The impact of religiosity, culture, legal environment and corporate governance on earnings management methods

This thesis examines several important aspects of the impact of religiosity, national culture, corporate governance, BIG4 auditors and legal environment on earnings management practices in the U.S. and 63 other countries. First, the study investigates the extent to which religious socials norms of the firms’ environment interact with corporate governance and BIG4 audit to affect managers’ motivation to engage in expense and revenue misclassification in order to influence reported core earnings. The results show that religiosity decreases misclassification and complements corporate governance and the Sarbanes-Oxley Act (2002) to mitigate classification shifting in high, rural and geographically centralised segment areas. In a religious social norm environment, the study finds that managers have a disincentive to shift revenue items from, and core expenses into, special items to inflate reported core earnings to avoid market penalties and beat analysts’ forecasts, even more so in the presence of board independence. In addition, the study shows that the interactive term between religiosity and audit from the big four auditors also lowers the presence of misclassification. Overall, the results show that religiosity lessens misclassification and complements corporate governance and audit against the misclassification of revenue items or core expenses. Second, the study examines the extent to which religiosity, firms’ legal environment, and the interaction between these two variables affect accrual-based and real-activities earnings management. The results suggest that religiosity, legal environment and the interaction between them mitigate accrual-based earnings management. In contrast, the study observes a positive association between religiosity and real-activities earnings management, suggesting that religious social norms facilitate real-activities earnings management. However, the positive effect of religiosity on real activities is subdued when the study interacts the legal environment with religiosity. The results also indicate that firms’ corporate governance mechanism mitigates both accrual-based and real activities earnings management. Finally, in Chapter four, the study provides new international evidence by examining the relationship between the misclassification of core expenses into special items and country-wide religiosity, the national dimensions of culture, and the legal environment in developed, emerging and developing countries. The study observes that the interaction between religiosity and legal environment, or national cultural dimensions and legal environment, mitigates expense misclassification in developed, emerging and developing countries. Therefore, the positive effect of power distance, masculinity and uncertainty avoidance on earnings management can no longer be demonstrated when national dimensions of culture interact with the legal environment. In Chapter five, the study concludes, summarises and discusses some of its major findings and contributions. The limitations of the study, policy implications and suggestions for future research are also provided.