Foreign Ownership and Financial Reporting Quality in Private Subsidiaries

Abstract

In a sample of large private Spanish subsidiaries, we find that the magnitude of discretionary accruals is significantly higher when the parent company is foreign than when it is local. Our tests support the thesis of recent research on earnings management strategies within multinational corporations (MNCs), suggesting that the parent company’s incentives underlie the observed negative relation between foreign ownership and financial reporting quality at the subsidiary level. In particular, we find that: (1) the tenure of the controlling shareholder has a negative incremental effect on financial reporting quality in firms under foreign control, as opposed to subsidiaries of local groups; and (2) the negative association between foreign ownership and financial reporting quality is mainly driven by the subsample of subsidiaries with parent companies located in countries with higher institutional quality than Spain.

Keywords: foreign ownership; private firms; subsidiaries; earnings management; discretionary accruals; institutional quality

JEL Classification: F23, M41, M48