Do firms practicing integrated reporting engage in less myopic behavior? International evidence on opportunistic earnings management

• Published date: 01 May 2022
• Author: Yi (Ava) Wu,Shan Zhou
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/corg.12401

ORIGINAL ARTICLE

Do firms practicing integrated reporting engage in less myopic

behavior? International evidence on opportunistic earnings

management

Yi (Ava) Wu

1

| Shan Zhou

2

1

Department of Accounting and Finance,

School of Management, Zhejiang University,

Sydney, Hangzhou, People's Republic of China

2

Discipline of Accounting, The University of

Sydney, Sydney, New South Wales, Australia

Correspondence

Yi Wu, Department of Accounting and

Finance, School of Management, Zhejiang

University, Hangzhou, People's Republic of

China.

Email: avayi_wu@zju.edu.cn

Funding information

Accounting and Finance Association of

Australia and New Zealand (AFAANZ)

[Correction added on 23 March 2022, after

first online publication: The corresponding

author's email address has been updated in

this version.]

Abstract

Research Question/Issue: Earnings management is often perceived as a typical

response to managers' short-term objectives at the expense of long-term benefits.

However, this is not aligned with the most recent development in corporate

reporting—integrated reporting (IR)—which encourages long-term orientation and a

trustworthy, honest, and ethical corporate culture. We thus examine whether firms

practicing IR to a greater extent exhibit lower levels of earnings management.

Research Findings/Insights: Using multiple IR measures and an international sample

of 19,926 firm-year observations from 2008 to 2015, we document that while firms

practicing IR engage in less accrual-based earnings management, they do resort to

real activities earnings management. Such opportunistic earnings management

behavior is most pronounced when firms' incentive to manage earnings is high. We

also show that opportunistic earnings management behavior is moderated in coun-

tries and regions where IR is mandatory, where capital markets are more developed,

and where financial reporting is less frequent.

Theoretical/Academic Implications: Our study contributes to the growing literature

on whether IR is an effective governance tool in constraining earnings management

behavior. The results show that the institutional environment plays an essential role

in enabling corporate reporting initiatives such as IR to affect substantive internal

changes rather than being used opportunistically.

Practitioner/Policy Implications: Firms that practice IR to a greater extent are

associated with a lower level of earnings management in countries where IR is

mandatory, which contributes to the policy debate on mandating IR.

KEYWORDS

corporate governance, integrated reporting (IR), earnings management, corporate social

responsibility (CSR), institutional environment

1|INTRODUCTION

Corporate reporting has long been framed as a governance tool

to discipline corporate managers (Bushman & Smith, 2001;

Jensen & Meckling, 1976). The most recent development in corpo-

rate reporting—integrated reporting (IR)—is key to creating

long-term value for all stakeholders and society (Eccles &

Krzus, 2010; Fink, 2019; International Integrated Reporting

Council (IIRC), 2010; Securities and Exchange Commission

(SEC), 2018).

In contrast to other types of disclosure, IR has the dual objectives

of improving the quality of information available to external providers

Received: 14 August 2020 Revised: 2 July 2021 Accepted: 12 July 2021

DOI: 10.1111/corg.12401

290 © 2021 John Wiley & Sons Ltd Corp Govern Int Rev. 2022;30:290–310.wileyonlinelibrary.com/journal/corg

of financial capital and supporting integrated decision-making and

actions that focus on long-term value creation for the firm (Barth

et al., 2017; International Integrated Reporting Council (IIRC), 2013).

IR includes six capitals

1

: financial, manufactured, intellectual, human,

social and relationship, and natural. This multicapital approach propels

managers to take into account all capitals that need to be managed

and to consider them jointly. The guiding principles

2

of IR emphasize

a strategic focus and future orientation, as well as connectivity of

information, to address traditional financial reporting issues, with a

limited focus on historical performance and short-term earnings

numbers.

Earnings management is a typical response to managers'

short-term objectives at the expense of long-term benefits, which is

not aligned with IR. Whether IR is an effective governance tool to

curb earnings management behavior is an empirical question to

be answered. This question is important because it adds to the

debate on “whether IR achieves the dual objective to induce real

changes”(Grey, 2015; International Federation of Accountants

(IFAC), 2018, 2019).

