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Journal of Business Ethics

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12.08.2017 | Original Paper

Professional Accountancy Organizations and Stock Market Development

verfasst von: Hong Huang, Xiangting Kong, Albert Tsang

Erschienen in: Journal of Business Ethics | Ausgabe 1/2019

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Abstract

This study investigates the relationship between the ethical, educational, and disciplinary development of professional accountancy organizations (PAOs) in a given country and the development of that country’s stock market. Using a comprehensive measure based on the responses of the major PAOs in 36 countries to a questionnaire designed by the International Federation of Accountants to assess the development of PAOs internationally, we find a significantly positive association between the development of PAOs and stock market development. In addition, we find the positive association between the development of PAOs and stock market development to be more pronounced in countries with higher levels of investor protection, a stronger public enforcement environment, or lower levels of corruption, suggesting the importance of complementary institutions in the relationship between PAOs and stock market development. We also find that better-developed PAOs are associated with better-quality financial reporting. Finally, our result also shows that relative to the investigation and discipline mechanism and educational requirements imposed by PAOs, the ethical development of a country’s professional accountants appears to have the strongest positive association with a country’s stock market development.

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This definition of the profession was provided by the Australian Council of Professions in 1995 (also see http://www.psc.gov.au/what-is-a-profession).

For example, the UNCTAD-ISAR (The Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting of the United Nations Conference on Trade and Development) stated, “Accounting plays an essential role in economic development. High-quality corporate reporting is key to improving transparency, facilitating the mobilization of domestic and international investment, creating sound investment environments and fostering investor confidence, thus promoting financial stability.” See http://www.accaglobal.com/content/dam/acca/global/PDF-technical/global-economy/pol-tp-raed.pdf.

See Appendix 1 for a comprehensive list of the major PAOs of each country in our sample.

For each country, we create two overall measures of PAOs (i.e., one based on the answers to six general questions, PAO_general, and the other based on the answers to 25 more specific questions, PAO_specific) designed to assess the level of development of each PAO member of IFAC. In addition, we create three additional PAO measures for the three major dimensions of each PAO: (1) requirements for ethics (PAO_Ethics), (2) requirements for education (PAO_Education), and (3) level of investigation and discipline (PAO_Oversight). See Appendix 2 for further details on the definitions of these measures.

Analogous to the conclusion of our study, Joseph Stalin’s famous statement in 1923, “It doesn’t matter how the votes are cast, but how they’re counted,” suggests that the ethics of political practitioners play an important role in the development of a country’s political system.

IFAC states, “When professional accountancy organizations (PAOs) function properly, they have the power to support the production of high-quality information, contributing to public and private sector, economic growth, and the effectiveness of international aid.” Other studies show that higher quality financial reporting and a better information environment contribute to a lower cost of capital, higher liquidity, more efficient corporate investment, and better-functioning capital markets, ultimately leading to a better-developed stock market (La Porta et al. 1998; Bushman and Smith 2001; Healy and Palepu 2001; Frost et al. 2006; Hail and Leuz 2006; Hope and Thomas 2008; Biddle et al. 2009).

https://www.ifac.org/about-ifac/accountancy-profession-playing-positive-role-fighting-corruption.

In this study, we do not specifically differentiate between accountants and auditors because the ultimate natures of their roles in financial markets are similar—to provide credible and useful financial information to both internal and external users of financial reporting.

For example, the American Institute of Certified Public Accountants (AICPA) defines financial accounting as “the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.” This definition of financial accounting was formulated in 1941 by the AICPA Committee on Accounting Procedures.

See also “The accountancy profession’s role in creating public value” by ACCA (http://www.accaglobal.com/content/dam/acca/global/pdf/public-value-report.pdf).

Consistent with our argument, Demerjian et al. (2013) show that managers who are more knowledgeable about their business and their operating environment tend to make better judgments and estimates, and they thus have positive effects on firms’ financial reporting quality.

These costs include the risk of losing higher compensation and jeopardizing career development, individual reputation, and social status.

In line with this view, several studies report a higher level of auditor litigation risk to be positively associated with better audit quality (Khurana and Raman 2004; Venkataraman et al. 2008).

PAOs that are not recognized as substantial national organizations can only be admitted as associates rather than formal members. The associates of IFAC are not required to complete the self-assessment questionnaire used to establish PAOs development score by our study. More information about IFAC’s membership admission criteria and process can be found at https://www.ifac.org/system/files/uploads/CAP/IFAC-Membership-Admission-Criteria-and-Process.pdf.

The full survey comprises three major parts: Part I, whose aim is to obtain an understanding of the country’s regulatory framework; Part 2, which is a self-assessment questionnaire concerning the status quo institutions established or maintained by the PAO (we use this part to construct our PAO measure); and Part 3, which covers action plans demonstrating the progress the PAO has made in fulfilling its membership obligations and how it plans to do so in the future. We use a subset of questions in the self-assessment questionnaire that can be unambiguously quantified to construct the measures of PAOs.

