Differential reporting and earnings quality: is more better?

Abstract

PurposeWhen financial statements are public, the choice between alternative reporting regimes constitutes a signal that addresses external stakeholders. Generally, the choice of more complex regimes acts as a complement of firms' transparency. However, in the absence of audits, opportunistic behaviors could be incentivized. This study aims to test whether SMEs' choice between alternative accounting regimes is associated with earnings quality.Design/methodology/approachDrawing on the literature about accounting choices and earnings quality, this study investigates whether the same conclusions are confirmed for SMEs. Using a sample of 4,054 Italian companies and 12,114 observations, it compared four earnings quality proxies of a group of companies that opted for the “Full” rules and those of a subsample of the population of companies that applied the Simplified rules.FindingsThe results suggest that the signaling power of accounting rules' choice could lead to wrong conclusions for SMEs. Indeed, a positive relationship emerged (H1) between the choice of the “Full” rules and income smoothing behaviors, while the same choice appears to reduce the probability to disclose SPOS. Moreover, the results suggest that opportunistic behaviors are more frequent for firms that have settled in a “non-cooperative” social environment (H2).Research limitations/implicationsThis study could foster research on financial reporting quality in private firms.Practical implicationsComparing the quality of financial statements drawn up according to two alternative accounting regimes could provide useful suggestions for both users and regulators.Originality/valueThe results contribute to the limited literature on the implications of differential reporting. Finally, it enriches the literature about heterogeneity in accounting quality within private firms.