Institutional Factors and Earnings Management in the Asia-Pacific: Is IFRS Adoption Making a Difference?

VerfasserWijayana, Singgih

1 Introduction

We examine the significance of institutional factors influencing earnings management behaviour in the Asia-Pacific region, with specific reference to 17 key countries/jurisdictions, that is, Australia, Chile, China, Hong Kong (China), Indonesia, India, Japan, Korea Republic, Malaysia, New Zealand, Pakistan, Peru, Philippines, Russia, Singapore, Thailand, and Chinese Taipei. While International Financial Reporting Standards (IFRS) have been widely implemented in Europe, there has been a much slower and less widespread process of adoption in the Asia-Pacific. Hence, our interest is in explaining the effects of IFRS adoption and the key influential factors operating in the region over time. Our research is conducted in the context of the ongoing convergence of national accounting standards (NAS) towards IFRS. IFRS are claimed to be high quality accounting standards (IFRS-Foundation 2018). Under IFRS principles-based accounting standards, many allowable accounting alternatives have been removed and accounting measurements that better reflect a firm's economic position and performance are now required (Barth et al. 2008). Accordingly, their use is expected to restrict earnings management behaviour and promote high-quality financial reporting. The purpose of our paper is to assess the extent to which IFRS adoption has made a difference in this respect and to examine whether cultural values and the degree of accounting standards enforcement remain significant and persistent institutional factors explaining international differences in earnings management behaviour.

Earnings management is likely to vary across major countries in the Asia-Pacific for a number of reasons. First, countries in the Asia-Pacific exhibit a wide diversity of institutional settings (Guan et al. 2005) and quality of corporate governance (ACGA 2018). This diversity is likely to influence earnings management practice (e.g., Garcia-Meca and Sanchez-Ballesta 2009; Leuz et al. 2003) and, therefore, the convergence of accounting standards and the quality of financial reporting accordingly.

Second, the extent of IFRS adoption differs widely among countries in the Asia-Pacific and thus likely affects earnings management differently. For example, the use of IFRS as issued by the IASB is still not permitted in some countries, such as Indonesia, India, and Thailand (Deloitte 2018; IFRS 2018), despite many countries' leaders having emphasised the implementation of IFRS as a desirable set of global accounting standards. Given that a number of studies have documented that financial information under IFRS is of better quality than under NAS (Barth et al. 2008; Byard et al. 2011; Landsman et al. 2012), we expect the earnings management of firms in the Asia-Pacific to vary across countries according to the status of IFRS adoption over time. Firms in countries that mandatorily require IFRS, or are more highly converged with IFRS, are thus expected to have a lower degree of earnings management relative to those that do not permit the use of IFRS or have a lower degree of convergence with IFRS.

Our research also examines whether national culture explains variations in earnings management in the Asia-Pacific region. To date, the studies of earnings management under IFRS have focused largely on accounting standards and other formal institutional factors that likely affect the quality of financial information (e.g., Ball et al. 2000, 2003; Byard et al. 2011; Houqe et al. 2012, 2014; Landsman et al. 2012; Sun et al. 2011) or on regions other than the Asia-Pacific (e.g., Gray et al. 2015; Houqe et al. 2016). Extending these prior studies, our research examines whether informal institutional factors, such as culturally derived accounting values, significantly affect the earnings management behaviour of listed firms in the Asia-Pacific region. Given that prior studies have documented the relationship between cultural values and earnings management (e.g., Braun and Rodriguez 2008; Desender et al. 2011; Guan et al. 2005; Han et al. 2010), we expect that the variation in earnings management behaviour across the Asia-Pacific can be explained to some extent by cultural values. In addition, the Asia-Pacific countries appear to have a high variation in their degrees of accounting standards enforcement (Brown et al. 2014) and a much slower and less widespread process of IFRS adoption. Accordingly, we expect that the variability of earnings management in the Asia-Pacific countries can also be explained to some extent by the degree of accounting standards enforcement.

