Do management reports on internal control over financial reporting improve financial reporting?

Sections 404a and 404b of the Sarbanes–Oxley Act require management and external auditors, respectively, to report on the adequacy of a company’s internal control over financial reporting (ICFR). Larger public firms were first required to file a management report and have an external audit of ICFR in 2004. Smaller public firms were first required to file a management report on ICFR in 2007 but are exempt from the attestation requirement. We investigate the distinct effect of management reports on financial reporting quality. We find that management reports on ICFR improve reporting quality and demonstrate that there are financial reporting benefits from the management report requirement on its own without attestation.     

‘Does accounting regulation matter?’: An experience of international financial reporting standards implementation in an emerging country

The study investigates the balance between accounting regulation and political influences in the implementation of International Financial Reporting Standards (IFRS) in an emerging country. Forty-three interviews were conducted, from 2010 to 2013. Additionally, enforcement documents from 1998 to 2013 in relation to IFRS were evaluated. The study reveals that lack of accounting regulatory framework and political influences are hindering the effective implementation of IFRS. Most importantly, regarding the balance between accounting regulation and political influences, a high level of political influences is adding more apprehension to the implementation of IFRS. The study contributes to the policymaking agenda of the IFRS implementation literature. The findings are relevant to other emerging economies. In particular, local and international policy makers should rethink the path of the global implementation of IFRS.     

Is there a relation between audit fee cuts during the global financial crisis and banks’ financial reporting quality?

As a result of the global financial crisis (GFC), several audit clients were able to negotiate lower audit fees for the years 2008 and 2009. However, the PCAOB has expressed concern that lower audit fees might lead to lower audit effort and lower audit quality and financial reporting quality. This study examines the relation between audit fee cuts and banks’ financial reporting quality. Specifically, we focus on earnings management via loan loss provisions (LLP), the relation between current period LLP and future loan charge-offs, i.e., LLP validity, and the timely recognition of loan losses. For banks audited by Big 4 auditors, we find that income-increasing abnormal LLP are decreasing in audit fee cuts and LLP validity is increasing in audit fee cuts. For banks audited by non-Big 4 auditors, LLP validity is higher for banks that received a fee cut of more than 25% relative to other banks audited by non-Big 4 auditors. We do not observe an association between timely loan loss recognition and cuts in audit fees except for banks audited by non-Big 4 auditors and exempt from internal control audits where a fee cut of more than 25% is associated with less timely loan loss recognition. Overall, the findings suggest that Big 4 auditors constrained earnings management via LLP in banks that received cuts in audit fees. Our findings have important implications for regulators, investors, and others.     

Audit committees’ social capital and financial reporting quality

We draw on social capital theory to examine the relationship between audit committee (AC) members’ social capital and financial reporting quality. Using US data for the period 2001–2010, our results suggest that non-AC directors’ social capital does not appear to be relevant to financial reporting quality. As far as AC members are concerned, our findings show a negative relationship between their social capital and financial reporting quality, suggesting a ‘dark side’ to social capital. Specifically, we find that sitting in multiple ACs (centrality) has a negative impact on reporting quality only for those AC members designated as financial experts. When other proxies for social capital are considered (connectedness, brokerage position and strong ties), our results show that the quality of financial reporting significantly decreases with the social capital of non-financial experts sitting in the AC. We contribute to prior research by: (i) relying on social capital theory, which is widely neglected in accounting research, (ii) using multiple metrics to capture the complex dimensions of social capital, and (iii) discriminating between the effects of financial and non-financial experts’ social capital on reporting quality. Our results suggest policy-makers might wish to limit financial experts’ multiple directorships as well as assess the actual contribution of non-financial experts to AC effectiveness.     

Is financial reporting shaped by equity markets or by debt markets? An international study of timeliness and conservatism

We hypothesize debt markets—not equity markets—are the primary influence on “association” metrics studied since Ball and Brown (1968 J Account Res 6:159–178). Debt markets demand high scores on timeliness, conservatism and Lev’s (1989 J Account Res 27(supplement):153–192) R ², because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in prices. Single-country studies shed little light on debt versus equity influences, in part because within-country firms operate under a homogeneous reporting regime. International data are consistent with our hypothesis. This is a fundamental issue in accounting.     

Managerial labor mobility and banks’ financial reporting quality

This paper explores the relationship between managers’ labor mobility and the financial reporting quality of banks. Using the state-level adoption of the Inevitable Disclosure Doctrine (IDD) as an exogenous shock discouraging labor mobility, we show that adoption of the IDD is associated with a decline in financial reporting quality, as measured by discretionary loan loss provisions. The effect is larger for banks with managers who have limited outside job opportunities and smaller for banks with tight regulatory oversight. Our results support the view from the career concern hypothesis that bank managers facing restrictions on mobility have greater incentives to engage in discretionary accounting.     

