Abstract

This research explores earnings quality as a quality measurement of optimism and trust in future returns, where the highly sustainable business has driven up obedience and compliance as a sign of prudent and consistent accounting policy. Manipulation activity is a widely open chance for opportunistic motives, associated with low certainty as a handicap to estimate high accuracy future returns. All observations in the Indonesia-listed manufacturing companies occurred from 2010 to 2022; this causal research uses moderated regression with the dummy variable in testing hypotheses and robust checks. This purposive sampling research has 154 companies with an unbalanced panel; two testing models on equity and earnings are used as sensitivity testing of positive perception. The high-prospected firm pointed out the persistent willingness to implement positive earnings management with this high consistency accounting treatment, which has been transformed into no violation. A positive correlation exists between high earnings quality and future returns, including concentration on real earnings as symbolized by a rational decision model. High-quality accounting information is valid information in predicting the going concerned, linked up to anticipating the peach-lemon effect, where business growth and dividends are used as a signaling effect. This centralized one-platform of the financial reporting system and going private is aimed to minimize the chance of misleading information and anticipate the low-prospected. The highly prospective has high consistency accounting treatment and proper tax management as the validated sustainability indicator, and the rationality modeling is modified from the simplex-linear programming as simulative modeling concerning the Decision Tree and Bayes Theorems.

Introduction

As proven by some empirical research last decade, high-quality financial reporting has been a crucial prerequisite for investors to monitor and check the capability of management to reach better prospects. The decision usefulness of accounting information is meaningful information because of the high obedience to the regulation (i.e., González-Sánchez et al., 2023; Jian et al., 2023). Structural knowledge of real earnings has recognized that consistency and prudent accounting have connected constructively with the market price movement; inevitably, this adverse signal pointed to a low probability of reaching a highly sustainable business model (i.e., Rezaee and Tuo, 2019; Park et al., 2021). Ping (2016) accentuated that low accruals positively impact investor perceptions with no chance of abnormal returns as a dysfunctional function. Therefore, earnings quality exists as a high–accuracy guideline of optimism and confidence as a decisive standpoint in calculating the expected returns when the volatile movement of agency cost has been a destructive consequence of sustainable performance; subsequently, this pragmatic evidence is reinforced by Akbari et al. (2019), Uzezi (2022), Beardsley et al., (2023), and Al-Asfour and Abu Saleem (2023)), underlining the proper tax management has been prioritized for keeping on the investor’s faith and belief.

The dividend is a “puzzle”, reflecting a myopia perspective of designing this payout policy as optimism of future growth opportunities (i.e., He et al., 2017; Alghazali et al., 2023; Sikalidis et al., 2023), Sidhu et al. (2023) found this payout policy measures the managerial capability of keeping on the business sustainability, particularly in anticipating the financial distress. The prominent role of the signaling effect is to smooth the unpredictable movement of market price, signifying the high risk; this research found a classic phenomenon of high-yielded dividend policy as a gap of research, where the annual average dividend payout ratio is higher than sales and earnings growth. In practice, the pattern of this payout policy has been explored in the Indonesia Capital Market, considering the magnificent performance as number 4 worldwide and the highest index growth in the Southeast Asia region area; accurately, the representative data distribution can be used to generalize the current circumstances of the signaling effect (see Appendix 1 Table 6). Concerning the manufacturing industry sector as an ultimate attractiveness in this capital market (see Appendix 1 Table 7), this sector had extraordinary growth during the Pandemic, representing an irrecusable occurrence. An annually detailed average comparison between the dividend payout and the business growth of sales and earnings is depicted in Fig. 1 below.

