财务报告质量与稳健会计：法律与政治制度的影响

Financial Reporting Incentives for Conservative Accounting:The Influence of Legal and Political InstitutionsRobert M. Bushman*Kenan-Flagler Business SchoolUniversity of North Carolina at Chapel HillChapel Hill, North Carolina 27599phone: (919) 962-9809 fax: (919) 962-4727email: bushman@Joseph D. PiotroskiGraduate School of BusinessUniversity of Chicago1101 E. 58th StreetChicago, Illinois 60637-1561phone: (773) 834-4199 fax: (773) 702-0458email: fjpiotro@This Draft: September 2004* Corresponding author. We appreciate the useful comments of two anonymous referees, Ross Watts (the editor) and seminar participants at the University of Chicago, University of California Davis, Hong Kong University of Science and Technology, Stanford University, University of Texas at Austin, and University of Technology Sydney. We thank the Kenan-Flagler Business School, University of North Carolina at Chapel Hill and the Graduate School of Business of the University of Chicago for financial support.Financial Reporting Incentives for Conservative Accounting:The Influence of Legal and Political InstitutionsAbstractWe exploit cross-country variation in institutions and observed accounting conservatism to investigate financial reporting incentives for conservative accounting created by a country’s legal/judicial system, securities laws, political economy, and tax regime, and provide evidence on channels through which specific institutions manifest their influence on observed conservatism. We find that firms in countries with high quality judicial systems reflect bad news in reported earnings faster than firms in countries with low quality judicial systems, after controlling for legal origin. In countries with high judicial quality and high usage of public bonds or more diffuse ownership structures, conservatism is higher. Also, strong public enforcement aspects of securities law discourage “optimism” by slowing recognition of good news in earnings relative to firms in countries with weak public enforcement aspects. In contrast, private enforcement aspects of securities law have no impact on conservatism. Another key finding is that firms in countries with common law legal origin and political economies characterized by high risk of expropriation of assets by the state and high state ownership of enterprises speed the recognition of good news and slow the recognition of bad news in earnings relative to firms in countries with less political involvement in the economy. This result is reversed in countries with civil law legal origin and high risk of expropriation of assets by the state and high state ownership of enterprises.IntroductionIn this paper, we explore how reported accounting numbers are shaped by the institutional structure of the country in which firms are domiciled. We seek deeper understanding into the nature of financial reporting incentives created by an economy’s institutional structure. We focus on financial reporting incentives related to accounting conservatism.1 To this end, we empirically analyze relations between key characteristics of economy-level institutions and observed accounting conservatism, and provide evidence on channels through which specific institutions manifest their influence on observed conservatism. Channels investigated include the use of accounting numbers in designing debt and compensation contracts, in supporting securities-related litigation, in motivating the behavior of public-sector regulators, and in mediating the relations between politicians and private sector business firms.The underlying premise of our analysis is that a country’s legal/judicial system, securities laws, political economy, and tax regime create incentives that influence the behavior of corporate executives, investors, regulators and other market participants. Such incentives shape the properties of reported accounting numbers through a complex interplay of accounting standards, legal, market, regulatory, and political pressures, and reporting discretion exercised by managers. Thus, a complete understanding of the realized properties of accounting numbers, including conservatism, must incorporate the influence of financial reporting incentives generated by existing institutions.The persistent influence of conservatism on accounting practice suggests that conservatism confers benefits to economic agents who use, prepare or regulate financial reports. For example, Basu (1997) notes that conservatism has influenced accounting practice for at leastfive hundred years, and Sterling (1970, p. 256) stresses the highly influential impact of conservatism on the principles of valuation in accounting. To investigate the sources of these economic costs and benefits, we extend earlier cross-country research (e.g., Ball, Kothari and Robin (2000) and Ball, Robin and Wu (2003)) examining the association between country-level institutions and conservative accounting practices. Following Holthausen (2003), we take a more quantitative approach towards classifying the countries used in these comparisons. Our data allows us to exploit cross-country variation in institutions and observed accounting conservatism to directly examine the influence of a range of institutions on conservatism, including thelegal/judicial system, securities laws, political economy, and tax regime.With respect to countries’ legal/judicial systems, we find that investor protections embodied in corporate law and the efficiency and impartiality of the judicial system play a significant role in creating incentives for timely loss recognition. Firms in countries with strong investor protections and high