< PreviousA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 20 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r hesitancy on our part to discuss price is seen by prospects as an indication that we believe our price is too high. Be prepared to discuss price without coughing, choking, or stammering. We must credibly, comfortably, and confidently tell each prospect, “this is the price.” The authors strongly recommend avoiding using qualifiers when describing one’s rates. For example, the statement, “our usual price is $15,000” implies that there is more than one price; the prospect will want to know about any lower options. Instead, simply say, “our price is $15,000.” Discussions about rates should be handled in a matter-of-fact way, as if discussing the time of day. Make a Statement The authors believe that price makes an important statement about credibility. If a firm’s rates are too low, prospects will wonder about weaknesses in that firm’s experience. With the exception of price-buyers, people believe they get the service they pay for and that when rates are higher, there are probably good reasons. When our rates are noticeably higher than other firms, prospects may ask why. And this may be a golden opportunity to explain our value. This is the time to discuss our competitive advantages, which go back to our expertise, responsive service, and commitment to beating deadlines. This is also a good time to discuss the prospect’s perception of quality. Quality does not mean “best,” the authors explain. Rather, it means conformance to the client’s standards and expectations. In other words, quality means the right service for each client’s needs. Conclusion Having studied salespeople, including professionals who sell their own services, Steinmetz and Brooks found that those who are most successful have two things in common. First, they are comfortable and confident when discussing their rates. Second, they passionately take care of their clients by becoming watchdogs who ensure that whatever was promised is actually delivered. How to Sell at Margins Higher than Your Competitors also provides helpful tips on using service as a competitive advantage, facing competitors’ price cuts, setting rates, and other topics. The authors’ practical, time-tested recommendations would be valuable to anyone who wants to be compensated for the full value of their expertise. VE Stephen D. Kirkland, CPA, CMC, CFF, is a compensation, tax, and financial consultant with Atlantic Executive Consulting, LLC. Since 1995, he has served as an expert witness in U.S. Tax Court and other courts to opine on reasonable compensation amounts and related issues. His presentations at NACVA conferences and webinars have explained the complexities of normalizing owner compensation in business valuations. He has also given presentations and written articles explaining how consultants can be paid reasonable rates for their expertise. More information about his background is available at ReasonableComp.biz. When our rates are noticeably higher than other firms, prospects may ask why. And this may be a golden opportunity to explain our value.Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module PRICING U.S. Cost of Capital Module Basic (two most recent years) Single User . . . . . . . . . . . . . . . . . . . . . $310 . . . . . . . . . +$129 per Basic additional user U.S. Cost of Capital Module Pro (all years, 1999 to present) Single User . . . . . . . . . . . . . . . . . . . . . $595 . . . . . . . . . . +$299 per Pro additional user *The U.S. Cost of Capital Module Basic subscription has EVERYTHING contained in the regular Basic U.S. Cost of Capital Module, but limits the number of cost of capital analyses/downloads based on your subscription level. 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Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module DATA INCLUDED IN THE U.S. COST OF CAPITAL MODULE SIZE PREMIA AND RISK PREMIA g CRSP Deciles 1–10 size premia, plus the 10th Decile split g Risk Premium Report Size Study size premia and “risk premia over the risk-free-rate” g Risk Premium Report Risk Study “risk premia over the risk-free rate” g High-Financial-Risk Study size premia and “risk premia over the risk-free rate” g Comparative Risk Study (fundamental risks of companies comprising Risk Premium Report Size Study portfolios) RISK-FREE RATES g Spot long-term risk-free rates (from the Federal Reserve, updated daily) g Duff & Phelps long-term normalized risk-free rate (adjusted for impact of flights-to-quality, actions of the Federal Reserve, and inflation expectations) U.S. EQUITY RISK PREMIA (ERPS) g 1926–present Historical (i.e., realized) ERP g 1926–present Supply-side ERP g Duff & Phelps Recommended ERP (reflecting current point in business cycle) “SIZE” TABLES Includes CRSP Deciles Size Study and Risk Premium Report size premia tables that are viewable within the Navigator. 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To learn more, visit www.NACVA.com/store_home.asp or call Member/Client Services at (800) 246-2488. NEW ENHANCED FEATURES NEW! Now Included in KeyValueData Bundles at no additional cost, OR BUY standalone! 