The Financial Reporting Quality of Public Companies: The Cultural Dimension 9781003280088

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The Financial Reporting Quality of Public Companies

The factors determining the formation of accounting principles in different countries have long been studied. Cultural conditions have been identified as one of the reasons for national variations. This issue is particularly important when there is an effort to harmonise and standardise accounting principles, in order to create a uniform system, which may be adopted globally. This book explores the impact of cultural conditions on the financial reporting quality of public companies preparing financial statements according to International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). It discusses the main trends in the theory of capital and earnings in the economy.  The book focuses on the relationship between the cultural dimensions under analysis, such as power distance, individualism/collectivism, masculinity/femininity, strong uncertainty/weak uncertainty, short/long time orientation and indulgence/restraint, and the properties of the financial results; persistence, predictive value, accrual adjustments, and earnings smoothing. It identifies the determinants – cultural conditions that have a statistically material impact, either positive or negative, on various attributes of the quality of the financial results of public companies. The book contains an up-to-date, in-depth description of the financial statements of public companies, across a variety of countries and sectors. The publication is addressed to researchers and students concerned with the functioning of capital markets and financial reporting quality and those who would like to expand their knowledge in the field of behavioural finance, as well as investors in capital markets. Katarzyna Mokrzycka-​Kogut is an Assistant Professor in the Department of Financial Accounting, Cracow University of Economics, Cracow, Poland.

Routledge Studies in Accounting

39 Auditor Going Concern Reporting A Review of Global Research and Future Research Opportunities Marshall A. Geiger, Anna Gold and Philip Wallage 40 Accounting Ethics Education Making Ethics Real Edited by Alberto J. Costa and Margarida M. Pinheiro 41 Business Models and Corporate Reporting Defining the Platform to Illustrate Value Creation Lorenzo Simoni 42 Accounting and Auditing Standards for Islamic Financial Institutions Mohd Ma’Sum Billah 43 Quality Management and Accounting in Service Industries A New Model of Quality Cost Calculation Wojciech Sadkowski and Piotr Jedynak 44 Artificial Intelligence in Accounting Organisational and Ethical Implications Othmar Lehner and Carina Knoll 45 The Financial Reporting Quality of Public Companies The Cultural Dimension Katarzyna Mokrzycka-​Kogut For more information about this series, please visit www.routle​dge.com/​ Routle​dge-​Stud​ies-​in-​Acc​ount​ing/​book-​ser​ies/​SE0​715

The Financial Reporting Quality of Public Companies The Cultural Dimension Katarzyna Mokrzycka-​Kogut

First published 2023 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2023 Katarzyna Mokrzycka-​Kogut The right of Katarzyna Mokrzycka-​Kogut to be identified as author of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-​in-​Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-​in-​Publication Data A catalog record has been requested for this book ISBN: 978-​1-​032-​24783-​0 (hbk) ISBN: 978-​1-​032-​24784-​7 (pbk) ISBN: 978-​1-​003-​28008-​8 (ebk) DOI: 10.4324/​9781003280088 Typeset in Bembo by Newgen Publishing UK

Contents

List of figures  List of tables  List of important acronyms/​initialisms 

vii viii x

Introduction 

1

1 Earnings as a measure of economic profit in the theories of economics and finance and accounting 

5

2 The concept and measurement of cultural determinants in economic sciences 

56

3 Quality of earnings as one of the objectives of financial reporting of public companies 

91

1.1 Capital and profit in economic theory  5 1.2 The concept of earnings and their measurement in accounting theory  20 1.3 The significance and application of earnings in theories of economics and finance  29

2.1 The concept of culture, diversity, and cultural determinants  56 2.2 Quantitative measurement of cultural determinants  62 2.3 Major studies of cultural diversity in economic sciences  72

3.1 Qualitative characteristics of financial statement information  91 3.2 Attributes of financial information quality  97 3.3 Capital market actors as major users of reporting information  103

4 Measures of earnings quality in accounting theory and in empirical research in accounting  4.1 4.2 4.3 4.4 4.5

Earnings management  115 Earnings predictability  122 Earnings persistence  124 Decision relevance of earnings  126 Earnings smoothing  131

115

vi Contents

5 Analysis of the impact of cultural determinants on the quality of earnings illustrated with the example of European public companies 

143

6 Conclusions 

189

5.1 Purpose of the study, research hypotheses, and research methodology  143 5.2 Study sample characteristics and study period  150 5.3 Study results  167 5.4 Analysis of results and an economic interpretation thereof  180

Bibliography  Online sources  Legal acts  Name index  Subject index 

194 216 217 218 221

Figures

1 .1 1.2 1.3 2.1 3.1 3.2 5 .1 5.2 5 .3 5.4 5.5 5.6 5.7

Main trends in capital theory  11 A micro-​macroeconomic perspective of capital  13 Income statement vs statement of other comprehensive income  26 Cultural categories  74 Links between the qualitative characteristics of useful financial information in the 1989 and 2010 conceptual frameworks  93 Hierarchy of qualitative characteristics according to the IASB Conceptual Framework for Financial Reporting  94 Study sample by country  151 Structure of the study sample by cultural circle –​accrual adjustments  153 Structure of the study sample by cultural circle –​persistence  157 Structure of the study sample by cultural circle for the predictability attribute  161 Structure of the study sample by cultural circle for the earnings smoothing attribute  165 Cluster analysis of explanatory variable parameters for a reporting entity using Ward’s method  169 Cluster analysis of G. Hofstede’s cultural determinants using Ward’s method  171

Tables

1 .1 1.2 2 .1 2.2 2.3 2.4 3.1 3 .2 3.3 5.1 5.2 5 .3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 5.15

An overview of selected definitions of capital  Characteristics of traditional and contemporary approaches to the definition and measurement of earnings  Selected definitions of culture  Strengths and weaknesses of the GLOBE model  Linkage between G. Hofstede’s cultural dimensions and S. J. Gray’s values attributed to accounting  Selected research findings referring to the output of G. Hofstede and S. J. Gray  Terminological order of relations: data –​information –​ message –​knowledge  Key attributes of information quality in decision-​making  Basic attributes of information quality  Size and characteristics of the study sample –​initial stage  Number of companies by sector classification based on search criteria  Sample size for the study of accrual adjustments  Study sample size by country and year-​accrual adjustments  Study sample size in the persistence study  Study sample size by country and year-​persistence  Study sample size in the predictability study  Study sample size by country and year-​predictability  Sample size for the study of earnings smoothing  Study sample size by country and year-​earnings smoothing  Correlation matrix of the variables in the model  Correlation matrix of G. Hofstede’s variables occurring in the J. J. Jones model  Results of regression analysis with robust estimators for accrual adjustments  Nature of the relationship between cultural dimensions and earnings management  Regression results with robust estimators –​earnings predictability 

12 23 58 71 78 79 98 101 102 151 152 153 154 157 158 161 162 165 165 168 170 172 173 175

List of tables  ix 5.16 Nature of the relationship between cultural dimensions and earnings predictability  176 5.17 Regression results with robust estimators –​earnings predictability  177 5.18 Nature of the relationship between cultural dimensions and earnings predictability  178 5.19 Regression results with robust estimators –​earnings smoothing 179 5.20 Nature of the relationship between cultural dimensions and earnings smoothing  180 5.21 Proposed and found relationships between cultural determinants and the level of earnings management  181 5.22 Relationship between cultural determinants and the level of earnings management in global studies  181 5.23 Analysis of the relationships between cultural dimensions and quality attributes: earnings predictability, earnings persistence, and earnings smoothing  185 6.1 The size of the study sample in relation to the quality attributes of earnings  191

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Important acronyms/​initialisms

AR CAPM CAR CFA CVS EAC EFRAG ERC FASB GLOBE IASB ICAEW IFRS SFAC 3 SNA TFV AC US GAAP WVS CFFR

abnormal return capital asset pricing model cumulative abnormal return the Chartered Financial Analyst Chinese Value Survey earnings association coefficient European Financial Reporting Advisory Group earnings response coefficient Financial Accounting Standards Board Global Leadership and Organizational Behavior Effectiveness International Accounting Standards Board Institute of Chartered Accountants in England and Wales International Financial Reporting Standards Statement of Financial Accounting Concepts No. 3 social network analysis true and fair view Polish Accounting Act US Generally Accepted Accounting Standards Board World Values Survey Conceptual Framework for Financial Reporting, 2010 (The Conceptual Framework)

Introduction

In recent years, both theoreticians and practitioners of finance and accounting have become increasingly interested in seeking significant relationships between the individual economic categories reported in financial statements and cultural circumstances. Earnings are one of the most important economic parameters, the determination and presentation of which are matters dealt with to a great extent in the domain of accounting. This category has its roots in the functions it serves in economy. It is important for the users of financial statements when it comes to decision-​making. Market participants are interested in the earnings shown in a financial statement but try to stay up-​to-​date with forecasts formulated mainly by independent analysts at the same time.This translates largely into how capital is allocated by potential investors. A number of studies show that the reported earnings differ from the forecast values, and the capital market reacts strongly to the sign and value of any such difference. Poor quality of reported information leads to investors making wrong decisions. Access to information enables a market participant to decide whether to enter into a transaction or not –​ and on what terms to enter into a given transaction. Thus, the availability of information may affect the effectiveness of the mechanisms of valuation of a trading entity. In the light of the above, institutions that lay down accounting regulations should make sure that the reporting data created is of high quality. One could hazard a claim that one of the most valuable resources of the modern world is information. It should be noted that when it comes to financial information, meaning information which supports economic decision-​ making, International Financial Reporting Standards (IFRS) do not refer to the quality of financial information –​but rather to its usefulness. The quality requirement is actually imposed on financial statements. Financial reports are drawn up according to specific rules. These rules concern both formal and content-​related issues and require an expert auditor to verify the correctness of such reports. All this makes it fair to say that the quality of financial statements determines their rank in the domain of providing information about the financial situation of economic entities.1 Accounting theorists have developed quantitative measures of the quality of reporting information, most of which are limited to the quality of earnings. As DOI: 10.4324/9781003280088-1

2 Introduction argued by J. Francis, P. Olsson, and K. Schipper, measures of earnings quality can be divided into accounting measures and market measures.2 Accounting measures include persistence, predictive value, accrual adjustments, and earnings smoothing. These measures are created on the basis of accounting values, i.e. earnings, cash flows, accrual adjustments, and then estimated based on accounting data. Accrual adjustments are the most frequently used model applied in measuring the phenomenon of active earnings management. Understanding the causes of this phenomenon and how it is impacted by different factors is important when interpreting, controlling, and aiming to curb it. The efforts to actively manage earnings can manifest themselves in the motivation of managers, their willingness to manage, and in the existing constraints and limitations. The issue of the cultural influence on financial reporting can be considered as one of the said limitations. Identifying the main determinants affecting earnings makes it possible to predict the decisions made by managers. It may therefore seem that problems associated with cultural differences do not play any significant role. It would be fair to assume then that exploring cultural diversity and examining its impact on earnings management is therefore pointless, at least from a theoretical point of view. Practice shows, however, that although the vast majority of people’s values and motivations to act are common or very similar, this minority related to cultural differences tends to cause misunderstandings in international business –​and such misunderstandings can be very costly. Cultural studies face many difficulties, and the belief that economic phenomena are governed by factors that originate in culture has been long rooted in economics. Foreign researchers refer to culture as a factor that determines economic phenomena.3 In Polish empirical accounting research, earnings management is discussed quite rarely, but a couple of interesting papers addressing the matter have been published recently. When it comes to foreign studies, the quality of financial statements is one of the most popular research areas in accounting. The concept of culture is ambiguous, carries a relatively broad meaning, and is used in many academic disciplines. Authors consider and define the term ‘culture’ in many different ways. It can be thus assumed that culture is a multidimensional concept, consisting of diverse norms and values, characteristic of certain groups.4 Empirical research looks for determinants of earnings management at the country level, i.e. cultural determinants. The identification of essential cultural factors that affect the extent of earnings management allows predicting the actual behaviour of managers. Knowledge of cultural differences can be important for expert auditors, potential investors, and other individuals who make use of financial statements. Research to date has focused on the impact of cultural background on the extent of active earnings management, remaining limited to the four cultural dimensions proposed by G. Hofstede, i.e. power distance, masculinity vs femininity, collectivism vs individualism, and uncertainty avoidance. In recent years, the said range of dimensions has come to include

Introduction  3 two more dimensions, associated with pragmatic long-​term orientation and indulgence vs restraint. The studies conducted so far have generally addressed the impact of cultural determinants on the management of earnings, while much less research has dealt with other attributes of the quality of earnings –​ persistence, predictability, and smoothing. The main objective of this book is to analyse the impact of culture-​ specific factors on the quality of earnings using the example of public companies5 drawing up financial statements according to International Accounting Standards/​IFRS. The measures featured in G. Hofstede’s model were used as measures of cultural conditions. The purpose of the book has been defined in both theoretical and practical terms. The theoretical area of the book includes an analysis of domestic and foreign literature sources addressing the issue of the quality of earnings in different countries. The practical aim of the book is to identify the determinants –​the cultural factors that have a statistically significant impact (be it positive or negative) on the various attributes of the quality of earnings of public companies. In line with the aim of the book, the author’s main hypothesis and four specific hypotheses have been verified. As a result of the conducted theoretical deliberations and an analysis of the findings of the existing research as offered in the literature on the subject, the main hypothesis has been formulated. This hypothesis implies that cultural determinants significantly affect the quality of earnings of public companies. The following specific hypotheses have been formulated to verify the main hypothesis: H1 Cultural determinants significantly affect the management of earnings in public companies; H2 Cultural determinants significantly affect the predictability of earnings in public companies; H3 Cultural determinants significantly affect the persistence of earnings in public companies; and H4 Cultural determinants significantly affect the smoothing of earnings in public companies. Chapter 1 covers the most important trends in accounting and capital theory, crucial for measuring the quality of earnings. There is also an overview of the concepts of earnings from the point of view of different accounting theories. Chapter 2 presents the concept and the subject matter of measurement of cultural determinants in economic sciences. Chapter 3 focuses on the concept of the quality of earnings considered from the angle of the qualitative characteristics of financial statements, which determine the usefulness of information contained in financial statements to their recipients. Chapter 4 offers a closer look at the measures of earnings quality in accounting theory and empirical research. Chapter 5 discusses the findings of empirical research carried out with the use of financial statements of public companies as the

4 Introduction main source of data. The conclusion summarises the theoretical discussion and the empirical research conducted and synthesises the conclusions drawn from the hypotheses proposed.

Notes 1 J. Błażyńska, Jakość informacji o sytuacji finansowej jednostek gospodarczych, Zeszyty Naukowe Uniwersytetu Ekonomicznego w Katowicach, Katowice 2016, Issue 284, p. 45. 2 J. Francis, P. Olsson, K. Schipper, Earnings Quality, Foundations and Trends in Accounting 2006,Vol. 1, Issue 4, pp. 3–​38. 3 K. Kostro, Zagadnienia kulturowe w ekonomii, Gospodarka Narodowa 2009, Issue 3, pp. 27–​29. 4 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, Gospodarka Narodowa, 2015,Vol. 275, pp. 83–​102. 5 In this book, public companies are understood as companies listed on stock exchange.

1 Earnings as a measure of economic profit in the theories of economics and finance and accounting

1.1  Capital and profit in economic theory The subject explored by the science of finance is the phenomena and processes associated with the generation and allocation of money that make it possible for the public and private sectors to operate.This science explains the economic and social content of public funds and tries to grasp the causal relationships occurring between the accumulation of public money and the existing economic, social, and political processes. When it comes to the field of economic sciences, finance has been experiencing a highly dynamic development over the past years, which has resulted in finance becoming a separate scientific discipline.1 Much of the output of the financial sciences was produced when the discipline was not yet separate from economics.2 S. Owsiak3 argued that: ‘finance is an economic discipline par excellence. In the light of the above, the analysis of financial phenomena should be carried out from the perspective of the economic and social content of these phenomena […].’W. Frąckowiak had a similar view on the science in question,4 claiming that: the science of finance is relatively young. The development of this science dates back to the second half of the 20th century. It did not come about on its own. On the contrary, it came to being out of the existing body of economic theory, and that is where one should look for the paradigms upon which it laid its own foundation later on […]. Indicating the paradigm of financial sciences –​if at all possible at this stage of the discussion –​is a great challenge, mainly due to the amount of views and theories, as well as the lack of a clear classification of individual theoretical concepts. An interesting overview of the contemporary development of paradigms in economic sciences was offered by W. Frąckowiak, who distinguished four stages of it.5 The first of these stages, lasting until the end of the 19th century, was the bloom of political economy and –​later on –​of microeconomics. The foundations of economic science at that time included the homo economicus DOI: 10.4324/9781003280088-2

6  Earnings as a measure of economic profit theory, the equilibrium theory of the desired state, the law of supply and demand with the equilibrium price, and the theory of the ‘invisible hand of the market,’ as well as profit maximisation as the main driving force behind the business activity of enterprises. The second stage dates back to the end of the 19th century and the beginning of the 20th century. The paradigms adopted at that time were: the general equilibrium theory concept (L. Walras, V. Pareto, J. R. Hicks, and A. Hansen) and the macroeconomic equilibrium model (J. R. Hicks and A. Hansen’s IS-​ LM model), the principal-​agent theory, theories not considering profit as the sole and main purpose of business activity, and the concept of linking profit with a reward for taking risk (F. Knight) or linking profit with innovation (J. A. Schumpeter). The third stage of the development of paradigms in economic sciences, especially in finance, is connected with the rapid development of financial institutions in the second half of the 20th century and the process of progressive globalisation and European integration, as well as with the increase in the number of commodity-​free transactions. According to W. Frąckowiak, the most important achievements of this period in the field of science of finance are: the hypothesis of information efficiency of the capital market with the assumption of full liquidity of financial markets (H. Markowitz, E. F. Fama); the theory of investment risk based on the Gaussian distribution of reward and loss; and the theory of capital cost and structure (F. Modigliani, M. H. Miller). The fourth stage of the development of paradigms in economic sciences has been seen in most recent times. This period is characterised by a multi-​polar model of the world and extremely free movement of capital, raw materials, and goods. According to W. Frąckowiak, the main areas of interest in economic sciences in that period were: a new perspective of inflation (A. Greenspan); the role and valuation of derivatives; the concept of corporate governance; and a new approach to describing reality, taking into account the achievements of behavioural finance (D. Kahneman, A. Tversky). In order for a scientific view to be formulated properly, it requires the terminology used to be clear, unambiguous.6 The claim provided an impetus for literature research in the fields of accounting theory and science. In making an attempt to explain what a ‘theory’ and an ‘accounting science’ are, it is necessary to first define the term ‘theory’ and to consider whether accounting can be referred to as a ‘theory’ or ‘accounting theories.’ The dictionary definition of the term ‘theory’ explains it in two ways: as more general concept and as a concept that is closely related to science. In its general sense, theory is understood as7: • • •

structured knowledge that explains a particular domain of reality,8 a general concept based on the knowledge and understanding of certain relevant factors that affect a certain reality, and9 a structured set of statements and claims concerning any field.10

Earnings as a measure of economic profit  7 Theory considered in scientific terms is defined, in turn, as11: •

•

a system of logically and factually organised statements, linked internally by means of specific logical relationships, occurring in a given science and fulfilling the criteria of scientific accuracy and methodological correctness adopted in the science in question, and12 a set of laws, definitions, and hypotheses forming a factual and logical whole; knowledge explaining some field of phenomena –​unlike practice, to which it nevertheless remains related.13

K. G. Szymański defines a theory as a set of interrelated statements and claims describing a particular subject domain, where these statements and claims are more or less closely related to each other. He sees the term ‘theory’ used in reference to a compact or a more or less elaborate, refined concept.14 A. Szychta has a similar view on the issue. He defines the term ‘theory’ as an explanation of a given subject matter –​such as budgeting theory.15 In the literature on the subject, one can find the term ‘theory’ used to refer to a set of empirically unproven judgements or to a set of hypotheses.16 Ultimately, ‘theory’ is considered the antonym of the term ‘practice,’ which implies that theory is an abstraction, a construction, something that stands in opposition to things or facts that exist in the real world.17 Scientific theory has a different structure and a different degree of justification and internal consistency in individual sciences.18 In the formal sciences, it is a set of axioms and logical sequences. In the empirical sciences, which include accounting, a scientific theory is defined as: • • •

a set of sentences explaining certain phenomena, forming a logically consistent unit of scientific knowledge about a given field –​together with the scientific laws and hypotheses that explain it, a system of statements concerning a given domain and containing a range of theoretical terms, i.e. referring to objects or properties that are not directly observable, and a system of laws of science, general hypotheses, and definitions related logically and factually in a way that all less general statements can be derived from the most general statements and formulated in such a way that they can be empirically verified.19

After analysing the above terminology, one can formulate an own definition as follows: a theory is understood as a set of concepts and definitions, axioms, and theorems that describe a specific field, such as accounting. The purpose of scientific theory is not only to describe and explain but also to predict facts, especially in the empirical sciences. Juxtaposing the two terms, i.e. ‘theory’ and ‘accounting,’20 it can be said that accounting theory is a set of concepts, categories, and principles through which

8  Earnings as a measure of economic profit the economic reality –​i.e. the material and financial situation –​of an analysed economic entity is presented.21 According to E. A. Hendriksen and M. F. van Breda, accounting theory is a coherent, consistent, and internally logical set of hypothetical, conceptual, and pragmatic principles that form a general frame of reference to study the nature of accounting, which enables a better understanding of the existing practice, creates a conceptual structure for evaluating the practice of accounting, and sets the direction for the development of new methods and procedures.22 W. Brzezin, in turn, points to the following functions of accounting theory23: • • • •

generalising function, involving proper systematisation and combination of appropriately generalised statements in object-​related, subject-​related, functional, and methodological perspectives into a logical whole, communicative function, which consists in providing information (general concepts) equally understandable to specialists in a given field of knowledge, predictive function, which involves studying the changing accounting environment and, on that basis, forecasting the changes that will occur in the domain of accounting, and practical function, which is manifested in the application of the ‘findings of accounting theory’ to individual accounting disciplines through their appropriate generality and non-​contradiction with the claims of specific disciplines.

In the light of the views quoted above, accounting theory can be considered in two aspects, meaning: • •

as a science that generalises the practical experience of accounting as a system of economic records and investigates all the theoretical problems arising in connection with its functioning and24 as a general theory of accounting understood as a set of hypotheses, concepts, models, and theories that make it possible to explain, evaluate, and predict the phenomena of accounting practice and act as a starting point for the formulation of new concepts and procedures.25

In the Polish law governing scientific activity, accounting is not listed as a scientific discipline –​it is part of a scientific field. It is positioned in the domain of social sciences, in the field of economic sciences, which includes the following scientific disciplines: economics, finance, and management and quality sciences.26 According to A. Jarugova, accounting is a science by virtue of its methodology, while the fact that it is goal-​oriented makes it an applied science.27 According to K. G. Szymański, in turn, accounting is both a practical and a theoretical science. The theoretical nature of the science of accounting is manifested in the formulation of descriptive and explanatory sentences, and its practical nature can be seen in the use of purposive directives.28

Earnings as a measure of economic profit  9 The contemporary research conducted in the field of accounting as a social discipline is marked by a variety of research currents, subjects, and theories drawn from other academic disciplines to provide research assumptions or to guide the researchers’ reasoning. This results in a large number of publications by authors from many different countries. Nowadays, the main role in the development of the science of accounting is played by the research and publications of authors29 from the English-​speaking parts of the world. For many years, the foreign scientific community has been classifying and describing research, theories, paradigms, perspectives, and research trends in accounting, etc.30 Accounting can be considered part of the science of finance, which deals with the generation of financial information in the microeconomic domain, which then becomes a space for other theories of finance on a macroeconomic scale.The current research is conducted in a domain where accounting, finance, and the capital market overlap, which makes its findings difficult to group. This proves the strong relationship between accounting science and financial theory and economic theory. M. Andrzejewski has carried out an in-​depth analysis of the issues occurring commonly in this area,31 providing arguments for the inclusion of accounting into the discipline of finance understood in broad terms. The solutions accepted at the level of accounting regulations, affecting the formation of earnings and their distribution, have a significant influence on the process of allocating resources in economy and in the distribution of wealth earned in a society among different social groups. This has to do in particular with the determination of earnings, the criteria for recognising assets and liabilities, the quality of supervision, or the contracting process.32 The financial statements presented should offer a true and fair view of an entity’s assets, financial situation, and profit or loss. In order for such purpose to be fulfilled, transactions and other economic events must also be presented truthfully, fairly, and clearly in accounting ledgers.33 As proven by both experience and literature on the subject, the main cognitive problem of accounting –​as well as of most economic sciences –​is the category of capital and the question of how to measure this quantity.34 The terms ‘capital’ and ‘profit’ are used in both business practice and academic discussions. An analysis of the concept of capital was offered by M. Dobija in ‘Teoria pomiaru kapitału i zysku.’ The origin of the word ‘capital’ is associated with the Latin adjective capitale, which, corresponding to the noun caput, means simply ‘head’ or ‘manager.’ In this sense, there has been a search for an analogy with the English term chief, meaning ‘boss,’ ‘manager,’ or its French equivalent –​chef.35 When considering the various uses of the term, it is acknowledged that the original meaning was used in expressions referring to the amount of money borrowed, either in the essential sum of money making up the debt as opposed to interest (capitalis pars debiti in Latin), or as the sum of money necessary to start commercial activity.36 On the other hand, in a different oft-​quoted Latin phrase –​ papitale dicitur omne quod possidetur, capital means all the goods in one’s possession.37 It is later pointed out that in English literature the word capital,

10  Earnings as a measure of economic profit or rather capitall, was first used in the 16th century, in a textbook38 teaching merchants how to keep account books.39 The earliest interpretations of the concept involved many controversies and were understood in different ways, depending on the situation and purpose. The first disparities that occurred took the form of doctrines in capital theory. The classification of capital addressed characteristics and qualities in the material, monetary, individual, and social dimensions –​including the relationship with time.40 Studies of capital and profit intertwine and overlap due to the very nature of the relationships that exist between these abstract concepts. M. Dobija pointed out that capital is an abstract ability to perform work.41 Such a theory of capital incorporates two principles which govern capital: the principle of conservation of capital and the principle of spontaneous dispersion of capital. A mathematical model of capital growth has been constructed for the purpose of this theory. This model suggests explicitly that there is a possibility for profit to occur in the context of the capital employed, and that the source of profit is the ‘risk premium.’42 S. Skrzypek reviewed the concepts of ‘capital’ featured in the literature published from the period of antiquity to the first half of the 20th century. His review led him to finding four directions existing in the domain of capital science.43 Different views, concepts, and –​eventually –​scientific theories related to the concepts of capital and profit have been emerging since as early as the 15th century. The first direction is associated with the evolution of the category of capital from technical-​economic concepts to social concepts, based on social-​civic relations44 and legal norms. The substantive theories of capital (A. Smith, J. S. Mill, D. Ricardo), the entire classical school of thought, German economists (M.  Weber, K. Diehl, A. Amon), Anglo-​Saxon economists (T. Carver, F. W. Taussig, E. R. A. Seligman), as well as some Italian scientists (V. Pareto), lean towards the technical-​economic understanding of the idea of capital. A. Smith, E. von Böhm-​Bawerk, R. Wagner, K. Knies, and others tried to depart from a purely technical understanding of the problem, coming up with a theory that was half technical-​economic and half socio-​economic. Such transitional theories include theories of capital as a sum of money (G. Cassel, C. Menger, et al.) and the theory of capital as a power to dispose of assets in economic practice (J. A. Schumpeter, W. Heller, H. Singer, et al.). The last stage includes the theories of G. Schmoller, W. Sombart, and St. Grabski, which are based partly on the traditional output of A. R. J. Turgot, J. B. Say, and F. Skarbek. The next direction is the development of the understanding of the idea of capital initially as a stock of goods through the monetary theory to the understanding of capital as a sum of values. The third direction involves separating the meaning of ‘capital’ from the form of economic activity. The term referred only to companies. In ancient times, the concept of capital was associated with a form of farming. Its modern use, in turn, has to do with conducting business activity in the form of a company.

Earnings as a measure of economic profit  11

Capital PRODUCTION CAPITAL

material approach

funds approach

NON-PRODUCTION CAPITAL

money capitals

Figure 1.1 Main trends in capital theory. Source: Author’s own work based on: K. Marchewka, Główne nurty w kategorii kapitału, Ruch Prawniczy, Ekonomiczny i Socjologiczny 2000, LXII,Vol. 3, p. 116.

The final –​fourth –​direction is the evolution of the view of capital, i.e. from a production factor to the basis of a company’s income.45 The development of the trends that may have resulted in the arrival at a coherent, uniform definition of capital has not led to a consensus on the matter of capital in economics, finance, and accounting. Basically, taking into account the second and the fourth direction of development, it can be concluded that the concept of capital in its current form is as it was in the initial phase of evolution of this term.46 The directions discussed above are shown in Figure 1.1. In the first trend, capital is understood solely as economic, material, or capital goods which will be used to create new goods in the future. This view focused on a certain volume, a stock of specific goods in relation to the macroeconomic dimension as social capital and the microeconomic dimension as fixed capital. The second direction presents the so-​called monetary interpretation of the notion of capital, which has come to be recognised as a fund. According to this interpretation, capital refers to goods –​but in its accounting dimension. It was considered as the so-​called value of goods or directly as a stock of money, or as a fund distributed for the purchase of goods used in production. It is also identified with working capital. The two trends above concentrate first and foremost on income in the form of return on capital. There is also a third direction. Its nature was somewhat distinct, originating from the funds approach. It did not directly encompass production, but spoke of capital in the form of: ‘rentier capital,’ ‘loan assets,’ ‘given to another entity for a fee,’ ‘income-​generating amount saved,’ etc. In this case, there is a resource that has no direct use in current production. It is therefore an ‘income-​type’ resource, i.e., obtained most often in the form of interest, which has been defined as money capital.47 An overview of selected definitions of capital is provided in Table 1.1. In economics, there are two approaches to the nature of capital, i.e. a macroeconomic approach and a microeconomic approach, which are counter

12  Earnings as a measure of economic profit Table 1.1 An overview of selected definitions of capital Author

Definition

J. Czekaj, Z. Dresler

All items listed on the liability side of a company’s balance sheet and representing the source of funding for the assets accumulated in the company K. Jajuga Capital represents assets that can be used to gain benefits in the future, including to produce other assets I. Fisher Capital is any resource, anything that has value and is used to produce goods and services, which is important for the growth and development of economy P. L. Bernstein Capital is a specific economic category which encompasses goods (resources) accumulated to engage in and advance economic activity, and which is characterised by a value that has the capacity to grow A. Duliniec Capital refers to funds (financial resources) entrusted to a company by its owners and creditors A. Smith Capital is the part of resources that brings the capital’s owner the expected income Source: J. Czekaj, Z. Dresler, Podstawy zarządzania finansami firm, PWN, Warsaw 1995, p. 92; K. Jajuga, Elementy nauki o finansach, PWE,Warsaw 2007, p. 12; A. Duliniec, Struktura i koszt kapitału w przedsiębiorstwie, PWN, Warsaw 1998, p. 11; P. L. Bernstein, Capital Ideas Evolving, John Wiley & Sons, Inc., Hoboken, NJ 2007, p. 23; A. Smith, Badania nad naturą i przyczynami bogactwa narodów, PWN, Warsaw 2007, p. 306; W. Gos, Definiowanie i interpretacja zysku i kapitału, Finanse, Rynki Finansowe, Ubezpieczenia, Szczecin 2015, Issue 77, s. 73; K. Marchewka, Główne nurty w kategorii kapitału, Ruch Prawniczy, Ekonomiczny i Socjologiczny 2000, LXII,Vol. 3, pp. 105–​120.

to each other48 (Figure 1.2). Nowadays, the concept of capital in economic sciences49 is used both in microeconomics –​with reference to an enterprise –​ and in macroeconomics –​with reference to the national economy as a whole, including the theory of distribution, the theory of economic growth, and the theory of business cycle. Capital is treated as the resources of an economic entity, but also as sources of financing the assets of a business. In the terminology encompassing the concepts used in accounting, the former corresponds to the category of assets, and the latter –​to the category of liabilities or, actually, ‘accounting’ capital. The inconsistent understanding of capital in economics makes the notion not fully comprehensible to researchers. It is now difficult to consider the abstractness of capital and its ability to multiply when the category is understood as the identity of specific assets which do not multiply (or ‘grow’) on their own. In this sense, it is important to distinguish asset management from capital management, as indicated by Y. Ijiri.50 He argued that a very important task of a ‘capital manager’ is to raise capital and invest it in a profitable project that will yield the maximum rate of return. In the case of a ‘resource manager,’ their job is to manage a given project efficiently in order to maximise the return on that project. There is a subtle yet important difference that explains the distinction between capital and resources.

Earnings as a measure of economic profit  13 Macroeconomic perspective of capital Money capital

Microeconomic perspective of capital

Capital

Money

Debt

Borrowed resources

Equity

Own resources

Stocks Money capital means of production

Fixed assets

Financing by equity

Production capital

Financing by debt

Non-production capital Use of assets

Source of assets

Figure 1.2 A micro-​macroeconomic perspective of capital. Source: Based on: W. Brzezin, Ogólna teoria rachunkowości, Wydawnictwo Politechniki Częstochowskiej, Częstochowa 1995, p. 102, cited after: B. Kurek, Historia badań kapitału i zysku, [in:] M. Dobija (ed.), Teoria pomiaru kapitału i zysku, Publishing House of the Cracow University of Economics, Kraków 2010, p. 13.