Conclusion

These results can be concluded; firstly, earnings quality had tested positively on investor perception when it covered up obedience and compliance. Manipulation activity and tax management are critical P(MAQ, H|DTAQ.Hi)x P(MAQ, H) P(MAQ, H|DTAQ, Hi)x P(MAQ, H) + P(MAQ, H |DTAQ, Lo).x P(DTAQ, Lo) M. Siladjaja and J. Jasman Journal of Open Innovation: Technology, Market, and Complexity 10 (2024) 100191 10 measurable factors in predicting high future certainty; the prudent accounting treatment reflects high consistency in publishing high earnings quality. Secondly, the dividend is used as the most effective signaling effect, which affects earnings quality differently; the positive contribution to earnings quality is a guideline for efficient contracting. Conversely, tax management and dividends have been connected to an exclusively mutual relationship aimed at smoothing the internal conflict intensity; nearly, the management is concerned with the dividend in obtaining a low cost of capital as an absolute comparative advantage. The high sales growth is an indicator of going concern, which is tested to drive up higher obedience and compliance; the high-prospected firm is assured of a highly sustainable business model, including high compliance with a minimum chance of agency costs and tax exposure. Finally, the high rationality perspective illustrated the conceivably interactive feedback between management and investors in predicting each party’s decision precisely as a comprehensive illustration of positive earnings management as optimism and confidence in the future.

The pattern of earnings management has various methods for calculating the residual error as a predictive signal of obedience and compliance because running fair value measurement is acknowledged internationally as a principal-ruled accounting standard. Commonly, the same perception of accounting treatment can be formed worldwide. The testing on the manufacturing-industry sector shows the practical implication for all regulators who must continuously monitor the business sustainability regarding the trust in this capital market. Implicitly, this calculation model can be implemented in other countries when earnings management has been tested as an open chance of discretionary behavior in reporting the actual performance; both consequences of efficient contracting and opportunity motives as a leading role of signaling effect have a critical influence on illustrating the real earnings management, covering up obedience to accounting standards and compliance with tax regulation. When the prospect theory pushes the positive contribution on the expected future returns, it is a challenge for this research to prove this theory; hence, this predictive simulation has been proposed with simplex-linear programming in calculating the maximum returns and minimum cost,

Abstract

We examine the impact of institutional ownership on earnings quality in China. We have employed two proxies of earnings quality: discretionary accruals and real earnings management. Using 19,743 firm-year observations from 2009 to 2017, we find that firms with higher institutional ownership are more likely to display higher earnings quality in lower discretionary accruals and lesser real activities manipulation. Our results are robust after controlling for endogeneity.

Introduction

Since the early 1990s, China has conducted a series of accounting, auditing, and stock market reforms to ensure convergence with IFRS, greater participation of home-grown audit firms in the audit market, liberalization of its stock markets and “…incentivize the development of institutional investors, including opening Chinese stock exchanges to qualified foreign institutional investors, social security funds, and insurance companies” (Lin and Fu, 2017, p. 17). All these reforms have resulted in a more vibrant stock market with greater participation of institutional investors. Institutional ownership of China’s A-Shares market capitalization (18.7%) doubled in 2021 compared to 2014 and is over ten times higher than in 2003 (Lin and Puchniak, 2021). In spite of the reforms and growing institutional ownership, concentrated ownership, particularly the presence of state-owned enterprises (SOEs), remains a common feature of the Chinese stock market. Given its comparatively weaker institutional environment, we examine whether institutional investors influence earnings quality in Chinese A-share firms.

Prior research shows that good corporate governance plays an important monitoring role, which improves accounting quality (Becker et al., 1998; Francis and Krishnan, 1999; Xie et al., 2003). As part of corporate governance in this paper we examine whether institutional investors influence earnings quality in Chinese A-share firms. The active monitoring hypothesis suggests that institutional investors are likely to manage their investment due to their magnitude of investment actively. Such active monitoring has been shown to improve stock price performance (Jiambalvo et al., 2002) and firm profitability (Lin and Fu, 2017; Guo and Platikanov, 2019; Ding et al., 2020). In advanced economies, the quality of earnings increases with an increase in institutional ownership (Velury and Jenkins, 2006). However, earnings quality may be imperiled by institutional investors who predominantly focus on short-term gains, pressuring corporate managers to make accounting decisions that boost short-term earnings at the expense of long-term value (Graves and Waddock, 1990; Laverty, 1996; Porter, 1992). For example, Chen et al. (2015) find that higher institutional investment in Chinese firms is associated with less conservative financial reporting as institutional investors in the Chinese market have short-term investment incentives. However, no study has examined whether institutional ownership impacts the quality of accounting earnings proxied by accruals and real earnings management in China.

