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Comparability is a central feature of financial reporting systems. Comparability is defined by FASB (2010, 19) as “the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items.” The Accounting Principles Board ranked comparability as one of the most important objectives of financial reporting and Generally Accepted Accounting Principles have underscored the importance of comparability for the past four decades. Using empirical measures of financial statement comparability, studies confirm that comparability plays an important role in analyst following, audit fees, credit risk, acquisition decisions, stock price volatility, the cost of debt, the cost of equity, and cash holdings. This dissertation, investigates the impact of comparability on trade credit, earnings management through classification shifting, and on non-Big4 auditors. Prior studies find that comparable firms enjoy a lower cost of equity capital and a lower cost of debt. They should, therefore, require less trade credit. I also find that comparable smaller and/or financially distressed firms require less trade credit whereas they normally require higher levels of trade credit. The results presented in my first essay support this hypothesis in that comparability and trade credit are significantly negatively associated. The results presented in my second essay show that managers’ earnings management through classification shifting is significantly influenced by the degree of financial statement comparability with other firms. I also find that comparable firms engage in less classification shifting and that the impact of comparability is more pronounced after the passage of the Sarbanes Oxley Act. The results presented in my third essay show that companies audited by non-Big4 auditors are less comparable than the companies audited by Big4 auditors. Non-Big4 auditors are thus less likely to be able to apply the same audit process to multiple clients. I find that this results in greater audit effort, as proxied by higher audit fees, for Non-Big4 firms.

In this thesis, I examine earnings management issues in the UK context. The thesis consists of three essays. The first chapter investigates whether managers base their trade-off decisions among real earnings management, accruals-based earnings management, and classification shifting, on the costs, constraints and timing of each strategy in the UK. The empirical evidence suggests that some, but not all, costs and constraints play a role in managers’ trade-off decisions. Further, contrasting between firms that are most likely to have manipulated earnings and firms that are not likely to have manipulated earnings, I find no difference in the relation of constraints towards all earnings management forms. This indicates that cost and constraints do not capture entirely what they are designed to, in the first place. Finally, I document evidence that is consistent with managers using real and accruals-based earnings management as substitutes but fail to find evidence that classification shifting acts as a substitute. The second essay studies the effect of income smoothing via accruals-based and real earnings management on the relationship between current stock returns, current earnings and future earnings. I measure income smoothing as the contemporaneous correlation between changes in earnings management proxies and pre-managed income. Using a sample of non-financial publicly listed firms in the UK, I show that both accruals-based and real income smoothing measures are associated with significantly positive share price anticipation of earnings. These results are robust to different stock returns specifications, income smoothing measure calculations, abnormal accruals models and accumulation periods of stock returns. In the third and final essay, I investigate the impact of the level of accruals-based and real earnings management on measures of the amount of performance commentary in annual reports for a large sample of UK public firms. I use automated textual analysis to construct disclosure scores based on the amount of performance and causal commentary. The results suggest that firms with higher levels of earnings management have lower levels of disclosure of performance and causal commentary. The presence of bad news for the firm (missed analyst forecast, underperformance or earnings decline) affects the relationship between disclosure and accruals-based earnings management but not the relationship between disclosure and real earnings management.

The full text will be available at the end of the embargo period: 31st December 2024.