Audit committee disclosure tone and earnings management

Abstract

PurposeThis paper examines the effect of audit committee (AC) reporting, measured by the tone of audit committee disclosures, in improving financial reporting quality as proxied by earnings management.Design/methodology/approachThe authors focus on the textual properties of AC reports, particularly the tone of AC disclosure, and their impact on financial reporting quality proxied using real and accruals-based earnings management. For additional analysis, the authors use a financial reporting index and matched sample. The analysis is based on a sample of UK FTSE 350 firms.FindingsThe analysis suggests that AC reports are not boilerplate but varied in language. The authors find AC reporting is negatively associated with both real and accruals-based earnings management. In our additional tests, the authors find a positive association between financial reporting quality index and reporting tone.Research limitations/implicationsOverall, this paper provides baseline evidence for future research and policy making and reveals that ACs reporting what they have done increases transparency and impacts on reporting quality.Practical implicationsOverall, this paper suggests that the tone of AC reports seems to convey information that affects the communication function of AC reporting and thereby helps to improve reporting quality.Originality/valueThough the importance of AC disclosures in improving reporting quality is well recognised in policy guidelines and governance recommendations, no study has employed computer-based textual analysis of AC reports and investigated the effect of AC disclosure tone and the role it can play in achieving higher reporting quality.