Since the seminal work of Basu (1997) on earnings conservatism, numerous cross-countries studies have been conducted to examine how institutional structure influences earnings conservatism. The following studies provide evidence that institutional structure, including the legal/judicial system, securities laws, and political economy, create incentives that influence the behaviour of corporate executives, investors, regulators and other market participants, which indirectly shape the properties of accounting numbers, in particular earnings conservatism.
Ball et al. (2000) examine earnings conservatism in code-law and common-law countries that include seven international GAAP regimes (Australia, Canada, United States, United Kingdom, France, Germany and Japan). The study documents substantial variation in asymmetric timeliness of earnings across regimes, where common-law countries exhibit higher earnings conservatism than
26
code-law countries. This result suggests legal and institutional environments have a significant influence on earnings conservatism in the countries examined. Ball et al. (2000) argue that enhanced common-law disclosure standards reduce the agency costs of monitoring managers, thus countering the advantage of closer shareholder-manager relationships in code-law countries. Another study by Giner and Rees (2001) examines earnings conservatism in three distinct legal traditions: French code (or civil) law, German code-law and English common law. The results show that earnings conservatism is stronger in the United Kingdom than in France or Germany. By concentrating on European countries, Giner and Rees (2001) minimise the impact of other social and economic differences and thereby isolate legal and accounting effects more clearly.
Extending the previous studies, Bushman and Piotroski (2006) examine the influence of legal and political institutions on earnings conservatism using a sample of firms from 38 countries from 1992 to 2001. They find that firms in countries with a high-quality judicial system recognise bad news in a more timely fashion than firms in countries with a low-quality judicial system. In addition, strong public enforcement of securities is positively associated with slowness in the recognition of good news, while private enforcement of securities law has no effect on conservatism. In terms of state involvement in the economy, evidence from common-law countries (civil-law countries) reveals that firms facing high state involvement in the economy report earnings aggressively (conservatively). This evidence suggests that managers adjust their financial reporting in response to legal and political institutions.
27
In the United States, Lobo and Zhou (2006) examine the effect of the introduction of the Sarbanes-Oxley Act (SOX) on earnings conservatism. Since SOX requires the CEO and CFO of all exchange-listed firms to certify the material accuracy and
thereby providing greater incentives to report earnings conservatively. Consistent with the prediction, Lobo and Zhou (2006) find an increase in earnings conservatism in financial reporting following SOX. In addition, post-SOX financial reports have lower discretionary accruals than those in the period preceding SOX.
Raonic, McLeay, and Asimakopoulos (2004) assess the impact of country-level disclosure regimes, legal enforcement, and the importance of equity markets on earnings conservatism of European firms. They find higher earnings conservatism for firms domiciled and listed in different markets, showing a varying level of earnings sensitivity to market news. This is partly due to the interaction between the different institutional factors that drive the demand for accounting earnings recognition. In short, the study concludes that regulatory enforcement is positively associated with the bias towards conservatism while equity market exposure appears to be positively associated with greater timeliness in earnings recognition.
Grambovas, Giner, and Christodoulou (2006) extend Ball et al. (2000) and Raonic et al. (2004) by providing further evidence on earnings conservatism from the United States and from European Union (EU) countries. They find earnings have become more conservative in the EU as well as the United States. However, there is little evidence on differences in earnings conservatism between the two regions.
28
From the results, they argue that the changes in this property of earnings in both regions are attributable to a common factor that affects firms in both locations and is not limited to the economic convergence process that happened in EU countries.
Numerous studies have documented evidence that accounting standards have a significant impact on earnings conservatism. Accounting standards play a critical role in corporate governance by informing investors and by making contracts more verifiable (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998). A study by Pope and Walker (1999), which assesses the differences between conservatism in the United States and the United Kingdom, finds differences in the timeliness of income recognition in the two regimes operating under separate sets of accounting standards. In the United Kingdom, the write-offs of large transitory losses through extraordinary items was tolerated before the introduction of FRS No. 3 in 1993; however, in the United States, those items would be classified as components of ordinary earnings. The results suggest that the incentives facing UK firms to classify bad news earnings components as extraordinary items were strong over the sample period. Barth, Landsman, and Lang (2008) examine whether the application of International Accounting Standards (IAS) in 21 countries is associated with higher accounting quality. They find that firms applying IAS have more timely loss recognition, less earnings management, and more value relevance of accounting information, than firms applying non-US domestic standards.
29