Does national ethical judgement matter for earnings management?

Abstract

Purpose This study aims to analyse the association between country-level ethical judgement and earnings management and the role that firm-level enforcement and the quality of accounting standards play in this association. Design/methodology/approach The analyses are based on a sample of 45,889 firm-year observations from 34 countries between 1998 and 2018. Based on the World Values Survey questionnaire, this study constructs a comprehensive index of the ethical judgement of each country. Findings The empirical findings suggest that firms from countries where ethically suspect behaviours are less acceptable are associated with lower levels of accruals-based earnings management and that firm-level enforcement and the quality of accounting standards dampen such association. Practical implications The results contribute to the debate about ethical issues in the accounting profession in an international context, adding to the sustainable development debate given that the creation of long-term value for firms is intrinsically related to business ethics and good quality financial reporting. Social implications When it is known that countries’ ethically-related judgements reduce the level of earnings management, actions can be taken by regulators and other stakeholders to build fairer societies with a more sustainable view, given that the quality of the financial reporting is inextricably linked to how income and wealth are distributed. Originality/value While previous literature documents that ethical judgement at both the individual and organizational levels matter as key determinants of the way managers are involved with unethical accounting practices, this study investigates the role of ethical judgement at the country level in explaining earnings management.