Abstract

This article systematically reviews 94 accounting and finance studies that address the real effects of financial reporting. Whereas the effects of financial reporting on capital suppliers’ decisions traditionally have received much attention, recent research has generated important new insights into the feedback effects of financial reporting on the reporting firms’ real activities (e.g., investments or allocation and use of resources). We identify the consequences of financial reporting for (1) the reporting firm, (2) its peer firms, and (3) the input and output markets. We also highlight the effects of firms’ internal controls over financial reporting and consider how accounting and auditing regulations influence and contribute to real effects. The studies we review are consistent in their findings that high-quality financial reporting is positively associated with the efficiency of the reporting firm’s resource allocation. Many studies also suggest a positive association between high-quality financial reporting and an efficient allocation of resources in the real sector, which can also benefit other market participants like consumers or employees. The article concludes with an outlook on fruitful research opportunities.

Introduction

Most accounting research focuses on the capital market effects of financial reporting. Financial reporting informs investors, creditors, and the public about firms’ activities, net assets, financial position, and results of operations. It thus decreases information frictions when firms need to fund (new) projects and activities. A large portion of the literature on the effects of financial reporting addresses efficiency problems in the capital market by investigating the decisions taken by capital suppliers (e.g., Ball and Sadka, 2015, Ball et al., 2009, Botosan, 2006, Dye and Sridhar, 2002, Verrecchia, 2001). However, the relevance of financial reporting for the real sector, which includes firms’ decisions on investments and the production and consumption of goods and services, has received considerably less attention. Nevertheless, a small but fast-growing strand of the accounting and finance literature investigates the effects of financial reporting on the real sector. These effects are also referred to as real effects.

Most real effects studies investigate the economic effects of financial reporting on the investments and operations of the reporting firm (e.g., Biddle et al., 2009, García Lara et al., 2016, Kanodia and Sapra, 2016, McNichols and Stubben, 2008). An increasing number of studies also address the effects of a firm’s financial reporting on its peer firms. Examples of such studies are Badertscher et al., 2013, Beatty et al., 2013, Durnev and Mangen, 2009, and Li (2016), who find that misreporting can distort the peer firms’ investment and operational efficiency. The reason is that the peers seem to rely on misleading economic prospects. In contrast, peer firms might benefit from learning about market uncertainties from another firm’s financial report (Badertscher et al., 2013, Bernard et al., 2020, Durnev and Mangen, 2020). Finally, a few studies investigate the real effects of finanical reporting for the aggregate input or output market. These studies are consistent in their finding that financial reporting can facilitate the efficient allocation of resources across firms, for example, by reducing differences in productivity within an industry (Breuer, 2021, Francis et al., 2009, Hann et al., 2020). However, there is scarce research on the real consequences of financial reporting for other market participants in the input or output market. Yet real effects for consumers can exist in the output market, if, for example, firms change their pricing policies (Li, 2016, Sadka, 2006) or differentiate their products (Bernard et al., 2020) in response to their competitors’ financial reports. Furthermore, in the labor input market, financial reporting relates to firms’ labor investment efficiency (Choi, 2021, Jung et al., 2014, Kedia and Philippon, 2009), and this ultimately has implications for employees.

Conclusion

This review article summarizes 94 studies on the role of financial reporting for the real sector, focusing on (1) the reporting firm, (2) its peer firms, and (3) the input and output market. First, we find that most of the studies investigate real effects for the reporting firm. The findings of these studies suggest that high-quality financial reporting is positively associated with firms’ investments and operations efficiency. The reporting of (in)efficient internal controls can be interpreted as a moderating factor in firms’ efficiency in real decisions. Second, an increasing number of studies investigate the real effects of financial reporting for the reporting firm’s peers. These studies suggest that high-quality financial reporting can improve the efficiency of peer firms’ real decisions through learning. Low-quality reporting, on the other hand, can be misleading and result in inefficient real decisions by peer firms. Third, we find that only a few studies focus on the real consequences of financial reporting at the aggregate level. The findings suggest a positive association between industry- or country-level measures of financial reporting quality and the efficient allocation of resources across firms (e.g., by increasing product market competition). However, the economic implications of financial reporting for other market participants (e.g., consumers or employees) remain insufficiently explored. For example, consumers might benefit from an increase in product market competition resulting from high-quality financial reporting. Moreover, financial reporting quality positively relates to firms’ labor investment efficiency, which can affect employees. Finally, we observe that an increasing number of studies investigate the real effects of accounting and auditing regulations. These studies suggest that financial reporting regulations addressing the needs of capital market participants can have unintended economic consequences for firms and other market participants in the real sector.