It needs to be noted that accounting distinguishes between the terms ‘assets’ and ‘capital,’ which do not cause misconception or confusion.51 As argued by Y. Ijiri: ‘double-​entry accounting consists of two kinds: a classificational double-​entry accounting and a causal double-​entry accounting. Both rely on the equality of debits and credits.’52 Double-​entry accounting describes the same resource taking into account both assets and capital.This means that every resource has a source of origin. This source of origin is the capital that corresponds in value to the resource in question. Modern capital theory along with accounting provides opportunities for agreement to be reached between scholars and practitioners on the measurement of capital and its changes over time –​meaning profit or loss.53 The problem of the uniform content of the term ‘capital’ depends on the ontological basis adopted to define it. The distinction between the commonly understood capital as used by merchants and entrepreneurs and the scientific approach to this idea became clearer with the appearance of the concept of capital as proposed by A. Smith.54 An attempt to explain and clarify the above concept was made as part of the most popular international dictionary study,55 conducted at Yale University. According to the study in question, in the ‘pre-​ Smith’ period there were many terms in which capital existed as ‘the basis of debt as opposed to interest,’ ‘a fund as opposed to a stream,’ ‘the present wealth rather than what remains of it,’ or ‘a merchant resource as opposed to a profit

14  Earnings as a measure of economic profit stream.’56 These concepts concerned trade and the situation of businesses. The idea which prevailed in that period was that capital was treated as a stock of goods used in the process of production. D. Hume argued for interpreting capital as tangible goods only, understood as means of production. On the other hand, he distinguished capital from money and took the view that money should not be equated with wealth.57 The monetary concept of capital originated in the works of A. R. J. Turgot, who considered capital as income-​producing savings and ‘saved goods’58 and in the works of his follower, J. B. Say. A. Smith’s views were a certain breakthrough because he combined the material concept of capital (real capital, commodity capital) and the monetary concept of capital (money), offering a quite controversial interpretation of capital. He considered all capital as productive capital,59 viewing its growth as the main means of expanding wealth. A. Smith divided capital into fixed and working capital as well as into social and individual capital. He was also the first to mention the factor of production.60 These concepts laid the foundation for the development of two main currents of capital theory. The relevant classification was offered by J. R. Hicks,61 who coined the terms ‘fundists,’ for whom capital represented the sum of the value of capital goods, i.e. a fund, and ‘materialists’ or ‘realists,’ who considered capital as a stock of physical goods which could be used to produce new goods in the future.62 The category of ‘fundists’ included A. Smith and almost all British classical economists, K. Marx, and the well-​known marginalists’ –​W. S. Jevons or E. von Böhm-​Bawerk. ‘Materialists,’ in turn, included E. Cannan, A. Marshall, A. C. Pigou, J. B. Clark, and J. M. Keynes with the initial version of his concept.63 According to J. R. Hicks, gross income should be defined as the sum of goods flowing to the income maker during a given period.64 The income-​producing part of one’s property is identified with utility property, the part intended to be used to acquire new value is to generate the net income, and the part that is a cost in relation to the latter is referred to as capital.65 Using J. R. Hicks’ language, the above composition is the sum of the values of those parts –​meaning a fund.66 Gross income is viewed differently by J. M. Keynes, who speaks of it as the difference between the amounts gained in a given period from sales and operating (running) costs. Then, income equals gross profit. In order to obtain net profit, the estimated value of additional fixed costs must be subtracted from income and gross profit.67 The above considerations require defining such notions as income, i.e. an increase in the value of assets gained from one source of income, and so-​called bonuses, which involve an increase in the value of assets not resulting from one’s conscious, intentional activity –​and which are not net income per se. Individual capital is defined as a value and accounting concept that provides a way to determine net income relative to the outlay incurred.This encompasses the values of everything but one’s own labour that individual income can produce, meaning so-​called individual capital goods.68 Social or national capital is defined, among others, as goods that bring income to society as a result of production.69

Earnings as a measure of economic profit  15 The increasing discrepancies between the concepts of individual and social capital are addressed by E.Taylor, who describes three main trends characterising these discrepancies. The first of these trends recognises only social capital, which has taken on a production, tangible nature. The advocates of this concept include: W. S. Jevons, the English and German classics, and the Lausanne school of mathematics. The next trend draws a line between individual capital as a factor of distribution and social (production) capital as a factor of production. The exponents of this school of thought include e.g. J. K. Rodbertus, R. Wagner, H. Storch, R. Rau, E. von Böhm-​Bawerk, A. Marshall, S. Głąbiński, or E. Philipowich.70 The third –​last –​trend starts with individual capital considered to have some value, without considering the social aspect thereof. This approach was supported by e.g. J. B. Clark, I. Fisher, K. Marx, C. Menger, J. A. Schumpeter, or G. Cassel.71 The concepts in which the relationships between income and capital were explored originated in the works of A. Smith, A. R. J. Turgot, or D. Ricard.72 A. Smith did not overlook the issue of profit on capital –​but he did not elaborate on it either. He introduced the concepts of benefits, meaning returns on capital, which included profit and interest.73 Profit is the income derived from capital by a person who uses it in production, while interest, or the price of a loan, is the income derived by a person who does not use their capital themselves –​but lends it to someone else.74 A. Smith’s conclusions are an important contribution to the human capital currently considered.75 According to R. W. Garrison, interest exists because there is a primary return on capital.76 D. Ricardo, on the other hand, uses an example to prove that the amount of profit depends on wages,77 and that interest is a form of discount resulting from the advances contributed to the payroll fund. A. R. J. Turgot, in turn, reduced the idea of income to that of a capital of a land rent to which anyone can be entitled at any time by purchasing land.78 He is the author of the first general theory of profit on capital. The classical approach –​as opposed to the productive use of capital owned by an entrepreneur –​acknowledges the existence of a so-​called surplus value or excess value of profit, proportional to the amount of the capital invested. These assumptions laid the ground for the emergence of theories of different approaches to return on capital. E. von Böhm-​Bawerk calls the first theories colourless theories and names A. Smith, for whom such excess does exist, an exponent of the said school of thought.79 E. von Böhm-​Bawerk distinguished the concepts of ‘future income’ and ‘present pleasure gained from expenditure of wealth.’ His output provided a solid foundation for N. W. Senior’s abstinence theory. He defined oversensitivity as the equivalent of a component of production costs included in the price –​meaning abstinence.80 M. Leod is a harsh critic of the theory of profit, rejecting the view that income is a component of the cost of production.81 He argues against D. Ricard’s theory according to

16  Earnings as a measure of economic profit which the amount of income depends on the state of labour wage.82 He also denies J. R. McCulloch’s labour theory –​as well as N. W. Senior’s abstinence theory.83 In this context, it is impossible to ignore the theory of productivity endorsed by J. B. Say, who uses it to explain that the return on capital depends on the latter’s productivity.84 He divided income into four types: wages, land rent, interest, and profit. In discussing the problem of the role of profit made on capital, it is important to mention two opposing theories that were advocated by J. S. Mill and J. K. Rodbertus and K. Marx –​the theory of labour and the theory of exploitation.85 Return on capital is associated with some excess value gained from the capital used by an entrepreneur at a given time. There are also differences in the understanding of the terms profit, income, and interest on capital. A. Smith claims that profit and interest do not coincide. He believes that the rate of interest depends on the rate of profitability of tangible capital, which creates a demand for capital based on its amount.86 D. Ricardo, in turn, considers these issues synonymous. He considers ‘profit’ as return on capital or primary interest. J. B. Clark shares this view, referring to income earned from means of production as rent, and describing interest as income understood as an outcome of the economic resources of production force.87 He also spoke of capital as perpetual and indestructible –​as opposed to changeable and destructible goods.88 In this perspective, capital does not arise, mature, or disappear. Similarly, F. Knight stressed the indestructibility and perpetuity of capital by separating it from destructible capital goods.89 In contrast, I. Fisher compared capital to an abstract economic power.90 He explained the phenomenon of interest by underestimating the past satisfaction of needs, thus treating every income as a percentage of the capital produced.91 An interesting idea is offered by L. Walras, who claims that capitals are capital goods and incomes are income goods.92 He considers capital goods as factors of production alongside employment and natural forces. He explored the relationship of return on capital and interest on money, concluding that these relationships cannot be treated in the same way. He also argued that an important aspect to consider is the existing dependence on prices and the ways to influence them.93 J. A. Schumpeter offered yet another view, assuming that profit was not income earned on capital. The idea of profit has been associated with the Marxian school of thought.94 According to K. Marx, capital exists in the context of value, and has to do also with social capital, including not only the values of tangible productive capital but money as well.95 J. M. Keynes, however, links the issue of capital and interest rate with the theory of investment.96 He proposed the concept of the ‘marginal efficiency of capital,’ which is the ratio of the expected income to the supply price or the replacement cost of an asset.97 Generalising the analysis offered so far, one can conclude that the concept of capital has always to do with income, meaning surplus value appearing

Earnings as a measure of economic profit  17 over time or as a form of some sort of sacrifice or choice. Income takes the form of gross income or net income. It can also be equated with profit, which is associated with the tangible (material) –​or production –​perspective of capital. In this work, the term capital has been formulated and will be understood as defined below98: Capital originates from the field of economics and finance. It includes goods –​wealth, resources, assets –​financial goods, especially when they are used to start or continue a business. In broad terms, capital is a ‘self-​multiplying’ value. The definition first stresses that capital is not only money and goods, but also technology or other intangibles. Second, not all values are capital –​only invested ones, i.e. those whose possession gives the owner certain benefits. Capital is the source of present and future income –​or future satisfaction of its owners or shareholders.99 These issues have been explored further in the contemporary considerations of neo-​neoclassicists and neo-​Keynesians. This interest in the subject matter can be associated with the analysis of economic growth processes, which was accompanied by an analysis of changes in the distribution of the growing social product among factors of production and socio-​economic classes, and by a study of the impact of capital accumulation, technical progress, and investment decisions. The above philosophy, represented in particular by P. Samuelson and R. M. Solow, is based primarily on the production function. It treats human labour and capital on equal terms, viewing labour and profit as remuneration. The debates taking place between the different schools addressed the issues of the rate of income on investment and the rate of return. According to R. M. Solow, the most fundamental concept in capital theory is that of the rate of return on investment. His contribution involved taking into account the technical advances and highlighting the relationship between savings and investments and long-​term production capacity growth. He treats the rate of return on investment as a link between capital theory, understood as the microeconomic theory of allocation of resources and prices, and the theory associated with aggregation and approximation, which deals with the outcomes of decisions concerning savings and investments.100 According to R. M. Solow: ‘In short, we really want a theory of interest rates, not a theory of capital.’101 J. Robinson, representing the neo-​Keynesian school of N. Kaldor and L. Pasinetti, instead, focused on the role of investment in the process of generation of savings and accumulation of capital. Another problem, addressed by theoreticians in the context of analysing capital from the production perspective, was how to measure capital. Neo-​neoclassicists argued that aggregate capital could be expressed in terms of value. The other school of thought, in turn, explored the possibility of measuring capital using units of labour time.102 J. Robinson explored the category of ‘entrepreneur capital.’ She also dealt with the concept of ‘rentier capital.’ She defines a rentier as ‘an individual whose income comes from owning assets such as debts or credits, and refers to capital

18  Earnings as a measure of economic profit as a quantity of value –​and associates this concept directly to deposits and the rentier income earned from them.’103 Capital has been analysed and discussed in many different ways and from many different perspectives, as proven by the multitude of interesting definitions of this concept that can be found in literature. One such example is J. Hirshleifer’s classification, which divides capital into: • • •

real capital, treated as a set of capital goods at a given point in time, capital value, as the present stream of the value of future income, and liquid capital, defined as the sum of current funds available or intended for investment –​or so-​called investment funds.104

M. Dobija argues that economic profit is nowadays defined as the difference between revenues and total costs, including opportunity and risk costs.105 These costs are typically greater than historical costs. They consist of elements that tend to be overlooked in accounting. Accounting profit takes into account only explicit costs and omits implicit costs. It is therefore greater than economic profit.106 M. Dobija referred to the principle of dualism and considered both the reality of assets in the sense of participation in economic processes and the abstractness and measurability of capitals. He uses analogy in his discussion –​he argues that capital is an abstract ability to perform some work and uses basic concepts characterising the nature of energy to offer a theoretical description of the matter in question. Just as energy is not created from nothing, capital is subject to natural, spontaneous diffusion. According to the first principle of thermodynamics, no capital gain resulting from internal operations is possible. The random diffusion to which capital is subject is a source of risk balanced by the risk premium taking the form of profit in a market economy.107 P. Wojtowicz claims that ‘profit is an increase in the value of capital, it is indispensable because any other situation undermines the sense of existence of economic activity.’108 It is not a return to the views endorsed in the neoclassical model, according to which the maximisation of profit is the main purpose of economic activity. It is precisely the case of the contractual model where departing from profit maximisation considered as the main objective of economic activity in no way diminishes the role of profit.109 R. M. Cyert and J. G. March,110 authors of the contractual model, pointed to the role of profit and named it one of the five objectives of the activity of an economic entity, stressing the variety of sub-​objectives of individuals acting under specific circumstances and being part of such an entity.111 Summarising the above discussion, it is hard not to notice the many discrepancies in the interpretation of the concepts of ‘capital’112 and ‘profit’ and the resulting differences in the attempts made to clarify the key notions and ideas used in different theories.113 The categories of capital and profit are inseparable from each other. Profit is an increase in capital over a certain period of time.114 The concept of capital is one of the most ambiguous categories to define. In

Earnings as a measure of economic profit  19 modern economic sciences, the definition of capital is used in macroeconomic and microeconomic terms, referring to the whole of economy or enterprises. The term is a general category that encompasses three quite different economic phenomena: real (physical) capital, monetary capital, and human capital.115 Capital is a concept that is defined and interpreted in many different ways, depending on the economic field (economics, finance, accounting, etc.). In the microeconomic approach to the category of capital, two distinct concepts have been adopted: • •

wealth, which plays an active role, and thus it is listed on the asset side of the balance sheet and capital, which plays a passive role. It is manifested in the sources of wealth financing on the liabilities side of the balance sheet.

The distinction between capital considered in the financial perspective and capital viewed in the context of accounting stems primarily from a different understanding of its essential functions. Capital viewed in accounting terms follows its traditional definition and refers to the elements of liabilities on a company’s balance sheet. It also expresses a carrying value which is not a stream. It results in assets that generate a financial surplus, which is a stream.116 Speaking in most general terms, capital can be defined as the accumulated good used to develop further production and the monetary resources used in production.117 Capital is a desirable good because it makes it possible to engage in activities that increase its value and enable one to achieve and maintain competitive advantage in the market.118 The theory of economics and the theory of accounting have not worked out a scientific concept of profit to date –​only a range of its various tool variants used for different purposes.119 From an accounting point of view, accounting profit is a more or less ideal measure of economic profit. In accounting, earnings are expressed in monetary terms, attributed to an economic entity and calculated for a given accounting period. An important aspect of determining an economic entity’s earnings in modern accounting is the use of the accrual method.120 To conclude the discussion above, it is necessary to point out that in 2005, in a three-​volume work entitled Capital Theory, C. Bliss, A. J. Cohen, and G. C. Harcourt offered their own different views on capital theory. They made their individual take on the subject very clear in the introduction to the first volume, stressing that the theory of capital is an infamous subject on account of the controversies and the resulting tensions between the two concepts of capital, i.e. the physical concept and the value concept. The controversies that have arisen over the last hundred years are the result –​on the one hand –​of the integration of production into a theory of value, which is based on rarity, and –​on the other hand –​of the integration of capital and time with equilibrium models. It can be argued that the originators (J. B. Clark, F. Knight, I. Fisher, and Y. Ijiri) and advocates of the theory of capital, separating capital from matter, came really

20  Earnings as a measure of economic profit close to creating a theory of capital reflecting an abstract category as an economic ability to perform work.121

1.2 The concept of earnings and their measurement in accounting theory Nowadays, accounting is considered as a theory of measurement of economic values as well as a system of such measurements, aimed at assessing the current and future situation of economic entities.122 Detailed information on the valuation methods essential to the proper interpretation of the values obtained is presented in financial statements. In order for this information to be reliable and not misleading or confusing, entities should disclose the assumptions adopted in the valuation carried out.123 Earnings can be defined as an accounting measure of the economic profit of a business entity.124 At the same time, it is an economic parameter that is widely discussed in the domain of accounting. This category has specific functions in the economy. Some of the most important of them include125: • • • • • •

measurement of an individual’s accomplishments over a specific period of time, a source of financing of the development of an enterprise, supporting decision-​making and control processes, identifying areas where resources can be used effectively, affecting the behaviour of capital market participants, and a determinant of market valuation of stocks and debt securities.

On the other hand, earnings ‘[…] are marked by ambiguity and multifacetedness.’126 K. Czubakowska, W. Gabrusewicz, and E. Nowak127 define earnings as a measure of ‘economic benefits achieved by an economic entity, which is a resultant of processes contributing to these benefits becoming greater and processes causing them to become smaller.’ The principles of measuring earnings depend on the adopted definition of economic events, methods of valuation of assets and liabilities, and the concept of capital preservation. Measurement of earnings is also affected by the approach to financial reporting. By adopting these criteria, earnings can be measured by following one of these two approaches128 • •

the result approach and the balance approach.129

The result approach is a conventional perspective on an economic entity’s earnings. Here, earnings are measured based on a profit and loss account, in line with the transactional approach. In the transactional approach, the main purpose of accounting is to provide information about past events.130 The focus here is on the proper definition, recognition, and measurement of revenues and

Earnings as a measure of economic profit  21 expenses as categories that affect earnings. In this approach, assets and liabilities are categories derived from revenues and expenses. The role of the balance sheet and balance sheet categories is stressed in the balance sheet approach. What is important here is to correctly determine the value of the components of the balance sheet. Earnings are measured from a balance sheet perspective, which results in revenues and expenses defined as changes in the values of assets and liabilities being derived from individual balance sheet categories. Earnings are therefore affected –​and shaped –​by changes in the values of assets and liabilities.131 Regardless of the concept adopted, earnings are measured in accounting by means of a comparison of two opposing streams, i.e. profit streams and loss streams.132 The category of profit and loss has evolved over the years, just like the entire domain of accounting.133 A. Szychta points to two economic concepts which are the starting point in defining and measuring the profit resulting from activity undertaken in a given period. These concepts are134: • •

the concept of profit –​increase in prosperity (wealth) –​and the concept of profit maximisation –​a measure of a company’s performance and of the outcomes of the decisions made by the company’s management.135

According to the first concept, capital is the stock of wealth at a given time, and profit is the benefit gained by an economic unit from the use of the capital it owns. According to the second concept, profit is a measure of the effectiveness –​or performance –​of a company and its management.136 There are many different concepts of measures of earnings or financial performance of business entities in accounting theory and practice. Since the capital market is the natural habitat of companies, there is a need to look for and use more adequate measures to assess the effectiveness of the activity and development of business entities, which will then enable the convergence of occurring events between the information policy of managers and the expectations of other stakeholder groups. The arising problems have to do with the effectiveness and efficiency of communication with the market –​with financial statements being an essential element of this communication. It is fair to conclude that the primary function of financial statements is to offer information, motivation, and an incentive to make decisions. A piece of information about an enterprise’s earnings included in a financial statement is considered useful if it correlates with decisions being made or changed by its users.137 Financial performance is a challenging concept, which is abstract to measure and requires accounting estimates and professional judgement. P. M. Dechow, W. Ge, and C. Schrand138 proposed a definition of financial performance involving two perspectives. In the one-​period model, they defined financial performance as the sum of the period’s cash flows from one period and the occurring changes in the liquidation value of net assets. In the multi-​period

22  Earnings as a measure of economic profit model, in turn, financial performance consisted of the following elements: cash flows generated at a given time; present values of cash flows –​generated in future periods –​which are the result of current actions, or present values of changes in the liquidation value of net assets –​the result of current actions taken. Earnings should be a measure of financial performance. According to the concept of the authors,139 it is a function thereof. It is extremely rare to see earnings being equal to financial performance. P. M. Dechow, W. Ge, and C. Schrand named three aspects of earnings, explaining them as follows140: •

•

•

The end-​of-​period earnings for all user groups are the basis for making various decisions in given economic entity. State authorities that establish accounting regulations should take all stakeholder groups into considerations. It is possible to establish an accounting policy and choose the relevant valuation methods. At present, there is some freedom in the choice of valuation principles –​despite the attempts to eliminate alternative approaches. This becomes apparent in new and complex business transactions. There are varying levels of implementation of regulations in accounting –​ encompassing countries, sectors, or companies. The concept of financial performance is a category that is difficult to measure and abstract, which requires accounting estimates, and this can translate into both unintentional and intentional errors and mistakes.141

D. Dhaliwal, K. R. Subramanyam, and R. Trezevant argue that the above has been the subject of debate since the 1930s.142 In 1966, Financial Accounting Standards Board (FASB) was presented a selection of key arguments. It was decided that the biggest problem with reporting earnings was the matter of inclusion of the outcomes of extraordinary events and prior period adjustments.143 In accounting theory and in accounting regulations, two concepts of profit can be identified, which correspond to the result achieved by an entity, determined in accounting systems, and presented in financial statements. These concepts are144: current operating performance and comprehensive income. Comprehensive income is a consequence of the application of a concept called the clean surplus account, where changes in equity that occur and do not arise from an entity’s transactions made with its owner should be recognised as a result of its activity performed during the reporting period.145 Transactions with owners should be reported separately, as argued in International Accounting Standards (IAS) 1. Despite the demands called for in financial reporting regulations, it is acceptable for the change in the value of assets and liabilities to pass by the income statement and go to the balance sheet or the statement of changes in equity.146 The opposite of the first of the above concepts is dirty surplus accounting. Here, it is acceptable to have certain changes in the net asset value, other than changes related to owners’ transactions, bypassing the income statement. They are recognised directly in equity in the balance sheet147 in the form of so-​called dirty surplus. The ‘dirty surplus’ model is characteristic of

Earnings as a measure of economic profit  23 the current operating profit approach. J. Gierusz148 argues that a good example of the above is the Polish Accounting Act, where the amounts resulting from revaluation of assets and liabilities to fair value are lost in the amount of equity.149 The nature of the traditional and modern approach to defining and measuring earnings has been covered by J. Gierusz and J. Gawrońska, who stressed that the principles of measurement of earnings are closely related to the adopted definition of an economic event, the methods of determining the value of assets and liabilities, and the concepts of capital preservation (Table 1.2). J. Gierusz and J. Gawrońska offer a division into traditional and modern approaches to earnings. The qualities attributed to concepts occur in practice at a varying degree of intensity and should be approached carefully. An important aspect here is the noticeable trend of changes and the direction of transformations, which both make it possible to establish the causes and consequences of the occurring processes. The year 1980 should be considered crucial in changing the approach to the earnings category. This year, the FASB published a definition of comprehensive income in Statement of Financial Accounting Concepts No. 3.150 The notion of comprehensive income appeared in International Financial Reporting Standards (IFRS) in 2009 along with a revision of IAS 1.151 In semantic terms, where earnings are determined at the operational level, it is a measure of the achievements of an economic entity and describes the effectiveness of the decisions made by its management. In structural terms, this quantity is an illustration of the effects of economic transactions. Material resources and sources of financing are valued according to historical cost and any potential revaluations are charged to equity outside the income statement. The most important principles are the principle of realisation and the principle

Table 1.2 Characteristics of traditional and contemporary approaches to the definition and measurement of earnings No.

Item

Measurement Traditional

Contemporary Comprehensive income Concept of wealth Enterprise activity-​based approaches Fair value

1 2 3

Scope of earnings Semantic aspect Structural aspect

Operating income Performance measure Transactional approach

4

Valuation of assets and liabilities Accounting principles

Historical cost

5 6 7

Qualities of information Impact of accounting policies

Principles of prudence, realisation Credibility Small

Principle of matching Usefulness (relevance) Big

Source: J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2012,Vol. 66, Issue 122, p. 30.

24  Earnings as a measure of economic profit of prudence. When it comes to the qualities of information, what matters is the credible and reliable presentation of the economic entity’s situation. In this perspective, the possibility to affect earnings by means of accounting policies remains unnoticed.152 What can be found here, in turn, is a close connection between tax law and balance sheet regulations, which translates into little significance of deferred tax.153 In the semantic aspect, comprehensive income refers to the concept of wealth. In light of this approach, profit ‘is the difference between the amount of capital available for distribution at the end of the reporting period and the amount of capital invested at the beginning of that period.’154 According to the Conceptual Framework for Financial Reporting: ‘only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital.’155 When it comes to the structural point of view, the contemporary approach to measuring earnings156 is based on the operations of a business. This category not only encompasses the effects of economic transactions but also takes into account the changes in the prices of the resources owned by a given economic entity. The expectations of managers are the results of events taking place in an entity’s environment, which the entity is able to control or influence to a very limited extent. Certain specific assumptions or expectations will be reflected, for example, in asset write-​downs or in the earnings generated by long-​term contracts. This results in a shift from valuation at historical cost to fair value.157 Prudence, understood as caution, ‘[…] in using subjective judgements necessary to make estimates under conditions of uncertainty,’158 is absent from the new Conceptual Framework, and the realisation principle does not apply thereto. Qualitative features include usefulness, i.e. the ability of information to influence decision-​making. Information becomes reliable when it becomes fully compliant with all IFRS. There is also an increasing importance of accounting policies, especially in two areas159 • •

balance sheet valuation of assets and liabilities –​a choice is made between historical cost and fair value –​and place of presentation (category) of the effects of revaluation –​operating profit (income statement) or revaluation reserve (statement of changes in equity or statement of comprehensive income).160

Due to the increasing discrepancies between balance sheet and tax regulations,  deferred tax assets and liabilities have been gaining in importance.161 It is impossible to name all of the sources of the distortions presented. According to the literature on the subject, there are two causes underlying the processes in question. The first is the growing importance of value-​based management. The second is the changing information needs of investors.162 M. Bojańczyk163 claims that: ‘value management encompasses the principles, propositions, and solutions for strategic and operational decisions made with the aim to maximise the value of the enterprise.’ The two opposing options

Earnings as a measure of economic profit  25 of creating value for owners of capital (shareholders) or other stakeholders (stakeholders) is the comprehensive income concept, which refers directly to the former. The primary objective of a company is to maximise value. In the case of an investor, maximising value is important only when the company is able to generate a rate of return higher than the capital invested. It is possible to notice gradual changes in shareholders’ requirements regarding the content and the form of information provided in financial statements. Instead of focusing on recording retrospective events, accounting should be a prospectively oriented system that makes it possible to assess the future resources of the analysed entity as well as the potential of this entity to generate cash flows.164 An entity may present the components of its earnings as part of a single statement or in two separate statements. Statements prepared in accordance with IAS/​IFRS feature the following result categories: net income and comprehensive income. There is a view according to which a comprehensive income statement captures two valuations at the same time, i.e. it includes the net profit/​loss associated with the historical cost valuation, and comprehensive income is combined with fair valuation. A significant factor for the introduction of the statement of comprehensive income was the financial instruments project. Fair value-​based valuation brought to light the issue of revenue/​cost being recognised in equity. K. Grabiński offers other arguments speaking in favour of the concept of comprehensive income.165 The literature on the subject emphasises the fact that comprehensive income combines both concepts of profit measurement.166 The results of managing a business in relation to a given reporting period are presented in the income statement. Capital gains and losses, subject to realisation in subsequent years, are recognised in other comprehensive income and equity. As A. Szychta points out, determining and presenting two categories of financial performance in the financial statements of public companies, both describing their earnings in a given reporting period (net profit or loss and total comprehensive income) should provide the users of the statements of these companies with a basis for an assessment of the achievements of a given company and its management in a given period and for drawing conclusions regarding the impact of the total comprehensive income and its components on the increase of the company’s shareholder value, as well as make it possible for them to forecast changes in the net profit (loss) in the periods to follow.167 A traditional income statement shows accrued and realised economic benefits related to the current period. In contrast, a statement of other comprehensive income shows accrued economic benefits that will be realised in future periods (Figure 1.3). Such a report is the result of adopting a new concept of presenting information about comprehensive income, and just about net income.168 The new

26  Earnings as a measure of economic profit Income statement • actual revenues – • actual expenses

Statement of other comprehensive income • Components of other comprehensive income (capital gains and losses)

= net financial result

= other comprehensive income

Accrued and realised benefits (loss of benefits) economic concerning the current period

Accrued benefits (loss of benefits) economic concerning future periods

= TOTAL COMPREHENSIVE INCOME

Figure 1.3 Income statement vs statement of other comprehensive income. Source: Author’s own work based on: J. Gad, Pozostały wynik całościowy oraz wynik finansowy netto w świetle oceny dokonań jednostki, Finanse, Rynki Finansowe, Ubezpieczenia Issue 74, Research Papers of the University of Szczecin Issue 855, Szczecin 2015,Vol. 1, p. 633.

approach resulted in amendments to IAS 1 ‘Presentation of Financial Statements’ regarding the scope and components of a financial statement. The introduction of the statement of comprehensive income is a significant moment in the debate on the accounting theory and practice that has been held since the 1930s.169 At the time, there existed two opposing concepts170: • •

the concept of profit as an increase in wealth (value) owned by the owners (the concept of comprehensive income or all-​inclusive income) and the concept of profit as a measure of performance of a company and its management (the concept of current operating performance or net profit).

Based on the comprehensive income concept, accounting regulations assume a model of clean surplus, which determines the change in the book value of equity excluding transactions with owners in a given accounting period –​with the change to be reflected in the result for a given period.171 According to this

Earnings as a measure of economic profit  27 concept, changes in equity, excluding an entity’s transactions with its owners, should be included in the entity’s income statement for a given period. The division of equity into an ‘owner’ part and an ‘income’ part made it necessary to present the changes therein in three sections in financial statements.172 The comprehensive income concept proposes adopting fair value valuation as the starting point.173 It refers mainly to the income statement, which should encompass all items comprising revenues and expenses. Regardless of their recurrence or transitionality and irrespective of their degree of cash realisation of revenues and expenses, but taking into account the accrual method.174 In 1997, the US FASB stated as follows: ‘analysts’ predictions can be useful in stock valuation only if they relate to comprehensive income; moreover, the price-​ earnings ratio can be properly interpreted only if it is calculated on the basis of comprehensive income.’175 The literature on the subject provides other arguments for the concept of comprehensive income176: • • • • •

the concept of comprehensive income as clean surplus is internally consistent, i.e. it is less susceptible to manipulation and is in line with valuation theory,177 comprehensive income encompasses all sources of value creation in an entity, comprehensive income obliges managers to pay attention to all factors that can affect value creation in their company, comprehensive income minimises the negative impact resulting from the phenomenon of earnings management performed by an entity’s managers,178 and comprehensive income better represents an entity’s ability to generate profit in the future.179

A. Szychta180 stresses that the theory and practice of accounting defines earnings determined on the basis of the concept of comprehensive income as a measure of the increase in wealth of the owners of an entity. Based on the current operating profit, earnings are defined as a measure of the performance of businesses. The concept of comprehensive income seems to have been born out of the need to organise the form of presentation of information in financial statements. The main objective was to separate changes in equity resulting from settlements (transactions) made with owners from changes not resulting from such settlements (transactions).181 A statement of comprehensive income presents all of the gains and losses that an entity has made, regardless of where they are recognised (period result or other equity items).182 So far, there has been no common view on the predictability of earnings, calculated according to the concept of current operating profit or according to the concept of comprehensive income. The matter of what effect the inclusion of extraordinary and non-​recurring items has on the above has not been

28  Earnings as a measure of economic profit settled either. Proponents of the current operating profit concept believe that recognising extraordinary items not related to the core business of an entity negatively affects the predictive ability of the reported earnings. They argue that the reported earnings should be marked by persistence over time. Therefore, revenues and expenses should be limited to only those that concern for the entity’s recurring core activities.183 According to the concept of net profit as derived mainly from operating profit, earnings are understood as the result of a comparison of an entity’s revenues and profits and costs and losses in a given period, presented in the form of a traditional income statement. According to the regulations included in the Polish Accounting Act as the legal basis for financial reporting in Poland, income and profits should be understood as: probable economic benefits of a reliably estimated value, which may arise during a reporting period in the form of increases in the value of assets or decreases in the value of liabilities, that will result in an increase of the equity or a decrease of the equity deficit in a manner other than through contributions made by shareholders or owners.184 Revenues and expenses of a non-​recurring and extraordinary nature as well as those that do not originate from an entity’s core business should be excluded from the income statement and moved to other elements of the financial statement, i.e. to the statement of changes in equity or directly to the balance sheet. These items are referred to as dirty surplus and are often difficult to identify for those who read financial statements.185 B. and K. Grabiński argue that the main purpose of the concept of net profit in financial reporting is to establish a relatively permanent, lasting financial result (earnings) over time as an outcome of repeated transactions. On the other hand, changes in e.g. the macroeconomic conditions or extraordinary events, over which the management of an entity has little or no control, should be excluded from the income statement by means of dirty surplus and transferred to other elements of the financial statement. Such a situation may be tempting for managers to manipulate the value of earnings, which is called earnings management in accounting theory. It can be thus concluded that this is a major drawback of the current earnings approach, which somewhat forces the creation of a dirty surplus.186 Dirty surplus is difficult for users of financial statements to identify, which can be used as a way to inflate financial results.The phenomenon was observed as early as 1934 by W. Paton, then in 1937 by G. O. May, and in 1940 by A. C. Littleton.187 The choice between the current operating performance concept and the comprehensive income concept is also a question of which of them is a better, more perfect measure of economic profit and, at the same time, a better basis for holding managers accountable for the resources entrusted to them. If earnings are adopted as a form of management accountability, the idea is to make current operating profit include only those revenues and expenses that depend on

Earnings as a measure of economic profit  29 management –​because such a result is a better measure of the effectiveness of management’s decisions and actions.188 Meanwhile, the implementation of the concept of comprehensive income forced the need to analyse those profits and losses, made by an economic entity as a result of its activities, regardless of where they are recognised in financial reports. It should be noted that public disclosure of the amount of an entity’s comprehensive income –​and its components –​is becoming essential for users of financial statements. Thanks to a statement of comprehensive income, users get a better overview of the current activities of the business entity considered and, at the same time, are better able to predict the development of the entity’s financial performance in the future.189 Measurement of earnings is currently considered as one of the most important challenges in accounting. Its role increases with the distribution of ownership and managerial functions. In countries where the banking sector is the main source of financing for businesses, balance sheet is given more importance. But in countries where the primary sources of financing come from the capital market, income statement plays a greater role.190 According to empirical studies conducted so far in Poland and worldwide, it is earnings –​next to cash flows –​which are the main determinant of the decisions made by investors.

1.3 The significance and application of earnings in theories of economics and finance Nowadays, accounting is understood as a system of economic measurement –​including the measurement of profit as a specific economic category. Earnings are used as a measure of an economic entity’s business performance. In the accounting system, earnings are determined on the basis of the adopted accounting regulations and accounting principles resulting therefrom. Earnings calculated for a given reporting period are disclosed and presented in financial statements.191 There is no question that the role of financial statements in a market economy is very significant. They act as an important set of information, useful in evaluating the condition of enterprises and helpful to their recipients in making decisions.192 The guiding principle of accounting is the principle of true and fair view. For years, this principle has been an indicator of the purpose of financial reporting, which is to provide reliable and true information about an entity’s assets and financial performance. In Article 4.1 of the Polish Accounting Act, the principle of true and fair view is named as the first of many principles described in the content of the act. It used to –​and has continued to –​be the guiding accounting principle to which other accounting principles are subordinate.193 Through reporting information, accounting is to provide a true and fair view of the assets, the financial position, and the financial result –​i.e. earnings –​ of economic entities. It thus provides information that should offer a reliable overview of a given entity’s situation.194 Thanks to this principle, the accounting information produced becomes very reliability.195 An important thing to point out here is that the amendments introduced in 2013 to the Polish Accounting

30  Earnings as a measure of economic profit Act retained a reference to this fundamental principle. This is also consistent with the content of the new EP directive196 on financial reporting.197 Earnings are a measure of the business effectiveness of organisations. They are expressed in monetary units as the difference between an entity’s revenues and profits and its expenses and losses,198 recognised in line with the principles of accrual and matching.199 Since these events occur over time, they must be assigned to the accounting interval used in the calculation.The value of earnings can be either positive or negative. When it is positive, it is a gain. When it is negative, it is a loss. When deciding to run a business, an entrepreneur commits their time and money to it with the aim to make a profit as quickly as possible. No one wants to make losses, but such a scenario is also likely. Information about the increase and decrease in earnings of business entities is very important in the context of market economy.200 The elements that affect the financial results (earnings) for a given accounting period can include201: • •

revenues earned and expenses incurred in connection with transactions made during the period and revenues and expenses resulting from balance sheet valuation; accruals and accounting estimates are particularly important in this category.