1 1 4 5 2 3 2 3 4 Duff&Phelps_VE_Ad_Mar_2021.indd 13/4/21 8:31 AMA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 22 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r This column provides summaries of contemporary research in valuation and forensic account- ing. Summarized manuscripts—selected from numerous academic research outlets—cover significant developments that affect the ever-changing val- uation and forensic accounting landscape. The objective is to increase awareness of recently completed research that advances knowledge of these subjects. As this column evolves, The Value Examiner encourages readers to forward relevant manuscripts or working papers for consideration. Please send links or files or with Academic Research Briefs in the subject line. A Test of IPO Theories Using Reverse Mergers Authors: Paul Asquith, MIT Sloan School of Management and National Bureau of Economic Research, and Kevin Francis Rock, University of Chicago Booth School of Business Source: http://ssrn.com/abstract=1737742 Summary Asquith and Rock (A&R) investigate many of the theories1 explaining why IPO returns are large and significantly positive 1 Loughran and Ritter (2004) postulate that the reason IPOs are underpriced by underwriters is to protect themselves from a lack of demand that would lead to losses for the underwriter. They also hypothesize a second reason for underpricing IPOs is to reward clients or large customers. Liu and Ritter (2010) proposed a third theory, the “spinning theory,” which occurs when an IPO’s firm management colludes with underwriters and is rewarded with allocations of hot IPOs by the underwriter. Liu and Ritter (2010b) also propose a fourth theory, “analyst lust,” where all-star analyst coverage makes the future price of the issued stock high enough to compensate for the greater initial underpricing. on the issuance date.2 They begin their study by pointing out that reverse mergers (RMs) provide a different way to go public. Further, the announcement-day price reaction to RMs for the bidding firm is similar to the initial-day price reactions to IPOs. A&R use RMs for out-of-sample tests of the various IPO theories and they find that most of the theories are unsupportable. Simply put, RMs are a method of going public without the use of underwriters. Motivation for the Study A&R call attention to the fact that the current stockholders of the bidding firm become the majority shareholders of the combined firm in a merger. For an RM, the opposite holds true as the target company’s shareholders obtain majority control of the merged firm. Hence, the target firm is the surviving firm and the name of the bidding firm is frequently changed to the name of the target firm. If the target company is private, its shares are exchanged for the public company’s shares and the shareholders in the private company now possess the majority of the pubic company’s stock. When the target is private, the public firm is usually a nonoperating enterprise, or shell, with few tangible assets, that is merged into the previously private operating company. A&R point out that there are two significant functional differences between RMs and IPOs. The first difference lies in the fact that an IPO performs a financing role where new shares of stock are sold and equity capital is usually raised for a firm. This does not necessarily hold true for RMs. While the amount of equity capital is usually increased in an RM, the manner in which it is raised is more indirect. Furthermore, the assets of the public company may include 2 There are several other theories that explain how first-day IPO increases are motivated by underwriter and manager incentives. Academic Research Briefs By Peter L. Lohrey, PhD, CVA, CDBV Note: The views expressed in this article are those of the author and do not necessarily reflect the opinions, policies, or positions of BKD CPAs & Advisors, the author’s colleagues, or any other organization or person. /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// ACADEMIC REVIEWA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 23 tax loss carryforwards or cash, which are now available to the merged firm. In addition, there could be a concurrent or successive private investment in public equity (PIPE) transaction or additional equity offerings. The second significant difference is that there is no underwriter involved in an RM. This difference serves as the basis for A&R’s test of IPO theories. Many of the theories that explain the first-day price increase of IPOs depend on IPO rules and both the underwriters’ and firm management’s motivations. Therefore, since RMs—which do not require underwriter involvement—provide an alternative to IPOs, they offer an out-of-sample test for IPO underpricing hypotheses. In terms of the literature that asks why a private company would prefer to go public via an RM instead of an IPO, Gleason, Rosenthal, and Wiggins (2004), and Aydogdu, Shekhar, and Torbey (2007) argue that RMs provide a more affordable way for private companies to go public. In addition, A&R contend that the practitioner literature arrives at the same conclusion. It basically asserts that an RM avoids the formal IPO process, which requires the use of underwriters along with the associated guidelines and expenses. Design and Execution of Study A&R obtained a sample of RMs for the period 1980 to 