Accruals quality and the cost of debt: the European evidence

• Pages: 333-351
• DOI: https://doi.org/10.1108/IJAIM-01-2018-0008
• Published date: 07 May 2019
• Date: 07 May 2019
• Author: Yasser Eliwa,Andros Gregoriou,Audrey Paterson
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Accruals quality and the cost of

debt: the European evidence

Yasser Eliwa

School of Business and Economics, Loughborough University, Loughborough, UK

and Faculty of Commerce, Cairo University, Cairo, Egypt

Andros Gregoriou

Business School, University of Brighton, Brighton, UK, and

Audrey Paterson

University of Aberdeen Business School, Aberdeen, UK

Abstract

Purpose –This paper aims to investigate the empirical relationship between the cost of debt (CoD) and

accruals quality (AQ) of European listed firms during the period of 2005 to 2014. Also, it aims to test the

impact ofthe interrelationship between the financialcrisis (2008-2009) and AQ on CoD. Finally, we decompose

AQ into two components; the innate (InnateAQ) and discretionary components (DiscAQ); and test their

relationshipswith CoD.

Design/methodology/approach –To empirically examine the relationship between AQ and CoD,a

sample including 15 member states of the EU is constructed. AQ proxy is based on the McNichols (2002)

modification of Dechow and Dichev (2002) model. A univariate analysis and a multivariate analysis are

conducted to examine the relationship between AQ and CoD after controlling for firm characteristics and

institutionalvariables.

Findings –We find a significant negative associationbetween AQ and CoD in a vast proportion of the 15

countries under review. Also, the results indicatethat during the crisis period, creditors pay relatively more

attention to thequality of accounting information than during thepre-crisis period when they determine CoD

of firms. Moreover, we report a link betweenthe magnitude of this relationship and national characteristics

and provide evidence of the significant effectsof national characteristics and market forces on CoD.Finally,

we find that InnateAQdrives the relationship with CoD.

Practical implications –This paper provides up-to-dateevidence on the economic consequences of AQ

and IFRS in the capital market.The results should, therefore, be of interest to managers,creditors, regulators

and standard-setters.

Originality/value –To the best of the authors’knowledge,this is the first paper to investigate the effects

of AQ on CoD for European listed firms. Also, it examines the impact of financial crisison the association

between AQand CoD.

Keywords EU, IFRS, Earnings quality, Accruals quality, The cost of debt

Paper type Research paper

1. Introduction

The main objective of a financial accounting system is to help users to make valuable

decisions. Consequently, it is expected in the capital market that high-quality accounting

information supportsinvestors and creditors to make better judgments and decisions (Ewert

and Wagenhofer, 2012). This implies that accounting information plays a fundamental role

in the capital market (Lim et al.,2015;Naharet al.,2016).Accordingly, previous studies tried

to find out how the accounting informationin the capital market affects external suppliers of

capital by examining the impact of the accounting information quality on the cost of debt

Accruals

quality and the

cost of debt

333

Received30 January 2018

Revised21 February 2018

Accepted6 March 2018

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 2, 2019

pp. 333-351

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-01-2018-0008

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

(CoD)(Francis et al.,2006). This paper attempts to provide an answer to this question by

empirically investigating the relationship between accruals quality (AQ) as a measure of

accounting qualityand CoD in 15 European countries.

Further, we decompose AQ into two components, the innate component (InnateAQ),

which reflects the economic fundamentalsand business environment, and the discretionary

component (DiscAQ), which reflects the quality of accounting standards and the

management reporting choices, and test whether each component has the same effect on

creditors’decisions in the EU market after the adoption of IFRS in 2005. Previous studies

argue that both components are priced in the US market (Francis et al.,2005;Core et al.,

2008).

In addition, all global capitalmarkets have suffered from the subsequent of the financial

crisis described in the media as the “credit crunch”after the collapse of the US mortgage

market in 2008. Of particular note is the effect the credit crunch had on the economic

environment of European firms, which is characterised by a lack of liquidity (Duff and

Einig, 2009;Iatridis and Dimitras,2013;Bowen and Khan, 2014;Trombetta and Imperatore,

2014). In this context, we investigate the impact of macroeconomic factors –the 2008

financial crisis –on the relationshipbetween AQ and CoD.

Therefore, this study contributesto the growing area of accounting quality research in a

number of ways. First, this study has been one of the first attempts to thoroughly examine

the effects of AQ on CoD for European listed firms. Further, using a sample from the

European market has two advantages:

(1) To test the influence of AQ on CoD, it is essential to keep other elements constant.

Accordingly, using the European setting is an appropriate choice as, since 2005,

European-listed firms have adopted the International Financial Reporting

Standards (IFRS). Regardless of their nationality, all firms in the sample have,

mandatorily, adopted the IFRS. Consequently, any differences among European

countries regarding the strength of the relationship between AQ and CoD in the

financial crisis cannot be linked to the differences of using local accounting

standards.

(2) Previous literature has used single-country samples, which leads to an uncertainty

of external validity of the findings. Using a sample of European countries with a

larger geographical area counterbalances country-specific factors and, therefore,

provides solid evidence. Also, adding regulatory and institutional factors to the

main model will make it possible to investigate the impact of those factors on the

association between AQ and CoD (Filip and Raffournier, 2014).

Second, this study examinesthe impact of the financial crisis on the association between AQ

and CoD for European listed firms. The financial crisis, the effects of which have been

omitted by prior studies that examine the relationship between AQ and CoD, has a

significant effect on the firms’performance,which might motivate managers to manipulate

earnings. In this regard, Filip and Raffournier (2014) assert that the consequences of the

financial crisis on accounting quality are still not entirely explored and needs additional

investigations.

Third, this study investigates the separate impact of InnateAQ and DiscAQ on CoD in

the EU. Most of the previous studies that discussed this relationship focused on the USA

and found that creditors price both InnateAQ and DiscAQ in the capital market (Francis

et al., 2005;Core et al.,2008). In the same vein, IFRS, the principles-based standards that

have been applied in the EU since 2005, could offer management the opportunity to

manipulate accounting information, or help them to reflect the economic positions of their

IJAIM

27,2

334