Abstract
This paper proposes a broad measure of the country-level intensity of the main monitoring activities that are likely to affect financial reporting quality. The overall indicator (FRC) is a composite indicator combining three components, which measure the intensity of three different financial reporting controls (FRCs) exercised through corporate governance, audit, and enforcement. The indicator design adds to country measures used in accounting research in several ways. First, it employs recent process-oriented data to capture the intensity of controls in a regulatory context that is characterized by increasing harmonization. Process data can be updated periodically, and thus is also suitable for longitudinal analyses. Additionally, the development of the FRC indicator applies standard techniques for constructing composite indicators without a priori assumptions and weights. The paper presents the values of the FRC indicator in 17 European countries, revealing a diversified mix of FRC intensity across Europe. Our analysis shows that the three domain-specific indicators, which can also be used separately, measure different aspects of the intensity of financial reporting controls rather than an overall country attribute. Consistency analyses also show that the FRC indicator is not capturing a latent construct of financial reporting quality present in other metrics, thus providing support for its innovative use in cross-country accounting research.
Similar content being viewed by others
Change history
08 January 2021
A Correction to this paper has been published: https://doi.org/10.1007/s10997-020-09556-4
Notes
This stream of studies also tried to overcome the limits of a ‘law-on-the-books’ approach by proposing an index based an international survey of law firms, which were asked to measure subjectively the degree of legal protection of minority shareholders with particular reference to private enforcement mechanisms (Djankov et al. 2008; used by Glaum et al. 2013).
For example, ESMA Guideline 5 deals with the selection criteria employed in the regular monitoring activity of the national enforcer, and establishes that “indications from the auditors of misstatements, whether in their reports or otherwise, will normally trigger a selection of the financial information in question for examination. Indications of misstatements provided by auditors or regulatory bodies as well as grounded complaints should be considered for enforcement examinations”.
On the contrary, Larcker et al. (2007) find that key dimensions of corporate governance have little relation to a sample of accounting restatements.
For more information, please see https://esg.csrhub.com.
References
Abbott, L. J., Parker, S., & Peters, G. F. (2004). Audit committee characteristics and restatements. Auditing, 23(1), 69–87.
Aguilera, R. V., Desender, K., Bednar, M. K., & Lee, J. H. (2015). Connecting the dots: Bringing external corporate governance into the corporate governance puzzle. The Academy of Management Annals, 9(1), 483–573.
Ahmed, A. S., Neel, M., & Wang, D. (2013). Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), 1344–1372.
Amable, B. (2003). The diversity of modern capitalism. New York: Oxford University Press.
Amiram, D., Bozanic, Z., Cox, J. D., Dupont, Q., Karpoff, J. M., & Sloan, R. (2018). Financial reporting fraud and other forms of misconduct: a multidisciplinary review of the literature. Review of Accounting Studies, 23(2), 732–783.
Anagnostopoulou, S. C. (2017). Accounting quality and loan pricing: The effect of cross-country differences in legal enforcement. The International Journal of Accounting, 52(2), 178–200.
Aobdia, D. (2019). Do practitioner assessments agree with academic proxies for audit quality? Evidence from PCAOB and internal inspections. Journal of Accounting and Economics, 67(1), 144–174.
Armstrong, C., Barth, M., Jagolinzer, A., & Riedl, E. (2010). Market reaction to the adoption of IFRS in Europe. The Accounting Review, 85, 31–61.
Ayres, I., & Braithwaite, J. (1992). Responsive regulation: Transcending the deregulation debate. New York: Oxford University Press.
Ball, R., Kothari, S. P., & Robin, A. (2000). The effect of International Institutional factors of properties of accounting earnings. Journal of Accounting and Economics, 29, 1–51.
Ball, R., Robin, A., & Wu, J. S. (2003). Incentives versus Standards: properties of accounting income in four East Asian countries. Journal of Accounting and Economics, 36, 235–270.
Beasley, M. S. (1996). An empirical analysis of the relation between the board of director composition and financial statement fraud. The Accounting Review, 71, 443–465.
