How to Measure Country level Financial Reporting Quality?

Qingliang Tang a,*, Huifa Chen b, Zhijun Lin c

School of Business, University of Western Sydney, Australia

School of Economics & Management, Shanghai Maritime University, Peoples Republic of China
c
Department of Accountancy & Law, Hong Kong Baptist University, Hong Kong
b

We thank the participants at the 6th International Conference on Asian Financial Markets, Fukuoka, Japan, the 7th
International Business Research Conference, Sydney, and workshop participants at the University of Western
Sydney and the University of South Australia, Neal Arthur and Sidney Gray for their insightful comments and
suggestions on earlier versions of this paper. Dr. Qingliang Tang acknowledges financial support from the
Accounting & Finance Association of Australia and New Zealand for the project. Dr. Huifa Chen acknowledges
financial support from the grants of National Natural Science Foundation of China (NSFC, No. 70872067),
Science & Technology Innovation Program of Shanghai Municipal Education Commission, Peoples Republic
of China (No. 12YS068), Science & Technology Program of Shanghai Maritime University, Peoples Republic
of China (No. 20110062) and China Scholarship Council. Any remaining error is the responsibility of the
authors.
*

Corresponding author: Dr. Qingliang Tang, School of Business, University of Western Sydney, Locked Bag
1797, Penrith South DC, NSW 2751, Australia, Tel: +61 2 9685 9465, Fax: +61 2 9685 9339, E-mail:
q.tang@uws.edu.au.

Electronic copy available at: http://ssrn.com/abstract=2114810

ABSTRACT
This study constructs six accounting and auditing indicators to develop a comprehensive
index to measure financial reporting quality of 38 main capital markets in the world from
2000 to 2007. In order to test the validity of the methodology, we use the index to tests
national institutional impact on financial reporting quality and find results that are consistent
with our prediction and previous studies. The evidence suggests the innovative quality
measure is appropriate and provide a useful tool for researchers who concern financial
reporting quality at country level.
Keywords: Country level financial reporting quality, financial reporting quality indicators and
index

Electronic copy available at: http://ssrn.com/abstract=2114810

1. Introduction
In pace with the rapid growth in international business and the globalization of capital
markets, financial reporting plays an important role in promoting international trades, capital
flows, economic growth and cross-country merger and acquisition. Prior studies document
that high quality financial reporting is beneficial to reduce information asymmetry and cost of
capital (e.g., Diamond and Verrecchia, 1991; Leuz and Verrecchia, 2000; Bhattacharya and
Daouk, 2002; Bhattacharya et al., 2003; Frankel and Li, 2004; Francis et al., 2004, 2005;
Daske et al., 2008), improve the efficiency of capital resource allocation (Sun, 2006;
Bushman et al., 2011) and corporate governance (Bushman and Smith, 2001).
Numerous efforts have been made by national and international organisations (including
stock market regulatory institutions and standards setters such as SEC, IASB, FASB,
IOSOCO) to improve financial reporting quality. However, there is a lack of an adequate
measure of the quality of financial reporting particularly at country level. While there is
plenty of firm level research, the methods adopted are not appropriate for cross country
analysis. Firm level differences in financial reporting quality are associated with management
motivation, while national differences reflect characteristics of the legal systems, capital
market development, investor protection (Leuz et al., 2003), corporate governance practices
(La Porta et al., 2000b), culture (Gray, 1988; Gray and Vint, 1995; Guan et al., 2005;
Doupnik, 2008; Guan and Pourjalali, 2010), and accounting standards, etc. This motivates us
to develop a method to measure the quality of national financial reports using accounting and
auditing data.
Financial reporting quality refers to the extent to which the financial statements provide
true and fair information about the underlying financial position and economic performance
(FASB, IASB, ASB [UK], and AASB [Australia]). Financial reporting quality could differ
due to complex interactions among many factors, so that it is inherently difficult to measure,
especially across borders. This study attempts to analyze the outcomes of accounting and
auditing systems and identify proxy indicators for financial reporting quality. A candidate
indicator that is under consideration meets all of the following criteria: 1) The indicator can
be reasonably, reliably measured; 2) Data for measuring the indicator is available; and 3)
3

Interpretation is straightforward, i.e., there is a direct link between the value of the indicator
variable and the reporting quality. More specifically, this study uses measures that are
intended to capture six dimensions of accounting and auditing quality: the loss avoidance
ratio, the profit decline avoidance ratio, the accruals ratio (i.e., scaled accruals), the qualified
audit opinion ratio, the non-Big 4 auditors ratio and the audit fee ratio (i.e., scaled audit fee).
We focus on them because prior studies have suggested that these indicators may capture the
strength of the link between financial reporting and underlying economic performance. This
study then develops a financial reporting quality index based on the six indicators for 38 main
capital markets in the world from 2000 to 2007 (per market per year). An overall financial
reporting quality index (FRQI, based on eight years average of the yearly indexes) is
constructed to determine the overall rank of financial reporting quality of each market. Note
this index is determined by the national institutional system and is first used in literature as a
proxy for national financial reporting quality.
In order to test whether the method is appropriate, we apply this index in an empirical
study of the impact of national institutional factors on reporting quality. If our methodology is
valid, we should find results that are consistent with our prediction and prior research. Using
data from 166,903 annual financial statements from 2000 to 2007 of publicly listed firms in
38 main capital markets around the world, we find that: 1) developed markets (such as United
States, United Kingdom, Australia, Japan and Germany) have higher financial reporting
quality than emerging markets; 2) Capital markets with stronger investor protection have
higher financial reporting quality; 3) The strength of legal enforcement also plays an
important role; and 4) Finally, despite that enormous international efforts have been made
towards the convergence, our results show that considerable diversity in accounting and
auditing still existed around the world; hence the effectiveness of global harmonisation
remains a crucial issue to be further explored.
These results are highly consistent with that documented by previous studies and thus
suggest that the methodology of this study is a valid measure of national financial reporting
quality. Prior studies typically use accounting variables only (e.g., Leuz et al., 2003;
Bhattacharya et al., 2003; Francis and Wang, 2008), which reflects a partial and incomplete
picture of reporting practices and quality. To improve the methodology we add auditing
4

factors to evaluate the reporting quality. Auditing is an independent verification that enhances
financial statement reliability and usefulness (Francis et al., 1999). Since auditing is an
integral part of the system, the inclusion of auditing variables would better reflect overall
financial reporting quality.
The rest of the paper is organised as follows. The next section discusses the
methodological issues in the measurement of country level financial reporting quality with
the development of proxy measures. Section 3 provides the data and presents financial
reporting quality of 38 national capital markets using our reporting quality index. Section 4 is
an application of our financial reporting quality index in a cross board study. The purpose of
the study is to test the validity of our methodology. We summarize our findings and discuss
the implications and limitations in the final section.
2. Country level financial reporting quality measure
2.1. Selection of financial reporting quality indicators
Financial statements are the result of managements representations and the auditors
assurance to outsiders about the validity of those representations (Krishnan, 2005). Therefore,
we consider both accounting and auditing aspects to determine the indicators of national
financial reporting quality.
2.1.1. Loss avoidance ratio
The first indicator is a measure of earnings management. The shareholders of public
firms with a dispersed ownership are likely to use a simple and explicit earnings-based
benchmark to assess firms financial position and economic performance. This gives
managers incentives to manipulate earnings in order to present a more favourable picture to
maximise their compensation and maintain their employment with the firm (Healy and
Wahlen, 1999). These incentives for self-wealth maximisation of managers would result in a
higher than expected number of firms with small profits. Prior studies support this conjecture.
For example, Burgstahler and Dichev (1997) present persuasive evidence that firms in the
United States actively engage in earnings management to avoid reporting losses. Prospect
theory provides an alternative explanation for the loss avoidance and profit decline avoidance
managerial behaviour. Prospect theory suggests that individuals value functions are concave
5

in gains and convex in losses (Kahneman and Tversky, 1979). Therefore, if zero is a natural
reference point for change in profit, then managers will manipulate earnings so the change is
positive. Such earnings management behaviour obscures the relationship between accounting
earnings and underlying economic performance, thus reduces financial reporting quality.
Following prior research, we define small profit (small loss) firms as firms with net
income scaled by lagged total assets between 0 and 1 percent (between -1 and 0 percent), and
the loss avoidance ratio is the ratio of the total number of small profit firms divided by the
total number of small loss firms (Burgstahler and Eames, 2003; Leuz et al., 2003; Burgstahler
et al., 2006; Jacob and Jorgensen, 2007). The higher the ratio is, the greater the level of
earnings management is, and thus the lower financial reporting quality is. The formula for
loss avoidance ratio for capital market k, year t is as follows:
Loss Avoidance Ratiok ,t

Total number of small profit firmsk ,t

(1)

Total number of small loss firmsk ,t

2.1.2. Profit decline avoidance ratio

The second indicator is profit decline avoidance ratio. Barth et al. (1999a, 1999b) show
that firms with longer strings of consecutive profit increases are priced at a premium, and that,
when these firms experience declines in profit, the premiums fall sharply. Similarly,
DeAngelo et al. (1996) find that a break in a pattern of consistent earnings growth is
associated with a substantial decline in stock price. Beatty et al. (2002) demonstrate that
public banks have more incentives to report steadily increasing earnings and tend to report
less small profit declines (relative to private banks). In summary, the price penalties for
falling short of prior profit, together with the possible effect of the stock price on managers
compensation package, gives managers of publicly traded firms a considerable incentive to
report a pattern of increasing profit.
Consistent with prior research (Burgstahler and Dichev, 1997), this study defines small
profit increase (decrease) firms as firms with change in net income scaled by lagged total
assets between 0 and 0.005 (between -0.005 and 0). The ratio decreases in financial reporting
quality. The formula for profit decline avoidance ratio for capital market k, year

is as

follows:

Profit Decline Avoidance Ratiok,t =

Total number of small profit increase firmsk ,t

Total number of small profit decrease firmsk ,t

(2)