The structure of a statement of earnings –​an income statement or a statement of comprehensive income –​does not clearly indicate which revenues and expenses are attributable to completed transactions and which result from balance sheet valuations.There are no questions regarding realised revenues and expenses incurred. These categories are recognised as results (earnings). If there are any unrealised revenues and costs, those that result from fair valuation raise particular doubts as to the appropriateness of recognising them as categories affecting the earnings and reporting them on a par with actually completed transactions. It is necessary to consider whether changes in market conditions that arise from different valuation methods (including fair value) should affect a business entity’s earnings management.202 Financial statements are a source of essential financial information for the decision-​making processes of an enterprise. Under IAS 1, financial statements are intended to provide information about a business entity’s financial position, about the results of its operations, and about any changes in its financial condition. The information obtained should be useful to the recipients and helpful in making judgements and opinions enabling the achievement of the objectives pursued by a given entity. A financial statement contains information marked by qualities that satisfy stakeholders. Financial quantities are documented, measured, and presented in line with accounting standards. An important element of a financial statement is the bottom line –​earnings. It tells the user of a statement whether a business entity is profitable or loss-​making. The purpose of a business entity’s activity is to increase value (corporate value or shareholder value) and profit. As found by P. Wójtowicz,203 the existence

Earnings as a measure of economic profit  31 of uncertainty204 and the need to overcome its effects is one of the main reasons for people to interact and act together within an enterprise, which is also the reason for opportunistic behaviour. The consequences of such behaviour and the problems associated therewith are addressed within the framework of corporate finance and accounting theories. These theories affect accounting in its broadest sense and are important in terms of earnings management. For the purpose of this work, only the most important of said theories will be mentioned. These include: the agency theory (also referred to as the principal-​ agent problem), the information asymmetry theory, the signalling theory, the hypothesis of information efficiency of capital markets, the capital asset pricing model (CAPM), the portfolio theory, and the arbitrage pricing theory. One of the major finance theories that has a significant impact on accounting is the agency theory, also known as the agency costs theory.205 It is described as the relationship between the owners of a business and the management hired to act on behalf of the former. An agency relationship is defined as a contract where one or more persons engage another person to perform services on their behalf –​including making strategic decisions.206 At first, the agency theory was associated with the relationship between managers and shareholders, but it is now also linked with the relationship between lower rank management staff and their subordinates.207 The agency theory focuses on solving two problems, i.e.: the divergence between the goals of the principal and the agent and the distribution of risk.208 According to the agency theory, in some circumstances managers (agents) may take actions that are inconsistent with the expectations of shareholders (principals), like paying excessive remuneration or resisting a value-​enhancing takeover bid.209 In a typical agency relationship, it is assumed that the information advantage lies with the agent. The principal needs information regarding any actions taken –​as well as information regarding the environment that affects the agent’s performance.210 As N. J. Saam noticed, the agency theory holds an implicit assumption which concerns the power relationship between the principal and the agent. There is an asymmetry of power, with the majority of it resting clearly with the principal in the case of the agency theory.211 For instance, a principal may have tools that can make an agent want to perform better. The fact that a principal is able to ‘motivate’ an agent as described above results exactly from said asymmetry of power working to the advantage of the former.212 A principal may make decisions to encourage and persuade an agent to act in the principal’s interest, which can be considered as acting in a twofold manner213: 1 Acting to bond the interests of the agent with the interests of the supervisor, where the resulting costs are referred to as bonding costs. They are additional remuneration paid to the agent with the aim to make sure that the act as expected and stay motivated or to compensate for losses incurred as a result of negative management decisions made. In listed companies, such costs may mean requiring managers to devote their time to preparing

32  Earnings as a measure of economic profit quarterly and annual reports, or agreeing to make a portion of their remuneration conditional on the financial performance. The usual practice is to transfer the final binding costs onto the agent. 2 Acting to monitor the actions taken, which means putting in place a control mechanism. Such expenses are referred to as monitoring costs and have to do with measuring, observing, and controlling the agent’s actions and performance. Monitoring costs may include an audit of statements, performed by a certified expert auditor, or costs associated with implementing internal control measures within a given business entity. In practical terms, these costs are borne by the principal, who will want to transfer them onto the agent in the long run. J. Godfrey, A. Tarca, J. Hamilton, and S. Holmes214 signal that the level of monitoring –​and the costs involved therein –​ depends on shareholder confidence in the management board, as well as on the board’s general reputation. Board members make efforts to enhance and keep their reputation good, which may translate into less scrutiny and thus more freedom to act and make decisions. The principal’s main objective is to influence the agent in such a way that they make decisions which are both advantageous to the capital owner and optimal from their own perspective. Such a situation may not occur without incurring monitoring and binding costs. The more a management board looks out for the interests of shareholders through high-​quality financial reporting, the less the need for –​and the less the cost of –​supervision or scrutiny. The relationship between these costs is therefore inverse. According to M. C. Jensen and W. H. Meckling, in most agency relationships, despite the fact that both parties incur costs, there will be a constant divergence between the decisions made by the agent and those made by the principal.215 The cost involved in this divergence has been referred to as residual loss. This loss occurs whenever an agent acts in an opportunistic manner, partially or completely contrary to the principal’s interest, thereby increasing the amount of costs to be borne by the principal.216 The main reasons for the divergence between owner and management preferences include: risk aversion, time horizon, and dividend policy.The source of agency costs is the level of risk aversion of owners and management. The agency theory posits that the level of risk aversion is higher among managers than among owners, who, by investing their savings in other shares and earning income from their own work, significantly diversify the risk of their personal investments. The case is different when decisions are made by owners because the situation of a business entity affects their personal financial condition. As a result, managers prefer lower risk projects and shareholders prefer higher risk projects with higher returns. Each party acts with the aim to achieve the expected outcomes –​but over different time horizons. Shareholders want to build value over the long term, while managers focus on arriving at the desired results in the short term. The last factor behind the occurrence of agency costs is the different approach to dividend policy. Managers prefer to retain available

Earnings as a measure of economic profit  33 funds to expand the structures of the organisation they manage. Shareholders, in turn, expect a higher return on the capital employed.217 The agency theory carries important implications for financial reporting. It also explains the motivation of managers in managing earnings.The preferences and expectations of shareholders provide the starting point for actions taken by managers, who adopt their own objectives –​which are not always in line with the objectives of the former. High agency costs have a negative impact on the profitability and core economic performance of a business entity. Reporting actual results in financial statements very often makes shareholders act to reduce agency costs, and this is, in turn, disadvantageous to management boards as it may even lead to their dismissal in extreme cases. To avoid negative consequences, managers may resort to manipulating the amount of earnings or other reported items.This is not to say that the above is a standard practice. However, engaging in such behaviour tends to be quite tempting.218 The global literature on the subject includes many empirical studies confirming the significant impact of agency theory on accounting.219 It needs to be noted that within an economic entity there are shareholders, interested in the actual financial condition of the economic entity, and managers, who are unable to show that the entity has achieved satisfactory financial results when there is a market downturn. However, accounting regulations allow for a variety of alternatives that managers can make use of. H. Lin220 has noticed that accounting policies are used for the day-​to-​day needs of management boards of business entities, where depreciation policies have proven useful. It has also been proven that the average level of managers’ involvement in companies’ shareholding structures has a positive impact on the timeliness of accounting disclosures. The existing empirical studies exploring the agency theory include valuable studies of its impact on financial statement auditing, which appears to be a source of motivation for managers to manage earnings.221 Empirical studies also confirm the positive impact of business performance on the amount of remuneration of managers, which means that the better the performance, the higher the pay.222 However, in certain conditions, this relationship was weak or completely absent. As noted by P. Wójtowicz, the reason for this could be the low quality of financial statements. The lower the quality, the greater the likelihood of adoption of non-​financial measures to determine the amount of remuneration.223 This concept seeks to measure managerial performance by analysing the performance of the enterprise, in line with the decisions made in a decentralised organisation. Another significant theory used in both accounting and finance is the information asymmetry theory. It was created by J. E. Stiglitz,224 who drew from the idea of imperfect capital markets.225 According to this theory, the insiders and outsiders of a company have different levels of access to information. Those with good access to information may be in a privileged position in the capital markets, which does not inspire confidence in the market and its actors.226 One of the causes of information asymmetry is the separation of management and ownership functions.227 Information asymmetry occurs both during the process

34  Earnings as a measure of economic profit leading to the conclusion of a contract (the so-​called ex ante stage) and after the conclusion of the contract (the ex post stage). At the ex ante stage, information asymmetry suffers from the problem of adverse selection,228 while at the ex post stage, there occurs the problem of the so-​called moral hazard. Adverse selection occurs when entities use information available only to them when deciding whether or not to enter into a contract. As a result, those who choose to conclude a contract are not a representative sample of the entire population.229 Moral hazard involves using information not available to others to gain an advantage at the expense of another party to the contract. O. E. Williamson230 points out, however, that if opportunism does not occur,231 the problem of adverse selection does not occur either. Also, if the postulate of unbounded rationality were satisfied, there would be no problem of moral hazard.232 Information asymmetry in corporate finance refers to a situation where at least one interest group has more and better information about the future of a business entity than other groups. The reason for the asymmetry of information in this case is obvious: management has full knowledge of the entity’s past and knows much more about its future than other interest groups. The advantage is clearer because the management board is the body shaping the entity’s future to a great extent. Investors, on the other hand, rely greatly on information they receive from the management board.233 Today’s businesses that compete in capital markets pay attention to the structure of their disclosures, particularly in the area of voluntary disclosures. Both excessive and deficient information alike can have a negative impact on the communication process.234 E. Walińska argues that: ‘today, however, the real challenge is not to increase the number of disclosures but to provide information that is relevant and useful, and to present it in an understandable, user-​friendly format.’235 S. A. DiPiazza shares this view, stating that: ‘part of our problem is that we are great at creating new things to report, but what we haven’t done well is create a framework to consolidate all these things.’236 Reports are a way for a business entity to communicate with its stakeholders, whose support can often determine the further operation and even existence of the entity. A knowledgeable user will only interpret a financial statement correctly if they are provided with the information they expect. The assumption is that a higher quality of earnings reduces the occurrence of information asymmetry in a capital market –​and increases its efficiency. Investors make better decisions regarding their investments on the basis of high-​quality earnings. Earnings management not only fails to reduce information asymmetry but very often shapes the desired picture of an entity’s financial situation from the management’s point of view, thus influencing the decisions made by stakeholders.237 The signalling theory is associated with the agency cost theory and the contracting theory. Its underlying idea is that the management board of an economic entity provides financial information to investors to enable them to make sound decisions. According to the signalling theory, if an economic entity’s management board has an optimistic outlook, they will try to communicate this outlook in the information published in financial statements.

Earnings as a measure of economic profit  35 When the outlook is pessimistic, the management board will signal its concerns accordingly. According to the signalling theory, there is a strong incentive among managers to communicate their expectations about the future of the entity they manage. Such behaviour involves voluntary rather than mandatory disclosure.238 As emphasised by A. Duliniec, this theory draws from both the theory of information asymmetry and the theory of the hierarchy of funding sources, and is an extension of the analysis encompassed by the theory of funding sources. According to the signalling theory, economic agents first use internal sources of financing, and after these sources are exhausted, they turn to external sources (issuance of debt securities, hybrid instruments, equity securities).239 When a management board is aware that the situation of the entity they manage is getting worse, they may decide to issue new shares to raise the necessary share capital. It is then possible to see the response of investors to the issuance of new shares, which takes the form of a reduction in the valuation of their value. The signalling theory takes into account the occurrence of information asymmetry in capital markets. Decisions to increase debt are perceived as a good move because the recipients of such information assume that the business entity is in a financial shape good enough to pay its obligations under the debt in a timely manner. In contrast, a decision to increase share capital and issue new shares may be interpreted as an action to transfer some of the risk onto new investors, which may lead to lower share valuation. In consequence, managers treat equity capital as the last source of funding considered.240 The amount of internal funding depends on the dividend policy as well as on the entity’s investment policy. In an article entitled The Capital Structure Puzzle,241 S. C. Myers argues that dividend policy is adapted to investment needs, with business entities trying to keep payouts relatively constant. The desire to make dividend payouts stable and the volatility in the area of profitability and investment needs may mean that it will be necessary to engage additional resources. In the former case, these resources will come to be a result of the liquidation of cash reserves shown on the balance sheet or of the sale of securities. An important aspect of the hierarchy theory is the assumption that the dividend payout policy is constant. Businesses try to keep dividends stable because they fear that investors might interpret a decrease in the amounts of the dividends paid as a deterioration in a given company’s situation. Fixed dividends limit the ability to dispose of the profit earned. Especially in times when the operating cash flows generated are low and when there occur increased capital expenditures –​when internal sources of funds may not be sufficient.242 One effective way to signal an entity’s situation is to increase the debt ratio. An increase in debt is usually a clear signal of expected high cash flows in the future. Investors who are aware of information asymmetry look for signals that confirm their expectations regarding an economic entity’s future situation. An important signal, for instance, is the announcement of a dividend payment. Business practice shows that the level of dividend payout is related to the market value of the shares.243 All actions taken aim to convince investors that the information provided is credible. The quality of the presented earnings as perceived

36  Earnings as a measure of economic profit by the market does matter here.244 It is possible to notice here the relationship between the quality of earnings and the cost of capital. The higher the quality of earnings, the lower the cost of capital. The efficiency of financial markets can be viewed in different terms –​ transactional efficiency, allocative efficiency, and informational efficiency. The financial market efficiency theory is related exactly to the last of the above categories. According to the theory in question, markets are efficient if asset prices fully reflect all of the available information. This means that investors operating in the market are unable to achieve extraordinary profits even if they make use of the most sophisticated investment in existence. The theory of efficient markets is said to have been founded be E. F. Fama, who was the first to formulate a comprehensive theory describing this phenomenon.245 He also identified the sufficient (but not prerequisite) conditions that determine the informational efficiency –​or simply efficiency –​of a market.246 These conditions are as follows: there are no transaction costs, information is commonly available free of charge to all market actors, and all market actors perceive –​and evaluate –​ the incoming information that determines current and future share prices in the same way. If these conditions were necessary for a market to be efficient, it would be possible to immediately conclude that market efficiency is a state that is unachievable in practice. On account of the fact that these conditions are not met by any existing market, building a theory based on real-​life conditions would be impossible. In order for a market to communicate a price change resulting from the acquisition of important information to its actors, some market actor must make decisions that ultimately affect that change.The market mechanism is not an abstract being. It is a specific arrangement of the game of supply and demand, generated by entities acting in their best interests –​ precisely on the basis of the amount of information they have. Another way to make a theory that is not supported by reality credible is to change the boundary conditions –​to define the properties that describe an efficient market in such a way that these conditions can actually occur. These include247: a large number of market actors (which increases the probability of the formation of the price of assets discounting all relevant information as a result of multiple transactions); homogeneity of products (the parameters of the trading assets should be universal in order for one to be able to compare these assets); the way the market is organised (the establishment of legal regulations conducive to information efficiency); random nature of the influx of new information (which means in practice that it is impossible to predict the timing of the appearance of this information).248 The adoption of the market parameterisation method does not solve the problem of insufficient overlap between theory and reality either because the conditions described above may be satisfied by particular markets in many different ways. It would therefore be necessary to determine the degree to which these markets meet these conditions and to draw a line that separates the state of fulfilment of these conditions from the state of unfulfilment thereof.249

Earnings as a measure of economic profit  37 This would then imply a need to set a benchmark for subsequent conditions. However, this method can also be considered far from perfect. Studies of stock market efficiency in the context of Polish economic practice have been conducted by J. Czekaj, M. Woś, and J. Żarnowski.250 The authors point to the positive verification of the set hypothesis on the efficiency of the Polish capital market. The mechanism of share price formation is comparable to the mechanisms occurring in developed capital markets. No key differences between the efficiency of the Polish and American markets have been reported. There are classic links between the efficiency theory of capital markets and accounting in the works of W. M. Cready and J. K. Shank,251 H. Bierman,252 or J. C. McKeown.253 The possibility to recognise recurring and non-​recurring elements of earnings has crucial practical implications for investors. The recurring portion of earnings (recurring earnings) is included in market share valuations prior to report disclosure. The non-​recurring portion of earnings (non-​recurring earnings), or –​using the nomenclature of J. R. Hicks –​unexpected earnings, also known as residual earnings in the language of economic literature, affects valuation after report disclosure.254 Such earnings are treated as new information. When the disclosed earnings are higher than expected, share prices increase. When the situation is opposite, these prices decrease. The effect of information about earnings reaches its peak within a few or even several quarters.255 The impact of new information on the extent of share price changes depends on many factors. The most important ones include the expected persistence of non-​recurring earnings of a given current period over time.256 It can be therefore argued that earnings treated as ‘one-​offs’ by the market will have little impact on share prices. In contrast, earnings expected to last longer will have a greater impact on said prices. It is important to stress that this will depend on the degree of market efficiency.257 The higher the quality of financial reporting, the stronger the quality of earnings supports the efficiency of capital markets. It should be also noted that the theory of capital market efficiency has its opponents, like S. Grossman and J. E. Stiglitz, who deny its fundamental concepts in a straightforward manner.258 An important aspect of the development of the research into the accounting in capital markets is the CAPM.259 It was developed by J. Lintner260 and W. F. Sharpe.261 The model makes it possible to determine the level of the expected return for investors in efficient capital markets at a given risk. The main underlying assumptions of the CAPM are262: no taxes on investors’ personal income, no agency costs, perfect divisibility of financial instruments, no impact of individual investors’ transactions on the price of securities, possibility to borrow or lend unlimited amounts at a risk-​free rate, decision-​making based only on the rate of return and the risk of a given security, similar investor preferences, existence of short sales, and an unlimited number of transactions and decision-​making processes.263 In the CAPM, investors act in accordance with the principles of the portfolio theory and invest in efficient portfolios, i.e. portfolios that lie on the capital market line (CML).264 E. A. Hendriksen and M. F. van Breda265 argue that the efficient markets hypothesis and the CAPM have important

38  Earnings as a measure of economic profit implications for accounting as well as for its further development. The presentation of new accounting information will result in an immediate response of share prices due to the change in the expected return and risk measure β. The CAPM is a practical tool because of its utility in conducting empirical studies of accounting in stock exchange markets. According to researchers,266 it is necessary to consider shifting the focus in accounting from the methods and means of calculating earnings to the study of risk, which is so important to investors.267 The CAPM makes it possible to examine the interrelationship between the rate of return and accounting profit.268 Another important theory of capital markets is the portfolio theory, created by H. Markowitz.269 Stock market investors often diversify their investment portfolio. Modern portfolio theory (MPT) involves combining assets to form various possible combinations in order to minimise the risk to which the overall portfolio may be exposed.270 The primary objective of constructing an investment portfolio is to minimise the uncertainty of asset return for a given expected portfolio return. In MPT, risk is measured as the standard deviation and variance in the probability distribution of future returns.271 The guiding ideas of the theory in question are: risk aversion of investors, distribution of stock returns,272 and shares representing the expected portfolio return.273 The cornerstones of the portfolio theory are the pooling of assets into properly diversified portfolios of shares of different entities and the need to assess the level of risk –​not at the level of each individual, but the share of risk by way of a diversified portfolio of securities. An important term in this context is the so-​called efficient portfolio, which is one for which there is no other portfolio with the same expected return and less risk –​and one for which there is no other portfolio with the same risk and higher expected return.274 Such portfolios are marked by maximised returns combined with minimised levels of the total risk associated with a given portfolio.275 The portfolio theory and CAPM have had a significant impact on the development of the theory and empirical research in the domain of accounting.276 The last theory discussed is S. A. Ross’ arbitrage pricing theory.277 The fundamental foundation of this theory is the law of one price. According to this principle, a given good cannot be sold at two different prices. The arbitrage pricing theory significantly affects the process of accounting valuation. The solid theoretical foundation of fair value arbitrage, despite the criticism that has occurred, is attracting more and more supporters. In light of the law of one price, the value of a company is equal to the present value of its future cash flows –​assuming that the occurring conditions remain stable. In the literature on the subject, the links between accounting and the portfolio theory are mentioned by many authors dealing with this topic.278 It has been noted that portfolio managers could estimate the β coefficient more accurately using models based on accounting data –​including using earnings.279 Earnings and other information provided in financial statements are used to measure the value of economic entities. Earnings and net cash flows are the primary measures of an economic entity’s financial condition. Affecting

Earnings as a measure of economic profit  39 the earnings made and expenses incurred by an entity, e.g. through the level of depreciation or the applied methods of inventory valuation, translates into the valuation of the entity in a capital market. The findings of most academic studies show that there is a semi-​strong form of information efficiency in capital markets. The level of efficiency varies depending on e.g. the environment, the cultural setting, and the capital market. It is generally assumed that a strong form of information efficiency does not occur. The market response is most often examined from the point of view of earnings. Sometimes based on other items included in the statement. Nonetheless, earnings are considered the most relevant summary measure of value in a financial statement.280 In the empirical studies into finance and accounting conducted over the past two decades, there has been a lot of focus on the relationship between the accounting information reported in an entity’s financial statements and the market response in the form of a change in share prices.281 The pioneering studies in this area are those carried out by R. Ball and P. Brown282 and W. H. Beaver in 1968. The researchers aimed to verify a hypothesis which assumed that information was useful if it affected investor behaviour in the capital market. Also, W. H. Beaver283 came forward with the concept of information content, which he understood as a change in expectations regarding the outcome of an event, especially in terms of the probability of future returns on a capital investment, or a change in market value. The conducted research showed the market’s response to information reported in financial statements and provided evidence of this information’s decision-​making utility for investors. The studies carried out by R. Ball and P. Brown and W. H. Beaver gave rise to the most important trends in modern accounting. Later on, the research focused not only on the fact of existence of a market response but also on the magnitude of that response.The intensity of market response to financial statement disclosures can be interpreted as a measure of the significance of accounting information. If the market responds quickly –​and overreacts –​to the reported information, it means that accounting works really well. On the other hand, if the accounting information disclosed in financial statements does not affect the share price of the reporting entity, or if the error is minor –​at the level of statistical error, it means that accounting does not serve its purpose in supporting the efficiency of the capital market, whose task is, after all, to optimally allocate resources in the economy.284 The concept of the quality of accounting earnings was popularised in the late 1980s. In particular, it has to do with the research conducted by B. Lev,285 who equated the quality of earnings with information content and showed a correlation between accounting earnings and the rate of return on shares of a given public company. P. M. Dechow, W. Ge, and C. Schrand286 proposed the following definition: higher quality earnings provide more information about the features of a firm’s financial performance that are relevant to specific decision made by a specific decision-​maker. The quality of earnings will therefore depend on the relevance of the decisions made based on the information obtained. It appears that the quality of earnings is determined by two

40  Earnings as a measure of economic profit factors: the fundamental financial and economic efficiency of the entity and the accounting and financial reporting system adopted. In the case of the first of these factors, J. Francis, P. Olsson, and K. Schipper287 use the concept of innate sources of earnings quality. It stems from the288 business model and the operating environment, as well as the particular features of a given economic entity. The other factor that determines the quality of earnings is the financial reporting process, which consists of e.g. controlling and management decisions, or the quality of the information system in use. The decision-​making utility of financial information is encapsulated in two dimensions: its usefulness in assessing an economic entity’s ability to generate cash and in determining the capability of this economic entity’s management to exercise fiduciary functions. It is the capital market actors who determine where and under what conditions capital is allocated through their decisions and behaviour. Pure financial reports contribute to the emergence of the phenomenon called information asymmetry. Due to information asymmetry, there occurs an information gap between an economic entity and its potential and current investors. It is necessary to bear in mind that such a gap concerns other stakeholders as well.289 Some of the most important sources of information used in the decision-​ making process include financial statements as well as the valuation of an entity’s economic value and its comparison to market value. Depending on the method adopted, one can arrive at a different range of information required to determine the value of an entity. Very often, the quality of reporting is understood as the utility of the information a report contains for decision-​making from the point of view of company valuation. An issue worth exploring in more depth is the quality of the reported earnings and the manner in which they are presented.The form of presentation may actually reduce the quality of reported earnings by aggregating items with varying degrees of persistence or realisation. It can also have a positive effect and improve the quality of reported earnings –​by separating out items with similar characteristics. This problem was investigated by J. Gierusz,290 who proposed a new reporting formula for income statements. To conclude, the most important concepts of corporate finance and capital markets that have an impact on the domain of accounting include: the agency theory, the information asymmetry theory, the signalling theory, the efficient capital market theory, the CAPM, the portfolio theory, and the arbitrage pricing theory. The agency theory encompasses the choice of the accounting policy, earnings management process, contract implementation based on accounting values, etc. On the other hand, the information asymmetry theory should be considered together with the signalling theory. They can be found in the standard-​setting process, the efficiency of markets in the disclosure of accounting records, investor behaviour, and stock price fluctuations based on information available and data quality. The information that accounting generates does not have to be comprehensible to everyone. The important thing is that they are useful to those who deal with –​i.e. read –​accounting information. The CAPM and the capital markets efficiency theory offer an

Earnings as a measure of economic profit  41 opportunity to study how markets respond to accounting disclosures. The CAPM has brought with it a shift in the focus of accounting research from the methods and manner of determining earnings to the study of investor risk.The portfolio theory and the market model prove that the form of presentation of data in financial reporting does not matter.291 Information considered useful by investors is information that can cause a change in the level of the interest rate and risk. What is important to mention here is that accounting is not the only source of information for investors. The last of the theories discussed here –​the arbitrage theory –​is the beginning of the development and practical application of fair value valuation.

Notes 1 K. Kuciński, Metodologia nauk ekonomicznych. Dylematy i wyzwania, Difin, Warsaw 2010, p. 40. 2 K. Jajuga, Elementy nauki o finansach, PWE, Warsaw 2007, p. 97. 3 S. Owsiak, Podstawy nauki finansów, PWE, Warsaw 2002, p. 14. 4 W. Frąckowiak, Czy ukształtuje się nowy paradygmat finansów?, [in:] W. Frąckowiak, J. Szambelańczyk (eds.), Ku nowemu paradygmatowi nauk o finansach, Research Papers 144, Publishing House of the Poznań University of Economics and Business, Poznań 2010, p. 85. 5 W. Frąckowiak, Czy ukształtuje się nowy paradygmat finansów?, op. cit., p. 85. 6 M. Gmytrasiewicz, Teoretyczne podstawy modeli ewidencji księgowej, SGPiS, Warsaw 1977, p. 8. 7 M. Remlein, Teoria a nauka rachunkowości, Studia Oeconomica Posnaniensia 2014, Vol. 2, Issue 4 (265), p. 122. 8 Nowa encyklopedia Powszechna PWN, PWN,Vol. 6, Warsaw 1997, p. 36. 9 M. Szymczak (ed.), Słownik języka polskiego, PWN,Vol. 2,Vol. 3,Warsaw 1995, p. 459. 10 Wielka encyklopedia PWN, PWN,Vol. 27, Warsaw 2007, p. 327. 11 M. Remlein, Teoria a nauka rachunkowości, op. cit., pp. 122–​123. 12 Wielka encyklopedia PWN, op. cit., p. 327. 13 W. Kopaliński, Słownik wyrazów obcych, Wiedza Powszechna, Warsaw 1975, p. 969. 14 K. G. Szymański, Problemy metodologiczne nauki rachunkowości, SGPiS, Warsaw 1988, p. 28. 15 A. Szychta, Teoria rachunkowości Richarda Mattessicha w świetle podstawowych kierunków rozwoju nauki rachunkowości, FRRwP, Warsaw 1996, p. 25. 16 K. G. Szymański, Problemy metodologiczne nauki rachunkowości, op. cit., p. 28. 17 A. Szychta, Teoria rachunkowości Richarda Mattessicha w świetle podstawowych kierunków rozwoju nauki rachunkowości, op. cit., p. 25. 18 M. Remlein, Teoria a nauka rachunkowości, op. cit., pp. 122–​123. 19 J. Samelak, Determinanty sprawozdawczości finansowej przedsiębiorstwa oraz kierunki jej dalszego rozwoju, University of Economics in Poznań, Poznań 2004, pp. 11–​ 12; 22–​24. 20 Cf.: W. Gabrusewicz, A. Kamela-​Sowińska, H. Poetschke, Rachunkowość zarządcza, PWE, Warsaw 2000, p. 21. 21 M. Remlein, Teoria a nauka rachunkowości, op. cit., p. 123. 22 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, PWN, Warsaw 2002, pp. 43–​44.

42  Earnings as a measure of economic profit 23 W. Brzezin, Ogólna teoria rachunkowości, Publishing House of the Częstochowa University of Technology, Częstochowa 1998, pp. 11–​12. 24 M. Gmytrasiewicz, T. Peche, G. Świderska, Teoretyczne podstawy rachunkowości, PWN, Warsaw 1980, p. 22. 25 M. Dobija (ed.), Teoria rachunkowości w zarysie, Publishing House of the Cracow University of Economics, Kraków 2005, p. 232. 26 Regulation of the Minister of Science and Higher Education of 25 September 2018 on fields of science, scientific disciplines, and artistic disciplines (Journal of Laws of the Republic of Poland of 2018, item 1818). 27 A. Jarugowa, Niektóre wyznaczniki rozwoju rachunkowości, [in:] A. Jarugowa (ed.), Współczesne problemy rachunkowości, PWE, Warsaw 1991, pp. 12–​13. 28 K. G. Szymański, Problemy metodologiczne nauki rachunkowości, op. cit., p. 52. 29 Some of the contributing researchers include: R. S. Kaplan, R. Cooper, D. Norton, R. L. Watts, J. L. Zimmerman, R. Mattessich, R. J. Chambers, A. Hopwood, W. F. Chua, R. W. Scapens. 30 W. F. Chua, Radical Developments in Accounting thought, Accounting Review 1986, Vol. LXI, Issue 4, pp. 601–​665; cf.: R. Mattessich, Critique of Accounting, Quorum Books, Weston, CT–​London 1995; A Riahi-​Belkaoui, Accounting Theory, South-​Western Cengage Learning 2004; B. Ryan, R. W. Scapens, M. Theobald, Research Method and Methodology in Finance and Accounting, Thomson, London 2002; M. Smith, Research Methods in Accounting, Sage Publications, London 2003; K. Grabiński, Zarządzanie zyskami jako jeden z kierunków rozwoju pozytywnej teorii rachunkowości, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2010, Vol. 56, Issue 112, pp. 71–​82. 31 M. Andrzejewski, Korygująca funkcja rewizji finansowej w systemie rachunkowości, Publishing House of the Cracow University of Economics, Kraków 2012, pp. 17–​40. 32 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016, p. 15. 33 I. Olchowicz, A. Tłaczała, Sprawozdawczość finansowa według krajowych i międzynarodowych standardów, Difin, Warsaw 2009, p. 24. 34 M. Dobija (ed.), Teoria rachunkowości. Podstawa Nauk Ekonomicznych, Publishing House of the Cracow University of Economics, Kraków 2014, pp. 19–​20. 35 E. Cannan, Early History of the Term Capital, Quarterly Journal of Economics 1921, Vol. 35, p. 43. 36 K. Marchewka, Główne nurty w kategorii kapitału, Ruch Prawniczy, Ekonomiczny i Socjologiczny 2000, LXII,Vol. 3, pp. 105–​106. 37 E. von Böhm-​Bawerk, Capital and Interest,The Controversy over the Concept of Capital, Libertarian Press, South Holland, IL 1959, p. 13. 38 The book in question is: L. Pacioli, Summa de arithmetica geometria proportioni et proportionalità from 1494. 39 E. Cannan, Early History of the Term Capital, op. cit., p. 43. 40 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., p. 106. 41 M. Dobija, Abstract Nature of Capital and Money, [in:] L. M. Cornwall (ed.), New Developments in Banking and Finance, Chapter 4, Nova Science Publishers, Inc., New York, NY 2007, pp. 89–​114. 42 M. Dobija, Teoretyczne przesłanki wartości godziwej, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2006,Vol. 32, Issue 88, pp. 39–​54.

Earnings as a measure of economic profit  43 43 S. Skrzypek, The Pojęcie kapitału w literaturze, Archives of the Lwów Scientific Society, Section II,Vol. XXVI, Book I. A Scientific Society with a subsidy from the Ministry of Religion and Public Education, Ekonomia Printing House, Lviv 1938, pp. 5–​6. 44 Satisfying the needs of society through new production because exchange alone –​ i.e. without the creation of new assets –​could lead to starvation. 45 B. Kurek, Historia badań kapitału i zysku, [in:] M. Dobija (ed.), Teoria pomiaru kapitału i zysku, Publishing House of the Cracow University of Economics, Kraków 2010, pp. 11–​12; S. Skrzypek, Pojęcie kapitału w literaturze, op. cit., pp. 5–​6. 46 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. Historia i krytyka teorii zysku z kapitału, Gebethner and Wolff, Warsaw 1924,Vol. 1, pp. 1–​9. 47 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., p. 116. 48 B. Kurek, Historia badań kapitału i zysku, op. cit., p. 12. 49 G. Musialik, Kapitał w ekonomii i rachunkowości –​potrzeba reinterpretacji, Research Papers of the Wrocław University of Economics and Business Issue 488, Wrocław 2017, p. 165. 50 Y. Ijiri, Segment Statements and Informativeness Measures: Managing Capital vs. Managing Resources, Accounting Horizons 1995,Vol. 9, Issue 3, p. 61. 51 Cf.: E. Walińska, A. Rzetelska, A. Jurewicz, Kapitał własny spółek kapitałowych jako kategoria prawa i ekonomiczna sprawozdania finansowego, Wydawnictwo Uniwersytetu Łódzkiego, Łódź 2016. 52 Cf.: Y. Ijiri, The Foundations of Accounting Measurement, Prentice Hall, Englewood Cliffs, NJ 1967, Republished by Scholars Book Co., Houston 1967, p. 102; Y. Ijiri, Theory of Accounting Measurement, Studies in Accounting Research, American Accounting Association, Sarasota 1975, Issue 10, p. 81; A. Riahi-​Belkaoui, Accounting Theory, 5th ed., Thompson, London 2004, p. 45. 53 B. Kurek, Historia badań kapitału i zysku, op. cit., pp. 13–​14. 54 I. Fisher, Precedents for Defining Capital, Quarterly Journal of Economics 1908, Vol. 18, pp. 386–​408. 55 72 of the most popular economic and business dictionaries published in the 17th, 18th, and 19th centuries were analysed. 56 Quotations from e.g. Dictionnaire de Lacademie francaise, Paris 1694, cf.: Vocabolario degli Accademici della Crusca,Venezia 1612; N. Bailey, Dictionarium Britannicum,T. Cox, London 1730; W. Rider, A New Universal English Dictionary, W. Griffin, London 1759; F. Lieber, Encyclopedia Americana, Philadelphia, PA 1830. 57 E. Taylor, Historia rozwoju ekonomiki, Part 1, PWN, Poznań 1957, p. 43. 58 F. A. Fetter, Recent Discussion of the Capital Concept, Quarterly Journal of Economics 1900, Issue 11, p. 19. 59 I. Fisher, Precedents for Defining Capital, op. cit., p. 401. 60 E. Taylor, Historia rozwoju ekonomiki, cz. 1., op. cit., p. 73. 61 Cf.: J. R. Hicks, Wartość i kapitał. Studia nad kilkoma podstawowymi zagadnieniami z teorii ekonomii, PWN, Warsaw 1975. 62 J. R. Hicks, Perspektywy ekonomii-​szkice z teorii pieniądza i teorii wzrostu, PWN, Warsaw 1988, pp. 183–​202. 63 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., pp. 106–​107. 64 Cf.: M. Kędzior, Zależność rentowności przedsiębiorstw od czynników mikroekonomicznych, makroekonomicznych i instytucjonalnych w wybranych państwach Unii Europejskiej, Publishing House of the Cracow University of Economics, Kraków 2016, pp. 17–​18. 65 E. Taylor, Wstęp do ekonomiki, Part 2, Dom Książki Polskiej w Warszawie, Poznań 1936, p. 136.