Conclusions

In this paper, we examine the impact of institutional ownership on earnings quality in China, a capital market characterized by SOEs and concentrated ownership, creating incentives for self-serving and opportunistic behaviors such as misuse of insider information and earnings management. Employing two proxies of earnings quality: discretionary accruals and real earnings management, and using 19,743 firm-year observations from 2009 to 2017, we find that firms with higher institutional ownership are more likely to display higher earnings quality both in the form of lower discretionary accruals and lesser real activities manipulation.

When we conducted a sub-sample analysis based on state ownership, the results showed that institutional ownership reduces |DACC| in the non-SOE subsample but not in the SOE subsample. In contrast, institutional ownership is associated with a significantly lower level of real activities manipulation in SOE firms but not in non-SOE firms. These results imply that higher institutional ownership is significantly associated with higher earnings quality in both SOE and non-SOE firms, but the channel of the effect is different. For SOE firms, it is via reduced real management activities, while in non-SOE firms, it is via improved accruals management. When we further classify SOE firms into local and central SOEs, we find that institutional ownership constrains real activity manipulation only in the local SOEs. Our results are robust after controlling for endogeneity.

These results have important policy implications for regulators, investors, and audit firms in China. For example, our findings will help external capital providers and other stakeholders assess the pervasiveness of earnings management and the integrity of the financial reporting of Chinese SOE and non-SOE firms. Our findings suggest that in SOE firms, institutional ownership can be instrumental in improving earnings quality, which is a major issue.

1. Introduction

2. The governance role of financial education

3. Investor education indices and investor protection variable

4. Research design and sample

5. Empirical results

6. Robustness tests

7. Conclusion

Acknowledgements

Research Data

References

Abstract

Previous studies emphasize the importance of investor legal protection on financial reporting quality. We argue that investors’ awareness of their legal rights and understanding of the financial products play complementary roles. Financially welleducated investors are more likely to be able to understand investment-related information and less likely to be tricked, hence can pressure managers to eschew misappropriate behavior. This paper explores the role of investor financial education as a corporate governance mechanism in the context of earnings quality. Using data from 43 countries during the sample period of 1994 to 2012, we find that earnings quality is higher in countries with better financial education after controlling for various institutional environments. Interestingly, the positive effect of financial education on earnings quality exists only in countries with stronger investor legal protection, indicating a complementary role of financial education. Our study provides evidence on the role of financial education in investor protection.

Introduction

Since the financial markets and products have become more and more complicated, policymakers in both developed and developing countries recognize the growing importance of financial literacy and investing resources in financial education programs. Especially after the outbreak of the global financial crisis, financial literacy and financial education are considered as a key pillar of financial market stability because financial education can enhance level of investor protection. A large body of research has addressed the role that financial education and literacy play on investors’ individual financial behavior (e.g., Graham et al., 2009; van Rooij et al., 2011, 2012; Giofré, 2017; Bellofatto et al., 2018; Hsiao and Tsai, 2018; Krische 2019) 1 . However, it is little known whether financial education affects corporate policy on financial reporting. This study fills in this gap by exploring the impact of investor financial education on earnings quality in an international setting.

1- Introduction

2- Institutional background, theoretical framework, literature review, and research hypotheses

3- Research design

4- Empirical results

5- Endogeneity

6- Conclusions

References

Abstract

We examine the association between corporate social responsibility (CSR) and earnings quality using CSR ranking data from Rankins (RKS) and four measures of earnings quality. Using a sample of 2580 Chinese listed firms for fiscal years 2009–2015, with 14,807 firm-year observations, we find that CSR firms and those with higher CSR ratings are less likely to engage in earnings management than non-CSR firms and those with lower CSR ratings, and their earnings are more persistent and more accurately predict future cash flows from operations. State ownership and marketization moderate the relationship between CSR disclosures and earnings quality.

