Intensity of product market competition, institutional environment and accrual quality

Abstract

Purpose This paper aims to investigate the joint effect of product market competition (PMC) and institutional environment on accrual quality. Design/methodology/approach The sample covers a large data set of 52,138 firm-year observations from 35 countries over the period of 2011-2015. Using the weighted least square regression, the study estimates PMC and institutional environment on accrual quality. The study measures PMC based on Herfindahl-Hirschman index, anti-director rights index (ADRI) based on the revised and updated La Porta et al.'s (1998) and accrual quality using the modified Dechow and Dichev (2002) model proposed by McNichols (2002). The study also uses a series of specification tests using alternative measures for each variable. Findings The study finds that highly intensified PMC relates to a lower quality of accruals. The results also show that accrual quality is better in countries with stronger institutional environment, specifically countries with higher ADRI, investor protection, judicial independence, protection of minority shareholders’ interests, protection of property rights, strength of the auditing and reporting standards, efficacy of corporate boards and corporate ethics. The findings suggest that institutional factors weaken the negative impact of PMC intensity on accrual quality, hence suggesting that institutional environment has a significant role to enhance accrual quality among firms in highly intensified industries. Practical implications The findings provide additional insights to policymakers and regulators on the importance of strong institutional and industry environment that can provide incentives and extra governance mechanisms besides the conventional firm-level corporate governance. Originality/value This study contributes in understanding the impact of intensity of PMC on accrual quality internationally and subsequently highlights the role of institutional environment as significant country-level governance in determining financial reporting quality, particularly accrual quality.