Beasley, M. S., Carcello, J. V., Hermanson, D. R., & Lapides, P. D. (2000). Fraudulent financial reporting: Consideration of industry traits and corporate governance mechanisms. Accounting Horizons, 14(4), 441–454.
Beasley, M.S., Carcello, J., Hermanson, D., & Neal, T. (2010), Fraudulent Financial Reporting: 1998-2007-An Analysis of US Public Companies. Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Beekes, W., Brown, P., Zhan, W., & Zhang, Q. (2016). Corporate governance, companies’ disclosure practices and market transparency: A cross country study. Journal of Business Finance & Accounting, 43(3–4), 263–297.
Bonetti, P., Magnan, M. L., & Parbonetti, A. (2016). The influence of country- and firm-level governance on financial reporting quality: Revisiting the evidence. Journal of Business Finance & Accounting, 43(9–10), 1059–1094.
Brown, P., Beekes, W., & Verhoeven, P. (2011). Corporate governance, accounting and finance: A review. Accounting and Finance, 51, 96–172.
Brown, P., Preiato, J., & Tarca, A. (2014). Measuring country differences in enforcement of accounting standards: An audit and enforcement proxy. Journal of Business Finance & Accounting, 41(1–2), 1–52.
Brüggemann, R., & Patil, G. (2011). Ranking and prioritization for multi-indicator systems. New York (NY): Springer Verlag.
Burgstahler, D. C., Luzi, H., & Leuz, C. (2006). The importance of reporting incentives: Earnings management in European Private and Public Firms. The Accounting Review, 81(5), 983–1016.
Byard, D., Li, Y., & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial analysts’ information environment. Journal of Accounting Research., 49(1), 69–96.
Cai, L., Rahman, A. R., & Courtenay, S. M. (2008). The effect of IFRS and its enforcement on earnings management: An international comparison. Available at SSRN: http://ssrn.com/abstract=1473571.
Callao, S., Cimini, R., & Jarne, J. I. (2016). Value relevance of accounting figures in presence of earnings management. Are enforcement and ownership diffusion really enough? Journal of Business Economics and Management, 17(6), 1286–1299.
Carcello, J. V., Hermanson, D. R., & Ye, Z. S. (2011). Corporate governance research in accounting and auditing: insights, practice implications, and future research directions. Auditing: A Journal of Practice & Theory, 30(3), 1–31.
Carcello, J. V., & Nagy, A. L. (2004). Audit firm tenure and fraudulent financial reporting. Auditing: A Journal of Practice & Theory, 23(2), 55–69.
Cascino, S., & Gassen, J. (2014). What drives the comparability effect of mandatory IFRS adoption? Review of Accounting Studies, 20(1), 242–282.
Charitou, A., Karamanou, I., & Kopita, A. (2018). Are analyst stock recommendation revisions more informative in the post-IFRS period? Journal of Business Finance & Accounting, 45(1–2), 115–139.
Christensen, H. B., Hail, L., & Leuz, C. (2013). Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics, 56, 147–177.
Coffee, J. C., Jr. (2007). Law and the market: The impact of enforcement. u. Pa. L. Rev., 156, 229.
Committee of European Securities Regulators (CESR) (2007). CESR’s review of the implementation and enforcement of IFRS in the EU. Available at: http://www.esma.europa.eu/system/files/07_352.pdf.
Committee of European Securities Regulators (CESR). (2009). CESR Reassesses Application of Standard No 1 on Financial Information in Europe. Paris, France: CESR.
Coram, P., Ferguson, C., & Moroney, R. (2008). Internal audit, alternative internal audit structures and the level of misappropriation of assets fraud. Accounting & Finance, 48(4), 543–559.
Courtis, N. (2006). How countries supervise their banks, insurers and securities markets. London: Central Banking Publications Ltd.
Dal Maso, L., Kanagaretnam, K., Lobo, G. J., & Terzani, S. (2018). The influence of accounting enforcement on earnings quality of banks: Implications of bank regulation and the global financial crisis. Journal of Accounting and Public Policy, 37(5), 402–419.
