The document investigates how shareholder protection affects the relationship between accrual accounting and the value relevance of accounting measures across countries. It finds: 1) A higher use of accrual accounting negatively impacts the value relevance of accounting measures in countries with weak shareholder protection. 2) Strong shareholder protection attenuates the negative effect of accrual accounting on the value relevance of earnings. 3) Accrual accounting does not negatively affect earnings' value relevance in countries with strong shareholder protection.

1. ELSEVIER Journal of Accounting and Economics 30 (2001) 401--420
JOURNALOF
Accounting
&Economics
www.elsevier.com/locate/econbase
Accounting standards and value relevance of
financial statements: An international
analysis *
Mingyi Hung*
Leventhal Schuul uf"Accuuntin!J and M arshall Sdwul uf"Business, University uj"Suuthem Califumia,
Los Angeles, CA 90089-0441, USA
Accepted 19 April 200 I
Abslract
Using 17,743 finn-year observations of industrial companies in 21 countries from
199 1 to 1997, this paper finds that the use of accrual accounting (versus cash
accounting) negatively affects the value relevance of financial statements in countries
with weak shareholder protection. This negative effect, however, does not exist in
countries with strong shareholder protection. These findings are co nsistent with the
belief that shareholder protection improves the effectiveness of accrual accounting, and
suggest the importance of considering shareholder protection when formulating
accounting policies related to accruals. (G! 2001 Elsevier Science B.V. All rights reserved.
JEL classification: GIS; i141
Keyword 1.· International financial reporting; Accounting standards; Accrual accoun ting
* I am grateful to Jennifer Babcock, who not only provided indexes of global accounting
standards bul also shared many important insights lhat substamially contribuled to the paper. I
thank Paul Asquith, Paul Healy, S.P. Kothari, and G. Peter Wilson for their encouragement and
guidance. T also thank Charles Chen (the referee), Mark DeFond, Mary Ellen Carter, K.R.
Suhramanyam, Rohert Trezevan t, Rehecca Tsui, Vim Van der Stede, Eric Volff, Jerry
Zimmerman (the editor), and workshop participants at Bank of .Japan, Boston College, Emory
Universily, Massachusetts Institule of Technology, Tulane University. University of British
Columbia, Universily of Southern California. Waseda University, and the 2000 American
Accounting Association Annual Meeting.
*Tel.: - 1-213-740-7377; fax: - 1 -2 1 3-747-2~ 15.
E-1nail address: mingyih@usc.cdu (lvl. Hung).
Ol fiS-4101/01 /$ - see front matter (Q 2001 Elsevier Science B.V. All rights reserved.
PTT: S 0 1fi 5 - 4 1 0 1 (0 1) 0 0 0 1 1- R

2. 402 M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420
1. Introduction
This paper investigates the relation between accrual accounting and the
value relevance of accounting measures in countries with different levels of
shareholder protection. This issue is important because accrual accounting,
which transforms cash flows into earnings, is a key feature of any accounting
system. The study finds that stronger shareholder protection, an institutional
factor characterizing a country's corporate governance environment (La Porta
ct al., 2000), improves the effectiveness of the accrual system. This finding
suggests the importance of considering shareholder protection when formulat-
ing accounting policies related to accruals.
Accrual accounting provides hcttcr matching of revenues and expenses than
cash accounting and therefore makes accounting information more value
relevant. However, accrual accounting also presents more opportunities for
managers to manipulate accruals for personal gain and hence may cause
accounting information to be less value relevant. Consequently, an accounting
system mandating more accrual accounting (hereafter, referred to as 'a higher
use of accrual accounting') has offsetting effects on the value relevance of
accounting information.
I argue that managers are more likely to behave opportunistically in an
environment with weak shareholder protection (La Porta et al., 1997). Since a
higher usc of accrual accounting provides managers with more opportunities to
manage earnings and poor shareholder protection exacerbates this managerial
propensity, I predict that a higher use of accrual accounting negatively affects
the value relevance of accounting information in markets with weak
shareholder protection. In addition, since strong shareholder protection deters
managers from manipulating accruals, I predict that strong shareholder
protection will attenuate this negative impact.
Using 17,743 firm-year observations of industrial companies in 21
countries from 1991 to 1997, I test the impact of accrual accounting on the
value relevance of accounting numhcrs for countries with different levels
of shareholder protection. I measure a country's use of accrual accounting
by the frequency of accrual-related accounting standards and evaluate the
level of shareholder protection hy antidircctor rights and legal system
(La Porta et a!., 1996; Ball et a!., 2000a,b). Following prior studies, I define
the value relevance of financial statements as the ahility of accounting data to
summarize information impounded in market prices (Chang, 1998; Francis and
Schipper, 1999). As in Chang (1998), I focus on two summary accounting
performance measures from financial statements: earnings and return on equity
(R0 £).
1
1
This study docs not address operating cash flows because the usc of accrual accounting only
aft'ccts earnings, not cash flows.

