Abstract

We investigate whether accounting information system quality has an impact on the level and efficiency of firms’ investments. While firms’ growth depends on investment and financing decisions, accounting information is fundamental for the decision-making of several stakeholders. We assess the accounting information system quality by discretionary accruals, whereas the investment inefficiency is estimated by the residuals of an investment regression for a sample of 3073 Portuguese SMEs from 27 industries, over the period from 2016 to 2021 using a panel regression analysis. The empirical evidence suggests that firms exhibiting higher accounting information system quality tend to invest more. In addition, firms with a lower accounting information system quality have more inefficient investments, as they tend to engage in more overinvestment, although this is not significant for underinvestment. Therefore, this study provides new evidence regarding the impact of accounting information systems on investment that may be useful for several stakeholders, such as managers, creditors, regulators, and academics, by providing evidence for SMEs, where empirical studies are scarce.

Introduction

Accounting information system quality is essential to accurately communicate the current and expected financial/economic position of firms. Financial statements are the main source of information for stakeholders to make decisions (Francis et al. 2004; Yuan et al. 2022). Therefore, it is essential that the information disclosed is transparent and reflects the true and fair view of the firm. Bhattacharya et al. (2013) for the United States and Cerqueira and Pereira (2015) for Europe find empirical evidence that the quality of accounting information contributes to mitigating information asymmetry which in turn means a reduction in the cost of raising funds. Therefore, prior literature has investigated factors that may lead to activities that degrade accounting information system quality, aiming at creating mechanisms to mitigate those activities, thereby improving accounting information system quality. However, Jones (1991) argues that these activities are not easy to detect.

In the context of agency theory and stakeholder theory, the decision-making of investors and creditors depends on the quality of the accounting information system, as mentioned by McNichols and Stubben (2008) and Biddle and Hilary (2006). In the case of investment, it is a fundamental factor for the sustainability and growth of firms, which implies attracting investors and/or obtaining funding from banks. Firms have assets available to develop their economic activities due to their investment ability, affecting their intrinsic value. In addition, Alkafaji et al. (2023) emphasize that investment in information technology tends to reduce the cost of producing accounting information and increases its reliability. The efficiency of a firm’s investment directly affects its survival and development and, in macroeconomic terms, the allocation of resources in society. However, investment inefficiency is usually observed in most firms, specifically overinvestment or underinvestment. Therefore, Ma and Jeong (2022) argue that it is necessary to promote the efficiency of firms’ investment. In the same vein, Gaio et al. (2023) and Lambert et al. (2007) suggest that the increase in the quality of financial reports leads to relevant economic implications in firms, such as the efficiency of investments made. Moreover, Pereira et al. (2023a) find empirical evidence that Portuguese small and medium entities (SMEs) with higher levels of investment tend to have a more conservative accounting practice to capture investors’ confidence.

Conclusions

This study analyzes the effect of accounting information system quality on the investment level and investment efficiency of Portuguese SMEs. From the empirical evidence obtained in this study, it is possible to conclude that firms with a higher accounting information system quality have a greater tendency to invest. This can be explained by the fact that these firms with a higher accounting information system quality exhibit more reliable and transparent financial statements, so they convey greater confidence to investors and banks, and it is possible to attract more financing that can be subsequently allocated to investment in fixed assets.

To further develop the analysis, the association of accounting information system quality with investment (in)efficiency is analyzed. The results suggest that a lower accounting information system quality enhances the trend of overinvestment. In this sense, managers tend to report a better financial performance to capture more funds for financing investments. Therefore, if the financial statements do not report the true and fair view of the firms, managers may fall into the error of overinvestment, namely in projects with a negative NPV, which in turn may lead to a waste of resources and affect the survival and growth of the firms. Regarding the underinvestment, the lower quality the accounting information system, the lower the tendency for underinvestment. This result is the opposite to Linhares et al. (2018) and Verdi (2006) and may be explained by the fact that even if financial statements give the true situation, shareholders may not invest, even with positive NPV opportunities, if the indebtedness level is high, as it would imply that most of the benefits would be captured by the creditors (Pereira et al. 2023a).

Abstract

     This study examines whether influenza-like illnesses (ILIs), a potential threat to the conduct of public company audits, are associated with audit outcomes. Because the peak months of flu season overlap with audit busy season, audit offices most at risk of ILIs may be adversely affected. The demanding nature of audit busy season and the culture of audit firms may compel employees to go to work sick, a phenomenon known as presenteeism. When auditors go to work with flu-like symptoms, cognitive functioning is impaired, resulting in brain fog. This impairment may influence auditors’ ability to exercise judgment and professional skepticism, leading to adverse outcomes. Using data collected from the Centers for Disease Control and Prevention (CDC) we find that the filing of audit reports is delayed and audit quality suffers in audit offices most at risk of influenza-like-illnesses. The observed effects of health impairments on company outputs have broad implications for both the audit profession and workplaces as a whole.

