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Journal of Management and Governance

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05-07-2020

From enforcement to financial reporting controls (FRCs): a country-level composite indicator

Authors: Alberto Quagli, Corrado Lagazio, Paola Ramassa

Published in: Journal of Management and Governance | Issue 2/2021

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Abstract

This paper proposes a broad measure of the country-level intensity of the main monitoring activities that are likely to affect financial reporting quality. The overall indicator (FRC) is a composite indicator combining three components, which measure the intensity of three different financial reporting controls (FRCs) exercised through corporate governance, audit, and enforcement. The indicator design adds to country measures used in accounting research in several ways. First, it employs recent process-oriented data to capture the intensity of controls in a regulatory context that is characterized by increasing harmonization. Process data can be updated periodically, and thus is also suitable for longitudinal analyses. Additionally, the development of the FRC indicator applies standard techniques for constructing composite indicators without a priori assumptions and weights. The paper presents the values of the FRC indicator in 17 European countries, revealing a diversified mix of FRC intensity across Europe. Our analysis shows that the three domain-specific indicators, which can also be used separately, measure different aspects of the intensity of financial reporting controls rather than an overall country attribute. Consistency analyses also show that the FRC indicator is not capturing a latent construct of financial reporting quality present in other metrics, thus providing support for its innovative use in cross-country accounting research.

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This stream of studies also tried to overcome the limits of a ‘law-on-the-books’ approach by proposing an index based an international survey of law firms, which were asked to measure subjectively the degree of legal protection of minority shareholders with particular reference to private enforcement mechanisms (Djankov et al. 2008; used by Glaum et al. 2013).

For example, ESMA Guideline 5 deals with the selection criteria employed in the regular monitoring activity of the national enforcer, and establishes that “indications from the auditors of misstatements, whether in their reports or otherwise, will normally trigger a selection of the financial information in question for examination. Indications of misstatements provided by auditors or regulatory bodies as well as grounded complaints should be considered for enforcement examinations”.

On the contrary, Larcker et al. (2007) find that key dimensions of corporate governance have little relation to a sample of accounting restatements.

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Title: From enforcement to financial reporting controls (FRCs): a country-level composite indicator
Authors: Alberto Quagli
Corrado Lagazio
Paola Ramassa
Publication date: 05-07-2020
Publisher: Springer US
Published in: Journal of Management and Governance / Issue 2/2021
Print ISSN: 1385-3457
Electronic ISSN: 1572-963X
DOI: https://doi.org/10.1007/s10997-020-09518-w

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