44  Earnings as a measure of economic profit 66 J. R. Hicks, Perspektywy ekonomii –​szkice z teorii pieniądza i teorii wzrostu, op. cit., p. 183. 67 J. M. Keynes, Ogólna teoria zatrudnienia, procentu i pieniądza, Book 2, Chapter 6, PWN, Warsaw 1956, p. 79. 68 E. Taylor, Wstęp do ekonomiki, Part 2, op. cit., pp. 135–​137. 69 E. Taylor, Wstęp do ekonomiki, Part 1, Dom Książki Polskiej w Warszawie, Poznań 1936, p. 64. 70 S. Skrzypek, Pojęcie kapitału w literaturze, op. cit., p. 32. 71 E. Taylor, Wstęp do ekonomiki, Part 2, op. cit., pp. 150–​163. 72 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., pp. 110–​111. 73 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. Historia i krytyka teorii zysku z kapitału, op. cit., pp. 70–​78. 74 R.W. Garrison, Austrian Capital Theory and the Future of Macroeconomics-​Pre-​Keynesian Macroeconimics, Millsdale College Press 1991, p. 304. 75 B. Kurek, Historia badań kapitału i zysku, op. cit., p. 16. 76 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. Historia i krytyka teorii zysku z kapitału, op. cit., pp. 60–​70. 77 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. Historia i krytyka teorii zysku z kapitału, op. cit., pp. 87–​96; cf.: M. Blaug, Teoria ekonomii, PWN, Warsaw 1994, pp. 135–​137. 78 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. History and Criticism of the Theory of Profit from Capital, op. cit. pp. 64–​70; K. Marchewka, Main Currents in the Category of Capital, op. cit. p. 111. 79 E. von Böhm-​Bawerk, Kapitał i zysk z kapitału. Historia i krytyka teorii zysku z kapitału, op. cit., pp. 72–​73. 80 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., p. 111. 81 Principles of Economical Philosophy, London 1872, I, p. 638. 82 Elements of Political Economy, London 1858, p. 145. 83 Principles of Economical Philosophy, op. cit., I. p. 634 and II, p. 62. 84 Cf.: M. Dobija (ed.), Teoria pomiaru kapitału i zysku, Publishing House of the Cracow University of Economics, Kraków 2010, p. 170. 85 The labour theory treats profit made on capital as remuneration for certain work performed by capitalists. The theory of exploitation argues that excess value does not correspond to any natural excess, but is generated only by means of reduction of just wages paid to workers. 86 E. Taylor, Historia rozwoju ekonomiki, cz. 1., op. cit., p. 81. 87 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., p. 112. 88 S. Skrzypek, Pojęcie kapitału w literaturze, op. cit., pp. 127–​128. 89 S. Skrzypek, Pojęcie kapitału w literaturze, op. cit., p. 131. 90 B. Kurek, Historia badań kapitału i zysku, op. cit., p. 17. 91 J. A. Schumpeter, Teoria rozwoju gospodarczego, PWN, Warsaw 1960, pp. 330–​332. 92 J. R. Hicks, Perspektywy ekonomii –​szkice z teorii pieniądza i teorii wzrostu, op. cit., pp. 200–​202. 93 K. Wicksell, The Influence of the Rate of Interest on Prices, Economic Journal 1907, XVII, pp. 213–​220. 94 S. Mikosik, Teoria rozwoju gospodarczego Josepha A. Schumpetera, PWN, Warsaw 1993, pp. 86–​94. 95 D. Harvey, The Limits to Capital, Basil Blackwell, Oxford, 1982, p. 257. 96 Cf.: D. G. Luenberger, Teoria inwestycji finansowych, PWN, Warszawa 2003, pp. 200–​230.

Earnings as a measure of economic profit  45 9 7 J. M. Keynes, Ogólna teoria zatrudnienia, procentu i pieniądza, op. cit., pp. 159–​170. 98 W. Tyc, Kapitał ludzki jako zasób czynników wytwórczych, [in:] D. Kopycińska (ed.), Teoretyczne aspekty gospodarowania, Katedra Mikroekonomii Uniwersytetu Szczecińskiego, Szczecin 2005, pp. 129–​134. 99 W. Tyc, Kapitał ludzki jako zasób czynników wytwórczych, op. cit., pp. 130–​134. 100 G. C. Harcourt, Spory wokół teorii kapitału-​Cambridge contra Cambridge, PWE,Warsaw 1975, pp. 152–​158. 101 R. M. Solow, Teoria kapitału i stopa przychodu, PWN, Warsaw 1967, p. 21. 102 J. Robinson, Some Problems of Definition and Measurement of Capital, Oxford Economic Papers 1959,Vol. 11, Issue 2, June, pp. 157–​166. 103 J. Robinson, Akumulacja kapitału, PWN, Warsaw 1958, pp. 56–​60. 104 J. Hirshleifer, Investment, Interest and Capital, Prentice-​Hall INC, Los Angeles, CA 1970, pp. 153–​194. 105 M. Dobija (ed.), Teoria rachunkowości w zarysie, op. cit., p. 122. 106 Cf.: M. Dobija, Model rachunku wyników w warunkach efektywnego rynku jako metoda pomiaru okresowego przyrostu kapitału własnego, Publishing House of the Cracow University of Economics, Kraków 1997; M. Dobija, Koszty ryzyka i syntetyczny wskaźnik ryzyka jednostki, Research Papers of the Cracow University of Economics, Issue 557, Kraków 2001. 107 M. Dobija, D. Dobija, Deterministyczna premia za ryzyko?, Master of Business Administration 2006, Issue 1 (72), pp. 6–​12. 108 P. Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, Publishing House of the Cracow University of Economics, Kraków 2010, p. 54. 109 P. Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, op. cit., p. 54. 110 R. M. Cyert, J. G. March, A Behavioral Theory of the Firm, 2nd ed., Prentice-​Hall, Englewood Cliffs 1992, pp. 47–​50. 111 P. Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, op. cit., pp. 53–​54. 112 The views on capital of selected representatives of economic thought are listed in Table 1.1. 113 K. Marchewka, Główne nurty w kategorii kapitału, op. cit., pp. 113–​117. 114 B. Kurek, Historia badań kapitału i zysku, op. cit., p. 11. 115 T. Beck, R. Levine, Industry Growth and Capital Allocation: Does Having a Market –​ Or Bank-​Based System Matter?, Journal of Financial Economics 2002,Vol. 64, Issue 2, pp. 147–​ 151; T. Łuczka, Kapitał jako przedmiot gospodarki finansowej małego i średniego przedsiębiorstwa. Wprowadzenie do finansów przedsiębiorstwa, Wydawnictwo Politechniki Poznańskiej, Poznań 1997, p. 45. 116 Cf.: J. Iwin-​ Garzyńska, O finansowej istocie kapitału. Esej, Scientific Publishing House of the University of Szczecin, Szczecin 2006, p. 15. 117 H. Towarnicka, Strategia inwestycyjna przedsiębiorstwa, Publishing House of the Wroclaw University of Economics, Wrocław 2003, p. 20. 118 K. Janasz, Determinanty struktury kapitału w przedsiębiorstwie, University of Szczecin, [in:] Studies and Papers of the Faculty of Economics and Management Issue 21 (ed.), Przedsiębiorstwo zorientowane na wiedzy, Research Papers Issue 629, Szczecin 2011, pp. 103–​104. 119 P. Van Cauwenberge, I. de Beelde, On the IASB Comprehensive Income Project: An Analysis of the Case for Dual Income Display, ABACUS 2007,Vol. 43, Issue 1, p. 23.

46  Earnings as a measure of economic profit 120 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 39. 121 B. Kurek, Historia badań kapitału i zysku, op. cit., pp. 19–​20. 122 P. Bielawski, Modele wyceny bilansowej instrumentów finansowych w świetle ogólnej teorii rachunkowości, Publishing House of the Cracow University of Economics, Kraków 2010, p. 104. 123 B. Wacławik, P. Zieniuk, Ujawnienia informacji o metodach wyceny instrumentów finansowych według regulacji międzynarodowych. Zarys problemu, [in:] A. Kuzior, A. Szewieczek (eds.), Współczesne problemy i kierunki transformacji rachunkowości i rewizji finansowej. Współczesne problemy rachunkowości i rewizji finansowej, Vol. 1, Wydawnictwo Uniwersytetu Ekonomicznego w Katowicach, Katowice 2016, p. 127. 124 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 40. 125 Cf.: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016, p. 40; Międzynarodowe Standardy Sprawozdawczości Finansowej, SKwP, IFRS Foundation 2011, p. A 48; E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, PWN, Warsaw 2002, pp. 324–​351; J. Gierusz, Koszty i przychody w świetle nadrzędnych zasad rachunkowości, ODDK, Gdańsk 2010, p. 224. 126 A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2010, Vol. 59, Issue 115, p. 117. 127 K. Czubakowska, W. Gabrusewicz, E. Nowak, Przychody, koszty, wynik finansowy przedsiębiorstw, PWE, Warsaw 2009, p. 181. 128 K. Tkocz-​Wolny, Wycena bilansowa środków trwałych i jej wpływ na wynik finansowy, Research Papers of the University of Economics in Katowice, Issue 253, Katowice 2016, p. 135. 129 K. Grabiński, Wycena i jej aktualizacja w warunkach kryzysu gospodarczego, [in:] B. Micherda (ed.), Rachunkowość wobec kryzysu gospodarczego, Difin, Warsaw 2010, p. 44. 130 J. Gierusz, Koszt historyczny czy wartość godziwa –​dylematy wyceny w rachunkowości, Zeszyty Teoretyczne Rachunkowości, Warszawa 2011,Vol. 62, Issue 118, p. 11. 131 L. Poniatowska, Wpływ wyceny bilansowej na definiowanie i pomiar wyniku finansowego, Studia i Prace Kolegium Zarządzania i Finansów, Issue 130, SGH, Warsaw 2013, p. 121; K. Tkocz-​Wolny, Wycena bilansowa środków trwałych i jej wpływ na wynik finansowy, op. cit., p. 135; M. Głębocka, Koszt historyczny i wartość godziwa a przydatność decyzyjna sprawozdań finansowych–​wybrane problemy, Google Scholar, pp. 157–​ 160. https://​stu​dyli​bpl.com/​doc/​1047​564/​koszt-​hist​oryc​ zny-​iwa​r to%C5%9B%C4%87go​dziw​aapr​zyda​tno%C5%9B%C4%87-​decyzy​jna (17.10.2018). 132 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, Zeszyty Teoretyczne Rachunkowości, SKwP,Warsaw 2012,Vol. 66, Issue 122, p. 33; K. Tkocz-​Wolny, Wycena bilansowa środków trwałych i jej wpływ na wynik finansowy, op. cit., p. 136. 133 Cf.: A. Szychta, Teoria rachunkowości Richarda Mattessicha w świetle podstawowych kierunków rozwoju nauki rachunkowości-​studium metodologiczne, Fundacja Rozwoju Rachunkowości w Polsce, Warsaw 1996; M. Turzyński, Umowy o usanie aktywów w świetle historyczno-​teoreorecznego dyskursu rachunkowości, Wydawnictwo Uniwersytetu

Earnings as a measure of economic profit  47 Łódzkiego, Łódź 2012; M. Turzyński, Koncepcje zysku w retrospektywnym ujęciu Meyera i Lichtensztejna, [in:] A. Szychta (ed.), Teoria i praktyka współczesnej rachunkowości. Zagadnienia wybrane, Wydawnictwo Uniwersytetu Łódzkiego, Łódź 2011; A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2010,Vol. 59, Issue 115. 134 A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, op. cit., p. 119; A. Szychta, Wynik całościowy w sprawozdaniach finansowych spółek publicznych, [in:] I. Sobańska, M. Turzyński (eds.), Rachunkowość audyt i kontrola w zarządzaniu, Wydawnictwo Uniwersytetu Łódzkiego, Łódź 2011, pp. 82–​85. 135 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, op. cit., pp. 294–​295, 353. 136 B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości-​wybrane problemy, [in:] B. Micherda (ed.), Współczesne uwarunkowania kwantyfikacji w rachunkowości, Difin, Warsaw 2013, p. 166. 137 A. Sajnóg, Siła predykcji zysku całkowitego w kształtowaniu przepływów pieniężnych przedsiębiorstwa, Research Papers of the University of Economics in Katowice Issue 322, Katowice 2017, pp. 187–​188. 138 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences, Journal of Accounting and Economics 2010,Vol. 50, Issue 2, p. 347. 139 The authors in question are: P. M. Dechow, W Ge, C. Schrand. 140 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies,Their Determinants and Their Consequences, op. cit., p. 343. 141 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 40–​41. 142 D. Dhaliwal, K. R. Subramanyam, R. Trezevant, Is Comprehensive Income Superior to Net Income as a Measure of firm Performance?, Journal of Accounting and Economics 1999, Issue 26, p. 44. 143 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 41–​42. 144 K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny –​użyteczność decyzyjna w świetle badań naukowych, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2012,Vol. 66, Issue 122, p. 55, and B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości –​wybrane problemy, op. cit., p. 166. 145 A. Szychta, Dochody całkowite w sprawozdaniach finansowych największych spółek notowanych na GPW w Warszawie, Acta Universitatis Lodziensis. Folia Oeconomica Issue 263, Łódź 2012, p. 67, and B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości-​wybrane problemy, op. cit., p. 166. 146 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 44. 147 A. Szychta, Dochody całkowite w sprawozdaniach finansowych największych spółek notowanych na GPW w Warszawie, op. cit., p. 67, and B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości-​wybrane problemy, op. cit., p. 166. 148 J. Gierusz, Reklasyfikacja kosztów i przychodów ze sprawozdania z całkowitych dochodów do rachunku zysków i strat-​przyczyny, zakres i konsekwencje, Zarządzanie i finanse 2014,Vol. 12, Issue 2, pp. 192–​193. 149 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 45.

48  Earnings as a measure of economic profit 150 B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości-​wybrane problemy, op. cit., p. 165, and J. Turyna, Koncepcje pomiaru wyniku finansowego przedsiębiorstwa według standardów międzynarodowych oraz polskiego ustawodawstwa: wybrane zagadnienia, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2004, Vol. 21, Issue 77, p. 233. 151 Międzynarodowe Standardy Sprawozdawczości Finansowej, op. cit., pp. A 428–​A 430. 152 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., p. 31. 153 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, op. cit., pp. 321–​330. 154 A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, op. cit., p. 123. 155 Międzynarodowe Standardy Sprawozdawczości Finansowej, op. cit., p. A 455. 156 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., p. 32. 157 Cf.: H. Chłodnicka, Wartość godziwa czy koszt historyczny?, Research Papers of the Rzeszów University of Technology, Rzeszów 2011; J. Gierusz, Koszt historyczny czy wartość godziwa-​ dylematy wyceny w rachunkowości, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2011, Vol. 62, Issue 118; K. Mokrzycka, M. Ziajor, Koszt historyczny a wartość godziwa-​koszty i korzyści, [in:] K. Świetla (ed.), Praktyczny wymiar rachunkowości-​ podatki-​rewizja manipulacje, Fundacja UEK, Kraków 2015; P. Wójtowicz, Czy wartość godziwa zastąpi koszt historyczny?, Research Papers of the Cracow University of Economics, Kraków 2011; A. Mazur, Wartość godziwa a nadrzędne zasady rachunkowości, [in:] J. Gierusz, T. Martyniuk (eds.), Kluczowe problemy teorii i praktyki rachunkowości, Sopot 2011, Vol. 1; P. Wójtowicz, Koszt historyczny czy wartość godziwa? Jak mierzyć wynik finansowy?, [in:] Ed. by Employees of the Accounting Department of SGH, Problemy współczesnej rachunkowości, SGH Warsaw School of Economics, Warsaw 2009; M. Rówińska, Wartość godziwa w rachunkowości finansowej i osłonowej w zakresie instrumentów finansowych, Publishing House of the University of Economics in Katowice, Katowice 2011. 158 Międzynarodowe Standardy Sprawozdawczości Finansowej, SKwP, IFRS Foundation 2007, p. A 56. 159 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., pp. 31–​32. 160 Cf.: E. Śnieżek, M.Wiatr, Rachunkowość a tendencyjne kreowanie obrazu działalności przedsiębiorstw, [in:] J. Gierusz, T. Martyniuk (eds.), Kluczowe problemy teorii i praktyki rachunkowości, Vol. 1, Faculty of Management of the University of Gdańsk, Sopot 2011; J. Gierusz, Poziom wyceny wyrobów gotowych w świetle definicji aktywów, [in:] Papers and Publications of the Faculty of Management of the University of Gdańsk, Rachunkowość-​wybrane aspekty, Gdańsk 2006, Issue 4. 161 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., p. 32. 162 I. Sobańska, Rachunkowość zarządcza, [in:] I. Sobańska (ed.), Rachunkowość zarządcza. Podejście operacyjne i strategiczne, C. H. Beck, Warsaw 2010, p. 92; J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., p. 32; cf.: E. Walińska, Koncepcja zysku całościowego a wartość bilansowa przedsiębiorstwa, [in:] T. Kiziukiewicz (ed.), Zasoby i procesy w rachunkowości jednostek gospodarczych, Difin, Warsaw 2009.

Earnings as a measure of economic profit  49 163 M. Bojańczyk, Wzrost znaczenia zarządzania wartością przedsiębiorstw, [in:] G. K. Świderska, Wpływ zakresu ujawnianych informacji na zaufanie do rynków kapitałowych i organizacji gospodarczych, Oficyna Wydawnicza SGH, Warsaw 2011, p. 166. 164 J. Gierusz, J. Gawrońska, Ewolucja pojęcia wyniku finansowego a pomiar jego jakości, op. cit., pp. 32–​33. 165 K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny-​użyteczność decyzyjna w świetle badań naukowych, op. cit., pp. 47–​56. 166 B. Bek-​Gaik, Pomiar i prezentacja wyniku całościowego w rachunkowości-​wybrane problemy, op. cit., pp. 167–​168. 167 A. Szychta, Dochody całkowite w sprawozdaniach finansowych największych spółek notowanych na GPW w Warszawie, op. cit., p. 85. 168 A. Wszelaki, Zasady sporządzania sprawozdania finansowego banku w świetle założeń koncepcyjnych Międzynarodowych Standardów Rachunkowości, [in:] B. Micherda (ed.), Perspektywy rozwoju rachunkowości, analizy i rewizji finansowej w teorii i praktyce, Studia i Prace Uniwersytetu Ekonomicznego w Krakowie Issue 14,Wydawnictwo Uniwersytetu Ekonomicznego, Kraków 2010, pp. 115–​118. 169 D. Dhaliwal, K. R. Subramanyam, R. Trezevant, Is Comprehensive Income Superior to Net Income as a Measure of Firm Performance, op. cit., 44. 170 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, op. cit., pp. 294–​295; S. Newberry, Reporting Performance: Comprehensive Income and Its Components, ABACUS 2003,Vol. 39, Issue 3, p. 327. 171 J. O’Hanlon, P. Pope, The Value-​Relevance of UK Dirty Surplus Accounting Flows, British Accounting Review 1999,Vol. 31, p. 459; J. A. Ohlson, Earnings, Book Values, and Dividends in Security Valuation, Contemporary Accounting Research 1995, Vol. 11, Issue 2, pp. 161–​182. 172 A. Sajnóg, Wartość predykcyjna zysku całkowitego spółek akcyjnych, Folia Oeconomica 2017, Issue 2 (328), p. 11. 173 K. Kanagaretnam, R. Mathieu, M. Shehata, Usefulness of Comprehensive Income Reporting in Canada, Journal of Accounting and Public Policy 2009, Vol. 28, p. 352; A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, op. cit., p. 124. 174 S. F. Cahan, S. M. Courtenay, P. L. Gronewoller, D. R. Upton, Value Relevance of Mandated Comprehensive Income Disclosures, Journal of Business Finance & Accounting 2000,Vol. 27, Issue 9 and 10, November/​December, p. 1277. 175 S. F. Cahan, S. M. Courtenay, P. L. Gronewoller, D. R. Upton, Value Relevance of Mandated Comprehensive Income Disclosures, op. cit., p. 1277. 176 K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny –​użyteczność decyzyjna w świetle badań naukowych, op. cit., pp. 48–​49. 177 D. Dhaliwal, K. R. Subramanyam, R. Trezevant, Is Comprehensive Income Superior to Net Income as a Measure of Firm Performance, op. cit., p. 45. 178 D. Chambers, T. Linsmeier, C. Shakespeare, T. Sougiannis, An Evaluation of SFAS No. 130 Comprehensive Income Disclosure, Review of Accounting Studies 2007, Vol. 12, p. 561. 179 K. Kanagaretnam, R. Mathieu, M. Shehata, Usefulness of Comprehensive Income Reporting in Canada, op. cit., p. 352. 180 A. Szychta, Pomiar i prezentowanie wyniku całościowego spółki kapitałowej w sprawozdaniu finansowym, op. cit., p. 137. 181 B. Bek-​Gaik, Ujęcie skutków wyceny w wartości godziwej w sprawozdaniu z dochodów całkowitych, [in:] B. Micherda, M. Andrzejewski (eds.), Sprawozdawczość i rewizja

50  Earnings as a measure of economic profit finansowa. Problemy kwantyfikacji wartości, Publishing House of the Cracow University of Economics, Kraków 2013, p. 27; E. Walińska, Bilans jako fundament sprawozdawczości finansowej w kontekście zmian współczesnej rachunkowości, Oficyna Wolters Kluwer Business, Warsaw 2009, p. 121. 182 B. Bek-​Gaik, Ujęcie skutków wyceny w wartości godziwej w sprawozdaniu z dochodów całkowitych, op. cit., p. 27. 183 K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny –​użyteczność decyzyjna w świetle badań naukowych, op. cit., p. 49. 184 Accounting Act of 29 September 1994 (Journal of Laws of the Republic of Poland of 2013, Article 3(1) item 30). 185 A. Sajnóg, Wartość predykcyjna zysku całkowitego spółek akcyjnych, op. cit., p. 10; K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny –​użyteczność decyzyjna w świetle badań naukowych, op. cit., p. 49. 186 B. Grabińska, K. Grabiński, Propozycja interpretacji podstawowych pozycji sprawozdania z zysku całkowitego sporządzonego zgodnie z MSR 1, Research Papers of the Cracow University of Economics, Kraków 2012, Issue 13, p. 302. 187 J. O’Hanlon, P. Pope, The Value-​Relevance of UK Dirty Surplus Accounting Flows, op. cit., p. 460. 188 K. Grabiński, Sprawozdanie z zysku całkowitego a bieżący zysk operacyjny –​użyteczność decyzyjna w świetle badań naukowych, op. cit., p. 49. 189 A. Sajnóg, Wartość predykcyjna zysku całkowitego spółek akcyjnych, op. cit., p. 12. 190 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 46. 191 M. Rówińska, Wynik finansowy a kanony rachunkowości, Research Papers of the University of Economics in Katowice, Katowice 2016, Issue 253, p. 118. 192 M. Remlein, Finansyzacja i jej skutki w sprawozdaniu finansowym polskich spółek giełdowych branży paliwowej, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2015, Issue 82 (138), p. 132. 193 M. Rówińska, Kierunki zmian sprawozdawczości finansowej jednostek gospodarczych na tle polskich i międzynarodowych regulacji rachunkowości, Research Papers of the University of Economics in Katowice, Katowice 2015, Issue 240, pp. 115–​116. 194 More on the problem of reliability of reporting information: B. Micherda, M. Szulc, Współczesne uwarunkowania kwantyfikacji w rachunkowości, Research Papers, PTE, Kraków 2012, Issue 12. 195 W. Gos, Wybrane uwagi na temat istoty rachunkowości, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2008,Vol. 44, Issue 100, p. 71. 196 Directive 2013/​34/​EU of the European Parliament and of the Council defines the concept of true and fair view as follows: annual financial statements should be prepared on a prudent basis and should give a true and fair view of an undertaking’s assets and liabilities, financial position, and profit or loss. 197 M. Rówińska, Kierunki zmian sprawozdawczości finansowej jednostek gospodarczych na tle polskich i międzynarodowych regulacji rachunkowości, op. cit., 116. 198 Revenues and profits as well as costs and losses considered earnings categories are listed in the Polish Accounting Act (Act of 29 September 1994, Article 3.1.30–​ 3.1.31). IFRSs, in turn, indicate revenues and costs as earnings categories (IFRS Conceptual Framework does not consider profits and losses as separate components 2013, para. 4.25). 199 These principles are explained in Article 6.1-​2 of the Polish Accounting Act (Act of 29 September 1994).

Earnings as a measure of economic profit  51 200 H. Ronek, Wynik finansowy w rachunkowości, Annales Universitatis Mariae Curie-​ Skłodowska Lublin –​Polonia, Lublin 2013, Issue XLVII, p. 133. 201 M. Rówińska, Wynik finansowy a kanony rachunkowości, op. cit., p. 119. 202 M. Rówińska, Wynik finansowy a kanony rachunkowości, op. cit., pp. 118–​119. 203 P. Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, op. cit., p. 18. 204 According to F. H. Knight, uncertainty can be divided into measurable and unmeasurable. Measurable uncertainty is related to the concept of risk. Risk refers to events whose occurrence can be estimated and predicted with the use of probability calculus. As F. H. Knight emphasised, risk is so much different from uncertainty per se that it is actually not uncertainty. Real uncertainty occurs when we cannot determine the distribution of probability of an event and are unable to quantify it. (Cf.: R. H. Coase, The Nature of the Firm, Economica, New Series 1937, Vol. 4, Issue 16; E. Czarny, E. Nojszewska, Mikroekonomia, PWE, Warsaw 2000, pp. 220–​221.) 205 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, [in:] K. Grabiński, M. Kędzior, J. Krasodomska (eds.), Współczesna rachunkowość na rynkach kapitałowych, Difin, Warsaw 2014, p. 41. 206 M. C. Jensen,W. H. Meckling, Theory of the Firm: Managerial Agency Costs and Owner Ship Structure, Journal of Financial Economics 1976,Vol. 3, Issue 4, p. 308. 207 M. J. Hatch, Teoria organizacji, PWN, Warsaw 2002, p. 329. 208 K. M. Eisenhardt, Agency Theory: An Assessment and Review, The Academy of Management Review 1989,Vol. 14, Issue 1, pp. 57–​74. 209 D. J. Denis, A. Sarin, Agency Theory and the Influence of Equity Ownership Structure on Corporate Diversification Strategies, Strategic Management Journal 1999,Vol. 20, Issue 11, pp. 1071–​1076. 210 N. J. Saam, Asymmetry in Information versus Asymmetry in Power: Implicit Assumptions of Agency Theory?,The Journal of Socio-​Economics 2007,Vol. 36, Issue 6, p. 827. 211 N. J. Saam, Asymmetry in Information versus Asymmetry in Power: Implicit Assumptions of Agency Theory?, op. cit., p. 836. 212 I. Szwedziak-​Bork, Zastosowanie teorii agencji w zarządzaniu, [in:] K. Klincewicz (ed.), Zarządzanie, organizacja i organizowanie. Przegląd perspektyw teoretycznych, Scientific Publishing House of the Faculty of Management of the University of Warsaw, Warsaw 2016, p. 255. 213 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 21–​22. 214 J. Godfrey, A. Tarca, J. Hamilton, S. Holmes, Accounting Theory, John Wiley & Sons, Sidney 2010, p. 376. 215 M. C. Jensen, W. H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics 1979, Vol. 3, Issue 4, pp. 305–​360. 216 M. Cieślak, Podejście etyczne w rachunkowości a jakość sprawozdań finansowych, Publishing House of the Poznań University of Economics and Business, Poznań 2011, p. 45. 217 M. Rankin, P. Stanton, S. McGowan, K. Ferlauto, M. Tilling, Contemporary Issues in Accounting, Milton, Wiley & Sons, Singapore 2012, p. 137. 218 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 22–​26.

52  Earnings as a measure of economic profit 219 Cf.: A. Shuto, T. Takada, Managerial Ownership and Accounting Conservatism in Japan: A Test of Management Entrenchment Effect, Journal of Business Finance & Accounting 2010, Vol. 37, Issues 7–​8, pp. 815–​840; A. Jorissen, D. Otiey, The Management of Accounting Numbers: Case Study Evidence from the ‘Crash’ of an Airline, Journal Accounting and Business Research 2010, Vol. 40, Issue 1, pp. 3–​38; M. C. Jensen, E. F. Fama, Separation of Ownership and Control, Journal of Law and Economics 1983,Vol. 26, Issue 2, pp. 301–​325. 220 H. Lin, Accounting Discretion and Managerial Conservatism: An Intertemporal Analysis, Contemporary Accounting Research 2006,Vol. 23, Issue 4, pp. 1017–​1041. 221 P. O. Christensen, J. S. Demski, H. Frimor, Accounting Policies in Agencies with Moral Hazard and Renegotiation, Journal of Accounting Research 2002, Vol. 40, Issue 4, pp. 1071–​1090. 222 H. G. Barkema, L. R. Gomez-​Mejia, Managerial Compensation and Firm Performance: A General Research Framework, Academy of Management Journal 1998, Vol. 41, Issue 2, pp. 135–​145. 223 P. Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, op. cit., p. 22. 224 According to J. E. Stiglitz, a well-​functioning accounting system should reduce information asymmetry and contribute to better market functioning (e.g. capital markets). For it is said that capitalism would not have emerged without sound accounting, capable of providing a reasonably accurate picture of a company’s equity and profits. Ordinary shares are supposed to provide a share in a company’s profit; but when a company can just embellish some old data, who will buy its shares? (J. E. Stiglitz, Szalone lata dziewięćdziesiąte, Wydawnictwo PWN, Warsaw 2006, p. 137) 225 J. E. Stiglitz, A Re-​Examination of the Modigliani-​Miller Theorem, American Economic Review 1969,Vol. 59, Issue 5, pp. 784–​793. 226 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., p. 47. 227 It needs to be stressed that the problems involved in separating ownership and management functions affect usually large enterprises. In the case of small-​and medium-​sized businesses, managerial functions are performed by the owners of the business –​usually in a centralised manner. The issue is covered in more detail by T. Martyniuk in Krajowa czy międzynarodowa rachunkowość dla małych przedsiębiorstw. Rachunkowość wczoraj, dziś i jutro, SKwP, Warsaw 2007, p. 116. 228 The problem of adverse selection was first addressed by G. A. Akerlof [1970], who discussed it using the example of the used car and credit markets. (Cf.: G. A. Akerlof, The Quarterly Journal of Economic, The MIT Press 1970,Vol. 84, Issue 3, pp. 488–​500). 229 D. Begg, S. Fischer, R. Dornbusch, Mikroekonomia, PWE, Warsaw 2007, p. 407. 230 O. E.Williamson, The Mechanisms of Governance, Oxford University Press 1996, p. 15. 231 O. E. Williamson defines opportunism as behaviour intended to intentionally mislead or deceive others, obscure or distort facts or information. 232 A. Daniłowska, Asymetria informacyjna i jej przezwyciężenie na rynku kredytów rolniczych, Roczniki Nauk Rolniczych 2008, Series G,Vol. 95, Book 3/​4, p. 40.