2.1.3. Accruals ratio

The third indicator is the accruals ratio (also called scaled accruals), which is a measure
of accruals quality. Prior studies use accruals to measure earnings aggressiveness (e.g.,
Bhattacharya et al., 2003). Accruals magnitude reflects the degree of aggressiveness or
conservativeness of accounting policy. An aggressive accounting policy tends to delay the
recognition of losses and accelerate the recognition of gains, while a conservative accounting
policy does the opposite. Ball et al. (2000) argue that accounting conservatism implies a more
timely incorporation of economic losses into accounting earnings than economic gains, which
arises to reduce information asymmetry between managers and investors. Since managers are
more likely to report economic gains and might have incentives to suppress information
about economic losses, bad news information is more credible and timely incorporation of
economic losses into accounting earnings provides a quick feedback about bad business
decisions that managers may sometimes be reluctant to disclose.
The level of accruals is used to measure the degree of aggressiveness of an accounting
system. If we hold cash flow from operations realization as constant, we would expect
accruals to increase as earnings aggressiveness increases. Following previous studies, we
measure the accruals quality using accruals divided by lagged total assets (i.e., accruals ratio).
The following equation is used to calculate the firm-level accruals ratio (Healy, 1985; Jones,
1991; Dechow et al., 1995; Sloan, 1996):
Accruals Ratioi ,t

(CAi ,t Cashi ,t ) (CLi ,t STDEBTi ,t TPi ,t ) Depi ,t

TAi ,t 1

(3)

where CAi ,t is the change in current assets for firm i at year t, Cashi ,t is the change in cash
for firm i at year t, CLi ,t is the change in current liabilities for firm i at year t,

STDEBTi ,t is the change in short-term debt included in current liabilities for firm i at year t,
TPi ,t is the change in income taxes payable for firm i at year t, Depi ,t is the depreciation and

amortization expenses for firm i at year t, and TAi ,t 1 is the total assets for firm i at year t-11.
Then, the median observation of the firm-level accruals ratio (rather than the average to avoid
or minimize the influence of extreme values) of the firms in a capital market is used to
measure the market level reporting quality (e.g., Leuz et al., 2003). A smaller accruals ratio
suggests less managerial discretion and earnings management, and therefore, higher financial
reporting quality of the capital market in question.
Prior studies also use discretionary/abnormal accruals to detect firm-level earnings
management (e.g., Dechow et al., 1995, 2003; Jones et al., 2008). Discretionary accruals are
typically measured as the difference between total accruals and estimated non-discretionary
(normal) accruals that are determined by various cross-sectional discretionary accruals
models, e.g., the Jones model, the modified Jones model, the adapted Jones model, the
modified Jones model with book-to-market ratio and cash flows from operations, etc. (Jones,
1991; Dechow et al., 1995, 2003; Larcker and Richardson, 2004; Geiger and North, 2006;
Jones et al., 2008). The discretionary accruals are not employed because we do not have a
theory to estimate normal accruals in an international setting2.

2.1.4. Qualified audit opinion ratio

Next, we consider auditing variables. Financial statements are the representations of
management, and individual investors use them to make decisions but rely on the auditor to
verify the credibility of financial statements (Firth, 1978; Chow and Rice, 1982; Dopuch et
al., 1986; Chen et al., 2000). As an audit can effectively reduce and mitigate information
asymmetry, auditing is an integral part of the modern financial reporting system. When we
evaluate an accounting system in a capital market we should adequately consider the
auditors opinion and assurance on financial reports. An auditor may issue an unqualified or a
qualified opinion based on his/her examination. A qualified audit opinion is prima facie
evidence of low financial reporting quality, holding audit quality constant. Thus, the fourth
indicator is:
1

One of the reviewers of an early version of the paper pointed out the reversing nature of accruals. While we admit there is
inherent limitation, our method is consistent with previous studies in a similar research setting and context (Leuz et al., 2003;
Bhattacharya et al., 2003; Francis and Wang, 2008). For example, Bhattacharya et al. (2003) use total accruals in their study
that covers 34 countries from 1984 to 1998.
2
Discretionary accruals were hardly used in prior cross-country studies (e.g., Meuwissen et al., 2007; Francis and Wang,
2008; Wysocki, 2009) due to heterogeneity of institutional systems in national capital markets across borders.

Qualified Audit Opinion Ratiok,t =

Total number of qualified audit opinionsk ,t

Total number of the auditeesk ,t

(4)

2.1.5. Non-Big 4 auditor ratio

When we compare the proportion of qualified audit opinions between two capital
markets, we need to consider the identification of the auditors who issued the report. A low
quality auditor may issue an unqualified opinion without rigorous substantive testing. So we
introduce the fifth indicator, non-Big 4 auditor ratio, as a measure of external audit quality.
Auditing standards and practices, auditor training and education and the degree of auditor
independence varies across countries and so is the auditor quality. It is expected that a high
level of auditor quality is associated with a high quality of financial reporting. Therefore,
auditor quality is an important dimension of financial reporting quality.
Following prior research, we adopt auditor size as a proxy. Although large auditing firms
are not immune from audit risk and audit failure, large auditors are generally perceived as
being more independent (DeAngelo, 1981a, 1981b), more experienced, having a higher
industry expertise (Carcello and Nagy, 2003; Krishnan, 2003) and making larger investments
in professional education and training (Dopuch and Simunic, 1980). Big 4 auditors3 are more
prudent in order to protect their brand name since they have more to lose than non-Big 4
auditors in the event of

reputation loss (Krishnan, 2005). Based on the above analysis, it is

expected that high quality auditors will affect earnings quality by constraining aggressive
reporting of accruals and persuading clients to reveal economic losses in a timely fashion. So
the fifth indicator of financial reporting quality is non-Big 4 auditor ratio, and the formula is
as follows.

Non - Big 4 Auditor Ratiok,t = 1

Total number of firms that are audited by Big 4 auditorsk ,t

Total number of the auditeesk ,t

(5)

2.1.6. Audit fee ratio

Though large auditors generally deliver better services, it does not mean all large
auditors (or small auditors) provide the same quality of audit services. Thus we use the audit
fee to further differentiate auditing quality within the groups of large as well as small auditors.
3

We use the term Big 4 auditors throughout the paper to refer to Deloitte Touche Tohmatsu, Ernst & Young, KPMG and
PricewaterhouseCoopers. But Big 4 auditors include Arthur Andersen before 2002.

Different auditors (whether in larger or small auditor groups) charge different fees and we
conjecture the audit fee is associated with the audit quality. It is well known that the audit fee
charged is directly based on the working hours of auditors, and the hour rate is different
among partners, managers and junior audit staff, suggesting audit fee is highly related to
experience, expertise, knowledge of auditor, ceteris paribus. The difference in experience and
knowledge of auditing staff determines or at least is a decisive factor for the audit quality.
Auditor experience and expertise is the result of investment by auditing firm, and the audit
fee charged must compensate for the investment in audit quality including training, education,
working experience for audit staff, etc. From the clients perspective, audit fee represents the
expected quality of services the client pays for. Thus holding all else constant, the more the
audit fee paid the better the audit service acquired. From the auditors perspective, an
increase in the auditors non-detection penalty would increase the audit fee because in a
competitive audit market the fee must compensate the auditor for the higher expected loss
(Newman et al., 2005). If the inherent risk is perceived high, auditing firms will assign the
engagement to more competent and experienced staff thus resulting in a higher charge of
audit fee. In other words, a higher audit fee reflects the higher level of auditor efforts to
control and minimize the risk of audit failure. Thus, audit fee is a measure of audit quality
that complements, rather than duplicates the auditor size indicator. Since the audit fees are
also determined by other factors such as the complexity of transactions, volume of audit
services, quality of internal control and so on (e.g., Simunic, 1980; Palmrose, 1986; Hay et al.,
2006), we use total assets to control for these factors. The high quality of audit service would
have a positive impact on financial reporting quality4. So our last financial reporting quality
indicator is the audit fee ratio:

Audit Fee Ratioi,t =

Audit feei,t
Total assetsi,t

(6)

We use the median observation of firm-level audit fee ratio (rather than the average) for a
capital market in this study. The audit fee ratio increases in the quality of financial reporting
of the capital market.
4
Note we argue that audit fee is related to audit quality under the assumption of competitive audit market as opposed to
monopoly market.

10

2.2. Calculation of financial reporting quality index (hereafter FRQI)

Given the six individual indicators per capital market per year, we adopt an overall
quality index method (PricewaterhouseCoopers, 2001; Kurtzman et al., 2004; Kurtzman and
Yago, 2007, 2008) to calculate the financial reporting quality index (FRQI) for the sample
markets. The steps of this method application are as follows. First, we rank capital markets by
the six individual financial reporting quality indicators as defined above. All indicators,
except for audit fee ratio (which is positively related to reporting quality), are negatively
associated with financial reporting quality. Second, for each indicator of the first five (except
for audit fee ratio), the market with the lowest (highest for audit fee ratio) indicator value is
assigned a score of 100, and the score of other markets are calculated as a percentage of the
top score respectively5. Next, the scores for each indicator are equally weighted to calculate
the yearly financial reporting quality index (FRQI) for each capital market (i.e., FRQI = the
arithmetic average of the scores of 6 indicators)6. The index increases in reporting quality.
Finally, the eight-year average of FRQI determines a markets overall FRQI (or OFRQI) and
rank, which reflects the number of total markets of our sample that sit above it. Table 1
summarizes the definition and measurement of financial reporting quality indicators and both
yearly and overall FRQI.
Insert Table 1 here
3. Data and descriptive statistics

3.1. Sample and data

We select listed companies on 38 main capital (i.e., stock) markets in the world for this
study.