quality judicial systems reflect bad news in reported earnings numbers in a more timely fashion than firms in countries characterized by weak investor protections and low quality judicial systems.Further, we specifically examine the role of securities law in influencing conservatism, disaggregating securities law into two distinct dimensions: public enforcement and private enforcement aspects.2 In doing so, we find that firms in countries with strong public enforcement characterized by an independent, powerful, public enforcer appear to curb “optimism” by slowing the recognition of good news in reported earnings numbers relative to firms in countries with a weak public enforcement. This result is consistent with the hypothesis put forth in Watts1 Accounting conservatism is commonly conceptualized as an asymmetric degree of verification required to recognize good news as gains relative to that required for recognizing bad news as losses (e.g., Basu (1997), Ball, Kothari and Robin (2000) Watts (2003a)).2 We discuss these two aspects in detail in section 2 of the paper.(2003a) that self-interested regulators are penalized more for overstated accounting numbers than understated numbers. In contrast, private enforcement aspects of securities law as embodied in disclosure requirements and burden of proof requirements of the liability regime have no impact on conservative financial reporting.A novel feature of the paper is our analysis of the influence of political economy on incentives for conservative reporting. We find that in countries characterized by high state involvement in the economy firms speed recognition of good news and slow recognition of bad news in reported earnings relative to firms in countries with less state involvement.3 This is consistent with a scenario where a “benevolent” government intervenes in poorly performing firms, and firms seek to avoid such interference by exploiting reporting discretion to portray an optimistic outlook. It is also consistent with publicly traded firms with partial state ownership being pressured by the state to optimistically tilt their reporting decisions.In further analysis, we address whether the implications of political involvement in the economy differs fundamentally in countries with weak investor protections relative to those with strong investor protections. We document that in common law countries (with presumably stronger investor protections), high state involvement leads firms to speed recognition of good news and slow recognition of bad news relative to firms in countries with less state involvement. In contrast, in civil law countries (with presumably weaker investor protections), high state involvement leads firms to slow recognition of good news and speed recognition of bad news relative to firms in countries with less state involvement. Thus, managers appear to adjust their financial reporting in response to the nature of the State’s involvement.3 We measure the extent of state involvement using measures of the risk of expropriation of assets by the state and high state ownership of enterprises.Finally, we find mixed results with respect to the influence of tax regimes on conservatism.Our emphasis on institutional incentives for conservatism both complements and extends the arguments of Watts (2003a,b). Watts (2003a) explicates four distinct channels that may influence equilibrium levels of conservatism: 1) contracting; 2) shareholder litigation; 3) regulation; and 4) taxation. Our primary research design cannot directly test the validity of these individual explanations, because it is not possible to construct a one-to-one mapping from institutional influences to explanations. For example, a specific institution can impact conservatism through contracting, litigation or regulatory channels, through all three at once, through two out of three, et cetera. Thus, while we will relate institutional influences to the contracting, litigation, regulatory and tax explanations, our institutional-level tests do not claim to be directly testing these alternating theories.Building on Watts’ explanations and our primary institution-level findings, we extend our institutional analysis to investigate several channels through which specific institutions could manifest their influence on observed conservatism. The main contributions of this analysis are to provide more direct evidence on the individual explanations for conservatism and to illustrate that the relative impact of a given channel on the equilibrium level of observed conservatism is a function of the institutional structure of the country. In other words, the presence of certain institutional structures creates an environment conducive to activities that will generate a demand for conservative reports. For example, the prevalence of explicit contracts that use accounting information in an economy (such as compensation or private debt contracts) is dependent on the existence of a legal/judicial regime that facilitates the efficient enforcement of contracts written on verifiable information signals. If the use of accounting information for contracting purposes isa channel that creates demand for conservative reports, then conservatism should be greater in countries with both a strong legal/judicial regime and a high prevalence of contract use.We find support for the hypothesis that in countries with high quality judicial systems, contracting is an important channel through which the level of conservatism is influenced. Specifically, we find that conservatism is higher in countries with both high quality judicial regimes and high relative usage of private bonds, and