Tran Thi Thuy Linh et al | 621 The impact of the foreign ownership on the real earnings management of firms in Vietnam TRAN THI THUY LINH University of Economics HCMC – linhtcdn@ueh.edu.vn NGUYEN THANH NHA nhatdg@yahoo.com HOANG THI PHUONG ANH anhtcdn@ueh.edu.vn DANG THI VY NGOC dangthivyngoc2013@gmail.com Abstract The paper analysed the impacts of the foreign ownership on the behaviour of the real earnings management of firms in Vietnam and the difference in the quality of operating income between firms with high and low levels of the foreign ownership Data of 167 firms listed on the Vietnam Stock Exchange for the duration from 2011 to 2015 was taken as the case study and the regression models which are OLS, Robust and 2SLS were applied Results of this study demonstrated that the foreign ownership contributed to the behaviour of the real earnings adjustment of firms; a high level of the foreign ownership was found to positively affect the real earnings management of firms in Vietnam In addition, this study supported the knowledge spillover theory that highly skilled foreign investors had the tendency to assist their owned firms to improve the earnings quality on financial reports Therefore, it was important for financial managers to develop appropriate strategies to manage and improve the quality of financial reports according to the International Financial Reporting Standards (IFRS) This helped increase competitiveness and transparency of firms to attract more foreign investors on the Vietnam Stock Exchange Keywords: foreign ownership; real earnings adjustment; real earnings management; earnings quality; abnormal levels of operating cash flows 622 | ICUEH2017 Introduction In emerging markets, foreign investors play an important role in improving the quality of financial reports of domestic firms (Huang and Shiu, 2009) They can promote the management of domestic firms by using the voting right to influence decisions of managers or to announce divestment from domestic firms (Aggarwal et al., 2005; Gillan and Starks, 2003) According to the report of World Bank in 2016, the foreign investment increased by 40%, which was approximately $1.8 trillion in 2015; this was the highest since the global financial crisis in 2008 Therefore, foreign investors and investment greatly affect the financial management of firms In Vietnam, for the past 10 years, the Government has developed and loosened regulations of attracting foreign investment Together with the admission of the international trade organisation, this has contributed significantly to the integration of Vietnam into the world market Vietnam has removed barriers for foreign investors and facilitate both indirect and direct capital investment Using 167 firms listed on Vietnam Stock Exchange as the case study, this paper focuses on analysing impacts and relationship between the foreign ownership and earnings quality of these firms The objectives of this study are to uncover: (1) influences of the foreign investment on the earnings management of firms and (2) impact of high and low levels of the foreign ownership on the earnings quality of firms Background theories and empirical studies 2.1 Background theories The study of impacts of the foreign ownership on the earnings quality was based on the asymmetric information theory and the knowledge spillover theory The asymmetric information theory was studied by George Akerlof, Michael Spence and Joseph Stigliz (1970) Regarding to the earnings management, the asymmetric information occurs when managers take the advantage of the fact that foreign investors have very little information of situation of firms and domestic market and, therefore, make fraudulent acts, adjust profit and indicators on financial reports These activities lead to the fact that investors, particular foreign investors, cannot control behaviours of firms; they are classified as the moral hazard In addition, the standards and regulations Tran Thi Thuy Linh et al | 623 of accounting in a particular country may cause restrictions on the understanding of foreign shareholders Therefore, in a firm with a large number of foreign shareholders, managers can manage and adjust income for their own purposes This is called the asymmetric information which is less favourable by foreign investors than domestic investors As pointed out by Choe et al (2001) and Dvorak (2005), in the Indonesian market, domestic investors have more profit compared to foreign investors Thus, according to the asymmetric theory, the real earnings adjustment is more likely on firms with higher level of the foreign ownership The knowledge spillover theory Alfred Marshall (1890) was the first researcher studying impacts of the kwowledge spillover theory, which was extended by the economist Kenneth Arrow (1962) and Paul Romer (1986) Later, Edward Glaeser, Hedi Kallal, José Scheinkman and Vàrei Shleifer (1992) developed a theory called MAR spillover Accoring to Carlino (2001), the spillover facilitates exchange of ideas and promotion of creativity and innovation which are the important factors for sustainable economic development of countries Based on this theory, the concentration of firms in a similar industry helps spread knowledge and initiate growth and innovation Regarding to issues of the real earnings management, knowledge of accounting and management is enhanced via foreign investors, which enables firms to effectively monitor business activities and report financial status Therefore, the knowledge spillover theory suggests that firms with high level of the foreign ownership tend to perform more real earnings adjustment in a comparison with ones having low level of the foreign ownership 2.2 Empirical studies Xiao et al (2004) argued that foreign investors faced more challenges due to the asymmetric information than the domestic investors did and managers had more information of status of firms and market compared to foreign investors Therefore, real earnings adjustment is still likely in firms having high foreign ownership Similarly, Klai and Omri (2001) showed that the presence of foreign investors reduced the quality of financial reports Adebiyi and Olowookere (2006) argued that firms with high level of foreign ownership are associated with high real earning adjustment On the contrary, other studies showed that, with better knowledge and information, foreign investors