, Financial reporting quality, Corporate governance, IFRS, Code-law country,
Continental accounting system
Paper type Research paper
1. Introduction
Corporate investment is a fundamental issue in the finance literature due to its important
impact on firm value. According to Tobin (1969), corporate investment is only determined by
the investment opportunities of firms. However, there are many market frictions, such as
information asymmetry and agency costs, that can make firms’ investment irresponsive to
investment opportunities and lead to sub-optimal investment (Jensen, 1986; Shleifer and
Vishney, 1997; Myers and Majluf, 1984; Lambert et al., 2007). There are two types of inefficient
investments, namely: overinvestment where the company invests in projects with negative
net present value, and underinvestment where the company has insufficient resources to
finance investments with a positive net present value.
Previous literature (Biddle and Hilary, 2006; Biddle et al., 2009; Chen et al., 2011; Gomariz
and Bellesta, 2014) show that the quality of financial reports alleviates information
asymmetry and leads to best corporate investment decisions. The authors document that a
rich informational environment improves the efficiency of capital allocation by mitigating
market frictions and reducing both under and overinvestment issues.
This evidence, however, is mainly limited to large publicly listed US companies. In this
paper, we examine the role of financial reporting quality (FRQ) for French listed firms, a
context very different from that examined in previous studies by moving from a common-law
country to a code-law setting, allowing us to examine the importance of FRQ under conditions
that may be less favorable to mitigate under- and overinvestment.
It is widely accepted that financial reporting practices are influenced by the country’s legal
environment and ownership structure (Ball et al., 2000; Leuz et al., 2003; Soderstrom and Sun,
2007), and these features could make FRQ less conductive to alleviating market frictions and
mitigating sub-optimal investment, due to several factors.
First, French firms are more closely held and have greater managerial ownership,
meaning that there is a strong alignment between ownership and management (Houcine and
Houcine, 2020). With greater ownership concentration, large shareholders can take
advantage of their controlling positions and direct private benefits for personal
consumption (Chen et al., 2011). So, French firms may be less affected by traditional
agency problems, but rather by conflicts between minority and large shareholders in the
meaning of Morck et al. (1988), which makes them less demanding for high-quality financial
information. Second, given the increased ownership concentration, shareholder turnover is
lower suggesting that shareholders play a more active role in management, which reduces
their reliance on the financial reports for monitoring managerial decisions (Ball and
Shivakumar, 2005). Third, since the majority of French companies are small and mediumsized, the banks are their main capital provider and may have privileged access to private
information and play a more active role in the management (e.g., Van Tendeloo and
Vanstraelen, 2008; Houcine and Houcine, 2020), which would reduce firms’ dependence on
financial reporting for decision-making. In addition, in a “code-law” environment, the
accounting and tax systems are closely aligned, which reduces the value relevance of
accounting information (Ali and Hwang, 2000; Atwood et al., 2010). Finally, it is argued that
the role of accounting information is limited in an environment characterized by low investor
protection and concentrated ownership structures (Ball et al., 2000; Chen et al., 2011).
Thus, the differences in the French legal environment, its accounting standards and the
properties of earnings compared to the US setting, allow us to examine the importance of
accounting information when it is expected to be less conductive in mitigating
underinvestment and overinvestment.
We extend previous research on the economic consequences of variations in FRQ and
introduce three conditioning hypotheses. First, high-quality accounting information is likely
more desirable in mitigating information asymmetry and agency costs when there is a better
corporate governance system. Thus, we examine whether firms’ investment efficiency is more
sensitive to FRQ when they have a stronger corporate governance system. While, previous
research examines the importance of the corporate governance system in other contexts, our
study is the first to relate corporate governance, FRQ and firms’ investment efficiency.
Second, we consider the role of IFRS in promoting investment efficiency, as most of the
prior studies ignore it. Our study complements previous research by examining how IFRS
adoption affects the strength of the relation between FRQ and investment decisions. Given
that IFRS adoption is expected to reduce information asymmetry by improving the
transparency and comparability of financial information (Ashbaugh and Pincus, 2001; Barth
et al., 2008; Daske et al., 2008; De Fond et al., 2011; Li, 2010), it follows that it should help to
mitigate opportunistic management behavior and enable capital providers to better
distinguish between value-creating and value-destroying investments, thereby improving
investment efficiency.
Finally, we consider the role of tax incentives, as most of the studies ignore tax
considerations (Hanlon and Heitzman, 2010; Chen et al., 2011). Our study extends previous
research by examining the impact of tax incentives on the strength of the relation between
FRQ and investment efficiency. Based on prior literature, tax considerations are especially
important for firms that operate in a code law setting (Barth et al., 2008; Daske et al., 2008),
where accounting and tax reporting compliance is associated with lower quality earnings
(Atwood et al., 2010) that distorts investment decisions (Cummins et al., 1994).
As accounting and tax conformity are higher in code law countries than in common law
countries, examining a code-law country allows us to investigate whether the investmentFRQ relation still exists in an environment where tax considerations are important and where
compliance could skew investment decisions (Cummins et al., 1994).
Our results show that FRQ improves investment efficiency, reduces overinvestment, but
has no effect on underinvestment. Our findings also reveal that better corporate governance
and IFRS implementation enhances firms’ investment efficiency.
This study contributes to the existing literature of investment efficiency in the following
ways: First, it provides empirical evidence that FRQ improves firms “investment efficiency in
a code-law setting where FRQ is considerably lower. Our research could be considered as a
review of the boundary conditions of the importance of accounting information in a such
context. Second, this study highlights the importance of corporate governance as a source to
mitigate conflicts of interest, and thus ensure the efficiency of corporate investment. Third,
this study contributes to the literature by revealing that earnings quality plays a more
prominent role in enhancing investment efficiency when the corporate governance
environment is strong. Thus, our study casts a new light on the effect of governance
mechanisms on investment efficiency in France. Moreover, our study extends previous
research by providing a piece of empirical evidence that the role of IFRS in enhancing
investment efficiency depends on the various agency problems encountered. Ultimately, our
paper enriches the literature with an interesting framework on the effect of FRQ, corporate
governance mechanisms, and IFRS adoption on internal management decisions, particularly
in a setting where investors” interests are poorly protected.
The paper is organized as follows. Section 2 presents a review of literature and develops
hypotheses. Section 3 describes the research design, including the sample, variables
definitions and empirical models. The results are provided in section 4, while section 5
presents the conclusions of the study.
Impact of FRQ
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2. Literature review and hypotheses development
2.1 Financial reporting quality and investment efficiency
One objective of FRQ is to facilitate the efficient allocation of capital by improving firms’
investment decisions (Chen et al., 2011). Financial theory demonstrates that a better FRQ
mitigates both under and overinvestment problems through different channels. First,
improved FRQ contributes to the efficiency of investments by reducing selection, liquidity
risk and information risk (Diamond and Verrecchia, 1991; Leuz and Verrecchia, 2000; Easley
and O’Hara, 2004; Lambert et al., 2007). Second, according to Fama and Jensen (1983),
enhanced FRQ can help various corporate control mechanisms in preventing managers from
the expropriation of the company’s wealth by increasing the ability of the board in its
stewardship function as well as providing capital suppliers with greater assurance on
managers’ activities. Third, a better FRQ can improve the efficiency with which managers
make investment decisions. Indeed, according to McNichols and Stubben (2008), investment
decisions depend on expectations of investment benefits, and these benefits in turn depend on
expectations of future growth and demand for products. Thus, high FRQ can help managers
formulate more accurate expectations and identify better investment opportunities, thereby
improving investment efficiency, even in a world without adverse selection and/or moral
hazard (Bushman and Smith, 2001).
