Earnings quality across different reporting regimes

Abstract

PurposeSince the UK Companies Act 1981, different reporting standards have developed for different classes of company to reduce the reporting burden on non-listed companies. There are now different regimes for listed, large private, medium-sized, small and micro companies. This strategy raises the issue of whether earnings quality across the different classes of company is comparable. The paper aims to discuss this issue.Design/methodology/approachThe paper uses the smoothness of earnings to measure reporting quality across the different types of companies from 2006 to 2013, based on 514,000 observations. Smoothness is an indicator of poor quality.FindingsThe authors find that listed companies have the highest earnings quality, closely followed by small and micro companies. In contrast, large private and medium-sized companies have much lower earnings quality. Overall, the authors find companies which switch between reporting regimes have lower earnings quality. The authors also find that earnings quality is not affected by the small company exemption from audit.Research limitations/implicationsCompanies filing abbreviated accounts are excluded since they do not file an income statement. The recent revisions to UK GAAP (FRS 102 and FRS 105) are not examined due to insufficient data.Practical implicationsThe Financial Reporting Council’s (FRC) strategy of reducing the financial reporting and auditing obligations for small companies seems not to have significantly affected earnings quality. However, the FRC may need to review the reporting requirements of large private and medium-sized companies and also the option of companies to switch between reporting regimes; in these settings earnings quality appears to be weaker.Originality/valueThe paper studies the effect of earnings quality across the different reporting regimes in the UK. Novel and important features of the study are that the sample covers a wide variety of small and micro companies which have not been analyzed previously; the results are disaggregated by year, for assurance that the results are not driven by a single rogue year; and the authors also address the small company exemption from audit, and the flexibility of non-listed companies to switch between regimes.