3. M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420 401
Controlling for tax and financial reporting conformity, the study has three
primary findings. First, a higher usc of accrual accounting negatively a!Tccts the
value relevance of accounting measures for countries with weak shareholder
protection. Second, strong shareholder protection attenuates accrual account-
ing's negative effect on the value relevance of earnings. Finally, accrual
accounting does not negatively affect earnings' value relevance for countries
with strong shareholder protection.
My interpretation of the results depends on the assumption that price
formation is roughly the same across countries. However, price formation
likely varies across countries and is likely correlated with shareholder
protection. A plausible scenario is that countries with strong shareholder
protection arc likely to have more private information production and
mandated disclosures, which ceteris paribus decrease earnings' value relevance
by causing prices to lead earnings more. In this scenario, countries with strong
shareholder protection would display a relatively lower association between
earnings and stock returns because prices would lead earnings to a greater
extent. Therefore, high shareholder protection would appear to reduce the
value relevance of earnings. However, this scenario works against finding
support for my hypotheses.2
My findings contribute to the literature on earnings' properties in two ways.
First, since a country has a fairly constant accrual system, previous
within-country studies generally compared the value relevance of
earnings with that of cash flows (e.g., Ball and Brown, 1968; Bowen et al.,
1987; Dechow, 1994; Cheng et al., 1996). My study complements these
within-country studies by comparing the value relevance of earnings
across di!Terent countries' accrual systems. Second, prior cross-country
studies have mainly examined the relation between country-specific factors
and the value relevance of accounting numbers (Alford et a!., 1993; Ali and
Hwang, 2000; Ball ct al., 2000a, b).3
This study adds to these cross-country
studies by addressing the impact of shareholder protection on the relation
between the usc of accrual accounting and the value relevance of accounting
information.
The paper is structured as follows. Section 2 develops the research
hypotheses. Section 3 presents the research methodology. Section 4 dcscrihcs
the sample selection and variable definitions. Section 5 shows the empirical
results. Section 6 summarizes the findings and concludcs the study.
2
Tl is possihle that there are also other unspecified scenarios, where shareholder protection affects
not jusl earnings but also price formalion via non-accouming-based information. lhat could
provide allernative explanations for the resulls.
3
Allhough La Porta el al. (1996. 1997, 2000) discuss the relalion belween accounting standards
and institutional factors across countries, their proxy for accounting standards is the disclosure
level based on annual reports rather than the attribute of the accounting standards.

4. 404 M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420
2. Hypothesis development
Accrual accounting systems are expected to generate more value relevant
accounting performance measures (i.e., earnings and ROE) than cash nows
because accrual systems are better at matching revenues and expenses (Ball and
Brown, 1968; Dechow, 1994; and Cheng eta!., 1996). Thus, accrual accounting
performance measures help investors better assess firm values and operating
performance than operating cash flows.
However, accrual systems also allow managers to opportunistically
manipulate accruals. Because managers make estimates for the accrual system
and are often evaluated and rewarded based on accounting performance
measures, managers might manipulate accruals for personal gain (Healy, 1985;
DeAngelo, 1988; McNichols and Wilson, 1988) and thus cause accounting
measures to he less value relevant.
Consequently, movement toward a higher use of accrual accounting has
offsetting effects on the value relevance of accounting measures. For example,
consider accounting for pensions. U.S. standards require that pension costs be
recognized (i.e., accrued) in the balance sheet and charged to earnings when the
costs are incurred. Recognizing pension costs when incurred, rather than when
paid, better matches revenues and expenses and thus generates more value
relevant performance measures for U.S. companies. However, a U.S. manager
might hias the estimate of a company's pension expense downward (upward) to
prevent a negative earnings surprise (take a bath) and thus reduce the value
relevance of earnings to investors. As a result, the net impact of adopting
accrual pension accounting on the value relevance of accounting performance
measures is unclear.
However, strong shareholder protection in the marketplace should attenuate
management opportunism (Jensen and Meckling, 1976; Holmstrom, 1979).
Alternatively, >veak shareholder protection in the marketplace will exacerbate
the opportunism. Therefore, I argue that managers are more likely to
manipulate accruals in weak shareholder protection environments than in
strong shareholder protection environments. For example, the U.S. has many
mechanisms for oppressed shareholders to make legal claims against directors,
but Germany has few such mechanisms (La Porta ct al., 1996). While U.S.
managers who materially misrepresent earnings generally face shareholders'
class action suits and securities regulators' investigations, German managers
rarely face such consequences. Due to the higher cost of opportunistic
behavior, U.S. managers, relative to German managers, are less likely to
exhibit such behavior.
The preceding discussion leads to two hypotheses. First, since a higher
usc of accrual accounting provides more opportunities for earnings
management and inadequate shareholder protection exacerbates this manage-
rial propensity, I predict that the use of accrual accounting will negatively

5. M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420 405
aflect the value relevance of earnings in countries with weak shareholder
protection.
H~pothesis I. The usc of accrua l accounting negatively reduces the value
relevance of accounting performance measures (i.e., earnings and ROE) in
countries with weak shareholder protection.
Second, since shareholder protection deters managers from manipulating
accruals, rpredict that strong shareholder protection will reduce the ncgativc
impact of accrual accounting on value relevance.
H~pothesis 2. Strong shareholder protection reduces the negative impact of
accrual accounting on the value relevance of accounting performance
measures.
3. Research design
This section discusses the method for measuring the use of accrual
accounting, evaluating shareholder protection, calculating the value relevance
of accounting performance measures, and assessing the link between tax
reporting and financial accounting.
3.1. Use of accrual accounting
The use of accrual accounting represents the extent that the accounting
system deviates from a cash method of accounting. To measure the use of
accrual accounting, I create an accrual index from the data in the 1993
International Accounting Summaries by Coopers and Lybrand (Coopers &
Lybrand, 1993).4
I assume the accounting standards in 1993 are representative
of my sample period, 1991- 1997. One concern is that several countries in my
sample began modifying their national accounting standards to conform to
Internationa l Accounting Standards (lAS) during the period analyzed.
However, Joos and Lang (1994) suggest that harmonizing national accounting
standards to achieve greater conformity is a slow process.
I compute the accrual index hy equally weighting 11 accrual-related
accounting standards for each country. Among the accounting standards
summarized in Coopers and Lybrand (1993), I select 11 standards that arc
directly related to the timing differences between cash receipt/disbursement and
revenue/expense recognition. For example, one accrual-related accounting
standard is accounting for research and development (R&D). All else equa l, a
4
1 thank Jennifer Babcock for graciously providing the accrual indexes for the sample countries.