Most of the previous literature supports this prediction and shows that a better FRQ
enhances investment efficiency by mitigating both over and underinvestment problems.
Biddle et al. (2009) find for a sample of US firms that FRQ is positively associated with
investment efficiency and alleviate both under-investment and over-investment. Chen et al.
(2011), for private firms in emerging markets, show that higher FRQ helps under-investment
firms to make investments, and over-investment firms to decrease investment. Gomariz and
Ballesta (2014), examine the role of FRQ and debt maturity in investment efficiency with a
sample of Spanish listed companies. By distinguishing between over-investment and underinvestment, they report that higher FRQ reduces over-investment, while lower debt improves
investment efficiency. They also find that short-term debt is the main mechanism used to
control under-investment and FRQ is only relevant when the short-term debt level is low
(higher maturities). More recently, Bzeouich et al. (2019) find that there is a negative
relationship between earnings management and investment efficiency for French listed firms.
Their finding supports the theoretical perspective of the agency theory, as the propensity of
firms to engage in earnings management practices is associated with high managerial
opportunistic behavior and asymmetric information issues, leading to the problem of under
and overinvestment. For an emerging market, Tunisia, the results of Houcine (2017) show that
FRQ exacerbates information asymmetry levels and increases underinvestment, but fails to
alleviate the costs associated with managerial control and overinvestment problems. However,
Shahzad et al. (2019) find that higher FRQ is associated with higher Investment Efficiency
for Pakistan firms. Their results of this study are consistent with the arguments presented by
the agency theory alignment hypothesis and the resource-based enterprise vision.
Based on the above discussion, we test whether FRQ firms have an impact on investment
efficiency for French listed firms. We examine if FRQ helps to alleviate both under-and overinvestment problems and mitigates capital investment inefficiencies. Our first hypothesis is
as follows:
H1. Financial reporting quality is negatively associated with both under-investment and
over-investment.
2.2 Corporate governance and investment efficiency
In addition to examining the overall effect of FRQ on investment efficiency, we explore other
conditional effects: corporate governance, IFRS implementation and tax incentives. We first
investigate the effect of corporate governance on the effect of FRQ on investment efficiency.
The financial literature emphasizes the important role of corporate governance in alleviating
agency problems and its impact on the efficiency of corporate investment (Jensen, 1986, 1993;
Shleifer and Vishny, 1997; Triole, 2001; Becht et al., 2002). According to Stein (2003), one of the
most prevalent and important factors affecting firms’ efficient investments is corporate
governance. Indeed, a large body of research suggests that better corporate governance
mechanisms improve investment efficiency. Chen and Chen (2011) show that the efficiency of
the investment allocation process is better for diversified firms with high board independence,
low board busyness, high institutional ownership, high outside director ownership, high CEO
equity-based pay, high audit equity and strong shareholder rights. Bertrand and Mullainathan
(2003) and Giroud and Mueller (2010) find that firms with more effective governance have
better information disclosure, less asymmetric information and fewer agency problems,
leading to more efficient investment decisions, while firms with poor governance are associate
with underinvestment problems, suggesting that better governance mitigates
underinvestment. The results of Billett et al. (2011) reveal that for firms with greater
opportunity to overinvest, good governance plays a positive role in reducing overinvestment,
while poorly governed firms are associated with overinvestment. However, Biddle et al. (2009)
show that corporate governance does not mitigate investment inefficiency and increases
(decreases) investment regardless of whether a firm is more or less likely to overinvest
(underinvest). Chen et al. (2017) examine the monitoring effect of governance mechanisms on
investment efficiency in China. The authors find that ownership concentration has a negative
impact on investment efficiency, while the adoption of incentive-based compensation and
institutional investors exert a positive effect. More recently, Bzeouich et al. (2019) highlight the
importance of board monitoring to reduce agency costs and ensure the efficiency of corporate
investments in the French context. Their results show that board size, independence and
gender diversity are positively associated with investment efficiency, and these board features
moderate the relationship between earnings management and investment efficiency. These
findings suggest that earnings quality plays a more prominent role in guiding managers to
choose the right investments when the corporate governance environment is strong.
Based on the above discussion, we note that poor governance is associated with problems
of over/under-investment, and better corporate governance would help alleviate asymmetric
information and agency problems, leading to more efficient investment decisions. This
discussion motivates our second hypothesis:
H2. The relation between FRQ and investment efficiency is stronger for firms with better
corporate governance.
2.3 IFRS and investment efficiency
We examine whether the association between FRQ and investment efficiency is strengthened
after the adoption of IFRS, which is supposed to lead to higher FRQ. IFRS is intended to
standardize the presentation of firms’ financial statements through setting global accounting
standards that require comparable information in the financial reports and ensure a high
FRQ. The adoption of these new standards imposes the principles of substance over form [1]
and the materiality [2], which contribute to strengthen accounting transparency.
Accordingly, the transition to IFRS is expected to improve investment efficiency by
reducing information asymmetry through increasing transparency, comparability and the
quality of the accounting information disclosed. Thus, decreasing information asymmetry
would be an important factor in ensuring the usefulness of accounting information in the
decision-making process, leading to an improvement in firms ’investment efficiency.
Few studies examined the relation between the adoption of IFRS and investment
efficiency. Lenger et al. (2015) show that IFRS adoption by European public and private firms
is positively associated with higher FRQ and improves investment efficiency. Andre et al.
Impact of FRQ
corporate
governance
and IFRS
EMJB
(2014) examine whether conservatism, considered one of the dimensions of FRQ, is associated
with investment efficiency for a sample of French firms before and after the mandatory
adoption of IFRS in 2005. Their results show a significant decrease in conservatism after
IFRS adoption, and in the pre-IFRS period, conservatism limited over- and under-investment,
but that in the post-IFRS period, conservatism plays no role in improving investment
efficiency. Biddle et al. (2016) examine whether voluntary or mandatory adoption of IFRS
enhances capital investment efficiency across 26 countries. Their findings reveal a positive
association between mandatory IFRS adoption and capital investment efficiency, and this
association is stronger in countries with weaker legal protections, more concentrated
ownership, and local GAAP that differs more from IFRS. Recently, Gao and Sidhu (2018)
provide new evidence on the real effects of mandatory IFRS adoption. Their results reveal
that the probability of underinvestment in capital expenditures decreases for firms in
countries with mandatory adoption of IFRS; compared to firms in countries that do not have
such requirements, however, the probability of over-investment remains unchanged.
Most of these previous research documents that IFRS adoption increases investment
efficiency, and the impact of IFRS adoption on investment efficiency may vary in importance
depending on mandatory or voluntary adoption, the institutional and legal characteristics of
the country. We consider that IFRS adoption affects investment efficiency through more than
one channel. Since IFRS adoption is presumed to reduce information asymmetry, it has a
direct effect on improving investment efficiency. Otherwise, because adoption of IFRS is
related to higher FRQ and higher FRQ improves firms’ investment efficiency, it will indirectly
improve investment efficiency. This leads us to formulate the following hypothesis:
H3. The relation between FRQ and investment efficiency is stronger for firms that have
implemented IFRS.
2.4 Taxation and investment efficiency
Finally, we explore the conditional effect of tax incentives. Tax has a significant impact on
business operations and may have different effects on accounting information depending
on the accounting system (Chen et al., 2011). France follows the continental accounting
system based on the principle of regularity and for which the main role of accounting
numbers is accountability (Lois et al., 2019, 2020). This accounting system remains strongly
influenced by taxation with high conformity between accounting and tax reporting, which
means that financial statements serve as a basis for taxation (Chen et al., 2011).
