This paper investigates the effect of investment horizons of foreign
investors on the quality of accounting earning and the value relevance of
earning information. Previous domestic literatures have mostly used foreign
investors’ ownership as proxy for foreign investment. But recently, some
papers suggested that investment horizons of foreign investors are more
proper as the proxy of foreign investors than foreign investors’ ownership.
Chen et al.(2007) argue that all institute as investor face a cost-benefit
analysis of monitoring versus trading for the investment firm. As monitoring
costs decrease with the length of investment horizons in the firm and
monitoring benefits increase with it, they argue that long-term institutional
investors will specialize in monitoring and influencing efforts rather than
trading. Based on their argument, I expect the foreign investors’ monitoring need increases with their investment horizons. And there is a difference in
the goal of foreigners’ investment between short-term investment and
long-term investment. In general, investors focus on the internal value of
investment firm when they consider long-term investment. So my prediction
is that long-term foreign investors would have higher quality of accounting
earning.
The value relevance of accounting information has been considered an
important area of accounting research since the introduction of capital
market based accounting research by Ball and Brown(1968). Value relevance
studies examine the usefulness of accounting information by considering the
contemporaneous relationship between accounting information and the stock
price. More specifically, these studies examined the usefulness of main items
of financial statements by examining the size of R
2 and the significance of
regression coefficients from the information perspective (Barth et al. 1998;
Collins et al. 1999; Francis and Schipper 1999). However, these studies
typically assume market efficiency, firm characteristics and surrounding
factors are assumed as independent in the evaluation of stock prices,
because these factors reflect idiosyncratic risks. Recently, inconsistent with
the efficient market hypothesis (EMH), there have been frequent reports of
market anomalies, and thus, there has been a need for examining the value
relevance from the measurement perspective. If a market is not efficient,
then there exist information asymmetry and different levels of rationality
among investors, which in turn can lead to different results for the same
piece of information(Black 1986; Merton 1987). For these reasons, this study
analyzed relative usefulness of the earning information in terms of the
relationship of between the value relevance of earning information and
investment horizons of foreign investors. If investors appreciate and reflect
the difference in investment horizons of foreign investors in their decision
making, there would be the difference of the value relevance of earning
information according to investment horizons of foreign investors. So, my
prediction is that the longer the investment horizons of foreign investor, the
higher the value relevance of earning information.
On the other hand, previous overseas literature defines the portfolio
turnover ratio as the proxy variable of investment horizon of institutiona investors. The portfolio turnover ratio means how frequently an institutional
investors rotates his positions on all stocks of his portfolio, for any given
time. Prior studies characterize institutional investors in terms of their
portfolio turnover ratio. For example, short-term investors are defined as
those exhibiting a high portfolio turnover. But it is important to note that
portfolio turnover ratio is not based on the firm level but on the portfolio
level. So this paper uses the trading turnover ratio of foreign investors
suggested by Kim and Jang(2012) on each firm, not the portfolio turnover
ratio.
I analyzed whether the investment horizons of foreign investors affect the
quality of accounting earning that are measured by discretionary accrual(Ball
and Shivakumar, 2006) for 1,628 firm-year samples listed on Korean stock for
the 2008-2011 period. And I analyzed whether the investment horizons of
foreign investors affect at the extent to which stock prices reflected earning
information for 1,909 firm-year sample listed on Korean stock for the
2008-2011 period.
The results of the study are summarized as follows. Firstly, I find that
foreign investors’ ownership has significant positive relationship with the
quality of accounting earning without considering their investment horizons,
as in the previous literatures. But considering their investment horizons, I
find that he quality of accounting earning do not increase as foreign
investors’ ownership increases. To analyze the effect of the investment
horizons in more detail, I divide foreign investors into long-term investors
group and short-term investors group. I find that there is significant positive
relationship between foreign investors’ ownership and the quality of
accounting earning only for the long-term investor group. These empirical
results mean that the quality of accounting earning does not depend on the
ownership level of foreign investors but on their investment horizons.
Secondly, I analyze on the degree that the investment horizons of foreign
investors affect at the extent to which stock prices reflected earning
information. I find that the more investment horizons of foreign investors
increase, the more the degree of the value relevance of earning information
increase. On the other hand, these findings were supported by additional
analyses that used additional discretionary accruals(Dechow and Dichev, 2002; McNichols, 2002), that analysis used the sample is only made up firm that
has foreign investors’ ownership more than 3% high and is controled the
size of firm. Therefore, according to this study, a study on foreign investors
and accounting information should take into account their investment
horizons, and the previous literature without considering them has a limit.