6. 40fi M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420
country that requires R&D expenditures to be capitalized and amortized, such
as Finland, will have a higher accrual index than a country that requires R&D
expenditures to be immediately expensed, such as the U.S. The accrual index
excludes accounting treatment of measurement issues, such as asset revaluation
and inflation adjustment, because such treatment does not involve direct cash
receipt/disbursement.5
An accounting standard is assigned a weight of one if it applies accrual
methods.6
For example, in the U.S., accounting for other post-retirement
benefits is assigned a weight of one since it requires the benefits to be accrued,
but in Japan, it is assigned a zero because it does not require this. Panel A of
Table l further explains the assignment of weights. Table 2 lists the resulting
accrual indexes for the sample countries. Table 2 shows that the U.S. requires
the most accrual accounting, 0.86, and Switzerland the least, 0.32.
Table 2 also compares the accrual indexes among the M uellcr et al. (1994)
accounting clusters. These clusters are based on the overall similarity of
countries' accounting practices. Mueller et al. classify countries into four
clusters: British-American, Continental, South American, and Mixed Econo-
my. The sample countries fall into either the British- American or the
Continental clusters. Table 2 shows that the accrual indexes are similar for
countries in the same accounting cluster, which is expected since the accrual
indexes are based on accounting standards. For example, Australia, Canada,
the U.K., and the U.S. all belong to the British- American cluster and have
accrual indexes around 0.8. The average accrual index is 0.75 for countries in
the British-American cluster and 0.57 for those in the Continental cluster, with
the difference significant at p-value less than 0.01.
3.2. Proxies for shareholder protection: Antidireclor rights indexes and legal
systems
I use two alternative proxies for the level of shareholder protection
in a country, antidirector rights and legal systems, based on La Porta
et al. (1996) and Ball et al. (2000a), because there is no single agreed-
upon measure for shareholder protection.7
The first proxy for share-
holder protection is antidirector rights. Since shareholders exercise
5
Since the impact ofassets revaluation on value relevance of earnings has generated great interest
among researchers (Faston el al., 1993; Barth and Clinch, 199R), T rerun the tests after including
accounting standards on the revaluation of properly, plant, and equipment, and on the revaluation
of intangibles in the accrua l index. The results are similar.
6
1 use an equal weighting method because there is no well-defined theory for other weighting
methods. I note that the importance or an accounting standard varies across countries but see no
reason that the equal weighting will bias the results.
7
1 also combine antidircctor rights and legal systems to form a single proxy for shareholder
protcct.ion. The results are qualitatively the same.

7. M. Hung i Jnw·nal nf Accounting and Rconnmics 30 (200 /j 401- 420 407
Table l
Procedures for calculating accrual and tax-hook conformi ty indexes." The accrual index measures
the use of accrual accounting and the tax-book confom1ity index measures the link between tax
reporting and financial accounting
Accounting standards
Panel A: Accrual index
Goodwiii/Ts it capitalized?
Equity method/Is it required?
Depreciation/Is additional accelerated
depreciation allowcd'lb
Purchased intangiblc"jls it capitalized?
Developed intangible0
/Ts it capitalized?
R&D expenditurejls it capitalized?
Interest capitalization/Is it capitalized?
Finance lease/Is it capitalized?
Percentage of completion/Is it allowed0
Pension/Arc future pension costs accrued''
Other post-retirement benefits/Are
they accrued?
Panel B: Tax-book cvnfurmity index
Avcragc consensus cstimatc of the
relation between tax and financial
reporting.
Do deferred taxes exist?
Does legal form dominate substance?
Ts additional accelerated
depreciation allowed?
Do amortization periods depend
on tax laws?
Docs lease capitalization depend
on tax law0
Rating
1-Yes 0.5-Yes (< = 5 Years)
0-May expense
!-Yes 0-No
l-No 0-Yes
!-Required 0.5-Pcrmittcd 0-Not permitted
1-Permilled 0.5-Limited 0-Not t-x:mlitted
1-Permilled 0.5-Limited 0-Nott-x:mlitted
!-Permitted 0-Not permitted
!-Yes 0.5-0ptional/limited 0-No
!-Required 0.5-Either 0-Not permitted
!-Yes 0-No
1-Yes 0-No
- l if the resulting number from the
calculation below is greater than
0 = 0 othcrwisc
!-Strong 0.5-Modcratc/significant
0-Weak
l-No deferred tax 0.5-Limited
0-Ycsjrecognize
1-Yes 0.5-Sometimes 0-No
1-Yes 0.5-Limitt:d 0- o
!-Yes 0.5-Limited 0-No
!-Yes 0.5-Limited 0-No
Weight
1/1 1
lfl l
lfl l
lfl l
1/1 1
1/1 1
lfl l
lfl l
lfl l
lfl l
1/1 1
60%
20%
5%
5%
" Indexes are provided by Jennifer Babcock. Data sources are Coopers and Lybrand (1 993) and
Alexander and Archer (1995).
b Additional accelerated depreciation refers to accelerated depreciation methods other than
declining balance, double-declining balance, and sum-of-the-years'-digits methods.
c Excluding goodwill and R&D costs.
their rights by voting for directors, La Porta et a!. (1996) measured
worldwide antidircctor rights by the case with which shareholders
exercise their right to vote. They found that countries with strong anti-
director rights have larger and more liquid capital markets, which implies

8. 40R M. Hung i Jnw·nal nf Accounting and Rconnmics 30 (200 /j 401- 420
Table 2
Accrual index, accounting duster, antidireclor rights index, legal system, and lax-hook conformity
index hy country"
Country Accrual index Accounting Antidirector Legal system Tax-book
cluster rights index conformity index
Australia 0))2 British-A.merican 4 l 0
Belgium 0.6~ Continental 0 0 l
Canada O.R2 Rritish- American 4 I 0
Denmark 0.55 Continental ] 0 0
Finland 0.55 Continental 2 0 I
France 0.64 Continental 2 0
Germany 0.41 Continental 0 I
Hong Kong 0.64 British-American 4 0
Treland O.R2 Rritish- American ] I 0
Ttaly 0.45 Continental 0 0
Japan 0.55 Continental 3 0
Netherlands 0.73 British American 2 0 0
New Zealand 0.73 British American 4 I 0
Norway 0))2 Continental 3 0 0
Singapore 0.64 Rritish- American ] 0
South Africa 0.6R Rritish- American 4 I 0
Spain 0.77 Continental 2 0
Sweden 0.59 Continental 2 0
Switzerland 0.32 Continental 0
U.K. 0.!!2 British-American 4 0
u.s. 0.!!6 British-American 5 0
a Dejiniliuns: Accrual index represents the degree to which the accounting system moves away
from a cash method measure of performance. A higher index value indicates higher use of accrual
accounting. The index is constructed as reported in Table l. Accounting clusta refers to the cluster
classification assigned according to the country's accounting practices by Mueller et al. (1994).
Antidirectnr rig/us index indicates how easy it is for shareholders to exercise their voting rights. This
index is the antidirector right index constructed hy La Porta et al. (1996). This index ranges from 0
to 5. It aggregates the following components of shareholder rights: (I) the ability to vote by mail,
(2) the ability to gain comrol of shares during the shareholders' meeting, (3) the possibility of
cumulative voting for directors, (4) the case of calling an extraordinary shareholders meeting, and
(5) the availability of mechanisms allowing minority shareholders to make legal claims against the
directors. Legalsyswm equals I if common law and equals 0 ifcode law. ?ax-bonk cnnfnrmily index
shows the convergence between tax reporting and fin ancial accounting. Tt equals I for countries
with high tax-book conformity and equals 0 for coumries with low conformity. The index is
constructed as reported in Table I.
that antidirector rights
and stimulate outside
markcls.8
discourage opportunism by incumbent managers
investors' willingness to participate m capital
~ Another implication for their results is that coumries with strong antidirector rights probably
have more information production (i.e., analysts, news releases, mandated disclosures, conference
calls, etc.). I thank the editor for providing this insight.