Daske, H., Hail, L., Leuz, C., & Verdi, R. (2008). Mandatory IFRS reporting around the world: Early evidence on the economic consequences. Journal of Accounting Research, 46(5), 1085–1142.
Davis, L. R., Soo, B. S., & Trompeter, G. M. (2009). Auditor tenure and the ability to meet or beat earnings forecasts. Contemporary Accounting Research, 26(2), 517–548.
Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation: an analysis of firms subject to enforcement action by the SEC. Contemporary Accounting Research, 13, 1–36.
Demmer, M., Pronobis, P., & Yohn, T. L. (2015). Financial statement-based forecasts and analyst forecasts of profitability: The effect of mandatory IFRS adoption. Available at: http://ssrn.com/abstract=2544566.
Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2008). The law and economics of self-dealing. Journal of Financial Economics, 88(3), 430–465.
Ege, M. S. (2015). Does internal audit function quality deter management misconduct? The Accounting Review, 90(2), 495–527.
ESMA (2014). ESMA Guidelines on enforcement of financial information. October. Available at http://www.esma.europa.eu/system/files/2014-esma-1293en.pdf.
ESMA (2015). Report. ESMA report on enforcement and regulatory activities of accounting enforcers in 2014. Available at: https://www.esma.europa.eu/document/esma-report-enforcement-and-regulatory-activities-accounting-enforcers-in-2015.
ESMA (2017). Peer review on guidelines on enforcement of financial information. Peer Review Report. Available at: https://www.esma.europa.eu/sites/default/files/library/esma42-111-4138_peer_review_report.pdf.
ESMA (2019a). Report. Enforcement and Regulatory Activities of European Accounting Enforcers in 2018. Available at: https://www.esma.europa.eu/document/enforcement-and-regulatory-activities-european-accounting-enforcers-in-2018.
ESMA (2019b). Guidelines on the enforcement of financial information (ESMA/2014/1293). Available at: https://www.esma.europa.eu/sites/default/files/library/esma_32-67-142_compliance_table_guidelines_on_the_enforcement_of_financial_information.pdf.
European Commission (2000). Communication from the Commission to the Council and the European Parliament EU. Available at: https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A52000DC0359.
Fédération des Experts Comptables Européens (FEE) (2001). Enforcement mechanisms in Europe. A Preliminary Investigation of Oversight Systems, April.
Florou, A., & Pope, P. F. (2012). Mandatory IFRS adoption and institutional investment decisions. The Accounting Review, 87(6), 1993–2025.
Francis, J. R., Michas, P. N., & Seavey, S. E. (2013). Does audit market concentration harm the quality of audited earnings? Evidence from audit markets in 42 countries. Contemporary Accounting Research, 30(1), 325–355.
Gao, R., & Sidhu, B. K. (2018). The impact of mandatory international financial reporting standards adoption on investment efficiency: Standards, enforcement, and reporting incentives. Abacus, 54(3), 277–318.
Geiger, M. A., Lennox, C. S., & North, D. S. (2008). The hiring of accounting and finance officers from audit firms: How did the market react? Review of Accounting Studies, 13(1), 55–86.
Glaum, M., Landsman, W. R., & Wyrwa, S. (2018). Goodwill impairment: The effects of public enforcement and monitoring by institutional investors. The Accounting Review, 93(6), 149–180.
Glaum, M., Schmidt, P., Street, D. L., & Vogel, S. (2013). Compliance with IFRS 3- and IAS 36-required disclosures across 17 European countries: company and country-level determinants. Accounting and Business Research, 43(3), 163–204.
Glaum, M., & Street, D. L. (2003). Compliance with the disclosure requirements of Germany’s New Market: IAS versus US GAAP. Journal of International Financial Management and Accounting, 14(1), 64–100.
Holthausen, R. W. (2009). Accounting standards, financial reporting outcomes, and enforcement. Journal of Accounting Research, 47, 447–458.