Consequently, in the continental accounting model, tax could be a major burden on the
informational role of earnings and would affect the strength of the relation between FRQ
and investment decisions. Cummins et al. (1994) state that in an environment where tax
considerations are important, conformity between accounting and tax could distort
investment decisions. Ali and Hwang (2000) show that the value relevance of accounting
information is lower in countries with higher book-tax conformity. Similarly, Atwood et al.
(2010) show that the continental accounting model is associated with lower earnings quality
(less persistence and less reliability). Chen et al. (2011) find that the relation between FRQ
and investment efficiency is decreasing in incentives to minimize earnings for tax purposes.
Accordingly, tax incentives could have a significant impact on the usefulness and the
informative role of accounting information, and the degree to which firms will face fiscal
pressures (i.e., higher tax rates and stronger tax enforcement), would affect the impact of
FRQ on investment efficiency.
Based on this discussion, the informational role of FRQ would be reduced for companies
seeking to minimize taxes, and its effect in alleviating the under or over- investment problem,
might be less pronounced for firms with a strong incentive to manage earnings for tax
purposes. This leads us to formulate the following hypothesis:
H4. The association between FRQ and investment efficiency is less pronounced for
companies that have incentives to manage earnings for tax purposes.
3. Research design
3.1 Proxy for firm-level investment efficiency
According to Biddle et al. (2009), investment efficiency means to undertake projects with a
positive net present value under no market frictions (adverse selection, agency costs).
Following previous research (e.g., Biddle et al., 2009; Chen et al., 2011; Houcine, 2017;
Boubaker et al., 2018), we estimate efficiency as the deviation from expected investment using
a model that predicts investment in terms of growth opportunities. We then take the residuals
of this regression as firm-specific proxy of investment inefficiency. The model is as follows:
Investi;t ¼ β0 þ β1 Sales Growthi;t−1 þ εi;t
(1)
Where Investi;t is the total investment in machinery, equipment, land, building, research and
development expenditures minus the sale of fixed assets scaled by lagged total assets.
Sales Growthi;t−1 is the change in sales for firm I in year t1 scaled by lagged total assets.
εi;t is the residual error of the model which measure the firm’s investment deviation from
its expected investment. This measure is computed for each firm by industry and on a yearly
basis and allows us to rank firms into two groups. Firms with negative residuals are classified
as under-investing firms, while those with positive residuals are considered overinvesting firms.
We use two approaches to test whether better FRQ improves investment efficiency. The
first examines the relationship between FRQ and investment inefficiency, while taking into
accounts growth opportunities. The second approach investigates this relationship after
segregating between firms that over-invest and those that underinvest.
To test the first hypothesis (H1), whether FRQ reduces investment inefficiency, we use the
following model:
Inefinvi;t ¼ β0 þ β1 FRQi;t−1 þ βn Xi;t i;t−1 þ Industry dummies þ Year dummies þ εi;t−1 (2)
Following Chen et al. (2011), to test our hypotheses H2, H3 and H4, we add the interaction
effects of corporate Gov index, tax and IFRS with FRQ measures. We predict a positive
coefficient on FRQ3TAX and a negative coefficient on FRQ3IFRS and FRQ3GOV. We
estimate the following models:
InvEffi;t ¼ β0 þ β1 FRQi;t−1 þ β2 GOVi;t−1 þ β3 FRQi;t−1 3 GOVi;t 1 þ βn Xi;t i;t−1 þ εi;t (3)
InvEffi;t ¼ β0 þ β1 FRQi;t−1 þ β2 IFRSi;t−1 þ β3 FRQi;t−1 3 IFRSi;t−1 þ βn Xi;t−1 þ εi;t
InvEff i;t ¼ β0 þ β1 FRQi;t−1 þ β2 TAXi;t þ β3 FRQi;t 3 TAXi;t þ βn Xi;t i;t þ εi;t
(4)
(5)
Where Inefinvi;t is the dependent variable measuring investment inefficiency for firm i at year
t. We use two different proxies of the dependent variable. The first is based on a parametric
methodology defined as the absolute values of the residuals from the investment model
(Equation (1)), as described above. The second proxy is based on a non-parametric
methodology, namely, Data Envelopment Analysis (DEA). The dependent variable is the
inefficiency score. We use the (DEA) methodology to measure investment efficiency, as a
result of multiple input–outputs combinations. We choose the production approach,
pioneered by Beston (1965), who considers investment as a result of a combination of inputs,
such as sales growth, debt and human capital. We follow prior literature (Berger et al., 1996;
Wheelock and Wilson, 2000; Boubaker et al., 2018) and choose three inputs and two outputs
(Table 6). The inputs are sales growth, number of employees and leverage, while the outputs
Impact of FRQ
corporate
governance
and IFRS
EMJB
are two proxies of investment, namely, capital expenditures to total sales and total
investments to total sales. Thus, in the first step, we adopt the variable return to scales with
oriented output to measure the scores of investment inefficiency on a yearly basis.
In line with Boubaker et al. (2018), the second approach consists of examining whether
FRQ is negatively associated with the extent of investment inefficiency for firms that overinvest and under-invest. To test our hypotheses H2, H3 and H4, we add the interaction effects
of corporate Gov index, tax and IFRS with FRQ measures. To do this, we estimate model (2)
for both groups of firms: over-investment groups (with positive residuals) and underinvestment (with negative residuals). The dependent variable is defined differently than the
previous model and corresponds either to the positive residuals obtained from the investment
efficiency model (Equation (1)), or to the absolute value of the negative residuals.
3.2 Proxy for financial reporting quality (FRQ)
In the financial and accounting literature, there are several models to estimate FRQ and no
model is superior to others (Dechow et al., 2010). According to Francis et al. (2005), FRQ
measures can be divided into two groups: market-based measures and accounting-based
measures. In this study, we employ three accounting proxies of FRQ that have been used
extensively in the prior research (Houcine, 2017; Boubaker et al., 2018). These measures relate
to accruals quality and are based on the idea that “accruals are estimators of future cash flow,
and earnings will be more predictive of future cash flows when there is lower estimation error
embedded in the accruals process” Biddle et al. (2009), p. 116.
The first measure is obtained from the performance-matched accruals model proposed by
Khothari et al. (2005). Specifically, we use the following model:
1
þ β2 ΔRevi;t þ β3 PPEi;t þ β4 ROAi;t þ εi;t
(6)
TAccri;t ¼ β0 þ β1
assetsi;t−1
Where TAccri;t is total accruals, ΔRevi;t is the annual change in revenues, PPEi;t is the value of
tangible fixed assets, ROAi;t is return on assets and εi;t represents the discretionary accruals.
Following Chen et al. (2011), all variables except ROA are scaled by lagged total assets. In this
paper, we use the absolute value of discretionary accruals as a proxy of FRQ and multiply it
by (1), so a higher value reflects higher FRQ.
The second proxy of FRQ is based on discretionary revenues developed by McNichols and
Stubben (2008):
ΔARi;t ¼ β0 þ β1 ΔRevi;t þ εi;t
(7)
Where ΔARi;t is the annual change in accounts receivable, and ΔRevi;t represents the annual
change in revenues. All terms are deflated by lagged total assets. The residuals for equation
(3) capture the discretionary revenues. Using the same methodology as the last model, FRQ is
equal to the absolute value of the residuals multiplied by (1). Thus, a higher value
represents higher FRQ.