9. M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420 409
The antidirector rights index, drawn from La Porta et al. (1996), ranges from
zero to five. Each country starts with an index value of zero and receives an
additional point for each of the following:
1. The country allows shareholders to vote by mail.
2. The country does not require shareholders to deposit their shares before the
shareholders' meeting.
3. The government allows cumulative voting for directors.
4. T he minimum percentage of share capital that entitles a shareholder to call
an extraordinary shareholder meeting is less than 5%.
5. Minority shareholders are allowed to make legal claims against the directors.
The second proxy for shareholder protection is a country's legal system,
generally classiAed as common law or code law. I assign the legal system a
value of one if it is common law and zero if code law. Common-law countries
are likely to exhibit greater shareholder protection than code-law countries
because their public shareholders are more willing to provide funding to
companies. Common law originated in England and was established chiefly by
judges who resolved speciAc factual disputes. Code law (or civil law) originated
in ancient Rome and was instituted as rules of conduct linked to concepts of
justice and morality. Ballet al. (2000a) suggest that common laws are adapted
to contracting in open, public markets, and code laws are appropriate for
contracting between a small number of parties. Thus, in common-law
countries, such as the U.K. and the U.S., companies rely heavily on public
shareholders and creditors as sources of capital. In contrast, in code-law
countries, such as France and Germany, companies typically rely on
employees, managers, banks, and governments.
Table 2 presents the antidirector rights indexes and legal systems for the
sample countries. A high association should exist between antidirector
rights and legal system because both factors are proxies for shareholder
protection. As expected, the data indicate that common-law countries
have higher antidirector rights than do the code-law countries. For example,
the U.S., a common-law country, has a score of Ave, the highest antidirector
rights score. In contrast, Belgium and Italy, both code-law countries, have a
score of zero, the lowest antidirector rights level. The mean (median)
antidircctor rights is 3.89 (4.00) for the common-law countries and 1.75
(2.00) for the code-law countries, with both differences significant at p-values
less than 0.01.
3.3. Value relevance of accounting pe1j'ormance measures
Following recent U.S. studies on value relevance, I define value relevance as
the ability of an accounting measure to capture or summarize information that

10. 4 10 M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420
aflects firm value.Y Using this definition, researchers often measure value
relevance as the association between an accounting measure and stock returns
and operationalize the value relevance in two ways: a portfolio-returns
approach and a regression-variations approach. I usc the portfolio-returns
approach to operationalize the value relevance of accounting measures because
of its statistical superiority over the regression-variations approach (Kothari
and Zimmerman, 1995; Francis and Schipper, 1999).
The portfolio-returns approach defines the value relevance of accounting
measures as the proportion of information in security returns captured hy the
accounting measures (Alford et al., 1993; Chang, 1998; Francis and Schipper,
1999). This approach measures value relevance as the total return that could be
earned from a portfolio based on perfect foresight of earnings. Value relevance
is scaled by the total return earned on a portfolio based on advance knowledge
of market prices.
I use the following procedure to calculate the value relevance of accounting
performance measures. First, at the end of each year, 1 rank firms in each
country-specific sample hy change in net income (f../'1/f), change in ROE
(f...ROE), and market-adjusted return (AdjRel). Next, following Alford et al.
(1993) and Francis and Schipper (1999), 1 compute 15-month cumulative
market-adjusted returns ending three months after the fiscal year, for three
hedge portfolios:
/'...NI portfolio refers to the cqually weighted hedge portfolio formed on the
basis of /'...N I and scaled by beginning-of-year market value. I take long
positions in stocks with the highest 40% of f.. IVI and short positions in the
lowest 40% of each year.
/'..ROE portfolio refers to the equally weighted hedge portfolio formed on the
basis of f..ROE. I take long positions in stocks with the highest 40% of f...ROE
and short positions in the lowest 40% of each year.
AdjRet portfolio refers to the equally weighted hedge portfolio formed on
the basis of A((jRet. 1 take long positions in stocks with the highest 40% of
AdjRet and short positions in the lowest 40% of each year.
Finally, I calculate the value relevance of earnings and ROE as the ratio of
the corresponding return earned from the f...JVI and f..ROE portfolios divided
by the return earned from the AdjRet portfolio.
3.4. Tax-book conformity
Previous studies (Joos and Lang, 1994; Ali and Hwang, 2000) document that
accounting information in countries with a strong link between tax and
~ See Francis and Schipper (1999) for discussions of alternalive de(initions of value relevance.
Note that the definition of value relevance also depends on the information production system (or
price formation process).