Abstract

     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.

Introduction

     Since the 2008 global financial crisis, accounting and finance researchers have shown considerable interest in bank transparency. The crisis highlighted the economic impact of bank opacity and gave rise to the notion that a lack of information on bank asset quality can harm financial stability. The opacity of banks can exacerbate agency problems by hindering market discipline, and increase the risks of panic and contagion during a crisis (Nier and Baumann, 2006, Morgan, 2002). During the recent global financial crisis, investors sought information on banks’ exposure to risks, but this was not readily available. Along with explicit government backing of the banking system, the public disclosure of stress test results helped to relieve the panic by providing investors with the needed information (Jungherr, 2018).1 Since then, extensive literature has discussed how much transparency in banking should be required, and how transparency affects financial stability (see Acharya and Ryan (2016) for a survey). There is, however, still a paucity of research identifying the determinants of bank transparency, despite the necessity of effective monitoring and regulations. We aim to fill this gap by examining the effect of bank managers’ labor mobility on financial reporting quality.

     In this paper, we define labor mobility as the degree of friction in the labor market, in terms of how easily individuals can transfer from one job to another. Job switching is an important channel through which individuals increase their compensation or find better-suited jobs (Topel and Ward, 1992). Therefore, the possibility of job switching is used as leverage in negotiating compensation levels and working conditions both explicitly and implicitly. This is well demonstrated by recent retention awards to bank executives, that were granted as competition for talent intensified among banks.2 The observed efforts made by banks to retain executives imply that a restriction on labor mobility would lower managers’ bargaining power in the job market. Accordingly, managers’ career concerns would increase. In response, to secure bargaining power, managers may have higher incentives to window-dress their performance by distorting information disclosed to the public. Consequently, the financial reporting quality would be compromised (hereinafter, we refer to this proposed effect as the career concern hypothesis). There are a number of studies on industrial firms testing and supporting this hypothesis (Ali et al., 2019, Chen et al., 2018, Tang et al., 2021), but not yet for banks.

Concluding remarks

     The 2008 global financial crisis confirmed a longstanding concern around bank opacity, namely that a lack of information on banks’ asset quality can lead to greater systemic risk. Given the economic impact of bank opacity, it is necessary to understand the determinants of banks’ financial reporting quality to enhance financial stability. To this end, we evaluate the effect of managerial labor mobility on financial reporting quality at banks. We focus on the degree of labor mobility because it constrains managers’ outside job opportunities, and thus affects their career concerns. This is particularly important in the banking industry because of its opaque nature. Despite the existence of accounting rules and regulations, bank managers still have some discretion over financial reporting due to their informational advantages and expertise in bank operation (Beatty and Liao, 2014; Kim and Kross, 1998; Cornett et al., 2009). We conjecture that a restriction on labor mobility motivates earnings management by triggering managers’ career concerns, and thereby impairs financial reporting quality at banks.

     This paper evaluates the impact of a legal shock discouraging labor mobility (i.e., the IDD) on discretionary provisioning by banks. We find that banks accrue loan loss provisions in a more discretionary manner after their home state adopts the IDD. Rejecting the IDD has the opposite effect, i.e., reducing discretionary provisions. These results suggest that restrictions on labor mobility impair the financial reporting quality of banks, making it harder for outside investors and regulators to understand bank fundamentals. We further perform a number of tests on the heterogeneous effects of the IDD. We find larger effects of the IDD on discretionary provisioning for smaller banks, private banks, and banks with fewer peers in the local market. These results support the view that managers’ career concerns are the channel through which labor mobility affects financial reporting quality. We also use alternative measures of financial reporting quality: the validity of provisions in estimating future loan losses, and just-meeting-or-beating earnings benchmarks. Our results using the alternative measures are broadly consistent with the earlier findings. First, after IDD adoption, banks’ loan loss provisions become less accurate estimations of actual loans charged off in the subsequent period. Second, we provide evidence that IDD adoption increases bank managers’ use of accounting discretion to meet or beat an earnings benchmark.