2008 from Thomson’s SDC Platinum database, which identifies a merger as an RM if the target firm’s shareholders own more than 50 percent of the merged firm’s stock. They restricted the SDC sample to RMs where the bidding firm was listed in the database of the Center for Research in Security Prices (CRSP)3 when the merger took place. This restriction eliminated all of the smaller over-the-counter (OTC) RMs that occurred during the 1980 to 2008 time period. A&R divided their sample of RMs into three subsamples: 1. Public-public 2. Public-private 3. Public-nonpublic subsidiary of another firm They found that market reactions to public-public RMs were analogous to those for non-reverse mergers. In contrast, public-private and public-nonpublic subsidiary RMs had market reactions comparable to those of IPOs. The most frequent subsample that occurred consisted of public-private RMs. For the public-public subsample of RMs, the bidding firm’s mean excess returns were negative and insignificant on both the announcement day and the outcome day. The target firm’s excess returns were 7.3 percent positive and significant on the announcement day. These results support those of Jensen and Ruback (1983) and Adrade, Mitchell, and Stafford (2001) for non-reverse mergers. 3 CRSP is an affiliate of the University of Chicago’s Booth School of Business. Since reverse mergers—which do not require underwriter involvement—provide an alternative to IPOs, they offer an out-of-sample test for IPO underpricing hypotheses.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 24 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r Conclusion and Implications A&R note that when a company goes public via an RM, it does not necessarily raise more capital. They found that 21.3 percent (33 of the 155 public-nonpublic RMs) had simultaneous PIPE offerings combined with the RM. They also found that 17.4 percent (27 of the 155 public-nonpublic RMs) had public shell companies. Of the 27 public shell companies, 85 percent (23) did not engage in PIPE financing within the first 12 months following the completion of an RM. In regard to the many theories that exist to explain why IPO returns are large and significantly positive on the issuance date, several propose that the IPO price increase happens because the underwriters intentionally underprice the offering to safeguard themselves from losses or to compensate some of their clients. Some theories focus on behavioral concerns related to managers’ investment decision processes, while others rely on the value-boosting effect of the public market’s liquidity. A&R conclude by observing that most of the theories that are used to explain IPOs do not explain the market’s similar reaction to RMs. The only justifications that can be applied to both IPOs and RMs are the ones that include increases in trade volume due to the market’s preference for newly listed companies. However, the reasons provided for increased trading volume in IPOs—such as the underpricing of shares by underwriters or the marketing aspects of a “roadshow,”4 do not apply to RMs. Financial Reporting Quality of Chinese Reverse Merger Firms: The Reverse Merger Effect or the Weak Country Effect? Authors: Kun-Chih Chen and Qiang Cheng, Singapore Management University, Ying Chou Lin, Missouri University of Science and Technology, Yu-Chen Lin, National Cheng Kung University, and Xing Xiao, Tsinghua University Source: The Accounting Review 91, no. 5 (September 2016), 1363–1390. 4 A roadshow is a series of presentations made in various locations leading up to an IPO. The roadshow is a sales pitch or promotion made by the underwriting firm and a company’s management team to potential investors before going public. Summary Chen, Cheng, Lin, Lin and Xiao (CCLL&X) investigate why Chinese reverse merger (RM) firms possess inferior financial reporting quality compared to Chinese American depositary receipt (ADR) firms. They also found that U.S. RM firms had similar financial reporting quality to matched U.S. IPO firms. Finally, they found that Chinese RM firms displayed lower financial reporting quality than U.S. RM firms. CCLL&X’s results demonstrate that the usage of the RM process is linked to poor financial reporting quality only in Chinese firms—due to the weaker enforcement of regulations in China compared to accounting regulation enforcement in the U.S. CCLL&X also found that Chinese RM firms had lower CEO turnover performance sensitivity—which is a gauge of bonding incentives—along with weaker corporate governance, which explains the weaker financial reporting quality in Chinese RM firms. These results suggest, in general, that the RM process provides Chinese firms with poor bonding incentives combined with poor governance even though they gain access to U.S. capital markets. This explains why there is weak financial reporting quality for Chinese RM firms. Motivation for the Study The first motivation for this study is to determine why Chinese RM firms had so many accounting problems from 2000 to 2011. CCLL&X point out that most of the RM deals during this period were initiated by U.S. public shell firms,5 which acquired private Chinese operating firms. In a typical RM transaction, the original U.S. public firm survives, while the original private shareholders keep control of the entity. The primary reason for the popularity of these transactions lies in the speed and lower costs that RM transactions offer, especially compared to the IPO process. 