Our last measure is accrual quality based on the Dechow and Dichev (2002) model, as
modified by McNichols and Francis et al. (2005). According to Houcine (2017), this measure
relies on the idea that earnings that map more closely into cash flow are more desirable. In this
study, we use the following regression:
TCAccri;t ¼ β0 þ β1 CFOi;t−1 þ β2 CFOi;t þ β3 CFOi;tþ1 þ β4 ΔRevi;t þ β5 PPEi;t þ εi;t (8)
Where TCAccri;t represents total current accruals calculated as the difference between
the annual change in non-cash current assets and the annual change in current noninterest-bearing liabilities, CFOi;t−1, CFOi;t and CFOi;tþ1 are the cash flow from operations for
years t1, t and tþ1 respectively, ΔRevi;t is the annual change in revenues from year t1 to
year t, PPEi;t is the value of tangible fixed assets and εi;t represent the estimation error.
Accruals quality is computed as the absolute value of the residuals multiplied by (1).
Consequently, a higher value of the residuals indicates higher FRQ.
Following Houcine (2017), we calculate an aggregate measure for FRQ based on the
methodology of Biddle and Hilary (2006) by adding three binary variables depending on
whether DISACC, ACCRQUA and DISCREV, have a better value than the median value in the
cross-sectional sample.
3.3 Other explanatory variables
3.3.1 Proxy for corporate governance index (CGI). To test hypothesis 2, we construct a
corporate governance index. Several measures and various indexes of corporate governance
have been developed in the financial literature (e.g., Gompers et al., 2003). Based on the
previous studies and international benchmarks (e.g., corporate governance principles of
OECD), we develop a multidimensional measure of governance index that contains 30 items
related to board directors, shareholder rights, disclosure and transparency (see Appendix).
The corporate governance index (CGI) adopted in this study is calculated by employing the
content analysis technique using the information provided by the annual reports of firms. We
construct an unweighted index by using the dichotomous method, which is the most
commonly used approach by previous literature (Beiner et al., 2006; Garay and Gonzalez,
2008; Gompers et al., 2003). For each item, the score is 1 if the firm follows this procedure or
discloses the information and 0 otherwise. The score for each firm and for each dimension of
CGI is computed as follows:
Pnj
Xij 3 100
CGIj ¼ i¼1
nj
Where CGIj represents the corporate governance index for firm j and ranges from 0 to 100, Xij
is the score for each item and varies between 0 and 1 and nj is the number of total items. The
higher the score for a firm, the more well-governed the firm is deemed to be.
3.3.2 IFRS and tax burden variables. To test hypotheses 3 and 4, we use indicator variables
to capture IFRS implementation and tax burden. IFRS is mandatory in the consolidated
accounts of French listed companies since 2005 and it takes a value of 1 if the company
applies IFRS, 0 if not. Following Chen et al. (2011), our measure of tax pressure refers to
managers’ perceptions of whether tax rates impose a major or serious impediment to business
operations and growth. We use an indicator variable that takes a value of 1 when the
corporate tax rate is higher than the median corporate tax rate in the cross-sectional sample,
and 0 otherwise.
3.3.3 Control variables. Following previous literature, (e.g., Biddle et al., 2009; Houcine,
2017, Boubaker et al., 2018, etc), we include in our models a set of firms’ characteristics to
explain the change in a firm’s investment efficiency. The control variables comprise firm size,
firm age, financial slack, asset tangibility and external audit quality.
In the financial literature, several variables are related to the size of the firm: market
capitalization, turnover, total assets, total sales. In our study, we choose total assets (Chen
et al., 2011; Soleimany and Farshi, 2012) and introduce the natural logarithm of total assets in
the models. Company age, which is an indicator of the life cycle of company and measured as
the logarithm of the number of years of practice (Brown and Caylor, 2006; Ben Cheikh and
Zarai, 2008). The third variable is related to financial slack. It reflects the extra money that the
business has in case of declining sales, income, or profits. It is the equivalent of a company’s
savings. Some studies have shown that slack allows the company not only to adapt to internal
pressures, but also to adopt to fluctuations in its environment (Bourgeois, 1981). The financial
slack equals the amount of cash the company has divided by total assets. We also include the
Impact of FRQ
corporate
governance
and IFRS
EMJB
tangibility assets which are measured as the company’s tangible capital assets divided by
total assets. Finally, the effect of audit quality is included, which could have an effect on
investment efficiency. Audit quality is proxied by the presence of an independent auditor.
The independence of the auditor is measured as the amount of fees. If the amount of these fees
is published, we assign 1, if not 0.
3.4 Variables measurement
Table 1 (Panel A) presents a summary of the measures of all the variables of the different
models and Panel B shows the inputs and outputs adopted for the efficiency score.
Variables
Label
Measure
(Panel A): presents a summary of the measures of all the variables of the different models
Investment
INVEST
A measure of total investment proxied by total PPE and research
and development expenditures minus sale of fixed assets scaled by
lagged total assets
Overinvestment
OVI
The positive residuals of the investment model
Underinvestment UNDI
The negative residuals for the investment model
Sales Growth
Growth
A proxy of sales growth calculated as the change in sales for firm I
in year t–1 scaled by lagged total assets
DISACCR
Discretionary
The measure of accruals quality derived from the performanceaccruals
matched model proposed by Khothari et al. (2005)
ACCRQUA
Accruals quality
The measure of accruals quality derived from Dechow and Dichev
(2002) model, as modified by McNichols
DISCREV
Discretionary
A proxy of discretionary revenues developed by McNichols and
revenue
Stubben (2008)
AGR
Aggregate
A proxy for the three FRQ measures into a summary index,
measure
calculated through a simple methodology of Biddle and Hilary
(2006) by summing three binary variables based on whether
DISACC, ACCRQUA and DISCREV, have a better value than the
median value in the cross-sectional sample
GOVINDX
Governance index
The corporate governance index calculated by employing the
content analysis technique using the information provided by the
annual reports of firms and constructed as an unweighted index
using the dichotomous method. For each item, the score is 1 if the
firm follows this procedure or discloses the information and
0 otherwise
IFRS
IFRS
IFRS represents a binary variable, which takes the value one if the
companies apply the IFRS, zero if not
TAX
TAX
Tax is a dichotomous variable that takes the value 1 when the
corporate tax rate is higher than the average corporate tax rate, and
takes the value of zero otherwise
SIZE
Firm size
SIZE is the natural logarithm of total assets
AGE
Firm age
Age is measured as the logarithm of the number of years of practice
SLACK
Financial slack
Slack is the ratio of cash balance and short-term investment lagged
by total assets
TANG
Tangibility ratio
Tangibility is the total capital assets lagged by total assets
AUDIT
Audit quality
AUDIT quality is an indicator variable that takes the value 1 if the
amount of audit fees is published and zero, otherwise
Table 1.
Variables’ definition
Inputs
Outputs
(Panel B): Inputs and outputs adopted for the efficiency measure
Sales growth
Number of employees
Debt/total assets
expenditure/total sales
Total investment/total sales
4. Empirical analysis
4.1 Sample selection
Our sample is an unbalanced Panel of 125 French firms belonging to the CAC All-Tradable
index. The data spans a ten-year period from 2008 to 2017. We chose 2008 as a starting date to
examine the aftermath of the IFRS adoption by French listed firms (2005) and the
implementation of the Financial Security Law (2003), which greatly impacted the corporate
governance practices in France, as well as the consequence of the 2007 Global Financial Crisis
2007 on firms’ investment.