Introduction

     Influenza (the flu) infects as many as 60.8 million people in the U.S. each year (CDC, 2017), approximately 20 percent of the population. The magnitude of individuals with the flu results in significant productivity loss in the workplace, where employees lose 69 percent of expected working hours while sick (Van Wormer et al., 2017). As auditing requires high cognitive functioning, a capability that is impaired when auditors are sick, we predict that audit firms are highly susceptible to the costly effects of influenza-like illnesses (ILI). Flu season peaks in the months of December through March and therefore directly overlaps with audit busy season.1 Although the timing of the flu is consistent year-to-year, the severity and distribution of the disease vary over time and across states. This study examines the risk of contracting an influenza-like illness and its impact on auditors’ work.2

     Employees who have the flu often go to work sick, an act referred to as presenteeism, which limits their productivity on the job (Goetzel et al., 2004, Hemp, 2004, Hansen and Anderson, 2008, Schultz et al., 2009, Petrie et al., 2016). Anecdotal evidence suggests that auditors rarely stay at home when sick. To corroborate this, we conduct an exploratory survey, the results of which identify that 87 percent of auditors go to work while sick.3,4 Among other debilitating physical conditions, presenteeism is characterized by an influenza-induced phenomenon commonly referred to as “brain fog,” a symptom that reduces alertness, memory, and accuracy (Smith et al., 2004).5 Audit work requires judgment, professional skepticism, and overall high cognitive functioning, and thus, brain fog may negatively influence auditors’ work. If this is the case, impaired cognitive functioning may result in longer audit delays and impaired audit quality. However, auditors consistently work under pressure and may be able to overcome the negative effects of an ILI.6 Regardless, we predict that when auditors are at greater risk of an influenza-like illness, audit report lag will be prolonged and audit quality will suffer.

Conclusion

     This paper investigates whether influenza-like illnesses, whose peak season directly overlaps with audit busy season, are associated with audit outcomes. We examine the impact of ILIs on audit delay and quality and find that audit delay, measured with report lag and the likelihood of non-timely filings, increases when auditors are more likely to be at risk of an ILI and ILI symptoms induce inefficiencies in the audit. We find that audit quality, measured with discretionary accruals and material weakness errors, declines in states with the worst ILI outbreaks. Overall, our results suggest that ILIs may impair auditors’ judgment and decision-making abilities. To our knowledge, this is the first study to examine the association between auditor health and audit outcomes.

     The results of this study are highly informative to audit firms. We propose that the effects of ILIs on audit outcomes arise when auditors go to work while sick. The heavy demand of busy season workloads may create environments in which auditors feel like taking a sick day is not an option. In addition, culture and work-life-balance initiatives within a firm or office may influence auditors’ decision to work while sick. This issue further extends to inter-firm relationships, where interactions with other engagement team members may drive perceptions of the appropriateness of working while sick. If auditors did not work while sick, firms and offices would have better visibility into the impact of influenza on productivity and be able to assign additional resources to audit tasks, as needed. Our evidence may encourage audit firms to evaluate policies that incentivize working while sick.

Abstract

Purpose – Recent studies on the securities market’s differential pricing of earnings components indicate that cash flows from operations are valued more highly than extreme total accruals. However, no previous study has examined whether cash flows from operations have a higher valuation than moderate total accruals. Therefore, this study examines the securities market’s differential pricing of cash flows from operations and both moderate and extreme total accruals

Design/methodology/approach – The study’s sample is divided into two sub-samples: a moderate total accruals sub-sample; and an extreme total accruals sub-sample. To evaluate whether cash flows have a higher valuation when compared to total accruals, for the entire sample and for each of the two sub-samples, the study examines the statistical significance of the difference between slope coefficients of cash flows and total accruals for regression of returns on both unexpected cash flows from operations and unexpected total accruals

Findings – Consistent with prior research, results from the entire sample show a differential higher valuation of cash flows when compared to total accruals. Another finding, consistent with recent studies, is that cash flows from operations have a higher valuation when compared to extreme total accruals. However, there is no higher differential valuation of cash flows over moderate total accruals. These findings support the decomposition of earnings into the components of cash flows from operations and total accruals only when total accruals are extreme (rather than moderate).

