Economic Consequences of Accounting Enforcement Reforms: The Case of Germany

Abstract

This study investigates recent reforms in financial reporting enforcement in Germany. The objective of these reforms was to promote a consistent and faithful application of accounting standards. Using a difference-in-differences approach, we find some evidence of a decrease in earnings management, an increase in stock liquidity, and, to a limited extent, an increase in market valuation for companies that fall under the new enforcement regime. Our results also provide some support for the notion that companies characterized by an overall low level of enforcement through other internal and external mechanisms are particularly affected by these reforms. The results are largely robust in several sensitivity analyses, but the results must be interpreted with caution because we cannot completely rule out the possibility of other explanations.

Acknowledgements

We thank two anonymous reviewers, Steven Young and Salvador Carmona (the editors) for their very helpful comments and suggestions. We also thank Wolfgang Bühler, Adolf Coenenberg, Roland Füss, Thomas Günther, Axel Haller, Norbert Herzig, Carsten Homburg, Christoph Kuhner, Bernhard Pellens, Thomas Schildbach, Thorsten Sellhorn, Dirk Simons, Christian Stadler, Rolf Tschernig, Jens Wüstemann, Stephen Zeff, and the participants of the 2008 AAA Annual Meeting in Anaheim, the 2009 AAA Annual Meeting in New York, the Annual Congress of the EAA 2009 in Tampere, the Annual Congress of the EAA 2010 in Istanbul, and the Ruhr-University Doctoral Colloquium in Accounting in November 2009 for their helpful comments and suggestions. This study was supported by the Ruhr-University Research Schools. Any remaining errors are ours.

Notes

A very similar definition of enforcement is provided by FEE (2002).

We thank an anonymous reviewer for suggesting this type of analysis.

Such a binary variable cannot be implemented as we use company fixed effects.

We note that our research design (inclusion of specific control variables and the estimation methodology including company-fixed effects) is not adequate to detect general differences in our measurement variables between accounting principles.

We are aware that the aggregation of continuous and binary variables (as also used in other studies, for example by Armstrong et al., 2010) is potentially problematic as principal components analysis is conceptually designed for continuous variables only. We keep this concern in mind when interpreting our findings.

As a starting point for the sample selection, we use the yearly lists of the Hoppenstedt Aktienführer. We also require sufficient data for 2002 and 2007 if necessary. To capture the effects of the enforcement reforms, we use a specific period definition. Fiscal years beginning in the interval from July 1 of year t to June 30 of year t+1 are defined as period t, whereas stock market measures are calculated on a daily basis over this interval.

Corrections resulting from this double-check influence our findings. We find less significant negative impacts for our earnings management measures and stock liquidity measures and even no substantial changes in our market valuation measures using the original accounting principle-information from Datastream Worldscope.

This assumption influences the findings for our stock liquidity as well as for our market valuation measures. If we require a higher proportion of available daily observations our sample size decreases and is even more biased toward larger companies. All findings within our regression analyses indicate an overall lower impact of the enforcement reforms, which is in line with H4; however, all findings are still significant at conventional levels.

Different from our original regression approach given in equation (1), we do not include CROSSL _it because this is a static variable for all companies included in the matched sample approach.

A company could switch back only if it left this stock segment or merged with all subsidiaries to avoid presenting consolidated financial accounts. However, in other stock segments (especially in the Open Market), a switch back to local GAAP was not restricted.

Additional information

Notes on contributors

Jürgen Ernstberger

Paper accepted by Salvador Carmona.

Michael Stich

Paper accepted by Salvador Carmona.

Oliver Vogler

Paper accepted by Salvador Carmona.