The effect of international accounting diversity on the integration of capital markets

Date of Completion

January 1998


Business Administration, Accounting




This dissertation investigates whether accounting diversity may affect international integration of capital markets. More specifically, it examines (1) whether differences in accounting standards are negatively associated with levels of capital market integration; (2) whether international diversification benefits reduce the negative impact of accounting diversity on capital market integration; and (3) how investors deal with unfamiliar accounting rules when making foreign investments.^ The results from this dissertation provide three important findings. First, accounting diversity is negatively associated with the level of capital market integration, supporting the argument that accounting differences are an informational barrier that impedes capital market integration. Second, international diversification benefits are positively associated with the level of capital market integration. This finding suggests that people may be willing to invest in foreign countries despite accounting differences because of diversification benefits. Third, when making investment decisions in foreign countries with different accounting standards from those of the US, US investors appear to rely on (1) earnings forecasts from companies' local analysts, and (2) companies' cash flows as coping mechanisms to overcome accounting differences. However, capital market integration cannot be assured by using these two coping mechanisms.^ There are three important contributions of this dissertation. First, understanding the role of accounting diversity in the integration of capital market has economic and policy implications. There are economic benefits associated with internationally integrated capital markets. If accounting diversity impedes capital market integration, there is the potential for losses in economic welfare. Thus, the results of this dissertation may serve to inform policy makers of the need and desirability of harmonizing accounting standards. Second, it is important to understand investor behavior in making foreign investments. Understanding possible investor coping mechanisms will provide a better understanding of how international capital markets function. Third, economics studies suggest that informational barriers are the most plausible reason for the low integration. Yet this theory has not been tested due to the difficulty of measuring an informational barrier. This study tests this theory by developing an index of accounting diversity, a possible information barrier, and then testing its impact on capital market integration. ^