A capital market in our sample must have at least 300 total firm-year observations

from 2000 to 20077. As some countries may contain more than one stock exchange8, if this is
5

If a markets accruals ratio is positive, then the score on the accruals ratio of the market is assigned zero. In a robustness
test, if a capital markets accrual ratio is positive, then the negative score on the accruals ratio is used to calculate the
market-years FRQI, the results are virtually unchanged (not tabulated).
6
In our sample, the audit fees data of seven markets (i.e., Santiago Stock Exchange, Athens Stock Exchange, Indonesia
Stock Exchange, Korea Exchange, Mexican Stock Exchange, Moscow Interbank Currency Exchange (MICEX) and Taiwan
Stock Exchange) are not available from the Worldscope database for 2000 to 2007. In this case, the scores for the first five
financial reporting quality indicators (i.e., score on the loss avoidance ratio, score on the profit decline avoidance ratio, score
on the accruals ratio, score on the qualified audit opinion ratio, and score on the non-Big 4 auditor ratio) are used to calculate
the market-years FRQI.
7
For example, the Istanbul Stock Exchange (Turkey) and the Buenos Aires Stock Exchange (Argentina) are not included as
the total firm-year observations are less than 300 from 2000 to 2007.
8
In our 38 sample capital markets, 19 national markets have only one stock exchange (e.g., Austria, Belgium, France, Hong
Kong, Singapore, Taiwan), 8 markets have two stock exchanges (e.g., Chinese Mainland, Korea, Sweden, Thailand, UK), 3

11

the case, we chose the stock exchange(s) that is (are) the most important in the country.
Regarding sample firms, we only include companies that have financial statement data in the
Worldscope database needed to calculate the reporting quality indicators for at least three
consecutive years. In addition, consistent with prior studies (e.g., Hung, 2001; Francis and
Wang, 2008), financial institutions (i.e., those with four-digit Standard Industrial
Classification Codes between 6000 and 6999) are excluded from the sample due to their
distinct regulation and disclosure requirements. Our final sample consists of 166,903
firm-year observations (see far-right column of Table 2).
Insert Table 2 here

3.2. Descriptive statistics of firm-year observations and financial reporting quality of capital
market
Table 2 presents the overall FRQI (OFRQI) and ranking, yearly FRQI, market
development level and sample distribution. It shows that the total firm-year observations per
market range from 445 observations for the Portugal market (Euronext Lisbon) to 28,513
observations for the Japan market (Tokyo Stock Exchange). There are 21 (17) developed
(emerging) markets in our sample (see column 5 of Table 2).
The third column of Table 2 shows that the US market (NYSE) gets the highest overall
FRQI 42.49 (i.e., average of eight yearly FRQI), which ranks the US first in our sample. The
UK market (London Stock Exchange, 40.19) ranks next and the Finland market (NASDAQ
OMX Helsinki, 40.15) ranks the third on the list. The overall FRQI also indicates that
Australia (Australian Securities Exchange, 38.39), Japan (Tokyo Stock Exchange, 38.22),
Germany (Frankfurt Stock Exchange, 32.77) and three Scandinavian markets ((i.e., Finland,
Denmark [NASDAQ OMX Copenhagen] and Sweden [NASDAQ OMX Stockholm]) are
among the top 10 markets in terms of financial reporting quality. The overall FRQI of
Pakistan (Karachi Stock Exchange, 20.06), Malaysia (Bursa Malaysia, 19.26), Indonesia
(Indonesia Stock Exchange, 17.52), India (Bombay Stock Exchange, 16.34) and China
(Chinese Mainland Stock Exchange, 12.18) are among the lowest financial reporting quality
markets have three (i.e., Chile, Pakistan and Russia), Australian and Spanish markets have four, Canadian market has five,
Brazilian and Japanese markets have six, German market has eight, Indian and American markets have more than ten stock
exchanges. We select only one or two stock exchanges to represent the countrys capital market. For example, we choose
NYSE, because we believe NYSE is more representative for US capital market than other stock exchanges such as
NASDAQ, etc.

12

markets, which is consistent with prior studies that these markets9 have the greatest level of
earnings management in financial reporting (Leuz et al., 2003). The remainder columns of
Table 2 respectively report the yearly FRQI and rank (in parentheses) of our sample markets.

3.3. Descriptive statistics of financial reporting quality indicators

3.3.1. Loss avoidance ratio
Panel A of Table 3 presents eight-years average and rank (in parentheses) for the six
reporting quality indicators respectively. The mean of loss avoidance ratio (LAR) is 3.30,
which indicates the number of small profit firms is on average more than three times of that
of small loss firms10. This skewed distribution in favour of small profit firms suggests
earnings management is an international phenomenon and loss avoidance is one of the major
earnings management objectives. If we take the average ratio 3.30 as a benchmark, any
market whose ratio is above (below) 3.30 is a high (low) risk market with respect to earnings
management activities. High risk markets include: China (Chinese Mainland Stock Exchange,
17.16), Indonesia (Indonesia Stock Exchange, 5.48), Portugal (Euronext Lisbon, 5.24), Spain
(Madrid Stock Exchange, 5.11), Russia (MICEX 5.00), Japan (Tokyo Stock Exchange, 4.34),
India (Bombay Stock Exchange, 4.15) and Taiwan (Taiwan Stock Exchange, 4.11), while low
risk markets include Chile (Santiago Stock Exchange, 1.39), South Africa (Johannesburg
Stock Exchange, 1.40), Australia (Australian Securities Exchange, 1.46), Norway (Oslo Stock
Exchange, 1.58), Finland (NASDAQ OMX Helsinki, 1.70), Canada (Toronto Stock Exchange,
1.74), US (NYSE, 1.75) and UK (London Stock Exchange, 1.77).
Insert Table 3 here

3.3.2. Profit decline avoidance ratio

The overall eight year average of profit decline avoidance ratio (PDAR) is 1.61, which is
much lower than the loss avoidance ratio. The result suggests that firms have stronger
incentives to avoid a loss than to avoid a profit decrease. The best PDAR ratios are found in
the capital markets of Taiwan (1.06), India (1.11), Korea (Korea Exchange, 1.19), Brazil
(BM&FBOVESPA, 1.21), Sweden (NASDAQ OMX Stockholm, 1.22), Greece (Athens
9

Leuz et al. (2003), using cluster analysis, grouped these capital markets as insider economies with weak legal enforcement
cluster.
10
Our average loss avoidance ratio is slightly higher than that (3.196) reported in prior research using data of 31 countries
for 1990 to 1999 (Leuz et al., 2003). If we use the same 31 sample countries, the average loss avoidance ratio in 2000 to
2007 is 2.97 (not reported).

13

Stock Exchange, 1.26), Mexico (Mexican Stock Exchange, 1.27) and Israel (Tel Aviv Stock
Exchange, 1.30). High risk markets in profit decline avoidance activities include Spain
(Madrid Stock Exchange, 2.91), Russia (2.59), New Zealand (New Zealand Stock Exchange,
2.51), Ireland (Irish Stock Exchange, 2.34), Pakistan (Karachi Stock Exchange, 2.11), Austria
(Vienna Stock Exchange, 1.99), Indonesia (1.91) and Hong Kong (Hong Kong Stock
Exchange, 1.90).

3.3.3. Accruals ratio

The overall eight-year average accruals ratio (AR) is -0.035311. Using this as a
benchmark; we found that low earning management risk markets include Belgium (Euronext
Brussels, -0.0591), Austria (Vienna Stock Exchange, -0.0578), Germany (-0.0574), Finland
(-0.0534), Netherlands (Euronext Amsterdam, -0.0522), Denmark (NASDAQ OMX
Copenhagen, -0.0510), Norway (Oslo Stock Exchange, -0.0461), France (Euronext Paris,
-0.0454), Switzerland (SIX Swiss Exchange, -0.0454), Sweden (NASDAQ OMX Stockholm,
-0.0450) and UK (-0.0449). The high risk markets are China (-0.0124, which also shows a
highest loss avoidance ratio), India (Bombay Stock Exchange, -0.0137), Taiwan (-0.0156),
Greece (Athens Stock Exchange, -0.0179), Singapore (Singapore Exchange, -0.0181),
Indonesia (-0.0191), Hong Kong (-0.0191), Malaysia (Bursa Malaysia, -0.0194), Brazil
(BM&FBOVESPA, -0.0222), Korea (-0.0237) and Russia (MICEX, -0.0252)12.

3.3.4. Qualified audit opinion ratio

Next, we go through the auditing indicators. First, the overall eight-year average of
qualified audit opinion ratio (QROR) is 3.78%. We found the ratio varies considerably across
national capital market. In some markets firms received a pretty high percentage of qualified
audit opinions, e.g., Portugal (Euronext Lisbon, 20.77%), Australia (13.07%), Thailand
(Stock Exchange of Thailand, 12%), Indonesia (9.17%), Philippine (Philippine Stock
Exchange, 8.99%), Spain (Madrid Stock Exchange, 8.63%), Greece (8.54%) and Brazil
(8.20%). But, in other markets the ratio is quite low, for example, Japan (0.04%), Taiwan

11

This is lower than -0.02141 found by Bhattacharya et al. (2003) that cover 34 countries from 1984 to 1998. If we use the
same 33 countries (excluding the Istanbul Stock Exchange in Turkey), the average accruals ratio in 2000 to 2007 is -0.0362.
12
Note the ratio is calculated excluding financial firms. If the financial institutions are included, this ratio is -0.0254, which
is higher than that of the sample (i.e., -0.0353) excluding financial institutions. The result seems consistent with prior
research. For example, Beatty et al. (2002) demonstrate that public banks have more incentives to report steadily increasing
earnings and tend to report less small profit declines.

14

(0.26%), France (0.31%), Germany (0.63%) and Sweden (0.72%).

3.3.5. Non-Big 4 auditor ratio

The average non-Big 4 auditor ratio (NBAR) is 42.39% in our sample, suggesting a
huge difference in terms of audit market distribution. In the US market (NYSE), Big 4
auditors occupied nearly 94% of the audit market, while in Pakistan and India it is only
7.70% and 11.63%, respectively. In the worlds largest emerging market, China, the Big 4
auditors accounted for 12.20% of the audit market. These results suggest large auditors have
less influence in developing markets. However, the market difference also exists in developed
markets. For example, the Big 4 auditor ratio is about 35% in France, which is much lower
than that in the US (93.49%), Switzerland (86.15%), Spain (85.69%), Belgium (85.24%),
Ireland (83.06%) and Italy (Borsa Italiana, 80.47%).

3.3.6. Audit fee ratio

The average audit fee ratio (AFR) of eight years is about 0.12%, i.e., the audit fee
accounts for 0.12% of total assets in our sample. The top three highest audit fee ratios are
found in the UK (0.33%), Australia (0.31%) and Israel (Tel Aviv Stock Exchange, 0.22%),
while the bottom three lowest audit fee ratios are in Pakistan (0.01%), India (0.02%) and
China (0.03%).
In short, we find that the above six indicators present fairly large differences in financial
reporting quality across our sample markets. To the extent that the values of these indicators
are the outcome of the application of national accounting and auditing standards, the results
do not suggest substantial convergence of financial reporting and auditing practices around
the world.