Introduction

The primary goal of business organizations has recently refocused from profit maximization to increasing shareholder wealth and protecting the interests of other stakeholders including society and the environment (Rezaee, Zhang, Dou, & Gao, 2016). The link between financial performance, including earnings quality, and corporate social responsibility (CSR) performance has been extensively examined in accounting and finance literature (Huang & Watson, 2015). Some research reports that firms focusing on CSR performance are less likely to engage in earnings management (Kim, Park, & Wier, 2012), experience better financial and market performance, and exhibit lower cost of capital (Dhaliwal, Li, Tsang, & Yang, 2011; Ghoul, Guedhami, Kwok, & Mishra, 2011; Goss & Roberts, 2011; Ng & Rezaee, 2015). Fatemi, Fooladi, and Tehranian (2015) document that in certain circumstances CSR expenditures contribute to firm valuation. Dechow, Sloan, and Zha (2014) argue that earnings are important to investors and that earnings quality and nonfinancial performance indicators, in addition to financial earnings, affect stock prices. Sharma (2013) argues that CSR achievement is more challenging for Asian companies than for their Western counterparts. However, CSR activities and related performance and disclosures have been gaining more attention in recent years in China (McGuinness, Vieito, & Wang, 2017). Motivated by the inconclusive results of CSR-related research in developed countries, we examine the association between CSR and earnings quality in a fast-developing market and economy, China. We focus on China for several reasons.

We propose and validate a new measure of earnings quality based on a hidden Markov model. This measure, termed earnings fidelity, captures how faithful earnings signals are in revealing the true economic state of the firm. We estimate the measure using a Markov chain Monte Carlo procedure in a Bayesian hierarchical framework that accommodates cross-sectional heterogeneity. Earnings fidelity is positively associated with the forward earnings response coefficient. It significantly outperforms existing measures of quality in predicting two external indicators of low-quality accounting: restatements and Securities and Exchange Commission comment letters.

Introduction

Earnings reports are affected by both a firm’s fundamental performance and the measurement process as governed by reporting standards, auditing technology, and managerial discretion (e.g., Dechow et al., 1998; Nikolaev, 2017). Prior research has used the statistical properties of earnings (e.g., smoothness, kinks in earnings, and target beating) and regression-based abnormal accrual models to measure the quality of earnings (for a review, see Dechow et al., 2010). In regression-based models, researchers separate the “abnormal” portion of accruals from the “normal” portion related to fundamental performance and define accruals quality based on abnormal accruals (e.g., Dechow and Dichev, 2002). Yet recent studies point out that an important issue with this approach is that proxies for unobservable “true” earnings may confound performance shocks with reporting discretion (e.g., Guay et al., 1996; Ball, 2013; Dichev et al., 2013; Owens et al., 2017). Our approach uses a structural model to separate accounting quality from the process of true earnings, thereby significantly alleviating the concern of having to rely on the noisy proxies. We assume that each firm transitions among states according to a Markov process. The fundamental performance of the firm is its state, which is either Low (L) or High (H). The firm’s state is unobservable; however, in each period, the firm issues an earnings signal, which is either low (l) or high (h). The probability that the firm issues a particular signal depends on the unobservable state, so inferences about the firm’s state can be made from its earnings signals.

Audit committee financial expertise is the most prominent feature of audit committee effectiveness that has caught the attention of regulators in recent years (CAQ, 2016; Griffin, 2016). In the USA, the Securities and Exchange Commission’s (SEC’s) original definitioni of financial expert, proposed by the Sarbanes–Oxley Act (SOX), was considered to be too narrow and controversial because it was restricted to only the accounting financial expertise of audit committee members who have qualifications and experience as public accountants; namely, Chartered Professional Accountants (CPAs) and Chartered Financial Analysts (CFAs) (Bryan-Low, 2002). Later, SEC’s final rule broadenedii the scope of audit committee financial experts (ACFEs) under Section 407 of SOX by including accounting financial experts (AFEs) and non-accounting financial experts (NAFEs). Among the latter are financial experts (e.g., investment bankers and financial analysts) and supervisory experts (e.g., chief executive officers (CEOs) and firms’ presidents). Likewise, other countries have specific requirements for ACFEs. A plethora of research explores the effectiveness of the ACFEs’ role in overseeing the financial reporting quality of public companies. There is also an ongoing debate about which type of expertise, by definition, has a stronger association with earnings quality: accounting or nonaccounting expertise. Some studies propose a narrower definition of financial expert (Dhaliwal, Naiker, & Navissi, 2010; Krishnan & Visvanathan, 2008), while others suggest the advantages of a broader definition (Davidson, Xie, & Xu, 2004; Kusnadi, Leong, Suwardy, & Wang, 2014). Further research supports the claim that having both accounting and non-accounting experts on an audit committee can be beneficial in terms of earnings quality (Carcello, Hollingsworth, Klein, & Neal, 2008; Nelson & Devi, 2013).

