Introduction The value relevance of disclosures of liabilities of equity‐accounted investees UK evidence

1. Introduction

By testing for their value relevance, this study ex- amines the usefulness to investors of mandated disclosures by UK firms of the investor-firm share of liabilities of equity-accounted associate and joint venture investees. The study uses UK data for the period from 1998 to 2003, immediately follow- ing the date of the introduction by the UK’s Accounting Standards Board ASB of FRS 9: Associates and Joint Ventures ASB, 1997. Motivated in part by concern that single-line eq- uity accounting was being used as an off-balance- sheet-financing device which had the effect of concealing the level of group gearing ASB, 1996, FRS 9 introduced for the first time strict thresholds governing disclosures by UK firms of the investor-firm share of the underlying gross as- sets and liabilities of equity-accounted investees, and forced a substantial increase in such disclo- sures. On the grounds that joint ventures are sub- ject to joint control by the investor firm whereas associates are only subject to its significant influ- ence, FRS 9 also introduced a distinction between associate investees and joint venture investees, re- quiring a higher and more prominent degree of dis- closure in respect of joint ventures. We examine the value relevance of the FRS 9-mandated disclo- sures of the liabilities of equity-accounted in- vestees, which are the amounts by which the net investments in investees for which disclosures are made would have to be grossed up to give the in- vestor-firm share of the gross assets and liabilities of those investees. In light of the concerns about concealment of group gearing that partly motivat- ed the investee-liability disclosure requirements of FRS 9 and in light of the findings of previous US research, we predict that the mandated disclosures are negatively associated with the market value of equity of the investor firm, and therefore have a negative coefficient in a value-relevance regres- sion. In light of the possibility that the creditors of joint ventures might be more likely than those of associates to have explicit or implicit recourse to Accounting and Business Research, Vol. 37. No. 4. pp. 267-284. 2007 267 The value relevance of disclosures of liabilities of equity-accounted investees: UK evidence John O’Hanlon and Paul Taylor Abstract—This study examines the value relevance of mandated disclosures by UK firms of the investor-firm share of liabilities of equity-accounted associate and joint venture investees. It does so for the six years following the introduction of FRS 9: Associates and Joint Ventures, which forced a substantial increase in such disclosures by UK firms. Since the increased disclosure requirements were partly motivated by concern that single-line equity accounting concealed the level of group gearing, and in light of previous US results, it is predicted that the man- dated investee-liability disclosures have a negative coefficient in a value-relevance regression. The study also ex- amines whether value-relevance regression coefficients on investee-liability disclosures are more negative for joint ventures than for associates and whether they are more negative in the presence of investor-firm guarantees of in- vestee-firm obligations than in the absence of such guarantees. The study reports that the coefficient on all investee- liability disclosures taken together has the predicted negative sign, and is significantly different from zero. It finds little evidence that the negative valuation impact of liability disclosures is stronger for joint venture investees over- all than for associate investees overall, or stronger for guarantee cases overall than for non-guarantee cases overall. There is, however, some evidence that the impact for joint venture guarantee cases is stronger than that for joint venture non-guarantee cases and stronger than that for associate guarantee cases. Key words: Equity accounting; joint ventures; associates; FRS 9; value relevance The authors are, respectively, Professor of Accounting and Lecturer in Accounting in the Department of Accounting and Finance, Lancaster University Management School. The study has benefited from the helpful comments of Steven Young, Pelham Gore, Pauline Weetman editor and an anonymous referee, and of participants at a workshop at the University of Melbourne. The authors thank the Centre for Business Performance at the Institute of Chartered Accountants in England and Wales for financial support, and Victoria Wang and Noordad Aziz for assistance in the collection of data. Correspondence should be addressed to John O’Hanlon, Department of Accounting and Finance, Lancaster University Management School, Lancaster University, Lancaster, LA1 4YX, UK. Tel: 44 01524 593631. Email: j.ohanlonlancast- er.ac.uk. This paper was accepted for publication in May 2007. Downloaded by [Universitas Dian Nuswantoro], [Ririh Dian Pratiwi SE Msi] at 01:09 01 October 2013 the assets of the investor firm and in light of the greater and more prominent disclosure that FRS 9 required for joint ventures relative to associates, we also examine whether the value-relevance re- gression coefficient on investee-liability disclo- sures is more negative for joint ventures than for associates. Furthermore, because of the recourse to the assets of the investor firm conferred by an in- vestor-firm guarantee of investee-firm obligations, and in light of the findings of previous US re- search, we examine whether the value-relevance regression coefficient on investee-liability disclo- sures is more negative in the presence of investor- firm guarantees than in the absence of such guarantees. The findings of the study indicate that disclo- sures of liabilities of equity-accounted investees, which enable equity-accounted net investments to be grossed up by financial statement users, are negatively associated with the market value of eq- uity of the investor firm. This is consistent with the concerns about off-balance-sheet financing that helped motivate the requirement for such disclo- sures under FRS 9. The study finds little evidence that the negative valuation impact of liability dis- closures is stronger for joint venture investees overall than for associate investees overall, or stronger for guarantee cases overall than for non- guarantee cases overall. There is some evidence that the impact for joint venture guarantee cases is stronger than that for joint venture non-guarantee cases and stronger than that for associate guaran- tee cases. The remainder of the paper is organised as fol- lows. Section 2 gives the background to the study, outlining relevant issues relating to accounting for associates and joint ventures and the results of re- lated research. Section 3 describes the research de- sign. Section 4 gives details of the data used in the study. Section 5 reports the results. Section 6 con- cludes.

2. Background