Hope, O. K. (2003). Disclosure practices, enforcement of accounting standards, and analysts’ forecast accuracy: An international study. Journal of Accounting Research, 41(2), 235–272.
Horakova, M. (2011). How countries supervise their banks, insurers and securities markets. London: Financial Publishing Limited.
Humphrey, C., Loft, A., & Woods, M. (2009). The global audit profession and the international financial architecture: Understanding regulatory relationships at a time of financial crisis. Accounting, Organizations and Society, 34(6), 810–825.
International Federation of Accountants (IFAC) (2011). Member Body Compliance Program. Available at: http://www.ifac.org/ComplianceAssessment/published.php.
International Finance Corporation (IFC) - World Bank Group (2015). A Guide to Corporate Governance Practices in the European Union. Available at: https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/ifc+cg/resources/guidelines_reviews+and+case+studies/a+guide+to+corporate+governance+practices+in+the+european+union.
Isidro, H., Nanda, D., & Wysocki, P.D. (2016). Financial reporting differences around the world: What Matters? Available at SSRN: https://ssrn.com/abstract=2788741.
Jackson, H. (2007). Variation in the intensity of financial regulation: Preliminary evidence and potential implications. Yale Journal on Regulation, 24, 253–291.
Jackson, H., & Roe, M. (2009). Public and private enforcement of securities laws: resource-based evidence. Journal of Financial Economics, 93(2), 207–238.
Kaufmann, D. (2007), Governance matters VI: aggregate and individual governance indicators, 1996-2006 (Vol. 4280). World Bank Publications.
Kaufmann, D., Kraay, A., & Mastruzzi, M. (2009). Governance matters VIII: Governance indicators for 1996–2008. Washington, D.C.: World Bank Policy Research.
Kaufmann, D., Kraay, A., & Mastruzzi, M. (2011). The worldwide governance indicators: Methodology and analytical issues. Hague Journal on the Rule of Law, 3(2), 220–246.
Kinney, W. R, Jr., Palmrose, Z. V., & Scholz, S. (2004). Auditor independence, non-audit services, and restatements: Was the US government right? Journal of Accounting Research, 42(3), 561–588.
Klein, A. (2002). Audit committee, board of director characteristics, and earnings management. Journal of Accounting and Economics, 33(3), 375–400.
Knechel, W. R., Krishnan, G. V., Pevzner, M., Shefchik, L. B., & Velury, U. K. (2013). Audit quality: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 32(1), 385–421.
La Porta, R., Lopez-De-Silanes, F., & Shleifer, A. (2006). What works in securities laws. Journal of Finance, 61(1), 1–36.
Leuz, C. (2018). Evidence-based policymaking: Promise, challenges and opportunities for accounting and financial markets research. Accounting and Business Research, 48(5), 582–608.
La Porta, R., Lopez-De-Silanes, F., Shleifer, A., & Vishny, R. W. (1997). Legal determinants of external finance. The Journal of Finance, 52(3), 1131–1150.
La Porta, R., Lopez-De-Silanes, F., Shleifer, A., & Vishny, R. W. (1998). Law and finance. Journal of Political Economy, 106(6), 1113–1155.
Landsman, W. R., Maydew, E. L., & Thornock, J. R. (2012). The information content of annual earnings announcements and mandatory adoption of IFRS. Journal of Accounting and Economics, 53, 34–54.
Larcker, D. F., Richardson, S. A., & Tuna, I. (2007). Corporate governance, accounting outcomes, and organizational performance. The Accounting Review, 82(4), 963–1008.
Lennox, C. S., & Pittman, J. A. (2010). Big five audits and accounting fraud. Contemporary Accounting Research, 27(1), 209–247.
Leuz, C. (2010). Different approaches to corporate reporting regulation: How jurisdictions differ and why. Accounting and Business Research, 40(3), 229–256.
Leuz, C., Nanda, D., & Wysocki, P. (2003). Earnings management and investor protection: An international comparison. Journal of Financial Economics, 69(3), 505–527.
