Financial reporting quality and dividend policy: New evidence from an international level

This study examines the link between financial reporting quality and dividend payout across 76 countries. We find that financial reporting quality increases dividend payout after controlling for firm and country specifics. We also investigate different channels that moderate the relation between financial reporting quality and dividend payout. We find that the positive association between high-quality financial reporting and dividend payout is more pronounced when firms have free cash flow problems, face severe information asymmetry, and are located in countries with weaker minority shareholder protection rights. Interestingly, we find evidence that high reporting quality enhances firms' payment of dividend even when these firms already overpaying their shareholders. However, the relation becomes weaker when firms overpass the optimal level of dividend payout. The findings remain consistent after several robustness checks, thus highlighting the effectiveness of more transparent disclosure of financial information in reducing information asymmetry related to firms' internal agency costs and their relationships with external parties.     

The Influence of Country‐ and Firm‐level Governance on Financial Reporting Quality: Revisiting the Evidence

This paper examines how firm‐level governance and country‐level governance interplay in shaping financial reporting quality. Using IFRS adoption as a source of variation in firms’ reporting discretion, and a large sample of European firms that mandatorily switch to the new set of standards, we find that in countries with low enforcement and weak oversight over financial reporting, only firms with strong board‐level corporate governance mechanisms experience an increase in financial reporting quality, consistent with firm‐ and country‐level governance mechanisms being substitutes. However, in countries with high enforcement and strict oversight over financial reporting, firms with either strong or weak board‐level governance mechanisms experience an increase in financial reporting quality, even if the increase is larger for the former group. Overall, our findings indicate that in the debate about the effects of governance on the quality of financial reporting, it is important to consider both country‐ and firm‐level corporate governance mechanisms.     

Discretion in revenue recognition timing and comparability: Evidence from the implementation of SOP 97-2

An objective of financial reporting regulation is to encourage the production of decision-useful information. This paper examines the association between the level of discretion allowed in accounting standards and comparability, a key characteristic of decision-useful reporting. To study this link, I investigate changes in comparability around regulation SOP 97-2, which decreased discretion in the timing of revenue recognition on software-related transactions. Using a difference-in-differences research design, I find a positive association between discretion and comparability for affected firms, relative to control firms. This result is attenuated for firms with low reporting quality prior to the rule change and those that experienced a larger direct impact on their revenue recognition practices. This paper furthers understanding of the linkage between reporting discretion and the decision-usefulness of accounting outputs. Additionally, the results highlight the complex interactions between various financial reporting attributes.     

Financial reporting quality and outsourcing of accounting tasks: Evidence from small private firms

This study explores whether the financial reporting quality of small firms differs between firms that outsource accounting tasks and firms that perform these tasks internally. Using accruals quality as a measure for the financial reporting quality and a sample of small Finnish limited liability firms, we find that the quality among the firms is positively related to the decision of purchasing accounting services from an external service provider. This result is also economically significant. The evidence shows that outsourcing of accounting tasks such as the preparation of the statutory financial statements and longer outsourcing relationships increases reporting quality. However, outsourcing of additional tasks, such as payroll processing, does not result in higher quality. These findings are consistent with previous studies showing that small firms in general lack the resources and expertise to prepare high quality financial reports. We provide evidence of an important yet under-researched area of financial reporting quality among small firms.     

Do stock prices reflect undisclosed financial statement information? Evidence from the OTCBB

I exploit a regulatory change that mandated that Over-the-Counter Bulletin Board (OTCBB) firms must comply with the reporting requirements of the 1934 Securities Exchange Act. I use this change to examine the association between equity values and financial statement data in voluntary and mandatory disclosure environments. Before the change, disclosure of financial statement information was voluntary for most of these firms. I study firms that initiate SEC filing after the change and classify them as disclosing and nondisclosing based on whether they voluntarily disclosed financial statement information before the regulatory change. In these firms’ initial SEC filings after the eligibility rule, they retroactively disclose financial statement information for the year prior to compliance with the rule. Thus I can observe previously withheld financial data. I find that the choice to voluntarily disclose is negatively associated with firm characteristics related to proprietary costs and with situations in which accounting information plays a less important role in resolving information asymmetry. For nondisclosing firms, I find evidence that equity values reflect financial statement data, even though this information was not publicly available, and that compliance with mandatory SEC disclosure requirements strengthens this association. For disclosing firms, I find evidence that suggests investors viewed their voluntary disclosure of financial statement data as credible and fail to find evidence that compliance with mandatory reporting requirements enhances this association.     

