The Effects of Legal Protections and Control-Ownership Divergences on Investor Perceptions of Foreign Earnings

Abstract

The purpose of this study is to investigate the impact of corporate internationalization, governance structures, and legal protections on the foreign earnings response coefficient (FERC). The FERC is a measure of the value-relevance of foreign earnings. We collected data on 3653 Taiwanese firms that had overseas investments. We examined the impact of the site of their overseas investments and the nature of the legal code of the investee country on the investor perceptions of firms’ reported foreign and domestically-generated earnings. We also examined the impact of corporate governance arrangements (e.g., the difference between the owners’ cash flow and voting rights on the same components of the firms’ earnings.

Our empirical findings suggest that an aggressive internationalization strategy (foreign direct investment) has positive effects on the value relevance of foreign earnings, but that this strategy is impacted by the firm’s own corporate governance arrangements and the target of its overseas investment efforts. While foreign investments bring about growth and profits it exposes the investors to the risk of expropriation by investee countries and corporate insiders.

Keywords: internationalization, corporate governance, investor legal protection, value relevance of foreign earnings

JEL Classification: G34, G38, M41