Kinked accounting? Small loss avoidance in Europe and (not) the US

Figures & data

Table 1. Descriptive statistics for the US and European samples.

Statistic	N	Mean	SD	Min	P25	Median	P75	Max
US
MCap	65,052	4171	22,041	20	141	473	1818	1,304,756
Total Assets	65,052	3182	16,924	20	143	427	1615	797,800
NI	65,052	0.035	0.126	−0.500	−0.001	0.050	0.098	0.499
Europe
MCap	50,625	2479	10,701	20	92	260	10,115	260,649
Total Assets	50,625	3380	15,435	20	129	356	1391	532,474
NI	50,625	0.048	0.091	−0.499	0.014	0.047	0.088	0.500

Notes: N: number of firm-years; MCap: market capitalization; NI: net income scaled by total assets at the beginning of the year. MCap and Total Assets in million USD.

Figure 1. Frequency distributions and kernel densities for scaling with total assets.

The distributions are shown for four years spread over the sample period. Left graphs: sample of US firms; right graphs: sample of European firms. Vertical line at zero scaled earnings. Earnings are scaled with total assets at the beginning of the year. A bar in the diagram represents a width of 0.005. SLD: small loss deviation; SPD: small profit deviation.

Figure 2. Discontinuity measures for the US and Europe for scaling with total assets.

The discontinuity measures capture the share of excess observations (pos. sign) or missing observations (neg. sign) in the intervals of scaled earnings directly below and above the zero threshold. SLD: small loss deviation; SPD: small profit deviation. Earnings are scaled with total assets at the beginning of the year.

Figure 3. Results for matched industry samples.

Discontinuity measures analogous to Panels B1 and B2 in Figure 2 (interval width 0.015). SLD: small loss deviation; SPD: small profit deviation.

Table 2. Results of time-series regressions.

	Full sample		Matched sample
	SLD	SPD	SLD	SPD
Panel A: US
Interc	−0.27${}^{\ast \ast \ast }$	0.12${}^{\ast \ast \ast }$	−0.25${}^{\ast \ast \ast }$	0.10${}^{\ast \ast \ast }$
	(−8.08)	(5.54)	(−7.56)	(3.09)
Time	0.01${}^{\ast }$	−0.004${}^{\ast }$	0.006${}^{\ast }$	−0.005
	(2.00)	(−1.84)	(1.84)	(−1.58)
$D_{\mathrm{SOX}}$	0.05	−0.03	0.04	−0.01
	(0.77)	(−0.82)	(0.55)	(−0.20)
Adj. $R^2$	0.46	0.44	0.39	0.25
Panel B: Europe
Interc	−0.34${}^{\ast \ast \ast }$	0.14${}^{\ast \ast \ast }$	−0.35${}^{\ast \ast \ast }$	0.12${}^{\ast \ast \ast }$
	(−11.32)	(5.88)	(−11.22)	(3.72)
Time	0.004	0.0002	0.004	0.002
	(1.51)	(0.08)	(1.45)	(0.78)
$D_{\mathrm{SOX}}$	−0.005	−0.009	0.02	−0.05
	(−0.11)	(−0.23)	(0.32)	(−0.93)
$D_{\mathrm{AR}}$	0.002	−0.04	−0.01	−0.04
	(0.04)	(−1.10)	(−0.30)	(−0.80)
Adj. $R^2$	0.14	−0.03	0.18	−0.04

Note: ${}^{\ast }$ p < 0.1; ${}^{\ast \ast }$ p < 0.05; ${}^{\ast \ast \ast }$ p < 0.01.

The regression model is specified in Equation (5(5) $D{M}_t=\alpha +{\text{β}}_1\cdot \mathrm{Time}+{\text{β}}_2\cdot D_{\mathrm{SOX}}+{\text{β}}_3\cdot D_{\mathrm{AR}}+{ϵ}_t,$(5) ). SLD: small loss deviation; SPD: small profit deviation. ‘Matched sample’ refers to the matched industry sample. The interval width is 0.015. $D_{\mathrm{SOX}}$ is a dummy variable equal to 1 for years from 2003 (US) or 2008 (Europe) and 0 for earlier years. $D_{\mathrm{AR}}$ is a dummy variable equal to 1 for years from 2016, when the Audit Regulation (AR) No 537/2014 was implemented, and 0 for earlier years.

Figure 4. Comparison of small loss avoidance before and after European SOX.

SLD is the small loss deviation for an interval width of 0.015. The solid line is the regression line, the dashed line is the 45 degree line. The red diamond indicates the weighted average of the European countries (with the number of observations as weights). The country codes are defined in Table A2 in the Appendix.

Table 3. Results of cross-country regressions.