Management’s personal ideology and financial reporting quality

Review of Quantitative Finance and Accounting - We investigate the relation between managers’ personal ideologies and financial reporting quality. We use Federal Elections Commission data to...     

Have SFAS 166 and SFAS 167 improved the financial reporting for securitizations?

Critics have alleged that securitization accounting prior to 2010 was among the causes of the recent financial crisis. In response to this criticism, the Financial Accounting Standards Board (FASB) implemented two new accounting standards, SFAS 166 and SFAS 167, to improve the financial reporting for securitizations. Bank regulators have stated their belief that SFAS 166/167 will result in a consolidated balance sheet (and risk-based capital ratios based thereupon) that better reflects a bank's exposure to risk related to securitized assets. We document that, by ceding retained power or influence through the servicing/special servicing functions to third parties, SFAS 166/167 resulted in real effects to the extent that banks (particularly those that were weakly capitalized) achieved their accounting objectives in the post-SFAS 166/167 period through legitimate transaction structuring in line with the intent of the new rules. Further, we use capital market participants’ assessments of risk retention by sponsoring banks as a benchmark, and provide evidence consistent with bank regulators’ beliefs. In particular, following SFAS 166/167, equity investors of sponsoring banks do not consider (consider) as risk relevant securitized assets that receive off-balance sheet (on-balance sheet) treatment. Securitized assets that are consolidated under SFAS 166/167 exhibit the same risk relevance as assets that are not securitized, despite contractual provisions that would seem to imply substantial risk transfer.     

Value or Glamour? An empirical investigation of the effect of celebrity CEOs on financial reporting practices and firm performance

In this study, I investigate the impact of managerial reputation, as proxied by high‐profile awards to CEOs, on financial reporting practices and firm performance. Using a sample of 269 awards given to 189 celebrity CEOs (CEOs who win awards) from 1987 to 2003, I compare within‐firm changes in financial reporting practices and firm performance before and after each CEO wins their first award. I find that celebrity CEOs engage in more conservative accounting practices and are less likely to engage in opportunistic earnings management to meet short‐term earnings benchmarks. In addition, firm performance improves after celebrity CEOs win awards.     

Does financial reporting misconduct pay off even when discovered?

Review of Accounting Studies - Experts and popular belief contend that it pays to engage in financial misconduct. We hand-collect data on three subsamples of severe misconduct cases, between 2003...     

Has Australian financial reporting become more conservative over time?

This study examines whether Australian financial reporting became more conservative over the period of 1993–2009. Unlike the United States and European evidence in Givoly and Hayn (2000) and Grambovas et al. (2006) , the Australian evidence is not consistent with the notion that conservatism has increased over time. The degree of conservatism fluctuates without any obvious trend over the 17‐year period, especially for the constant sample of firms appearing throughout the period. We also examine the impact of mandatory International Financial Reporting Standards (IFRS) adoption on accounting conservatism in Australia. Our evidence suggests the adoption of IFRS has led to a decrease in conditional conservatism (i.e. asymmetric timeliness).     

Do accounting standards matter to financial analysts? An empirical analysis of the effect of cross-listing from different accounting standards regimes on analyst following and forecast error

This paper explores whether the effects of cross-listing on analyst following and forecast error differ among firms with different accounting standards. The results reveal a higher increase in the number of analysts for cross-listed firms that follow their home country's GAAP prior to cross-listing and reconcile or switch to IAS/US GAAP or UK GAAP after cross-listing, compared to those that adopt IAS or US GAAP prior to cross-listing. We find that firms that switch to IAS/US GAAP have a higher increase in analyst following after cross-listing compared to firms that reconcile to IAS/US GAAP. In addition, we find a higher increase in analyst following after cross-listing for firms from low-level accounting standards environments compared to firms from high-level accounting standards environments. Our results show evidence of an increase in the magnitude of analysts’ forecast error after cross-listing for firms that follow their home country's GAAP pre-cross-listing but reconcile post-cross-listing to IAS/US GAAP or UK GAAP. On the other hand, we report a decrease in forecast error for firms that switch to IAS/US GAAP.     

How do CEO incentives affect corporate tax planning and financial reporting of income taxes?

We examine how different accounting metrics used to evaluate CEO performance for annual bonuses affect the level of corporate tax planning as well as financial reporting for income taxes. We predict and find that firms using cash flow metrics report lower GAAP and cash effective tax rates (ETR) than firms using earnings metrics. We also find that firms using after-tax earnings metrics report lower GAAP ETRs but similar cash ETRs as firms using pre-tax earnings metrics. Further analyses show that firms using after-tax earnings metrics are more likely to designate foreign earnings as permanently reinvested and have lower discretionary reserves for tax uncertainty. Hence, it appears that both types of firms engage in similar levels of tax planning, but firms evaluating CEOs with after tax-earnings metrics incentivize different financial reporting choices.     