11. M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200/ j 401- 420 4 11
financial accounting is less value relevant. Thus, I control for this link by using
a tax-book conformity index that shows the convergence between tax reporting
and financial accounting. Based on Coopers and Lybrand (1993) and the 1995
European Accounting Guide, edited by Alexander and Archer (Alexander and
Archer, 1995), I aggregate the average consensus estimate of the proximity of
tax and financial accounting systems with other tax-related indicators shown in
Panel B of Table 1. The higher the n um bcr, the stronger the link between tax
and financial reporting.
To be consistent with prior studies (Alford ct al., 1993; Ali and Hwang,
2000), I use a high/low coding scheme to classify the resulting numbers from
the tax-book conformity index calculation. 10
I assign the index a one if the
resulting number is greater than zero and assign a zero otherwise (i.e., one
designates high tax-book conformity, and zero designates low tax-book
conformity). T he final numbers, provided in Table 2, arc similar to those in
prior studies. 11
4. Sample selection, variable definitions and descriptive statistics
4.1. Sample
I select the sample from the intersection of the Global Vantage Industrial;
Commercial and Issue Files. I initially include countries with more than 100
total firm-year observations, if they have at least one observation each year. I
restrict the sample to industrial firms (SIC codes 2000-3999 or 5000-5999), as
in Alford et al. (1993). I use this restriction to increase the homogeneity of the
sample and the comparability of the results across countries.
In addition, each firm-year o bservation must satisfy four requirements. First,
firm-year observations must have sufficient data to calculate change in net
income (!J.Nf), change in ROE (!J. ROE), and returns ( Ret). Second, firm-year
observations must not include the highest or lowest 1% values of each variable
(NI, !J.N I, ROE, !J.ROE, and R et) within each country. Third, firms must not
change their fiscal year-end during the sample period. 1-ior example, if a firm
changes its fiscal year-end in 1994 from June to December, its 1994 net income
might cover only Junc 1994 to Decem bcr 1994. This would make the relation
bet>veen net income and annual returns in 1994 inconsistent >vith the relation in
10
The resulting numbers fall toward extreme values. Therefore, it seems reasonable to assign the
tax-hook conformity index as a hinary variable rather than a continuous one. The results are
qualitatively the same regardless of the specification of the tax-book conformity index (i.e.,
cominuous versus binary).
11
I have identical lax-book conformity classifications for the 16 countries, except Norway, in
Alford et al. (1993). I repeat the analyses after changing the dassification for Norway. The
qualitative results do not change.

12. 4 12 M. Hung i Jow·nal of Accounting a11d Rconomics 30 (200/ j 401- 420
Table 3
Distribution of finn -year observations hy country and fiscal year"
Country Total 1991 1992 1993 1994 1995 1996 1997
Australia 336 42 44 45 48 48 64 45
Belgium 87 8 12 l l l l 12 14 19
Canada 93g 130 125 l2g 125 140 147 143
Denmark 151 12 l l 12 13 32 35 36
Finland 90 10 12 10 10 14 15 19
France 442 49 54 49 50 57 89 94
Germany 869 100 I l l 113 116 138 157 134
Hong Kong 105 12 13 12 14 18 17 19
Ireland 124 13 17 lg lg 21 20 17
Italy 109 12 14 13 13 13 19 25
Japan 1,865 231 236 213 235 232 259 439
Netherlands 309 JO 40 4 1 44 44 49 55
New Zealand 43 5 5 6 6 8 8 5
Norway 107 15 15 15 16 17 16 13
Singapore 218 23 28 27 29 4 1 39 31
South Africa 90 l l 13 13 13 13 12 15
Spain 146 6 8 21 21 27 32 31
Sweden 94 15 17 10 10 11 16 15
Switzerland 138 18 16 11 14 24 26 29
U.K. 2,410 313 326 341 372 376 388 294
U.S. 9,072 1,273 1,283 1,321 1,347 1,307 I,295 1,246
Total 17,743 2,334 2,400 2,450 2,525 2,593 2,717 2,724
" Sample: Tselect 17,743 firm-year observations from the Global Va11tage flldzmrial/Commercial
and Issue Files from 1991 to 1997. Tn selecting, Tuse the fo llowing criteria: (1) each country needs to
have more than 100 initial total firm-year observations, provided that it has at least one ohservation
each year, (2) only industrial firms (SIC codes 2000 3999 or 5000 5999) are included, (3) each firm-
year observation needs to have sufficient data to compute change in net income, change in ROE,
and returns (4) firms do not change their fiscal year-end (5) firm-year observations do not have th e
highest or lowest l% values of net income, change in net income, ROE, change in ROE, and returns
within each country, and (o) firm-year data are prepared under domestic accounting standards.
prior years. Fourth, finn-year data must be prepared under domestic
accounting standards, rather than other standards such as lAS or modined
U.S. standards.
The sample selection procedures yield 17,743 nm1-year ohservations from
1991 to 1997 for the 21 countries listed in Table 2.12
Table 3 lists the
distribution of finn-year observations by country and fiscal year. The size of
nm1-years for these sample countries ranges from 43 (New Zealand) to 9,072
12
I have three more sample coumries than Alford et al. (1993): Finland, New Zealand. and South
Africa. I usc a more recent time period so these countries pass the requirement of initial 100 firm-
year observations.