Abstract

     We study financial reporting and disclosure practices in China using survey methods similar to prior studies of U.S. firms (i.e., Graham et al., 2005; Dichev et al., 2013). Comparing earnings features, motives to manage and smooth earnings, and voluntary disclosure practices between the two countries, we reveal three major differences. First, Chinese firms exhibit a stronger preference for predictive, relative to verifiable, attributes of earnings that can signal stable firm performance to their stakeholders. Second, smooth earnings are desired by various stakeholders and can be achieved through coordination among connected stakeholders, which is conceptually different from earnings management. Third, Chinese firms consider public disclosure as less relevant in the reduction of the cost of capital. In addition, Chinese firms do not have a bias towards conservative reporting. We explain and reconcile these differences as resulting from some unique institutional features of China. Our study provides novel field evidence that contributes to, expands, and directly corroborates existing empirical studies.

Introduction

     China’s economic significance has grown in recent decades, making it the second largest economy in the world. While China has continuously introduced new regulations to assimilate shareholder-driven practices of financial markets in the West, various institutional differences spanning cultural norms and socio-economic structures still play a considerable role in shaping the Chinese capital market. For instance, prior studies suggest that connections among many non-arm’s length stakeholders contribute to the functioning of capital markets in China (e.g., Ball et al., 2000; Allen et al., 2005; Wong, 2020). In this paper, we use a field-based survey approach to directly study how such institutional factors shape firms’ financial reporting and disclosure practices in China.

     A survey approach enables us to extend prior archival studies, providing evidence about unobservable coordination efforts and private communication channels among non-arm’s length stakeholders in China. While a series of surveys of CFOs at U.S. public firms have allowed academics to validate and reconcile findings on financial reporting and disclosure practices in the accounting and finance literature (e.g., Graham and Harvey, 2001; Graham et al., 2005; Dichev et al., 2013), these survey findings primarily reflect the financial reporting incentives of arm’s length shareholders. Our study extends this prior research by examining firm responses in China, where information demand is shaped by various stakeholders that are non-arm’s length. Moreover, our study complements the extensive archival literature on financial reporting and disclosure practices in China (Lennox and Wu, 2022).

Conclusion

     This paper provides novel field-based evidence on financial executives’ opinions and perceptions for financial reporting and disclosure practices in China. Chinese executives of public firms are directly asked about their incentives and the motives for their firms’ financial reporting and disclosure practices. Using financial executive opinions and motives at U.S. firms as a benchmark, we find that Chinese firms differ in what they consider as “high quality earnings”, in their motives for earnings management and earnings smoothing, and in their incentives to disclose bad news relative to good news voluntarily. Further field-based evidence suggests that these differences are primarily rooted in the institutional differences associated the dominance of retail investors, concentrated ownership structures, weak legal systems, and the role of diverse stakeholder groups – including arm’s length investors and non-arm’s length stakeholders.

     Our field evidence is consistent with a stakeholder-driven corporate governance model in China. Financial reporting is often considered as a vehicle to mitigate agency conflicts between firms and outside shareholders. The Chinese setting highlights that financial reporting may also have the important role of signaling stable performance to a variety of different stakeholders, including customers, suppliers, employees, and the government. Many of them constitute non-arm’s length stakeholders, and may have private communication channels with firms, which undermines the effect of public disclosures to mitigate agency problems. That is, public disclosure in China helps to signal the ability to coordinate among major stakeholders to maintain stable firm performance.

Abstract

     This research examines whether the characteristics of top management teams are related to financial statement comparability. Considering the foreign experienced CEOs (FCEOs) in Chinese listed firms from 2005 to 2018, we show that it can increase financial statement comparability. We argue that firms led by FCEOs will enhance information environment and governance mechanisms by minimizing agency issues, consequently generating more comparable financial statements. Through further investigation, we find that the relationship between FCEOs and comparability is stronger when CEOs possess a financial and accounting background and when they have overseas professional experiences. fthe relationship is weaker with the existence of higher economic policy uncertainty. Finally, we identify financial reporting as an important channel that explains the relationship between FCEOs and comparability. Findings remain consistent after numerous robustness checks and supplementary investigations comprising lag of independent variables, generalized method of moment, instrumental variable approach, propensity score matching, and alternative comparability measures. Overall, the findings suggest that CEOs’ foreign experiences are associated with corporate outcomes.

