Do wealthy economies have better accounting quality? International evidence

• Author: Jochen Zimmermann,Erekle Pirveli
• Date: 01 April 2019
• Published date: 01 April 2019
• DOI: http://doi.org/10.1002/jcaf.22382

EDITORIAL REVIEW

Do wealthy economies have better accounting quality?

International evidence

Erekle Pirveli

1

| Jochen Zimmermann

2

1

Business School, Caucasus University,

Tbilisi, Georgia

2

Faculty of Business Administration,

University of Bremen, Bremen, Germany

Correspondence

Erekle Pirveli, Business School, Caucasus

University, Saakadze Str. 1, Tbilisi 0102,

Georgia.

Email: epirveli@cu.edu.ge

Funding information

Shota Rustaveli National Science

Foundation, Grant/Award Number:

YS15_2.5.2_7; DAAD-Rustaveli Joint

Research Program, Grant/Award Number:

57410711; Fulbright's Visiting Scholar

Program, Grant/Award Number: 68160299

Abstract

Purpose: The purpose of this article is to empirically test whether wealthy econo-

mies have better accounting quality (AQ) compared to their “poor”counterparts.

Design/methodology/approach: To test the formulated hypothesis, this article

examines accounting and market data of 40 countries' capital markets, obtained

from Compustat Global and Compustat North America, and spanned throughout

the last quarter of century, from 1992 to 2016. Country wealth and controlling- and

valuation-usefulness of accounting information are proxied by gross domestic

product per capita, conditional accounting conservatism and value relevance of

earnings and book values, respectively.

Findings: Descriptive analysis, consistent with the prior literature, reveals that

controlling-usefulness and valuation-usefulness of accounting information signifi-

cantly negatively correlate with each other, putting them as alternative (rather than

compatible) objectives of the accounting system. The major finding shows that

wealthy economies report significantly more controlling-useful but about equally

valuation-useful accounting information compared to their poor counterparts.

Practical implications: The findings are interesting from investors as well as stan-

dard setters' perspective.

Originality/value: According to Ball (Journal of International Accounting

Research (2016), 15(2), 1–6), wealthy economies are likely to invest more in the

establishment and development of a country-level reporting infrastructure such as

accounting, financial, legal and political systems, which should ultimately lead to

better AQ. This article argues that wealthy economies are likely to report more

controlling-useful, but not necessarily more valuation-useful accounting informa-

tion compared to the poor ones. This argument is based on the fact that on the one

hand decision makers within the wealthy economies' capital markets are likely to

intensively utilize various alternative sources of information, implying a lower

demand on accounting information as a source of valuation decisions. On the other

hand, demand for controlling-useful accounting information would exist even

while utilizing other (external) sources of information as the inside (managerial)

information helps the management to efficiently control and plan the firm

activities.

Received: 19 March 2019 Accepted: 21 March 2019

DOI: 10.1002/jcaf.22382

92 © 2019 Wiley Periodicals, Inc. wileyonlinelibrary.com/journal/jcaf J Corp Acct Fin. 2019;30:92–110.

KEYWORDS

accounting conservatism, accounting quality, country wealth, country-level determinants of financial

reporting, earnings quality, financial reporting infrastructure, value relevance of earnings and book

values

1|INTRODUCTION

Accounting quality (AQ) shows the extent to which account-

ing system accomplishes its objective—to help users of

accounting information in decision-making (FAS Board,

1978, 2010). AQ embodies the principle that financial state-

ments should be as helpful as possible to investors and other

capital providers in making their resource allocation deci-

sions. Starting from 1970s, AQ has been intensively studied

in the light of time-series as well as cross-sectional analysis.

1

Recently, globalization and the technological progress have

both stimulated a considerable rise in the volume of interna-

tional studies on AQ (Ball, 2016; Kothari, 2001). Interna-

tional research on AQ is of utmost importance as it helps us

to learn the effects of country-level determinants on the

international reporting practices (Ball, 2016; Ball et al.,

2000). Shortly to summarize international literature in the

field, AQ is expected to be higher in countries with interna-

tionally accepted accounting rules and sundry accounting

professions, strong financial intermediaries, and efficient

legal and political systems.

2

First, accounting information is

expected to be of less use under accounting regimes which

heavily allow corporate managers for the personal judgments

(Barth et al., 2008; Levitt, 1998). Second, strong financial

systems, reflected into powerful financial intermediaries

such as the banks and the stock markets, lead to scrutinized

assessment of accounting reports and therefore to a strong

demand on accounting information (Ball, 2001; Teoh et al.,

1998). This puts the insiders under a concomitantly higher

pressure to diligently prepare their accounting reports. Third,

operating environments where investors and shareholders

feel highly protected due to investor-friendly legal rights and

efficient enforcement mechanisms, attracts outsiders, condi-

tions markets' development, and therefore lead to better AQ

(Leuz et al., 2003; Watts & Zimmerman, 1986). Finally,

highly corrupted operating environments, in the attempt to

attain preferential treatments from authorities, incentivize

corporate managers to manage earnings for their own bene-

fits (Dechow et al., 2010; Soderstrom & Sun, 2007).

While revealing country-level determinants of AQ, prior

literature

3

has almost solely focused on country-group com-

parisons (e.g., capital market- vs. debt-based economies;

common-law vs. code-law legal origin countries; jurisdic-

tions following the locally dictated accounting rules vs. the

ones following the internationally recognized standards).

The distinguished country-level determinants of AQ

(accounting, financial, legal and political systems) have been

able to detect and explain the cross-country differences in

AQ across country-groups, but failed to do so in a pooled

sample. As group differences could be driven by one

(or several) strong player(s) within the group, comparisons

across country clusters do not allow us to reveal a hol-

istic/precise picture on the drivers of international AQ.

Ball (2016) argued that country wealth can explain the

cross-country differences in AQ at a country level. His argu-

ment is based on the fact that wealthy economies would be

characterized with better reporting infrastructures such as

accounting, financial, legal and political systems which

should ultimately condition high quality accounting num-

bers. Inconsistent to him, this article argues that while asso-

ciating country wealth and AQ, it is essential to segregate

between the two different sets of informational environments

such as controlling-usefulness and valuation-usefulness of

accounting numbers. This call for the distinction between

the two different sets of informational environments is ratio-

nalized by the agency theory as well as by the fact that AQ

constitutes an allusive concept and the various measure-

ments of it weakly or even negatively correlate with each

other. As next, it is argued that wealthy economies are likely

to report more controlling-useful but not necessarily more

valuation-useful accounting information. This prediction is

based on the following logic. The diversity and intensity of

the use of alternative sources of information (analyst fore-

casts, technical/algorithm-based analysis, press releases and

conference calls) is likely to be higher within the wealthy

economies. In these economies, the competition is fierce and

investors attempt to base their investment decisions on all

possible sources of information, not solely looking to often

times “delayed”financial statements. If country wealth

would indicate on a more intensive utilization of other

sources of information at the local capital markets, it would

imply a lower demand on accounting information as a

source of valuation decisions. On contrary, demand for a

controlling-useful accounting information would exist even

while utilizing other (external) sources of information as the

inside (managerial) information helps the management to

efficiently control and plan the firm activities and

maintain/increase its competitiveness. Overall, a higher

demand on a controlling-useful, but not necessarily on a

valuation-useful accounting information is hypothesized

within the wealthy economies.

PIRVELI AND ZIMMERMANN 93