13. M . Hung i Jnw·nal nf Accounting and Rconnmics 30 (200 /j 401- 420 411
(the U.S.). The number of firms grows over time mainly because of the
increasing coverage of international companies in the Global Vantage Files.
4.2. Variable defmitions
The earnings variable (.1/f) is net income before extraordinary items scaled by
the beginning-of-year market value. The ROE variable (ROE) is earnings
divided by beginning-of-year equity book values. The market value variable
(M V) is price multiplied by numbcr of shares outstanding at fiscal year-end. If
a firm has multiple issues, I use the oldest issue because the identification of the
primary issue is not available. The return variable (Ret) is the 15-month
compound return (adjusted for dividends and splits) ending three months after
the fiscal year-end. Market-adjusted return (Ar(jRet) is return minus the return
on the equally weighted market portfolio in the firm's country.
Table 4 shows the descriptive statistics of Ret, NI, and ROE across countries.
Mean returns fall between - 8.0% (Japan) and 41.4% (Spain). The standard
deviations of returns range from 31.7% (Japan) to 60.5% (Norway). This wide
range shows the importance of controlling for market volatility across
countries, and therefore supports my usc of the portfolio-returns test instead
of the regression-variations test. Returns are also positively skewed (medians
lower than means) across all countries except New Zealand. The mean
(median) N I fall between 1.5% (2.0%) in Japan and 146.9% (13.3%) in
Sweden.13
Finally, the mean (median) ROE fall between 3.1 % (3.8%) in Japan
and 17.9% (17.7%) in South Africa.
5. Empirical results
Table 5 provides the market-adjusted returns for the /I,Nl, /I,ROE, and
AdjRet portfolios and value relevance measures of IV/ and ROE for the sample
countries. For example, the U.S.'s market-adjusted returns are 30.6% for the
/I,Nl portfolio and 80.4% for the AdjRet portfolio. Consequently, the value
relevance of l'.lJ, the returns for the /l,l'·.lJ portfolio divided by the returns for the
AdjRet portfolio, is 38.0%. This number indicates that about 40% of perfect
foresight returns arc available to U.S. investors with advance knowledge
13
My sample descriptive statistics o r Rei and i'>'l are comparable with Ball et al. (1998) for the
seven countries in their study. Other multicountry studies (Alford et al., 1993; Ali and H wang,
2000) do not provide descriptive statistics for comparison. T note that there are extreme
observations in :VI for Sweden, even though Thave deleted observations with extreme 2% values. T
ran domly check an nual reports for the companies with extreme values. The observations appear to
be data errors in Global Van/aye Files. T herefore. I delete two Swedish companies with NI greater
than 300% and repeat the analyses. The revised standard deviation of 11/I for Sweden reduccs to
under 60% from over ~00%. The qualitative results do not change.

14. 4 14 M. Hung i Jnw·nal nf Accounting and Rconnmics 30 (200/ j 401- 420
Table 4
Descriptive statistics of return, net income, and return on equity (HOP-)''
Ret(%) :VI(%) H()f; ( % )
Country N Mean Med. Std. Mean Med. Std. Mean Med. Std.
dev. dev. dev.
Australia 336 26.3 lH 39.3 5.4 7.1 ll.l 9.5 11.0 12.1
Belgium ~7 27.3 21.0 36.2 l:LO 7.0 9.!:l 14.7 14.0 9.6
Canada 93R 21.6 LU 46.9 3.] 6.1 16.4 5.9 R.6 21. 1
Denmark 15 1 16.9 11. 1 35.5 R.7 7.R 7.9 11.4 11.7 7.5
Finland 90 30.0 22.8 49.6 16.2 11.4 37.2 9.7 13.3 37.1
France 442 28.0 22.0 39.8 5.2 6.2 11.9 9.2 10.3 12.7
Germany 869 11.6 6.2 33.2 3.5 4.6 11.3 6.1 7.8 16.9
Hong Kong 105 l2.!:l 4.2 53.2 7.0 7.3 lH 14. ~ 14.9 17.7
Treland 124 31.7 23.8 43.2 R.6 9.4 10.1 15.9 14.6 17.2
Ttaly 109 37.3 23.6 59.0 4.1 7.0 17.7 5.1 7.2 12.4
Japan 1,865 - 8.0 - 12.3 31.7 1.5 2.0 3.2 3.1 3.8 6.9
. etherlands 309 28.0 23.5 34.5 9.1 9.1 5.8 17.9 16.6 12.4
New Zealand 43 14.1 15.0 41.3 6.0 7.2 12.4 11.6 l l.l 13.2
Norway 107 34.0 l!:l.2 60.5 9.!:l 9.9 10.9 17.9 l5.!:l 22.7
Singapore 21R 3.1 - U 36.8 3.8 4.3 4.R 7.8 7.3 9. 1
South Africa 90 24.7 14.4 45.8 10.7 8.9 9.7 17.9 17.7 7.9
Spain 146 41.4 30.7 55.4 4.8 7.6 19.5 10.4 10.5 16.3
Sweden 94 35.4 29.0 40.3 146.9 13.3 866.1 15.9 16.0 16.3
Switzerland l3!:l 25.!:l 20.6 40.3 15.5 11.7 42.9 9.9 9.4 13.0
U.K. 2,410 19.2 16.0 3!:l.O 6.1 7.1 10.1 14.7 14.3 l!:l.9
U.S. 9,072 20.5 15.2 45.9 2.2 6.0 18.0 8.0 11.7 28.1
a Sample: I select 17,743 firm-year observations from the Glubal Van/aye /ndustrialfCummercial
and Issue Fih•s from 1991 to 1997. I usc the following criteria: (l) each country needs to have more
than 100 initial total firm-year observations, provided that it has at least one observation each year,
(2) only industrial firms (SIC codes 200Q-3999 or 500Q-5999) arc included, (3) each finn-year
observation needs to have suffici ent data to calculate change in net income, change in RO1-:, and
returns (4) firms do not change their fiscal year-end (5) firm-year ohservations do not have the
highest or lowest I% values ofnet income. change in net income, ROE. change in ROE, and returns
within each country. and (6) firm-year da ta are prepared under domestic accouming standards.
Variable definitions: lV denotes the number of firm-year observations. Ret denotes 15-month
returns ending three months after the fisc.al year-end, adjusted for dividends and stock splits. NI
denotes net income before extraordinary items, scaled hy heginning-of-year market value. RO/<,·
denotes return on equity.
of earnings. This percentage 1s comparable to the findings in Alford
et aL (1993).
Table 6 reports the Pearson and Spearman correlations among the value
relevance of .NI, value relevance of ROE, accrual index, tax-book conformity
index, and the proxies for shareholder protection (antidirector rights index and
legal system). The upper (lower) triangle of Table 6 shows the Pearson
(Spearman) correlation coefficients. Table 6 shows that the accrual index is

