For the purpose of having accurate results they used discretionary accruals as an Inverse measure of earnings quality. The study was inducted on a large sample of firm observations from 46 countries for the years 1998-2007. This paper argues that earnings quality Is a Joint function of Investor protection and the quality of accounting standards. FIRS adoption improves earnings quality only if strong investor protection is present. However, increasing the degree of investor protection without adoption of FIRS does not improve financial reporting quality.
The authors also argue that despite having high quality accounting standards, lower investor protection causes managerial discretion within an organization that impedes production of high quality accounting numbers. The major strength of the paper is the importance of its research topic which is indisputable. High quality financial reporting is essential in helping investors to make informed decisions with regard to future investments in the company.
Moreover, this issue Is relevant for a large audience since FIRS is so widely used, in about 134 countries in the world. The chosen topic for research has the potential of offering new valuable insights to the already existing literature. Since, it is a debatable issue among academics whether FIRS adoption improves earnings quality or not. We will begin by presenting the strong points of the research paper. Firstly, the authors have succeeded at explaining the importance of the factors chosen for the study as drivers of earnings quality.
One, high quality accounting standards put pressure on management to engage in fewer earnings management and to deliver numbers that represent a true and fair view of the organization’s value and performance (Rewet and Wagoner, 2005). And two, strong investor protection portrays the accounting environment In which firms operate. Secondly, the authors presented a broad literature review from which they have extrapolated their hypotheses. In our opinion, the most value adding hypothesis Is the third one, because It Is a less studied aspect compared to the previous two.
The Idea of Investigating the Interaction of FIRS adoption and Investor protection on earnings quality derived from Tasked et al. ‘s paper (2008). They acknowledged this Idea as being” an Interesting avenue for future research”. Thirdly, House et al. Have also succeeded at taking into consideration the potential Limitations of the study, such as biased results because of uneven country representation, results driven by LOS use, o the existing literature by taking a new approach and examining the interaction between two important determinants of earnings quality it ended up reinforcing previous cross-country studies on this subject.
This indicates a lack of value adding and originality. In the next paragraphs we will elaborate in detail about several areas of concern we have identified in the paper. To begin with, the first two hypotheses that are tested have already been studied and showed to be true. There are a number of papers arguing that earnings quality is positively associated with FIRS adoption, as well as with investor protection. In 2003, Else et al. Found that less earnings management takes place in countries that have strong investor protection and legal enforcement, which also have developed equity markets and dispersed ownership structure.
A more recent study conducted by Birth et al. (2008) suggested that the countries which are more likely to recognize losses in an appropriate manner and less susceptible to practicing earnings smoothing are the ones that adopted FIRS. All in all, adopting high quality financial reporting standards is an obligatory condition for obtaining quality earnings without being a sufficient one, as throng investor protection is essential for achieving greater financial transparency patriarchate et al. (2003), Ball et al. (2003)). In their paper House et al. Mom to the same conclusions which do not represent a new perspective for existing literature. Next, whether FIRS adoption improves earnings quality or not is a debatable topic and there are research proving it, which House et al. Also did, but there are papers proving exactly the opposite as well. The authors have mentioned some of these contradictory studies, but have failed to follow up on them and build arguments against them. For example, Palpitation and Nobles (2006) argue that in Europe the introduction of FIRS did not inevitably increase earnings quality.
Moreover, in Germany and UK information asymmetry became more volatile. This means that the quality of financial reporting was not ameliorated, despite the fact that these two countries are considered to have a strong investor protection system. Another research has managed to show that in Sweden the quality of financial reporting also decreased after FIRS adoption (Penance, 2008). These three countries, Germany, I-J, and Sweden scored high on many of tested criteria in House et al. ‘s paper, such as throng board independence and minority protection, enforcement of accounting and auditing standards.
We believe the authors should have made an attempt at identify the reasons why FIRS did not improve financial reporting quality in these special cases, despite them having good-working institutions. To continue, from the point of new of research approach the paper also cannot be considered a valuable contribution. The authors assert that the existing international studies focus on developed economies and use a limited number of countries, while their research also includes emerging economies and uses more countries. A few examples that rove the contrary are Else et al. 2003) who used a sample of 31 countries and Francis & Wang (2008) who examined 42 countries both taking into consideration developed and emerging markets. Moreover, House et al. Have eliminated several countries from the sample to avoid biased results coming from uneven country representation decreasing their sample. Less related to the content itself, but still highly important is the structure of the paper which can be improved. It was hard to clear conclusions for each of them separately. In addition, they have made several good statements that have the potential of creating value and contributing to the existing literature.
For example, they have mention that the present international accounting setting (the adoption of FIRS) provides an opportunity to examine why there are differences in earnings quality and understanding the global impact of FIRS adoption. However, none of these statements made in the introduction have been developed. Overall, this study mostly reinforces the idea that accounting practices are influenced by a country’s institutions on which a body of research already was conducted. Various forces that drive earnings quality have already been studied from different perspectives and using distinct approaches.
The importance of ownership structure, capital market structure and development, tax system, legal system, economic development, investor protection shape accounting standards which in turn affect the quality financial reporting are already well documented (Burgomaster et al (2007), Ding et al (2007)). Therefore, we would suggest extending the research in a different direction that might represents a gap in academic literature starting with issues the authors mentioned themselves. In particular, to examine why there are differences in earnings quality across countries that adopted FIRS and understanding he global impact of FIRS adoption.