Government quality,auditor choice and adoption of IFRS: A cross country analysis

We examine the association between country-level government quality and firms' choice of external auditors. Using a cross-sectional sample of 142,193 firm-year observations from 46 countries over 1998–2007, we show that the government quality of a country has a significant positive effect on the likelihood of choosing Big 4 auditors by firms in that country. We also show that firms in countries with strong governments that have adopted IFRS are more likely to choose Big 4 than non-Big 4 auditors. To our knowledge, this is the first study of its kind to provide direct evidence on the role of government quality in firms' choice of external auditors. Choice of a Big 4 auditor may be regarded as a proxy for the demand for high quality financial reporting, and thus the results provide insights for policy makers on the importance of government quality toward improving financial reporting quality in a country.     

Auditor Independence,Non‐Audit Services,and Restatements: Was the U.S. Government Right?*

Do fees for non‐audit services compromise auditor's independence and result in reduced quality of financial reporting? The Sarbanes‐Oxley Act of 2002 presumes that some fees do and bans these services for audit clients. Also, some registrants voluntarily restrict their audit firms from providing legally permitted non‐audit services. Assuming that restatements of previously issued financial statements reflect low‐quality financial reporting, we investigate detailed fees for restating registrants for 1995 to 2000 and for similar nonrestating registrants. We do not find a statistically significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements, but we do find some such association for unspecified non‐audit services and restatements. We find a significant negative association between tax services fees and restatements, consistent with net benefits from acquiring tax services from a registrant's audit firm. The significant associations are driven primarily by larger registrants.     

Beyond Tax Avoidance: Offshore Firms’ Institutional Environment and Financial Reporting Quality*

We explore how firms’ operations in Offshore Financial Centers (OFCs) through subsidiaries or affiliates affect the quality of financial reporting. Using a unique and large sample of firms that have headquarters in the 15 countries with the strictest legal regimes and have subsidiaries or affiliates in OFCs, we find that such firms exhibit lower financial reporting quality than comparable firms without OFC operations. We also find that as OFC characteristics become more prevalent, firms are more likely to engage in both accrual‐based and real earnings management. More importantly, after disentangling OFC characteristics into the opportunity for tax avoidance, regulation arbitrage and secrecy policies, we find that beyond tax avoidance, regulation arbitrage and the secrecy policies of OFCs significantly affect financial reporting quality. The causal effect of OFC operations is supported by the analysis of financial reporting quality when firms set up OFC operations. Our findings are robust to various additional tests addressing potential endogeneity issues. We conclude that the assessment of a firm's institutional environment must encompass the registration status of its subsidiaries or affiliates as well as its own.     

An Empirical Investigation of the Effect of CFO Power on Disclosure Quality

We examine the association between chief financial officer (CFO) power and disclosure quality, measured using financial statement disaggregation disclosure and analyst forecast disclosure. Empirically, we validate that CFO power, measured by multiple dimensions, is positively associated with firms’ disclosure quality. We also find that this positive association between CFO power and disclosure quality is stronger when firms exhibit higher governance monitoring and accounting quality. Further analysis shows that our main results hold across multiple disclosure quality tests. Our findings are robust to addressing endogeneity issues using two-stage least squares, Heckman selection bias, and propensity score matching analyses. The results highlight the importance of CFO power for the accounting reporting process and decision-making.     

Earnings quality and short selling: Evidence from real earnings management in the United States

Prior research provides evidence consistent with managers using real earnings management (REM) to increase earnings. This study examines whether short sellers exploit the overvaluation of firms employing REM. I find that firms with more REM have higher subsequent short interest. The positive relation between REM and short interest is more pronounced in settings where the costs associated with accrual‐based earnings management are high, such as when a firm has low accounting flexibility or faces greater scrutiny from a high quality auditor. I also find some evidence that short sellers respond to REM more than to other fundamental signals of firm overvaluation. My inferences are robust to the use of propensity score matching. Collectively, my evidence suggests that short sellers not only trade on REM information, but they also trade as if they understand the substitutive nature of alternative earnings management methods. This study provides additional insight into the important role that short sellers play in monitoring managerial operating decisions and overall earnings quality.     

