Abstract
۱٫ Introduction
۲٫ Institutional background, literature, and hypotheses development
۳٫ Research design and descriptive statistics
۴٫ Main results, placebo test, and robustness tests
۵٫ Cross-sectional analyses
۶٫ Why and how is accounting quality increased?
۷٫ Concluding remarks
Appendix A. Variable definitions
Appendix B. Variable construction of the dependent variable, FRQ
Appendix C. Results for propensity score matching probit regression
References
Abstract
This paper examines the impact of corruption culture on accounting quality (AQ) of listed firms at the municipal level in China. We consider municipalities with (without) corrupt top government officials as having high (low) corruption culture. To isolate the effect of corruption culture, we use the arrest of corrupt officials (the events) to capture the change in local corruption culture, and apply the difference-in-difference method to compare AQ of firms operating in the jurisdictions of corrupt officials pre and post the events, compared to control firms. We find that AQ of firms affiliated with corrupt officials is higher after the events, which is robust to the placebo test, time-trend analysis, and various robustness tests. We complement the literature by showing that the increase in AQ is greater for firms associated with more powerful officials and having stronger connections with corrupt officials. Moreover, the positive effect on accounting quality is stronger in the post-2012 period. Further, we document that firms improving AQ after the events issue more SEOs and have lower cost of capital. Finally, analyses on channels firms used to improve AQ show that firms switch to higher quality auditors, have better internal control, and issue more management forecasts. This study has implications for policymakers in countries that suffer from corruption.
Introduction
Accounting plays an essential role in terms of resource allocation and economic growth (Biddle et al., 2009; Piotroski and Wong, 2012), as it bridges communication between business firms and capital markets, and serves as the foundation for various contracts, e.g., managerial and debt contracting (Watts and Zimmermann, 1986; Rajan and Zingales, 2003). Due to the importance of accounting, it is warranted to examine the impact of various factors on accounting quality. Ball et al. (2003) show that accounting quality is profoundly affected by market and political forces that influence managers’ incentives.1 While acknowledging the contributions of this study, Holthausen (2003) criticises the heterogeneity issues in its setting of four East Asian countries. We follow up Ball et al. (2003) by focusing on the impact of one specific aspect of political forces, i.e., regional corruption culture on accounting quality, and adopting a setting of a single country to mitigate the above concern. This paper examines how local corruption culture could affect accounting quality (AQ) of firms operating in the region using data from China. Corruption culture is measured by whether the top government officials that have the highest power in the region are corrupt.2 Guiso et al. (2006, p. 26) suggest that ‘‘Power is not merely domination but hegemony – that is, the ability to influence society morally and intellectually”. Moreover, Liu (2016) argue that corruption could be affected by political environment. We consider regions with corrupt top officials as having strong corruption culture and regions without corrupt top officials as having weak corruption culture.3 Dass et al. (2017) show that there is significant regional variation in terms of ‘‘corruption culture” in the United States, and public firms in more corrupt regions exhibit a greater propensity for corruption. When a corrupt top official is arrested on charges of corruption, this occurs as a shock to the public including both the corrupt officials themselves and the affiliated firms. This official will be removed from her post and this is very likely to affect the regional corruption culture because the connection between the corrupt official and firms is broken.