Li, S. (2010). Does mandatory adoption of international financial reporting standards in the european union reduce the cost of equity capital? The Accounting Review, 85(2), 607–636.
Lobo, G. J., & Zhao, Y. (2013). Relation between audit effort and financial report misstatements: Evidence from quarterly and annual restatements. The Accounting Review, 88(4), 1385–1412.
Naiker, V., & Sharma, D. S. (2009). Former audit partners on the audit committee and internal control deficiencies. The Accounting Review, 84(2), 559–587.
Organisation for Economic Co-Operation and Development (OECD) (2005). Handbook on Constructing Composite Indicators. Methodology and User Guide. Available at: https://www.oecd.org/sdd/42495745.pdf.
Pope, P. F., & McLeay, S. J. (2011). The European IFRS experiment: Objectives, research challenges and some early evidence. Accounting and Business Research, 41(3), 233–266.
Pownall, G., & Wieczynska, M. (2018). Deviations from the mandatory adoption of IFRS in the European Union: Implementation, enforcement, incentives, and compliance. Contemporary Accounting Research, 35(2), 1029–1066.
Prather-Kinsey, J., & Meek, G. K. (2004). The effect of revised IAS 14 on segment reporting by IAS companies. European Accounting Review, 13(2), 213–234.
Preiato, J., Brown, P., & Tarca, A. (2015). A comparison of between-country measures of legal setting and enforcement of accounting standards. Journal of Business Finance & Accounting, 42(1–2), 1–50.
Quagli, A., Avallone, F., Ramassa, P., & Motta, L. (2018). Measuring the effectiveness of National Enforcers in the IFRS Context: A proactive approach. International Business Research, 11(6), 151–164.
Quagli, A., & Ramassa, P. (2017). L’enforcement dell’informativa contabile [Financial reporting enforcement]. Turin: Giappichelli Editore.
Reichelt, K. J., & Wang, D. (2010). National and office-specific measures of auditor industry expertise and effects on audit quality. Journal of Accounting Research, 48(3), 647–686.
Romanus, R. N., Maher, J. J., & Fleming, D. M. (2008). Auditor industry specialization, auditor changes, and accounting restatements. Accounting Horizons, 22(4), 389–413.
Singleton-Green, B. (2015). The effects of mandatory IFRS adoption in the EU: A review of empirical research. Information for Better Markets, London: ICAEW.
Street, D. L., & Gray, S. J. (2002). Factors influencing the extent of corporate compliance with International Accounting Standards: Summary of a research monograph. Journal of International Accounting, Auditing and Taxation, 11(1), 51–76.
UNCTAD (2017). Monitoring of Compliance and Enforcement for High-quality Corporate Reporting: Guidance on Good Practices. United Nations Publication.
Verriest, A., Gaeremynck, A., & Thornton, D. B. (2013). The impact of corporate governance on IFRS adoption choices. European Accounting Review, 22(1), 39–77.
Viarengo, L., Gatti, S., & Prencipe, A. (2018). Enforcement quality and the use of earnouts in M&A transactions: International evidence. Journal of Business Finance & Accounting, 45, 437–481.
Wingate, M. (1997). An examination of the cultural influence on audit environment. Research in Accounting Regulation, 11, 129–148.
Zhao, Y., & Chen, K. H. (2008). Staggered boards and earnings management. The Accounting Review, 83(5), 1347–1381.
Acknowledgements
We would like to acknowledge and gratefully thank the guest editors and the reviewers for their helpful comments. Our particular thanks for valuable comments received from Ann Tarca, Luzi Hail, Stuart McLeay, Véronique Blum, Alfred Wagenhofer and other conference participants.
Author information
Authors and Affiliations
Corresponding author
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
The original online version of this article was revised: In the original publication of the article the following text and tables were published incorrectly.
Rights and permissions
About this article
Cite this article
Quagli, A., Lagazio, C. & Ramassa, P. From enforcement to financial reporting controls (FRCs): a country-level composite indicator. J Manag Gov 25, 397–427 (2021). https://doi.org/10.1007/s10997-020-09518-w
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10997-020-09518-w