The influence of culture on real earnings management

Abstract

Purpose The purpose of this paper is to extend prior literature regarding the interrelationships between national culture and accounting practices. Design/methodology/approach Using Hofstede’s (1980) cultural indices, the authors employ hierarchical linear modeling to examine the impact of economic growth (emerging markets), country, and culture on real earnings management (REM) for a sample of firms from 31 countries. Findings The results reveal a negative association between REM and Hofstede’s (1980) measures of individualism, masculinity, and uncertainty avoidance, but a positive association with power distance. These results hold even after controlling for discretionary accruals. The results further reveal that measures of investor protection are subsumed by culture. Research limitations/implications The findings are limited by the use of Hofstede’s (1980) data. There is, however, a significant body of research that continues to rely on and support the use of Hofstede’s model. Practical implications The results should be of significant importance to investors who should consider cultural characteristics when assessing firm reported performance, and should prompt auditors and regulators to apply greater scrutiny to the financial reports in cultures characterized by high levels of power distance, especially given the apparent tradeoffs between accruals and REM. Social implications The results reveal that status as an emerging market does not influence managers’ use of REM, and that the strength of a country’s investor protection mechanisms are subsumed by culture. Similarly, accounting systems (e.g. International Financial Reporting Standards), by themselves, do not bring about a convergence of managerial behavior. Rather, investors should consider culture when making decisions regarding capital allocation. Originality/value The increasing trend toward economic globalization and accounting harmonization makes the understanding of differences in accounting practices, and the possible impact of national culture on manager’s decisions, more important than ever. This research links REM to cultural values and tests for evidence that national culture, values, and structures of investor protection affect REM in the ways they affect managers’ attitudes toward the management of earnings through accruals.

Cultural Determinants of Corporate Governance: A Multi-Country Study

“…Regarding the study hypotheses, Model 4, that considers Power Distance (PD) as the independent variable for cultural dimension, showed a positive and significant relationship between PD and EM, which corroborates the first hypothesis (H1: Earnings management is positively related to the degree of Power Distance). This finding is in line with the studies of Callen et al (2011) and Paredes and Wheatley (2017). In Model 5, that simultaneously considers the four dimensions of culture, the relationship between PD and EM was not significant.…”

“…In a scenario of economic globalization and harmonization of accounting practices, Paredes and Wheatley (2017) applied hierarchical linear modeling to investigate the impact of economic growth (emerging markets), country, and culture on real earnings management in a sample of companies from 31 countries. They used the Hofstede model to measure cultural dimensions.…”

National Culture and Corporate Rating Migrations

“…A high PD score is related to a high degree of earnings management (Paredes and Wheatley 2017). Corporate managers exhibit strong influences on financial reporting choices and prefer not to disclose information to preserve power inequalities (Zarzeski 1996).…”

“…The conflict of interest between shareholders and creditors, and the extent of protection toward shareholders and creditors vary markedly across countries (Li et al 2013). Paredes and Wheatley (2017) find that measures of investor protection are "subsumed" by culture. Culture affects managers' decisions to hire a Big Four auditor (Hope et al 2008).…”

“…Licht et al (2005);Hope et al (2008);Hofstede et al (2010);Fidrmuc and Jacob (2010);Kanagaretnam et al (2011);Zheng et al (2012);Paredes and Wheatley (2017) Individualism vs. collectivism Individualism encourages the pursuit of personal interests, autonomy and an active determination of one's destiny. Collectivism stresses conformity and adherence to societal norms and regulationsChui et al (2002); Licht et al (2005); Tsakumis et al (2007); Fidrmuc and Jacob (2010); Han et al (2010); Hofstede et al (2010); Shao et al (2010); Kanagaretnam et al (2011); Zheng et al (2012); Li et al (2013); Shao et al (2013) Masculinity vs. femininity Masculine countries strive for a performance society and value assertiveness, material accomplishment, ambition, competition and success.…”