The effects of the European debt crisis on earnings quality

Abstract

The present study examines whether and to what extent the recent crisis in the European Union (EU) had an impact on the quality of the reported earnings of listed firms in countries with weak fiscal sustainability (Spain, Greece, Ireland, Italy, and Portugal)—countries that have been forced to apply harsh austerity measures and are practically under financial supervision by EU authorities. This study also examines whether incentives for earnings management, probably induced by the crisis, have led to differential effects in earnings quality. The earnings quality attributes examined include value relevance, timeliness, conditional conservatism, smoothing, management, persistence, and predictability. The reported results show that during the crisis, the change in most determinants of earnings quality favors higher earnings quality. However, the results also suggest that in the case of firms that exhibit the biggest discretionary accruals over a single period, most of the earnings quality attributes signal a decrease in earnings quality. These results persist, even when using controls for extremely poor performance. Therefore, the results of this study indicate that, on average, earnings quality has improved in the crisis period; however, in the presence of incentives for earnings management, earnings quality deteriorates.