Variable Var	Interc	V ar	$\mathrm{Sub}2$	$\mathrm{Var}\cdot \mathrm{Sub}2$	$\mathrm{Adj}.R^2$
Panel A: OLS
Common Law	−0.32${}^{\ast \ast \ast }$	0.18${}^{\ast }$	0.07	−0.05	0.12
	(−8.89)	(1.82)	(1.33)	(−0.33)
UAI	−0.26${}^{\ast \ast \ast }$	−0.003${}^{\ast \ast }$	0.03	0.002	0.10
	(−6.41)	(−2.13)	(0.47)	(1.23)
LTO	−0.30${}^{\ast \ast \ast }$	−0.002	0.06	0.001	−0.01
	(−8.15)	(−0.95)	(1.19)	(0.19)
Shareholder Rights	−0.35${}^{\ast \ast }$	0.01	0.18	−0.02	−0.05
	(−2.32)	(0.37)	(0.84)	(−0.56)
Corporate Transparency	−0.51${}^{\ast }$	0.03	0.16	−0.01	−0.03
	(−1.98)	(0.81)	(0.44)	(−0.27)
Panel B: WLS
Common Law	−0.29${}^{\ast \ast \ast }$	0.15${}^{\ast \ast \ast }$	0.03	0.01	0.61
	(−10.09)	(4.61)	(0.68)	(0.22)
UAI	−0.17${}^{\ast \ast \ast }$	−0.004${}^{\ast \ast \ast }$	0.04	0.001	0.34
	(−10.01)	(−3.25)	(1.45)	(0.64)
LTO	−0.21${}^{\ast \ast \ast }$	−0.003${}^{\ast \ast \ast }$	0.03	−0.0004	0.46
	(−10.60)	(−3.31)	(1.03)	(−0.32)
Shareholder Rights	−0.07	−0.02${}^{\ast }$	0.08	−0.01	0.26
	(−1.23)	(−1.94)	(1.01)	(−0.60)
Corporate Transparency	0.02	−0.03${}^{\ast }$	0.11	−0.01	0.23
	(0.22)	(−1.86)	(0.72)	(−0.50)

Note: ${}^{\ast }$ p < 0.1; ${}^{\ast \ast }$ p < 0.05; ${}^{\ast \ast \ast }$ p < 0.01.

The regression model is specified in Equation (6(6) $\mathrm{SLD}={\alpha }_1+{\alpha }_2\cdot \mathrm{Sub}2+{\text{β}}_1\cdot \mathrm{Var}+{\text{β}}_2\cdot \mathrm{Var}\cdot \mathrm{Sub}2+ϵ,$(6) ). The dependent variable is SLD for an interval width of 0.015. Common Law: equal to 1 for the common law countries US and UK and 0 otherwise. UAI: Uncertainty Avoidance Index of Hofstede et al. (2010) less 50. LTO: Long-Term Orientation Index (based on the World Value Survey) of Hofstede et al. (2010) less 50. Shareholder Rights: Index of shareholder rights (World Bank). Corporate Transparency: Index of country-specific company transparency (World Bank). Sub2 is a dummy variable equal to 1 for years after European SOX (2008-2019) and 0 before (1988-2007). Weighting in the WLS regression is by the number of observations per country. The number of observations is 30 (15 countries and 2 subperiods).

Figure 5. Relationship of small loss avoidance with UAI and LTO.

Upper panels: UAI, lower panels: LTO. Left graphs cover the subperiod before European SOX (1988–2007), the right graphs cover the subperiod after European SOX (2008–2019). SLD is the small loss deviation for an interval width of 0.015 based on pooled data of the respective period. UAI is the Uncertainty Avoidance Index, LTO is Long-Term Orientation. The blue solid line (black dashed line) is the WLS (OLS) regression line. The red diamond indicates the weighted average of the European countries (with the number of observations as weights). The country codes are defined in Table A2 in the Appendix.

Table A1. Discontinuity measures in the US and European samples.

