Related-Party Transactions and Stock Price Crash Risk: Evidence from China

This paper investigates the association between related-party transactions (RPTs) and stock price crash risk in China. Our investigation is motivated by the controversy in the RPT literature over whether RPTs are value enhancing or opportunistic. Through the lens of stock price crash risk, we reveal that RPTs may violate the arm’s-length assumption of regular market-based transactions, impairing the representational faithfulness and verifiability of accounting data and, consequently, increasing the risk of future price crash. Importantly, we find that this detrimental economic consequence of RPTs is driven by abnormal RPTs that are opportunistic in nature. Our analyses also extend to operating RPTs, related-party loans, and two types of opportunistic RPTs: tunneling and propping. The positive association between RPTs and stock price crash risk is not mediated by financial reporting quality, suggesting that the risk factors associated with RPTs are operational. Our main results remain robust to a series of tests done to address the potential endogeneity between RPTs and stock price crash risk.

On qualitative characteristics of financial reporting

The article generalizes the role of accounting and reporting in information provision for enterprise activities. It is claimed that, on the one hand, financial reporting provides a guide in identifying accounting items, accounting nomenclatures, and information flows of synthetic and analytical accounting. On the other hand, a balance sheet and other reporting items are used to complete the reporting process, and afterwards on the basis of detailed accounting data a number of summarized indicators are calculated for different users of information. Special emphasis is given to the fact that with advancing computer and telecommunication technology it is becoming easier to achieve the required timeliness and completeness of accounting and reporting data. Thus, the focus should be on ensuring a high level of accounting and reporting information. The paper reveals some essential qualitative characteristics of reporting information targeted towards consumers and necessary for decision-making. The latter, the focus on using information for making decisions, is exactly what reporting should be primarily aimed at. A number of essential qualitative characteristics and limitations of usefulness of reporting information for management are comparatively assessed. These characteristics include relevance which comprises timeliness, necessity, and feedback as well as reliability of information: verification, representational faithfulness and independence. Comparability of reporting information is singled out among matching qualitative characteristics. In addition to qualitative characteristics, one should pay due attention to limitations related to comparison of benefits and costs of information, significant restrictions in response to the prudence concept (conservatism), and accept threshold (materiality). Other qualitative characteristics proposed by different authors are also analyzed. The article also highlights important approaches to improving the quality of reporting information in order to fully meet the needs of different groups of users, harmonize national and international regulations for generating key performance indicators in financial reporting, and attract foreign investment to Ukraine’s economy. The current issues of accounting and financial reporting in accordance with national and international standards are considered. A comparative assessment of qualitative characteristics is carried out in fulfilment of the international regulations (The Conceptual Basis of Financial Reporting) and National Accounting Standards of Ukraine. Some proposals on harmonization of national and international standards for the formation of financial reporting are put forward.

Related-Party Transactions and Audit Fees: Evidence from China

ABSTRACT This paper investigates the effect of related-party transactions (RPTs) on audit fees in China. RPTs may violate the arm's-length assumption of regular market-based transactions, impairing the representational faithfulness and verifiability of accounting data and, as a consequence, increase clients' auditor-assessed business risk. The presence and magnitude of such transactions are therefore likely to increase audit fees. On the other hand, audit fees could be lower for firms with RPTs because auditors face less difficulty in verifying them, as opposed to third-party transactions. We first consider the effect of RPTs on audit fees, and document relatively high audit fees associated with RPTs. This lends support to the conjecture that RPTs are seen as increasing audit risk. We then extend this baseline case by considering the effects on audit fees of different classes of RPTs, of the different parties involved in RPTs and, finally, of the interaction between product-market competition and RPTs. We first document a negative (positive) association between RPTs involving sales and purchase of goods and services (RPTs related to intercorporate loans). We also find that audit fees are relatively high for RPTs involving loans and capital transfers when listed parents transact with their subsidiaries. Finally, we find that audit fees are relatively low for RPTs within competitive industries.

Financial Engineering and the Arms Race Between Accounting Standard Setters and Preparers

SYNOPSIS This essay analyzes some problems that accounting standard setters confront in erecting barriers to managers bent on boosting their firms' financial reports through financial engineering (FE) activities. It also poses some unsolved research questions regarding interactions between preparers and standard setters. It starts by discussing the history of lease accounting to illustrate the institutional disadvantage of standard setters relative to preparers in their speeds of response. Then, the essay presents a general theorem that shows that, independent of how accounting standards are written, it is impossible to eliminate all FE efforts of preparers. It also discusses the desirability of choosing accounting standards on the basis of the FE efforts the standards induce preparers to engage in. Then, the essay turns to accounting boards' concepts statements; it points out that no concept statement recognizes the general lack of goal congruence between preparers and standard setters in their desires to produce informative financial statements. We also point out the relative lack of concern in recent concept statements for the representational faithfulness of the financial reporting of transactions. The essay asserts that these oversights may be responsible, in part, for standard setters promulgating recent standards that result in difficult-to-audit financial reports. The essay also discusses factors other than accounting standards that contribute to FE, including the high-powered incentives of managers, the limited disclosures and/or information sources outside the face of firms' financial statements about a firm's FE efforts, firms' principal sources of financing, the increasing complexity of transactions, the difficulties in auditing certain transactions, and the roles of the courts and culture. The essay ends by proposing some other recommendations on how standards can be written to reduce FE. JEL Classifications: M31.