To ensure greater homogeneity in the sample, we limit our analysis to non-financial
companies (industries, distribution, automobile, raw materials, air transport and
telecommunication). Financial companies are excluded because of the different nature of
their investments, the specific characteristics of the structure of their assets and liabilities and
the nature of their accruals, as well as due to the different regulations to which they are
subject. Following Boubaker et al. (2018), we also eliminate companies that report information
for fewer than five consecutive years and those that do not disclose information on
investment such as capital expenditures and research and development expenditures. These
selection criteria led us to reduce the initial sample of 250 companies to a final sample of 125
companies. The accounting and financial data are from Worldscope. Data on corporate
governance were hand-collected from annual reports retrieved from the AMF website and
specific firm websites
Impact of FRQ
corporate
governance
and IFRS
4.2 Descriptive statistics
Table 2 reports the descriptive statistics for the dependent and explanatory variables.
Table 2 reports the descriptive statistics for the dependent, explanatory and control
variables described above. On average, capital investment (INVST) across all firm-years
equals 27%, and nearly 33% of firms overinvest, while only 2% of firms underinvest. This
preliminary result shows that firms in our sample tend to over-invest rather than underinvest. We can explain this result by the tendency of managers to expropriate existing
resources when there is an excess of funds, preferring investing even in projects with
negative present value to maximize their personal welfare. However, based on the mean value
(1.70) of firm age, we notice that firms are young and, therefore, still have not reached
maturity to generate excess liquidity. So, we rather attribute the overinvestment to the poor
Variables
INVEST
OVI
UNDI
GROWTH
DISACC
ACCRQUA
DISCREV
AGR
GOV
IFRS
TAX
SIZE
AGE
SLACK
TANG
AUDIT
N
Mean
Std. Dev
P25
P75
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
1,250
26.8
32.86
0.021
2.007
0.045
0.0654
6243.01
6499
0.705
0.66
0.656
5.62
1.69
0.132
0.461
0.889
27,96
3.79
0.057
10.17
0.461
0.293
6509.108
6509.184
0.131
0.47
0.473
0.119
0.42
0.145
0.374
0.342
0
25,39
0.001
30.8
0.068
0.875
138821
138821
0.2
0
0
14.72
1.38
0.005
0
0
437,02
28.72
0.003
3.43
9.336
3.959
3,977
3,990
1.1
1
1
25.47
1.91
0.61
0.735
1
Table 2.
Descriptive statistics
EMJB
project selection process. Concerning the accruals quality proxies, discretionary revenues
(DISCREV) have the lowest average compared to the two other proxies. For instance,
Accruals quality and discretionary accruals have respectively a mean value of 0.065 and
0.045. This level is much higher than that found by Garcia-Teruel et al. (2009) for Spanish
firms (0.0144) and by Francis et al. (2008) for US firms (0.0159), meaning that on average,
French firms have higher FRQ, which could positively impact investment efficiency. It
appears that 66% of French firms have adopted IFRS, which could explain the better quality
of their accruals compared to firms in other countries. In addition, 65% of firms pay a high tax
rate and 89% of the French firms are audited by one of the Big 4 auditors. Concerning the rest
of the explanatory variables, the mean value of firm size is 5.62, meaning that French firms
are on average smaller compared to the Belgian firms (9.2) as stated in Bauwhede et al. (2015)
and slightly larger than the Italian firms (4.064) as stated in Beltrame et al. (2017). This finding
confirms that French firms in our sample have not yet reached maturity. The mean value of
financial slack ratio is 0.15; this ratio is largely below the ratio (1.35) found by Carmo et al.
(2016) for Portuguese firms, meaning that French firms do not have excess liquidity.
Compared to Belgian firms in Bauwhede et al. (2015) or Italian firms in Beltrame et al. (2017),
French firms have substantial tangibility assets, meaning that they invest a lot in capital
assets.
4.3 Multivariate Analyses
The analysis of the relationship between FRQ and investment efficiency is based on the
estimation of Equation (2). Following Boubaker et al. (2018), we use two proxies for the
dependent variables: a non-parametric one based on the DEA approach, and a parametric one
based on the absolute values of the residuals extracted from the firms’ investment model
(Equation 1). We use cross-sectional time-series regressions and the fixed effects model has
been excluded, since the model includes time invariant variables (IFRS and Tax). The
Lagrange multiplier test for random effect is first performed to determine which model is
used: the random effect or pooled regression. The Lagrange multiplier test retained the pooled
regression. To test for Heteroscedasticity and autocorrelation problems, we performed
respectively the Breusch–Pagan and Durbin Watson tests. The result of the two tests shows
the presence of heteroscedasticity and the absence of autocorrelation. In order to solve the
heteroscedasticity problem, we use FGLS regressions.
4.3.1 Empirical results of the non-parametric approach. Table 3 reports the results for FRQinvestment efficiency relationship using the non-parametric approach. The estimated
Variables
Table 3.
FRQ-investment
efficiency relationship
using the nonparametric approach
Constant
FRQ
SIZE
Slack
AGE
AUDIT
TANG
p > χ2
L M test
Breusch
Bagan
DW
DisACC
Coef
DisRev
Coef
z
Accrquality
Coef
z
AGR
Coef
z
9.953**
0.017
0.469*** 0.006
0.191**
0.019
0.178
0.115
0.059*
0.056
0.207**
0.027
0.019
0.221
0.000
1.000
0.000
14.62*
0.067
0.092*
0.058
0.204** 0.012
0.848
0.144
0.009*
0.063
0.474*
0.054
0.025
0.215
0.000
1.000
0.0170
20.958** 0.017
0.542** 0.002
0.115** 0.012
0.496
0.717
0.006
0.146
0.261
0.031**
0.058
0.09
0.000
1.000
0.000
9.108** 0.073
0.243*
0.091
0.531
0.12
0.963
0.176
0.047
0.416
0.621
0.134
0.015
0.429
0.000
1.000
0.000
1.008
1.972
1.031
1.001
coefficients on FRQ are significantly negative across all test specifications, which indicates
that a better FRQ decreases the inefficiency of investment. This result also suggests that
firms with better FRQ are less likely to engage in earnings management, which improves
investment efficiency since it is based on more reliable financial information. A comparison of
the size of the estimated coefficients on FRQ indicates that the coefficients on DisAcc and
AccQuality is four times that of DisRev. More precisely, investment inefficiency decreases by
46.9, 54.25 and 9.2% when DisAcc, Accquality and DisRev increase respectively by one-point.
This finding means that DisAcc and AccQuality capture a more forward-looking aspect of
FRQ and exerts more control over management’s investment decisions. Overall, the results
support previous studies examining the economic consequences of FRQ (Biddle et al., 2009;
Chen et al., 2011, etc), and indicate that FRQ affects managerial investment decisions and that
one important benefit from having a better FRQ is improving investment decisions, through
mitigating information friction that may undermine investment efficiency.
As for control variables, we find that the coefficient on firm size is negative and
significant, meaning that large firms have probably implemented better internal control
systems and higher levels of governance mechanisms, which improves the efficiency of their
investments. The coefficient associated with audit quality is negative and significant too.
This finding indicates that auditor’s independence is more likely to curb managerial valuedestroying activities. However, the coefficient on AGE is partially significantly negative,
meaning that aged companies arrived at maturity and are no longer concerned with the
optimal allocation of capital. The coefficients on SLACK and TANG are negative but not
significant, meaning that cash holdings and tangibility do not affect investment decisions
for our sample of firms.