Corporate Pyramids,Conservatism and Cost of Debt: Evidence From Taiwan

This study investigates the extent to which the span of corporate pyramids (as measured by the number of ownership layers) is associated with higher agency costs of debt, and whether conservatism can moderate the agency cost. Consistent with corporate pyramids generating higher agency costs and information asymmetries between corporate insiders and outside creditors, we find a positive association between the number of investment layers and cost of debt. However, we also find that multi-layered firms mitigate organizational opaqueness through increased financial reporting conservatism, which results in lower cost of debt capital. These findings provide new insights into the relationship between organizational structure and financial reporting quality.     

Stock price crash risk and internal control weakness: presence vs. disclosure effect

This study examines the stock price crash risk for a sample of firms that disclosed internal control weaknesses (ICW) under Section 404 of the Sarbanes‐Oxley Act (SOX). We find that in the year prior to the initial disclosures, ICW firms are more crash‐prone than firms with effective internal controls. This positive relation is more pronounced when weakness problems are associated with a firm's financial reporting process. More importantly, we find that stock price crash risk reduces significantly after the disclosures of ICWs, despite the disclosure itself signalling bad news. The above results hold after controlling for various firm‐specific determinants of crash risk and ICWs. Using an ICW disclosure as a natural experiment, our study attempts to isolate the presence effect of undisclosed ICWs from the initial disclosure effect of internal control weakness on stock price crash risk. In so doing, we provide more direct evidence on the causal relation between the quality of financial reporting and stock price crash risk.     

Directors’ and Officers’ Liability Insurance and Aggressive Tax‐Reporting Activities: Evidence from Canada

This paper examines the relationship between directors’ and officers’ liability insurance (D&O insurance) and firms’ aggressive tax reporting. Using large Canadian public companies listed on the TSX300 and relying on several measures to capture aggressive tax‐reporting activities, including GAAP effective tax rates, cash effective tax rates, and the total and residual book‐tax differences, I find that D&O insurance exhibits a strong negative relationship with the GAAP effective tax rates and a strong positive relationship with both the total and residual book‐tax differences. However, there is generally no evidence showing that D&O insurance is associated with the cash effective tax rates. I interpret these results as indicating that D&O insurance reduces the tax expenses reported in the financial statements but not the actual tax paid. In other words, D&O insurance contributes to financial tax management but not to cash tax savings. Further tests in this study reveal that firms with fluctuating D&O coverage limits engage in more aggressive tax reporting than other firms, suggesting that managers may consider the level of D&O insurance that they purchase when they make aggressive tax‐reporting decisions.     

The effect of financial reporting quality on corporate dividend policy

This study examines how financial reporting quality affects corporate dividend policy. We find that higher quality reporting is associated with higher dividends. This positive association is more pronounced among firms with more severe free cash flow problems and among firms with higher ownership by monitoring-type institutional investors. Further analysis of the relation between reporting quality and under?/over-payment of dividends suggests that reporting quality largely mitigates underpayment of dividends. Additionally, both a granger causality test and a difference-in-difference analysis of dividend changes around a quasi-exogenous reporting event yield evidence consistent with the direction of causality going from financial reporting to dividends. Overall, these findings are consistent with financial reporting quality acting as a governance mechanism that induces managers to pay dividends by disciplining free cash flow problems. Our findings support the view that dividends are the result of enhanced monitoring (Jensen 1986; La Porta, Lopez-de-Silanes, Shleifer, and Vishny 2000).     

Perks and the informativeness of stock prices in the Chinese market

While the literature shows that perks can affect firm values positively or negatively, we argue that firms with higher perks are more likely to be associated with a lower quality of financial reporting, which, in turn, can affect the informativeness of stock prices. Based on hand-collected data on perks from Chinese listed firms, we find that firms with lower perks are associated with higher informativeness of stock prices (or lower R-square). Moreover, the positive association between perks and R-square is shown to be weaker for firms with higher financial reporting quality through audit and earnings quality measures.     

