An Accounting Approach to Law and Finance: -A cross-European study using earnings multiples

Abstract: This research paper is an attempt to combine two extensively researched disciplines, namely the field of “Law and Finance” and the field of international accounting. “Law and Finance” theory finds that there are institutional differences between countries in the way the legal system protects minority shareholders, where higher minority shareholder protection ultimately leads to companies being valued higher by the market. However, in their methodology, previous studies on the field have to a great extent disregarded the large differences in accounting that also influence firm values. Based on financial data of 1026 companies, from 15 different European countries during 1995-2006, this paper empirically analyzes if using a methodology that adjusts for accounting differences alters the previous finding on “Law and Finance”. Using earnings multiples as a tool, this study confirms that “Law and Finance” has an impact on firm values. Nonetheless, due to the overriding accounting discrepancies, the impact only becomes observable after controlling for financial reporting differences. Finally, since multiples are affected by “Law and Finance”, the study examines if using multiples in the appraisal technique known as Multiple valuation has a distorting effect on the valuation. Here the study shows that due to how Multiple valuation is performed, the “Law and Finance” effect is leveled out.