The State Expropriation Risk and the Pricing of Foreign Earnings

Abstract

We examine the pricing of U.S. multinational firms’ foreign earnings in regard to their risk of expropriation and unfair treatment by the governments of the countries in which their international subsidiaries are located. Using 8,891 firm-years observations during the 2001-2013 period, we find that the value relevance of foreign earnings increases with the improvement of the protection from state expropriation risk in the subsidiary host-countries. Our results are not driven by the earnings management practice, investor distraction, country informativeness, and political and trade relationship of a foreign country with the US. Furthermore, our results are robust to the confounding effects of country factors, measurement error in the variable of the risk of expropriation, influence of private contracting institutions, and endogeneity in the decision of location of subsidiaries.

Discussion of: The State Expropriation Risk and the Pricing of Foreign Earnings

“…They contend and find that, when subsidiary country expropriation risk declines, the value relevance of foreign earnings increases. Hasan et al (2021) view their evidence as consistent with the idea that investors discount foreign earnings when they perceive the risk of expropriation and unfair treatment by foreign governments to be high.…”

“…I argue that Hasan et al (2021)'s maintained assumption is rather strong, as it neglects the realistic possibility that the pricing of foreign subsidiary earnings is also a function of subsidiary earnings quality. Second, the evidence in Hasan et al (2021) mainly relies on a cross-sectional identification strategy and thus their findings are to be interpreted with this caveat in mind. Third, while Hasan et al (2021) are careful in designing a number of sensitivity tests to account for the influence of confounders, potential alternative explanations for their documented findings are hard to rule out.…”

“…The study of Hasan et al (2021) aims to contribute to the longstanding stream of the literature that examines the pricing and value relevance of foreign earnings (e.g., Thomas, 1999;Callen et al, 2005;Hope et al, 2009), as well as to the nascent literature that investigates the within-MNC determinants of financial reporting transparency (e.g., Dyreng et al, 2012;Beuselinck et al, 2019).…”

“…First, related to the study's theoretical underpinnings, a maintained assumption of Hasan et al (2021) is that the pricing of foreign subsidiary earnings is only explained by investors discounting foreign subsidiary earnings to account for subsidiary country risk of expropriation in their investment decisions-that is, investors rely less (more) on foreign subsidiary earnings when subsidiary country risk of expropriation is high (low). I argue that Hasan et al (2021)'s maintained assumption is rather strong, as it neglects the realistic possibility that the pricing of foreign subsidiary earnings is also a function of subsidiary earnings quality. Second, the evidence in Hasan et al (2021) mainly relies on a cross-sectional identification strategy and thus their findings are to be interpreted with this caveat in mind.…”

“…Second, the evidence in Hasan et al (2021) mainly relies on a cross-sectional identification strategy and thus their findings are to be interpreted with this caveat in mind. Third, while Hasan et al (2021) are careful in designing a number of sensitivity tests to account for the influence of confounders, potential alternative explanations for their documented findings are hard to rule out.…”