Individual Assignment 1

“Summary report of an article about financial reporting”

ACCT 610

MSc Finance

Prof: Ali A. Alnodel

Students name and ID:

 Amal Alsalloum - 421200442

About article
This assignment summarizes the article titled “How to Measure Country-Level Financial
Reporting Quality?” written by Qingliang Tang, Huifa Chen, and Zhijun Lin. The article
published in Journal of Financial Reporting and Accounting vol. 14 ss 2.

Article summary
Given the importance of global investments and globalization in capital markets, and the
relationship of the quality of financial reports to the cost of capital, corporate governance and
improving the distribution of capital sources. The study question relates to the importance of
finding a measure of the quality of financial reports internationally (country-level). Despite the
high interest and the large number of studies concerned with finding measures for the quality of
financial reports on more narrow scales (companies, industries ...), there is a lack of study on the
country-level that would enhance the confidence and aspirations of foreign investors in light of
global activity.

The study assumes the possibility of measuring the quality of financial reports at the country-
level through analyzing the accounting and auditing systems along with a number of indicators.

The work on the analysis of 38 capital market (state) data covering the period from 2000 to 2014
to find the index for the quality of financial reporting and ranking capital markets on this basis. It
is worth noting that financial institutions were excluded from the study due to the difference in
disclosure policies. The authors chose the indicators of the quality of the financial reports based
on their measurability, availability of necessary data, and clarity of their interpretations, which
were summarized by six indicators supported by recommendations from previous studies, they
are the loss avoidance ratio (LAR), profit decline avoidance ratio (PDAR), accruals ratio (AR)
qualified audit opinion ratio (QAOR), non-Big Four auditor ratio (NBAR), and audit fee ratio
(AFR).

By calculating the indicators, then following the method of the general financial reporting quality
index. The index is found by ranking the capital markets on the basis of indices, where all
indicators represent an inverse relationship with the quality of the financial report, except for
AFR, which has a direct relationship with it. The lowest score is evaluated in the inversely related
indicators with a score of 100, and then the rest of the capital markets are evaluated by calculating
it as a percentage of those of the highest quality. Then the results are calculated, weighed, and
aggregated. Then the annual financial reporting quality index is calculated. Finally, the average is
calculated and the capital markets ranking.

The result, which can be considered consistent, showed that the financial reporting quality index
is higher among developed countries than developing countries, which reflects the average lower
of the indicators loss avoidance ratio (LAR), accruals ratio (AR) qualified audit opinion ratio
(QAOR), non-Big Four auditor ratio (NBAR) and higher average of the indicators audit fee ratio
(AFR) and profit decline avoidance ratio (PDAR) to reflect the high quality of financial reports at
the corporate and country-level in developed countries.
The analysis of the correlation between the six indicators showed that all the coefficients were
less than 0.5. Univariate analysis using the Pearson and Spearman correlation matrix shows that
the financial reporting quality index has a negative relation with the rights of the outside investor,
positive relation with the legal enforcement, a significantly positive relation with firm size, and a
negatively associated with profitability and firm growth. Multiple regression analysis shows a
positive but not significant coefficient of investor protection, positive and significant coefficient
of legal enforcement and firm size but not for leverage, negative and significant coefficient of
profitability and firm growth. A number of robustness tests have been run as changing some
financial reporting quality indicators weighting (the same), substitute for Big Four auditors Big N
auditors that are full members of the Forum of Firms (FOF), and do additional tests with samples
from 2005 to 2014 to see if the IFRS adoption affect the rank of countries in terms of financial
reporting quality ( the ranks of countries didn’t change significantly). This may be caused by the
existence of other factors than accounting standards, and measure auditing indicators that are
not necessarily affected by IFRS.

Investors build their investment decisions based on the financial reports, the availability of a
measure to rate the quality of financial reports at a country-level will help evaluate markets
risk. The study measure is the first that used accounting and auditing system analysis.
Findings were typical international tests. These results show many opportunities for future
researches and help identify the impacts of changes in accounting standards or regulations to
help improve financial reporting quality in the country. The study had faced a lack of data
especially on emerging markets which limited the ability to take other indicators into
account.