Earnings as a measure of economic profit  53 233 A. Skowroński, Wpływ asymetrii informacji na decyzje finansowe przedsiębiorstw, Ruch Prawniczy, Ekonomiczny i Socjologiczny 2005, LXVII,Vol. 3, p. 151. 234 J. Gad, Sprawozdawczość biznesowa wobec założeń teorii agencji, Zarządzanie i Finanse 2013,Vol. 2, p. 174. 235 E. Walińska, Bilans jako fundament sprawozdawczości finansowej w kontekście zmian współczesnej rachunkowości, op. cit., p. 164. 236 Interacting the Business Reporting Supply Chain.A Report Based on the Recommendations from Key Business Leaders from Around the World IFAC, March 2011, p. 31. 237 E. Śnieżek, M. Wiatr, Wpływ luki informacyjnej na modyfikacje ujawnień informacji o wyniku finansowym-​wyniki badań brytyjskich spółek publicznych należących do indeksu [in:] Polityka rachunkowości a kształtowanie wyniku finansowego, Studia Ekonomiczne, Faculty Research Papers 2014, Issue 201, pp. 352–​353. 238 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 26. 239 A. Duliniec, Wybór źródeł finansowania a optymalna struktura kapitału w przedsiębiorstwie, Zeszyty Naukowe Uniwersytetu Szczecińskiego, Issue 855, Finanse, Rynki Finansowe, Ubezpieczenia, Vol. 2, Issue 74, Scientific Publishing House of the University of Szczecin, Szczecin 2015, p. 77. 240 J. Błach, Ewolucja teorii struktury kapitału, Finanse, Warsaw 2009, Issue 1, p. 101; D. Kordela, M. Pawłowski, Gospodarka finansowa przedsiębiorstwa. Długoterminowe decyzje finansowe, e-​Libri, Kraków –​Legionowo 2018, p. 13. 241 S. C. Myers, The Capital Structure Puzzle, Journal of Finance 1984,Vol. 39, Issue 3, pp. 575–​592. 242 S. C. Myers, Still Searching for Optimal Capital Structure, Journal of Applied Corporate Finance 1989, Vol. 6, Issue 1, pp. 4–​14; cited after: J. Kubiak, Polityka dywidend w świetle teorii hierarchii źródeł finansowania, Zarządzanie i Finanse 2013, Issue 2, p. 204. 243 J. Grzywacz, Przydatność teoretycznych zasad kształtowania struktury kapitału w przedsiębiorstwie, Research Papers of the Mazovian State University in Płock, Płock 2013,Vol. XVII, p. 19. 244 J. Godfrey, A. Tarca, J. Hamilton, S. Holmes, Accounting Theory, op. cit., p. 376. 245 E. F. Fama, The Behavior of Stock Market Prices, Journal of Business 1965,Vol. 38; and E. F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, Journal of Finance 1970,Vol. 25, pp. 383–​417. 246 E. F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, op. cit., pp. 383–​417, cited after: S. B. Buczek, Efektywność informacyjna rynków akcji. Teoria a rzeczywistość, SGH, Warsaw 2005, pp. 15–​19. 247 A. Szyszka, Efektywność Giełdy Papierów Wartościowych w Warszawie na tle rynków dojrzałych, Poznań University of Economics and Business, Poznań 2003, p. 17, cited after: S. B. Buczek, Efektywność informacyjna rynków akcji. Teoria a rzeczywistość, op. cit., p. 17. 248 Except, of course, for information published periodically –​such as company financial reports. 249 M. Janicka, Efektywność rynków finansowych –​teoria a praktyka, Acta Universitatis Lodziensis. Folia Oeconomica, Łódź 2008, Issue 221, pp. 168–​171. 250 J. Czekaj, M. Woś, J. Żarnowski, Efektywność giełdowego rynku akcji w Polsce z perspektywy dziesięciolecia, PWN, Warsaw 2001, pp. 158–​159.

54  Earnings as a measure of economic profit 251 W. M. Cready, J. K. Shank, Understanding Accounting Changes in an Efficient Market –​ A Comment, Replication, and Re-​Interpretation, The Accounting Review 1987, Vol. 62, Issue 3, pp. 589–​596. H. Bierman, The Implications to Accounting of Efficient Markets and the Capital Asset Pricing Model, The Accounting Review 1974,Vol. 49, Issue 3, pp. 557–​562. 252 H. Bierman, The Implications to Accounting of Efficient Markets and the Capital Asset Pricing Model, The Accounting Review 1974,Vol. 49, Nr 3, s. 557–​562. 253 J. C. McKeown, Understanding Accounting Changes in an Efficient Market: Analysis of Variance Issues, The Accounting Review 1987,Vol. 62, Issue 3, pp. 597–​600. 254 N. Jegadeesh, J. Livnat, Revenue Surprises and Stock Returns, Journal of Accounting & Economics 2006,Vol. 41, Issue 1–​2, pp. 147–​171. 255 S. P. Kothari, J. Lewellen, J. B. Warner, Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance, Journal of Financial Economics 2006, Vol. 79, Issue 3, pp. 537–​568. 256 D. Collins, S. P. Kothari, An Analysis of Intertemporal and Cross-​Sectional Determinants of Earnings Response Coefficients, Journal of Accounting and Economics 1989, Vol. 11, Issue 2–​3, pp. 143–​181. 257 P. Wójtowicz, Czy wynik całościowy jest potrzebny rynkowi kapitałowemu?, [in:] I. Sobańska, T. Wnuk-​ Pel (eds.), Rachunkowość w procesie tworzenia wartości przedsiębiorstwa, University of Humanities and Economics in Lodz, Łódź 2009, pp. 155–​158. 258 M. Janicka, Efektywność rynków finansowych –​teoria a praktyka, op. cit., p. 175. 259 Capital Asset Pricing Model. 260 J. Lintner, Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics 1965, Issue 47, pp. 132–​160. 261 W. F. Sharpe, Capital Asset Process: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance 1964,Vol. 19, pp. 425–​442. 262 K. Jajuga, T. Jajuga, Inwestycje. Instrumenty finansowe. Ryzyko finansowe. Inżynieria finansowa, PWN, Warsaw 2004, p. 168. 263 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., p. 55. 264 https://​anal​izy-​progn​ozy.pl/​anal​iza-​progn​oza-​finans​owa/​inw​esty​cje/​capm/​ (30.04.2018). 265 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, op. cit., pp. 202; 206. 266 This concerns: E. A. Hendriksen and M. F. van Breda. 267 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., pp. 59–​60. 268 G. I.White, A. C. Sondhi, D. Fried, The Analysis and Use of Financial Statements, John Wiley & Sons, Hoboken, NJ 2003, p. 168. 269 H. M. Markowitz, Portfolio Selection, Journal of Finance 1952, Vol. 7, Issue 1, pp. 77–​97. 270 K. Jajuga, Finance-​ Change of Paradigm in Teaching and Research, Argumenta Oeconomica 1995, Issue 1, p. 53. 271 G. Jasinski, Evolutionary Optimization in Modern Portfolio Theory, Scientific Bulletin of Chelm Section of Mathematics and Computer Science 2008, Issue 1, p. 116. 272 E. A. Hendriksen, M. F. van Breda, Teoria rachunkowości, op. cit., p. 196. 273 J. Czekaj, Z. Dresler, Zarządzanie finansami przedsiębiorstw. Podstawy teorii, PWN, Warsaw 2005, p. 38.

Earnings as a measure of economic profit  55 2 74 www.skarb​iec.biz/​domy-​mak​lers​kie/​mar​kowi​tza.htm (11.10.2018). 275 A. Michałowski, Równoległe metody ewolucyjne w nowoczesnej teorii portfelowej i ich implementacja na GPU, Master’s Thesis,Warsaw University of Technology 2014, p. 20. 276 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., pp. 55–​58. 277 S. A. Ross, The Arbitrage Theory of Capital Asset Pricing, Journal of Economic Theory 1976,Vol. 13, pp. 341–​360. 278 These researchers include: S. D.Young, M. A. Berry, D. W. Harvery, J. R. Page. 279 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., pp. 62–​63. 280 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 80–​82. 281 B. Grabińska, K. Grabiński, Propozycja interpretacji podstawowych pozycji sprawozdania z zysku całkowitego sporządzonego zgodnie z MSR 1, op. cit., pp. 304–​305. 282 R. Ball, P. Brown, An Empirical Evaluation of Accounting Income Numbers, Autumn, Journal of Accounting Research 1968,Vol. 6, Issue 2, p. 161. 283 W. H. Beaver, The Information Content of Annual Earnings Announcements, Journal of Accounting Research 1968, Issue 6, Supplement, pp. 67–​92. 284 B. Grabińska, K. Grabiński, Propozycja interpretacji podstawowych pozycji sprawozdania z zysku całkowitego sporządzonego zgodnie z MSR 1, op. cit., p. 305. 285 B. Lev, On the Usefulness of Earnings and Earnings Research: Lessons and Directions from Two Decades of Empirical Research, Journal of Accounting Research 1989, Vol. 27, Supplement Printed in USA, pp. 153–​192. 286 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies,Their Determinants and Their Consequences, op. cit., p. 344. 287 J. Francis, P. Olsson, K. Schipper, Earnings Quality, op. cit., pp. 17–​18. 288 Cf.: J. Michalak, B. Bek-​Gaik, M. Karwowski, Model biznesu jako wyzwanie dla rachunkowości, Wydawnictwo Nieoczywiste, Łódź 2018, pp. 7–​165. 289 E.Maćkowiak,Polityka rachunkowości a kierunki zmian raportowania w przedsiębiorstwach, Studia Ekonomiczne 2014, Issue 201, p. 185. 290 J. Gierusz, Koszty i przychody w świetle nadrzędnych zasad rachunkowości. Pojęcia, klasyfikacja, zakres ujawnień, ODDK, Gdańsk 2005, p. 236. 291 M. Kędzior, Wpływ najważniejszych teorii finansów przedsiębiorstw i rynków kapitałowych na współczesną rachunkowość, op. cit., pp. 63–​64.

2 The concept and measurement of cultural determinants in economic sciences

2.1 The concept of culture, diversity, and cultural determinants The concept of culture is ambiguous, carries a broad meaning, and is used in many academic disciplines. Authors consider and define the term ‘culture’ in many different ways. More than 150 definitions of culture were proposed in the 20th century. According to C. Kluckhohn,1 culture consists in patterned ways of thinking, feeling and reacting, acquired and transmitted mainly by symbols, constituting the distinctive achievements of human groups, including their embodiments in artifacts; the essential core of culture consists of traditional (i.e. historically derived and selected) ideas and especially their attached values. G. Hofstede defines culture as: ‘the collective programming of the mind that distinguishes the members of one group or category of people from another.’2 C.W. Hill defines culture as:‘a system of values and norms that are shared among a group of people and that when taken together constitute a design for living.’3 The authors of the GLOBE cross-​cultural model4 defined culture as: ‘shared motives, values, beliefs, identities, and interpretations or meanings of significant events that result from common experiences of members of collectives that are transmitted across generations.’5 It should come as no surprise that R. Williams referred to culture as: ‘one of the two or three most complicated words in the English language,’ and R. Borofsky compared the search for a definition of culture to ‘trying to cage the wind.’6 J. G. Herder claimed that ‘there is nothing vaguer than the word culture.’7 It can be thus assumed that culture is a multidimensional concept, consisting of diverse norms and values, characteristic of certain groups.8 The variety of approaches and interpretations does not address the problems of defining the word ‘culture.’ Over the last few decades, many typologies of cultures have been developed and used in the analysis of business operations. They stress the various elements based on which the division into different types of cultures has been made.The important aspect here is that elements of culture DOI: 10.4324/9781003280088-3

Cultural determinants in economic sciences  57 are not only material products but also organisations, rules of social coexistence, social institutions, manners of conduct, criteria for evaluating behaviour, or patterns of behaviour. In many parts of the world, there is a strong emphasis on common roots and shared cultural heritage. However, there are still significant cultural differences between countries. This is also true for the different parts of the European Union, where the socio-​cultural9 attitudes are quite uniform, standardised. In some countries, there is internal cultural diversity. In China, for instance, there occur very significant cultural differences between the individual provinces.10 Over the years, the word ‘culture’ has been interpreted in many different ways. It was originally associated with land cultivation or farming but since the 16th century, it has made its way to other areas. Later on, culture was linked to human intellect and spirit. Since the 19th century, the term ‘culture’ has been used in a broader sense. G. Klemm was one of the first authors to associate culture with all aspects of social life by including: ‘customs, arts and skills, domestic and public life in peace or war, religion, science and art.’11 Table 2.1 includes the various definitions of culture, which illustrate the differences in interpretive approaches. One can notice that these definitions have emerged from a variety of academic disciplines, ranging from anthropology and psychology to sociology –​and are related to different contexts.12 D. Throsby mentions two ways of interpreting the concept of culture, distinguishing broad and narrow approaches. He argues that the broad approach to culture is an anthropological or sociological interpretation thereto, and treats culture as: ‘a set of attitudes, beliefs, mores, customs, values, and practices which are common to or shared by any group. The group may be defined in terms of politics, geography, religion, ethnicity or some other characteristic.’13 Viewing the approach in this way makes it possible to distinguish cultures such as European culture, youth culture, or corporate culture. Such reasoning can be applied to the analysis of the impact of cultural factors on business activities, but it can also be used in the study of the relationship between culture and economic development. According to D. Throsby, the narrow approach focuses more on functionality. It encompasses actions taken by individuals and the effects of those actions, which are both a result of the particular aspects of their lives. This interpretation is related to the characteristics that the actions taken should have. D.Throsby argues that these characteristics include: creativity, generating and transmitting symbolic meaning, and producing results that are some form of intellectual property.14 Broad and narrow approaches to the definition of culture in relation to anthropology and sociology can also be traced in the classic definition by E. B. Tylor.15 The trend of defining culture in broad terms includes also the concept proposed by P. R. Cateora and P. Ghauri. They define all parts of human existence as culture, distinguishing material culture, social institutions, education, belief system, aesthetics, and language.16 Thus, in a broad approach, culture encompasses the entirety of the objective achievements of mankind and consists of lasting values, both tangible and intangible, as well as a set of learnt behaviours shared by social groups and transmitted

58  Cultural determinants in economic sciences Table 2.1 Selected definitions of culture Author

Definition

J. G. Herder

Culture is the improvement of an individual, his/​her qualifications and skills which are acquired both in executive and intellectual aspects M. Harris Culture refers to the set of thoughts and actions learnt by members of a given social group E. T. Hall Communication is culture and culture is communication W. H. Goodenough Culture means the accepted beliefs and standards shared by a group of people. It helps individuals in deciding who they are, who they could become, how to feel, what to do, etc. V. Cronin Culture is a system of knowledge, common beliefs, and views. It is an overriding contract which defines the rules governing the actions and opinions of a given social group S. C. Jain Culture is all the learnt behaviour and values which are transmitted to all the individuals living in a given society A. Kłoskowska Culture is the external world of objects and thoughts shaped by generations, which affects people. It cannot be a creation of a single individual but is a product of coexistence and cooperation, which is being developed and enriched in the course of generations R. Linton Culture is a configuration of the learnt behaviour and effects of behaviour, the elements of which are shared and passed on by members of nationalities A. Man Hoebel Culture means the integrated sum of learnt acquired ways of behaviour which are shared and used by members of society and transmitted to their successors J. Szczepański Culture means all products of human activity, material and non-​material, values and accepted ways of conduct, objectivised and accepted in any community, and passed on to other communities and future generations E. B. Tylor Culture or civilisation is the entirety, containing knowledge, beliefs, art, morals, law, customs, and all other abilities and habits acquired by humans as members of society S. Czarnowski Culture is a collective achievement. It encompasses products of successive generations, including ideas or objects creatively processed by successors Source: P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, Publishing House of the Wrocław University of Economics and Business, Wrocław 2014, p. 15; and A. Karwińska, Kultura, [in:] J. Hausner, A. Karwińska, J. Purchla (eds.), Kultura a rozwój, National Centre for Culture Poland, Warsaw 2013, pp. 57–​58.

through the process of socialisation. S. Czarnowski,17 J. Szczepański,18 and A. Kłoskowska share this view.19 B. Suchodolski’s concept, according to which culture is the totality of human achievements, socially fixed and accumulated throughout history, constantly expanded by new creative works and efforts of

Cultural determinants in economic sciences  59 all societies, seems to be in line with the above as well. This division can also include the level of advancement of societies, groups, and individuals in a given historical period, determined by the degree of development of the forces of nature, the state of knowledge, and the artistic creativity achieved, as well as the forms of community life and social coexistence.20 A narrow understanding of the term culture involves a dichotomous division into material and spiritual culture.21 A. Kłoskowska, like A. Weber, argues that it consists of artistic activity, perception of the world, ideas, and religion.22 It is a characteristic perspective on all human activity that has to do with the aesthetic, intellectual, or moral domain of human life.23 Culture is a concept that is difficult to define clearly, which makes it hard to transform it into a measurable variable and to conduct empirical research. In an effort to identify cultural concepts and dimensions that may be helpful in describing the cultural determinants of the quality of earnings, it is possible to make use of the typology of cultures proposed by G. Hofstede. The field of cultural finance relies to a great extent on the ever-​improving G. Hofstede’s cultural model. Based on studies conducted in 50 countries, he empirically distinguished a number of cultural dimensions, universal to each country.24 G. Hofstede defines a cultural dimension as ‘[…] an aspect of a culture, which can be measured in relation to another culture.’25 The theory that he proposed implies the existence of four main cultural dimensions.26 In his research, based on the criteria indicated by A. Inkeles and D. J. Levinson, he identified four fundamental dimensions of culture: 1 2 3 4

power distance (from small to large), collectivism and individualism, femininity and masculinity, uncertainty avoidance (from weak to strong).

Later on, M. H. Bond27 proposed a fifth cultural dimension –​the long-​term orientation. Most recent studies include the sixth dimension, discovered by M. Minkov and referred to as indulgence –​restraint.28 Another concept analysed is the classification devised by F. Trompenaars and Ch. Hampden-​Turner.29 It refers to the concepts proposed by T. Parsons and E. A. Shils and F. R. Kluckhohn and F. L. Strodtbeck,30 which distinguish seven value judgement processes –​in other words, seven dimensions of culture. These are: 1 2 3 4 5 6 7

universalism –​particularism, individualism –​collectivism, specific –​diffuse, neutral –​emotional, achievement –​ascription, sequential –​synchronous, internal control –​external control.

60  Cultural determinants in economic sciences The concept analysed as next is the GLOBE model, which is a kind of critical continuation of G. Hofstede’s research. In the early 21st century, an international team managed by R. J. House conducted a research project that has been considered one of the most ambitious undertakings in the field of research into cultural differences.31 The proposed analysis model has been named GLOBE.32 It consists of nine cultural dimensions33: 1 2 3 4 5 6 7 8 9

uncertainty avoidance, power distance, institutional collectivism, in-​group collectivism, gender egalitarianism, assertiveness, future orientation, performance orientation, humane orientation.

Another concept taken into consideration is that proposed by S. H. Schwartz,34 who used a two-​level value analysis. The concept involved judging the characteristics of individuals at the individual level as well as cultural characteristics at the population level. Individual level values include power, achievement, hedonism, stimulation, self-​direction, universalism, benevolence, tradition, conformity, and security. In subsequent studies, the ten dimensions initially obtained at the individual level were reduced to seven cultural dimensions35 • • • • • • •

harmony, embeddedness, hierarchy, intellectual autonomy, affective autonomy, egalitarianism, mastery.

At the cultural level, the seven value types form three higher tier dimensions. S. H. Schwartz uses here the concept of value dilemmas, the first of which is the dilemma manifested in the autonomy –​embeddedness opposition. The second dilemma takes the form of the opposition of hierarchy –​egalitarianism. The third value dilemma is the harmony –​mastery opposition. In cultures where harmony is of great value, there is emphasis on adapting to the world, appreciating and understanding its diversity, and rejecting an exploitative attitude.36 The last of the analysed concepts is the one described in the World Value Survey (WVS) project.37 In the research carried out by R. Inglehart and his colleagues, two dimensions were considered: traditional values –​secular-​rational values and survival –​self-​expression.38

Cultural determinants in economic sciences  61 Like in the case of the notions of ‘culture’ and ‘culture typology,’ there exist different views regarding the concept of cultural determinants, in terms of both its accompanying elements and its interpretations. J. Mikulowski-​ Pomorski pointed out that the cultural sources of a contemporary human being include: national and ethnic group, language, religion, family, gender, education, profession, social class, organisation, institution, or media –​and each of these sources affects the personality of man.39 A different approach can be found in the works of F. Bradley, V. Terpstra and R. Sarathy, P. R. Cateora and P. Ghauri. An area of concern is the social elements categorised as cultural determinants. The lack of consensus translates into a lack of clarity when it comes to cultural elements as well. The elements of the cultural environment that have a significant impact on conducting business in foreign markets include: 1 2 3 4 5 6

values and attitudes, religion, verbal and non-​verbal communication, community organisation, education, material culture.

The first five elements listed are classified as intangible culture.They include spiritual elements –​values, religion –​and intellectual aspects –​education, attitudes, or verbal and non-​verbal communication.Together with material culture, they form a national culture. There are value systems in society that most definitely have an impact on business. Countries differ on this issue due to different cultural backgrounds. In European cultures, values and attitudes will include safety, career, environmental protection, as well as leisure activities. Different value systems will be found, in turn, in South American or Asian countries. Attitudes and values are related to stereotypes and biases that influence purchasing behaviour.Values and attitudes also include aesthetics, which consists of such elements as folk customs, plastic arts, dance, theatre, or music. Aesthetics have an impact on brand success in both domestic and foreign markets through the design, symbolism, or colours used. In many countries, a lot of attention is paid to particular colours and their significance.40 Major religions include Christianity, Buddhism, Hinduism, Islam, and Judaism. It is a factor that unites nations, affecting people’s beliefs, social norms, and value systems. Affiliation with a particular religion can be associated with certain behaviour and conduct –​and this behaviour and conduct is marketable. Marketing activities in different countries are different as they are run taking into consideration the dominant religion in a given country or region.41 The main tool of human communication is spoken language. Not knowing the language of a given market has a negative impact on the economic results and the image of a business. It also significantly affects the negotiation process with foreign partners and the effectiveness of the promotional activities

62  Cultural determinants in economic sciences run. The problems of product names or advertising slogans are also connected with this element of cultural determinants. There are records of plenty of spectacular mishaps of many famous brands. Non-​verbal communication –​meaning gestures and body language –​plays a very important role here. Other essential components of non-​verbal communication include the significance of touch and physical distance in communication, research on the use of space, voice intensity and timbre, laughter, silence, sobbing, olfactory communication, as well as clothing and physical appearance.42 The system of education provides information which influences the behaviour of populations. Access to education has a great impact on the overall advancement of societies, creating more or less favourable conditions for development. Education and quality affect purchasing behaviour, starting with basic skills like writing and reading. A thorough analysis of the education system of a given country makes it possible to design a well-​thought-​out marketing strategy for foreign markets.This makes it possible, in turn, to tailor the planned market activities, and translates into a correct reception of the communicated message among the target audience, thus making the message –​and the strategy –​more effective. The idea of ‘material culture’ considered in broad terms means the entirety of material goods and the production and technological means and skills of a given society. Material culture plays an important role in affecting demand and assimilating technological innovations. It is also important for the quality and types of products offered. These categories have a direct impact on the conducted marketing activities.43 The notion of ‘social organisation’ concerns the way in which relationships between members of a society are arranged and organised. The problems considered in this area relate to the position of men and women, social groups, or the family. This is an important issue when it comes to shaping behaviour, creating social patterns, and lifestyles. It also has implications for market-​related activities. The subject matter under consideration here was culture, one of the basic concepts of the humanities, defined differently for the purpose of each discipline, which leads to vagueness.44 Contemporary business entities operate in an environment, the immanent feature of which is changeability. They must have a thorough and current knowledge of economics and management. To run a business effectively and successfully, it is important to be familiar with the particularities of the country where the business operates or whose representatives one has to engage with in negotiations. These elements play an even greater role especially in the context of the increasing globalisation and the dynamic development of multinationals.45 Therefore, culture is the factor on which the future of business entities operating in international markets may depend.

2.2  Quantitative measurement of cultural determinants The diversity and complexity of social phenomena cause researchers to constantly search for effective methods to measure and analyse them. The issue of

Cultural determinants in economic sciences  63 culture, despite having been studied and analysed for decades, remains still relevant. It has been a subject of keen interest since the 1980s, which marked the peak of its popularity. Cultural studies are far from simple.46 The multitude of studies dealing with culture is a result of the ambiguity of the concept in the first place.47 In 1979, G. Burrell and G. Morgan48 formulated four paradigms for social sciences: functionalist, radical structuralist, interpretative, and radical humanist.The above paradigms are also applied in cultural studies. Categorising a research project into a specific group will make it possible to categorise the research conducted in the field of culture. By remaining within the functionalist paradigm, treating culture as a dependent variable, it is possible to study the relationship between culture and organisational performance. The study of culture is a complex process, and the selection of methodology is a consequence of the choices made in terms of the adopted ontological and epistemological assumptions.49 The study procedure should include the following stages: definition of the research problem and definition of the research objectives, determination of the object of the study, and determination of the methods and techniques used to measure and analyse data. In the process of studying social phenomena –​including culture, it is possible to make use of both quantitative and qualitative studies. The choice of the research method depends on what the research objective is, taking into account the strengths and weaknesses of the methods considered. If the goal is to study a large research sample and the findings are going to be generalised for an entire population, the choice should be quantitative research. On the other hand, when a specific problem is to be analysed, especially a new one, qualitative research will work best.50 Since the culture-​related studies conducted by G. Hofstede, R. J. House, and other researchers fall within the functionalist paradigm, which refers to population in general, the discussion to follow will focus on quantitative measurement. Scientific research on cross-​cultural differences has produced diverse research approaches and models to measure these differences and proposed a quantitative measurement of cultural differences based on so-​called cultural dimensions.The most relevant of them include the concepts put forward by F. R. Kluckhohn and F. L. Strodtbeck, E. T. Hall, F. Trompenaars, G. Hofstede, and the GLOBE model. They encompass all of the specific dimensions of a national culture. F. R. Kluckhohn and F. L. Strodtbeck identified five orientations that can be considered cultural dimensions. They concern the relationship of humankind to nature, social relations, human nature, sense of time, and human activity.51 The GLOBE cross-​cultural model identified nine cultural dimensions and six global leadership dimensions based on the culturally supported theory of implicit leadership.52 The best known, frequently cited, and positively verified in subsequent empirical research are the scope, typology, and dimensions of culture as proposed by G. Hofstede.53 In order to understand the research that G. Hofstede has conducted, it is necessary to define the basic concepts and characterise the dimensions he has proposed. He considered culture as the collective programming of the mind

64  Cultural determinants in economic sciences which distinguishes the members of one group or category of people from another. This definition is used in anthropology. It is important to stress that the concept of culture is not defined clearly in social sciences. Other concepts used by G. Hofstede are ‘dimension’ and ‘national culture.’54 A dimension is an aspect of a phenomenon that can be measured and quantified, while a national culture is the collective programming of the mind resulting from growing up in a particular country.55 G. Hofstede has distinguished the following dimensions of national cultures: ‘power distance’ (PDI), ‘collectivism and individualism’ (IDV), ‘femininity and masculinity’ (MAS), ‘uncertainty avoidance’ (UAI), and ‘long-​term and short-​term orientation’ (LTO). These terms have been used before in social sciences. They describe each of the problems they represent. The cultural dimensions form a four-​dimensional model of cultural differences, and each country occupies a specific position on the scale for a given dimension. An individual cultural dimension applies to the entire set of social phenomena, as proven by empirical research. They occur in specific combinations, but from a rational point of view, they do not need to have anything in common. In the case of the IBM study,56 it was possible to obtain comparable data from 40 countries at the very outset, which became a basis for demonstrating the cultural differences between groups.57 The term ‘power distance’58 describes the emotional space that separates subordinates from superiors.59 The indicators for this dimension60 were calculated on the basis of questions asked of IBM employees who held the same positions in different countries. The answers received were encoded on a scale from 1 to 5. Next, a standard sample, consisting of respondents pursuing particular professions, was selected and the mean –​or percentage –​values of those giving the same answers were calculated. This laid the foundation for compiling a table containing mean values and percentages, which illustrated the distribution of responses across the countries analysed. The survey questions were divided according to a factor analysis into specific subgroups (factors or clusters). The criterion adopted for the division was the regularity of the changes noted among the mean values and percentages of the responses obtained.61 The isolated subgroup consisted of questions concerning power, equality, and inequality. Based on the mean values of the responses received, a Power Distance Index (PDI) was established for a standard sample of employees in a given country. The calculation was based on a simple mathematical formula.The procedure involved assigning the same weight to each question and obtaining index values ranging from 0 (small power distance) to 100 (large power distance). The IBM database provided results for 57 countries. In other cases, the results were calculated based on repeat surveys or on estimates.62 The resulting index values are relative rather than absolute. The conclusion that the differences in the index values represent the diversity of national cultures was supported by the discovery of differences outside the IBM study population.63 By analysing the determinants of the occurrence of a certain power distance in particular societies, the following conclusions can be offered64:

Cultural determinants in economic sciences  65 • •

• •

there is a correlation between the language region and the intensity of power distance –​Latin countries –​large, Germanic countries –​small, the greater the latitude, the lower the level of power distance. Those parts of the world where cold climate prevails have developed societies that are more independent, characterised by a smaller power distance; the opposite is true in the warm countries of the South, such as the Philippines or Malaysia, the greater the population of a country, the higher the level of power distance, the higher the level of wealth of a country, the lower the level of power distance, although it should be stressed that this relationship is not always true –​as exemplified by Japan.

Countries where the level of power distance is high include Ecuador, Venezuela, Guatemala, Panama, Japan, Belgium, and France. In contrast, low power distance can be seen in Scandinavian countries, Anglo-​Saxon countries, and Germany.65 Since there is a strong tendency for a relationship to develop between the subordinate and the superior, power distance is the factor that has a big impact on leadership in an international setting.66 The countries participating in G. Hofstede’s research were assigned another indicator –​individualism. IDV is a dimension that concerns the relationship between an individual and a group, determining the individual’s place in the group as well as the group’s influence on the individual’s behaviour.67 A low level of IDV was found among collectivist countries, while a high level thereof was typical of individualist countries. This dimension was defined as individualism68 and collectivism.69 When it comes to the values of this dimension, there occur differences not only between countries but even within a single country. Therefore, the requirement of comparability and representativeness of the study was of great importance. A questionnaire survey was used in the analysis. It contained a set of 14 factors which influenced the job choice. The factors were given values ranging from 1 –​very important –​to 5 –​unimportant. The responses obtained made it possible to identify certain regularities. One was a manifestation of the dimension of individualism and collectivism, and the other was defined as masculinity and femininity. The factors of individualism and collectivism were assigned specific properties. Individualism included time off work, challenge, and freedom. In the case of collectivism, these were training, working conditions, and utilisation of people’s potential.The regularity discovered in the study was the polarisation of preferences. The way the individualism index was calculated was not analogous to the calculations for the power distance dimension. A statistical procedure was applied to the calculations, which made it possible to place a given country immediately on the dimension scale.The results obtained were multiplied by 25 and had the value of 50 added to fit within a range from 0 to 100.70 Based on the research, a second individualism/​collectivism (IDV) index was created.71 By analysing the above dimension, it can be concluded as follows72:

66  Cultural determinants in economic sciences • •

the wealthier the country, the higher the level of individualism, the colder the climate, the higher the level of individualism.

