20-F Reconciliations and Investors' Perceptions of Risk, Financial Performance, and Quality of Accounting Principles

Abstract

This paper investigates whether the increases and decreases to earnings and stockholders' equity presented in 20-F reconciliations influence perceptions of the risk of investing, the quality of the accounting principles, and the financial performance of the reporting firm. The research results indicate that subjects perceive the risk of a hypothetical firm filing a 20-F reconciliation with reconciliation decreases to be higher, and the quality of accounting principles lower, than a hypothetical firm either complying with U.S. GAAP or filing a 20-F reconciliation with reconciliation increases. Additional analysis suggests that these significant effects are due to a negative effect from the reconciliation decrease consistent with the effects predicted by attribute framing theory. The findings have implications for the SEC as they consider whether foreign registrants on U.S. exchanges should be allowed to comply with International Accounting Standards (IAS) without reconciliation to U.S. GAAP. These findings also have implications for foreign registrants on U.S. exchanges. The results indicate that firms that have higher non-U.S. GAAP earnings (and a consequent reconciliation decrease) should comply with U.S. GAAP as the reporting of a reconciliation decrease creates a negative perception of the firm.

20-F reconciliations and investment recommendations by financial professionals

“…These results are consistent with the effects predicted by attribute framing theory (Levin and Gaeth, 1988;Levin, Gaeth and Schneider, 1998;Levin, et al, 2002) and provide important insights into the impact of 20-F reconciliations on investment recommendations by financial professionals. In a further extension of Maroney and Ó hÓgartaigh (2005), these findings are also consistent with recent research studies (see e.g., Bradshaw, 2004;Jegadeesh et al, 2004) that have found that analysts' recommendations are based more on heuristics than on economic analyses.…”

“…Yates (1990) refers to framing as "variations in the presentation of a decision situation such that the decision maker constructs markedly different representations of that situation" (p. 361). Maroney and Ó hÓgartaigh (2005) find that the gains and losses represented in 20-F reconciliations differentially affect participants' (undergraduate and graduate accounting students) assessment of the quality of accounting principles and assessment of investment risk. Further, for participants most likely to invest in international stocks, assessments of financial performance were also lower in the case of reconciliation losses.…”

“…The current study contributes to the literature and significantly extends Maroney and Ó hÓgartaigh (2005) by examining investment decisions and recommendations routinely made by financial professionals. Given the importance of expertise and experience in financial decision-making (Slovic et al, 1972;Maines et al, 1997;Maines and McDaniel, 2000), the present study adds to our understanding of contemporary financial analysis as it assesses the potential for framing effects from the 20-F reconciliation on investment recommendations by financial professionals.…”

“…In a recent behavioral study, Maroney and Ó hÓgartaigh (2005) assessed the effects of 20-F reconciliation gains and losses on financial assessments of foreign registrants by individual non-professional investors. Maroney and Ó hÓgartaigh's (2005) findings were consistent with attribute framing theory and suggest that non-professional investors' perceptions of risk are significantly higher for a firm when it reports a reconciliation loss relative to when it reports a reconciliation gain or when it reports under U.S. GAAP. They also find that the perception of the quality of accounting principles is lower for a firm when it reports a reconciliation loss relative to when it reports a reconciliation gain or when it reports under U.S. GAAP.…”

Using Form 20-F reconciliations to internationalize an accounting course

“…The next question might be, ''what do you think this suggests about IFRS and US GAAP?' ' Maroney and Ó h Ó gartaigh (2005) found that when the reconciling items increased the reported income, investors perceived the non-US GAAP financial reporting principles to be of higher quality than when the reconciling items decreased reported income. The authors suggest that companies faced with incomedecreasing reconciling items may be better off filing their Form 20-F based upon US GAAP to avoid the negative framing issues associated with the reconciliation.…”