Correlation analysis indicates a significant positive association between the score of each PAO in countries with multiple PAOs.

While not all of the PAOs in our sample countries are affiliated with IFAC, the non-IFAC affiliated PAOs mainly operate like specialist bodies helping the work of accountants and auditors in specific fields such as taxation, forensic auditing, and systems auditing or for networking purposes. We conduct a search for each country included in our sample. Consistent with the specialized nature of these non-IFAC affiliated PAOs, we are only able to identify a few, such as The Association of International Accountants (AIA) and the Consultative Committee of Accountancy Bodies (CCAB) in the U.K., the National Association of State Boards of Accountancy (NASBA) and the Information Systems Audit and Control Association (ISACA) in the U.S., and the Hong Kong Business Accountants Association (HKBAA) and the Society of Chinese Accountants and Auditors (SCAA) in Hong Kong.

We perform additional analyses on an earlier sample period, 2000–2006, instead of 2007–2012. Our conclusions are unchanged.

The aggregate earnings management score from Leuz et al. (2003) is the average rank of two earnings-smoothing measures and two earnings-discretion measures, including the magnitude of accruals and small loss avoidance. Our results indicate that the positive association between the development of PAOs and the aggregate earnings management score measure introduced by Leuz et al. (2003) is mainly driven by the two earnings-smoothing measures. We find no significant relationship between the development of PAOs and any of the two earnings-discretion measures. As a result, we use the altered form of earnings quality measure developed by Leuz et al. (2003) and report only the results based on the two earnings-smoothing measures.

Frost et al. (2006) also measure the extensiveness of disclosure rules for each stock exchange. Our main results are qualitatively the same if we use stock exchange disclosure rules rather than the enforcement of those rules as a control.

As PAO_specific is the mean value of three components of development of PAOs that are available only in the partial sample, we can only examine its effect in the partial sample.

In our model, we follow Frost et al. (2006) in choosing country-level institutional variables to include for model validation and better comparison. However, it is also possible that other country characteristics that are likely to be correlated with the development of PAOs but are not included in the model may drive the results of PAOs on stock market development and accounting quality. To reduce such concern, we further include in our model several time-varying country-level controls including GDP per capita, a variable measuring the openness of a country (i.e., international trade as a percentage of GDP), and inflation. Data on GDP per capita and openness are obtained from IMD World Competitiveness Database and the data on inflation is obtained from the World Bank. We thank our reviewers for making this suggestion.

Moreover, to better distinguish between the rule of law and investor protection strength in a given country, we repeat our test by separating our overall LEGPRO variable into one variable that is more related to the rule of law (calculated as the mean of RL_F, FL_H, and RL_W) and another that is more related to investor protection (calculated as the mean of IP, SR, MIP_G, and IP_G). We find that our results are robust to this test model. Finally, the results remain robust to the exclusion of 2007 and 2008, the years in which the financial crisis occurred.

Conducting a similar test on firm-year-level data does not change our conclusion.

In an additional test, we also interact the development of PAOs with an aggregated earning smoothing measure to examine whether the relationship between PAOs and stock market development varies with firms’ earnings management. We find a significant and negative coefficient on the interaction term. This finding indicates that PAOs’ effect on stock market development is stronger in countries with lower earnings management.

The results are similar when the OLS regression model is used.

Although the average likelihood of restatement appears to be very high in Table 2, a more careful examination indicates that it is mainly driven by the restatement of firms in relatively small countries and firms with small firm size. For example, for both US and Canada, the average likelihood of restatement for firms in each of these two countries in our sample is about 11 %. This average appears to be reasonable given the fact that Capital IQ Compustat tends to have higher firm coverage and thus more small firms are included. Because firms with small size may be more likely to restate their financial information for multiple years during our sample period, in robustness test, we restrict our restatement sample to those firms with restatement for the very first time during our sample period and find our inference unaltered.

We directly test the significance of the differences between (1) the estimated coefficient for PAO_Ethics and that for PAO_Education, and (2) the estimated coefficient for PAO_Ethics and that for PAO_Oversight. In both tests, we find that PAO_Ethics has a statistically higher association with MARKDEV than PAO_Education and PAO_Oversight.

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Titel: Professional Accountancy Organizations and Stock Market Development
verfasst von: Hong Huang
Xiangting Kong
Albert Tsang
Publikationsdatum: 12.08.2017
Verlag: Springer Netherlands
Erschienen in: Journal of Business Ethics / Ausgabe 1/2019
Print ISSN: 0167-4544
Elektronische ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-017-3665-5

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