Introduction

     Top management team (TMT) characteristics, especially of CEOs, substantially influence corporate decisions (Lai and Liu 2018; Zhang 2018). Despite scholarly recognition of CEOs’ traits, such as expertise, tenure, personality traits, duality, education, and gender, CEO foreign experiences are a few of the factors currently gaining research interest. This stream of literature claims that foreign experienced CEOs1 (FCEOs) have a possible influenfgce on corporate decisions, such as compensation (Conyon et al. 2019), undertaking foreign IPOs (Duan, Hou, and Rees 2020), performance (Duan and Hou 2017), and corporate investment (Dai, Kong, and Liu 2018). However, one of the important issues that has not received scholarly attention is financial statement comparability (comparability, hereafter). Accordingly, the current study contributes to the literature by investigating how FCEOs affect comparability

     Comparability is a crucial element in financial reporting (International Accounting Standard Board 2010). Users of financial statements benefit from it given its role to facilitate understanding of accounting information and thus in coming up with informed decisions. Studies (e.g., De Franco, Kothari, and Verdi 2011; Zhang 2018) suggests that comparability enhances information quality while reducing acquisition and processing costs. Comparability can correspondingly diminish information asymmetry, which leads to higher innovation efficiency (Chircop et al. 2020); more efficient resource allocation (Kim et al. 2020); higher stock price information quality (Choi et al. 2019); greater accounting information’s relevance (Kim, Kim, and Musa 2018); lower cost of capital (Imhof, Seavey, and Smith 2017); and higher analyst coverage and forecast accuracy and lower forecast dispersion (De Franco, Kothari, and Verdi 2011). Despite extensive scholarly attention to the antecedents of comparability, research has scarcely focused on its determinants (Dhole et al. 2015; Francis, Pinnuck, and Watanabe 2014; Imhof, Seavey, and Watanabe 2018). We add to this line of research by studying how TMT characteristics (CEOs’ foreign experiences) explain comparability.

 Conclusio

     This study investigates whether FCEOs and their accounting and financial expertise are associated with comparability. It utilizes a sample of Chinese listed firms from 2005 to 2018 and found evidence that FCEOs significantly increase comparability. Notably, this this influence is more pronounced for CEOs with accounting and financial backgrounds. These conclusions remain valid after addressing endogeneity issues. Our additional analyses also suggest the following: the effect of FCEOs on comparability is stronger when CEOs have overseas employment experiences but weaker in the presence of higher EPU. Finally, we identify financial reporting quality as a channel explaining the nexus between FCEOs and comparability

      This research provides new evidence confirming the importance and influence of CEOs’ foreign experiences on comparability. It underscores the significance of foreign experiences as integral in the acquisition of human and social capital. It also adds to the increasing body of knowledge regarding the economic implications of CEOs’ foreign experiences. Our findings are useful to firms that wish to attract foreign talents by recognizing the prospect of FCEOs to minimize agency problems and offer potential external resources. For policymakers, acknowledging that FCEOs can effectively help improve comparability might inspire them to allocate potential resources to crafting policies that attract foreign expertise. Overall, the results offer important implications for policymakers and regulators with regard to the role of FCEOs

Abstract

     This study examines the effect of financial statement comparability on stock liquidity. Drawing from information asymmetry arguments, we posit that greater comparability increases financial transparency, which improves the information environment and increases stock liquidity. Our results show a positive relationship between comparability and stock liquidity. However, the effect of comparability on stock liquidity is only significant for non state-owned enterprises. Additionally, institutional ownership strengthens the impact of comparability on stock liquidity. Our findings suggest a more pronounced comparability effect on stock liquidity for firms with greater information opacity. Overall, our study indicates that higher comparability decreases information asymmetry and facilitates investors’ decision-making.

Introduction

     Financial Accounting Standards Board (FASB) (2010) suggests that financial statement comparability (hereafter comparability) is a fundamental qualitative feature of financial reporting. Comparability increases faithful representation and relevance of financial statements as well. Higher comparability enhances the magnitude of firm-specific information and boosts the extant information environment. Comparability facilitates identifying and understanding similarities and differences among different firms (Barth 2013). Relative evaluation of investment avenues would be impossible without comparable information, which makes comparability essential for investment purposes. Therefore, the FASB (2010) conceptual framework suggests that the chief objective of financial reports is to enhance comparability, which improves the usefulness of the information. Similarly, the SEC concept release1 suggests that comparability along with reliability and transparency are the ‘only way to achieve fair, liquid and efficient capital markets’. Thus, comparability, for its immense importance in equity valuation, has been given due importance in textbooks as well (Healy and Palepu 2012). The value of comparability for academics, capital market participants, standard setters, and practitioners makes it crucial to investigate the impact of comparability on stock liquidity. Comparability plays a vital role in the efficient utilization of resources (Kim et al. 2020), improving the informativeness of stock prices (Choi et al. 2019), enhancing acquisition efficiency (Chen et al. 2018), decreasing the cost of capital (Imhof, Seavey, and Smith 2017), reducing the crash risk (Kim et al. 2016), and improving firm value (Neel 2017).