15. M . Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420 4 15
Table 5
Cumulative market-adjusted returns to hedge portfol ios based on perfect knowledge of net income,
ROf:, and stock price, 1991- 1997 (15-month period ending three months a fter the fiscal year-end)"
!lNI portfolio D.ROE portfolio AdjRet
portfolio
Country Ad)Ret Proportion Ad)Ret Proportion Ad)Ret
(%) of AdjRer (%) of Ad}Ret (%)
portfolio(%) portfolio (%)
Australia 22.fi 33.9 31.2 46.R 6fi.(i
Belgium 2.7 4.7 21.0 36.7 57.4
Canada 24.5 30.7 31.6 39.7 79.5
Denmark 14.3 24.0 25.2 42.5 59.4
Finland !U 12.0 21.0 31.3 67.0
France 22.fi 33.6 32.7 4R.7 67.1
Germany 14.9 2R.5 14.2 27. 1 52.2
Hong Kong 19.9 26.2 21.6 28.4 76.1
Ireland 22.3 32.7 12.9 18.9 68.3
Italy 19.4 30.1 26.5 41.3 64.2
Japan ~ . 3 22.6 10.3 2~.1 36.6
Netherlands 15.4 27.4 23.4 41.6 5fi.3
New Zealand 36.fi 55.7 24.1 36.R 65.6
Norway 4.fi 5.3 17.1 19.R Rfi.5
Singapore 18.3 36.2 16.9 33.4 50.5
South Africa 22.4 30.4 3ll.O 51.6 73.ll
Spain 16.4 21.4 lU 15.4 76.6
Sweden 10.5 17.9 16.1 27.5 5R.6
Switzerland 28.7 48.6 39.4 66.7 59.0
U.K. 22.8 34.1 28.6 42.9 66.8
u.s. 30.6 3ll.O 34.6 43.0 goA
Average 1R.4 2R.3 23.7 36.6 65.2
" DPjillitinns: !'J.Nt denotes change in net income scaled by beginning-of-year market value. !'J. NJ
portfolio refers to the equally weighted hedge portfolio that takes long (short) positions in stocks
with the highest (lowest) 40% of t.NI. t.ROE denotes changes in ROE. D.ROE portfolio refers to
the equally weighted hedge portfolio that takes long (short) positions in stocks with the highest
(lowest) 40% of t.ROE. AdjRet denotes market-adjusted return. AdjRet portfolio refers to the
equally weighted hedge portfolio that takes long (short) positions in stocks with the highest (lowest)
40% of AdjHet.
positively associated >vith the antidirector rights index and legal system and
negatively associated with the tax-book conformity index (correlation
coefficients arc a ll significant at the 0.01 level). T he results suggest that
countries with a higher use of accrual accounting have stronger shareholder
protection and weaker alignment hetween their tax and financial reporting.
Additionally, the association bet>veen the value relevance of NI and legal
system is significantly positive at the 0.01 level.

16. 4 16 M. Hung i Jow·nal of Accounting and &anomies 30 (200/ j 401- 420
Table 6
Correlation coefficients of value relevance o f earnings, value relevance o f HOI:', accrual index,
antidirector rights index, legal system, and tax-hook conformity index; Pearson (Spearman)
correlation coelftcients in the upper (lower) triangle; two-tailed p-values in parentheses"
Variable Vai_Nf Vai_ROE Accrual index Anlidirector Legal system Tax-book
rigllls litdex conformity
index
Val_Nl 0.5 1 -0.06 0.33 0.51 - 0.2R
(0.02) (O.RO) (0.1 4) (0.01) (0.2 1)
Vai_ROE 0.56 - 0.28 0.01 0.10 - 0.05
(0.01) (0.22) (0.98) (0.67) (0.83)
Accrual index 0.20 - O.ot 0.65 0.57 - 0.64
(0.3g) (0.9g) ( <0.01) (0.01) ( <0.01)
A111idirectm· 0.43 0.21 0.64 0.7R - 0.7R
rights index (0.05) (0.36) (<0.01) ( <0.01 ) (<0.01)
Legal system 0.62 0.21 0.59 0.83 0 .75
(<0.01) (0.37) ( <0.0 l) ( <0.01) (<0.01)
Tax-book - 0.38 - 0.19 - 0.65 - 0.80 - 0.75
conformity index (0.09) (0.41) ( <0.01) ( <0.01) (<0.01)
" Definitions: I d efin e Vai_:VI, value relevance of earnings, as the market-adjusted return for the
;LV/ portfolio scaled hy the market-adjusted return for the AdjHet portfolio, as summarized in
column 3, laheled "Proportion of Ad}Net portfolio," ofTahle 5. Val_ROf:, value relevance of return
on equity, is the market-adjusted return for the !lROE portfolio scaled by the market-adjusted
return for the Ad)Ret portfolio, as summarized in column 5. labeled " Proportion of Ad)Ret
portfolio," of Table 5. Accrual index represents the degree that the accounting system deviates from
a cash measure of performance. A higher index indicates higher accrual accounting standards. The
index is constructed as reported in Table I. Anlidirec/Vr riyhts index indicates how easy it is for
shareholders w exercise their voting rights. This index is the antidirecwr rights index constructed
by La Porta et at. (1996). This index ranges from 0 to 5. It aggregates the following components of
shareholder rights: (l) the ability to vote by mail, (2) the ability to gain control of shares during th e
shareholders' meeting, (3) the possibility of cumulative voting for directors, (4) the ease of calling
an extraordinary shareholder meeting, and (5) the availahility of mechanisms of allowing minority
shareholders to make legal claims against the directors. Leyal s_rstem equals I if common law and 0
if code law. Tax-book Wl1/urmily index shows the con vergence between tax reporting and financial
accounting. It equals l for countries with high tax-book conformity and equals 0 for countries with
low conformity. The index is constructed as reported in Table l .
Table 7 presents a series of country-level ordinary least squares regre-
ssions for testing the hypotheses. Models 1 and 2 (Models 3 and 4) u se
value relevance of NI (value relevance of ROE) as the dependant variable.
Each regression model incIudcs Lhc following independent varia bles: Lhc
accrual index (Accrual), the interaction term between the accrual index and
the shareholder protccLion variable (Accruai*Antidirector rights in M odels 1
and 3 and Accruar,L egal system in M odels 2 and 4), the shareholder
protection variable (Antidirector rights in Models 1 and 3 and Legal