Prior research has shown that companies may set their levels of cash holdings by trading off the costs and benefits of larger liquidity reserves (Miller & Orr, 1966). Costs that have been analysed typically include low returns and possible tax disadvantages of cash reserves (Bigelli & Sánchez-Vidal, 2012) while usual benefits that have been identified are the reduction in transaction costs that would exist in the case of new capital raising or the liquidation of assets, the reduced likelihood of default, the avoidance of possibly expensive funding or even the shortage of financing alternatives (Kim, Mauer, & Sherman, 1998; Opler, Pinkowitz, Stulz, & Williamson, 1999). Reasons for a costly external financing relate in general to the presence of information asymmetries between firms and investors (Myers & Majluf, 1984) or to the existence of agency problems associated with underinvestment and asset substitution (Jensen & Meckling, 1976). Additionally, managers may pursue their own interests by maintaining large amounts of cash on companies’ balance sheets so as to keep sub-optimal levels of net debt, risk and/or dividends in comparison to those desired by shareholders (Easterbrook, 1984). With the exception of García-Teruel, Martínez-Solano, and SánchezBallesta (2009) who focused on Spanish firms prior to the adoption of IFRS by listed business groups, there has been, however, little research on the relation between cash reserves and earnings quality in an European setting. In the US context, Sun, Yung, and Rahman (2012) show a negative impact of earnings quality on corporate cash holdings. Chung, Kim, Kim, and Zhang (2015) document that companies in industries with greater levels of information asymmetry hold lower amounts of cash balances, consistent with a shareholders monitoring hypothesis where managers are restrained from holding large cash reserves that could be misused when their environment is more opaque. The UK is a particularly interesting setting to test the relationship between earnings quality and cash-holdings. This is not just due to earnings quality being usually perceived to be higher in Anglo-Saxon (common-law) accounting systems than in continental Europe (code-law) ones but also because, as Ball, Kothari, and Robin (2000) observe, “within the common-law group, there is less asymmetric conservatism in accounting income in the United Kingdom, a country we characterize in terms of lower political involvement in accounting, lower litigation costs and less issuance of public debt” (p. 4).

Accounting and finance have a long tradition of studying the relation between accounting earnings and stock market returns. This interest is driven by the importance of earnings to investment decisions and to the prediction of returns. In their asset allocation decisions, investors form expectations about the firm’s future cash flows and the risk associated with these cash flows (Fama 1970). As earnings contain information about the stream of cash flows, investors use earnings information to revise their expectations about future flows and this leads to a revision of stock prices. In other words, earnings are useful for stock price formation. Prior studies have focused on explaining the time series variation or the cross-sectional variation in the earnings-return relation. We propose to study both the temporal and cross-sectional variation in the relation between earnings, earnings changes and returns using an extension of the regime switching methodology introduced by Hamilton (1989): the heterogeneous regime switching methodology. The heterogeneous regime switching method can be summarized as follows. First, we estimate the time series variation in the earnings-returns relation for the sample firms for the period 1997–2010. The estimation method allows us to identify breaks in the time series of earnings-returns and to characterize each regime. As a result, we are able to let the data generating process determine the regime rather than identifying the breaks ex-ante which would be subjective. Second, each firm is assigned to a group (or cluster) based on how long it stays in one regime and the likelihood of switching to the other regime. Thus, the model is dynamic as it allows firms to switch between regimes across time. We identify two regimes. The low volatility regime corresponds to periods of low return volatility and a moderate association between earnings and returns. Both earnings and earnings changes are positively associated with returns but the magnitude of the earnings coefficients is smaller than in the other regime. The high volatility regime represents periods of high volatility in returns with earnings and earnings changes strongly associated with returns. This result is consistent with the idea that in periods of high price instability, such as financial crises, information about earnings is more important to investors than in ‘‘normal’’ periods. During bear market conditions, investors become more risk averse and fly from stocks with high levels of uncertainty about fundamental value (Lang and Maffett 2011). As financial information lessens uncertainty about the firm’s fundamental value and reduces risk perception, earnings become more important for investors (Lang and Maffett 2011). In other words, investors rely more on earnings information during market downturns because other information is more likely to reflect speculation and noise.