5 A public shell firm is identified as a public reporting U.S. Securities and Exchange Commission registrant that has little or no operating activities, no or minimal assets containing just cash and cash equivalents (see SEC Securities Act Release No. 33-8587). Broadly speaking, shell companies can be categorized as virgin shells, development stage shells, or natural shells.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 25 CCLL&X note that there were 448 Chinese RM deals from 2000 to 2011.6 They also point out that the RM process—in the U.S.—has been criticized as a “back door” or “shortcut” way to go public, since RM firms bypass SEC and U.S. stock exchange scrutiny that comes with an IPO. Hence, many skeptics believe that foreign RMs only “rent” the benefits of listing in the U.S. and do not improve the quality of their corporate governance or financial statement reporting. CCLL&X state that Siegel and Wang (2013) found that in 2010 and 2011, a number of Chinese RM firms were forced to restate their financial statements after several stockholder lawsuits claimed fraud. Templin (2012) found that from mid-2010 to mid- 2011, Chinese RM firms lost 80 percent of their market value. As a result, CCLL&X wonder whether the low financial reporting quality of Chinese RM firms results from the use of the RM method—which they call the “RM factor”—or whether it is due to weak legal enforcement over Chinese firms—which they call the “weak country factor.” Answering this question is the second motivation for the study. The third motivation for the study centers on what is called the “bonding hypothesis.” Prior studies by Coffee (1999) and Stultz (1999) assert that companies with poor minority stockholder protection signal their intention to respect stockholder rights by listing in a jurisdiction with greater market scrutiny, stricter regulations, and superior enforcement. CCLL&X test this hypothesis by comparing the financial reporting quality of Chinese RM companies to that of U.S. RM companies. Literature Considered in the Study This paper contains several significant contributions to the literature on cross- listing—especially the studies that investigate the impact of cross-listing on financial reporting quality. It also contributes to papers by Coffee (2002), Licht (2003), Siegel (2005), and Leuz (2006), who examined the impact of cross-listing on foreign firms’ strategic choices and firm value. One noteworthy difference between these studies and this paper is that the other studies use ADRs for their samples while CCLL&X use RM firms. It is important to note that Lang et al. (2003) found that firms cross-listed in the U.S. inform the public about bad news in a more expedient manner compared to the firms back in their home countries. Several previous studies have also focused on the financial reporting quality of cross-listed foreign firms compared to domestic U.S. firms. Lang et al. (2006) found that cross-listed firms were more inclined to participate in earnings management than U.S. domestic firms. Ndubizu (2007) found similar results, especially at the point in time of cross-listing. He also concluded that non-IPO ADR firms do not differ from IPO ADR firms in financial reporting quality. 6 CCLL&X also found that there were 135 Chinese ADRs (IPOs-ADRs) issued and listed on major U.S. stock exchanges and an additional 107 unsponsored or level 1 Chinese ADRs. Level 1 ADRs are the most basic type of ADR with the least amount of oversight by the SEC. Most companies issuing level 1 ADRs either do not pass the SEC’s minimum qualification or do not want to deal with the hassle. They only trade on OTC markets and foreign companies cannot raise capital with them. See Isaac Aydelman, "Should ADRs Be Added to Your Portfolio?," investorjunkie, last updated April 21, 2021, https://investorjunkie. com/investing/adrs/. Many skeptics believe that foreign RMs only “rent” the benefits of listing in the U.S. and do not improve the quality of their corporate governance or financial statement reporting.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 26 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r Many of the prior studies not discussed by CCLL&X (e.g., Coffee, 1999; Stulz, 1999), were built on the “bonding hypothesis,” which asserts that companies with poor minority stockholder protection signal their intention to respect stockholder rights by listing in a jurisdiction with greater market scrutiny, stricter regulations, and superior enforcement. It should be noted, however, that legal bonding strength had recently been scrutinized (e.g., by Licht, 2003; Leuz, 2006) before CCLL&X wrote their paper. Specifically, these papers pointed out that ADRs do not have to provide full U.S. GAAP financial statements; they only need to file SEC Form 20-F. In addition, other studies (e.g., Siegel, 2005; Licht et al., 2013) found that legal enforcement actions against foreign firms were infrequent and often yielded minor penalties. Design and Execution of Study CCLL&X ask whether the low financial reporting quality of Chinese RM