17. M . Hung i Jnw·nal nf Accounting and Rconnmics 30 (200/ j 401- 420 4 17
Table 7
Ordinary least squares regression o f value relevance of earnings and ROF; on accrual, antidirector
rights, legal system , and tax-book conformity. Tdefine value relevance of earnings and ROF: as the
return for the D.1V/ and .6.ROE portfolios scaled by the retLLrn for the AdjRet portfolio, as
summarized in columns 3 and 5 labeled " Proportion of AdjRet portfolio" of Table 5 (two-tailed p-
valucs in parentheses)"
Vai_NI Vai_ROE
Independent variahle Pred. Model I Model 2 Model 3 Model 4
s1gn
fnlercepl 0.81( <0.01) 0.60( <0.01) 0.96( <0.01) 0.80( <0.01)
Accrual - 0.97( <0.01) - 0.59(0.02) - 0.93(0.02) - 0.65(0.02)
Acauai•Anlidirector + 0.26(0.05) 0.23(0.1 0)
rights
A111idirectnr· rights - 0.11(0.1 4) - 0.14(0.15)
Accrual• Legal system 0.6fi(O.I fi) O.R2(0.14)
Legal system - 0.30(0.39) - 0.55(0.1 9)
Tax-book wnfvrmily - 0.05(0.48) - 0.03(0.67) - 0.07(0.40) - 0.08(0.34)
1V 21 21 21 21
Adj. R2
0.29 0.39 0.13 0.13
" D~/inilivns: Accrual represents the degree to which the accounting system deviates from a cash
measure of performance./ higher number indicates higher use of accrual accoLLnting. The variable
is constructed as reported in Table l. Anlidireclvr ri!Jhls indicates how easy it is for sharehold ers to
exercise their voting rights. This variable is the antidircctor right index constructed by La Porta
et al. (1990). This index ranges from 0 to 5. ll aggregates the following components of shareholder
rights: (l) the ability to vote by mail, (2) the ability to gain control o r shares during the
shareholders' meet.ing, (3) the possibility of cumulative vot.ing for directors, (4) the case of calling
an extraordinary shareholder mcet.ing, and (5) the availability of mechanisms of allowing minority
shareholders to make legal claims against the directors. Li'gal sysh•m equals l if common law and 0
if code law. Fax-bonk conformity shows the convergence between tax reporting and fi nancia l
accounting. It equals 1 for countries with high tax-hook confonn ity and equals 0 for countries with
low conformity. The variable is constructed as reported in Table l.
system in Models 2 and 4), and the tax-book conformity index (Tax-book
conformity).14
The inclusion of the interaction tem1 in the regression models tests the eiTect
of accrual accounting on the value relevance of accounting numbers for
countries with diiTerent levels of shareholder protection (M adda la, 1992). For
example, in Model 2, the coefficient of Accrual represents this effect for
countries with weak shareholder protection. The coefficient of Accruaf*Legal
14
To reduce the infiuence of outliers and ensure a no1mal distribution of the error terms for such
a small sample, I transform the value relevance measures and accrual indexes based on rank
transformation (Conover and !man, 1981) and repeat the regression analyses. The results are
similar to those discussed below.

18. 4 1R M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420
system shows the incremental effect when moving from an environment with
weak shareholder protection to one with strong shareholder protection. The
sum of the coefficients of Accrual and Accrual*Legal system represents this
cfTcct for country with strong shareholder protection.
Hypothesis I predicts that Accrual will have a negative coefficient. As
predicted, the coefficients of Accrual are significantly negative across all the
models at the 0.01 level based on a one-tailed test. The adjusted R2
s range from
0.1 3 to 0.39. This finding indicates that a higher use of accrual accounting
lowers the value relevance of accounting performance measures for countries
with weak shareholder protection.
Hypothesis 2 predicts that Accruaf*Antidirector rights and Accruaf*Legal
system will have positive coefficients. As predicted, the coefficient of Accrual*
Anlidirector rights in M odels 1 and 3 are positively significant at the 0.05 level
based on a one-tailed test. The coefficient of Acn·ual*Legal system in M odels 2
and 4 are positively significant at the 0.10 level based on a one-tailed test.
A further analysis testing the sum of the coefficients of Accrual and Accrual*
Antidirector rights (or Accrual and Accrual*Legal system) indicates that the usc
of accrual accounting does not negatively affect the value relevance of
accounting information for countries with strong shareholder protection. For
example, the two-tailed p-value from testing the sum of coefficients of Accrual
and Accrual*Legal system equals 0.85. Finally, although the control variable
Tax-book conformity has negative signs in all models, as expected, the
coefficients are not significant at any conventional level.
6. Conclusions
This paper investigates tl1e effect of accrual accounting on the value
relevance of financia l sta tements across countries. I analyze 17,743 firm-year
observations for industrial firms in 21countries during the period 1991 1997. I
show that the usc of accrua l accounting negatively afTccts the value relevance of
accounting performance measures (earnings and ROE) for countries with >veak
shareholder protection (i.e., countries with low antidirector rights or a code-
law system). In addition, strong shareho lder protection attenuates the negative
impact and increases the value relevance. Finally, accrual accounting does not
negatively afTcct the value relevance for countries with strong shareholder
protection (i.e., countries with high antidirector rights or a common-law
system).
There arc severa l limitations to interpreting the results. J-iirst, the study only
includes industrial companies and nearly all of the sample countries are
developed countries. The same results may not apply to non-manufacturing
companies or to emerging countries. Second, the study defines the value
relevance of financial statements as the ability of accounting numbers to

19. M. Hung i Jnw·nal nf Accounting a11d Rconnmics 30 (200 /j 401- 420 419
summarize the information that causes contemporaneous price changes. One
caveat of this definition is that it says nothing about whether investors usc
accounting numbers to set market prices. Third, the study focuses on a
composite attribute of national accounting standards (i.e., usc of accrual
accounting). Therefore, the findings do not infer how a particular standard
aflects the value relevance of earnings.
Overall, the results arc consistent with the belief that shareholder protection
improves the eflectiveness of accrual accounting. The findings suggest the
importance of considering institutional factors such as shareholder protection
when formulating accounting policies related to accruals.
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