Individualistic countries are the Anglo-​Saxon countries and the USA. In contrast, collectivist cultures are dominant in the following countries:Venezuela, Japan, and Pakistan. German culture and Polish culture are considered individualistic, but their clear collectivist tendencies can be found there as well. Individualistic or collectivistic attitudes seem to have a significant impact on the behaviour of supervisors and subordinates in one workplace, especially when each of them have different cultural backgrounds.73 The next dimension, referred to as ‘masculinity-​femininity,’ resulted from assigning significance to factors. Masculine factors include earnings, recognition, career advancement, and challenge. Feminine factors are, in turn, relationship with manager, cooperation with colleagues, place of residence, and job security. It needs to be stressed that the ‘challenge’ factor was a determinant of individualism, while other factors are related only to the dimension in question. The analysis shows that men pay attach significance to the factor of earnings and career advancement, while women focus more on the relationship with their managers and cooperation. In order to arrive at the components of the dimension, it is necessary to identify the correlation of masculinity indices. The Masculinity/​Femininity (MAS) indices were calculated in a similar way to that used to calculate the individualism indices.The factor analysis of the conducted research made it possible to determine each country’s position on the dimension scale.The results were multiplied by 20 and had the value of 50 added to fit within a range from 0 (country with feminine characteristics) to 100 (country with masculine characteristics). Later on, the MAS values were extracted from the means for the four purposes of the research project. The masculinity index cannot be linked to a country’s wealth.74 G. Hofstede claims that the primary determinants of cross-​cultural differences within this dimension are tradition and history.75 Countries where it was expected to have good interpersonal relationships with others, which led to the emergence of so-​called feminine cultures, include Sweden, Norway, Latvia, the Netherlands, or Belgium. In the countries where masculine qualities prevailed, strong masculine cultures have emerged. These include, for instance, Japan, China, Austria, Venezuela, or the Philippines.76 The fourth dimension explored in G. Hofstede’s study was the Uncertainty Avoidance Index (UAI).77 This is a dimension of national cultures, stretching between the poles of weak and strong uncertainty avoidance.78 The UAI can be defined as a society’s sensitivity to change, to situations that are new and difficult to predict.79 The researchers discovered differences occurring at the state level when they were analysing the PDI. A closer examination showed a strong correlation between three survey questions. These questions concerned job stress (recorded on a scale of 1–​5), compliance with workplace policies (mean scale of 1–​5), and length of service with the company (2 years at most, 2–​5 years, more than 5 years, until retirement). The research shows that there are differences in

Cultural determinants in economic sciences  67 the means for each country and that there occurs a strong correlation between the three questions asked. The PDI was calculated using the means calculated based on the responses to the first and second question, and the percentages of responses to the third question. A simple mathematical formula was used, which involved adding and subtracting three results, multiplying the value earlier by a constant, and then adding another constant. The formula was constructed in a way to make the questions asked have equal weight and the indices fit within a range from 0 (countries with low uncertainty avoidance) and 100 (countries with high uncertainty avoidance). This condition was not fully satisfied, as in some cases, the rates recorded were higher than the score limit in the range.80 The determinant of the cultural differences existing within this dimension is the history of a given nation. When considering this dimension, it is possible to draw a conclusion that cultures that do not accept uncertainty are more likely to be aggressive, violent, emotional, and intolerant. Cultures with a high level of tolerance for uncertainty are more reflective, do not give in to emotions, and act less aggressively.81 High levels of uncertainty avoidance were recorded for the following countries: Greece, Portugal, Malta, Japan, Poland, Belgium, France, Chile, Peru, and Argentina. An average level of uncertainty avoidance was reported for German-​ speaking countries. In contrast, cultures with low uncertainty avoidance levels include Scandinavian, Asian, African, Anglo-​Saxon, and Nordic countries.82 The fifth dimension is referred to as Long-​Term Orientation (LTO), and the opposite pole thereof is short-​term orientation. The LTO index expresses an orientation not only on near-​term and long-​term goals, but also on developing qualities that will make it possible to gain certain benefits in the future or nurture the past and present.83 In 2007, M. Minkov published an analysis of the WVS,84 proposing three new dimensions: exclusionism-​ universalism (correlated with collectivism), indulgence-​restraint (positively correlated with the role of friends and negatively correlated with the indication of thrift), and arrogance-​humility –​correlated (strongly and negatively) with LTO-​Chinese Value Survey (CVS).85 The WVS indicators of pride and religiosity create a strong cultural dimension and are correlated at the country level. A form of self-​enhancement was personal stability and equilibrium. These are qualities found at the short-​term pole of the LTO-​CVS dimension. The components of the World Values Survey that meet the requirements include thrift as a desirable trait in children (percentage of people who indicated ‘prudence’), national pride (percentage choosing ‘very proud’ –​counted negatively), and marking ‘service to others’ (percentage of people who indicated ‘very important’ next to ‘service to others’). The above components were strongly correlated with each other. At the country level, in turn, each was correlated with LTO-​CVS. The findings were the basis to calculate the LTO-​WVS indices for 84 countries. The difference arising from LTO-​CVS and LTO-​WVS concerns CVS. It was constructed by Chinese researchers. In China, the indices reached the highest values. The LTO dimension index was calculated for 23 countries, and any attempts to expand the survey produced negative results. LTO-​WVS is an

68  Cultural determinants in economic sciences attempt to recreate the significance of LTO. Calculations were made on the basis of a European database and an extended US database. National pride is related to the LTO-​WVS index. There is a strong correlation here with arrogance. Unlike the LTO-​CVS index, it is not correlated with a country’s wealth, while the LTO-​WVS is weakly (positively) correlated with wealth. LTO is typical for countries like South Korea, Taiwan, Japan, China, or Brazil. On the other hand, countries characterised by a short-​term orientation include Pakistan, Nigeria, the Philippines, Spain, and the Czech Republic.86 One of the most extensive and large-​ scale studies on the relationship between culture and leadership (the research was later expanded to include other aspects, i.e. national and organisational culture) was Project GLOBE. A total of 17,300 middle managers took part in the research project. They represented 951 organisations87 and 62 different cultures.The primary objective of this international and multi-​stage research project, coordinated by R. J. House, was to determine if and to what extent organisational practices and leadership effectiveness were affected by cultural background.88 The analysed cultures were compared to each other based on the theoretical model of culture and its definition adopted in the GLOBE project. An important aspect to notice is that the GLOBE model data highly correlate with G. Hofstede’s data from the 1960s and other data concerning cross-​cultural research. This proves that socio-​cultural practices and values do not change in the short term. Socio-​cultural changes occur basically in 50-​year or 100-​year periods, and sometimes even over longer time frames.89 An important component of the GLOBE model is the cross-​cultural research hypotheses set by the researchers. They stem from the adopted definition of culture and the assumption regarding the mutual influence of cultures, societies, and organisations. The GLOBE theoretical model consists of 15 theses.90 The GLOBE study used –​in the case of questions concerning cross-​cultural dimensions in the studied countries –​ a 7-​point scale based on a Likert scale, where 1 means ‘completely agree’ and 7 means ‘completely disagree.’91 For conceptual reasons, the GLOBE model extended G. Hofstede’s list of dimensions from five to nine. The dimensions of uncertainty avoidance and power distance were maintained. Collectivism was divided into two dimensions: institutional collectivism and in-​group collectivism. In the case of the masculinity–​ femininity dimension, the following dimensions were isolated: assertiveness and gender egalitarianism. LTO was replaced by future orientation. Two new dimensions emerged, i.e. humane orientation and performance orientation. The questionnaires used for the calculations were alpha (including 75 questions about the organisation’s culture) and beta (including 78 questions about the country’s culture).92 The first part of the survey asked questions describing the culture ‘as it is,’ and the second part asked for a rating describing it ‘as it should be.’ Eighteen indicators were constructed for each country.93 In R. J. House’s model, two versions of the questionnaire were used. Half of the survey respondents answered questions concerning the culture of ‘this society,’ and the other half answered questions concerning the culture of

Cultural determinants in economic sciences  69 ‘this organisation.’ Based on the research methodology so created, it was possible to make a cultural assessment of the studied societies according to the real behaviour typical of individual national cultures and the values that these cultures held. The two-​aspect view of the cultures of the societies studied can be considered novel and interesting.94 In the multi-​ country sample, some dimensions were highly correlated with each other. The dimensions ‘as it is’ and ‘as it should be’ appeared to be negatively correlated. G. Hofstede’s analysis showed that eighteen country-​ specific dimensions were combined into five groups. The strongest one, taking into account the GLOBE project, is strongly correlated with country wealth as well as with G. Hofstede’s cultural dimensions. This is true in the case of the following dimensions: power distance, individualism, and uncertainty avoidance. The next three groups were correlated with G. Hofstede’s dimensions.95 The questionnaire addressed the issue related to masculinity to a very small extent, referring to G. Hofstede. All information related to this dimension can be found in group five.The different research approach and –​at the same time –​the huge database of the GLOBE model reflected the structure of G. Hofstede’s model.96 Out of the 18 dimensions of the GLOBE project, at least nine were correlated with the PDI. The strongest correlation was observed between PDI and collectivism in the ‘as it is’ group. A weak correlation occurred between the PDI and the power distance from the GLOBE model in the ‘as it is’ group, while the PDI and the GLOBE-​version power distance of ‘as it should be’ were not correlated at all. In the case of the GLOBE power distance, there was a strong correlation with the UAI in both versions. It can be thus concluded that the GLOBE power distance is equivalent to G. Hofstede’s PDI index.97 The study of the GLOBE model defined and attempted to measure institutional collectivism and in-​group collectivism –​in both versions. It was found that 10 out of 18 GLOBE dimensions were correlated with IDV. A strong correlation occurred in in-​group collectivism in the ‘as it is’ version. Of the three other measures of collectivism in the GLOBE study, only institutional collectivism in the ‘as it should be’ group was negatively correlated with IDV –​and more strongly correlated with uncertainty avoidance.98 R. J. House distinguished four related conceptual dimensions instead of the terms ‘masculinity-​femininity.’ They overlapped with MAS in 48 countries and were correlated for the assertiveness dimension in the ‘as it is’ group. The strongest correlation with MAS occurred when the ‘as it is’ and the ‘as it should be’ versions of assertiveness were combined. The gender egalitarianism dimension in both groups was correlated with IDV –​but not with MAS. The performance orientation index in the ‘as it is’ group was strongly correlated with the IDV. In his book, G. Hofstede questions any significance of the humane orientation index in the GLOBE model.99 In 48 countries, the UAI was strongly negatively correlated with the GLOBE uncertainty avoidance in the ‘as it is’ version. In the ‘as it should be’ version, there was a weak positive correlation with the GLOBE uncertainty

70  Cultural determinants in economic sciences avoidance. There is a strong negative correlation between the two GLOBE versions.100 G. Hofstede argues that using the terms ‘power distance’ and ‘uncertainty avoidance’ in the GLOBE model leads to confusion.101 Another dimension of the GLOBE model, past orientation, was derived from the LTO index. Among the 49 countries, the LTO-​WVS index was significantly correlated with 6 of the 18 GLOBE indices. The correlations were negative with respect to ‘as it is’ performance orientation and in-​group collectivism in the ‘as it should be’ group. In the GLOBE project, future orientation in the ‘as it is’ group was not correlated with the LTO index. It was possible to notice a combination of low UAI and PDI. The ‘as it should be’ future orientation dimension was a combination of high PDI and low LTO-​WSV. An attempt to recreate the LTO in the GLOBE project failed.102 The GLOBE study identified also six dimensions of leadership (dependent variables), which were diagnosed among the managers participating in the study –​and which make it possible to distinguish effective from ineffective leaders: • • • • • •

values-​based charismatic leadership –​the ability to inspire and motivate subordinates, but also an expectation that the goals set will be fully achieved by following certain specific values, team-​oriented leadership –​the ability to build teams capable of achieving common goals, participative leadership –​defined as the degree to which subordinates and other members of an organisation are involved in the decision-​making process, humane-​oriented leadership –​typical of leaders who display a high degree of sensitivity and empathy, autonomous leadership –​characteristic of independent and individualistic leaders, self-​ protective leadership –​the ability to protect and defend oneself and one’s group without drawing attention to other members of the organisation.103

Researchers104 agree that each of the above leadership dimensions is partially universal and partially culturally determined. The lowest value of all GLOBE cultural dimensions was recorded for South Korea. The score was 2.50 and concerned the dimension of gender egalitarianism. The authors of the GLOBE model point to the special role and comprehensiveness of the gender egalitarianism dimension. The survey shows that responses with a score of around 1 indicate male dominance in society, and responses closer to 7 indicate female dominance. It is also interesting to juxtapose the GLOBE model with other cross-​cultural research projects.105 Based on the above analysis, there are more arguments speaking in favour of the GLOBE model, which appears to have more strengths than weaknesses (Table 2.2).

Cultural determinants in economic sciences  71 Table 2.2 Strengths and weaknesses of the GLOBE model Strengths of the GLOBE model

Weaknesses of the GLOBE model

• Comprehensiveness –​a broad temporal range and a great level of detail of the study • Inclusion of so-​called part cultures, e.g. Switzerland • Consideration of differentiation into cultural practices and cultural values in the study • Diversity of society and company cultures • Adoption of various research techniques • Methodological validity and a solid theoretical foundation of the model

• Lack of consideration of part cultures in some culturally diverse countries, such as the USA • Representativeness of the sample • In Canada, the study has been conducted only in the English-​speaking community

Source: Based on: M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, Gospodarka Narodowa 2015, Issue 275, p. 17.

The paradigm of the dimensional approach was introduced by G. Hofstede in a 1980 publication titled Culture’s Consequences and has since gained the status of normal science.106 Since the time of its publishing,107 the paradigm discussed there has been applied to the creation of several other theories on national cultures, and each of these theories has proposed its own classification of cultures. The dimensions paradigm was applied in the research conducted by Israeli psychologist S. H. Schwartz. The source of data was the output of M. Rokeach, who compared groups of Americans using a scale of 18 terminal values108 and 18 instrumental values.109 The research conducted was to determine the degree of significance of each value of the so-​called guiding value in one’s life. Responses were given on a 9-​point scale, ranging from -​1 (opposed to one’s values’) through 0 (not important) to 7 (supreme importance). S. H. Schwarz collected data from over 60 countries. Later on, the number of components and the number of countries increased to 79 in the 2009 online survey. The researcher made use of the SSA (Smallest Space Analysis) statistical procedures, and then divided the values analysed into ten dimensions. Country-​ level data analysis showed that there was a need for a different set of dimensions. There is a correlation between S. H. Schwarz’s indices and G. Hofstede’s indices, especially in the individualism-​collectivism dimension.110 S. H. Schwarz identified seven value categories –​at least five of which were correlated with IDV. When this was reduced to three groups, a strong correlation with IDV became apparent: autonomy-​embeddedness and egalitarianism-​mastery.111 The presented attempt to classify and characterise the quantitative measurement of cultural determinants is certainly incomplete as much more can be said and written about it. Nevertheless, the provided characteristics outline the relationships that exist between the studies discussed and show the

72  Cultural determinants in economic sciences correlation between particular factors. Being familiar with the characteristic features of other countries in relation to the distinguished dimensions is extremely advantageous for both individuals and economic entities intending to do business in another country. Such knowledge is useful in many areas of international business –​such as negotiation, conducting business, or designing advertising messages and campaigns. Proper quantitative measurement of cultural determinants makes it possible to better understand human behaviour and conduct in every area.112 Surely, the difficulties that do –​and will –​appear should not discourage researchers from further explorations of the issue of culture as it does not become any less relevant. On the contrary, the significance of culture is actually increasing. An important thing to stress is that the pace of economic and technological change in the modern world is really fast, but the cultural patterns formed over many years are not subject to such profound transformations. Empirical studies on cultural differences have been conducted over a longer period of time, which translates into an opportunity to compare the results obtained and gain a deeper insight into the cultural changes between individual countries.

2.3  Major studies of cultural diversity in economic sciences Culture matters. It determines almost everything. It cannot be overestimated and must be reckoned with.113 Such statements are supported by specific studies aimed to analyse the impact of cultural factors. They are not free of cultural stereotypes and simplifications. A scientifically correct explanation requires ‘robust’ cultural variables and the identification of a close relationship between a ‘cultural’ cause and an economic effect.114 Regardless of the difficulties cultural studies will encounter, the belief that economic phenomena are governed by factors that originate in culture has been long rooted in economics. Even A. Smith described economic life as a complex process, deeply rooted in the traditions and customs of society. M. Weber still remains an authority in this field, and even though his concepts differ in terms of quality and nature from current research, they are still frequently cited.115 Economics owes a lot to M. Weber’s output, example being the conviction that a strictly economic analysis is not always enough to explain economic reality, or the observation that economic growth is a culturally determined process. In Poland, the subject of the impact of culture on various areas of social life is raised eagerly, as proven by the considerable number of publications dealing with it.The level of interest in culture is also an outcome of the efforts of Polish economists –​although to a lesser extent than outside our country. Foreign researchers refer to culture as a factor that determines economic phenomena.116 A purely economic approach prevails among economists because studies focus almost exclusively on economic variables and are usually carried out in isolation from non-​economic factors.117

Cultural determinants in economic sciences  73 A quantitative approach that emphasises precision and mathematical rigour or formalism does not quite work in studies of cultural impact. Economists making use of the ceteris paribus rule may find it difficult to see the interdependence between many phenomena of a different nature. D. Landes claims that when studying culture, it is necessary to bear in mind that there are many other determinants of economic life besides culture. It is not enough to give a single good reason for a phenomenon because the factors determining the course of complex processes are always diverse in nature and interrelated with each other.118 Similarly, R. K. Pye argues that no strict causal relationships have yet been discovered, meaning relationships that could be used to rigorously determine the importance of individual cultural factors and values.119 The progressing formalisation and mathematisation of economics in the second half of the 20th century caused economists not so much to lose their interest in culture but, aware of their own analytical capabilities, to start interpreting culture as a result of economic forces.120 It was treated as a dependent variable, explained and described using hard independent variables of an organisational or economic nature. Many economists take an ambivalent approach to cultural factors. It is believed that economics makes use of economic categories of concepts used to explain market phenomena. Basically, science deals with the problem of rarity and analysis of logical choices. In this perspective, cultural issues are uncomfortable for economists because of their complex nature and the need to consider a very broad context in the conducted research. The multitude of definitions of the term ‘culture’ and the ‘qualitative’ rather than ‘quantitative’ nature of the essence of this term do pose a challenge.121 In a community, culture is based on accepted traditions and customs which reflect a certain established system of norms and values. Differences in value systems of particular societies determine the existence of many different cultural circles –​also known as Kulturkreise.122 S. H. Schwartz distinguished seven major universal cultural categories.123 These categories are listed in Figure 2.1. The illustrated division was the basis for further studies into cross-​cultural aspects. There are a number of studies, including those by M. Wang and P. S. Fischbeck,124 D. J. Levinson and K. Peng125 and A. C. W. Chui, S. Titman, and K. Wei,126 which provide evidence that cultural determinants affect the behaviour of individuals in a financial setting.127 Some of the most important studies identifying cultural factors include studies by G. Hofstede and their extended continuation by R. J. House et al. and the work of S. J. Gray. The theoretical grounds of G. Hofstede’s research were the studies of American researchers from the 1950s –​sociologist A. Inkeles and psychologist D. J. Levinson. They developed a list of factors that influence the functioning of societies, groups, and individuals within a culture.They claimed that all cultures of the world can be described by their differences in the ways in which they resolve conflicts, in the approach to the individual –​their subjectivity, their relationship with society, and their attitude towards authorities.128

74  Cultural determinants in economic sciences

Conservatism

Egalitarianismpartnership

Affective autonomy

CULTURAL CATEGORIES Intellectual autonomy

Harmony

Hierarchy

Mastery-individual skills and abilities

Figure 2.1 Cultural categories. Source: W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, [in:] E. Śnieżek, J. Piłacik, S. Doroba (eds.), Różne kraje –​ta sama rachunkowość?, Publishing House of the University of Lodz, Łódź 2017, p. 71.

Culture was discussed in an interesting way by G. Hofstede. He claimed that culture was the programming of the mind that distinguished one social group from another.129 G. Hofstede and G. J. Hofstede argue that Every person carries within him-​or herself patterns of thinking, feeling, and potential acting that were learned throughout the person’s lifetime. […] As soon as certain patterns of thinking, feeling, and acting have established themselves within a person’s mind, he or she must unlearn these patterns before being able to learn something different, and unlearning is more difficult than learning for the first time.’130 The term used to describe this pattern is ‘culture.’ G. Hofstede conducted an in-​depth analysis of the differences existing between cultures.131 In the late 1960s and early 1970s, he studied corporate employee behaviour in dozens of countries around the world.132 In the 1980s, he carried out research on the impact of cultural heritage on employee behaviour.133 G. Hofstede’s studies

Cultural determinants in economic sciences  75 involved an analysis of the behaviour of 116,000 employees working in 50 countries for one of the multinational corporations –​IBM. Four primary cultural dimensions that directly affect –​and shape –​countries’ organisational and legal systems and accounting regulations were identified134: 1 Power distance (large power distance vs small power distance) –​this category describes the extent to which different societies accept and expect that access to power varies and that power is distributed unequally. People may accept hierarchy and limited access to power or seek to equalise the rights of different social groups. Low rates of the index are found among democratic countries, which include the Germanic, Nordic, Baltic countries, the United States, and the United Kingdom. Higher rates are typical of Eastern European, Latin, Asian, Arab, and African countries. 2 Individualism vs collectivism –​individualism is characteristic of societies where ties between individuals are rather loose. Collectivism, in turn, is typical of societies in which members belong to close-​knit groups, such as family, which provide them with protection reciprocated by loyalty. A high degree of individualism is common among wealthy countries. There exists a correlation between the indices of individualism and power distance.The higher the PDI, the lower the individualism index. 3 Masculinity vs femininity –​describes the difference in gender roles. Masculinity is a feature of societies where social roles are gendered and clearly defined: men are expected to be assertive, tough, and goal oriented, while women are expected to be tender, modest, and attentive to the quality of life. In masculine cultures, there are clear differences in the roles of each gender. In the case of feminine cultures, the differences between these roles are less marked, less apparent. Both men and women share similar values. The rate of masculinisation does not depend on the wealth of the country. 4 Uncertainty avoidance (strong uncertainty vs weak uncertainty) –​the degree of threat felt by members of a culture in new situations. Observed in the attempts to make future events more predictable. It is possible to increase the level of predictability thanks to laws, regulations, and community customs.135   Later on, two additional dimensions of culture were defined –​as described below.136 5 Pragmatic LTO vs normative short-​term orientation –​societies with low values of this index are traditional social groups with a strong attachment to the past. A high level of this index is typical of societies with a pragmatic approach, unafraid of innovative changes. 6 Indulgence vs restraint –​members of societies which are considered indulgent are inclined to enjoy the pleasures of life. Unlike an indulgent society, a restrained society limits unnecessary consumption, and the rewards or benefits received come from professional achievement.

76  Cultural determinants in economic sciences Out of the five factors identified by G. Hofstede, the collectivism-​ individualism dimension proved to be the most popular one. Works that have become particularly known in this context137 include those by H. C. Triandis, who uses this factor to explain many cross-​cultural similarities and differences.138 He brought to light the theoretical relationships between individualism and cultural differences in many psychological processes, in the functioning of individuals and groups.139 G. Hofstede’s findings offer a solid foundation for further analysis in the area of the differences in cultural circles and their impact on other scientific fields. His research, however, has been subject to criticism, especially that conducted between 1968 and 1972140 A group of researchers, composed of R. J. House, P. J. Hanges, M. Javidan, P. W. Dorfman,V. Gupta, distinguished nine cultural dimensions141: • • • • • •

• • •

uncertainty avoidance –​the degree to which organisations and societies attempt to avoid uncertainty by seeking order and structure, relying on rules, directives, structures, and formal processes, power distance –​the degree to which members of an organisation or a society expect and agree that power should be shared unequally, institutional collectivism –​the degree to which society encourages and rewards collective distribution of resources, in-​group collectivism –​the degree to which individuals express pride, loyalty, and cohesiveness in their organisations or families, gender egalitarianism –​the degree to which a society minimises gender role differences while promoting gender equality, assertiveness –​the degree to which individuals in organisations or societies are aggressive, confident, and confrontational in social matters, towards society or organisations and in the relationships with them (i.e. expressing needs and opinions in an open manner), future orientation –​the degree to which an individual demonstrates future-​ oriented behaviour in a society or an organisation, performance orientation –​the degree to which societies or organisations encourage and reward individual achievement or innovation and the nature of the relationships between individuals in the society, humane orientation –​the degree to which an individual is supported and rewarded by society or organisations for their altruistic, friendly, forgiving, or generous behaviour.142

Based on the defined cultural dimensions, R. J. House and his associates defined groups of countries displaying cultural similarities.143 G. Hofstede’s output was adapted by S. J. Gray, linking cultural factors with accounting. He proposed four features of accounting which can take extreme forms depending on the environment. These are144: 1 Professionalism vs statutory control –​defines the ways in which accounting is regulated in a given country. Accounting professions or auditors expert

Cultural determinants in economic sciences  77 in accounting systems, qualified as professionals, play an important role here. In countries where the accounting system is regulated from the top down, these professions are treated as having no impact on balance sheet lawmaking. 2 Uniformity vs flexibility –​uniformity implies a preference for the consistent use of the same solutions over and over. Flexibility, in turn, makes it possible to apply different solutions in light of the changes taking place in the environment. 3 Conservatism vs optimism –​indicates a preference for a cautious approach to measurement and valuation. It finds expression mainly in the accounting valuation –​in contrast to the optimistic approach, where valuation is more risky, closer to the market value. 4 Secrecy vs transparency –​related to the level of disclosure in financial statements. A more transparent position involves being more open and publicly accountable with regard to the information shared.145 S. J. Gray combined the cultural characteristics identified by G. Hofstede with the self-​identified values of accounting (Table 2.3). Based on research,146 S. J. Gray distinguished groups of countries with similar socio-​cultural characteristics and similar accounting systems147: • • • • • • • • • •

Anglo-​Saxon countries (e.g. Australia, Canada, Ireland, New Zealand, the United Kingdom, the USA), Scandinavian countries (e.g. Sweden, Denmark, Norway), colonial Asian countries (Hong Kong, Singapore), African countries, highly developed Latin countries (e.g. Argentina, Brazil, Spain, Italy), underdeveloped Latin countries (e.g. Colombia, Ecuador, Mexico, El Salvador), highly developed Asian countries (Japan), underdeveloped Asian countries (Indonesia, Pakistan, India), Middle Eastern countries (Arab countries, Iran, Turkey), Germanic countries (e.g. Austria, Germany, Switzerland).

S. J. Gray used the division of countries proposed by G. Hofstede and formulated a set of values assigned to accounting. He took into account statutory control/​professionalism and uniformity/​flexibility –​and used them as the basis to determine the so-​called stability of accounting standards. Scandinavian and Anglo-​ Saxon countries tend to be flexible and rely on professional accounting and expert auditing organisations in the area of designing and adopting accounting regulations. They are characterised therefore by the variability of the adopted accounting solutions, which is a response to the dynamically changing environment in which business entities operate (flexibility), and by attaching great significance to the activities of professional accounting organisations for the establishment of accounting standards (professionalism). At

78  Cultural determinants in economic sciences Table 2.3 Linkage between G. Hofstede’s cultural dimensions and S. J. Gray’s values attributed to accounting G. Hofstede’s cultural dimensions and S. J. Gray’s accounting values Professionalism • Individualism • Weak opposition to the state of uncertainty • Striving for an equal distribution of power Uniformity • Strong opposition to the state of uncertainty • Accepting the hierarchical division of power • Collectivism Conservatism • Strong opposition to the state of uncertainty • Collectivism • Femininity Secrecy • Strong opposition to the state of uncertainty • Accepting the hierarchical division of power • Collectivism • Femininity

Statutory control • Collectivism • Strong opposition to the state of uncertainty • Accepting the hierarchical division of power Flexibility • Weak opposition to the state of uncertainty • Striving for an equal distribution of power • Individualism Optimism • Weak opposition to the state of uncertainty • Individualism • Masculinity Transparency • Weak opposition to the state of uncertainty • Striving for an equal distribution of power • Individualism • Masculinity

Source: C. Roberts, P.Weetman, P. Gordon, International Financial Reporting. A Comparative Approach, Financial Times-​Prentice Hall, London 2005, p. 185, K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016, p. 119; J. Krasodomska, Czynniki kulturowe, [in:] K. Grabiński, M. Kędzior, J. Krasodomska, Globalne uwarunkowania rachunkowości. Systemy, procesy, zmiany, PWN, Warsaw 2014, p. 55.

the same time, these countries are inclined to corporate disclosure and optimism –​in contrast to Asian and less developed Latin countries. These countries follow a uniform approach to the establishment of accounting principles and the adopted legal framework. They prefer discretion, which translates into a limited disclosure of information. Considering the Germanic countries and the more developed Latin countries, it is possible to see an inclination towards regulating the domain of accounting in an autonomous manner. These are countries with a tendency to exercise discretion to a greater extent than the more conservative Anglo-​Saxon or Scandinavian countries.148 The limitations identified in G. Hofstede’s and S. J. Gray’s output offer the basis for further research.Table 2.4 presents selected studies in this area from the period between 1990 and 2012. Studies taking into account cultural dimensions

Cultural determinants in economic sciences  79 Table 2.4 Selected research findings referring to the output of G. Hofstede and S. J. Gray Research authors

Characteristics

I. A. Eddie (1990)

A survey was conducted in 13 countries in the Asia-​Pacific region. The results obtained made it possible to verify all four of S. J. Gray’s hypotheses to be true An analysis of 27 countries made it possible to find correlations that supported the hypothesis of S. J. Gray in relation to secrecy A 29-​country study carried out with the use of regression analysis provided partial support for S. J. Gray’s hypotheses

S. J. Gray, H. M.Vint (1995) S. B. Salter, F. Niswander (1995) M. Sudarwan, T. J. Fogarty (1996)

M. T. Zarzeski (1996) M. L. Wingate (1997)

B. Jaggi, P.Y. Low (2000)

O. K. Hope (2003) G. P. Brown, R. P. Rodriguez (2008)

E. Heidhues, C. Patel (2011)

D. R. Borker (2012)

The study was conducted in one country –​Indonesia. It was found that there was a significant positive relationship between power distance and uniformity, uncertainty avoidance and unanimity, uncertainty avoidance and conservatism, and individualism and professionalism, which was in line with S. J. Gray’s hypotheses Seven countries were surveyed. Individualism, masculinity, and uncertainty avoidance were found to affect corporate disclosure policies The conducted analysis of 39 countries found no significant relationship between power distance and the extent of financial disclosure, which was contrary to S. J. Gray’s hypotheses The study involved conducting surveys in three common law countries and three code law countries. No significant relationships were found between culture and disclosure and the legal system for the surveyed common law countries. However, in the case of the code law countries, cultural variables were found to be significant. The direction of relationship was consistent only for individualism 39 countries were surveyed over 3 years. It was found that only individualism was related to the extent of disclosure The purpose of the study was to use S. J. Gray’s accounting values to explain earnings management in 31 countries. The analysis conducted revealed a positive relationship between the earnings management phenomenon and statutory control, uniformity, conservatism, and secrecy The study sought to identify factors that distinguish the German accounting system from others. The authors offered a range of doubts concerning the theoretical and methodological foundation of S. J. Gray’s research –​and stressed that it was used unquestioningly in further research The hypotheses posed by S. J. Gray were verified for Brazil, Russia, India, and China to determine the ease of implementing IFRS in these countries. The values attributed to IASB were not found to be fully present in any of the countries surveyed

Source: J. Krasodomska, Czynniki kulturowe, [in:] K. Grabiński, M. Kędzior, J. Krasodomska, Globalne uwarunkowania rachunkowości. Systemy, procesy, zmiany, PWN, Warsaw 2014, pp. 56–​57.

80  Cultural determinants in economic sciences continued to be undertaken also later on. Focusing on the first wave of research on the relationship between culture and accounting, it should be stressed that it is a kind of opposite perception of reality, shaping the model of accounting and the interpretation of accounting. The first interpretation to be cited is the concept of accounting development patterns by F. Choi and G. Mueller. They created a list of environmental factors that directly affect this development. The list is based on their thesis according to which the evolution of national accounting models had been observed in different parts of the world. Different aspects of accounting model creation –​based on non-​accounting factors –​have been adopted. F. Choi and G. Mueller’s149 set of factors includes the legal system, the political system, the nature of ownership in business, differences in the size and complexity of business entities, the social climate, the level of development of businesses, the degree of legal institutionalisation of business, the presence of special legal standards of accounting, the speed of emergence and adaptation of innovation in business, the phase and level of economic development, the growth factors in the economy, and the status of education and professional organisations of accountants. It appears that there are no cultural factors here, which can be found, in turn, in addition to other determinants of national accounting models e.g. in the works of C. Nobes. This author, elaborating on G. Mueller’s theory of accounting development,150 suggested distinguishing micro-​and macroeconomic factors that characterise accounting measurement in developed economies of the world. Addressing the microeconomic orientation, he named accounting models determined by business practice and their pragmatic origins, and then contrasted their patterns shaped by theory, economics, and the economy. With macroeconomic factors in mind, he based the differentiation of national accounting systems on a juxtaposition of two orientations, i.e. the legal-​tax-​government orientation and the government-​ economic orientation. Referring to the international differences between the various national accounting models, he listed eight determinants of dissimilarity, including the legal system, main providers of sources of funding, the tax system, professionalisation of the accounting profession, the historical levels of inflation, the state of theory development, past (historical) events, and culture. The presented classifications are based on the assumption that no single, most significant element is indicated in a set of factors that determine the nature of an individualised accounting model. The existing interrelationships create the space and environment in which a given national system of accounting measurement and disclosure functions. The opposite of the view above is the formula of viewing accounting specific to a country in light of profiling it by a single, important distinguishing characteristic or homogeneous group. This is the approach described, for instance, in the guidelines for the characteristics of the economic environment as the most important determinant of changes in national accounting models, or in the theory of determinism and cultural relativism of accounting. G. Mueller, H. Geron, and G. Meek noticed the impact of political, economic, legal, cultural, and education-​related conditions in the

Cultural determinants in economic sciences  81 formation of an individualised national accounting model, while taking into account the fact that in the group of determinants of this impact, the feature characterising the source of a company’s capital is very important.151 C. Nobes,152 in turn, points out that the literature on the subject offers a number of possible reasons determining the international diversity of accounting systems, but it does not offer a theory combining these factors. The attempt made to prove the weakness of accounting measurement and disclosure development models was based on the impact of cultural and institutional characteristics. The authors stress that the most significant factor distinguishing the different accounting systems is the strength or weakness of the external providers of capital that finance the company’s activities and operations.153 Among the many models of accounting development affected by the strong influence of a single factor –​or a uniform group of factors, there are also those that emphasise the importance of cultural aspects. They are based on the idea that ‘[…] accounting systems vary along cultural lines.’154 T. Doupnik155 conducted a theoretical analysis of the cultural dimensions distinguished by G. Hofstede from the perspective of the level of formation of balance sheet profits. Similar findings were obtained by S. Nabar and K. Boonlert-​U-​Thai,156 who observed a diversification in the level of balance sheet profit formation depending on the level of uncertainty avoidance. M. A. Geiger, B. T. O’Connell, P. M. Clikeman, E. Ochoa, K. Witkowski, and I. G. Basioudis, in turn, analysed the difference in the perception of earnings management depending on the cultural context. They found that professions which can be judged professionally are susceptible to cultural influences.157 J. L. Callen, M. Morel, and G. Richardson158 carried out a study into the relationship between earnings management and dimensions of culture with religion. Measures proposed by S. Stack and A. J. Kposowa were used for the analyses conducted. No statistical relationship between the type of religion and the level of religiosity and the limitation of the phenomenon of earnings management was found.159 The research conducted so far has taken into account the impact of cultural conditions on the level of earnings management. It has been, however, limited to the four cultural dimensions developed by G. Hofstede. In recent years, the said range of dimensions has come to include two more dimensions in relation to pragmatic LTO and indulgence vs restraint.160 Contemporary researchers of cultural determinants include S. J. Gray, S. Han,161 and L. Guan.162 In general, it can be argued that research on cultural determinants produces contradictory findings, while empirical studies prove that cultural factors play an important role in the practice of earnings management.163 It appears that S. Surdykowska is right in claiming that thanks to G. Hofstede’s and S. J. Gray’s research, we began to realise ‘how much the world of accounting –​generally considered hermetic and not very approachable or understandable for people from outside of it –​depends on other worlds: culture, business, etc.’164 The issue of the impact of cultural determinants is a very popular research topic nowadays. Factors conducive to research include the growth of global

82  Cultural determinants in economic sciences corporations, which are an environment of collaboration of employees from different cultural backgrounds, but also the popularity of the conducted international quantitative studies –​which enable making cross-​ cultural comparisons.165 It is important to draw inspiration for research from other social sciences –​including cultural anthropology, psychology, and sociology. To summarise the above discussion, it seems only fitting to quote the views of F. Trompenaars and Ch. Hampden-​Turner. They argue that no society can be classified into only one cultural dimension. What can be said, though, is what characteristics prevail in a given nation –​for each nation is composed of a range of diverse views.

Notes 1 C. Kluckhohn, The Study of Culture, [in:] D. Lerner, H. D. Larswell (eds.), The Study of Culture, Stanford University Press, Stanford, CA 1951, p. 86. 2 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, 3rd ed. –​amended, PWE, Warsaw 2011, p. 21. 3 C. W. Hill, International Business: Competing in the Global Market Place, D. Richard Irwin, Chicago, IL 1997, p. 67. 4 Cf.: R. J. House, P. W. Dorfman, M. Javidan, P. J. Hanges, M. S. de Luque, Strategic Leadership Across Cultures: GLOBE Study of CEO Leadership Behavior and Effectiveness in 24 Countries, Sage Publications, Thousand Oaks, CA, London, New Delhi 2013. 5 R. J. House, M. Javidan, Overview of GLOBE, [in:] R. J. House, P. J. Hanges, M. Javidan, P. W. Dorfman,V. Gupta (eds.), Culture, Leadership and Organizations. The GLOBE Study of 62 Societies, Sage Publications,Thousand Oaks, CA, London, New Delhi 2004, s. 15; M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, Gospodarka Narodowa 2015, Issue 275, LXXXV/​XXVI, p. 85. 6 D. Throsby, Ekonomia i kultura, Narodowe Centrum Kultury, Warsaw 2010, p. 18. 7 J. G. Herder, Myśli o filozofii dziejów, Elipsa, Warsaw 1962,Vol. 1, p. 4. 8 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., pp. 83–​102; M. Komor, Model międzykulturowy GLOBE, Handel wewnętrzny 2011, Issue 1 (330), pp. 11–​17. 9 Standardisation of Attitudes –​A collectivist type of cultural identity, which leads to standardisation of attitudes by confining an individual within strictly defined group boundaries, in a precisely delineated area of contact and communication with people from outside the individual’s own culture. This kind of identity translates into the ‘rationing’ of intercultural relationships, into subjecting these relationship to control –​performed often by specialised public institutions. For example, nowadays in Afghanistan and several other Islamic countries, members of one’s own cultural group are ‘shielded’ from exposure to foreign influences by banning radio or television. In extreme cases, there are restrictions of access to programmes broadcast by ‘external’ satellites. (Source:T. Paleczny, Socjologia tożsamości, Krakowskie Towarzystwo Edukacyjne sp. z.o.o. –​Oficyna Wydawnicza AFM, Kraków 2008, p. 99.) 10 M. Kotabe, K. Helsen, Global Marketing Management, Wiley, New York, NY 1998, p. 97. 11 M. Bartosik-​Purgat, Uwarunkowania kulturowe w marketingu międzynarodowym, Publishing House of the Poznań University of Economics and Business, Poznań 2004, p. 9.