Practical implications – A possible explanation for these results is that since accruals predict cash flows, total accruals – when moderate (i.e. not extreme) – are priced similarly to cash flows. These results reveal that when total accruals are moderate, earnings are a better proxy for the underlying cash flows (over the entire future horizon, not just the current period) than is cash flows. However, since total accruals are unlikely to persist in a permanent way over the years, these results indicate that the decomposition of earnings into the components of cash flows from operations and total accruals is consistent with the information set used to value equity securities. Therefore, separate disclosure of cash flows is value relevant. In addition, users of financial statements certainly need the cash flows information as an ex-post validation of the prior earnings.

Originality/value – This study’s contribution stems from its determination of the preferred level of disaggregation of earnings components (i.e. operating cash flows and total accruals). This is expected to help investors in their attempt to enhance the outcome of their informed investment and credit decisions.

Introduction

Reported numbers can be considered informative if they assist investors in making more informed decisions. When stock prices change in response to reported numbers, it can be presumed that investors’ valuation, buying, and selling decisions are influenced by reported numbers. It follows that reported numbers inform their decisions. Earnings can be divided into total accruals and cash flows from operations [1]. Earnings components (i.e. operating cash flows and total accruals) can be considered incrementally informative in relation to total earnings if they assist investors in making decisions that are more informed compared to those made when only the total is known. For example, if investors think that current cash flows are more or less informative when compared to total accruals with respect to their ability to predict future cash flows, then they are likely to be interested in learning about these earnings components and not simply total earnings. Identifying the preferred level of disaggregation regarding the elements of earnings can assist investors in making more effective investment and lending decisions. With these considerations in mind, the present study seeks to investigate the differential price of earnings components in the securities market.

Results

5.1 Stock returns and earnings components for the entire sample Table 2 presents the results regarding the relationship between stock returns and earnings components (i.e. cash flows from operations and total accruals) for the entire sample. The sum of the coefficients for the level and change in cash flows (α1þα3) is 1.218 (t 5 6.743), which is significant and positive at the 1% level. The sum of the coefficients for the level and change in total accruals (α2þα4) is 0.699 (t 5 11.311), which is significant and positive at the 1% level. These results suggest that both cash flows from operations and total accruals have incremental information content beyond each other.

Abstract

1. Introduction

2. Conceptual background and literature review

3. Hypotheses formulation

4. Methods

5. Results

6. Conclusions

Acknowledgements

References

Abstract

     We examine an unexplored side of management control systems (MCS): their links with real earnings management. We propose that interactive use of MCS supports management in identifying, evaluating, selecting, and implementing real actions that conceptually would be classified as real earnings management (REM). Interactive MCS use is predicted to enhance managerial REM actions that retain the focus of the organization on its strategic objectives, leading to higher future performance. We test our research model empirically with survey and archival data. The results support our predictions. Finally, we explore the role of other levers of control.

Introduction

     We examine the links between the interactive use of management control systems (MCS) and real earnings management (REM).1 REM refers to real actions taken to manage earnings that alter the timing and structure of investment, operating, and financing transactions (Schipper, 1989; Vorst, 2016). Examples of these actions include reducing R&D and advertising expenditures, offering aggressive credit terms, selling assets, overproducing, or repurchasing stock (e.g., Bushee, 1998; Graham et al., 2005; Roychowdhury, 2006; Ali and Zhang, 2015). Prior work provides mounting evidence that managers take REM actions to meet earnings targets.

     The financial accounting literature has devoted significant attention to earnings management, and generally views such practices as having adverse consequences (Dechow et al., 2010), but a growing body of research documents both benefits of REM and cases where REM can be value destroying.2 Gunny (2010) finds that firms that engage in REM to just meet earnings targets have relatively better subsequent performance than firms that do not engage in REM and miss or just meet their earnings targets. These findings are challenged by Bhojraj et al. (2009), who finds lower long-term market performance for firms that use REM to meet their earnings targets. Against this backdrop of mixed findings on the consequences of REM actions, a question arises as to the role of MCS in supporting managers in making decisions and taking these actions. In this paper, we examine whether the interactive use of MCS supports management in (i) taking real actions to meet earnings targets and that conceptually would be classified as REM, and (ii) making REM more successful in terms of improved organizational performance.

Conclusions

     We provide novel insights on the links between MCS and earnings management through the lens of the Levers of Control (LOC) framework (Simons, 1995). In doing so, we conceptualize the interactive use of MCS as a mechanism that spurns managerial search, discovery, and implementation of action plans to correct deviations from critical values of earnings. Our evidence indicates that using the interactive lever involves the organization in the development of action plans to achieve strategic objectives, leading to REM practices that ultimately improve firm performance, relative to firms that engage in REM actions without activating the interactive lever. Prior work examines the drivers of earnings management (e.g., Liu and Lu, 2007; Ali and Zhang, 2015; Kim et al., 2016; Liu, 2016), but does not focus on how managers use MCS to achieve benchmarks and, particularly how interactive use influences REM.