Conclusion

     This study explores the effect of the qualitative aspect of financial reporting, i.e. comparability, on the stock liquidity. Comparability improves the acquisition and processing of financial information leading to lower information asymmetry. Higher comparability improves the comparison of investment avenues and makes decision-making quick and eloquent. This study augments the previous studies that financial reporting bridges the gap among investors and reduces the adverse selection cost leading to higher stock liquidity. In this way, our study extends earlier literature by studying the effects of qualitative aspects of financial reporting.

     We document that higher comparability enhances the flow of information to the traders, reduces adverse selection, and increases stock liquidity. Our results remain identical when we use alternative comparability measures or alternative econometric specifications, e.g. lag of the primary independent variable, two-stage least square regression, and GMM. Further, we delve into the institutional settings of the Chinese market and explore the role of state ownership on the nexus of comparability and stock liquidity. We document that comparability has an insignificant association with liquidity in SOEs. The objectives, as well as decisions of SOEs, are different from NEOs. The support of the state reduces its default risk and improves its suitability for investment. We also examine the effect of institutional ownership on the relationship between comparability and liquidity. Our findings suggest that institutional ownership strengthens the relationship between comparability and liquidity. The findings also indicate that the effect of comparability on stock liquidity is significant only in the non-crisis period. Additionally, the impact of comparability on stock liquidity is profound for firms with higher information opacity.

Abstract

     A widespread perception exists that tax havens facilitate corporate opacity. This study provides new evidence on the association between tax havens and the transparency of firm financial reporting using a unique group of firms whose parent companies are incorporated in tax havens but whose headquarters or primary operations—that is, their base—are in nonhaven countries. While most research suggests a negative association between tax havens and transparency, I examine whether this association depends on the firm’s corporate governance environment as well as its capital market incentives. I find that the negative association is limited to firms subject to weak governance in the base country. In contrast, I find, among firms in stronger governance environments, a positive association between tax haven incorporation and transparency, which is most concentrated among firms with greater capital market incentives. My findings suggest that future researchers should use caution when assuming an unambiguous negative association between tax havens and corporate transparency. The study also provides unique evidence that tax planning can motivate higher transparency in certain settings.

Introduction

     A widespread belief exists that firms’ use of tax havens facilitates corporate opacity. Tax havens have unique regulations that can weaken shareholders’ ability to discipline managers and directors and can provide opportunities for reduced reporting quality or disclosure for tax haven–incorporated companies (Kun 2004; Moon 2018), which may motivate their managers to be less transparent. Many observers, including researchers, policymakers, and the media, have expressed concerns that tax havens let managers misbehave and hide information from financial statement users (e.g., Desai 2005; Morgenthau 2012; Black et al. 2013; Durnev et al. 2016, 2017; Atwood and Lewellen 2019). For example, the U.S. Senate has argued that the unique laws of tax havens can be used to circumvent U.S. securities safeguards, including disclosure requirements (U.S. Senate Permanent Subcommittee on Investigations 2006). Many sources also suggest that tax haven–incorporated companies provide financial information that is unreliable or insufficient to portray a firm’s economic situation.

Conclusion

     I provide new evidence on the association between tax haven use and financial reporting transparency using a unique sample of “tax haven firms” with tax haven–incorporated parents that are based primarily in a nonhaven country. I examine whether the association between tax haven incorporation and transparency is conditional on the firm’s corporate governance environment and capital market incentives. My results indicate that the association between tax haven incorporation and transparency depends on the strength of governance in the base country (i.e., the nonhaven country of headquarters or primary operations), in conjunction with capital market incentives. While I find an overall negative association between tax haven incorporation and transparency in the full sample, I find that firms facing weak country-level governance in the base country drive the baseline negative association. In contrast, I find that capital market incentives motivate tax haven firms to provide highertransparency, compared to other multinationals, among firms based in strong governance countries and firms based in weak governance countries with less severe potential internal governance problems. My study provides evidence that low transparency associated with tax havens is not ubiquitous, and the findings suggest that future researchers should use caution when assuming an unambiguous negative association between tax havens and transparency.