1- Introduction

2- Related literature and hypotheses

3- Methodology

4- Sample

5- Results

6- Conclusion

References

Abstract

We study the effects of country-level accounting enforcement on earnings quality of banks and whether bank regulation substitutes or complements the effect of accounting enforcement on bank earnings quality. We also examine whether the influence of accounting enforcement on bank earnings quality changed after the global financial crisis. Using a sample of listed banks from 40 countries between 2001 and 2014, and abnormal loan loss provisions (ALLP) as our main proxy for earnings quality, we document a consistent and strong association between accounting enforcement and bank earnings quality. More specifically, an increase in accounting enforcement decreases the level of ALLP and decreases the propensity to manage earnings to avoid losses. Furthermore, we provide empirical evidence that bank regulation complements the effect of accounting enforcement on bank earnings quality. Finally, unlike in the pre-crisis period, we find a positive association between accounting enforcement and income-decreasing ALLP in the post-crisis period, which indicates that stronger accounting enforcement is associated with more conservative earnings and higher loan loss reserves. Overall, our results indicate that accounting enforcement reduces opportunistic earnings management.

Introduction

We investigate the relation between country-level accounting enforcement and earnings quality of banks for a sample of publiclylisted international banks. We first examine how accounting enforcement by itself relates to bank earnings quality and then we examine the implications of bank regulation for the accounting enforcement-earnings quality relation. We also study whether the effect of accounting enforcement on earnings management changed after the global financial crisis. Banking is a unique industry where accounting standard setters and regulatory agencies may not always have similar objectives to bank regulators. Whereas accounting standard setters and regulators are more concerned about transparent financial reporting that reflects true economic performance, bank regulators may prefer conservative accounting practices that can lead to over-provisioning of allowances for bad loans that act as a cushion against financial difficulties in bad times. For example, banks’ loan loss provisioning practices came under scrutiny by the SEC’s task force on earnings management (The Wall Street Journal, November 16, 1998). This emphasis on reserves stems from the SEC’s broader concerns about earnings management in banking and other industries. Whereas some banks were trimming loss reserves to increase earnings and bolster their return on equity, other banks were being conservative by overly provisioning for loan losses (American Banker, June 29, 1998). In response to this concern, the SEC on November 16, 1998 ordered SunTrust bank to trim its 1994, 1995, and 1996 loan loss provisions, which resulted in an upward restatement of SunTrust’s profits for the three years and a reduction in its loan loss reserves to $666 million from $766 million.

The question of whether females tend to act more ethically or risk-averse compared to males is an interesting ethical puzzle. Using a large sample of US firms over the 1992–2014 period, we investigate the effect that the gender of a chief executive officer (CEO) has on earnings management using classification shifting. We find that the pre-Sarbanes–Oxley (SOX) Act period was characterized by high levels of classification shifting by both female and male CEOs, but the magnitude of such practices is, surprisingly, significantly higher in firms with female CEOs than in those with male CEOs. By contrast, our results suggest that following the passage of the punitive SOX Act, classification shifting by female CEOs declined significantly, whilst it remained pervasive in firms with male CEOs. This suggests that the observable differences in financial reporting behavior between male and female CEOs seem to be because female CEOs are more risk-averse, but not necessarily more ethically sensitive than their male counterparts are. The central tenets of our findings remain unchanged after several additional checks, including controlling for alternative earnings management techniques, corporate governance mechanisms, CEO and chief financial officer characteristics and propensity score-matching.