firms results from the RM factor or the weak country factor. First motivation: The RM factor. In order to focus on the potential RM factor effect for U.S. firms, CCLL&X compare U.S. RM firms with U.S. IPO firms. The only difference between these two sets of SEC registrants is the listing process. Hence, if loopholes in the RM process are the main driver of financial reporting quality, CCLL&X expect U.S. RM firms to have lower financial reporting quality than U.S. IPO firms. This leads to their first hypothesis: H1: Ceteris paribus, the financial reporting quality of U.S. RM firms is lower than that of U.S. IPO firms. Next, CCLL&X separate the potential RM factor effect for Chinese firms by comparing the financial reporting quality of Chinese RM firms with Chinese ADR firms. This methodology serves to hold constant the legal situation as both Chinese RM firms and Chinese ADR firms are exposed to the same legal requirements; they only differ in the choice of listing. This leads to their second hypothesis: H2: Ceteris paribus, the financial reporting quality of Chinese RM firms is lower than that of Chinese ADR firms. Second motivation: The weak country factor. Templin (2012) found that government watchdogs have inadequate enforcement authority over both Chinese RM firms and the Chinese auditors who prepare their financial statements. CCLL&X decided to test the impact of the weak country factor—weak legal enforcement over Chinese firms’ financial reporting quality—by controlling for listing choice. To do this, they compared the reporting quality of Chinese RM and U.S. RM companies. They hypothesize that if weak legal enforcement leads to lower financial reporting quality, then Chinese RM firms will have lower financial reporting quality than U.S. RM firms. Hence, their third hypothesis is: H3: Ceteris paribus, the financial reporting quality of Chinese RM firms is lower than that of U.S. RM firms. Third motivation: Chinese RM firms and Chinese ADR firms—bonding incentives and corporate governance. CCLL&X state that the bonding process relies on the idea that foreign firms willingly expose themselves to stringent rules and close supervision by market observers in more sophisticated capital markets as a tradeoff for the chance to acquire less expensive capital. When it comes to Chinese RM firms, CCLL&X wonder whether they have particularly weak bonding incentives due to the fact that the majority of insiders do not cash out right after the foreign RM transactions are completed. (See, e.g., Floros and Shastri, 2009b.) Hence, Chinese RM firms—unlike Chinese ADR firms—do not provide insiders with an increase in value owing to the fact that existing stockholders of RM firms do not immediately cash in. CCLL&X speculate that most of the corporate governance-related decisions made by U.S. listed Chinese operating companies are determined by the strength of their bonding incentives. When a company operates in a weak legal environment, such as China, adopting more effective governance procedures will provide a clear signal of its bonding incentives. China’s weak governance over its stock exchanges combined with weak control over its accountants leads CCLL&X to hypothesize that Chinese companies will not adopt more effective corporate governance procedures.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 27 CCLL&X investigate the potential differences in bonding incentives and corporate governance by using Chinese RM companies and Chinese ADR companies to test the following two hypotheses: H4a: Ceteris paribus, Chinese RM firms have weaker bonding incentives than Chinese ADR firms. H4b: Ceteris paribus, the strength of corporate governance is weaker in Chinese RM firms than Chinese ADR firms. CCLL&X gathered data from various sources, including Dealflow Media, the June 2011 Bloomberg report, and the U.S. listed Chinese companies included in USX China Index and cnYES.com, to arrive at an initial sample of 448 Chinese RM companies during the period 2000–2011. The final sample was reduced to 193 Chinese RM companies due to the inability to obtain either the needed SEC filings or the needed financial statement information from Compustat. CCLL&X followed the same procedure for U.S. RM companies. Their initial sample of 1,204 RM deals was collected from Dealflow Media. They then used the same data criteria to arrive at a final sample of 273 U.S. RM companies with 208 of them traded on the OTC market and 65 of them listed on the NYSE and AMEX stock exchanges. Chinese ADRs were selected from the information provided by Bank of New York, J.P. Morgan’s adr.com, cnYES.com, Sina.com, and the Halter USX China Index on a quarterly basis. ADRs that were traded in the OTC market were eliminated due to the fact that they were exempt from SEC reporting requirements and there was no information about them on Compustat. CCLL&X obtained stock price and stock return data from CRSP. Auditing data was collected from Audit Analytics. Thomson SDC New Issues database was used to find seasoned equity offerings and private placement data. Finally, PIPE data was collected from Sagient Research’s Placement Tracker database. The final sample used by CCLL&X to test their hypotheses came to 193 Chinese RM firms, 273 U.S. RM firms, and 142 Chinese ADR firms. Conclusion and Implications CCLL&X used a regression model introduced by Ball and Shivakumar (2006) to measure the conditional conservatism, based on the premise that companies that recognize bad news more quickly than other companies are usually considered to have higher financial reporting quality. They also used the probability of accounting restatements as a proxy for financial reporting quality. CCLL&X note that the outcomes based on restatements may or may not coincide with the results based on accrual-based financial reporting quality gauges. Companies that recognize bad news more quickly than other companies are usually considered to have higher financial reporting quality.