are more capable of spreading their expertise to domestic firms to improve the quality and 624 | ICUEH2017 efficiency of their business productivity According to Seaholes (2000), foreign financial institutions perform better than domestic ones, since the foreign ownerships creates significant economic benefits Based on studies in Canada, Italy, Germany, Japan, UK and US, Hejazi and Safarian (199) pointed out that the foreign ownership has positive spillover effects on efficiency and technology HallwardDriemeiter et al (2002) conducted surveys in Indonesia, South Korea, Malaysia, Philippines and Thailand and found that foreignowned enterprises in East Asia are more productive compared to other firms The study of Ho et al (2010) showed that, in small enterprises, the more the foreign ownership, the greater the relationship between technology investment and firm productivity; therefore, foreign investors tend to bring IT professionals to help small enterprises Abor and Biekpe (2007) demonstrated that foreign ownership has positive impact on the quality and productivity of small and medium enterprises According to Aydin, Sayim and Yalama (2007), foreign-owned enterprises contribute more to enhance the financial performance and improve the performance compared to owned enterprises in the county Gillan and Starks (2003) argued that foreign investors are the key role in promoting changes in the corporate governance of firms through direct monitoring by using their voting rights to affect managerial decisions or indirect monitoring by threatening to sell their shares Aggarwal et al (2011) investigated impacts of financial institutions on the corporate governance system and argued that a firm with investment from foreign financial institutions has a stronger foundation to promote the development of management According to Ben-Nasr, using data collected from firms in 45 different countries, Boubakri and Cosset (2015) showed that the higher level the foreign ownership the higher the quality of income Alaryan (2015) pointed out that the foreign ownership plays a vital role in ensuring the quality of profit Taking Jordan as an example, he found that the knowledge spillover theory was supported and that the higher foreign ownership leads to more control over the management of domestic business income Gue et al (2005) studies foreign shareholders and real earnings adjustment on financial reports and suggested that foreign shareholders have positive effects on the quality of the real earnings The higher the foreign ownership, the lower the real earnings adjustment; this is the factor to restrict real earnings adjustment Tran Thi Thuy Linh et al | 625 Research methodology 3.1 Research data Research data was collected from the following websites: http://cafef.vn/, www.hsx.vn, http://www.bvsc.com.vn/ The main sample of data used in this study was 167 firms listed on Ho Chi Minh Stock Exchange (HOSE) in the duration from 2011 to 2015 and contained 835 observations in main major disciplines including Consumer Discretionary, Industrials, Real Eastate, Materials and Consumer Staples Firms were categorised according to the Global Industry Classification Standards (GICS) Table Foreign ownership of different disciplines No Disciplines Consumer Discretionary Industrials Real Estate Materials Consumer Staples Total FO is the percentage of shares held by foreign investors The authors collected the data from http://s.cafef.vn/du-lieu.chn in the duration from 2011 to 2015 The classification was based on GICS and firms relating to utilities and finance were neglected Source: Stata analysis performed by the authors 3.2 Research hypothesis This study was based on the work of Guo et al (2015) which was focused on the Big Bang Accounting Reform in Japan Hypothesis 1: Firms with high levels of the foreign ownership involve in the management of the real earnings more than the ones with low levels of the foreign ownership, which supports the knowledge spillover theory 626 | ICUEH2017 Hypothesis 2: Firms with high levels of the foreign ownership involve in the management of the real earnings less than the ones with high levels of the foreign ownership, which supports the asymmetric information theory 3.3 Description of variables 3.3.1 Independent variables The foreign ownership (FO) of the firm, which was studies in the studies of Dahlquist et al (2003) and Leuz et al (2009), is the ratio of the number of shares held by foreign investors (which include private foreign investors, supporting funds and financial institutions) to the total amount shares of a firm For one firm, this variable is the measurement of influences of foreign investors on the domestic market at the end of each year FO is defined as !" = $%&'() +, -ℎ/)(- ℎ+01 '2 ,+)(345 356(-7+)- 9100 8+7/0 5%&'() +, -ℎ/)(- +, 7ℎ( ,3)& In addition, the regression model contains other variables showing the economic characteristics of the firm, which include: The size (SIZE) of the firm: The size of the firm has an important effect on the management of the real earnings (Roychowdhury 2006) SIZE is given by: ? = @5(8+7/0 / (7-) LEVERAGE: Previous studies showed that firms use the leverage to avoid breaking debt agreement when performing any activities relating the real earning management (Dichev and Skinner, 2002) This action is important since most of firms are supported by banks and creditors can hold important roles in monitoring business activities of firms LEVERAGE is calculated as @?C?DEF? = @+54 7()& 03/'3037(- 8+7/0 / (7- Return on assets (ROA): To control effects of financial performances on the real earning management, the regression model includes ROA which is a reliable index to justify financial performances of firms and to show efficiency in deploying assets 37(&-8+7/0 /-D"E = =5G+&( '(,+)( (97)/+)135/)2 (7- Tran Thi Thuy Linh et al | 627 Growth of assets (GROWTH): Roychowdhury (2006) showed that potential sustainable growth of assets can lead to substantial changes in the real earnings management 8+7/0 / (7- 35 2(/) FD"H8I = 8+7/0 / (7- 35 2(/) − −1 Absolute values of discretionary accruals (ABS_DA): Cohen et al (2008) showed the existence of the trade-off between the real earnings management and the saving management Therefore, ABS_DA was included in their study DA is estimated based on Kothari et al (2005) while ABS_DA is the remaining calculated from MN 8EKL = E