Flight to Quality in International Markets: Investors’ Demand for Financial Reporting Quality during Political Uncertainty Events

Abstract

We examine whether international equity mutual fund managers shift their portfolios toward stocks with higher financial reporting quality (FRQ) during periods of high political uncertainty. Our study is motivated by two primary factors. First, prior research shows evidence of fund managers’ “flight to quality” (e.g., to less risky securities) during periods of uncertainty. Second, recent theoretical research concludes that stocks with higher FRQ are assessed as less sensitive to systematic risk (such as political uncertainty). We employ national elections as exogenous increases in systematic risk in the local markets and accordingly use an international sample of mutual funds that focus on local markets. We find that mutual fund managers shift their equity holdings to stocks with higher FRQ during election periods when political uncertainty is higher. Such a flight‐to‐quality effect is less pronounced for elections with larger expected electoral margins in the pre‐election period (i.e., when the incumbent is more likely to win the election) and for countries with higher transactions costs. In contrast, the effect is more pronounced when governments have greater involvement in the local economy. Our inferences are robust to alternative proxies for political uncertainty and FRQ and to numerous other sensitivity analyses.

Impact of Board Characteristics, Audit Committee Characteristics And External Auditor on Disclosure Quality of Financial Reporting

“…Since financial information is critical in this regard. It becomes necessary to assess the extent to which quality reporting is done in preparing the financial statements (Chen, Hope, Li, & Wang, 2015). In the other hand, investors require information to gage the corporation for making their investment decisions (Johl, Kaur Johl, Subramaniam, & Cooper, 2013).…”

“…Importance of independent directors in the AC has always been forced to authenticate the monitoring and controlling of corporate management due to their opportunistic behavior (Armstrong, Guay, & Weber, 2010). Independent directors are stricter in discharging their responsibilities, and are in a better position to control and face complex situations, because their affiliation is not direct with the management of the company (Brandes, Dharwadkar, & Suh, 2015), as well as the provision of disclosure quality of financial statements (García Lara, García Osma, & Penalva, 2014;Chen, Hope, Li, & Wang, 2015). Based on agency theory, audit committee is considered as an important component for controlling the decisions of the management (Goodman, Neamtiu, Shroff, & White, 2013) In Malaysia, the president of Malaysian Institute of Accountant (MIA), Abdul Rahim, has cited the need for an effective AC.…”

“…The findings of the study are in accordance with the findings of Be´dard, Chtourou and Courteau (2004). Therefore, it is clear that more independent directors enhance the independency of AC and ultimately improve the disclosure quality of financial statements (García Lara, García Osma, & Penalva, 2014;Chen, Hope, Li, & Wang, 2015). In short, the forth hypothesis is accepted.…”

Discussion of “Flight to Quality in International Markets: Investors’ Demand for Financial Reporting Quality during Political Uncertainty Events”

“…At the core of Chen, Hope, Li, and Wang () (hereafter CHLW) is the question of whether investors demand higher financial reporting quality of the stocks they hold in anticipation of increased political‐economic uncertainty. To answer this question, CHLW look at whether portfolio managers around the world tilt the balance of their portfolios more toward firms with higher financial reporting quality in advance of major elections.…”

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In this paper, I provide a summary and discussion of Chen, Hope, Li, and Wang (2018). In my discussion, I summarize their main findings and focus on key conceptual aspects of their research design.

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