Enforcement of Accounting Standards in Germany: The Pre- and Post-Misstatement Development of Censured Firms

Abstract

This paper focuses on implementation of a two-tiered external financial reporting enforcement mechanism in Germany 2004. The first objective of the study is the systematically evaluation of the information contained in 151 disclosed error announcements. I find that error announcement on average contain 3.64 single errors and 77% affect the reported profit. Small, high levered and relatively unprofitable firms are overrepresented by the sample of misstatement firms. In a second step, I investigate the development of censured firms over time; I track the pre- and post-misstatement development of the firms in terms of balance sheet data, financial ratios and (real) earnings management. The analysis detects increasing leverage ratios and a decline in profitability overtime. In the year of misstatement firms report large total and discretionary accruals, indicating earnings management. Compared to matched control firms, significant differences in profitability, market valuation, earnings management and real activities manipulations are observable. A major contribution of this study is the examination of trends in financial data and (real) earnings management over a number of years round misstatement as well as the elaboration of the distinction to non-misstating firms. My results show the meaning of the enforcement of IFRS for the quality of financial reporting to standard setters, policy makers, and investors in Germany.