Academic journal article The American Journal of Economics and Sociology

Earnings Management and Cultural Values

Academic journal article The American Journal of Economics and Sociology

Earnings Management and Cultural Values

Article excerpt

Introduction

Aspects of national culture have been related to many areas of economics and management, such as foreign investment decisions (Tahir and Larimo 2004), international trade (Lewer and Van den Berg 2007), and economic growth (pryor 2005). Moreover, theorists, policymakers, and practitioners share the intuition that corporate governance reflects national culture (Bebchuk and Roe 1999). In this context, Shleifer (2002) argues that the practice of justice and the structure of society, rather than the law itself, are what matter for investor protection, and that laws are just a reflection of a broader societal stance. Pryor (2007) argues that when economic institutions are not imposed by force, the cultural characteristics are more likely to determine the economic system, rather than economic institutions. Licht et al. (2005) demonstrate that corporate governance laws relate systematically to the prevailing culture, and argue that in the long term, formal institutions should be consistent with the informal cultural environment. In addition, they emphasize that the comparative analysis of corporate governance laws cannot rely solely on the formal legal dimensions, but that the combination of both the cultural and the legal dimensions can yield insights obscured by using one approach alone. The combined approach thus militates against assessing legal regimes in isolation from their cultural environment.

The recent financial and economic crisis, together with the high profile corporate collapses in 2003-2004, have led to a debate concerning the quality of reported earnings and financial reporting, and raised the question of how to improve the financial and economical stability worldwide. Both the quantity and the quality of financial reporting constitute necessary conditions for development of market discipline by investors. Leuz and Wysocki (2008) survey the theoretical and empirical literature on the economic consequences of financial reporting and disclosure regulation, and argue that while there is a broad literature on the possible effects of disclosure, most of this literature is concentrated in the quantity rather than the quality of financial reporting that is made public. This analysis, which considers earning management measures, can contribute to a better understanding of the cultural dimensions driving managers' distortionary actions on the information they provide. The level of these actions affects the quality of the financial information that is disclosed, for any level of disclosure, and consequently affects the ability to develop an effective market discipline. Leuz et al. (2003) were the first to look at the relationship between investor protection and earnings management, and conclude that earnings management declines with investor protection. The objective of this study is to understand the relationship between culture, formal institutions, and strategic managerial actions. Specifically, this study explains the cross-country differences in the level of earnings management, using both dimensions of cultural and legal investor protection. Furthermore, this study adds to the current debate on financial stability by showing that policy measures to reduce earnings management are not "one-size-fits-all," but depend on the country's cultural context.

This study also contributes to the debate in the international corporate governance on whether countries should develop hard laws, such as the U.S. with the Sarbanes-Oydey Act 2002, or whether soft regulation, such as codes of good governance, are sufficiently effective to improve the existing corporate governance practices across countries, as well as to address the pressing issues of corporate accountability and disclosure. Much of the policy prescriptions, however, enshrined in codes of good corporate governance, rely on universal notions of "best practice," which often need to be adapted to the local contexts of firms, or translated across diverse national institutional settings (Aguilera and Cuervo-Cazurra 2004). …

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