Introduction

The introduction in the 1960s of a number of gender-focused equal opportunities laws, especially in developed countries, such as the 1963 Equal Pay Act of the US, helped in increasing women’s participation in the workforce (Khlif and Achek 2017). However, this did not necessarily lead to increased participation of women in senior management roles [e.g., board member or chief executive officer (CEO)] in companies, with ‘old-boys networks’ often cited as one of the major barriers to women’s executive career progression (Adams 2016). The past three decades have, however, witnessed significant increases in corporate, national and supra-national governance reforms, laws and affirmative initiatives explicitly aimed at increasing women’s participation in senior corporate executive roles (Adams 2016; Srinidhi et al. 2011). For instance, Canada, the EU, France, Norway, Italy and the UK have implemented either ‘hard’ or ‘soft’ gender-based quotas for large corporate board memberships, which have led to observable increases in women’s presence on corporate boards in these countries (Adams 2016; Adams and Ferreira 2009; Srinidhi et al. 2011). Discernibly, the strong push for gender-diverse corporate boards and executives is not only driven by ethical, moral and social fairness theories (Sun et al. 2017), but also economic benefits of the unique skills, experiences and talents that women bring to such roles (Carter et al. 2003, 2010). Unsurprisingly, a number of distinct empirical strands of research have emerged. An earlier relevant strand has examined the effect that gender-diverse corporate boards and women CEOs have on firm performance/value (Carter et al. 2003, 2010). With some exceptions (see Adams and Ferreira 2009; Kirsch 2017; Terjesen et al. 2009), the finding suggest that gender has a positive effect on firm performance/value (Carter et al. 2003; Gul et al. 2011; Liu et al. 2014; Ntim 2015; Shrader et al. 1997).1 Such positive gender effects have been attributed to rational-economic inspiredtheories, such as agency, resource dependence, stakeholder and stewardship theories, which indicate that the presence of women in boardrooms enhances board independence, monitoring, advisory capacity and resources through greater connection of the firm to the external environment (Adams 2016; Kirsch 2017; Terjesen et al. 2009). A more recent strand of the literature has focused on the effect that gender-diverse corporate boards and women CEOs have on corporate fraud and wrong-doing (Ho et al. 2015; Palvia et al. 2015; Peni and Vahamaa 2010; Sun et al. 2017).

Is earning quality likely to be higher or lower at companies with a higher level of corporate social responsibility (CSR)? The level of CSR is a measurement of socially responsible activities by companies that benefit stakeholders overall (Kim et al., 2012), such as increasing customers reliability and reducing pollution. Prior research has had conflicting results. For example, Kim et al. (2012), by using the global data from 2001 to 2009, suggest that companies with a higher level of CSR tend to have better earnings quality because they reduce their manipulation of earnings and deliver higher-quality financial information in a responsible manner. In contrast, Jensen and Meckling (1976) argue that managers of companies with a higher level of CSR work to pursuit self-interest or improve the firm’s reputation, at such firms, so earnings quality tends to decline, but so does manipulation of financial reporting. One possible reason for this apparent contradiction is that certain factors may affect the relationship between having a high level of CSR and earnings quality, such as the extent to which the managers restrict the manipulation of reported earnings. For example, Choi et al. (2013) and Sun et al. (2010) find that the relationship between the level of CSR and earnings quality is weaker when a firm’s percentage of institutional investors increases, whereas the relationship is stronger when the firm’s percentage of foreign investors increases. In China, Zhong and Fan (2011) examine the relationship between the level of CSR and the scale of earnings manipulation, demonstrating that companies with a higher level of CSR have more transparency and less earnings manipulation. Controlling shareholders play an important role in earnings quality (Wang 2013). The earnings quality is lower at state-owned enterprises (SOEs) than at private owned firms (POEs). However, POEs have a higher quality of earnings than SOEs listed on the S&P 500 stock index (Ali et al. 2007). In China, Xia and Fang (2005) show that enterprises controlled by the central government (CGCEs), enterprises controlled by local governments (LGCEs), and POEs are driven by different layers of local governments, such as provincial government, municipal government and county government. Therefore, companies that have different controlling shareholders will display different corporate behavior for different potential interests.

