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Earnings management and participation in accounting standard-setting

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Abstract

Recent economic and political science research suggests that the way public policy is set, and in particular the participation of those affected by it, impacts upon the outcome of the policy. Accounting standard setting has long offered such a possibility to participate via the due process approach followed by major standard setters. We review the literature on areas close to financial reporting and find arguments for why the possibility to participate in standard setting may have a positive effect on diminishing distortion of financial reporting. We also discuss reasons why such a compliance effect may be less pronounced in financial reporting. We conclude that the existence of this effect is an open question and conduct a lab experiment to examine whether the possibility to participate in accounting standard setting leads to reduced earnings management. Our results indicate that this is not the case. We interpret this result in light of recent evidence that enforcement and incentives are better predictors of accounting quality than financial reporting standards.

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Notes

  1. While beyond the scope of this study, it is worth noting that the lack of user participation is a matter of some concern to standard setters (Beresford 1993). Constituent participation is seen as essential to ensure the legitimacy of the standard setting process (Johnson and Solomons 1984; Schmidt 2002; Wallace 1990). Durocher et al. (2004) use semi-structured interviews with users to obtain knowledge about their perceptions of the Canadian standard-setting process. Among other reasons, they mention a lack of knowledge about procedures as an impediment to participation. In an extension of this research, Durocher et al. (2007) develop a model based on legitimacy, valence, instrumentality and expectancy to explain user participation. They suggest that the standard setters could use their model to increase user participation.

  2. We thank an anonymous referee for pointing this out.

  3. An example for such a claim would be receivables from goods and services.

  4. If this assumption is not fulfilled, there is no treatment which could detect an effect of the design of the standard setting process.

  5. The transferability to a professional context of research results gained by using students as experimental subjects has been discussed in the literature. A number of recent articles argue that student subjects are an attractive and cost-effective option, yielding results which in the majority of cases do not differ from those obtainable from experiments using professional subjects. Fréchette (2011) for example conducts a survey of studies which compare student and professional subject pools, finding that experiments using these yield the same conclusions in 69 % of the studies he surveys (where he finds differences, students are closer to theoretical predictions in 75 % of all cases). Druckman and Kam (2011) make a strong logical and statistical argument for why generalizing from political science experiments using student subject pools is in most cases unproblematic. Finally, Gächter (2010) argues for the use of student subject pools unless the research objective is specifically to compare different subject pools.

  6. Note that the pairwise correlation between dummy variables for a subject preferring the prudence principle and majoring in accounting is 0.064, \(p \hbox { value}=0.421\).

  7. In treatments CV and nCnV, the subject can report values from the set {0, 1, ..., 7}, such that a report of e.g. 5 would be converted to \(5/7 = 71.4\) %. In treatments CVD and nCnVD, subjects can report values from the set {4, 5, ..., 10}, such that a report of 5 would be converted to \((5-4)/(10-4) = 16.7\) %.

  8. See questions 5, 6, 9b and 9d in online Appendix A.2 for a translation of the questions originally posed to our subjects.

  9. Even if this result held more generally for subjects with greater accounting expertise, it would only constitute further evidence against our hypothesis of a positive effect from participation in accounting standard setting on compliance.

  10. In particular, we used a specification with the regressors shown in Table 3 plus variables containing subject demographic data, one with only CV, D, Ethical Concerns and PayoffMaximization, and one with only CV and D. We also ran probit and logit regressions with a binary variable equal to 1 if subjects misreported at any level and 0 otherwise.

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Acknowledgments

Our thanks for the funding of this research project go to the Austrian Financial Reporting and Auditing Committee. We furthermore thank audiences at the 7th EIASM Workshop on Corporate Governance 2010 and at a research seminar of the Thurgau Institute of Economics 2011 for valuable comments.

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  1. Department of Accounting, Vrije Universiteit Amsterdam, Amsterdam, The Netherlands

    Roland Königsgruber

  2. Institute of Banking and Finance, University of Innsbruck, Innsbruck, Austria

    Stefan Palan

  3. Institute of Banking and Finance, Karl-Franzens-University Graz, Graz, Austria

    Stefan Palan

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Königsgruber, R., Palan, S. Earnings management and participation in accounting standard-setting. Cent Eur J Oper Res 23, 31–52 (2015). https://doi.org/10.1007/s10100-013-0326-3

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