Directors skill and financial reporting quality

Motivated by theoretical models in economics which show that there is matching between CEO skill and firm size, we introduce a new measure of director skill which is based on the aggregate size of firms on which the director serves as an independent director. We validate our measure by showing that it is positively associated with director experience, financial expertise, industry expertise and managerial experience. We then examine whether our average measure of skill across board members is positively associated with monitoring quality. Controlling for the endogenous relationships between board composition and financial reporting quality, we find a positive association between our board measure for skill and monitoring quality, and we show that directors have a causal impact on monitoring effort and outcomes. Furthermore, consistent with the enhanced monitoring provided by skilled directors, we document a positive association between the level of and changes in our measure and firm value.     

Corporate Lobbying,Visibility and Accounting Conservatism

In this study, we examine the relationship between a firm's lobbying activities and financial reporting quality using a US setting where public scrutiny of corporate political activities is high. More importantly, we examine whether and how a firm's visibility shapes the relationship between its corporate lobbying activities and accounting conservatism. Adopting annual lobbying expenditure data to measure firms’ lobbying activities, and using a propensity‐score‐matching methodology to control for differences in firm characteristics between lobbying and non‐lobbying firms, we find a positive relationship between a firm's lobbying intensity and the degree of accounting conservatism in its financial reporting. We further find this positive relationship to be more pronounced in lobbying firms with a higher level of visibility. These results are robust after controlling for a firm's political connections, across various conditional conservatism measures, and across a number of visibility measures including firm size, the number of analysts following the firm, the age of the firm, the number of foreign stock exchanges that the firm is cross‐listed in, and the level of the firm's media coverage. Together, our findings add to the literature on how firms’ political activities shape their accounting practices in general, and accounting conservatism in particular. More importantly, our findings suggest that the heightened public attention paid to political activities in the US yields incentives for firms to be more conservative in their accounting practices.     

The Informational Role of Short Sellers: The Evidence from Short Sellers’ Reports on US‐Listed Chinese Firms

Using US‐listed Chinese firms as the setting, this paper studies a novel channel through which investors can acquire information about firms’ financial reporting quality, that is, the reports published voluntarily by short sellers. I find that short sellers tend to target firms that have financial reporting red flags and that exhibit ‘good’ operating performance and stock valuations. Targeted firms experience an average three‐day cumulative abnormal return (CAR) of ?6.4%, and ?13.6% for initial coverage of the firm, and the CARs are more negative when the reports allege more severe misconduct of the firms. Non‐targeted firms also experience losses in value following short seller reports, especially when they hire the same non‐Big 4 auditors as targeted firms and when their earnings quality is poor. In comparison, analysts fail to perform proper due diligence and are much less effective than short sellers in exposing misreporting risk in Chinese firms.     

Financial Reporting Quality,Structural Problems and the Informativeness of Mandated Disclosures on Internal Controls

Even before firms report internal control weaknesses under the Sarbanes–Oxley Act (SOX), they are characterized by structural problems, are prone to internal control weaknesses, and have low financial reporting quality. If the stock market incorporates much of this information during the pre‐disclosure years, investors are less surprised when firms subsequently report internal control weaknesses under SOX. We find that for the pre‐disclosure period, firms reporting internal control weaknesses under SOX, (1) had structural problems, (2) were prone to internal control problems, and (3) had low financial reporting quality. Further, we provide direct evidence that stock prices during pre‐disclosure years incorporate much of the information about structural problems, the likelihood of internal control weaknesses, and low reporting quality. Finally, we find that many of these value‐relevant factors are not related to announcement period returns when firms eventually disclose such problems under SOX and that limited new information about structural problems is generated around this date. Our results provide a compelling explanation for the muted stock price reaction around the mandatory disclosure date.     

Examining the spread of high quality reporting through the corporate network

This paper explores whether high reporting quality spreads through the network formed by shared directors. Consistent with the notion that positive information is generally less impactful than negative information in affecting behavior, I find that a firm's own reporting quality is not affected by sharing a director with a firm that is considered to have high reporting quality. However, I find that a firm's reporting quality improves when the firm shares a director with a high reporting quality firm and a firm that is highly connected in the network (i.e.: central). The results suggest that high reporting quality needs the endorsement of a high status firm such as a central firm to travel through the network. Furthermore, firms that are susceptible to poor reporting are the most receptive to the high reporting quality signal coming through central firms. Altogether, this study documents that central firms are in a position to initiate positive reporting contagion.