Abstract

     The main aim and contribution of this study is to outline and demonstrate the usefulness of a machine learning approach to address prediction-based research problems in accounting research, and to contrast this approach with a more conventional explanation-based approach familiar to most accounting scholars. To illustrate the approach, the study applies machine learning to predict a firm’s industry sector using the firm’s publicly available financial statement data. The results show that an algorithm can predict an industry sector with just this data to a high degree of accuracy, especially if a non-linear classifier is used instead of a linear classifier. Additionally, the algorithms were able to carry out an industry-firm pairing exercise taken from introductory accounting text books and MBA cases, with predicted answers showing a high degree of accuracy in carrying out this exercise. The study shows how machine learning approaches and algorithms can be valuable to a range of accounting domains where prediction rather than explanation of the dependent variable is the main area of concern.

Introduction

     The main aim and contribution of this study is to outline and demonstrate the usefulness of a machine learning approach to address specific research problems in accounting research, and to contrast this approach with a more conventional explanation-based approach familiar to most accounting scholars. To illustrate the approach, the study sets out to predict a firm’s industry sector, as specified by the North American Industry Classification System (NAICS), using the firm’s publicly available financial statement data. The results show that an algorithm can predict an industry sector with just this data to a high degree of accuracy, especially if a non-linear classifier is used instead of a linear classifier.

     The main difference between a machine learning approach and a conventional approach is that a machine learning approach is prediction-orientated whereas the conventional approach is explanation-orientated. In other words, a machine learning approach focuses primarily on the out-of-sample prediction of the dependent variable rather than the explanation of the dependent variable within-sample (Bao, Ke, Li, Yu, & Zhang, 2020). Prediction is not necessarily the same as explanation (Shmueli, 2010), and the machine learning approach is of value to a range of applications where prediction of a dependent variable is the main, and perhaps only, concern. Such applications are common in business and economics research (Kleinberg, Ludwig, Mullainathan, Nber, & Obermeyer, 2015). The measurement of success in prediction-orientated approaches is out-of-sample prediction accuracy rather than within-sample significance levels (p-values), and the theoretical specification of the conceptual model is, to a degree, determined by the algorithm, rather than a priori by the researcher.

Results

     The median values of the features for the target NAICS codes are displayed in Table 3. These descriptives are of interest because they provide insight into the potential predictive value of the feature. For example, some features are zero or near-zero for most firms: A6 Investments, L3 Unearned Revenue, and E2: Preferred Stock. It is unlikely these features will provide much predictive value in separating out firms into industry sectors.

     Correlations between the features are not tabulated for brevity, but it is apparent that some features are, virtually by definition, strongly correlated. For example, L5 Total Long-term Debt and R12 Long Term Debt/Capital. Given their high correlation, these features could serve as potential candidates for exclusion in future analysis.

     atures could serve as potential candidates for exclusion in future analysis. It is common in accounting literature to measure the performance of classifiers using the Receiver Operating Curve (ROC) (see e.g. Jackson & Wood, 2013). However it is not possible to do this here because the ROC is confined to binary classifiers, and is not appropriate for multi-label classification. Instead, we follow the approach common in the machine learning literature (Geron, 2019), and work with confusion matrices, precision, recall, and the F1 score.

This paper examines the association between the presence of female tainted directors on corporate boards and audit committees and (1) financial reporting quality and (2) audit fees. Female tainted directors are defined as female directors who have been directors of the firms that have previously been involved in financial failures and integrity indiscretions. Using real earnings management and audit fees as proxies for effective governance and board reputation, we find that firms with female tainted directors have higher real earnings management and higher audit fees. However, since prior literature has demonstrated that audit fees are higher for firms with female directors because female directors demand better auditing, we corroborate a supply-side effect of auditors charging higher audit fees when female tainted directors exist. We demonstrate this by showing that while there is an association between audit fee and real earnings management, this association is higher for firms with female tainted directors. Arguably, the governance and reputational benefits of female directors on boards are negated if such directors have tarnished professional reputations.

Introduction

This paper deals with the impact of female tainted directors on corporate boards and audit committees on the financial reporting quality and audit fees of US-listed firms.2 Female representation on corporate boards has long been the subject of research and remains an important issue for academics, professionals and policy-makers. Many academic researchers have argued that men and women have different ethical orientations (Singh et al., 2002). Women are believed to have values and interests that make them more sensitive to unethical behaviour than men (Betz et al., 1989; Limerick and Field, 2003; Stedham et al., 2007). Accounting researchers have found that female directors have better oversight of managers (Adams and Ferreira, 2009) because they do not belong to the old-boy networks; this facilitates more independent thinking in decision making (Adams et al., 2010). Further, firms with female directors facilitate more informed discussion (Daily et al., 2000), which reduces information asymmetry and increases earnings quality (Srinidhi et al., 2011). While each of the abovementioned studies has its own merits, none of the previous gender diversity studies differentiate the ethical orientation of female directors. To ensure that we capture the ethical orientation of these directors, we draw our evidence from the actual professional history of each director, based on the definition stated above.