Using IR, a firm may communicate information about its strategy,

business models, risks and opportunities, governance, compensation,

and sustainability to demonstrate long-term value creation, and the

extent of the integration of environmental, social, and governance

(ESG) factors into its business model and strategic priorities (Eccles &

Krzus, 2010). The improved transparency in turn helps firms to re-

build trust with key stakeholders (KPMG, 2018a, 2018b). More trans-

parent firms engage in less earnings management because such

opportunistic behavior is more easily detected (Lee et al., 2006;

Richardson, 2000). In addition, firms' commitment to broader non-

financial capitals, such as human capital and environmental capital,

helps build a positive image (e.g., Fombrun, 1996; Gao et al., 2014;

McWilliams et al., 2006). The reputational effect may discourage firms

from engaging in self-serving activities such as earnings management

because they diminish reputational benefit.

More than a reporting tool, IR can encourage “integrated think-

ing”

3

whereby a firm's strategy focuses on long-term value creation

thereby affecting real changes within the firm. Anecdotal and

empirical evidence has shown that the practice of IR helps firms

attract more long-term investors (Serafeim, 2015), which may poten-

tially discourage short-sighted investment and earnings management

behavior. Therefore, if IR encourages long-term orientation and

cultivates a trustworthy, honest, and ethical corporate culture, it is

likely that firms embracing the concept of IR will have less incentive

to manipulate earnings and are less likely to engage in earnings

management.

Nonetheless, a popular view in the social and environmental

accounting literature is that nontraditional reporting initiatives such as

corporate social responsibility (CSR) reporting and IR, which are

largely voluntary, principles-based, and subject to a significant level of

firm discretion, can only be used to manage stakeholders' perception

of firms and therefore have no, or even a positive, association with

opportunistic behavior (Boiral, 2013; Choi et al., 2013; Mahoney

et al., 2013; Michelon et al., 2015; Prior et al., 2008).

This argument suggests that firms may use IR to appear to be

transparent, long-term-oriented, and committed to broader social

good without affecting real changes, such as refraining from earnings

management activities. However, while firms may embrace the spirit

of IR, what do they do in practice? This study examines the empirical

question of whether firms' apparent commitment to IR is associated

with the level of their earnings management activities, which is much

less observable.

Since IR practice varies across countries,

4

an international sample

allows us to reveal any significant country effects. For example, is the

relationship between IR and earnings management conditional on

whether IR is mandated or voluntary, or is it conditional on country-

specific characteristics?

In our main analysis we use the IR measure from the Thomson

Reuters ASSET4 database, which covers an international sample of

19,926 firm-year observations between 2008 and 2015 as used in

Serafeim (2015). We assess firms' earnings management behavior

using both accrual-based and real activities earnings management

measures. Accrual-based earnings management is achieved by

exercising discretion in relation to the accounting methods or accrual

estimates used. This can bias reported earnings in a particular

direction without changing the underlying transactions. Real activities

manipulation is achieved by altering the timing or structure of an

operation, investment, or financing transaction. Unlike accrual-based

earnings management, real activities manipulation has actual eco-

nomic consequences for a firm's long-term value. Our results reveal

that while firms practicing IR to a greater extent have fewer

discretionary accruals, they resort to more real activities earnings

manipulation.

Further analyses show that the opportunistic earnings manage-

ment observed, that is, a decrease in discretionary accruals with a

concomitant increase in real earnings management, is most pro-

nounced when a firm's incentive to engage in earnings management is

high; in other words, among high-growth firms and when a firm needs

to avoid reporting a loss, or meet/beat last year's earnings. These

results suggest that while firms practicing IR may refrain from

engaging in accrual-based earnings management, possibly due to

reputational concerns, they switch to less observable means to

manage earnings when the pressure/incentive to manage earnings

persists.

We also observe that opportunistic earnings management

behavior is moderated in countries and regions where IR is mandated

(i.e., South Africa and the United Kingdom), where capital markets are

more developed (proxied by a country's disclosure index and the size

of the equity market), and where the financial reporting is less

frequent (e.g., semi-annually). This is consistent with some earlier

views that a widespread and fundamental change is expected only

once IR is globally mandated (Eccles & Krzus, 2010; Steyn, 2014).

Our results are robust to various means to alleviate endogeneity

concerns, alternative measures of earnings management, excluding US

firms in the sample or restricting our sample period to recent years

subsequent to the mandatory periods in South Africa and the

United Kingdom.

WU AND ZHOU 291