3.4. Univariate results of capital market development level on FRQI and financial reporting
quality indicators
Panel B of Table 3 shows that the financial reporting quality index (FRQI) is statistically,
significantly higher in the developed markets than in the emerging markets (both mean and
median are different at 1% significance level). In addition, the results reveal that the
developed markets have on average a lower loss avoidance ratio, accruals ratio, qualified
audit opinion ratio and non-Big 4 auditor ratio, higher audit fee ratio (both mean and median
are different at 1% significance level), but higher profit decline avoidance ratio (the median
15

difference is significant at 5% level), indicating that listed companies in the developed

markets have demonstrated a higher overall reporting quality as well as a better individual
quality indicators (except for the profit decline avoidance ratio).

3.5. Correlations among financial reporting quality indicators

Panel C of Table 3 presents a correlation matrix among the six financial reporting quality
indicators. The results show that the absolute values of all correlation coefficients are less
than 0.50, suggesting multicollinearity is not a serious issue and the six indicators reflect
distinct dimensions of financial reporting quality and do not suffer from an overlapping
problem. Note the Pearson (Spearman) correlation coefficient between audit fee ratio (AFR)
and loss avoidance ratio (LAR) is -0.342 (-0.407) (significant at 1% level). This evidence
indicates higher audit fees relate to lower loss avoidance ratio (i.e., higher financial reporting
quality) and justifies the utility of audit service in terms of its function to ensure the reliability
of financial statements.
4. Institutional system and financial reporting quality

4.1. Investor protection and financial reporting quality

In this section, we examine whether country level institutional factors affect the quality
of financial reporting. Many cross-country studies define investor protection as the extent to
which the national law protects investors, and document that investor protection affects
capital market development and corporate policy choices (see La Porta et al. 1997, 1998,
1999, 2000a, 2000b, 2002).
Prior studies argue and find evidence that strong investor protection limits managers
ability to acquire private control benefits and thus reduces their incentives to manage earnings
and increase the demand for greater transparency (La Porta et al., 1998; Ball et al., 2000;
Leuz et al., 2003; Burgstahler et al., 2006; Morris and Gray, 2007). Appropriate investor
protection establishment also significantly mitigates the negative effect of higher accruals on
the value-relevance of earnings (Hung, 2001) and results in earnings that are more likely to
reflect underlying firm performance and reduce analyst forecast dispersion (Chang et al.,
2000). On the other hand, capital markets with weaker investor protection institutions have a
lower demand for public information and less voluntary disclosure (Francis et al., 2005),
16

lower quality accounting standards and auditing (La Porta et al., 1998; Hung, 2001). Based
on the above discussion, we develop the following hypothesis:
Hypothesis 1. Ceteris paribus, capital markets with higher outside investor rights have

higher financial reporting quality.

We use the revised anti-director rights index13 developed by Djankov et al. (2008) as a
proxy for outside investor protection institutions. It is an aggregate measure of minority
shareholder rights that ranges from zero to six in scale. Higher values of the index indicate
that minority shareholders are better protected against expropriation by management or large
shareholders.

4.2. Legal enforcement and financial reporting quality

Prior research suggests that rules alone are unlikely to be effective without proper
enforcement (Bhattacharya and Daouk, 2002). There is evidence that legal enforcement plays
a relatively more prominent role in corporate governance than investor protection laws
(DeFond and Hung, 2004). A strong system of legal enforcement could substitute for weak
rules since active and well-functioning courts could step in and rescue investors abused by
management (La Porta et al., 1998). Capital markets with a strong legal enforcement
mechanism are expected to effectively implement securities and corporate laws and
accounting standards that further limit managers ability to manipulate earnings (Leuz et al.,
2003; Burgstahler et al., 2006; Hay et al., 1996). In a stronger enforcement environment,
there are more stringent consequences for corporate directors from financial misstatements in
terms of civil and criminal liabilities, and other punishment and sanctions imposed by
regulatory agencies (Francis and Wang, 2008). Therefore, it is expected that strong legal
enforcement mechanisms will reduce the management opportunistic behavior and moral
hazard. Thus we propose the following hypothesis:
Hypothesis 2. There is a positive association between the strength of legal enforcement and
13
The revised anti-director rights include (1) the ability to vote by mail, (2) the ability to gain control of shares during the
shareholders meeting, (3) the possibility of cumulative voting for directors, (4) the ease of calling an extraordinary
shareholders meeting, (5) the availability of mechanisms allowing minority shareholders to make legal claims against
directors, and (6) shareholders have preemptive rights that can be waived only by a shareholders vote. Compared to the
original anti-director rights index developed by La Porta et al. (1998), the revised anti-director rights index is based on laws
and regulations applicable to publicly traded firms in May 2003 for 72 countries (versus in 1993 for 49 countries). The key
difference between the original and revised indices of anti-director rights lies in the treatment of enabling provisions
(Djankov et al., 2008). In the robustness test, we use the original anti-director rights index as an alternative measure of
outside investor rights. The results are virtually unchanged.

17

financial reporting quality.

We use the rule of law index developed by Kaufmann et al. (2008) to proxy for legal
enforcement. It measures the extent to which agents have confidence in and abide by the rules
of society. The index covers many aspects of rule of law such as enforceability of government
and private contracts, confidence in the judicial system, the courts and police, property rights,
executive accountability, confiscation/expropriation, as well as the likelihood of crime and
violence, and so on (see Kaufmann et al., 2008, 76-77). The value of this index ranges from
minus 3 to plus 3, with large values associated with a higher level of enforcement.
We also consider firm size, financial leverage, profitability and firm growth that are
related to the quality of financial reporting. It is expected that firm size is positively related to
the FRQI. Firm size may proxy for many influences, and particularly larger firms are more
likely to be subject to public scrutiny, analyst following, media coverage and regulators
examination (Ball and Foster, 1982; Lang and Lundholm, 1993; Ahmed and Courtis, 1999).
As a result, these firms would adopt more conservative accounting policies and are more
likely to be audited by Big 4 auditors. Financial leverage and profitability are used to control
for other firm-specific influencing factors (such as debt financing). It is expected that firm
growth is negatively related to the FRQI as higher growth firms may engage in more earnings
management activities. Based on the discussion and prior studies, we construct the following
regression model to perform our tests.
FRQI k ,t 0 1 InvProk ,t 2 LegEnf k ,t 1SIZEk ,t 2 LEVk ,t 3 ROAk ,t
4Growthk ,t iYear Controlst k ,t

(7)

In the equation (7), the dependent variable is country level reporting quality proxy,
financial reporting quality index (FRQI) and the main explanatory variables are investor
protection (InvPro) and legal enforcement (LegEnf). The coefficients of InvProk,t and LegEnfk,t
are expected to be positive and significant, indicating that both play an important role in
determining the quality of financial reporting. We include year dummy variable to control for
its impact in the empirical analyses.

4.3. Empirical results

4.3.1. Univariate analysis
Insert Table 5 here
18

Table 5 presents Pearson and Spearman correlation matrix between financial reporting
quality index (FRQI) and the test (explanatory) and control variables. As expected, there is a
positive relation between outside investor rights (InvPro) and FRQI (but insignificant), and
between legal enforcement (LegEnf) and FRQI (significantly positive, p=0.000). This result is
consistent with the Hypothesis 1 and 2. Turning to the other variables, we find firm size
(SIZE) is positively and significantly related to FRQI (p=0.000), suggesting larger firms have
a higher financial reporting quality. There is no significant relation between financial leverage
(LEV) and FRQI. The profitability (ROA) and FRQI is negatively associated (p=0.000).
Finally, we find that, as predicted, the association between firm growth (Growth) and FRQI is
significantly negative (p=0.000).

4.3.2. Multiple regression analysis

Table 6 presents the multiple regression results of investor protection and legal
enforcement on financial reporting quality. As expected, both investor protection (InvPro) and
legal enforcement (LegEnf) are significantly and positively associated with FRQI (t=2.38,
p<0.05 and t=7.53, p<0.01, respectively). This result is consistent with Hypotheses 1 and 2. A
further test shows that the coefficient of LegEnf is greater than the coefficient of InvPro
(CLegEnf = 4.07 > CInvPro = 1.13 > 0; LegEnf = InvPro, F value =15.33p<0.01), indicating that
legal enforcement plays a more important role in determining the quality of financial
reporting than investor protection. That is, if the investor protection law is not rigorously
enforced, it would have limited or little effect on the quality of financial reporting14. Prior
study provides similar evidence. For example, DeFond and Hung (2004) demonstrate that
legal enforcement plays a more important role in explaining the association between CEO
turnovers and firm performance than outside investor rights index. This is because the
effectiveness of regulations largely depends on proper enforcement.
Insert Table 6 here
To address the concern of multicollinearity and autocorrelation, we check the variance
inflation factor (VIF) and Durbin-Watson value (D-W value) and report them in Table 7. The
VIF values of Model (7) are less than 3, which suggest that the multicollinearity problem is
14

Ball et al. (2003) document that in the emerging markets (i.e., four East Asian countries), the quality of accounting
information is less dependent on accounting standards and disclosure rules, but more dependent on the enforcement
mechanisms of the standards and rules.

19

remote in our analyses. The D-W value of Model (7) is close to 2, suggesting autocorrelation
does not appear as an issue in the research design. The above results also suggest that the
FRQI is likely to be a reasonably appropriate measure of the quality of financial reporting
system at country level. Note for the signs of the regression coefficients, the two-tailed tests
we applied are conservative statements of the results.

