The development of financial reporting quality in Eastern European Union countries in the aftermath of communism (Conference abstract)

Abstract

This is a study of the progress of eastern European Union countries with respect to the effective functioning of a financial reporting system, a foundation of efficient capital markets. Since efficient capital markets enhance capital allocation and give citizens opportunities to benefit from economic growth, financial reporting has effects that go beyond protection of investors. The eastern EU countries were until the fall of communism starting in 1989 planned socialist economies, which lacked not just the private ownership of firms, but also the system of law that would support a system of dispersed ownership. If one wishes to go beyond measuring earnings quality to understanding the reasons for it, one must understand the law that underlies it. The question in this study is how complete has been the transition from socialism to capitalism, as measured by the quality of financial reporting; that is, the extent of "earnings management." The paper starts by analyzing the evolution of the legal system as the supporting structure for good corporate governance, of which financial reporting is a part. On the basis of that analysis it proposes hypotheses about the level of earnings management compared with western EU firms, and it also develops hypotheses about the time series of earnings management. It uses the "small gain small loss" test that measures discontinuities around zero earnings to measure accounting manipulation. It uses a method that overcomes some of the limitations of the original methods of Burgstahler and Dichev (1997).</p