Capital controls as restrictions on capital flows are a tool proposed as a cure to the destabilizing market movements of the 1970s (i.e., Tobin, 1978) despite the criticism that they have received (Edwards, 1999). Capital controls resurfaced during the European Financial Crisis and the restrictions imposed on capital flows in Cyprus and Greece. These were the first instances of capital control implementation in the European Union’s history and had various effects on firms’ financial positions. By using a sample of EU countries and distinguishing between austerity and capital controls periods, we assess the effects of capital controls on the stock liquidity of firms. All of the sample countries have a common financial reporting framework (International Financial Reporting Standards -IFRS), and some of them implemented a range of different measures from less intensive, such as increases in tax rates, to more intensive, such as the enforcement of capital controls, in their effort to stabilize their economies. For the task at hand, we specifically engage two accounting determinants of information asymmetry, namely, conditional conservatism and the level of earnings management. Our results show that financial reporting quality as measured by higher conditional conservatism and lower earnings management is beneficial for liquidity. However, during the capital controls period, the relation between conditional conservatism and liquidity becomes negative, and this negative relation relates to less risky firms. Thus, the negative relation between conditional conservatism and liquidity is likely due to investors keeping more conservative firms in their portfolios as a measure against the crisis.

Introduction

The European Financial Crisis, which started as a debt crisis and continued as a generalized financial crisis, had a significantly more adverse impact on a number of South-European countries in relation to the rest of the Eurozone countries. The inability of these countries to borrow money through the markets due to escalating interest rates led to a number of measures that were targeted at limiting the negative effects of the crisis. These measures ranged from increases in tax rates or decreases in wages and pensions to restrictions of capital flows (Cyprus in 2013 and Greece in 2015). These circumstances were the first in which an extreme measure such as capital controls was used in the European Union, which certainly had an impact on the capital flows of the firms domiciled in the affected countries. The present study attempts to examine how such regulations on capital flows may help an economy to break free from the crisis downward spiral. To this extent, we emphasize the usefulness of financial reporting quality as a protecting mechanism against the crisis and underline the presence of the “flight to quality” phenomenon. Capital controls were devised as a measure of fiscal policy to limit market turbulence. For example, Tobin (1978) proposed the use of an international uniform tax on foreign exchange transactions (Edwards, 1999). These measures were particularly common until the 70s (Johnson and Mitton, 2003). However, due to the continuous effort by institutions such as the IMF for more liberalized emerging markets, the use of capital controls was reduced until the Asian Crisis (Bhagwati, 1998). Therefore, despite the controversy around the usefulness of capital controls (Edwards, 1999), there is a tendency of using these measures as a final solution during a financial crisis from a macroeconomic perspective (Krugman, 1998). For example, during the Asian Crisis, Malaysia used capital controls as a measure of reducing the effects of the crisis (Johnson and Mitton, 2003). Moreover, in the European Union, the financial crisis that affected the countries of the South and in particular, Cyprus and Greece, also led to the implementation of capital control measures to limit the drain of their banking systems.

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.