Table 4 reports the results for the incremental effect of corporate governance, IFRS
implementation and tax burden on FRQ-investment efficiency relationship. As before, the
main effect of FRQ is yet again significantly negative across all test specifications. A
comparison of the size of the coefficients associated with FRQ indicates that the coefficient on
DisAcc and AccQuality continues to have a greater value than that of DisRev.
Variables
Constant
FRQ
GOV
FRQ*GOV
IFRS
FRQ*IFRS
TAX
FRQ*TAX
SIZE
Slack
AGE
AUDIT
TANG
p > χ2
L M test
Breusch
Bagan
DW
DisACC
Coef
19.953***
0.491***
0.625***
0.647***
0.316**
0.524*
0.0009
0.048**
0.226*
0.107
0.195*
0.157*
0.093
0.000
1.000
0.000
1.010
z
0.007
0.002
0.003
0.005
0.037
0.015
0.112
0.020
0.077
0.195
0.056
0.023
0.122
DisRev
Coef
z
16.42*** 0.004
0.141** 0.091
0.416*
0.053
0.264*
0.059
0.188*
0.057
0.231** 0.025
0.006
0.155
0.058*
0.081
0.168*
0.058
0.418
–0.144
0.137*
0.063
0.127*
0.054
0.059
0.152
0.000
1.000
0.0170
1.191
Accrquality
Coef
z
23.198***
0.532***
0.611**
–0.636***
0.679**
0.595**
0.001
0.059**
0.102**
0.24
0.164**
0.164**
0.081
0.000
1.000
0.000
1.134
0.009
0.001
0.045
0.004
0.039
0.001
0.134
0.019
0.043
0.71
0.014
0.031
0.269
Impact of FRQ
corporate
governance
and IFRS
AGR
Coef
z
15.381
0.007
0.238** 0.048
0.471** 0.038
0.356** 0.029
0.249*
0.086
0.446** 0.039
0.006
0.458
0.038*
0.078
0.192*
0.085
0.184
0.568
0.091** 0.078
0.134** 0.026
0.114
0.137
0.000
1.000
0.001
1.169
Table 4.
The conditional effect
of corporate
governance, IFRS
implantation and tax
burden on FRQ–
investment efficiency
relationship using the
non-parametric
approach
EMJB
Turning to the estimated coefficients associated with CGI, all are negative across all test
specifications, meaning that a better CGI enhances investment efficiency. This result is also
economically important in that, ceteris paribus, investment inefficiency decreases by 62.5,
25.6 and 61.1% with a one-point increase in the CGI associated with, respectively DisAcc,
Accquality and DisRev. A possible explanation is that the French context is characterized by
a low level of antitakeover laws and therefore corporate governance becomes a more effective
disciplining device to curb managerial value-destroying activities. When we turn our
attention to the estimated coefficients on FRQ*CGI, they continue to be significantly negative
across all test specifications. We note that the economic significance of FRQ is more
pronounced by the inclusion of CGI. For instance, investment inefficiency decreases by 49.1
versus 64.7% with respectively a one-point increase in Discracc and Discr*CGI. This finding
means that the decrease in investment inefficiency with corporate governance is greater. This
result indicates that better corporate governance leads to improved FRQ, thereby
strengthening its monitoring role in mitigating inefficient investment decisions, and
facilitating efficient resource allocation decisions.
Turning to IFRS, all estimated coefficients are significantly negative, as well as the
estimated coefficient FRQ*IFRS that is significantly negative. We note that the inclusion of
this variable improved the economic significance of FRQ in that, ceteris paribus, investment
inefficiency decreases by 52.4, 23.1 and 59.9% with a one-point increase in the IFRQ*IFRS
associated with, respectively DisAcc, Accquality and DisRev. This finding means that the
increase in investment efficiency with IFRS is greater. This result suggests that the
importance of FRQ in mitigating inefficient investments is increasing in the presence of IFRS,
which is consistent with the fact that IFRS alleviates information asymmetry and increases
the utility of accounting information.
Regarding tax burden effect, the results show a non-significant coefficient for the tax
variable, which means that tax burden does not affect investment efficiency. However, contrary
to our prediction, the coefficient on the interaction term between FRQ and tax is negative and
significant, but very low in terms of economic significance. This finding is opposed to the
previous literature, suggesting that tax conformity does not distort investment decisions
(Cummins et al., 1994) and fiscal motivations do not undermine investment efficiency.
4.3.2 Empirical results of the parametric approach. Table 5 (Panels A and B) reports the
results across overinvestment and underinvestment groups for our first hypothesis H1. The
results of the estimation show a negative association between FRQ and overinvestment, but
only discretionary accruals are significant, meaning that only this measure of FRQ captures a
more forward-looking aspect of FRQ and exerts a monitoring role over managers “decisions.
This finding suggests that the discretionary accruals metric affects managers” investment
decisions and that one important benefit from having high accruals quality is decreasing
overinvestment, through mitigating information friction, which may hamper investment
efficiency. This result is also economically important in that, ceteris paribus, overinvestment
decreases by 34.1% when DisACC increases by one-point.
Otherwise, a credible interpretation of the meaninglessness of the variable measuring
accruals quality derived from Dechow and Dichev (2002) and that of discretionary revenues
developed by McNichols and Stubben (2008), is that these variables do not reliably capture
high accruals quality.
As for control variables, we find that the coefficient on firm size is negative and
statistically significant for all specification tests, meaning that larger firms do not seek to
overinvest. This result is consistent with prior research (Houcine, 2017; Boubaker et al., 2018,
etc.). Asset tangibility is positively correlated with overinvestment, which suggests that firms
with more tangible assets are more mature and tend to overinvest. Firm age, financial slack
and external audit, are not statistically significant, indicating that these variables do not
impact overinvestment for French firms.
Variables
DisACC
Coefficient
z
Overinvestment
DisRev
Accrquality
Coefficient
z
Coefficient
z
(Panel A) Investment Efficiency–FRQ relationship across over-invest groups
Constant
13.461**
0.032 12.175** 0.012 13.116** 0.030
FRQ
0.341*** 0.001
0.623
0.69
0.158
0.008
SIZE
0.181**
0.036
0.061*
0.089
0.108** 0.025
Age
0.006
0.411
0.003
0.231
0.012
0.136
Slack
0.12
0.246
0.055
0.487
0.119
1.061
Audit
0.082
0.418
0.031
0.14
0.03
0.17
TANG
0.037**
0.021
0.031**
0.018
0.031**
0.023
0.000
0.000
0.000
p > χ2
L M test
1.000
1.000
1.000
Breush
0.000
0.000
0.000
Bagan
DW
2.030
2.86
2.51
Variables
DISCACC
Coef
z
Underinvestment
DISCREV
Coef
z
ACCRQUA
Coef
z
(Panel B) investment efficiency–FRQ relationship across under-invest group
Constant
0.301**
0.019
0.296** 0.027 0.13**
0.016
FRQ
0.584
0.108
0.231
0.115 0.581
0.697
SIZE
0.006**
0.027
0.042** 0.036 0.02**
0.031
Age
0.004
0.719
0.001
0.516
0.002
0.329
Slack
0.005
1.13
0.028
0.88
0.002
0.15
Audit
0.006
0.701
0.019
0.318 0.013
0.341
0.023*** 0.028** 0.051** 0.013 0.021** 0.017
TANG
0.000
0.012
0.000
p > χ2
L M test
0.000
0.1946
1.000
Breush
0.000
0.000
0.000
Bagan
DW
1.35
2.08
2.08
AGR
Coefficient
z
Impact of FRQ
corporate
governance
and IFRS
23.195*
0.097
0.216
0.46
0.599**
0.019
0.8
0.71
0.103
0.431
0.661
0.146
0.026**
0.031
0.000
1.000
0.000
1.003
AGGR
Coef
z
0.290**
0.027
0.179
0.418
0.042*** 0.003
0.001
0.529
0.022
0.881
0.015
0.318
0.054**
0.027
0.012
1.1946
0.000
2.08
Table 5 (Panel B) reports the results for our firms’ Panel that underinvest. The results show a
non-significant negative association between FRQ and underinvestment for all test
specifications, meaning that FRQ does not reduce information asymmetry and thus
underinvestment problems for our sample of French firms. This finding supports the result of
Houcine (2017) for a sample of Tunisian listed firms. This result could be explained by the fact
that in a code-law country, creditors and investors rely more on private information than
public information to reduce the information asymmetry problem. Especially in France, bank
loans are the main financing source and loan granting is based on informal and personal
relationships, resulting in more information being conveyed through private channels to
decrease the cost of debt and consequently to reduce the underinvestment problem.