     A key assumption in our framework is that MCS use helps balance the needs for long-term investments, innovation, and constraints (Tuomela, 2005). To this end, we conceptualize MCS in terms of the LOC framework, since it pays special attention to the interplay of the different control mechanisms and to patterns of attention in managing organizational benchmarks (Mundy, 2010; Kruis et al., 2016). We examine a novel side of interactive use of MCS, looking at its links with REM. This sheds light on how control systems shape financial reporting and, consequently, have organizational consequences, via firm strategy or investment. Unlike prior research which generally uses archival data, we show evidence on how, through the lens of the LOC framework, managers mobilize their control systems in the search for solutions, deriving in earnings management.

Abstract

Keywords

1. Introduction

2. Related literature and hypotheses development

3. Research methodology

4. Sample and descriptive statistics

5. Main results

6. Conclusion

Declaration of Competing Interest

Acknowledgements

Data availability

References

Abstract

     This paper compares the informativeness of discretionary research and development (R&D) capitalization under IAS 38 with non-discretionary “as-if” R&D capitalization. While prior research consistently demonstrated capital market benefits of “as-if” capitalization, prior evidence for reported R&D capitalization are less favorable due to earnings management concerns. Because “as-if” studies are based on adjusted data assuming R&D capitalization, the resulting numbers are free from such concerns and may be more informative. We find that reported capitalized R&D is not associated with lower information asymmetry but positively associated with forecast errors. While market values are not associated with reported capitalized R&D, they are strongly associated with “as-if” capitalized R&D. Also, actual capitalization of development expenditures under IAS 38 is only as value relevant as when expensing all R&D. Our results are consistent with the notion that market participants undo actual capitalization and use the information on expensed R&D to develop their own estimates of R&D value. Our findings lend support to the proposition by Barker and Penman (2020) that deficiencies of the balance sheet that result from the uncertainty inherent in expenditures such as R&D, should be supplemented by more detailed information on the nature of the related expenses in the income statement.

Introduction

     The accounting for intangibles such as research and development (R&D) remains an unresolved question and a major discrepancy between International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP) (Lev, 2019). We use the German setting with highly R&D-intensive firms applying IFRS1 to compare the informativeness of discretionary R&D capitalization under IAS (International Accounting Standard) 382 with non-discretionary “as-if” R&D capitalization derived from additional disclosed information. Whereas prior research has consistently demonstrated capital market benefits of “as-if” capitalization (e.g., Lev & Sougiannis, 1996), such benefits are questionable for reported capitalized R&D under IFRS due to earnings management concerns (e.g., Dinh et al., 2016, Jones, 2011, Mazzi et al., 2019). However, actual and “as-if” capitalization have not yet been compared within the same setting. Because “as-if” studies are based on adjusted data where the actual accounting for R&D is undone and capitalization is assumed, the resulting numbers are free from earnings management and may hence be more informative.

Conclusion

     This paper compares the informativeness of actual capitalization under IAS 38 with “as-if” capitalization. While prior research consistently demonstrated benefits of “as-if” R&D capitalization, the results of studies that examine reported R&D capitalization are less favorable. Because the IASC’s decision to prescribe partial R&D capitalization was largely based on “as-if” studies, our analysis aims at resolving the conflicting evidence between studies of reported capitalized R&D vs. “as-if” capitalized R&D. Prior studies of actual R&D capitalization have found that reduced informativeness may be due to earnings management concerns. “As-if” studies are free from such concerns because they are based on adjusted data assuming R&D capitalization. Hence, the resulting numbers may be more informative.

     Whereas prior literature has focused on R&D reporting on the balance sheet, Barker and Penman (2020) argue that such expenditures inevitably lead to mismatching and, hence, deficiencies of the balance sheet due to the uncertain nature of intangibles. They propose that such deficiencies of the balance sheet be supplemented by more detailed information on the nature of the related expenses in the income statement. Market participants can use this information to develop their own estimates of the value of R&D ventures. This approach is consistent with that of “as-if” studies which use the information on expensed R&D to develop estimates of the value of R&D ventures independent from information provided on the balance sheet. Hence, our study provides evidence for testing the proposal in Barker and Penman (2020).

This paper investigates whether stock-for-stock acquirers undertake real activities to manage earnings before merger announcements. Our results show that stock-for-stock acquirers present unusually high levels of credit sales and overproduction in the quarter immediately before the merger announcement. We also find that the accruals feature of real earnings management can explain the stock-for-stock acquirers’ high discretionary current accruals. In addition, stock-for-stock acquirer firms that accelerate their credit sales experience subsequent market underperformance. Overall, we provide a novel insight into the accruals feature of real earnings management.