The question of what influences a firm’s financial reporting practice has been examined extensively in the accounting literature (Dechow, Ge, & Schrand, 2010). Prior studies approach this question by identifying factors at the market level (Leuz, Nanda, & Wysocki, 2003), the firm level (Klein, 2002; Lang, Raedy, & Wilson, 2006), and more recently the individual manager level (Ge, Matsumoto, & Zhang, 2011). However, the papers that study the influence of individuals on corporate financial reporting decisions focus on corporate executives, mostly CEOs and CFOs.1 This article investigates the impact on corporate financial reporting choices of a different group of individuals: audit committee members. Specifically, this article examines whether financial reporting decisions are affected by differences in individual characteristics among audit committee members that are generated from various factors such as personality, ethical beliefs, and personal experiences that are not directly observable. Audit committees of public firms play the role of ‘‘overseeing the accounting and financial reporting processes of the issuer and audits of the financial statements of the issuer.’’2 Such a role involves ‘‘reviewing and discussing with management, internal and outside auditors the annual audited financial statements . . . and quarterly financial statements’’ (Braiotta, 2004). Hence, the financial statements of a firm are the end product of a reporting process which involves both management and the audit committee. The audit committee sometimes makes substantial adjustments to the financial statements during this process, by resolving the dispute between outside auditors and management, gathering information from internal auditors, and/or overseeing management’s compliance with financial reporting standards and regulation (Caskey, Nagar, & Petacchi, 2010). Prior literature has identified various audit committee characteristics that are associated with financial reporting quality, such as independence (Klein, 2002), expertise (Be´dard, Chtourou, & Courteau, 2004), and busyness (Tanyi & Smith, 2014). A common feature of these studies is that they rely on observable characteristics of the audit committee: For example, the expertise of audit committee members is usually captured by their professional qualifications (e.g., Certified Public Accountant [CPA] or Certified Financial Analyst), and independence is measured by whether the member is a current or former employee, is a family member of an executive officer, or receives compensation from the firm other than for being a board member (Klein, 2002). These observable characteristics, while meaningful, may not capture the full picture of how audit committee members can influence their firms’ financial reporting. In particular, psychology studies find that an individual’s job performance and career outcomes are affected by numerous factors, such as personality traits (e.g., Hurtz & Donovan, 2000), self-perception (Judge, Erez, & Bono, 1998), ethical beliefs (H. Koh & Boo, 2001), and childhood experience (Blustein, Walbridge, Friedlander, & Palladino, 1991), to name but a few. These factors are often not directly observable but are likely to affect the effectiveness of monitoring by audit committee members, and thus in turn influence firms’ financial reporting practices. The goal of this study was to examine the overall effect of audit committee members on financial reporting that arise from these unobservable characteristics. Following prior literature, I label these characteristics as ‘‘styles’’ of audit committee members (Bertrand & Schoar, 2003).

1- Introduction

2- Literature review and hypothesis development

3- Data and research methodology

4- Results

5- Conclusion and discussion

References

Abstract

Concerns have been raised by regulators and investors about the increasingly complex financial reports that are becoming incomprehensible to ordinary investors. The readability literature attributes unreadable financial reports to the reporting firms’ operational complexity and/or the desire to obfuscate poor performance. At the same time, upper echelons theory from the management literature posits that top managers’ characteristics will impact the way the firm is managed, while business and social science research posits that individuals become more capable and ethical as they grow older. We expect older CEOs and executives to be more capable of explaining operating complexities and staying ethical in reporting, thus leading to more readable financial reports. Our results support this view.

Introduction

Financial reports are expected to convey information to outsiders who are not privy to inside information of the firm. Therefore, clarity of financial reports becomes important in order to ensure that the general investing public is able to understand the information in such reports and thus use them to make informed decisions about the firm. In fact, ‘understandability’ is one of the qualitative characteristics of financial reports highlighted in FASB’s conceptual framework for financial reporting (FASB, 2010). The readability of annual reports is an issue of concern for regulators and investors. Christopher Cox, the then chair of the SEC states that investors are turning away from reading annual reports due to increasing verbosity and jargon. More worryingly, he states that increased verbosity may be used to hide fraud (SEC, 2007). These sentiments are echoed by Warren Buffet as well (SEC, 2007). Confirming these concerns, research has shown that poor readability scores are associated with fraud (Blanco & Dhole, 2017), poor performance (Li, 2008), and earnings management (Lo, Ramos, & Rogo, 2017). Therefore, factors that improve the readability of financial reports would be of interest to regulators and investors. The upper echelons theory posits that the top management team (hereinafter the TMT) significantly impacts the strategy, direction, and operations of the firm (Hambrick & Mason, 1984). Wiersema and Bantel (1992) argue that TMT characteristics and demographics can predict the functioning of the TMT. This paper investigates the impact of executive age on the readability of annual financial reports. Humans mature as they grow older. This maturity will impact the business acumen, communication skills, and the ethical sensitivities of people. Research has shown that as people grow older and become more experienced, their decision-making skills improve (Huang, Rose-Green, & Lee, 2012; Li, Mayhew, & Kourtzi, 2009; Liden, Stilwell, & Ferris, 1996). Furthermore, older executives have better communication skills due to experience. Older individuals write better because they are more likely to activate both hemispheres of the brain in writing (Gray-Grant, 2013). Finally, research also shows older people exhibit greater ethical sensitivities compared to younger people (Borkowski & Ugras, 1998; Mudrack, 1989; Peterson, Rhoads, & Vaught, 2001; Sundaram & Yermack, 2007; Wimalasiri, 2001). These arguments have been used by Huang et al. (2012) to show that a firm’s earnings quality improves with CEO age