As for control variables, the coefficients for firm size and tangibility are negative and
significant. This finding indicates that larger firms have a higher proportion of tangible
assets that imply a higher firm liquidation value, which could reduce the cost of capital and
thus the underinvestment problems. For the other control variables, financial slack, firm age
and audit are not significant, meaning that they do not affect underinvestment.
Table 6 (Panels A and B) report the results for the incremental effect of corporate
governance, IFRS implementation and Tax burden on the relation between FRQ and
overinvestment/ underinvestment.
Table 5.
FRQ-investment
efficiency relationship
across under and overinvest groups
EMJB
Variables
DisACC
Coef
z
OVER-INVESTMENT
DisRev
Accrquality
Coef
z
Coef
z
AGR
Coef
z
Panel A: The conditional effect of corporate governance, IFRS implantation and tax burden on the Relation
between FRQ and overinvestment based on the DEA approach
Constant
9.822*** 0.007 12.85*** 0.002 12.361*** 0.009 8.745*** 0.007
FRQ
0.278*** 0.004
0.096** 0.047
0.132**
0.033 0.067*
0.074
GOV
0.410***
0.003
0.136**
0.045
0.316**
0.029
0.316**
0.028
FRQ*GOV
0.485*** 0.004
0.051*
0.052
0.103*** 0.002 0.017**
0.026
IFRS
0.310**
0.031
0.137*
0.058
0.328*** 0.006 0.318*
0.088
FRQ*IFRS
0.385*** 0.004
0.156** 0.047
0.413*** 0.002 0.146**
0.017
0.026
0.096*
0.061
0.034**
0.012 0.067**
0.011
TAX
0.018**
FRQ*TAX
0.032**
0.025
0.001*
0.063
0.021**
0.036 0.005**
0.031
SIZE
0.014**
0.040
0.016** 0.011
0.022**
0.021 0.019**
0.014
Slack
0.152
0.652
0.146
0.621
0.204
0.856 0.169
0.241
AGE
0.428
1.312
0.444
1.341
0.480
1.427 0.341
1.462
AUDIT
0.072
0.162
0.126
0.276
1.131
0.281 0.261
0.071
0.018
0.031*
0.090
0.081**
0.049 0.015*
0.079
TANG
0.032**
0.000
0.000
0.000
0.000
p > χ2
L M test
1.000
1.000
1.000
1.000
Breusch
0.0036
0.0170
0.0135
0.0153
Bagan
DW
2.017
1.972
2.007
1.729
Variables
Table 6.
The conditional effect
of corporate
governance, IFRS
implantation and tax
burden on FRQ –
investment efficiency
relationship across
under and over-invest
groups
DisACC
Coef
z
UNDER-INVESTMENT
DisRev
Accrquality
Coef
z
Coef
z
AGR
Coef
z
Panel B: The conditional effect of corporate governance, IFRS implantation and tax burden on the relation
between FRQ and underinvestment based on the DEA approach
Constant
0.125
0.047** 0.627** 0.047
0.237*** 0.008
0.372*
0.074
FRQ
0.441
0.85
0.010
0.461
0.112
0.300
0.109
0.641
GOV
0.981
0.253
0.793
0.469
0.032
0.813
0.931
0.638
FRQ*GOV 0.019** 0.046
0.012*
0.063
0.029**
0.026
0.025** 0.039
IFRS
0.098
0.025** 0.091*
0.069
0.032**
0.019
0.038** 0.049
FRQ*IFRS 0.099
0.036** 0.001** 0.046
0.029**
0.022
0.071*
0.061
0.196
0.435
0.151
0.180
0.163
0.348
TAX
0.134
0.147
FRQ*TAX 0.148
0.721
0.034
0.458
0.106
0.274
0.305
0.549
SIZE
0.030** 0.041
0.0317
0.062*
0.045
0.013**
0.016**
0.046*
Slack
0.011
0.105
0.007
0.161
0.007
0.108
0.013
0.137
AGE
0.154
0.51
0.143
0.104
0.152
0.148
0.139
1.123
AUDIT
0.055
0.391
0.056
0.409
0.057
0.479
0.064
0.486
TANG
0.006
0.061*
0.008*
0.087
0.013**
0.012
0.087*
0.058
0.0006
0.007
0.0165
0.0094
p > χ2
L M test
1.000
1.000
1.000
1.000
Breusch
0.000
0.000
0.000
0.000
Bagan
DW
2.0385
2.0351
2.0498
2.0938
For overinvestment group, we first note that, after controlling for corporate governance, all
FRQ measures become negative and significant at the 1% level. The inclusion of CGI improves
the significance of FRQ. This result is also economically important in that, ceteris paribus,
overinvestment decreases by 27.8, 9.6 and 13.2% when DisAcc, DisRev and Accquality
increase respectively by one-point. We also notice that DisAcc has the greatest effect in
reducing overinvestment. The main effect of corporate governance index is positive and
significant, suggesting that better corporate governance increases investment expenditure
across overinvestment firms. Our focus, however, is on FRQ3GOV, where we observe a
negative coefficient for all test specifications and note that DiscAcc continue to have the
greatest effect in reducing overinvestment. The result is also economically important in that,
ceteris paribus, overinvestment decreases by 48.5, 5.1 and 10.3% with a one-point increase in
the CGI associated with, respectively DisAcc, DisRev and Accquality. Overall, the results
suggest that the importance of FRQ is increasing in the presence of better corporate
governance, which is consistent with the fact that FRQ and corporate governance represent
monitoring tools to reduce the information asymmetry and agency costs.
Regarding IFRS, the main effect of the IFRS variable is negative and significant for all test
specifications and economically important. For instance, overinvestment decreases by 31,
13.7 and 32,8% when DisAcc, DisRev and Accquality increase respectively by one-point.
We emphasize, however, on the interaction FRQ*IFRS, which is significantly negative and
economically important. Indeed, overinvestment decreases by 38.5, 15.6 and 41.3% when
DisAcc, DisRev and Accquality increase respectively by one-point. The inclusion of IFRS
improves the significance of FRQ, which means that the importance of FRQ in mitigating
overinvestment is increasing in the presence of IFRS. This result indicates that IFRS
alleviates information asymmetry and increases the usefulness of accounting information.