Cultural determinants in economic sciences  83 12 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, Publishing House of the Wrocław University of Economics and Business, Wrocław 2014, pp. 13–​14. 13 D. Throsby, Ekonomia i kultura, op. cit., p. 19, cited after: P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., p. 14. 14 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 14–​16. 15 According to E. B.Tylor:‘culture or civilization, taken in its wide ethnographic sense, is that complex whole which includes knowledge, belief, art, morals, law, custom, and any other capabilities and habits acquired by man as a member of society.’ E. B. Tylor treated –​and used –​the terms ‘culture’ and ‘civilisation’ interchangeably. 16 P. R. Cateora, P. Ghauri, International Marketing, McGraw Hill Education, Berkshire 2000, p. 109. 17 S. Czarnowski, Kultura, Spółdzielnia Wydawnicza Książ, Warsaw 1946, p. 15. 18 J. Szczepański, Elementarne pojęcia socjologii, PWN, Warsaw 1978, p. 8. 19 A. Kłoskowska, Socjologia kultury, PWN, Warsaw 1983, pp. 19–​20. 20 Cf.: B. Suchodolski, Wychowanie a strategia życia, WSiP, Warsaw 1983. 21 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, Doctoral Dissertation, Poznań University of Economics and Business, Poznań 2011, p. 13. 22 A. Kłoskowska, Socjologia kultury, op. cit., p. 63. 23 J. Gajda, Antropologia kulturowa, Wydawnictwo Adam Marszałek, Toruń 2005, p. 17. 24 M. Czerwonka, Zróżnicowania kulturowe w zakresie awersji do strat, wybranych heurystyk i zniekształceń poznawczych, Research Papers of the University of Economics in Katowice, Issue 287, Katowice 2016, p. 24. 25 Cf.: G. Hofstede, Kultury i organizacje. Zaprogramowanie umysłu, PWE, Warsaw 2011. 26 Cf.: M. Czerwonka, Charakterystyka wskaźników modelu kulturowego Hofstede, [in:] J. Ostaszewski (ed.), O nowy ład finansowy w Polsce. Rekomendacje dla animatorów życia gospodarczego, Oficyna Wydawnicza SGH, Warsaw 2015. 27 A group of academic researchers from nine Asia-​ Pacific countries conducted a cross-​cultural study using a modified version of the Rokeach Value Survey (RVS); cf. B. Thompson, J. E. Levitov, P. A. Miederhoff, Validity of the Rokeach Value Survey, Educational and Psychological Measurement 1982, Vol. 42, Issue 3, pp. 899–​905. M. H. Bond, who participated in the aforementioned research, created a new questionnaire, the CVS, and conducted further research. Cf.: G. Hofstede, M. H. Bond, Hofstede’s Culture Dimensions: An Independent Validation Using Rokeach’s Value Survey, Journal of Cross-​Cultural Psychology 1984, Vol. 15, Issue 4, Western Washington University, pp. 417–​433; G. Hofstede, M. H. Bond, The Confucius Connection: From Cultural Roots to Economic Growth, Organizational Dynamics 1988, Vol. 16, Issue 4, pp. 5–​21. 28 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 52–​100. 29 F. Trompenaars, Ch. Hampden-​ Turner, Zarządzanie personelem w organizacjach zróżnicowanych kulturowo, Oficyna Ekonomiczna, Kraków 2005, pp. 58–​96. 30 Cz. Sikorski, Kultura organizacyjna. Efektywnie wykorzystaj możliwości swoich pracowników, C. H. Beck, Warsaw 2002, pp. 4–​12. 31 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 32–​36. 32 Global Leadership and Organizational Behavior Effectiveness. 33 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., pp. 83–​102; R. J. House, M. Javidan, Overview

84  Cultural determinants in economic sciences of Globe, op. cit., pp. 11–​14; M. Javidan, R. J. House, Cultural Acumen for the Global Manager: Lessons from Project Globe, Organizational Dynamics 2001, Vol. 29, Issue 4, pp. 293–​301; F. C. Brodbeck, Navigationshilfe für internationales Change Management. Erkenntnisse aus dem GLOBE Projekt, Organisations-​Entwicklung 2006, Issue 3, p. 19. 34 S. H. Schwartz, W. Bilsky, Toward a Universal Psychological Structure of Human Values, Journal of Personality and Social Psychology 1987,Vol. 53, Issue 3, pp. 550–​562. 35 S. H. Schwartz, Mapping and Interpreting Cultural Differences Around the World, [in:] H. Vinken, J. Soeters, P. Estes (eds.), Comparing Cultures. Dimensions of Culture in a Comparative, Brill, Leiden 2004, pp. 43–​73. 36 S. H. Schwartz, Basic Values: How They Motivate and Inhibit Prosocial Behavior, [in:] M. Mikulincer, P. Shaver (eds.), Prosocial Motives, Emotions, and Behavior: The Better Angels of Our Nature, American Psychological Association Press, Washington, DC 2010, pp. 221–​241. 37 WVS is a global research project which involves conducting periodic surveys on the values and beliefs that characterise different cultures and on the impact they have on social and political domains of life. Cf.: WVS website, www.worldv​alue​ssur​vey.org (14.05.2018). 38 M. A. Migdał, Kulturowe uwarunkowania zarządzania wiekiem w przedsiębiorstwach w wybranych krajach europejskich,Vistula University, Warsaw 2016, pp. 45–​48. 39 J. Mikulski-​Pomorski, Komunikacja międzykulturowa. Wprowadzenie, Publishing House of the Cracow University of Economics, Kraków 1999, p. 41., cited after: P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., p. 21. 40 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 22–​ 23; 44–​49. 41 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 23; 36–​44. 42 J. Mikulski-​Pomorski, Komunikacja międzykulturowa. Wprowadzenie. Publishing House of the Cracow University of Economics, Kraków 1999, pp. 92–​96; cited after: P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 24; 61–​83. 43 P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 25–​ 26; 85–​109; 110–​133. 44 A. Karwińska, Kultura, [in:] J. Hausner, A. Karwińska, J. Purchla (eds.), Kultura a rozwój, National Centre for Culture Poland, Warsaw 2013, p. 78. 45 L. Zbiegień-​Maciąg, Kultura w organizacji. Identyfikacja kultur znanych firm, PWN, Warsaw 2005, p. 9. 46 K. Gadomska-​Lila, Metodologia badań kultury organizacyjnej, Education Economists and Managers 2011,Vol. 3, Issue 21, pp. 11–​12. 47 J. Szydło, Paradygmaty kultury organizacyjnej, Economics and Management 2014, Issue 4, p. 85. 48 Cf.: G. Burrell, G. Morgan, Sociological Paradigms and Organizational Analysis, Heinemann, London 1979. 49 M. Kostera, Antropologia organizacji. Metodologia badań terenowych, PWN, Warsaw 2003, p. 20. 50 K. Gadomska-​Lila, Metodologia badań kultury organizacyjnej, op. cit., pp. 13–​16. 51 F. R. Kluckhohn, F. L. Strodtbeck, Variations in Value Orientations, Row, Peterson & Co., Evanston 1961, p. 12. 52 M. Komor, Teoria ukrytego przywództwa, Ekonomika i Organizacja Przedsiębiorstwa 2011, Issue 7 (738), pp. 3–​14.

Cultural determinants in economic sciences  85 53 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., pp. 85–​86; and P. Skulski (ed.), Kulturowe uwarunkowania biznesu międzynarodowego, op. cit., pp. 26–​35. 54 D. Subocz, Geert Hofstede –​praktyczne zastosowanie wymiarów kultur narodowych, Annales Universitatis Mariae Curie–​Skłodowska Lublin –​Polonia Vol. XXV, 1–​2, Lublin 2012, p. 42. 55 Cf.: G. Hofstede, G. J. Hofstede, Kultury i organizacje, PWE, Warsaw 2007. 56 The study was conducted by G. Hofstede. 57 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 46–​48. 58 This term was introduced by Mauk Mulder –​a Dutch social psychologist. 59 M. Muldera, Reduction of Power Differences in Practice: The Power Distance Reduction Theory and Its Applications, [in:] G. Hofstede, M. S. Kassem (eds.), European Contributions to Organization Theory,Van Gorcum, Assen 1976, pp. 79–​94. 60 The survey was conducted in 50 states and 3 multistate regions; cf. G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, 3rd ed. –​ amended, PWE, Warsaw 2011, p. 68. 61 The matrix adopted to conduct the factor analysis consisted of 32 questions and 40 countries; cf. G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, 3rd ed. –​amended, PWE, Warsaw 2011, p. 97. 62 G. Hofstede, Culture ’s Consequences: Comparing Values, Behaviors, Institutions, and Organizations Across Nations, Sage Publications, Thousand Oaks, CA, London, New Delhi 2001, pp. 501–​502. 63 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 68–​69. 64 G. Hofstede, G. J. Hofstede, Kultury i organizacje, op. cit., p. 87; and J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 56. 65 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 70–​72. 66 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 56. 67 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 56. 68 Individualism –​typical of societies where ties between individuals are loose and everyone acts with their own and their family’s best interests in mind. 69 Collectivism –​typical of societies where people belong to one cohesive, close-​knit group from birth. 70 The calculation method was applied to countries from the IBM database. In the repeated measures study, this index was calculated using a simple mathematical method based on the averages for the four job choice factors. Detailed grading rules are given at www.geerth​ofst​ede.nl. 71 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 102–​106. 72 G. Hofstede, Kultury i organizacje, PWE, Warsaw 2000, pp. 130–​131. 73 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 57. 74 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 148–​152.

86  Cultural determinants in economic sciences 75 G. Hofstede, Kultury i organizacje, op. cit., pp. 176–​213. 76 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 150–​151. 77 Uncertainty avoidance –​the degree of threat felt by members of a culture when faced with new, unknown, or uncertain situations. 78 D. Subocz, Geert Hofstede –​praktyczne zastosowanie wymiarów kultur narodowych, op. cit., p. 43. 79 M. Kostera, Postmodernizm w zarządzaniu, PWE, Warsaw 1996, p. 569. 80 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 198–​200. 81 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 58. 82 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 201–​202. 83 G. Hofstede, G. J. Hofstede, Kultury i organizacje, op. cit., pp. 222–​223; J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 59. 84 World Values Survey. 85 Correlation coefficient r =​ -​0.65 among 22 of the 23 countries surveyed in the CVS (all except Thailand, for which WVS data were unavailable). 86 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 258–​263. 87 The managers surveyed worked in industries such as finance, food, and telecommunications. 88 R. J. House, P. J. Hanges, M. Javidan, P. W. Dorfman,V. Gupta, Culture, Leadership and Organizations. The GLOBE Study of 62 Societies, Sage Publications, Thousand Oaks, CA, London, New Delhi 2004, p. 25. 89 F. C. Brodbeck, Navigationshilfe für internationales Change Management. Erkenntnisse aus dem GLOBE Projekt, op. cit., p. 17. 90 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., p. 13. 91 R. J. House, M. Javidan, Overview of Globe, op. cit., p. 21; cited after: M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., p. 12. 92 R. J. House, P. J. Hanges, M. Javidan, P. W. Dorfman,V. Gupta, Culture, Leadership and Organizations.The GLOBE Study of 62 Societies, op. cit., pp. 98–​99. 93 2 × 9 =​18, meaning nine dimensions of ‘as it is’ and ‘as it should be.’ 94 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., p. 13. 95 With uncertainty avoidance, individualism, and long-​ term orientation, respectively. 96 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 56–​57. 97 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 75. 98 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 109–​110. 99 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 153.

Cultural determinants in economic sciences  87 100 In the group of 48 countries, the correlation between the UAI and the GLOBE uncertainty avoidance in the ‘as it is’ version was r =​-​0.61***. In the case of the UAI and the GLOBE uncertainty avoidance in the ‘as it should be’ version, it was r =​ 0.37*. And between both versions, it was r =​ -​0.70***. Source: G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 206; 239. 101 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 206–​207. 102 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 264. 103 J. Furmańczyk, Kulturowe uwarunkowania przywództwa w międzynarodowych przedsiębiorstwach branży motoryzacyjnej w Polsce, op. cit., p. 72. 104 M. W. Dickson, D. N. Den Hartog, J. K. Mitchelson, Research on Leadership in a Cross-​cultural Context: Making progress and Rising New Questions, The Leadership Quarterly 2003,Vol. 14, pp. 729–​768. 105 C. G. Emrich, F. L. Denmark, D. N. Den Hartog, Cross-​Cultural Differences in Gender Egalitarianism: Implications for Societies, Organizations and Leaders, [in:] R. J. House (ed.), Culture, Leadership, and Organizations: The GLOBE Study of 62 Societies, Thousand Oaks, CA 2004, pp. 142–​157; M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., pp. 13–​16; M. Komor, Model międzykulturowy GLOBE, Handel wewnętrzny op. cit., pp. 14–​17. 106 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 43. The term ‘normal science’ is used in this discussion with reference to research that stems from one or more past scientific achievements which a given community of scholars currently accepts and treats as the foundation of its continued practice. If a scientific community is formed, it means that the scholars belonging to it unanimously accept a particular paradigm as the basis of their research –​and that they are faithful to a particular research tradition. T. Kuhn refers to such a research tradition as ‘normal science.’ Normal science is closely associated with the concept of paradigm. A paradigm ‘is to suggest that some accepted examples of actual scientific practice –​examples which include law, theory, application, and instrumentation together –​provide models from which spring particular coherent traditions of scientific research.’ (Source: http://​phi​loso​phic​alth​inkt​ank.blogs​pot.com/​2012/​ 01/​poje​cie-​para​dygm​atu-​w-​uje​ciu-​thom​asa.html (14.11.2018).) 107 The book in question is Culture’s Consequences. 108 Nouns describing the desired target states, e.g. equality; Source: G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 55. 109 Adjectives describing how they are achieved, e.g. honest; Source: G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 55. 110 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., pp. 55–​56. 111 G. Hofstede, G. J. Hofstede, M. Minkov, Kultury i organizacje. Zaprogramowanie umysłu, op. cit., p. 109. 112 D. Subocz, Geert Hofstede –​praktyczne zastosowanie wymiarów kultur narodowych, op. cit., p. 51. 113 These expressions were used explicitly by the individual authors in the titles of their studies and works. Cf.: L. Harrison, S. Huntington, Kultura ma znaczenie,

88  Cultural determinants in economic sciences Zysk i S-​ka, Warsaw 2003; cited after: K. Kostro, Zagadnienia kulturowe w ekonomii, Gospodarka Narodowa 2009, Issue 3, p. 27. 114 K. Kostro, Zagadnienia kulturowe w ekonomii, op. cit., pp. 27–​28. 115 The book in question is M.Weber, Etyka protestancka i duch kapitalizmu, Publishing House of the University of Warsaw, Warsaw 2011. 116 K. Kostro, Zagadnienia kulturowe w ekonomii, op. cit., pp. 28–​29. 117 An example of an exception to this rule is e.g. the joint work of economists and sociologists, a book: J. Kochanowicz, S. Mandes, M. Marody (eds.), Kulturowe aspekty transformacji ekonomicznej, Institute of Public Affairs, Warsaw 2007, which discusses the cultural dimension of the transformation of the Polish economy. 118 L. Harrison, S. Huntington, Kultura ma znaczenie, op. cit., p. 43. 119 K. Kostro, Zagadnienia kulturowe w ekonomii, op. cit., pp. 29–​31. 120 L. Guiso, P. Sapienza, L. Zingales, Does Culture Affect Economic Outcomes?, NBER Working Paper Series 11999, January 2006, p. 8.; cf.: www.resea​rchg​ate.net/​publ​ icat​ion/​4981762_​DoesCult​ureA​ffec​t_​Ec​onom​ic_​O​utco​mes (28.07.2018). 121 K. Kostro, Zagadnienia kulturowe w ekonomii, op. cit., p. 32. 122 W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, [in:] E. Śnieżek, J. Piłacik, S. Doroba (eds.), Różne kraje –​ta sama rachunkowość?, Publishing House of the University of Lodz, Łódź 2017, p. 71. 123 Cf.: S. H. Schwartz, Beyond Individualism/​Collectivism: New Cultural Dimensions of Values, [in:] U. Kim, H. C. Triandis, C. Kagitcibasi, S. C. Choi (eds.), Individualism and Collectivism:Theory, Method and Applications, Sage Publications, Thousand Oaks, CA, London, New Delhi 1994; A. C. W. Chui, A. E. Lloyd, C. C. Y. Kwok, The Determinants of Capital Structure: Is National Culture a Missing Piece to the Puzzle?, Journal of International Business Studies 2002, Issue 33, pp. 99–​127; K. Koleśnik, Wartości kulturowe a kształt systemów rachunkowości, Papers and Publications of the Faculty of Management of the University of Gdańsk, Gdańsk 2010, p. 109; cited after: W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, op. cit., p. 71. 124 Cf.: M. Wang, P. S. Fischbeck, Similar in How to Frame, But Different in What to Choose, Marketing Bulletin 2004,Vol. 15, pp. 1–​12. 125 Cf.: D. J. Levinson, K. Peng, Valuing Cultural Differences in Behavioral Economics, The ICFAI Journal of Behavioral Finance 2007,Vol. 4, Issue 1, pp. 32–​47. 126 Cf.: A. C. W. Chui, S. Titman, K. Wei, Individualism and Momentum around the World, Journal of Finance 2010,Vol. 65, Issue 1, pp. 361–​392. 127 M. Czerwonka, Zróżnicowania kulturowe w zakresie awersji do strat, wybranych heurystyk i zniekształceń poznawczych, op. cit., pp. 26–​29. 128 A. Inkeles, D. J. Levinson, National Character: The Study of Modal Personality and Sociocultural Systems, [in:] G. Lindzey, E. Aronson (eds.), The Handbook of Social Psychology IV, McGraw-​ Hill, New, York, NY 1954, pp. 418–​ 506; cited after: M. Szukała, Znaczenie kultur narodowych dla zarządzania, [in:] K. Klincewicz (ed.), Zarządzanie, organizacje i organizowanie –​przegląd perspektyw teoretycznych, Scientific Publishing House of the Faculty of Management of the University of Warsaw, Warsaw 2016, p. 440. 129 G. Hofstede, Kultury i organizacje. Zaprogramowanie umysłu, PWE, Warsaw 2000, pp. 39–​40; 46; 339–​340. 130 G. Hofstede, G. J. Hofstede, Kultury i organizacje, op. cit., p. 16. 131 http://​komu​nika​cja-​mied​zyku​ltur​owa.blogs​pot.com/​2013/​10/​pod​zia-​gee​r ta-​ hofst​ede.html (28.07.2018).

Cultural determinants in economic sciences  89 132 M. Czerwonka, Charakterystyka wskaźników modelu kulturowego Hofstede, op. cit., p. 282. 133 Findings were published in: Culture Consequences International Differences in Work-​ Related Values, Sage Publications, Newbury Park, CA 1980. 134 J. Krasodomska, Czynniki kulturowe, [in:] K. Grabiński, M. Kędzior, J. Krasodomska (eds.), Globalne uwarunkowania rachunkowości. Systemy, procesy, zmiany, PWN,Warsaw 2014, p. 50; and K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 115. 135 J. Krasodomska, Czynniki kulturowe, op. cit., pp. 50–​51; W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, op. cit., pp. 72–​73. 136 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 116. 137 Works known in cross-​cultural psychology include A. Kwiatkowska, J. Roszak, R. Sikora, B. Kuo, K. Karpinski, T. Gushchin, G. Gober, D. Matsumoto, and S. H. Yoo, H. R Markus, and S. Kitayama. (Cf.: D. Matsumoto, S. H. Yoo, Toward a New Generation of Cross-​Cultural Research, Perspectives on Psychological Sciences 2006, Vol. 1, pp. 234–​250; H. R., Markus, S. Kitayama, Kultura i Ja: Implikacje dla procesów poznawczych, emocji i motywacji, Nowiny Psychologiczne 1993, Issue 3, pp. 5–​20.). 138 H. C. Triandis, Culture and Social Behavior, McGraw-​Hill, New York, NY 1994; H. C. Triandis, The Psychological Measurement of Cultural Syndromes, American Psychologist 1996,Vol. 51, Issue 4, April, pp. 407–​415. 139 A. Kwiatkowska, Problemy metodologiczne w badaniach międzykulturowych i kulturowych, Psychologia Społeczna 2014,Vol. 9, p. 12. 140 J. Krasodomska, Czynniki kulturowe, op. cit., p. 53. 141 R. J. House, P. J. Hanges, M. Javidan, P.W. Dorfman,V. Gupta, Culture, Leadership, and Organizations:The Globe Study of 62 Societies, Sage, Thousand Oaks, CA 2004. 142 M. Komor, J. H. Schumann, Zróżnicowania kulturowe między Polską a Niemcami według wymiarów kultury Hofstede, op. cit., pp. 83–​102. 143 Cf.: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016, p. 117. 144 S. J. Gray, Towards a Theory of Cultural Influence on the Development of Accounting Systems Internationally, Abacus 24, 1988, pp. 1–​15; K. Koleśnik, Wartości kulturowe a kształt systemów rachunkowości, op. cit., p. 125; W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, op. cit., s. 73; E. Hajduga, Czynniki determinujące systemy rachunkowości, Research Papers of the University of Szczecin Issue 685, Finanse, Rynki finansowe, Ubezpieczenia Issue 46, Szczecin 2011, pp. 410–​411. 145 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 118. and J. Krasodomska, Czynniki kulturowe, op. cit., p. 54. 146 Concerns the research conducted by G. Hofstede and S. H. Schwartz. 147 L. H. Radebaugh, S. J. Gray, International Accounting and International Enterprises, Wiley, New York, NY 2001, p. 47; T. S. Doupnik, H. Perera, International Accounting, McGraw-​Hill Irwin, Boston, MA, 2009, p. 42; K. Koleśnik, Wartości kulturowe, a kształt systemów rachunkowości, op. cit., p. 130, cited after:W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, op. cit., p. 74.

90  Cultural determinants in economic sciences 148 W. Bartniak, M. Głowacka, Wpływ czynników kulturowych na system rachunkowości kraju, op. cit., p. 74; K. Koleśnik, Wartości kulturowe, a kształt systemów rachunkowości, op. cit., pp. 129–​131. 149 F. Choi, G. Mueller, International Accounting, Prentice-​Hall Inc., Hoboken, NJ 1984, pp. 41–​44. 150 G. Mueller, International Accounting, The Macmillan Company, New York, NY 1967; and G. Mueller, H. Gernon, G. Meek, Accounting –​An International Perspective, Irvin, London, San Francisco, CA, Kuala Lumpur, Johannesburg 1997. 151 G. Mueller, H. Gernon, G. Meek, Accounting –​An International Perspective, op. cit., pp. 7–​75; and S. T. Surdykowska, Rachunkowość międzynarodowa, Zakamycze, Kraków 1999, p. 63. 152 C. Nobes, Towards a General Model of the Reasons for International Differences in Financial Reporting, Abacus 1998,Vol. 34, Issue 2, pp. 162–​163. 153 J. Adamek, Kulturowe uwarunkowania krajowych systemów rachunkowości w świetle koncepcji wymiarów subkultury rachunkowości S. Graya, Zeszyty Teoretyczne Rachunkowości 2011,Vol. 62, Issue 118, SKwP, Warsaw, pp. 8–​12. 154 G. Hofstede, The Culture Context of Accounting, Plenary Session Papers and Discussants Comments from 1986 Annual Meeting of the American Accounting Association 1987, p. 2. 155 T. S. Doupnik, Influence of Culture on Earnings Management:A Note,Abacus:A Journal of Accounting, Finance and Business Studies 2008,Vol. 44, Issue 3, pp. 322–​324. 156 S. Nabar, K. Boonlert-​U-​Thai, Earnings Management, Investor Protection, and National Culture, Journal of International Accounting Research 2007,Vol. 6, Issue 2. 157 M. A. Geiger, B. T. O’Connell, P. M. Clikeman, E. Ochoa, K. Witkowski, I. G. Basioudis, Perceptions of Earnings Management: The Effects of National Culture, Advances in International Accounting 2006,Vol. 19, Issue 25, p. 340. 158 J. L. Callen, M. Morel, G. Richardson, Do Culture and Religion Mitigate Earnings Management? Evidence from a Cross-​ Country Analysis, International Journal of Disclosure and Governance 2011,Vol. 8, p. 104. 159 J. L. Callen, M. Morel, G. Richardson, Do Culture and Religion Mitigate Earnings Management? Evidence from a Cross-​Country Analysis, op. cit., p. 118. 160 Cf.: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016. 161 Cf.: S. Han, T. Kang, S. Salter, Y. K. Yong, A Cross –​Country Study on the Effects of National Culture on Earnings Management, Journal of International Business Studies 2010,Vol. 41, Issue 1, pp. 123–​141. 162 L. Guan, H. Pourjalali, P. Sengupta, J. Teruya, Effect of Cultural Environment on Earnings Manipulation: A Five Asia-​Pacific Country Analysis, Multinational Business Review 2005,Vol. 2, Issue 13, pp. 23–​41. 163 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 118–​125. 164 S. T. Surdykowska, Polski system rachunkowości finansowej w międzynarodowej perspektywie porównawczej, Research Papers of the Wroclaw University of Economics and Business Issue 876, Wrocław 2000, p. 216. 165 M. Szukała, Znaczenie kultur narodowych dla zarządzania, op. cit., p. 447.

3 Quality of earnings as one of the objectives of financial reporting of public companies

3.1  Qualitative characteristics of financial statement information Social and economic development has caused an increase in the degree of linkages between businesses and their environment. This results in a mutual need for the circulation of financial information between economic entities and their environment –​in the form of feedback. Since the 19th century, the main recipients of information included in financial statements have been business owners, who themselves have been making managerial decisions in those entities. In the 20th century, the development of the financial market led to the formation of new groups interested in financial information. This has resulted in growing pressure on the reliability of the accounting information provided.1 Financial information used to make economic decisions should have certain features that make it useful and –​at the same time –​should meet certain quality standards. Qualitative characteristics are the attributes of financial information created in the domain of accounting.2 The conceptual framework for financial reporting is clearly an important part of financial reporting regulations. R. Mala and P. Chand3 claim that this framework is the foundation for establishing new regulations. They prove that a properly designed framework has a positive impact on the accounting system’s ability to produce better-​quality reporting information while facilitating the interpretation and application of current standards. The International Accounting Standards Board (IASB) reporting framework has been structured to act as the basis for preparing and presenting financial statements with the needs of their users in mind. It is currently commonly believed that the conceptual framework for financial reporting is imperfect. An article by K. Grabiński and M. Kędzior4 provides arguments proving the need for changes to this framework. The framework in question is a so-​called constitution of financial reporting, defining the most essential elements of the financial reporting process. The IAS/​International Financial Reporting Standards (IFRS) framework points to the following: reporting objectives, qualitative characteristics, definitions, recognition and measurement methods for the components of financial statements, DOI: 10.4324/9781003280088-4

92  Quality of earnings and the concepts of capital and its behaviour.5 According to the IASB framework, the objective of financial reporting is to provide the financial information required by potential investors, lenders, and other creditors to make appropriate decisions. In contrast, the Financial Accounting Standards Board (FASB) names the usefulness of information to current and potential investors or creditors as well as to other users of this information to make rational investment-​related, credit-​related, and similar decisions as an important objective of reporting.6 It is this exact concept that has been recognised by the IASB and is considered to be updated in the new IAS/​IFRS conceptual framework.7 The IASB and FASB find the decision usefulness of reporting information as a significant element of said framework. It has been defined using the qualitative characteristics of useful financial information. For information to be considered useful, it must be helpful and present the economic reality it describes in a credible manner.8 In September 2010, the IASB published a new document developed jointly with the FASB on the Conceptual Framework for Financial Reporting. Currently, the IFRS Conceptual Framework includes two new chapters9 ‘The Objective of General Purpose Financial Reporting’ and ‘Qualitative Characteristics of Useful Financial Information.’ At the same time, the SFAC 8 ‘Conceptual Framework for Financial Reporting’ was published in the United States. The Conceptual Framework offered a new approach to the qualitative characteristics of financial statements. At present, according to the Conceptual Framework, there is a distinction between fundamental (superior) and enhancing (complementary) qualitative characteristics. Fundamental characteristics should be appropriate and faithfully reflect a company’s financial situation. Information deemed appropriate must be useful and relevant.10 Enhancing characteristics include: comparability, verifiability, timeliness, understandability, and transparency.11 Financial statements that meet the necessary qualitative characteristics should offer a true and fair view of the financial position of the entity they concern. Reliability, as the main feature of the quality of financial statements, according to the original wording of the Conceptual Framework of 1989, was replaced by the principle of faithful representation of the reporting entity’s financial condition. The qualitative characteristics of useful financial information were defined in the Conceptual Framework for the Preparation and Presentation of Financial Statements in 1989 and then in the Conceptual Framework for Financial Reporting in 201012 (Figure 3.1). In addition to the qualitative characteristics, it is also necessary to mention the enhancing and fundamental accounting principles discussed in the Conceptual Framework of IFRS and IAS 1. The increasing information-​related needs of stakeholders, especially investors, translate into a strive for the highest quality and usefulness of financial statements. In order for financial reporting to be useful, the information it provides needs to be accessible to the target audience and presented in a proper way.13 According to the Conceptual Framework, users of financial statements should have the necessary economic knowledge –​ including in the area of accounting –​and ‘demonstrate a willingness to read

Quality of earnings  93 1989 conceptual framework. Understandability

2010 conceptual framework. Usefulness – relevance

Verifiability Timeliness

Reliability Understandability Faithful representation Correctness (error-free) Neutrality

Faithful presentation

Completeness Completeness

USEFUL financial information

USEFUL financial information

Comparability Usefulness – relevance

Neutrality Comparability

Correctness (error-free)

Figure 3.1 Links between the qualitative characteristics of useful financial information in the 1989 and 2010 conceptual frameworks. Source: J. Błażyńska, Jakość informacji o sytuacji finansowej jednostek gospodarczych, Research Papers of the University of Economics in Katowice, Katowice 2016, Issue 284, p. 47.

the information presented carefully.’14 The decision usefulness of financial information is considered in two dimensions: its usefulness in assessing an economic entity’s ability to generate cash and in determining the capability of this economic entity’s management to exercise fiduciary functions.15 It is the capital market actors who determine where and under what conditions capital is allocated through their decisions and behaviour. Each standard is a systematically described, explained, and adopted standpoint of the International Council with respect to the accounting research problem considered.16 The IASB and FASB have both commented on the usefulness of the information that affects economic entities’ financial reporting,17 pointing out that the essence of useful financial information can be divided into two groups: • •

fundamental qualitative characteristics: usefulness and faithful representation of reality and enhancing qualitative characteristics: comparability, verifiability, understandability, and timeliness.

The IASB Conceptual Framework for Financial Reporting includes a hierarchy of qualitative characteristics (Figure 3.2).

94  Quality of earnings Decision usefulness of financial information

Constraints

Reporting

Significance

Confirmatory value

Predictive value

Understandability

Validity

Neutrality

Correctness

Coherence

Enhancement of qualitative characteristics

Comparability

Components of fundamental characteristics

Usefulness (relevance)

Faithful representation

Completeness

Fundamental characteristics

Cost constraints

Figure 3.2 Hierarchy of qualitative characteristics according to the IASB Conceptual Framework for Financial Reporting. Source: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016, p. 53.