Introduction

In a stock-for-stock merger, the higher stock price of the acquirer firm on the agreement date benefits the acquirer by lowering the number of shares used to purchase the target firm, thus reducing the cost of the acquisition. Previous studies show that acquirers exhibit higher discretionary current accruals (DCA) in the quarter immediately before their stock-forstock merger announcement, suggesting engagement in managing current accruals, and attribute acquirers’ subsequent underperformance to the reversal effects and litigation costs of the upward current accruals (Erickson and Wang, 1999; Gong et al., 2008; Louis, 2004). In this paper, we reinvestigate the upward management of current accruals of stock-forstock acquirers (stock acquirers) from the perspective of real earnings management (REM). Our motives for this investigation stem from the fact that merger announcements are important events that attract attention from market participants (Liu and McConnell, 2013; Louis and Sun, 2010; Maksimovic and Phillips, 2001; Schoar, 2002). Acquirers come under market scrutiny and have limited ability to engage in accrual-based earnings management (AEM) (Burnett et al., 2012; Chi et al., 2011; Cohen and Zarowin, 2010; Graham et al., 2005; Zang, 2012). Therefore, it is of interest to investigate whether stock acquirers use an alternative mean to boost their pre-merger earnings.

1. Introduction

2. Prior research and hypotheses

3. Accounting choices and bond spread: the influence of legal and financial institutions

4. Methodology

5. Research design

6. Results

7. Robustness checks

8. Conclusion

Declaration of Competing Interest

Appendix A. Rating scores

References

Abstract

We use a unique dataset of 11,497 corporate bonds issued by firms operating in 56 countries. The objective of the paper is to study the effect of timely loss recognition and accrual discretion on the design of public debt contracts in international bond markets, especially that previous research had more focus on bank loans rather than bonds. The paper provides an alternative explanation to prior literature for the relevance of timely loss recognition to the bond market, and clarifies more the role of accrual quality in debt contracting. We utilize our international sample to capture variations in the main analysis with respect to the legal enforcement in which the issuer firm operates, or the financial development of the market of issue. We find evidence that timely loss recognition is counterproductive with bond issuances, whereas accrual quality has a strong favorable impact on bond spread. The relevance of accounting choices to bond markets changes with the level of a country’s law enforcement and a market’s financial development. The paper encourages researchers to come up with different explanations for the influence of accounting choice on different types of debt contracts. It also highlights the role played by institutions to mitigate the effects.

Introduction

The corporate debt raised through capital international markets in the first quarter of 2018, amounted to 770.7 billion US dollars, 482.6 billion Euros, 56.3 billion British pounds, and 29.4 billion Australian dollars; among other issuances with other currencies and less amount1 . Though equity and debt are important sources of finance, equity markets have had the lion’s share in research; and debt markets remain to a large extent a black box. The fundamentals and stock market information of public corporations cannot get any easier to access. However, debt contract information has very specific databases that are costly. The paper takes a positive accounting theory approach, in which the core of the paper is how accounting choice affects contracting parties, and how managers use their discretion within the accepted set (the accounting standards) to reach a desired end state (see; Watts and Zimmerman, 1986); this type of research is very important because it tests the implications of accounting choice on debt contracting parties.

This study examines the impact of accounting comparability on financial reporting quality and the extent to which financial statement users understand the implications of firms’ accruals. We predict that comparability improves the information environment, which not only enhances the ability of managers to estimate accruals more accurately and signal their private information, but also improves investors’ comprehension of accruals. Utilizing restatements, the mapping of accruals into cash flows, earnings persistence, and audit fees as measures of financial reporting quality, we find that prior-period comparability is associated with higher financial reporting quality. We also provide evidence that comparability is positively associated with managerial forecast accuracy and precision, consistent with comparability improving the ability of managers to predict future firm performance. Furthermore, we find that when prior-period comparability is higher, current period discretionary accruals are less positively correlated with contemporaneous returns and less negatively correlated with future returns, consistent with our prediction that comparability improves the pricing efficiency of accruals. Our results are robust to controlling for the endogeneity of accounting comparability and several different empirical model specifications. Overall, our findings suggest that enhanced accounting comparability is beneficial to both preparers and users of financial statements.