Ethics and financial reporting are both topical issues that have instigated numerous debates in the academic as well as the business community (Schwartz 2004). In this study, we assess the effect of two potential sources of ethical principles, namely, CSR and membership in a Shariah index. The literature has defined CSR in various ways but in essence, it is a process by which organizations negotiate their roles within the surrounding society (Carroll 1979; McWilliams et al. 2006). Membership in a Shariah index is the adherence to an ethical code that relates to religion. The literature has also proposed this membership as another possible driver of moral activities (Weaver and Agle 2002; Conroy and Emerson 2004; Longenecker et al. 2004; Hood et al. 2014). In particular, Noreen (1988) contends that agency contracts with a religious mechanism can mitigate managers’ opportunistic behavior. Hence, we also focus on the relation between Shariah-compliant investment and the quality of financial reporting.1 This study develops the theoretical link between ethics and financial reporting by using two competing views: moral obligation and opportunistic behavior (Kim et al. 2012). First, firms benefit from conducting their business activities in a way that is honest, trustworthy, and ethical. Thus, firms have a tendency to comply with high moral standards (Jones 1995; Garriga and Melé 2004; Kim et al. 2012). In a similar vein, Kim et al. (2012) contend that firms that expend efforts and resources in designing and implementing ethical programs in order to serve the interests of societal stakeholders are more likely to provide transparent and reliable earnings information. However, managers might have an incentive to use ethical precepts as a strategic tool to obfuscate their opportunistic behavior, and in so doing, they can attempt to influence stakeholders’ perceptions of the firm (Hemingway and Maclagan 2004; Merkl-Davies and Brennan 2011). Thus, a firm might use an ethical practice as a label to create the perception of transparency, thereby avoiding scrutiny from stakeholders. The practice therefore assists firms in legitimizing their operations within society (Merkl-Davies and Brennan 2007). Thus far, the studies that examine the association between ethics and earnings quality provide mixed empirical results. With regard to CSR reporting, Prior et al. (2008) and Chih et al. (2008) both find that CSR firms are more likely to engage in aggressive earnings manipulation. However, Hong and Andersen (2011) and Kim et al. (2012) show that firms with higher CSR scores provide better quality information on earnings. In the case of religion and the quality of financial reporting, McGuire et al. (2011) and Dyreng et al. (2012) both show that religion-influenced firms are less involved in aggressive financial reporting and have higher accrual quality, lower restatements of financial statements, lower risk of fraudulent accounting, and lower forecast errors. In contrast, Callen et al. (2011) show that the extent of earnings management is not related to religion. Given that most of the research focuses almost exclusively on either CSR or membership in a Shariah index, this study examines the effect of both sources of ethical principles on the quality of financial reporting. Furthermore, whereas the literature that examines the link between Shariah and financial issues concentrates almost exclusively on Muslim countries, this study shifts the focus to rest of the world because Shariahcompliant investment has experienced considerable growth in recent years.

Cost of capital is currently a much debated issued in accounting and economic research. According to Munteanu (2011), cost of capital is the cost of a firm’s funds (both debt and equity), or, from an investor’s point of view “the required rate of return on a portfolio firm’s existing securities”. There is a thoroughly extended literature that examined different aspects, inside earnings quality, investor protection and IFRS adoption, of cost of capital. Hence, concerning the effects of investor protection on cost of capital, using various structural econometric models, Francis et al (2005), Esponisa and Trombetta (2007), Chen Boubakri and Ghouma (2010), Semper and Beltran (2014) and Blanco et al (2015) found that on average, the higher the level of investor protection, the lower is the marginal cost of capital – due to the lower risk premium. Furthermore, another variable that have a negative impact on cost of capital is IFRS adoption. Several authors have observed the consequences of adopting IFRS. The most representative paper that analyzed the impact of adopting IFRS on the cost of equity capital came from Munteanu (2011). He claimed that most of the studies distinguish in the first place the firms that voluntarily adopted IFRS from those that adopted them mandatorily. However, in general, even though IFRS was adopted voluntarily or mandatorily, Covrig et al (2007), Daske et al (2008), Patro and Gupta (2014), Castillo-Merino et al (2014) and Christensen et al (2015) confirmed that IFRS adoption enhances the comparability of financial statements, improves corporate transparency, decreases in the cost of collecting information, increases in competition and efficiency in the capital market by reducing the information asymmetry which in turn decreases the cost of capital. Earnings quality is another factor that has a negative impact on cost of capital. Specifically, there is a consensus view of the findings from Affleck-Graves et al (2002), Bhattacharya et al (2003), Kim and Qi (2010), Valipour and Moradbeygi (2011) and Persakis and Iatridis (2015) who tested the association between cost of capital and various earnings quality attributes. They confirmed that higher level of earnings quality leads to lower level of cost of capital.