4.4. Robustness tests

We run a number of robustness tests to check whether our results are sensitive to the
research design and model specifications.
First, we use equal weight (i.e., 1/6) to each of the 6 indicators to calculate the FRQI in
the main tests. However, some financial reporting quality indicators may be arguably more
important than others. For example, it can be argued that the LAR, PDAR and AR could be
more vital for measuring financial reporting quality than NBAR. Thus, we assign more weight
(i.e., 20%) to LAR, PDAR and AR and 13.3% weight to QAOR, NBAR and AFR,
respectively. The results (un-tabulated) are essentially the same.
Second, it can be argued that some large but non-Big 4 auditors perform equally good
audit work, thus the use of NBAR could be biased in favour of large auditors (i.e., Big-4) in
some countries15. To address this concern, we substitute Big-4 auditors with the Big N
auditors that are the full members of the Forum of Firms (FOF) of International Federation of
Accountants16 to calculate the non-Big N auditor ratio. Based on this new audit quality
indicator, we re-calculated the FRQI, the FRQI ranking and rerun the analyses. The results
(not tabulated) are virtually unchanged.
Third, we consider three widely used alternative measures of outside investor protection:
national legal system (i.e., common law versus code law), the original anti-director rights
index and the disclosure requirement index. Prior research shows that common law countries
15

For example, Panel A of Table 3 shows that the NBAR for the NYSE Euronext New York Stock Exchange is 6.51%,
which suggests that Big 4 auditors occupied nearly 94% of audit market in the NYSE Euronext New York Stock Exchange.
16
The Forum of Firms (FOF) is an association of international networks of accounting firms that perform transnational
audits, which is formally established in 2002. The full members of the FOF have committed to adhere to and promote the
consistent application of high-quality audit practices and standards worldwide, support convergence of national audit
standards with the International Standards on Auditing, and commit to meeting the FOFs membership obligations. Up to 13
April 2011, there are 22 full members of the FOF, i.e., BDO, Constantin Associates Network, Crowe Horwath International,
Deloitte Touche Tohmatsu Limited, Ernst & Young Global Limited, Grant Thornton International Ltd., HLB International,
IECnet, INPACT Audit Limited, JHI, JPA International, KPMG International Cooperative, Kreston International, Mazars,
Moore Stephens International Limited, PKF International Limited, PricewaterhouseCoopers International, RSM International
Limited, Russell Bedford International, SMS Latinoamrica, Talal Abu Ghazaleh & Co. International and UHY International
Limited.

20

provide stronger investor protection than code law countries due to common law countries
having a stronger orientation to private contracting and the protection of private property
rights (La Porta et al., 1998). The original anti-director rights index is an aggregate measure
of minority shareholder rights and ranges from zero to five (La Porta et al., 1998). The
disclosure requirement index measures the extent to which there is required disclosure of
information on insiders compensation, ownership by large shareholders, transactions with
related parties, etc. for firms issuing securities. A larger index value indicates stronger
investor protection (La Porta et al., 2006). We repeated the analyses and found the results
(unreported) are robust to the three alternative measures of outside investor rights.
Fourth, we repeated our tests using the following three alternative measures of legal
enforcement: the rule of law index17, the quality index of the legal system and enforcement,
and the Worldwide Governance Indicators. The quality index of the legal system and
enforcement is the mean value of three indices (i.e., efficiency of judicial system index, rule
of law index, and corruption index) (Leuz et al., 2003). The Worldwide Governance
Indicators18 are measured by the mean value of six indices (i.e., voice and accountability
index, political stability and absence of violence index, government effectiveness index,
regulatory quality index, rule of law index, and control of corruption index developed by
Kaufmann et al. (2008)). The results from using alternative legal enforcement measures do
not alter our inferences (unreported).
Finally, the results are also not sensitive to alternative measures of firm size (i.e., total
assets or market capitalization) and profitability (i.e., return on equity instead of return on
assets).
5. Conclusions and implications
The knowledge of financial reporting quality at country level is important for investors
and prior research shows investment risk is inversely related to financial reporting quality.
17

The rule of law index is an assessment of the law and order tradition in the country produced by the country risk rating
agency International Country Risk (ICR). It is the average of the months of April and October of the monthly index between
1982 and 1995 and the scale is from zero to ten (La Porta et al., 1998). A larger index indicates stronger legal enforcement.
18
The Worldwide Governance Indicators are based on hundreds of specific and disaggregated individual variables
measuring various dimensions of governance, taken from 35 data sources provided by 32 different organizations. They
assign these individual measures of governance to categories capturing these six dimensions of governance, and use an
unobserved components model to construct six aggregate governance indicators in each period. They cover 212 countries
and territories for 1996, 1998, 2000, and annually from 2002 to 2007. All six dimensions of governance range from minus 3
to plus 3 (Kaufmann et al., 2008).

21

Although the level of disclosure and accounting standards (e.g., IFRS, US GAAP) are often
used to proxy for financial reporting quality (e.g., Kurtzman et al., 2004; Kurtzman and Yago,
2007, 2008), there is lack of a reliable measure of national level financial reporting quality in
the accounting literature.
This paper extends the literature by constructing and employing the financial reporting
quality index (FRQI). This measure is innovative because the study is the first in literature to
use both accounting and auditing data to construct financial reporting quality indicators.
Using the index, we find our results of typical international tests are consistent with our
predictions and previous studies, suggesting the fFRQI is appropriate for country level
studies. Further research may adopt this quality measure to perform cross-country studies
such as investigating the impact of accounting reforms (e.g., IFRS adoption) as well as
changes in capital market legislation (e.g., the Sarbanes-Oxley Act) and corporate governance
on financial reporting quality around the world. In addition, the diversity of financial
reporting quality around capital markets in the world as documented in this study should
prompt market regulators, accounting standard setters and professional accounting bodies to
reinforce the efforts on international convergence of accounting and financial reporting
standards and practices.
One limitation of our study is that some data for the accounting and auditing indicators
are not available for some firms particularly in emerging markets. Another limitation is that
our sample includes only listed companies that may not fully represent financial reporting
practice of other organizations in the economies. Unavailable data further restrict our ability
to take into account of other potential indicators (e.g., accuracy of analysts earnings forecasts,
the ratio of firms with controlling shareholders) that may impact financial reporting quality at
country level, which is certainly an issue to be explored by future studies.

22

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97-110.
PricewaterhouseCoopers. (2001). The opacity index. A project of the Price Waterhouse Coopers endowment for
the study of transparency and sustainability.
Simunic, D. A. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research 22
(3), 161-190.
Sloan, R. G. (1996). Do stock prices fully reflect information in cash flows and accruals about future earnings?
The Accounting Review 71 (3), 289-315.
Sun, K., (2006). Financial reporting quality, capital allocation efficiency, and financial structure: an international
study. Working paper, University of Hawaii at Manoa.
Tang, Q. (2007). How to measure financial reporting quality internationally? Working paper, University of
Western Sydney.
Wysocki, P. (2009). Assessing earnings and accruals quality: U.S. and international evidence. Working Paper,
Massachusetts Institute of Technology.

26

Table 1
Measurement of financial reporting quality indicators and index
Variable
LAR

Variable Name
Loss
Avoidance
Ratio

Measurement
Loss avoidance ratio is the ratio of total number of small profit
firms divided by total number of small loss firms. Firms with net
income scaled by lagged total assets between 0 and 0.01 (between
-0.01 and 0) are defined as small profit (small loss) firms.

Source
Burgstahler
and Dichev
(1997); Leuz
et al. (2003)

PDAR

Profit
Decline
Avoidance Ratio

Profit decline avoidance ratio is the ratio of total number of small

profit increase firms divided by total number of small profit
decrease firms. Firms with change in net income scaled by lagged
total assets between 0 and 0.005 (between -0.005 and 0) are
defined as small profit increase (decrease) firms.

Burgstahler
and Dichev
(1997)

AR

Accruals Ratio

Accruals ratio is the capital markets median ratio of the firm-level

accruals scaled by lagged total assets, where accruals are
calculated as (current assets - cash) - (current liabilities short-term debt - tax payable) - depreciation and amortization
expense.

Dechow et al.
(1995); Sloan
(1996); Leuz
et al. (2003)

QAOR

Qualified
Audit
Opinion Ratio

Qualified audit opinion ratio is the ratio of total number of

qualified audit opinions divided by total number of the auditees.

NBAR

Non-Big 4 Auditor
Ratio

Non-Big 4 auditor ratio equals one minus Big 4 auditor ratio,

where Big 4 auditor ratio is the ratio of total number of firms that
are audited by Big 4 auditors divided by total number of the
auditees.

AFR

Audit Fee Ratio

Audit fee ratio is the capital markets median ratio of the firm-level
audit fee scaled by total assets (audit fee and total assets are both
in millions of US dollars).

FRQI

Financial Reporting
Quality Index

The financial reporting quality index is jointly determined by the

above six accounting and auditing indicators. For each indicator of
the first five, the capital market with the lowest indicator value is
assigned a score of 100, and other capital markets are calculated as
a percentage of the top score. The higher is the score the higher is
the financial reporting quality of a particular capital market. If a
capital markets accruals ratio is positive, then the score on the
accruals ratio of this capital market is assigned zero. For the audit
fee ratio, which is opposite to the first five indicators as the capital
market with the highest indicator value is assigned a score of 100,
and other capital markets are calculated as a percentage of the top
score. Each indicator scores are equally weighted to calculate the
FRQI for a capital market. If the audit fee ratio is not available in a
capital market, then the scores for the first five financial reporting
quality indicators (i.e., score on the loss avoidance ratio, score on
the profit decline avoidance ratio, score on the accruals ratio, score
on the qualified audit opinion ratio, and score on the non-Big 4
auditor ratio) are used to calculate the capital markets FRQI.

OFRQI

Overall Financial
Reporting Quality
Index

Overall financial reporting quality index equals eight years average

of yearly financial reporting quality index.