	US					Europe
Year	N	SLD	SPD	$t\left(S{D}_{-1}\right)$	$t\left(S{D}_1\right)$	N	SLD	SPD	$t\left(S{D}_{-1}\right)$	$t\left(S{D}_1\right)$
1988	1428	−0.09	0.03	−1.36	0.37	910	−0.39	0.09	−4.06	1.26
1989	1455	−0.31	0.05	−4.08	0.63	1338	−0.25	0.02	−3.19	0.84
1990	1345	−0.38	0.20	−5.72	3.21	1478	−0.41	0.08	−7.51	1.73
1991	1423	−0.36	0.26	−6.52	4.57	1524	−0.27	0.14	−5.42	2.90
1992	1586	−0.34	0.17	−6.15	3.17	1459	−0.27	0.23	−6.08	4.84
1993	1732	−0.32	0.13	−6.14	2.46	1569	−0.43	0.24	−10.71	5.43
1994	1818	−0.36	0.03	−5.65	0.68	1711	−0.39	0.23	−9.80	5.43
1995	2293	−0.25	−0.003	−3.89	−0.29	1220	−0.28	0.22	−4.48	3.27
1996	2570	−0.03	0.07	−0.43	1.36	1349	−0.16	0.15	−2.69	2.54
1997	2832	−0.19	0.06	−3.10	1.19	1468	−0.39	0.06	−6.12	1.28
1998	2780	−0.18	0.04	−3.18	1.17	1543	−0.37	0.10	−5.63	1.70
1999	2654	−0.14	0.05	−2.48	0.98	1553	−0.35	0.18	−6.57	3.24
2000	2363	−0.17	0.08	−2.62	1.24	1627	−0.29	0.16	−5.41	2.98
2001	2460	−0.07	0.09	−1.50	1.57	1684	−0.15	0.16	−3.07	3.31
2002	2320	−0.13	0.08	−1.99	0.96	1538	−0.23	0.18	−4.81	3.55
2003	2414	−0.08	−0.03	−1.15	−0.73	1643	−0.29	0.19	−7.26	4.31
2004	2436	−0.06	0.003	−0.78	0.35	1715	−0.29	0.10	−5.77	2.13
2005	2436	−0.09	0.03	−1.45	0.83	1867	−0.32	0.18	−6.09	3.54
2006	2390	−0.16	0.06	−3.19	1.38	1991	−0.25	0.14	−4.11	2.74
2007	2280	0.04	−0.05	0.90	−1.06	2144	−0.28	0.05	−4.91	0.73
2008	1981	−0.10	0.02	−1.30	0.41	1821	−0.21	0.14	−3.87	2.85
2009	2000	−0.10	0.07	−1.89	0.60	1756	−0.25	0.16	−5.31	3.79
2010	2032	−0.09	−0.02	−1.52	−0.34	1720	−0.33	0.18	−7.09	3.43
2011	1907	−0.03	0.02	−0.43	0.52	1639	−0.25	0.14	−5.05	2.36
2012	1865	−0.10	0.01	−1.51	0.15	1615	−0.16	0.07	−2.77	1.28
2013	1840	0.05	−0.05	0.28	−0.99	1624	−0.31	0.15	−5.96	3.31
2014	1888	−0.05	−0.005	−0.95	−0.10	1545	−0.24	0.17	−4.60	3.00
2015	1814	0.04	−0.12	0.99	−2.61	1468	−0.26	0.10	−4.68	1.89
2016	1748	−0.09	0.02	−0.84	−0.14	1457	−0.32	0.15	−5.94	3.14
2017	1694	−0.08	−0.0005	−1.00	−0.20	1549	−0.11	0.04	−2.32	0.43
2018	1633	0.02	−0.06	0.84	−1.18	1568	−0.25	0.08	−4.70	1.21
2019	1635	−0.19	−0.03	−2.61	−0.22	1532	−0.21	0.12	−4.08	1.98

Notes: Earnings are scaled by total assets. N: number of observations; SLD: small loss deviation; SPD: small profit deviation; $t\left(S{D}_{-1}\right)$ and $t\left(S{D}_1\right)$: standardized differences t-statistic for the first loss and profit interval, respectively. The measures are defined in Section 5.1. The interval width is 0.015.

Figure A1. Discontinuity measures for the US and Europe for scaling with the market value of equity.

The discontinuity measures capture the share of excess observations (pos. sign) or missing observations (neg. sign) in the intervals of scaled earnings directly below and above the zero threshold. SLD: small loss deviation; SPD: small profit deviation. Earnings are scaled with the market value of equity at the beginning of the year.

Table A2. Discontinuity measure and country characteristics before and after implementation of European SOX.

						1988–2007		2008–2019
Country	Code	UAI	LTO	SR	CT	N	SLD	N	SLD
United States	USA	46	26	4	5.40	43,015	−0.11	22,037	−0.03
United Kingdom	GBR	35	51	8	8	11,812	−0.15	5168	−0.14
France	FRA	86	63	6	8	4608	−0.29	3073	−0.31
Germany	GER	65	83	8	7	4419	−0.29	3180	−0.22
Sweden	SWE	29	53	9	7	1552	−0.11	1722	−0.29
Italy	ITA	75	61	8	7	1656	−0.24	1221	−0.29
Netherlands	NET	53	67	7	7	1556	−0.39	724	−0.49
Norway	NOR	50	35	8	9	871	−0.20	850	−0.004
Finland	FIN	59	38	7	6	900	−0.36	764	−0.25
Denmark	DEN	23	35	8	9	1065	−0.20	462	−0.19
Belgium	BEL	94	82	4	6	859	−0.40	530	−0.09
Spain	SPA	86	48	10	8	555	−0.44	639	−0.38
Greece	GRE	112	45	8	7	677	−0.25	483	−0.06
Austria	AUT	70	60	8	7	383	−0.60	297	−0.36
Portugal	POR	104	28	4	6	418	−0.44	181	−0.40

Notes: Earnings are scaled by total assets. UAI: Uncertainty Avoidance Index; LTO: Long-Term Orientation index; SR: Shareholder Rights index (World Bank); CT: Company Transparency index (World Bank). N is the number of observations and SLD the small loss deviation as defined in Section 5.1. The interval width is 0.015. The rows are sorted by the number of observations for the entire period.

Hofstede, G., Hofstede, G. J., & Minkov, M. (2010). Cultures and organizations: Software of the mind (3rd ed.). Mcgraw-Hill New York.

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