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8 October 2020 CFA Institute Journal Review

Integrated Reporting and Earnings Quality: The Moderating Effect of Agency Costs (Summary)

  1. Imrith Ramtohul, CFA

CFA Institute Journal Review summarizes "Integrated Reporting and Earnings Quality: The Moderating Effect of Agency Costs" by Victoria A. Obeng, Kamran Ahmed, and Seema Miglani, from the Pacific-Basin Finance Journal, April 2020.

Voluntary integrated reporting (IR, a non-accounting standard) has a positive impact on accounting information and the quality of reported earnings. Firms that use IR benefit from higher earnings quality compared with non-IR firms. Higher integration results in improved earnings quality. Managerial opportunism does not impact IR practice effectiveness. Also, firm complexity does not influence IR practice or earnings quality.

What Is the Investment Issue?

The authors look at the effects of voluntary integrated reporting (IR, which combines financial information with non-financial information) on earnings quality in order to explore whether IR practice encourages reporting of high-quality earnings.

How Did the Authors Conduct This Research?

The authors use three measurements to understand earnings quality: discretionary accruals, income smoothness, and earnings persistence. The IR score, an equal-weighted measure ranging from 0 (no integration) to 100 (the highest level of integration), quantifies four different aspects of a firm’s performance: economic, social, environmental, and governance. The authors use data from 2009 to 2015 for firms on the universal list of ASSET4. They identify IR firms using lists of IR adopters from the International Integrated Reporting Council and the Global Reporting Initiative. The authors remove from the analysis 116 IR firms from South Africa because the Johannesburg Stock Exchange requires its listed firms to prepare integrated reports. Another 47 IR firms are removed because of missing data, leaving 359 IR firms for the study. The ASSET4 database supplies IR score and corporate governance data. Worldscope provides accounting fundamental and stock market data, and World Bank data are used for information on investor protection.

IR practice allows for incremental improvement in accounting information quality. The authors find that whenever IR practice is undertaken to achieve greater integration, firm complexity does not influence its effectiveness.

What Are the Findings and Implications for Investors and Investment Professionals?

The authors document a higher level of earnings quality for firms using IR compared with non-IR firms. They find a positive relationship between voluntary adoption of IR practice and earnings quality. Although voluntarily adopting IR principles leads to better earnings quality in firms that have high agency costs, the balancing outcome of firm-level agency costs has less effect on voluntary IR practice and integration level. The authors find no evidence that managerial opportunism influences the effectiveness of IR practice for quality disclosure once greater integration is achieved. Furthermore, firm complexity appears not to materially affect the dynamic between IR practice and earnings quality.

Although voluntarily using IR principles is associated with better earnings quality for firms that have high agency costs, the authors find that the moderating effect of the latter has little effect on the relationship between voluntary IR practice and integration level. Moreover, they find that firm complexity does not change IR benefits when IR practice is followed to target greater integration.

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