Tang (2007)

27

Table 2
Overall and yearly financial reporting quality index, ranking, capital market development level and sample distribution
Rank Capital Market
(Stock Exchange)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23

US (NYSE Euronext
New York)
UK (London)
Finland (NASDAQ
OMX Helsinki)
Denmark (NASDAQ
OMX Copenhagen)
Australia (Australian)
Japan (Tokyo)
Sweden (NASDAQ
OMX Stockholm)
Israel (Tel Aviv)
Netherlands (Euronext
Amsterdam)
Switzerland (SIX
Swiss)
Norway (Oslo)
Ireland (Irish)
Germany (Frankfurt)
Belgium (Euronext
Brussels)
France (Euronext
Paris)
Canada (Toronto)
South Africa
(Johannesburg)
Austria (Vienna)
New Zealand (New
Zealand)
Mexico (Mexican)
Italy (Borsa Italiana)
Chile (Santiago)
Thailand (Thailand)

42.49

Developed

40.05 (6)

41.91 (3)

43.52 (7)

36.48 (8)

36.53 (4)

43.12 (1)

47.28 (1)

51.07 (2)

No. of
observatio
ns
11,119

40.91
40.15

Developed
Developed

46.18 (3)
33.92 (12)

43.42 (1)
38.10 (10)

43.40 (8)
36.16 (13)

36.29 (9)
31.11 (13)

37.76 (3)
56.23 (1)

42.09 (3)
40.33 (6)

42.54 (3)
46.88 (2)

35.61 (11)
38.47 (7)

12,379
1,045

38.72

Developed

48.76 (1)

41.84 (4)

32.26 (19)

48.63 (1)

35.08 (5)

37.79 (8)

34.49 (9)

30.96 (17)

922

38.39
38.22
38.13

Developed
Developed
Developed

45.53 (4)
37.36 (8)
39.69 (7)

39.28 (8)
43.36 (2)
38.84 (9)

45.00 (4)
46.83 (3)
47.34 (2)

34.99 (10)
39.53 (3)
37.72 (5)

30.15 (13)
32.52 (7)
42.39 (2)

40.70 (5)
34.26 (10)
28.62 (21)

33.35 (11)
36.41 (7)
40.29 (5)

38.09 (9)
35.45 (12)
30.15 (20)

9,710
28,513
2,391

36.48
36.18

Emerging
Developed

33.90 (13)
31.87 (14)

22.97 (29)
32.14 (15)

57.76 (1)
44.24 (6)

48.17 (2)
37.20 (6)

29.80 (15)
32.40 (8)

27.66 (22)
37.00 (9)

30.82 (16)
32.50 (12)

40.76 (5)
42.08 (4)

1,090
1,354

35.77

Developed

48.69 (2)

34.52 (13)

39.85 (9)

31.64 (12)

32.14 (9)

33.08 (12)

31.92 (14)

34.31 (14)

1,591

35.29
35.25
32.77
31.78

Developed
Developed
Developed
Developed

36.86 (9)
30.32 (16)
30.52 (15)
33.99 (11)

35.94 (12)
40.09 (7)
32.59 (14)
37.74 (11)

44.48 (5)
28.44 (21)
33.63 (16)
32.50 (18)

38.07 (4)
26.05 (23)
30.42 (14)
27.37 (17)

29.71 (16)
31.85 (10)
33.53 (6)
28.48 (17)

27.20 (23)
42.86 (2)
30.87 (15)
29.77 (18)

33.79 (10)
29.35 (18)
32.13 (13)
24.57 (25)

36.24 (10)
53.07 (1)
38.44 (8)
39.80 (6)

1,248
553
5,146
806

31.02

Developed

23.45 (30)

31.58 (16)

38.44 (10)

32.78 (11)

31.44 (11)

30.56 (17)

30.29 (17)

29.61 (21)

5,515

30.89
30.24

Developed
Emerging

36.25 (10)
44.85 (5)

30.30 (17)
28.53 (18)

34.38 (15)
24.59 (28)

26.94 (18)
26.51 (22)

22.70 (23)
30.66 (12)

32.62 (14)
41.72 (4)

31.61 (15)
23.17 (28)

32.31 (16)
21.91 (30)

10,605
2,376

29.80
29.69

Developed
Developed

23.87 (29)
29.51 (18)

41.34 (6)
26.41 (22)

35.55 (14)
26.38 (26)

27.80 (16)
28.34 (15)

30.13 (14)
23.20 (22)

29.27 (20)
29.60 (19)

22.84 (30)
28.23 (21)

27.63 (25)
45.86 (3)

611
698

29.27
28.38
27.62
27.41

Emerging
Developed
Emerging
Emerging

29.96 (17)
25.04 (26)
27.92 (20)
23.36 (31)

24.73 (26)
27.80 (20)
25.11 (24)
28.34 (19)

20.20 (34)
36.24 (12)
28.12 (23)
32.66 (17)

26.55 (21)
26.93 (19)
23.62 (24)
37.03 (7)

24.68 (20)
25.68 (19)
19.23 (27)
13.80 (32)

39.97 (7)
33.80 (11)
24.23 (25)
23.01 (28)

38.56 (6)
20.63 (33)
42.39 (4)
28.47 (20)

29.51 (22)
30.95 (18)
30.31 (19)
32.59 (15)

904
1,840
1,226
3,172

OFRQI
(overall)

CapitalMarket
Level

2000

2001

2002

FRQI (yearly)
2003
2004

2005

2006

2007

28

24 Spain (Madrid)
25 Philippine
(Philippine)
26 Taiwan (Taiwan)
27 Portugal (Euronext
Lisbon)
28 Brazil
(BM&FBOVESPA)
29 Russia (MICEX)
30 Hong Kong (Hong
Kong)
31 Singapore (Singapore)
32 Korea (Korea)
33 Greece (Athens)
34 Pakistan (Karachi)
35 Malaysia (Bursa
Malaysia)
36 Indonesia (Indonesia)
37 India (Bombay)
38 China (Chinese
Mainland)

27.10
25.67

Developed
Emerging

24.95 (27)
28.67 (19)

23.57 (28)
41.60 (5)

22.40 (32)
24.87 (27)

22.39 (26)
20.69 (29)

26.42 (18)
21.62 (25)

32.66 (13)
22.41 (30)

29.20 (19)
25.69 (22)

35.24 (13)
19.81 (31)

936
1,207

24.73
23.90

Emerging
Emerging

24.47 (28)
18.84 (34)

27.34 (21)
25.06 (25)

22.03 (33)
37.31 (11)

15.09 (36)
18.43 (32)

18.42 (29)
23.83 (21)

27.09 (24)
16.56 (35)

34.57 (8)
25.04 (23)

28.83 (24)
26.12 (26)

10,031
445

22.41

Emerging

15.44 (36)

24.13 (27)

28.07 (24)

20.49 (30)

22.64 (24)

23.21 (27)

21.52 (32)

23.81 (28)

2,395

22.31
22.10

Emerging
Developed

27.13 (21)
23.09 (32)

19.97 (34)
21.55 (31)

19.78 (35)
24.51 (29)

26.56 (20)
23.35 (25)

11.71 (35)
18.31 (30)

20.28 (33)
22.99 (29)

24.12 (26)
20.39 (34)

28.94 (23)
22.60 (29)

577
6,034

21.25
20.48
20.09
20.06
19.26

Developed
Emerging
Emerging
Emerging
Emerging

26.33 (22)
22.53 (33)
10.98 (37)
26.06 (23)
25.32 (25)

25.97 (23)
20.09 (33)
18.53 (35)
15.99 (37)
21.15 (32)

27.27 (25)
24.13 (30)
28.71 (20)
18.82 (37)
19.56 (36)

22.21 (27)
16.35 (33)
19.06 (31)
22.20 (28)
16.15 (35)

16.27 (31)
18.67 (28)
21.17 (26)
3.89 (38)
10.82 (37)

15.47 (37)
21.31 (32)
30.62 (16)
23.83 (26)
21.69 (31)

23.08 (29)
21.69 (31)
17.76 (35)
24.96 (24)
23.43 (27)

13.42 (35)
19.08 (32)
13.90 (34)
24.74 (27)
16.00 (33)

4,004
6,773
2,169
793
6,209

17.52
16.34
12.18

Emerging
Emerging
Emerging

26.00 (24)
17.18 (35)
9.93 (38)

22.36 (30)
16.07 (36)
12.74 (38)

23.92 (31)
28.18 (22)
16.55 (38)

13.65 (37)
16.23 (34)
6.51 (36)

12.88 (33)
12.86 (34)
11.23 (36)

16.71 (34)
13.11 (38)
16.22 (37)

17.33 (36)
14.28 (38)
15.65 (37)

7.34 (38)
12.80 (36)
8.62 (37)

2,007
6,536
11,973

9.93
48.76
29.70
28.30
9.67

12.74
43.42
29.55
28.07
8.75

16.55
57.76
32.06
30.48
9.73

6.51
48.63
27.36
26.74
9.35

3.89
56.23
25.29
25.18
10.20

13.11
43.12
29.06
29.43
8.47

14.28
47.28
28.98
28.84
8.34

7.34
53.07
29.64
30.23
10.88

445
28,513
4,392
2,088
5,452

Total
Minimum
Maximum
Mean
Median
Std. Dev.

12.18
42.49
28.95
29.48
7.75

Notes:
Annual financial statement data of all the publicly listed firms on 38 developed and emerging capital markets for 2000 to 2007 were obtained from the Worldscope database.
The overall rank of a capital market is determined by the overall financial reporting quality index (OFRQI) of individual markets. The higher is the OFRQI the higher is the rank. A capital markets rank
reflects the number of capital markets in the group under study that sit above it. The classification of developed markets and emerging markets is from Bhattacharya and Daouk (2002). FRQI is the
financial reporting quality index. The rank value of each stock exchange-year FRQI is in parentheses. The OFRQI and FRQI are as defined before.
The following is a brief description of 38 sample stock exchanges:
The Athens Stock Exchange (ASE) is a stock exchange located in Athens, Greece.
The Australian Securities Exchange (ASX) was created by the merger of the Australian Stock Exchange and the Sydney Futures Exchange in July 2006. It is the primary stock exchange group in Australia.
BM&FBOVESPA is Brazils largest stock exchange located at So Paulo, Brazil. On 8 May 2008, the So Paulo Stock Exchange (Bovespa) and the Brazilian Mercantile and Futures Exchange (BM&F)
merged, creating BM&FBOVESPA.
The Bombay Stock Exchange (BSE) is a stock exchange located on Dalal Street, Mumbai and is the oldest stock exchange in Asia and the largest stock exchange in India by market capitalization.
Borsa Italiana is Italys main stock exchange. It was privatized in 1997 and is a part of the London Stock Exchange Group since 2007.
Bursa Malaysia was previously known as Kuala Lumpur Stock Exchange (KLSE). The KLSE was renamed Bursa Malaysia Berhad on 14 April 2004, following the demutualization exercise, the purpose
of which was to enhance competitive position and to respond to global trends in the exchange sector by making themselves more customer-driven and market-oriented.