The joint effects of management incentive and information precision on perceived reliability in fair value estimates

Purpose – The purpose of this paper was to examine whether a less precise (or imprecise) estimate may increase investors’ confidence and improve investors’ perceptions of fair value reliability. The main criticism of fair value accounting has been its lack of reliability perceived by investors. Design/methodology/approach – A 2 × 3 randomized experiment was used where management incentive and information precision are manipulated. Findings – The results from this study indicate that perceived reliability is jointly affected by management’s incentives and information precision. Reliability rating is the highest for fair value stated as a point estimate with a specified confidence level attached to it. Further analysis indicates that higher perceived reliability is related to its representational faithfulness because participants perceive that a point estimate with a specified confidence level better matches uncertainty in measuring future cash flows. Originality/value – This is the first study to examine whether a less precise (or imprecise) estimate may increase investors’ confidence and improve investors’ perceptions of fair value reliability. Because of the subjectivity and uncertainty in fair value estimates, less precise fair value estimates may not be viewed as less reliable. In fact, using a precise format to represent fair value estimates may not be appropriate (neither reliable nor credible), because a precise point estimate fails to capture its underlying uncertainty in future cash flows. A less precise format could represent a credible choice for fair value because it reflects uncertainty and subjectivity and effectively communicates management’s assessments of variability in future cash flows.

Corporate social disclosures: a user perspective on assurance

Purpose – The purpose of this paper is to investigate corporate social disclosure (CSD) assurance from a stakeholder perspective within a study which encompasses both stakeholder preferences and demand drivers of CSD assurance. Design/methodology/approach – Stakeholder perceptions of and their demand for CSD assurance are examined through a questionnaire survey. The analysis is based on responses in an empirical study from 147 organisations which are investing, procuring and third-sector stakeholders. Findings – Overall, stakeholder comments suggest an emphasis on the importance of specialist environmental assurors and the role of trust. The demand for assurance is positively related to stakeholders’ assessment of the value of CSD and the use of information from information intermediaries such as responsible investment indices, and negatively related to stakeholder perceptions of CSD representational faithfulness. Research limitations/implications – This paper only draws on data from the UK. Similar research can be explored in a context outside the UK. Practical implications – Better understanding of stakeholder defined determinants of the demand for CSD assurance as well as their perceptions of CSD assurance will inform regulators and enable companies to better discharge accountability towards stakeholders. Originality/value – This is one of the few empirical studies that investigate CSD assurance and one of the first to focus on stakeholder perceptions of, and demand for, CSD assurance within a multiple stakeholder perspective, rather than practitioner or corporate perceptions of CSD assurance.

Do Financial Statement Users Judge Relevance Based on Properties of Reliability?

ABSTRACT Relevance and reliability (now referred to as “representational faithfulness”) are qualities of financial information that both the Financial Accounting Standards Board and the International Accounting Standards Board use in setting standards for financial reporting. Despite their importance, very little research has addressed how financial statement users apply these constructs. Via experiments set within the fair value context, we show that users do not view them as independent constructs. Instead, variations in properties that are associated with the reliability of a measurement influence users' assessments of the relevance of fair value. The relationship between assessed relevance and assessed reliability is unidirectional, in that factors underlying reliability influence judgments of relevance, but factors underlying relevance do not influence judgments of reliability. Our findings are important because inappropriate assessments of relevance can influence firm valuation. The results are particularly meaningful in the context of fair value because such measurements can vary widely in reliability. JEL Classifications: M41.

Accounting for Lease Renewal Options: The Informational Effects of Unit of Account Choices

ABSTRACT This study examines the informational effects of unit of account choices in the context of a proposed standard on lease accounting. Standard-setters have tentatively decided that leases in excess of one year should be recognized on a lessee's balance sheet, including optional lease periods, even though the lessee can choose not to renew the lease. We argue that this approach lacks representational faithfulness and creates an informational problem for users. Using an experiment, we show that the proposed treatment of renewal options has a negative effect on lenders' willingness to lend to a firm with renewal options. However, we also show that disaggregating the capitalized optional renewal periods from the fixed-term lease obligation mitigates some of the negative effects of the proposed approach, particularly when disaggregation occurs on the face of the financial statements. These results should be of interest to standard-setters as they deliberate changes to lease accounting and when considering the trade-offs that can arise with expansive unit of account choices. Data Availability: The experimental data are available for purposes of replication. Please contact the authors..