Are CFO debt-like compensation incentives associated with financial reporting quality?

We investigate whether CFO debt-like compensation incentives and their alignment with CEO debt-like compensation incentives are associated with financial reporting quality. He (2015) finds that CEO debt-like compensation incentives are associated with higher financial reporting quality. Consistent with agency theory, we extend He (2015) by considering CFO debt-like compensation incentives. Overall, we find that CFO debt-like compensation incentives are associated with better financial reporting quality while controlling for CEO debt-like compensation incentives. These effects are present when the CEO and CFO compensation incentives are aligned with the same party. Further, the CFO effect dominates that of the CEO when examining discretionary accruals, and complements the CEO effect for accrual quality. However, we are unable to find any evidence of an incremental joint effect from the alignment of the CEO and CFO debt-like compensation incentives.     

Have IFRS made a difference to intra-country financial reporting diversity?

According to the International Accounting Standards Board (IASB), International Financial Reporting Standards (IFRS) are intended to provide a common set of globally applicable accounting standards, having the ultimate aim of reducing international financial reporting diversity. Much previous research on standards harmonisation has been conducted on relatively small samples and in periods which pre-date the introduction of mandatory IFRS in the EU and Australia. Most of these studies have also relied on some form of indexing technique to measure harmonisation (such as the modified C-index) which have since been challenged in the literature. Based on a sample of 81,560 firm years, this study examines whether the mandatory IFRS regime has led to any significant reductions in overall financial reporting diversity by companies within the EU and Australia. Financial reporting diversity is proxied by the variability of several balance sheet, income statement and cash flow statement ratios measured over the pre-IFRS and post-IFRS periods. Variability is measured by the coefficient of variation (CV), a scale neutral measure of dispersion of a probability distribution. This measure avoids many of the methodological problems associated with index techniques. Notwithstanding some mixed findings, the group mean comparisons and multiple regression results indicate some statistically significant reductions in the variability of ratio measures in the post-IFRS period, even after controlling for factors such as firm size, industry and adoption status (whether a country is an IFRS adopter or not). While the results should be viewed as preliminary, they provide some tentative support for IASB’s current policy direction towards global accounting standards convergence (for instance, the IASB-FASB convergence project). The results also have implications for other countries contemplating a shift to IFRS, such as the United States and several Asian nations, including Japan and India. A useful direction for future research is to determine whether the same results hold using a more extensive post-IFRS sample.     

Does financial reporting regulation influence the value of cash holdings?

We investigate how the value of cash holdings changes following the mandatory adoption of International Financial Reporting Standards (IFRS), which is viewed as an exogenous shock to information asymmetry between firms and outside investors. Using firm-level data from 47 countries, we find that mandatory IFRS adoption has a negative and significant impact on the value of cash holdings. This result suggests that investors reduce their valuation of cash holdings when firms can have access to external financing at a lower cost under IFRS. The negative effect of IFRS is concentrated among financially constrained firms. Furthermore, we show that the effect is more pronounced in countries with strong legal enforcement. Overall, our evidence highlights that financial reporting regulation can have a significant effect on how outside investors value corporate cash holdings across countries.     

Does internal control over financial reporting really alleviate agency conflicts?

This study investigates whether internal control over financial reporting (ICFR) alleviates the managerial expropriation of corporate resources. We do this by examining the potential effects of material weaknesses in internal control on the values of corporate cash holdings and capital expenditures. Our findings suggest that ICFR facilitates the scrutiny and discipline of capital markets and thus alleviates the agency problems. Our results support the premise that high financial reporting quality impairs managers’ abilities to use corporate resources in a self‐serving manner.     

How credible is a too-big-to-fail policy? International evidence from market discipline

This paper analyzes in an international sample of banks from 104 countries if the sensitivity of the cost of deposits to bank risk varies across banks depending on their systemic and absolute size. We analyze a period before the 2007 financial crisis and control for endogeneity of bank size, intervention policies in past banking crises, and soundness of countries’ public finances. Our results are consistent with the predominance of the too-big-to-fail hypothesis, although this effect is stronger in countries that did not impose losses on depositors in past banking crises and in countries with sounder public finances.     

Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy?

This study explores the effect of cross-sectional and time-series differences in financial reporting attributes on the predictive ability of financial ratios for bankruptcy. We identify proxies for discretion over financial reporting, the importance of intangible assets, the comprehensiveness of the accounting model and recognition of losses. Each of our proxies for financial reporting attributes is associated with financial ratios that are less informative in predicting bankruptcy. Furthermore, our time-series tests reveal a decline in the predictive ability of financial ratios for bankruptcy and document that this decline is associated with our measures of financial reporting attributes.