Introduction

Regulators argue that comparability increases accounting information’s usefulness and enables financial statement users (hereafter users) to identify the similarities and differences between economic phenomena (Financial Accounting Standards Board (FASB), 2010). The Financial Accounting Standards Board (FASB) (1980) states that “investing and lending decisions…cannot be made rationally if comparative information is not available.” Financial statement analysis textbooks also stress the importance of comparability in judging a firm’s performance (e.g., Revsine, Collins, Johnson, & Mittelstaedt, 2011). Existing research on accounting comparability primarily focuses on its benefits to financial statement users such as financial analysts and creditors (e.g., De Franco, Kothari, & Verdi, 2011; Kim, Kraft, & Ryan, 2013). Very few studies have examined the implications of comparability for managers, an important party in the information production and dissemination process. Also, the implications of comparability for users have not been fully explored. To fill these gaps in the literature, we examine the impact of comparability on the quality of managers’ financial reporting and the extent to which investors understand the implications of firms’ accruals, given the impact of comparability on financial reporting quality.1 Following the Financial Accounting Standards Board (FASB) (2010) and De Franco et al. (2011), we define comparability as the extent to which similar economic transactions are accounted for similarly, and dissimilar transactions are accounted for differently.

This study examines whether auditor industry specialist duration (i.e., the cumulative number of years an audit firm can be deemed an industry specialist) affects earnings management. Using a sample of 17,546 observations during the period of 2006 to 2014, we find that audits performed by firms with longer industry specialist durations are associated with lower levels of earnings management, as proxied by the absolute value of discretionary accruals. This finding enhances the industry specialization literature by showing that, in the long run, specialist auditors constrain the accrual management activities of their clients. However, we also find that audits performed by firms with longer industry specialist durations are associated with greater levels of real earnings management. In turn, this is consistent with real earnings management surfacing as an unintended consequence of specialist auditors being able to better constrain the accrual management activities of their clients (Chi, Lisic, & Pevzner, 2011).

Introduction

This study investigates the role of time relative to industry specialization and auditor performance. Specifically, we examine whether auditor industry specialist duration (i.e., the cumulative number of years an audit firm can be deemed an industry specialist) affects earnings management. Obtaining a better understanding of the impact of specialist duration on auditor performance is important due to the tacit and transient nature of industry expertise. While prior studies recognize that expertise takes time to develop (Bonner & Lewis, 1990; Bonner & Walker, 1994; Goodwin & Wu, 2014), the effects of the auditor “seasoning” process has been largely ignored by preceding studies based on industry market share dominance (Gaver & Utke, 2019). Furthermore, several elements of the expertise puzzle, such as the dynamic environment of the audit profession and the challenges/opportunities associated with prolonged auditor tenures, further accentuate the importance of time as a determinant of the association between industry specialization and auditor performance. In this study, we distinguish between industry specialist duration (i.e., specialist tenure) and the current status of audit firms as industry specialists. We posit that there are two possible outcomes regarding the impact of specialist duration on earnings management. The first prospect is a negative association between duration and earnings management. This would suggest that an audit firm’s history as an industry specialist provides its staff with additional insights about its clients’ operations and industry, leading to more effective audits. That is, auditors with larger or dominant market shares benefit from greater exposure to clients from the same industry over time. This prediction is based on the notion that industry expertise follows market share dominance.

The purpose of this study is to further our understanding of the financial reporting implications of the CEO/CFO relationship by examining the influence of CEO power in the presence of CFO power on the financial reporting process. In so doing, we extend the prior literature in at least two ways. First, we provide evidence on the relationship between executive power (both CEO and CFO) and preferences for accrual earnings management (AEM), and real earnings management (REM). Second, we investigate whether CFO (CEO) power mitigates the influence of powerful CEOs (CFOs) in managing earnings (AEM or REM). Prior research suggests that CEOs and CFOs potentially have different preferences with respect to AEM and REM. CEOs are responsible for the strategic operations of the firm (i.e., current and future performance of the firm), while CFOs are ultimately responsible for the quality of financial reporting (Geiger and North 2006; Feng et al. 2011). Under the assumption that REM has negative consequences for the future performance of the firm (Bhojraj et al. 2009; Zang 2012), the presence of REM conflicts with the fiduciary responsibility of the CEO to the stakeholders of the firm. Similarly, assuming that AEM degrades the quality of financial reporting (Francis et al. 2008; Kim et al. 2012), the presence of AEM conflicts with the monitoring role of the CFO in the financial reporting process (Feng et al. 2011). Consistent with the above scenario, Graham et al.’s (2005, p. 36) survey evidence suggests that CFOs indicate a preference for REM over AEM in order to meet earnings targets. Further, Feng et al. (2011) find that when both the CEO and the CFO are charged in an SEC enforcement action, the CEO is significantly more likely to have been accused of orchestrating the AEM. In summary, this literature suggests that CEOs who have the ability to influence the earnings management process will rely on AEM, while CFOs who have the ability to influence the earnings management process will rely on REM. Our study extends prior literature by empirically investigating whether CEOs and CFOs have different earnings management technique preferences. While there is substantial evidence in the literature regarding the individual influence of both CEOs and CFOs over the financial reporting process (e.g., Geiger and North 2006; Jiang et al. 2010; Feng et al. 2011), how that influence is affected by the interplay between the two executives is not known. CFOs are the agent of CEOs (Graham and Harvey 2001), and a CEO has the power to replace a CFO who does not follow his/her preferences (Mian 2001; Fee and Hadlock 2004); thus, it may be the case that CEO preferences will dominate CFO preferences. However, power circulation theory challenges the notion that CEOs can indefinitely perpetuate their power (Ocasio 1994; Shen and Cannella 2002). Instead, the theory predicts that CEO power can be dissipated, in part due to contestation from other executives, who are viewed as rivals for the CEO’s position. In the specific context of financial reporting, asymmetric benefits and costs across executives could be factors as well. For example, the argument that CFOs bear higher potential litigation costs and reap fewer benefits from accounting manipulations than do CEOs (Mian 2001; Feng et al. 2011), suggests that this is likely a setting where CFOs will contest the CEO.