in countries with both high quality judicial regimes and more diffuse ownership structures. In contrast, absent a high quality judicial regime, this relation between the prevalence of contracting activities and conservatism does not exist, suggesting that contract usage alone, without a means of enforcing accounting-based contracts, is insufficient to generate a demand for conservative accounting reports.Our paper extends and complements a vibrant literature using cross-country data to investigate relations between conservatism and institutions. Raonic, McLeay and Asimakopoulos (2004) examine the impact of country-level disclosure regimes, legal enforcement and importance of equity markets on conservatism. They focus on set of European firms with equity traded on multiple exchanges, and provide limited evidence that bad news earnings sensitivity increases in legal enforcement, and good news earnings sensitivity decreases in disclosure. Lang, Raedy and Yetman (2003) document that loss recognition increases upon U.S. cross-listing, while Huijgen and Lubberink (2003) find that U.K. firms choosing to cross-list in the U.S. display more timely loss recognition. Both results are consistent with the incentives arising from the U.S.’s stronger legal and regulatory institutions. Finally, Ball and Shivakumar (2004) examine reporting practices of public versus private U.K. companies, and Buijink, Coppens and Peek (2004) examine reporting practices of public versus private firms across EU countries.Our paper is closely related to Ball, Kothari and Robin (2000) and Ball, Robin and Wu (2003) (see also Pope and Walker (1999)). Ball, Kothari and Robin (2000) investigate how differences in the demand for accounting income in different institutional contexts causes its properties to vary across a wide range of countries. Ball, Robin and Wu (2003) focus their analysis on four East Asian economies. In these papers, the authors offer a rich, qualitative discussion of how the institutional framework of a country can impact the extent of accounting conservatism realized in firms’ public financial reports. However, empirically, the only institutional characteristic directly incorporated into the formal analysis in these studies is whether the country has a common law or civil law legal origin.4 We find that after controlling for legal origin, conservatism is significantly related to a variety of other country-level institutions.Finally, our paper relates to prior research into cross-country determinants of financial reporting activities. Prior research includes papers on cross-country variation in the value-relevance of earnings (e.g., Alford, Jones, Leftwich and Zmijewski (1993), Ali and Hwang (2001), Fan and Wong (2003), Francis, Khurana, Pereria (2003), Geunther and Young (2000), Land and Lang (2002)), corporate transparency (Bushman, Piotroski and Smith (2004a)), earnings management (Burgstahler, Hail and Leuz (2004), Leuz, Nanda and Wysocki (2003), Bhattacharya, Daouk and Welker (2003)), disclosure regulation and enforcement (Frost (1999)), and disclosure intensity (Jaggi and Low (2000), Francis, Khurana, Pereria (2003)).The rest of the paper is organized as follows. Section 2 describes the conceptual framework of the paper, including a discussion of alternative explanations for conservatism, our4 While legal origin has been shown to be an important determinant of cross-country differences in financial development (see e.g., La Porta, Lopez-de-Silanes, Shleifer and Vishny (1997, 1998), Demirguc-Kunt and Maksimovic, (1998), and Beck, Demirgüç-Kunt and Levine (2002, 2003)), it is also the case that institutions can vary dramatically across countries with a similar legal origin.empirical institutional measures, and the conceptual justification for including them. Section 3 describes our data and research design and section 4 presents our empirical results. Section 5 discusses empirical extensions and robustness tests. Section 6 summarizes the paper. We note that descriptions of all empirical variables and their sources is included in Appendix 1 of the paper.2 Conceptual Framework: Institutional influences on conservative reportingWe maintain that observed conservatism is an equilibrium outcome resulting from the maximizing decisions of market participants subject to constraints.5 In this section, we delineate the underlying structure of accounting conservatism, discuss how country-level institutional constraints can create financial reporting incentives that influence the equilibrium level of observed conservatism, conjecture specific channels (e.g., Watts (2003a)) through which these institutionally motivated reporting incentives impact accounting conservatism, and present the precise measures we use in the empirical analysis.2.1 Underlying structure of accounting conservatismBefore discussing institution-driven reporting incentives, let us carefully delineate the underlying structure of accounting conservatism. Conservatism is often conceptualized as an asymmetric degree of verification required to recognize good news as gains relative to that required for recognizing bad news as losses (e.g., Basu (1997), Ball, Kothari and Robin (2000), 5 It is important to observe at the outset that we do not directly address the question of what level of conservatism is consistent with high quality accounting reports or with maximizing economic efficiency within an economy. In fact, while it is plausible that observed financial reporting evolves in relation to the constraints and opportunities generated by a country’s institutional framework, the resulting equilibrium financial reporting regime