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 28 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r In order to test H1 to H3, CCLL&X used a regression model with a dummy variable equal to one for a Chinese RM and zero otherwise. For H1, CCLL&X compared the financial reporting quality of U.S. RM firms to matched U.S. IPO firms to determine whether the RM factor led to lower financial reporting quality for U.S. RM firms. Their results show that the lower regulatory standards found in the RM process do not lead to lower financial reporting quality for U.S. RM firms. To test H2, CCLL&X compared the financial reporting quality of Chinese RM firms with Chinese ADR companies to determine whether the RM factor made any difference, given that both groups of companies are exposed to anemic law enforcement. Again, they used a regression model to conclude that the financial reporting quality of Chinese RM firms is lower than that of Chinese ADR firms. In summary, the results indicate that while the RM factor does not lead to lower financial reporting quality for U.S. RM firms, it does matter for Chinese RM firms. The third hypothesis, H3, was used by CCLL&X to determine whether the weak country factor led to lower financial reporting quality. Again, a regression model was used to compare Chinese RM and U.S. RM firms. This was done because both Chinese and U.S RM firms must comply with the same RM-related issues and filing regulations with the only difference being country-related issues. The regression results show that weak local law enforcement led to lower financial reporting quality at the Chinese RM firms. It should be noted that the estimated results indicate that Chinese ADR firms have similar financial reporting quality as U.S. RM firms. CCLL&X conclude that the lower financial reporting quality by Chinese RM firms is due to both the RM and weak country factors. CCLL&X relied on unmeasured results to conclude that Chinese RM companies had weaker bonding incentives than did Chinese ADRs. This finding was based on hand-collected data from financial statements filed by U.S.-listed Chinese companies in the Audit Analytics database. This result supported H4a, meaning that Chinese RM firms had weaker bonding incentives, or less incentive to improve corporate governance to signal their desire to protect minority stockholders’ rights. For the last hypothesis tested, H4b, CCLL&X investigated whether the RM process attracts Chinese firms with weak bonding incentives based on corporate governance characteristics, such as ownership structure, board of directors’ characteristics, and CEO compensation format. CCLL&X again used hand-collected data from SEC forms 10-K and 20-F, proxy statements, and insider ownership filed by Chinese companies during the 2000 to 2011 time period. CCLL&X found that Chinese ADR firms have higher insider ownership, fewer large foreign blockholders, and smaller, less independent boards of directors. They are also more likely to have CEOs who serve as board chair and less likely to have founder-CEOs or to grant CEOs option-based compensation. These results support H4b, which means that corporate governance is weaker for Chinese RM firms than it is for Chinese ADR companies. This paper expands the literature on Chinese RM and Chinese ADR companies by explaining why Chinese RM firms have lower financial reporting reliability. CCLL&X conclude that as a result of less rigorous quality compliance regulations, Chinese RM firms with reduced bonding incentives and weak governance have an opportunity to gain access to U.S. capital markets. These factors produce China RM companies with lower quality financial reporting. CCLL&X add that Chinese RM companies that have robust governance and hire Big Four auditors strengthen their financial reporting quality. VE Peter L. Lohrey, PhD, CVA, CDBV, is a director in the Forensics, Investigations and Litigation Services Practice at BKD, LLP, one of the largest accounting and advisory firms in the U.S. Located in BKD’s New York office, Dr. Lohrey specializes in business valuation for litigation, forensic, and financial reporting purposes. He also provides lost profits and other measures of damages for commercial litigation matters. Dr Lohrey is an adjunct accounting professor at Fairleigh Dickinson University’s Teaneck, New Jersey, campus. Email: plohrey@bkd.com. In summary, the results indicate that while the RM factor does not lead to lower financial reporting quality for U.S. RM firms, it does matter for Chinese RM firms. 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