The Reduction of Firms' Ownership Induced Agency Costs Following Financial Reporting Reform in the European Union

Abstract

We predict and find that regulations expected to harmonize and strengthen firms' financial reporting in the European Union (EU) in the early 2000s increase Tobin's Q ratios of firms with high agency costs due to (a) concentration of control (entrenchment) and (b) an excess of the largest shareholder's voting rights over cash flow rights. These results are consistent with stronger reporting standards enhancing firm value by mitigating incentives for controlling shareholders to expropriate minority shareholders. Increases in Tobin's Q associated with financial reporting reform are concentrated in EU firms that (a) are not cross-listed in the US; (b) have families as their largest shareholders; (c) are earnings-management-intensive prior to reform; and (d) attract low analyst following. These results suggest that minority shareholders of firms with the most severe perceived information asymmetries are among the major beneficiaries of EU financial reporting reform.

Keywords: International Accounting Standards, European Union, Agency Costs

JEL Classification: G38, G12, G29, G34, M41, M43, M44, M45