Article: Tuesday, 18 November 2014
Financial reporting scandals are often followed by media frenzies, and regulators are pressured to call into account the perpetrators as a warning to others. But adjusting legislation immediately after a scandal emerges is a waste of effort, according to new research by PhD candidate Miriam Koning of Rotterdam School of Management, Erasmus University (RSM). According to her findings, negative press on its own is enough to create a behavioural change.
When news came out in 2001 that energy company Enron lacked in disclosing its financial information and had misguided investors and external users, the media jumped on it on a large scale. The media spectacle, which was outspokenly negative about Enron and its practices, was undeniable for the public and industries. Regulators, who were alarmed by the financial reporting scandal, called for immediate restricting measures lawfully forcing the company’s management to be transparent about its profits and losses. Nonetheless, as financial misrepresentations kept popping up, the adjusted legislation was costly and did not always have a far-reaching effect on the financial industry. Konings concluded that a behavioural change in the financial world was not always achieved through legislative measures.
In the Netherlands, multinational retailer Ahold’s accounting scandal in also received a lot of negative mentions in Dutch media. With Enron in mind, following up with adjusted legislation would be the expected action of Dutch regulators. But this did not happen. Surprisingly, the unfavourable media attention in itself managed to curb potentially harmful and manipulative reporting practices. In addition, the negative press created awareness among investors, who became less prone to ‘buy’ potentially opportunistic information.
With her dissertation The Financial reporting Environment; The role of the media, regulators and auditors, Miriam Koning raises the question: how necessary is implementing adjusted legislation following negative media attention? Her research shows that outspoken negative media attention – which then influences the opinion of the public – reaches much further and is more effective than initially thought. Changing legislation is not necessarily required to control how people behave – the power of the media can cause this change in behaviour.
Koning’s research nuances and shines a different light on regulators’ immediate reflex reaction to come up with limiting measures in legislation. She urges regulators to allow time to see what an industry’s reaction to the media is before implementing new laws. For media organisations, Koning’s research confirms that the effectiveness of their reporting can keep industries in line with ethical and correct behaviour.
In addition, Koning’s research focuses on a remarkable change in the regulation of financial reporting that took place during the past decade: the diffusion of International Financial Reporting Standards (IFRS) across the globe. The competitive benefits of IFRS are commonly put forward and seen as a reason for why in just a decade the system is being used by 120 countries worldwide. But is effectiveness of IFRS the real reason for the quick global spread? Koning’s research explores alternative motivations that may have been driving the widespread acceptance of IFRS and finds that changing ideas and the desire for legitimacy also play a role.
Financial reporting is the process of disclosing financial information about a company to external users. This dissertation investigates three parties involved in the environment of financial reporting: the media, regulators and auditors. The media, or more specifically the financial press, are central to the first study, which shows that reporting practices are sensitive to critique in the financial press. Both reporting choices and investor decisions can be affected by negative press.
The second study in this dissertation examines a significant change in the regulation of financial reporting that took place during the past decade: the worldwide diffusion of International Financial Reporting Standards (IFRS). IFRS’ competitive benefits that are commonly put forward are not equally important for every country. The study investigates alternative motivations that may have driven the widespread acceptance of IFRS and discovers that changing ideas and the desire for legitimacy also play a role.
The third study explores auditor selection in a time when credible financial reporting is particularly salient, namely when a company goes public. Many firms switch to another audit firm when they go public. Different audit quality levels are selected depending on the firm’s characteristics, ownership or its offering. But despite the careful selection of an auditor, audit quality does not seem to reduce underpricing. Overall, this dissertation emphasises that we need to examine an organisation’s environment in order to enrich our understanding of its financial reporting.
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