29

The Chinese Mainland Stock Exchange includes Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE). SSE was re-established on 26 November 1990 and was in operation on December
19 of the same year, and SZSE was founded on 1 December 1990.
Euronext N.V. is a pan-European stock exchange, which was formed on 22 September 2000 following a merger of the Amsterdam Stock Exchange, Brussels Stock Exchange, and Paris Bourse, in order to
take advantage of the harmonisation of the European Union financial markets. In December 2001, Euronext acquired the shares of the London International Financial Futures and Options Exchange
(LIFFE), which continues to operate under its own governance. In 2002 the group merged with the Portuguese stock exchange. Then the Amsterdam Stock Exchange, Brussels Stock Exchange, Paris
Bourse and Portuguese Stock Exchange were renamed Euronext Amsterdam, Euronext Brussels, Euronext Paris and Euronext Lisbon. On 4 April 2007, Euronext merged with NYSE Group to form NYSE
Euronext, the first global stock exchange.
The Frankfurt Stock Exchange (FSE) is owned and operated by Deutsche Brse AG, which also owns the European futures exchange (Eurex) and the clearing company (Clearstream). FSE accounts for
over 90 percent of the turnover in the German market and a very large share of the European market.
The Hong Kong Stock Exchange (HKEx) is a stock exchange located in Hong Kong. It is Asias third largest stock exchange in terms of market capitalization behind the Tokyo Stock Exchange and the
Shanghai Stock Exchange. Hong Kong Exchanges and Clearing is the holding company for the exchange.
The Indonesia Stock Exchange (ISE) is a stock exchange based in Jakarta, Indonesia. It was previously known as Jakarta Stock Exchange (JSE) before its name changed in 2007 after merging with
Surabaya Stock Exchange (SSX).
The Irish Stock Exchange (ISE) is Irelands only stock exchange and has been in existence since 1793. It is an Irish private company limited by guarantee.
The Johannesburg Stock Exchange (JSE) Limited (previously the JSE Securities Exchange and the Johannesburg Stock Exchange) is the largest stock exchange in Africa.
The Karachi Stock Exchange (KSE) is a stock exchange located in Karachi, Sindh, Pakistan. It is Pakistans largest and oldest stock exchange, with many Pakistani as well as overseas listings.
The Korea Exchange (KRX) is the sole securities exchange operator in South Korea. It is headquartered in Busan, and has an office for cash markets and market oversight in Seoul. The Korea Exchange
was created through the integration of Korea Stock Exchange, Korea Futures Exchange and KOSDAQ Stock Market under the Korea Stock & Futures Exchange Act. The securities and derivatives markets
of former exchanges are now business divisions of Korea Exchange: the Stock Market Division, KOSDAQ Market Division and Derivatives Market Division.
The London Stock Exchange (LSE) is a stock exchange located in the City of London, England, within the United Kingdom. LSE is part of the London Stock Exchange Group.
The Madrid Stock Exchange (MSE) is the largest and most international of Spains four regional stock exchanges (the others are located in Barcelona, Valencia, and Bilbao) that trade shares and
convertible bonds and fixed income securities, and both government and private-sector debt. MSE is owned by BME Spanish Exchanges.
The Mexican Stock Exchange (BMV, Bolsa Mexicana de Valores) is Mexicos only stock exchange. It is the second largest stock exchange in Latin America (after Brazils BM&FBOVESPA) and the fifth
largest in the Americas by market capitalization.
The Moscow Interbank Currency Exchange (MICEX) is one of the largest universal stock exchanges in the Russian Federation and East Europe. MICEX opened in 1992 and is the leading Russian stock
exchange.
OMX AB is a Swedish-Finnish financial services company, formed in 2003 through a merger between OM AB and Helsinki Stock Exchange (HEX) plc, where OM AB (Optionsmklarna) was a futures
exchange founded by Olof Stenhammar in the 1980s to introduce trading in standardized option contracts in Sweden. OM acquired the Stockholm Stock Exchange in 1998. On 3 September 2003, the
Helsinki Stock Exchange (HEX) merged with OM, and the joint company became OM HEX. On 31 August 2004, the brand name of the company was changed to OMX. OMX then acquired the
Copenhagen Stock Exchange and the Iceland Stock Exchange in January 2005 and December 2006, respectively. OMX acquired the Armenian Stock Exchange and Central Depository in November 2007.
On 25 May 2007, NASDAQ agreed to buy the Swedish-Finnish financial company that controls seven Nordic and Baltic stock exchanges OMX to form NASDAQ OMX Group. As of 27 February 2008,
the deal was completed. Then the Copenhagen Stock Exchange, Helsinki Stock Exchange, Iceland Stock Exchange and Stockholm Stock Exchange were renamed NASDAQ OMX Copenhagen, NASDAQ
OMX Helsinki, NASDAQ OMX Iceland and NASDAQ OMX Stockholm.
The New Zealand Stock Exchange (NZX) is a stock exchange located in Wellington, New Zealand.
The NYSE Euronext New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the worlds largest stock exchange by market
capitalization. The NYSE is operated by NYSE Euronext, which was formed by the NYSEs 2007 merger with the fully electronic stock exchange Euronext.
The Oslo Stock Exchange (OSE) serves as the main market for trading in the shares of Norwegian companies. In additional to a wide range of domestic companies, the OSE attracts a lot of international
companies within petroleum, shipping and other related areas.
The Philippine Stock Exchange (PSE) is the national stock exchange of the Philippines. It is one of the oldest stock exchanges in Southeast Asia, having been in continuous operation since its inception in
1927.
The Santiago Stock Exchange (SSE) is Chiles dominant stock exchange.
Singapore Exchange Limited (SGX) is an investment holding company located in Singapore and providing different services related to securities and derivatives trading and others.
The SIX Swiss Exchange (formerly SWX Swiss Exchange), based in Zurich, is Switzerlands principal stock exchange (the other being Berne eXchange). SIX Swiss Exchange also trades other securities
such as Swiss government bonds and derivatives such as stock options.
The Taiwan Stock Exchange Corporation (TSEC) is a financial institution, located in Taipei, Taiwan. It is regulated by the Financial Supervisory Commission.
The Tel Aviv Stock Exchange (TASE) is Israels only stock exchange.

30

The Stock Exchange of Thailand (SET) is the national stock exchange of Thailand, which is located in Bangkok, Thailand.
The Tokyo Stock Exchange (TSE) is located in Tokyo, Japan and is the third largest stock exchange in the world by aggregate market capitalization of its listed companies.
The Toronto Stock Exchange (TSX, formerly TSE) is the largest stock exchange in Canada, the third largest in North America and the seventh largest in the world by market capitalisation. Based in
Canadas largest city, Toronto, it is owned by and operated as a subsidiary of the TMX Group for the trading of senior equities. A broad range of businesses from Canada, the United States, Europe, and
other countries are represented on the exchange.
The Vienna Stock Exchange (VSE) is the only stock exchange in Vienna, Austria, and one of the most established exchanges in Eastern and Southeastern Europe.

31

Table 3
Descriptive statistics
Panel A: Descriptive statistics of financial reporting quality indicators
Capital Market (Stock
Exchange)
Greece (Athens)
Australia (Australian)
Brazil
(BM&FBOVESPA)
India (Bombay)
Italy (Borsa Italiana)
Malaysia (Bursa
Malaysia)
China (Chinese
Mainland)
Netherlands (Euronext
Amsterdam)
Belgium (Euronext
Brussels)
Portugal (Euronext
Lisbon)
France (Euronext
Paris)
Germany (Frankfurt)
Hong Kong (Hong
Kong)
Indonesia (Indonesia)
Ireland (Irish)
South Africa
(Johannesburg)
Pakistan (Karachi)
Korea (Korea)
UK (London)
Spain (Madrid)
Mexico (Mexican)
Russia (MICEX)
Denmark (NASDAQ
OMX Copenhagen)
Finland (NASDAQ
OMX Helsinki)
Sweden (NASDAQ
OMX Stockholm)
New Zealand (New
Zealand)
US (NYSE Euronext
New York)
Norway (Oslo)
Philippine
(Philippine)
Chile (Santiago)
Singapore (Singapore)
Switzerland (SIX
Swiss)
Taiwan (Taiwan)
Israel (Tel Aviv)
Thailand (Thailand)
Japan (Tokyo)
Canada (Toronto)
Austria (Vienna)
Minimum
Maximum
Mean

LAR

PDAR

AR

QAOR

NBAR

AFR

2.89 (22)
1.46 (3)
2.42 (15)

1.26 (6)
1.54 (20)
1.21 (4)

-0.0179 (35)
-0.0371 (20)
-0.0222 (30)

0.0854 (32)
0.1307 (37)
0.0820 (31)

0.7964 (35)
0.4898 (29)
0.4171 (21)

n.a.
0.0031 (2)
0.0006 (20)

4.15 (32)
2.54 (16)
2.94 (23)

1.11 (2)
1.57 (22)
1.31 (9)

-0.0137 (37)
-0.0392 (17)
-0.0194 (31)

0.0489 (29)
0.0105 (12)
0.0268 (24)

0.8837 (37)
0.1953 (6)
0.4001 (20)

0.0002 (30)
0.0005 (23)
0.0004 (25)

17.16 (38)

1.70 (28)

-0.0124 (38)

0.0095 (9)

0.8780 (36)

0.0003 (29)

3.58 (28)

1.79 (29)

-0.0522 (5)

0.0084 (7)

0.1476 (4)

0.0014 (13)

2.61 (17)

1.65 (26)

-0.0591 (1)

0.0321 (26)

0.4430 (23)

0.0009 (19)

5.24 (36)

1.86 (30)

-0.0436 (12)

0.2077 (38)

0.4843 (27)

0.0004 (26)

3.39 (27)

1.62 (25)

-0.0454 (8)

0.0031 (3)

0.6469 (34)

0.0018 (6)

2.68 (18)
3.58 (29)

1.56 (21)
1.90 (31)

-0.0574 (3)
-0.0191 (32)

0.0063 (4)
0.0481 (28)

0.5470 (30)
0.3811 (17)

0.0015 (10)
0.0015 (9)

5.48 (37)
2.40 (14)
1.40 (2)

1.91 (32)
2.34 (35)
1.59 (24)

-0.0191 (33)
-0.0345 (22)
-0.0333 (23)

0.0917 (35)
0.0337 (27)
0.0215 (21)

0.6341 (33)
0.1694 (5)
0.4796 (26)

n.a.
0.0017 (7)
0.0015 (11)

2.30 (12)
3.39 (26)
1.77 (8)
5.11 (35)
2.25 (10)
5.00 (34)
2.70 (19)

2.11 (34)
1.19 (3)
1.32 (11)
2.91 (38)
1.27 (7)
2.59 (37)
1.58 (23)