2- LITERATURE AND HYPOTHESIS

3- RESEARCH DESIGN

4- RESULTS

5- CONCLUSION

REFERENCES

CONCLUSION

This study examines the effects of audit partner busyness on the cost of equity capital. Following the notion of corporate governance research on “busy director”, we use the busyness hypothesisto argue that the time and effort of an individual are finite. Thus, serving too many audit clients, and hence the associated task commitments, may result in poor audit performance, which increases information risk and, therefore, the cost of capital. We find support for this view, but only for the firm‐year observations audited by non‐Big 4 audit firms. We also argue that financial reporting quality mediates the effects of audit partner busyness on the cost of equity capital and find results that are supportive of this prediction as well. However, our documented association of an adverse effect of audit partner busyness on earnings quality contradicts Goodwin and Wu (2016), who found no significant association between partner busyness and earnings quality. Although our results are consistent with recent evidence from the emerging markets, we caution readers not to extrapolate our inference to all listed firms on the Australian Securities Exchange, based on our restricted sample only. Future research needs to further investigate the generalizability of Goodwin and Wu (2016) by investigating the mediating effect of financial reporting quality on, for example, stock price crash risk, which would be amenable to a larger sample size. Future research should also examine factors that determine an auditor’s decision to select potential clients in Australia. Existing research on this issue is mainly survey based and uses data from the USA. For example, Johnstone and Bedard (2003) suggested that auditors assess financial risk, audit risk, and auditor business risk, and consider whether engagement fees are sufficient to cover current and future expected engagement costs when selecting potential clients.

1- Introduction

2- Review of literature and hypothesis development

3- Database and methodology

4- Empirical results

5- Concluding

References

Abstract

Purpose: The purpose of this paper is to examine whether the stock market in India is efficient in the semi-strong form.

Design/methodology/approach: The study uses financial and stock market data of 1,135 listed Indian companies (non-financial) during 2003–2011 collected from Capital IQ to estimate discretionary accruals (DA) using modified Jones model (1995). The study also examines using the widely used Mishkin (1983) test to whether equity market prices accruals in India. The study is conducted for profit/loss-making firms separately as well as for a hedge portfolio of firms based on the lowest to highest accruals.

Findings: The empirical study of DA of 1,135 listed Indian companies (non-financial) during 2003–2011 shows that the estimated average DA of the corporate sector in India comes to 1 percent of the total assets of these firms. An empirical analysis whether equity market prices DA in India finds no evidence of investors/market pricing DA. Empirical evidence also finds that the results are invariant for profit/loss-making firms as well as portfolio of firms based on the lowest to highest accruals in the Indian context. The empirical evidence shows that the Indian equity market is inefficient with regard to the incorporation of accruals in expected returns of stocks