For tax burden effect, the main effect of FRQ is negative and significant, and contrary to
our prediction, we observe coefficients on the interaction terms FRQ*Tax that are negative
for all FRQ proxies. This result is opposite to our prediction that the role of FRQ in mitigating
the problem of overinvestment is reduced when the incentives of companies are mainly
focused on reducing taxes. The findings are contrary to the previous literature that tax
conformity may distort investment decisions (Cummins et al., 1994) and that fiscal
motivations undermine the usefulness of accounting information (Atwood et al., 2010; Chen
et al., 2011). We can explain this result by the fact that French companies are more involved in
attracting investors and are encouraged to signal to banks that they are in a good financial
position to obtain good-priced funds, which would discourage firms to manipulate earnings
for tax purposes.
The control variables, continue to load the same signs.
For underinvestment group, the results show mixed evidence. We first note that the main
effect of FRQ continues to be insignificant for all test specifications and the main effect of
corporate governance turns out to be not significant. This finding means that no effective
corporate governance mechanisms can help to mitigate underinvestment problems. Our
focus, however, is on FRQ3GOV, where we observe a significantly negative coefficient for all
test specifications. This result indicates that the importance of FRQ is increasing in the
presence of better corporate governance, providing evidence that FRQ and corporate
governance represent complementary monitoring tools to reduce information asymmetry.
For IFRS effect, the estimated coefficient is significantly negative for all test specifications,
and the main effect of the interaction FRQ3IFRS is also significantly negative. However, the
economic impact is low. This result indicates that the importance of FRQ in mitigating
underinvestment problem increases with IFRS. Overall, the findings support previous
literature (Biddle et al., 2016; Gao and Sidhu, 2018) that the association between FRQ and
investment efficiency remains after the adoption of IFRS, which is considered to reduce
information asymmetry and increase financial transparency.
For tax burden, the coefficient is negative and not significant, as well as, for the interaction
variable. One explanation of this result is that French companies are more involved in
attracting investors and are encouraged to signal to banks that they are in a good financial
position to obtain good-priced funds, which would discourage firms to manipulate earnings
for tax purposes.
The control variables, continue to load the same signs
Impact of FRQ
corporate
governance
and IFRS
EMJB
5. Sensitivity analysis
Our tests are based on the premise that FRQ affects investment efficiency. However, one
potential concern in this study is that the observed results could be driven by a reverse
causality problem. Indeed, firms with better investment efficiency may have more incentives
to disclose high-quality information. We take into account such endogeneity problem to
establish causality in this line of research, but we are unaware of theory suggesting a such
reverse relation. We consider a two-stage least squares model to model cross-sectional
variation in FRQ. Untabulated results show that no inferences are affected after controlling
for potential endogeneity of FRQ through this two-stage estimation.
Untabulated results also show that the results remain unchanged by using a parametric
approach in estimating investment inefficiency.
6. Conclusion
The empirical literature of investment efficiency supports the view that FRQ plays a
significant role in improving investment efficiency by reducing information asymmetries and
agency problems. In this paper, we investigate this relation in a setting of a code-law country
where FRQ may not have the same effect on investment efficiency. We extend previous
research by introducing new factors that may alter this relation. Using three proxies for FRQ
for both underinvestment and overinvestment scenarios, this research examines the effect of
corporate governance mechanisms, IFRS adoption and tax purposes on the relation between
FRQ and investment efficiency.
The results show mixed conclusions. The findings show that firms with better FRQ invest
more efficiently than others, and are less inclined to over-invest. This result appears robust to
our measures of investment efficiency and indicates that FRQ has an impact on managerial
investment decisions through reducing agency costs and asymmetric information. However,
the findings reveal that FRQ does not impact underinvestment, which suggests that in a codelaw country, the informal and personal relations, tend to replace the role of financial reporting
in reducing information asymmetry
Our results continue to hold after controlling for other factors that may affect the
association between FRQ and investment efficiency. We find that the effect of FRQ on
investment efficiency is increasing with better corporate governance which alleviates agency
problems and allows more efficient investment decision. The results also show that the
relation between FRQ and investment efficiency is stronger for firms that have implemented
IFRS. Finally, unlike previous studies, the relation between FRQ and overinvestment
continues to be negative for firms that have more incentives to manage their earnings for tax
purposes.
The implications of this study can be of great interest to practitioners, such as managers
and regulators. For managers, it is important to know the factors that determine investment
efficiency to make better decisions. Firms are encouraged to increase the quality of
information disclosed, to implement best practices of corporate governance and IFRS, which
would increase financial transparency, and improve investment efficiency. Our results also
provide arguments for regulatory entities to enforce further reforms that improve best
practices for corporate governance and encourage adoption of IFRS, particularly in a
context where investors’ interests are less protected than in common law countries. These
reforms would help align the interests of managers and outside shareholders to promote
investment efficiency. Our findings are also useful for regulators in code-law countries
with an institutional environment similar to the French market and who intend to transit
to IFRS.
Our study has some limitations. First, we only examine listed firms belonging to the CAC
All-Tradable index, so our results may not be generalized to non-listed firms that are different
from listed firms in several respects, and which represent the vast majority of French
economic activity. Second, this research does not distinguish between governmental
companies and private companies. The two types of firms have different governance
mechanisms, financial reporting, disclosure environments and ownership concentration.
Third, we recognize that investment efficiency and FRQ proxies may suffer from
measurement error and there might be a causality between these variables. Extending this
research to test these interesting issues may prove fruitful. Moreover, we can extend our
research to other European countries by referring to countries with respectively Anglo-Saxon
and continental accounting models, and comparing the extent to which FRQ impacts a firm’s
investment efficiency.
Notes
1. This accounting principle means that the economic substance of transactions and events must be
recorded in the financial statements rather than just their legal form in order to present a true and fair
view of the affairs of the entity.
2. This accounting principle states that financial reports only need to include information that will be
significant (material) to their users, meaning that transaction which is of insignificance importance
should not be recorded.
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EMJB
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Appendix
Corporate governance index items:
Role of the board of directors:
(1) Does the company have its own written corporate governance rules?
(2) Does the board provide a code of ethics or a statement of the conduct activity for all directors
and employees?
(3) The board of directors assesses the quality and content of the audit committee report in the
annual report?
(4) Have board members participated in corporate governance training?
(5) Does the company have an option plan with incentives for senior management?
(6) Does the board appoint independent committees with independent members to perform a
variety of essential responsibilities such as: audit, compensation and appointment of directors?
(7) Does the company indicate in the annual report the definition of independence?
(8) Does the company offer training to directors (including executive directors)?
(9) Does the company disclose the remuneration of independent non-executive directors?
(10) Does the company indicate in the annual report the size of the board of directors?
Impact of FRQ
corporate
governance
and IFRS
EMJB
Shareholder rights:
(1) Does the shareholders participate in the meetings?
(2) Does they participate in the appointment of directors?
(3) Does the company offer other property rights beyond the vote?
(4) They exercise their voting rights personally where in absentia?
(5) The right to obtain information in a timely and regular manner relevant to society
(6) They participate in the authorization to issue new shares
(7) Rights to sell shares
(8) The Supervisory Board and the Executive Board are elected by the general meeting of
shareholders
(9) Is there a preferential subscription, right?
(10) The right to receive dividends
Disclosure of information:
(1) Disclosure of corporate governance practices
(2) Disclosure of audit fees
(3) Disclosure of Audit Committee Information
(4) Disclosure of Remuneration Information of the Board and Executive Members
(5) Disclosure of financial performance information
(6) Disclosure of competitive position information
(7) Disclosure of Operational Risk Information
(8) The channels of access to information
(9) The company has a website
(10) Disclosure of financial ratio
Corresponding author
Asma Houcine can be contacted at: asma.houcine@gmail.com
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