To investigate whether earnings management varies with the extent of IFRS adoption, we calculate firms' accrual earnings management behaviour and collect firm level data about IFRS adoption during the period 2001-2016 for 17 major countries/jurisdictions across the Asia-Pacific. The year 2001 represents the base level of accounting standards convergence. The year 2016 represents a more current level of achievement toward the convergence of accounting standards after more than a decade of activity. Multivariate analyses are employed to investigate whether IFRS adoption, cultural values, and the degree of accounting standards enforcement explain variations in the earnings management behaviour of firms across the Asia-Pacific countries as would be expected.

The empirical results of our study make an important contribution to the question as to whether IFRS convergence and adoption is making an impact relative to ongoing cultural influences and the degree of accounting standards enforcement in the Asia-Pacific countries. After more than a decade of the global convergence process taking place, the impact of IFRS adoption is to restrict earnings management behavior. This is consistent with our expectations. Further, the empirical results demonstrate the influence of cultural values and the degree of accounting standards enforcement on international differences in earnings management.

Our study contributes to the policy debate among standard setters concerning the effectiveness of the convergence process towards IFRS. Convergence is a very important issue for Asia-Pacific countries as they must trade-off the potential of an economic integrated market against national autonomy (Apergis and Cooray 2014). Literature that has investigated the impact of IFRS and institutional factors on earnings management in the context of the Asia-Pacific region is very limited. We contribute to this literature by updating the measures used in the culturally derived accounting value of conservatism (Gray 1988). By including the more recent Hofstede culture dimensions of long-term orientation and indulgence in our definition of conservatism, we introduce an updated measure that represents conservatism more effectively than those used in previous studies (e.g., Hope et al. 2008; Salter et al. 2013). In particular, long-term orientation is incorporated because this dimension was set based on recognition of its relevance to Asia (Hofstede and Bond 1988). While the Hofstede dimensions have been criticised by some for their use in cultural studies (Baskerville 2003), they have been widely used and accepted, especially in respect of Asia, in the international business literature (Beugelsdijk et al. 2017; Ronen and Shenkar 2013).

The rest of our paper is organised as follows. In Sect. 2, we present the literature review and hypotheses development. Section 3 demonstrates how the data, sample, and research methodology will be used to investigate the hypotheses. Section 4 presents the empirical results. In Sect. 5, we present a summary and conclusions, including limitations of the study and suggestions for future research.

2 Literature Review and Hypotheses Development

2.1 Global Convergence of Accounting Standards in the Asia-Pacific

The global convergence of accounting standards has reduced the multiplicity of national accounting standards. Prior studies have documented that IFRS restricts earnings management, improves accounting earnings quality, and is useful for investors in making their investment decisions (Barth et al. 2008; Houqe et al. 2012; Landsman et al. 2012). Financial information under IFRS is affected by institutional factors (e.g., Ball et al. 2000) and reporting incentives (e.g., Byard et al. 2011; Christensen et al. 2015). In addition, IFRS is claimed to offer a single set of high quality accounting standards (e.g., Gordon et al. 2008; IFRS-Foundation 2018; SEC 2007). Therefore, their use in the market is expected to not only facilitate comparability, but also provide high quality financial reporting to investors. Theoretically, the higher the quality of financial information the lower the information risk, and hence the lower the cost of equity capital (Easley and O'Hara 2004). Thus, high quality IFRS financial statements encourage capital flows across nations, increase capital market efficiency, and reduce the cost of capital (e.g., Daske et al. 2008; Hail and Leuz 2006).

Given that IFRS is claimed to be high quality, a number of studies have examined earnings management behaviour and the quality of financial reporting under IFRS (Barth 2008; Barth et al. 2008; Houqe et al. 2014; Soderstrom and Sun 2007). The quality of financial reporting under IFRS appears to be higher than that under NAS (Barth et al. 2008; Houqe et al. 2012; Landsman et al. 2012), as indicated by less earnings management, timelier loss recognition, and greater value relevance of earnings (Barth et al. 2008). The underlying argument is that high quality IFRS accounting standards are characterised by fewer alternative accounting choices and higher quality accounting measurements. Consequently, IFRS is expected to help managers to more effectively report earnings persistence, to make fewer errors such as in bad debt provisions, and to make higher quality accrual estimations.

As part of ensuring a better quality of financial...

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