Introduction

Accounting principles provide managers considerable discretion in managing earnings. Earnings management (EM) is possible either by manipulating accruals (more by altering DA[1]) or by manipulating real activities (operational activities)[2]. Accruals are adjustments which accountants/managers which cause book earnings to differ from cash earnings (Dechow et al., 1995). The numerous scandals at the global level, especially the high-profile cases like Enron, WorldCom, Parmlat, Waste Management, Olympus, etc., and Satyam in India, have shown how managers managed earnings to meet market expectations or derive rents in the form of executive compensation. DA is widely considered as a proxy for EM. India has seen its own massive EM episodes. In 2009, Mr B. Ramalinga Raju, the Chairman and founder of Satyam Computer Services, a firm listed in US NASDAQ stock exchange, revealed a $2,260m fraud that he had perpetuated over the prior five years (2003–2008) (Mohapatra et al., 2015). Satyam was listed in both Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) when it became public in 1991; it was also listed in NASDAQ in 1999 and in NYSE in 2001 (Chakrabarti and Sarkar, 2010). In his confession letter to the BSE, Mr Raju famously states that the five years of falsifying Satyam’s accounts was “[…] like riding a tiger, not knowing how to get off without being eaten.” Episodes like Satyam raises questions on how reliable is financial information reported by firms in emerging market economies (Li et al., 2014). One of the hotly debated issues is whether investors/market has the ability to process cash flow and accrual components of earnings information. The debate is centered on the issue whether market is able to isolate information related to cash flows and accruals. Research by Sloan (1996) shows that stocks of high accrual firms earns negative abnormal returns in the subsequent periods. Fama and French (2008, 2015) identify accrual anomaly as one of the widely prevalent financial anomalies. The accrual anomaly is widely interpreted as evidence of market inefficiency. How does market react to accrual and cash flow component of earnings is an actively researched question. But most of the empirical studies are in the context of developed countries, and there is very little work with respect to emerging market economies. The study by Pincus et al. (2007) showed that cash flows and accruals are often undervalued in emerging economies. The subsequent study by Chen et al. (2010) in the context of Taiwan also confirms these conclusions – the use of DA to manage earnings is pervasive and investors tend to lose confidence in accounting earnings and thus tend to under-value earnings. This is inconsistent with the predictions of efficient market hypothesis (Fama, 1991). The study by Cupertino et al. (2012) with regard to Brazil (non-financial firms), on the other hand, confirms that the market correctly prices both accruals and cash flows. This conflicting evidence on accrual anomaly warrants a fresh look at the empirics especially in the context of emerging market economies like India. We examine this issue in the context of India which, in recent years, is the fourth best-performing stock market in the world[3] and is unique in terms of ownership structure, investor participation and long institutional reform process to enhance market efficiency (Dash and Mahakud, 2013, 2015; International Monetary Fund, 2013). The country is still based on Indian GAAP accounting standards, which provide considerable latitude for managers at arriving at the final earnings number and thus hide the underlying financial condition of the firm. Available evidence on testing stock market efficiency (weak form) finds that Indian stock market do not follow random walk, i.e. it is inefficient (Gupta and Basu, 2007; Thomas and Kumar, 2010; Harper and Jin, 2012).

We provide further evidence of the relationship between accruals and future CFO in the Australian context. Our contribution to the accounting literature stems from linking accruals related to operating, investing and financing activities – as well as their underlying asset and liability components – directly with future CFO. Linking accruals with future CFO is important for assessing the relevance of accruals for firm valuation. Thus, unlike previous studies that have focused on the reliability of accruals (e.g. Richardson et al., 2005; Oei et al., 2008; Lai et al., 2013a), we focus on the relevance of accruals in explaining CFO. A few previous studies (e.g. Barth et al., 2001; Cheng and Hollie, 2008; Farshadfar and Monem, 2013) have investigated the relative relevance of total operating accruals and the individual components of operating accruals with regard to explaining future CFO.1 However, Richardson et al. (2005) showed that ignoring investing and financing accruals in accrual-based research results in a loss of information and noisy measures of both the accrual and cash flow components of earnings. Hence, they called for future research to employ a broader definition and categorisation of accruals that incorporates accruals related to investing and financing activities. Providing further evidence of the usefulness of accruals thus categorised is important and timely, given the joint project between the International Accounting Standards Board (IASB) and the Financial Accounting Standard Board (FASB) that proposes the classification of all financial statement items into operating, investing and financing categories. The boards claimed that this separation could result in information that is more useful in decision-making than the information currently provided.2,3 However, this claim has yet to be tested empirically. Accordingly, we investigate a single but important research question: Does the categorisation of accruals into working capital, non-current operating and financing components enhance the ability of total accruals – and thus of earnings – to explain future CFO? According to Richardson et al.’s (2005) notation, these accrual components relate to the operating, investing and financing activities of a firm. We test our research question in the Australian setting because Australia has a well-developed capital market with a high level of investor protection, and it also has strict enforcement mechanisms (e.g. Leuz et al., 2003; Clarkson et al., 2011; Clinch et al., 2012). Given these factors, the quality of financial reporting is high in Australia (e.g. Cheung et al., 2010). Furthermore, Australia was an early adopter of IFRS. The comprehensive adoption of IFRS in Australia on 1 January 2005 has arguably given rise to the assumption that all preparers and users are familiar with the measurement bases and disclosure requirements under IFRS. More specifically, Australia has had cash flow reporting standards that are in keeping with the UK and the evolving International Standards. Therefore, the Australian setting reduces the possibility that the results of our study are affected by a poor-quality reporting regime or a weak regulatory environment.