-0.0277 (26)
-0.0237 (29)
-0.0449 (11)
-0.0413 (15)
-0.0360 (21)
-0.0252 (28)
-0.0510 (6)

0.0501 (30)
0.0103 (11)
0.0139 (16)
0.0863 (33)
0.0206 (20)
0.0227 (22)
0.0117 (14)

0.9230 (38)
0.6273 (32)
0.4300 (22)
0.1431 (3)
0.2755 (9)
0.3201 (13)
0.3659 (16)

0.0001 (31)
n.a.
0.0033 (1)
0.0005 (24)
n.a.
n.a.
0.0021 (4)

1.70 (5)

1.43 (16)

-0.0534 (4)

0.0083 (6)

0.2297 (7)

0.0013 (14)

2.26 (11)

1.22 (5)

-0.0450 (10)

0.0072 (5)

0.3855 (18)

0.0019 (5)

2.38 (13)

2.51 (36)

-0.0384 (18)

0.0250 (23)

0.3115 (12)

0.0012 (16)

1.75 (7)

1.38 (15)

-0.0399 (16)

0.0125 (15)

0.0651 (1)

0.0010 (18)

1.58 (4)
2.03 (9)

1.47 (18)
1.44 (17)

-0.0461 (7)
-0.0283 (26)

0.0099 (10)
0.0899 (34)

0.2785 (10)
0.2747 (8)

0.0012 (15)
0.0003 (28)

1.39 (1)
3.32 (25)
3.79 (30)

1.66 (27)
1.51 (19)
1.34 (12)

-0.0275 (27)
-0.0181 (34)
-0.0454 (9)

0.0084 (8)
0.0185 (19)
0.0145 (17)

0.3396 (15)
0.2881 (11)
0.1385 (2)

n.a.
0.0011 (17)
0.0014 (12)

4.11 (31)
2.88 (21)
2.81 (20)
4.34 (33)
1.74 (6)
3.08 (24)
1.39
17.16
3.30

1.06 (1)
1.30 (8)
1.34 (13)
1.36 (14)
1.32 (10)
1.99 (33)
1.06
2.91
1.61

-0.0156 (36)
-0.0425 (13)
-0.0416 (14)
-0.0296 (24)
-0.0380 (19)
-0.0578 (2)
-0.0591
-0.0124
-0.0353

0.0026 (2)
0.0115 (13)
0.1200 (36)
0.0004 (1)
0.0315 (25)
0.0153 (18)
0.0004
0.2077
0.0378

0.5971 (31)
0.3252 (14)
0.4898 (28)
0.4708 (25)
0.4458 (24)
0.3911 (19)
0.0651
0.9230
0.4239

n.a.
0.0022 (3)
0.0005 (22)
0.0004 (27)
0.0016 (8)
0.0006 (21)
0.0001
0.0033
0.0012

32

Median
Std. Dev.

2.75
2.56

1.53
0.42

-0.0375
0.0133

0.0195
0.0446

0.3956
0.2116

0.0012
0.0008

Panel B: Univariate results of capital market development level on FRQI and financial reporting quality
indicators
N
Indicators

Mean (Median)
Difference
(a)-(b)
10.25
(9.55)
-1.24
(-0.57)
0.16
(0.18)
-0.0160
(-0.0126)
-0.0284
(-0.0139)
-0.2064
(-0.1437)
0.0009
(0.0010)

Mean (Median)

Developed

Emerging

Developed (a)

Emerging (b)

FRQI

168

136

LAR

168

136

PDAR

168

136

AR

168

136

QAOR

168

136

NBAR

168

136

AFR

141

57

33.54
(32.64)
2.75
(2.25)
1.68
(1.43)
-0.0425
(-0.0407)
0.0251
(0.0126)
0.3316
(0.3473)
0.0015
(0.0014)

23.29
(23.09)
3.99
(2.82)
1.52
(1.25)
-0.0265
(-0.0281)
0.0535
(0.0265)
0.5380
(0.4910)
0.0006
(0.0004)

t (Wilcoxon rank
sum) test
10.92***
(9.90***)
-3.56***
(-2.67***)
1.34
(2.34**)
-7.44***
(-6.78***)
-4.54***
(-4.90***)
-9.19***
(-7.58***)
7.41***
(7.54***)

Panel C: Correlations coefficients among financial reporting quality indicators (N=304a)

LAR
LAR

PDAR

1.000

0.149

**

(0.009)
PDAR

0.167

**

1.000

(0.004)
AR

0.045

0.051

(0.434)
QAOR

-0.138

(0.016)
NBAR

0.025
(0.661)

AFR

AR

QAOR

-0.342**

0.017

0.146

(0.153)

(0.768)

(0.011)

(0.000)

**

-0.084

(0.003)

(0.242)

**

-0.236**

(0.000)

(0.001)

0.033

0.008

(0.569)

(0.891)

1.000

-0.171

0.112

0.215

(0.052)
0.192

**

(0.844)

(0.001)

**

**

-0.147

0.151

1.000

0.119

0.094

(0.573)

1.000

-0.159*

(0.010)

(0.008)

(0.104)

-0.113

-0.237

**

-0.095

(0.000)

(0.113)

(0.001)

(0.012)

(0.183)

-0.178

0.040

(0.038)

**

-0.407

AFR

0.082

(0.377)
0.011

NBAR

(0.025)
1.000

Notes:
Panel A:
The eight years average and rank (in parentheses) of six capital market level financial reporting quality indicators for year
2000 to 2007 by stock exchange are tabulated in Panel A.
n.a. denotes data is not available.

Panel B:
* ** ***

, ,
Significant at 0.10, 0.05 and 0.01 level respectively (two-tailed). t-test (Wilcoxon rank sum test) is used to test mean
(median) difference between developed markets and emerging markets. N is stock exchange-year observations.

Panel C:
* **

,
Correlation is significant at 0.05 and 0.01 level respectively (two-tailed). p-values are in parentheses. Pearson
(Spearman) correlation coefficients are in the upper (lower) triangle.
a
The number of observations of audit fee ratio are 198 due to audit fee data are not available in some stock exchanges.
All variables are as defined before.

33

Table 4
Description of variables
Variable

Variable Name

Measurement

Source

InvPro

Outside
Rights

Outside investor rights is proxied by the revised

anti-director rights index19, which is an aggregate measure
of minority shareholder rights and ranges from zero to six.

Djankov et
al. (2008)

LegEnf

Legal
Enforcement

Legal enforcement is proxied by the rule of law index,

which is a component measure of many rights (e.g., the
extent to which agents have confidence in and abide by
the rules of society, and in particular the quality of
contract enforcement, property rights, the police, and the
courts, as well as the likelihood of crime and violence)
and ranges from minus 3 to plus 3.

Kaufmann et
al. (2008)

SIZE

Firm Size

Firm size is the capital markets median of the firm-level

natural logarithm of sales in millions of US dollars.

Worldscope

LEV

Financial
Leverage

Financial leverage is the capital markets median ratio of

the firm-level financial leverage, which equals total
liabilities to total assets.

Worldscope

ROA

Profitability

Profitability is the capital markets median ratio of the

firm-level return on assets, which equals net profit to
lagged total assets.

Worldscope

Growth

Firm Growth

Firm growth is the capital markets median ratio of the

firm-level growth, which equals (current sales - lagged
sales) / lagged sales.

Worldscope

Investor

19

The revised anti-director rights index is not available for all eight years under study and we acknowledge the data
limitations (the same as some alternative measures of investor protection and legal enforcement in robustness tests). We note
that this is a common limitation in cross-country studies (e.g., Hung, 2001; Leuz et al., 2003; DeFond et al., 2007), and that
changes in country-level institutions are a slow process (North, 1990). To the extent that the revised anti-director rights index
changes over the investigation period, which may introduce noise into our measure of outside investor rights. However, we
have no reasons to believe this noise to bias towards supporting our hypotheses.

34

Table 5
Correlations coefficients among variables (N=304)
FRQI
FRQI

1.000

InvPro

-0.126*
(0.028)
0.577**
(0.000)
0.227**
(0.000)
0.106
(0.066)
-0.248**
(0.000)
-0.333**
(0.000)

LegEnf
SIZE
LEV
ROA
Growth

InvPro

LegEnf

0.011
(0.855)
1.000

**

-0.143*
(0.012)
-0.338**
(0.000)
-0.282**
(0.000)
0.127*
(0.026)
0.018
(0.760)

0.545
(0.000)
-0.026
(0.652)
1.000
0.148**
(0.010)
0.028
(0.621)
-0.244**
(0.000)
-0.294**
(0.000)

SIZE
**

0.218
(0.000)
-0.280**
(0.000)
0.087
(0.132)
1.000
0.388**
(0.000)
0.250**
(0.000)
0.089
(0.121)

LEV
0.078
(0.175)
-0.253**
(0.000)
0.049
(0.398)
0.350**
(0.000)
1.000
0.040
(0.483)
-0.040
(0.490)

ROA
**

-0.268
(0.000)
0.111
(0.054)
-0.358**
(0.000)
0.347**
(0.000)
0.224**
(0.000)
1.000
0.585**
(0.000)

Growth
-0.349**
(0.000)
-0.030
(0.603)
-0.371**
(0.000)
0.138*
(0.016)
-0.065
(0.261)
0.520**
(0.000)
1.000

Notes:
* **

,
Correlation is significant at 0.05 and 0.01 level respectively (two-tailed). p-values are in parentheses. Pearson
(Spearman) correlation coefficients are in the upper (lower) triangle. N is market-year observations.
All variables are as defined before.

35

Table 6
Regression results of investor protection and legal enforcement on financial reporting
quality
Variables
Intercept
InvPro
LegEnf
SIZE
LEV
ROA
Growth
Year Controls
Adjusted R2
F value
D-W value
N
Notes:

Predicted sign
?
+
+
+
?
?

Coefficients
estimates
15.27***
1.13**
4.07***
2.86***
1.16
-0.53**
-0.30***
included

Standard Error

t-statistics

VIF value

4.48
0.48
0.54
0.52
5.63
0.22
0.09

3.41
2.38
7.53
5.49
0.21
-2.44
-3.19

0
1.25
1.38
1.50
1.35
1.99
2.03

0.4014
16.63***
1.162
304

* ** ***

, ,
Significant at 0.10, 0.05 and 0.01 level respectively (two-tailed). N is market-year observations.
All variables are as defined before.

36