may reflect self-interested incentives of politicians or regulators (see Holthausen (2003) for a useful discussion of this issue). We discuss this further below in the context of our results and the extant literature on the institutional determinants of financial market development.Watts (2003a)). The idea of relative verification intensity embedded in this definition allows for accounting to be made more conservative by increasing the speed of bad news recognition holding the speed of good news recognition constant, decreasing the speed of good news recognition while holding the speed of bad news constant, or slowing the speed of good news recognition and simultaneously increasing the speed of bad news recognition. In all three cases, the degree of asymmetry between good news and bad news recognition has widened in a way that makes the speed of bad news recognition faster relative to good news recognition.This is not just a thought experiment, but an important component of research designs investigating variation in accounting conservatism across institutional regimes. For example, Ball, Kothari and Robin (2000) document that good news recognition is faster and bad news recognition is slower in code law relative to common law countries. In our paper, we document cases where institutional incentives lead to an impact on the speed of good news recognition alone, on the speed of bad news recognition alone, or on the speed of both good and bad news recognition simultaneously.6This distinction between slowing the recognition of good news versus speeding the recognition of bad news is intriguing. Unfortunately, we are unable to identify a convincing theory that explains the economic forces underlying this distinction or provides predictions concerning where and when particular mechanisms of generating conservative reports would be individually used. At this point, we continue to view these mechanisms as being different sides of the same conservatism coin.As an illustration, consider debt contracts. Shareholders have limited liability, which creates an incentive for shareholders to pay dividends and leave the debt-holders holding onlythe corporate shell. One means of reducing this conflict (and related costs) is for shareholders to contract to maintain a minimum verifiable lower bound level of investment in the company through the use of covenants that link dividends to accounting earnings. Because earnings’ role is to adjust the lower bound verifiable estimate of investment, accounting applies a lower verifiability requirement for losses and than for gains. In the extreme case of accounting for the liquidation of a company, where the role of accounting is to ensure that a company’s assets are distributed according to priority, interim distributions are made after anticipating all losses and not anticipating any gains.7 In this case, there are benefits to both anticipating all losses and not anticipating any gains. Focusing on the debt contract itself, lenders would be concerned with restricting over-optimism in reporting gains as well as encouraging timely loss recognition, because holding bad news recognition speed constant, more timely gain recognition would create slack in their covenants.Given that there appears to be benefits associated with both the deferral of gains and the acceleration of losses, observed differences in accounting practices could arise from asymmetry in the costs (or benefits) of slowing good news recognition relative to speeding recognition of bad news. It is likely that asymmetries in these costs are a function of the overall institutional framework of a country, where some institutional configurations lower the cost of utilizing one mechanism relative to the other. However, absent a robust theoretical framework, we make no predictions regarding the expected impact of a given institutions on the use of these different mechanisms for generating conservative accounting reports.6 For example, we document that firms in countries with strong public enforcement of securities laws recognize good news more slowly and bad news more quickly and that firms in countries with higher political involvement in the economy recognize good news relatively faster and bad news relatively slower (see Table 6).7 We thank Ross Watts for providing us with this discussion of the contracting role for conservatism.The remainder of this section is organized around our four institutional groupings:legal/judicial regimes, securities law, political economy, and tax regimes. All institutional variables and their sources are detailed in Appendix 1.2.2 Legal / Judicial RegimeA country’s legal / judicial institutions can influence incentives to produce conservative accounting numbers through several channels. First, theorists have long recognized the importance of verifiable information in optimal contract design. Models of principal-agent relationships generally assume the pre-existence of a court system that costlessly enforces contracts written on verifiable information variables (e.g., Holmstrom (1979)). Financial accounting systems, by emphasizing verifiable outcomes, supply a rich set of contractible variables. To the extent that the legal/judicial regime is conducive to the use of enforceable contracts as an efficient mechanism, there will likely be stronger demand for verifiable accounting measures by contracting parties in strong legal/ judicial regimes.Thus, to the extent that stronger legal/ judicial regimes lead to a more prominent role for the use of accounting numbers in formal contracts, firms in countries with stronger legal/ judicial regimes may respond to a higher “contracting” demand for conservative reporting. As noted in our discussion about debt contracting in section 2.1, a contracting explanation for conservatism can be premised on the limited liability of one of the contracting parties. An analogous argument applies to compensation contracts. In this case the limited liability party is the manager. His liability is limited by his wealth that is accessible to the company and its shareholders. Shareholders have a very difficult time extracting fraudulent overpayments to managers and damages for actions by managers. This generates a demand for deferral of compensationpayments until there is verifiable evidence of the result of the manager’s actions. The deferred compensation is the manager’s bond just like the net assets are the shareholders’ bond. This can generate a contracting demand for a verifiable measure that allows for distributions of the deferred compensation to managers once there is a verifiable lower bound evidence of the results of the manager’s actions. Conservative earnings provide a lower bound estimate of the effect of the manager’s actions just as they provide a lower bound estimate of net assets for debt contracting.8 Thus, we expect to observe more conservatism in countries where a high quality legal/judicial system supports a contracting demand for verifiable information variables.Second, high quality judicial systems could increase the expected gains from litigation initiated to remedy violations of investors’ rights. If accounting conservatism is driven by litigation pressure, and strong legal/ judicial systems increase the potential litigation costs to firms from overstating economic performance, we would again expect more conservative reporting practices in strong legal/judicial regimes.We explore the relation between conservatism and two institutional dimensions of a country’s legal / judicial regime: investor protections embodied in corporate law and the impartiality of the judicial system. Prior evidence suggests that legal protection of outside investors’ rights under corporate law and enforcement of those rights vary around the world. (See LaPorta et al. (1998)). We expect outside investors’ demand for verifiable financial8 We again thank Ross Watts for providing us with this argument. In addition, we thank an anonymous referee for raising the issue of whether managers are significantly compensated on stock prices in the U.S. (and elsewhere in the world) because contract designers understand the conservative nature of accounting and do not want compensation schemes to be so asymmetric. This conjecture implies that conservatism is generated by something other than a compensation contracting demand, and that in fact contracts based on accounting are driven away by conservatism. While we have been unable to find a cross-country database that would allow us to directly test this conjecture, we do document (in Table 7) that firms in countries with stronger legal/judicial regimes and more diffuse ownership structures use more conservative financial reporting. To the extent that more diffuse ownership is correlated with a higher use of compensation contracts based on earnings, this result is consistent with a compensation contracting demand for more conservatism.information and their ability to engage in successful litigation to increase with the protection of their rights. Prior evidence documents that common law countries generally have stronger legal protection of outside investors than do civil law countries (See LaPorta, Lopez-de-Silanes, Shleifer and Vishny (1998)).9 Following this literature, we proxy for the extent of investor protections under law with a dummy variable, CIVILLAW, which takes on a value of one for French, German or Scandinavian legal origin, and zero for common law legal origin. This common law versus code law distinction is the main empirical proxy for cross-country institutional differences used in Ball, Kothari, and Robin (2000). In our empirical analysis, we control for CIVILLAW, and investigate the extent to which other institutional features of a country influence conservatism over and above legal origin.The arguments above also suggest that the contracting demand for verifiable information variables and the incentives derived from litigation concerns will be higher in regimes with high quality judicial systems. We measure the quality of the judicial system with the variable JUDIMP, a measure of judicial impartiality. This measure attempts to capture whether a trusted legal framework exists for private businesses to challenge the legality of government actions or regulation. Country-year observations are classified as possessing a judicial system with high impartiality if the country’s most recent (i.e., nearest available) rating is greater than or equal to the median rating for that year in our sample. Ratings are available for calendar years 1995, 2000 and 2001, as reported in the Economic Freedom of the World’s 2002 annual report.Finally, while our primary emphasis is on the financial reporting incentives created by country-level institutions, we also employ an interaction analysis to provide evidence on9 The economics literature offers at least two reasons why common law countries provide stronger protection of outside investors’ rights (e.g., Beck, Demirgüç-Kunt and Levine (2002)). First, legal traditions differ in the priority given to the rights of individuals vis-à-vis the state. Under this theory, the decentralized nature of English common law evolved to generally protect property rights of individuals. Second, legal traditions may differ in their ability to。