Useful information is information that can influence the decisions made by its users.According to the conceptual framework, information can be considered useful even if some of its users do not intend to use it or have obtained the same information from other sources.18 Useful information is that which can influence the decision of the recipients thereof. It is such when it has predictive value or confirmatory value –​or both at the same time. In contrast, an aspect of predictability is materiality. Material information is information that affects the decisions of its users with respect to financial information concerning an enterprise when distorted or omitted.19 At the same time, the IASB said it could not specify uniform qualitative and quantitative materiality thresholds.20 Materiality depends on the size and type of asset which the reported information concerns. The main standard governing the formal and substantive basis of financial statements, referred to as general purpose financial statements, is IAS 1 –​‘Presentation of Financial Statements.’ A financial statement21 contains the

Quality of earnings  95 minimum information that business entities must present. According to IAS 1 para. 9, financial statements are a structured representation of the financial position and financial performance of an entity.The objective of financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions.22 Therefore, each financial statement is supplemented by an explanatory note where the user can find interesting, more detailed information. Financial statements according to IFRS clarify the scope of disclosures and indicate the possibility of presenting additional, crucial information for the reporting entity. In light of the above, the criteria of usefulness of information can be fulfilled by the inclusion of data in the form of notes.23 The second fundamental characteristic is the faithful representation of an entity’s financial position. It replaced the principle of true and fair view. In order for a representation to be fully faithful, it needs to be complete, error-​ free, and neutral. According to the Conceptual Framework, the definition of this characteristic is as follows: ‘to be useful in financial reporting, information must be a faithful representation of the economic and other phenomena that it purports to represent.’24 R. Mala and P. Chand pointed out that replacing the principle of true and fair view with faithful presentation was heavily criticised.25 For the sake of completeness, it is important to disclose all information necessary to understand a given phenomenon –​including descriptions or explanations. Descriptions include information on valuation methods (parameters) or generic groups of the items reported. It is not possible for information to be complete without explanatory notes. In addition to information that might be presented in other elements of the report –​especially in the statement of earnings and other comprehensive income and the statement of the financial position of the economic entity, information that does not qualify for inclusion in the permanent elements of the report should be presented in the context of a given characteristic.26 If information is to be considered neutral, notes play a special role as they contain any possible opinions or judgements. When creating explanatory notes, it is necessary to make sure that the information included therein is unbiased. Errors can occur in many different elements of financial statements. Omissions, if only for reasons of volume, may concern enhancing data.27 If a financial statement does not contain errors, it does not mean that it is accurate in every aspect. This means that: ‘there are no errors or omissions that are individually or collectively material in the description of the phenomenon, and the process used to produce the reported information has been applied as described.’28 To improve the usefulness of information in financial reporting, the IASB has defined four additional characteristics that enrich the qualitative characteristics (comparability, verifiability, timeliness, and understandability). Notes should include comparable data for another period or as of another date. Verifiability is a guarantee that the information reliably presents the economic phenomenon it describes.29 It also means that different independent users can reach a common standpoint that a given description is an accurate representation of

96  Quality of earnings the phenomenon in question.30 Verification of certain data requires the disclosure of specific assumptions or circumstances that support the information provided. Timeliness means that individuals or organisations will have time to access information that may affect their investment decisions. The older the information, the less useful it is. Preparing a given set of information requires a specific time frame. When making decisions related to the content of information in the explanatory notes, the reporting entity should take into account the time required to prepare the portion of this information which it has influence on. It may occur that users provided with extensive information are unable to use it due to the timing of its delivery. The explanatory notes developed should be clear and understandable to the target audience.31 There is a concern that the increase in the scope of disclosures in financial reporting and in the number of separate reports may cause an information overload and make the reported information less comprehensible. Published reports are sometimes chaotic, too lengthy, and inconsistent.32 Complex and more difficult information should not be intentionally omitted from the notes as this would make the presented data incomplete and unreliable. Understandability is defined as: ‘information [that] is classified, characterized, and presented clearly and concisely.’33 A user of financial information is an individual with good knowledge of a particular industry, able to analyse an economic entity’s reports. Due to the increased volumes of financial statements and more complex transactions, the user of such information will need a knowledgeable person to explain and help them understand some of the information in the statements.34 In addition to the characteristics that determine the high quality of financial statements, another element of great importance from the perspective of the recipient of the reported information is the cost constraints concerning the usefulness of financial reporting. After all, costs are one of the biggest constraints on the information that financial statements provide. Consideration should be given to the issue of the costs incurred in obtaining the information as these costs should not be greater than the benefits gained from the information. An economic entity incurs costs involved in the collection, processing, and distribution of economic information. In the case of users, the costs they incur concern data interpretation and analysis. The lack of relevant data forces economic entities to acquire the necessary information to make key decisions. The absence of such information forces the business entity to incur additional costs involved in obtaining it.35 It is important to notice that without proper notes, it is impossible to analyse the fundamental and enhancing qualitative characteristics of useful financial information. The conceptual framework discussed refers to qualitative characteristics more as guidelines. It should be noted that financial statements featuring certain qualitative characteristics make information as useful as expected. In practice, it is necessary to balance the various qualitative attributes

Quality of earnings  97 appropriately because even the most precise and reliable information becomes useless if it is presented too late. At the same time, the attribute of timeliness of information implies that the faster the information is available, the more useful it is in the decision-​making process. According to the conceptual framework in question, the benefits of acquiring information should be greater than the costs thereof.36

3.2 Attributes of financial information quality The growing competition in capital markets entails an increase in social responsibility for the natural resources consumed. At the same time, the expectations of business report users call for the implementation of continuous changes in the reporting of the current situation of economic entities and the prospects of their development. User expectations lead to continuous changes in the reporting of information about the current situation of a given business entity, which means that such information needs to be marked by certain quality characteristics to be useful.37 Nowadays, information is becoming an even more valuable resource. Large-​scale computerisation and the continuous development of data communication networks translate into an ever-​increasing amount of information. Unfortunately, with the development of the knowledge society, the excess and the diminishing quality of available information are also becoming an increasing problem.38 It is therefore possible to argue that one of the most essential resources of the modern world is information. In practice, information is accepted as a primary notion, undefinable in the normative sense. It can also be specified through the indication of its features, properties, and functions.39 When referring to the essence of the term ‘information,’ it is important to stress its relationship with such terms as data, message, and knowledge40 (Table 3.1). According to the conceptual framework for financial reporting, a financial statement should include a set of financial information. The financial information obtained is intended to be useful in the decision-​making process of the users of the reports. Useful information has been defined in the conceptual framework by identifying the fundamental and enriching qualitative characteristics of such information. According to J. Błażyńska, the adopted model of qualitative characteristics is conservative, which is proven by the fact that timeliness is considered as an enriching feature.41 G. Świderska,42 in turn, claims that reporting ‘is becoming less and less useful because it is unable to satisfy and respond to the dynamically changing conditions of business operations and the growing demands of investors.’ Acquiring information for the purpose of decision-​making cannot come ‘at any cost.’ Minimising the cost of acquisition and use of information proves that the information system is efficient. A measure of the value of the information generated for decision-​makers is the ratio of the degree to which the goal function is satisfied to the cost of production of the information in question, as shown in the formula below43:

98  Quality of earnings Table 3.1 Terminological order of relations: data –​information –​message –​knowledge Term

Interpretation

Data

• Data are non-​analysed facts, figures, and events that can be collected and then processed by human mind or a machine, subject to quantification and interpretation • Data may be processed, i.e. collected, recorded, stored, processed, modified, accessed, and deleted • Information is data or a stream of data in a specific context (data which area analysed, properly processed), information is therefore produced • Information contains one or more pieces of data, but not all data are information • Information in verbal or numerical form may present a thing, an object, an event, a process, or a phenomenon • Information may be processed, i.e. collected, recorded, stored, processed, modified, accessed, and deleted • Information can be used in the decision-​making process by either the producer or the user of the information, expanding their knowledge as a result • A message carries information and the recipient thereof can be a user of information; if information is useful, it can be used in the decision-​making process and enhance the recipient’s knowledge • A message is information transmitted by a sender to a receiver • Knowledge is a resource of information related to an individual, an organisation • Knowledge increases with the accumulation of information and other factors –​for example, of experience in using information processing tools

Information

Message

Knowledge

Source: J. Błażyńska, Jakość informacji o sytuacji finansowej jednostek gospodarczych, Research Papers of the University of Economics in Katowice, Katowice 2016, Issue 284, p. 43.

D Vi = C

[F 3 1]

where Vi –​value of information, D –​the degree of satisfaction of the goal function, and C –​cost of producing and obtaining the information. The value of information is determined by its usefulness. Information usefulness can be considered ex post and ex ante. Ex ante evaluation appears to be more relevant. Ex ante value estimation is more challenging because it involves estimating the expected benefits of using the information to make better, more accurate decisions. The literature on the subject mentions few attempts to measure the value of information for ex ante evaluation, e.g.V. Schindel’s model, Altrogge’s model using Bayes’ principle, and J. Marschak’s model.44

Quality of earnings  99 In general, the usefulness of information depends on the individual decision model adopted.The quality of information is inextricably linked to the prospective user and their needs –​as well as to the point at which the user will use the information in question. Therefore, a different set of information attributes, different weights determining the significance of those attributes, a different scale for evaluating them, etc., may be established for each user of reporting information.45 J. Błażyńska46 refers to B. Stefanowicz’s concept of evaluation of information usefulness47 and argues that the evaluation of information quality involves the study of the number of messages M contained in the set M, marked by a specific characteristic C to a degree that satisfies the use of the information, with the necessity to calculate the total index of information quality by means of a function reflecting the measure of the information’s fulfilment of the requirements specified in the form of a selected characteristic and the weight assigned to it and determined by the user for several characteristics of information. L. Bukowski and J. Feliks48 make use of a vector X, consisting of five selected parameters, corresponding to the attributes of information, to determine the value of the information in use. These parameters are defined in a specific way, and each of them will be evaluated by a panel of experts on a 10-​point scale and assigned to one of five classes for which a descriptive rating is provided; e.g. completeness –​very high, high, medium, low, very low. The proposed solution aimed to objectify experts’ evaluation involves introducing measures of evaluation uncertainty making use of fuzzy set logic. B. Iwasieczko49 suggests making use of the mechanism of SNA (Social Network Analysis) to evaluate the usefulness of reporting information. The essential elements of a network are its nodes, e.g. concepts. Its edges represent the relationships, the connections between the nodes. Typical measures of relationships in a network are: the number of relationships, the direction of relationships, the intensity of relationships, and the symmetry thereof.50 The weights assigned to edges can represent the strength of the relationship, the frequency of interactions, etc., and the primary measures include51: • • • •

degree of centrality –​the number of connections of a node with other nodes, eigenvector –​the value of a node’s eigenvector is proportional to the value of the eigenvectors of the nodes to which the node is directly connected, network density –​the ratio of the number of existing relationships to the number of all potential relationships in a given network, and clustering coefficient –​the density of the set of all nodes directly related to a given node, etc.

Using the SNA model, it is possible to generate a network of financial and non-​financial information to determine the scope of the minimum annual report on the basis of financial and non-​financial information and the relationship between them. J. L. Kulikowski, in turn, assumes in his vector concept of information utility value that qualitative characteristics will be assigned numerical measures so that the information utility value satisfies the condition of additivity in a five-​dimensional

100  Quality of earnings vector space for statistically independent information. In this concept, the relevance of information expresses its compatibility with the user’s needs. It can be therefore expressed as the ratio of the contained information units describing the information of relevance to the user to the total number of information units.52 In order to assess the usefulness of information, it is necessary to determine the following relationship: user –​situation –​purpose –​type of information –​qualitative characteristics of useful information.53 Factors affecting the usefulness of reporting information include, in addition to the qualitative characteristics of the information, experience, passage of time, the possibility and cost of processing and understanding financial information on the user’s end, the skills and knowledge of the users of the information in question, decision-​making processes, the obsolescence of financial information, and the possibility and cost of obtaining financial information.54 Assessing the decision usefulness of reporting information can be the final step in an information audit, the role of which is to provide methods to identify, evaluate, and manage the information resources of any business entity.55 Information is also considered in terms of its quality, but the challenge in defining the very term ‘information’ concerns also the aspect of quality. The concept of information quality is most often interpreted by the set of characteristics that information should demonstrate in the process of managerial decision-​ making. The issue of information quality characteristics has been discussed at length in the literature on the subject since the early 1970s.56 This applies mainly to works on information systems and accounting by many authors, including: G. H. Felthman, R. R. Sterling, T. J. Mock, M. N. Greenball, B. Langefors, J. L. Kulikowski, J. Kisielnicki, Z. Gackowski, T. Kiziukiewicz, T. Peche, Z. Messner, E. Terebucha, W. Malec, W. Flakiewicz, M. Niedźwiedziński, and many others.57 A comprehensive view of information attributes was offered by M. J. Eppler.58 He proposes 70 criteria for information, but as he says, this set should be limited because of its low utility and due to the fact that many of the criteria have common elements. He narrows down the attributes of information to the 16 most relevant, while assigning four levels to them. F. Naumann and C. Rolker59 stress that since there is a large number of criteria, it is of great importance to define them very precisely. This is especially important for subjective evaluations as the name of a criterion itself clearly tells the user what is being evaluated. The proposal of E. Kolbusz,60 who suggests introducing the concept of ‘usefulness’ of information instead of assigning attributes thereto can be considered as a certain consensus. This concept synthesises all the attributes that appear in the literature on the subject. Usefulness is relative and can be interpreted differently depending on the current needs of the user of information. For a particular user, in a particular situation, it is possible to obtain a certain configuration of information attributes that determine the usefulness of this information. These attributes become a certain measure of information quality in qualitative terms. By assigning values to these attributes and evaluating them, it is possible to determine the level of information quality.61 Quality,62 as a multidimensional concept, can be absolute and refer to: products, manufacturing, users, and values.

Quality of earnings  101 Information can also be evaluated for quality. It is important to bear in mind that the catalogue of information quality attributes is extensive. J. Błażyńska claims that an attempt to determine the attributes of financial information quality requires referring to the infological concept, where information is the content of the message, and the pragmatic aspect of information is the relationship between the message, the recipient, and the context.63 Table 3.2 offers an overview of how different authors classify information quality characteristics for decision-​making according to different criteria. It is Table 3.2 Key attributes of information quality in decision-​making Author

Year

R. R. Sterling M. N. Greenball G. A. Feltham

1970 Relevance, veracity, objectivity or subjectivity, particularity 1971 Relevance, costliness, objectivity 1972 Relevance, veracity, usefulness, informativeness, timeliness, cost/​benefit relationship, different scales of information for different purposes 1972 Formal at the producer level: representativeness, uniqueness, meaningfulness; empirical at the producer level: validity, reliability; intentional at the user level: usefulness, relevance, cost/​benefit relationship 1973 Relevance, usefulness, correctness, usefulness, experientiality, cost-​effectiveness 1974 Behavioural constraints –​understandability (simplicity, 1976 quality, comparability, compatibility with user concept); information value –​relevance, benefit/​cost relationship; decision context –​impact on decisions (relevance) 1987 Minimum criteria (availability, timeliness, reliability, comparability, information loss), optimisation criteria (reliability, processability, flexibility, efficiency, cost, response time, detail, stability, activity, priority, confidentiality, ease of use, security) 1994 Relevance, usefulness, completeness, timeliness, reliability, accessibility, cost-​effectiveness 1999 Relevance, timeliness, completeness, accuracy 2004 Relevance, timeliness, flexibility, communicability, clarity, completeness, flexibility, reliability 2006 Decision usefulness, utility, reported ‘just in time’ 2008 Relevance, timeliness, accessibility, usefulness, cost-​effectiveness 2010 Relevance (materiality), predictivity, timeliness, availability, cost-​effectiveness 2012 Attributes of individual pieces of data (accuracy, form, frequency, relevance, scope, originality, uniqueness, timeliness, time horizon), attributes of information sets (relevance, completeness, timeliness)

J. Motil

R. Kolman T. J. Mock

J. Kisielnicki

T. Kiziukiewicz A. Sopińska B. Stefanowicz A. Karmańska J. Zimmerman J. Jiambalvo J. Turyna

Information attributes

Source: B. Nadolna, Jakość informacji na potrzeby analizy decyzyjnej z wykorzystaniem kosztów relewantnych, Finanse, Rynki Finansowe, Ubezpieczenia, Issue 61, Research Papers of the University of Szczecin, Issue 765, Szczecin 2013, p. 454.

102  Quality of earnings difficult to find one generally acceptable definition of information quality. It is easier to explain quality on a case-​by-​case basis because quality means something different to users at different times. The meaning of information quality depends on the interpretation and the need of the recipient of information. It does not depend on quality itself. The target audience of information will define and understand the quality of information very differently.The definition of the needs of information users is constantly changing –​as is reality. Theorists dealing with this field of knowledge seek to describe the objective attributes of information from the angle that will make it possible to determine whether the information is valuable. The quality of information can be generally described by several attributes64 (Table 3.3). Table 3.3 Basic attributes of information quality No.

Attribute name, characteristics

Characteristic description

1

Relevance

2

Accuracy

3

Validity

4

Completeness

5

Coherence

6

Suitable form

7 8

Availability Compatibility

9

Reliability

Information responds to the needs of the recipient and is important for the recipient Information is adequate to the level of the recipient’s knowledge; it accurately and precisely illustrates and describes the topic it concerns Information is not outdated; its update cycle is consistent with its content; the rate of updates, the appearance of its successive versions is natural; it is appropriate to the time it addresses Information contains an optimal amount of data, sufficient to be able to transform information into concrete knowledge; the level of detail depends also on the needs of the recipient The different elements, the data work together; the form matches the content; the updates of the data are consistent with the purpose for which the data are collected (annual statistics) Adequate presentation of information and of the accompanying description make it possible to read and interpret the information presented (text, graphics) correctly Information is available to the target audience when it is needed Information is consistent with other information; congruent with reality; interpreted in the right context; functioning in a familiar system of communication; if alone, isolated –​it means nothing Information confirms the veracity of the data it features; it contains elements to acknowledge the accuracy of the message Ability to make changes to the information if, for example, the process is highly dynamic

10

Interactivity

Source: B. Bednarek-​ Michalska, Ocena jakości informacji elektronicznej. Pułapki sieci, Biuletyn EBIB, Issue 5/​2007, www.ebib.pl/​2007/​86/​a.php?bedna​rek (09.08.2018 r.) and Ł. Grudzień, Koncepcja oceny jakości informacji o procesach w systemach zarządzania, [in:] R. Knosola (ed.), Innowacje w Zarządzaniu i Inżynierii Produkcji, Oficyna Wydawnicza Polskiego Towarzystwa Zarządzania Produkcją, Opole 2012, p. 641.

Quality of earnings  103 Regardless of the division adopted and the synonyms used, relevance (materiality), which adapts information to make it able to respond to specific decision-​ making problems, is considered the primary attribute of information.65 This attribute indicates that the information should be tailored to the information needs of its users with solving a particular decision problem in mind. Information is expected to be useful and linked to a specific outcome. This means that the relevance of information in decision-​ making is affected by the strength of the following relationship: information need –​decision –​effect. In addition to the  above characteristics of information, the authors name also usefulness and timeliness as well as completeness and comprehensibility among the most important attributes of information. Reliability and completeness are affected to a greater extent by the producer of information. Reliability of information can be linked to its verifiability, i.e. verification and validation of its sources, and a reflection of certain characteristics of objects, processes, and phenomena.66 The quality of information is reduced by the distortions that arise in the communication path between the sender and the receiver.These can be sociological-​ psychological or technical-​ organisational distortions. The characteristics of information quality discussed above are the basic element of a system of qualitative characteristics: flexibility, availability, reliability, efficiency, economy, system response time, stability, priority, confidentiality, security, or ease of use.67 Financial statements continue to be a valuable source of financial information about business entities. Making decisions –​especially long-​term decisions –​ requires access to additional non-​financial information.68 Users of financial statements expect the published financial reports to be reliable. Recipients of information stress that reports should be organised and simplified, and that the information presented should be consistent, comparable, complementary, and non-​duplicate. There is a noticeable interest among investors and other users of financial statements in integrated reporting. It should be emphasised that attempts are being made to create different classifications of financial statement quality attributes. It also appears that J. Błażyńska, who believes that each determination of the quality of financial information requires referring to the relationship between the message, the recipient, and the context, is right. The bottom line is that the foundation of a rational and optimal decision is reliable information. The above discussion proves that qualitative characteristics give financial information its proper rank and importance in the decision-​ making process. Even if information is prepared in an accurate and reliable manner, it becomes useless when it is made available too late. At the same time, the attribute of timeliness of information implies that the faster the information is available, the more useful it is in the decision-​making process.

3.3  Capital market actors as major users of reporting information The FASB and IASB establish and govern the accounting regulations of the world, affecting many areas of financial reporting. The success of these two

104  Quality of earnings bodies is the development of a conceptual framework for financial reporting. The entire project was divided into several phases. The phase on the objectives and qualitative characteristics of financial statements has been completed.69 Difficulties involved in the implementation of the joint IASB and FASB project resulted in the decision to terminate the collaboration in this area in September 2012.70 The agreement between FASB and IASB led to the publication of a section of the Conceptual Framework for Financial Reporting that lists the user groups of financial statements. The developed conceptual framework indicates that financial statements are one of the available sources of information that can be acquired by users for decision-​making purposes.71 Financial reporting aims to cover the widest possible audience with its scope and content. The concept of ideal reporting exposes the inadequacies of the current form of the financial reporting system, which includes not only the regulations, the quality, and the effectiveness of the auditing system or the institutional and legal considerations, but also the cultural determinants affecting both producers and recipients of reporting information.The measure of imperfection is the difference between the book value of equity and the market capitalisation value of public companies. As a result, the category of fair value was introduced into accounting valuation, which came to be criticised after several years of use. The use of fair value in accounting valuation is cited as one of the causes of the crisis in financial markets.72 The emerging criticism of the current form of financial reporting does not change the fact that financial statements are a practical tool used to present the economic and financial situation of business entities. The target audience and users of financial statements include: owners and managers of companies, investors, employees, customers, competitors, the public, lenders, governments and its agendas, or stakeholders (stakeholder theory).73 Putting it in general terms, users of financial statements can be both external and internal audiences.74 Each of these groups uses financial reporting for different purposes. Financial accounting provides diverse financial information to external audiences –​including: potential investors, financial advisers and analysts, banks and lenders, government agencies, suppliers and other trade creditors, customers, and the public.75 It is the investors (owners) who are the main group of recipients of information. They enjoy a privileged position because they provide the capital necessary for the functioning of the economic entities they own. Shareholders and stakeholders, who commit their capital, are mainly interested in the degree of risk and uncertainty, as well as in the terms of return on their invested capital.76 Investors bear the greatest risk involved in running a business. They may not always count on dividend payments. Also, in the event of a bankruptcy, their claims are often the last to be settled. Therefore, financial statements intend to satisfy the needs voiced by the owners of capital. They are used in particular by minority shareholders, who are unable to obtain the information they need from other sources. Information can also be useful to other users, as financial reporting addresses the needs of the widest possible groups of target audience –​ not just the needs of a single group.77

Quality of earnings  105 The capital market is an important link of contemporary economy. This market is composed of financial streams, which result from cash flows transferred from economic units that hold capital to units where there is a demand for capital for investment. The direction of financial flows is determined by the participants –​actors –​of the capital market. Investors feel the need for information to streamline their decision-​making process. A financial statement, which includes a balance sheet, an income statement, a statement of changes in equity, a cash flow statement, and notes, is an important source of information used by capital market actors. This group is interested in information that will enable it to: determine the expected rate of return, estimate the probability of achieving the expected rate of return, assess the level of risk of a given investment, or make a decision to engage or not to engage in an investment project. In particular, this information makes it possible to estimate the company’s shareholder value and make investment decisions. Based on financial statements, investors evaluate the economic and financial situation of a business entity, identify the potential risks, and are able to determine the analysed entity’s future position in the market. It is important to bear in mind that reliable and credible information provided in financial statements is of great value to capital market actors. Capital market actors are mainly interested in relevant information that can have an impact on their decisions. This can be information coming from both the reporting entity and its environment or market.78 Lenders need information about an individual’s creditworthiness along with repayment of contractual interest within a certain period of time. Creditors seek information about resources, profitability, liabilities, liquidity, etc. They need this information to determine if the credit-​taking entity achieves the expected financial condition and performs well in the future. The government and its agencies are interested in information about resource allocation and economic activity in order to supervise the state’s economic and fiscal policy, determine the level of national income, or produce statistics describing macroeconomic categories.79 Suppliers look for information about the reporting entity’s capacity to make business transactions and about the prospect of paying its obligations on time. Customers are interested in the reporting entity’s material and financial situation and growth prospects, meaning factors associated with long-​term business transactions and attachment to the company’s products.80 Internal users include: owners, shareholders, managers, employees, and supervisory bodies. For them, the main source of information about the situation of the entity –​next to the financial statement –​is the report and an expert auditor’s opinion on the financial statement. Managers, in order to make decisions, plan, and control business processes, need information about the situation of the entity they manage.81 Properly organised reporting and efficient financial analysis systems can provide information through functions that secure the survival and growth of a business entity.82 Employees need information about the unit’s economic situation, salaries offered, and its ability to continue its operation.83

106  Quality of earnings The current version of the conceptual framework has narrowed the broad range of users of financial statements to investors, lenders, and other creditors, leaving other stakeholders outside the area of financial reporting. The framework does not offer explanations of the definition of users of financial reports. In broad terms, the definition includes the following creditors: contracting parties, employees, and governmental bodies. In a narrower perspective presented in the Conceptual Framework for Financial Reporting, there is a division of the group of financial report users into shareholders, board members representing shareholders, debt holders, banking institutions, or financial analysts.84 The interplay between accounting and capital markets has given rise to a new area of academic research named capital market research in accounting. The research concentrates on the search for and the determination of the nature of the relationship between the price of securities listed on capital markets and the information coming from financial statements.85 According to S. P. Kothari, there are four reasons for the development of capital markets research in accounting86: • • • •

examination of the information efficiency of capital markets from the perspective of accounting information reported in financial statements, the role of accounting in the social contracting process, examination of capital markets in the accounting standard setting process, and analysis in the area of economic valuation and fundamental analysis.

The year 1934 saw the publication of Security Analysis87 by B. Graham and D. L. Dodd.88 This work is considered the beginning of fundamental analysis. The main purpose of this analysis is to determine the value of the business entities analysed and to identify business entities valued incorrectly in the capital markets. The identification of entities misvalued by the market makes it possible to achieve profits with the adoption of a long time horizon as the market value will move gradually towards the economic value. The sources used in financial analysis, which affect the process and the outcome of decision-​making, include the financial statements of public companies.This means that financial reporting plays a significant role in the capital market by reducing information asymmetry while increasing the level of information efficiency of the capital market. The origins of capital markets research in accounting date back to the 1960s, following the proliferation of the theories of information efficiency of capital markets.89 In 1968, R. Ball and P. Brown published a paper90 which has become the most frequently cited academic paper in the field of accounting.91 An interesting research project was also carried out by W. H. Beaver, the findings of which were published in the same year. The purpose of this research trend is to determine whether a given financial statement contains any meaningful information for users –​other than information acquired from alternative publicly available sources. In their own research, B. Lev and T. Sougiannis92 estimate the value of intangible assets involved in expenditures on R&D. They undertake to demonstrate a statistical relationship

Quality of earnings  107 between the value of these hypothetical intangible assets and the amount of return on shares of the companies analysed. The findings obtained reveal a statistical relationship between the studied quantities while controlling other variables such as debt level, company size, book-​to-​market ratio, price/​earnings ratio, and beta. The research was narrowed down to companies engaging in R&D specific to the fastest growing sectors of the economy.93 E. F. Fama defines market efficiency as a situation where ‘the current market prices of securities fully reflect all available and relevant information.’94 The next major issue in finance theory in the study of capital markets in accounting was the emergence of the capital asset pricing theory –​CAPM. Two main theories of finance have laid the foundation for a new research approach, the so-​called event study. According to this approach, the appearance of new information in the capital market changes the share price. An extended version of the event study approach involves comparing the value of expected share prices with actual share prices and makes it possible to assess the market’s response to financial statement disclosures.95 A capital market response can be considered, for instance, a change in share price and the emergence of residual gains/​losses or an increase in trading volume after a financial statement is made public. The matter of identification of relationships between accounting information and market trading volume was investigated by W. H. Beaver, who published his research findings in 1968.96 The findings of his research project showed a relationship between price change and trading volume of the companies analysed and were consistent with R. Ball and P. Brown’s discoveries.97 Another important aspect of the research is the length of the period analysed (short, medium, long). T. Warfield and J. Wild’s 1992 study shows a relationship between share prices and financial information included in financial statements, the quality of which increases over a longer study period.98 The extension of the time horizon led to the emergence of a new methodological approach. It complemented the event study approach and focused on the study of the relationship between accounting information and market response, becoming known as association study or correlation study. D. Jeter and P. Chaney offer a proposal for examining market response in this methodological approach using the earnings association coefficient. M. Firth discovered another important factor of influence on the market response. His observation concerned the publication of a financial statement of a similar company from a given industry, which he referred to as the ‘information transfer’ phenomenon. Such information was found to affect the share prices of other similar companies operating in the same industry.99 P. Dumontier, P. Mendes, and B. Raffournier listed three main trends in capital markets research in accounting: • • •

analysis of the response between reporting volumes and investment returns over a longer time horizon, market response to new accounting information presented in the financial statements in terms of its usefulness, and the impact of capital markets on the accounting policy decisions of public companies.100

108  Quality of earnings The last domain of research considered focuses on the impact of a change in an accounting policy on the accounting results presented, calculated on an accrual basis.T. R. Archibald made an attempt to investigate whether the capital market can be ‘tricked’ by changing the accounting approach without changing the cash flows. In 1972, he published a study101 conducted on 69 companies. The entities analysed changed their accounting approaches in the field of fixed asset depreciation, replacing the accelerated depreciation method with the straight-​line method. The research conducted shows that the capital market cannot be fooled by changing the accounting policies applied.102 Recent decades have seen the emergence of the J. A. Ohlson model, which formally attempts to represent the value of a business entity using reported accounting quantities. Capital markets research continues to be a dynamically growing field of accounting. The IASB and FASB act to make sure that accounting regulations offer meaningful accounting information that could have a real impact on investor behaviour.103 Reporting information is taken advantage of by many users with different needs and expectations. The individual needs of user groups are not considered when financial statements are prepared. Information provided by reports should be reliable, understandable, and useful to a broad audience. The ongoing globalisation processes pose new challenges to financial reporting. The persisting differences in accounting regulations limit and prevent comparisons of information presented in financial statements. Reporting information has numerous attributes, which include reliability or timeliness. Initiatives aimed at harmonising and standardising the domain of financial reporting are justified and understandable. Harmonisation and standardisation of financial reporting improves the transparency and comparability of financial information necessary to make reasonable business decisions.104 In the age of free-​flowing capital, investors should be equipped with tools that let them assess and eliminate the risks that may exist. According to the theory of information efficiency, the capital market should present the published information –​including that contained in the financial statements of listed companies –​immediately in the share price.

Notes 1 W. Gabrusewicz, Rozwój przedsiębiorstw państwowych i jego ocena w gospodarce rynkowej, Wydawnictwo Akademii Ekonomicznej w Poznaniu, Poznań 1992, pp. 11–​18. 2 H. Buk, Nowoczesne zarządzanie finansami. Planowanie i kontrola, C. H. Beck, Warsaw 2006, p. 176, cited after: J. Pfaff, Wpływ rewizji finansowej na wiarygodność sprawozdania finansowego, Publishing House of the University of Economics in Katowice, Katowice 2008, pp. 57–​58. 3 R.Mala,R.Chand,Commentary on PhaseA of the Revised Conceptual Framework:Implications for Global Financial Reporting, Advances in Accounting, Incorporating Advances in International Accounting 2015,Vol. 1, Issue 2, pp. 209–​218. 4 K. Grabiński, M. Kędzior, Ocena opracowanego przez ISAB i FASB projektu założeń koncepcyjnych sprawozdawczości finansowej, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2011,Vol. 61, Issue 117, pp. 55–​88.

Quality of earnings  109 5 E.Walińska, A. Rzetelska, A. Jurewicz, Kapitał własny spółek kapitałowych jako kategoria prawna i ekonomiczna sprawozdania finansowego, Publishing House of the University of Lodz, Łódź 2016, p. 105. 6 Statement of Financial Accounting Concepts Issue 1, Financial Accounting Standards Board, 1978 par. 34. 7 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 52. 8 Cf.: E. M. Śnieżek, Sprawozdawczość przepływów pieniężnych. Krytyczna ocena i propozycja modelu, Publishing House of the University of Lodz, Łódź 2008, pp. 387–​ 395; R. Kamiński, Sprawozdawczość finansowa przedsiębiorstw w regulacjach polskich i międzynarodowych, Scientific Publishing House of Adam Mickiewicz University, Poznań 2015, pp. 110–​ 119; E. M. Śnieżek, M. Wiatr, Raportowanie przepływów pieniężnych w kontekście zmian we współczesnej sprawozdawczości finansowej, Oficyna Wolter Kluwer, Warsaw 2011, pp. 19–​76. 9 P. Kabalski, MSSF a ustawa o rachunkowości. Reguły i uzupełnienia, Rachunkowość 2015, Issue 8/​15, p. 20. 10 H. Buk, Międzynarodowe standardy rachunkowości, Część I, Publishing House of the University of Economics in Katowice, Katowice 2013, p. 20. 11 H. Buk, Krajowe i międzynarodowe standardy sprawozdawczości finansowej, Publishing House of the University of Economics in Katowice, Katowice 2014, p. 36. 12 J. Błażyńska, Jakość informacji o sytuacji finansowej jednostek gospodarczych, op. cit., p. 46. 13 M. Frymus, Sprawozdanie finansowe według Międzynarodowych Standardów Sprawozdawczości Finansowej źródłem informacji dla interesariuszy –​ujęcie jakościowe, Finanse, Rynki Finansowe, Ubezpieczenia Issue 2/​2016 (80), part 2, Publishing House of the University of Szczecin, Szczecin 2016, p. 442. 14 S. Hońko, Ogólna charakterystyka sprawozdania finansowego, [in:] W. Gos, S. Hońko, P. Szczypa, ABC sprawozdań finansowych. Jak je czytać, interpretować i analizować, CeDeWu, Warsaw 2013, p. 15. 15 P. Kabalski, Cele sprawozdań finansowych według projektu “Ram konceptualnych sprawozdawczości finansowej”, Zeszyty Teoretyczne Rachunkowości, SKwP, Warsaw 2009,Vol. 48, Issue 104, p. 21. 16 M. Walczak (ed.), Międzynarodowe i polskie regulacje rachunkowości w praktyce, Difin, Warsaw 2003, p. 35. 17 M. Cieciura, Pomiar jako jedna z naczelnych cech systemu rachunkowości finansowej w kontekście społecznej odpowiedzialności biznesu, [in:] Z. Luty, A. Łakomiak, A. Mazur (eds.), Przyszłość rachunkowości i sprawozdawczości-​ założenia, zasady, definicje. Ujawnienia informacji w sprawozdaniu finansowym, Research Papers of the Wrocław University of Economic, Wrocław 2013, Issue 314, p. 26. 18 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 52–​53. 19 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, [in:] Z. Luty, A. Łakomiak, A. Mazur (eds.), Przyszłość rachunkowości i sprawozdawczości –​ założenia, zasady, definicje. Ujawnienia informacji w sprawozdaniu finansowym, Research Papers of the Wrocław University of Economic, Wrocław 2013, Issue 314, p. 65. 20 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 53. 21 According to IAS 1, a complete financial statement consists of a balance sheet, an income statement with a statement of changes in equity showing: all changes in equity or changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders, a cash flow statement, and notes

110  Quality of earnings regarding the adopted accounting principles (policy), as well as other explanatory information. 22 H. Buk, Przegląd standardów rachunkowości stosowanych w Unii Europejskiej, [in:] H. Buk (ed.), Międzynarodowe Standardy rachunkowości w praktyce, CeDeWu, Warsaw 2018, pp. 28–​29. 23 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, op. cit., p. 65. 24 Międzynarodowe Standardy Sprawozdawczości Finansowej, op. cit., item CJ4. 25 R. Mala, P. Chand, Commentary on Phase A of the Revised Conceptual Framework: Implications for Global Financial Reporting, op. cit., p. 213. 26 According to para. 4.37–​4.38 of the Conceptual Framework. 27 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, op. cit., pp. 65–​66. 28 Międzynarodowe Standardy Sprawozdawczości Finansowej, op. cit., item CJ15. 29 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, op. cit., p. 66. 30 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 55. 31 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, op. cit., p. 66. 32 Governance & Collaboration. Establishing an “International Integrated Reporting Committee”, Accounting for Sustainability, Accounting, 2010,The Prince’s Charities, 2010, http://​pwc.blogs.com.pdf (16.12.2018). 33 Międzynarodowe Standardy Sprawozdawczości Finansowej, op. cit., item CJ30. 34 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 55. 35 A. Kusior, Informacje dodatkowe do sprawozdania finansowego i kierunki ich zmian, op. cit., p. 67. 36 Cf.: J. Samelak, Determinanty sprawozdawczości finansowej przedsiębiorstw oraz kierunki jej dalszego rozwoju, Publishing House of the University of Economics in Poznań, Poznań 2004, p. 67; M. Hulicka, Oszukańcza sprawozdawczość finansowa: wpływ rzetelności rewizji finansowej na efektywność nadzoru korporacyjnego i ograniczanie asymetrii informacji na rynku kapitałowym, Publishing House of the Jagiellonian University, Kraków 2008, p. 31; Międzynarodowe Standardy Sprawozdawczości Finansowej –​ International Accounting Standards Board, SKwP, Warsaw 2007, pp. 57–​58; A. Kuciński, Jakość sprawozdania finansowego w kontekście rynku kapitałowego, [in:] D. A. Mikulska (ed.), Polityka rachunkowości jednostki a jakość sprawozdania finansowego –​wybrane aspekty, Publishing House of John Paul II Catholic University of Lublin, Lublin 2012, p. 169. 37 J. Błażyńska, Atrybuty jakościowe współczesnych sprawozdań finansowych, Studia Oeconomica Posnaniensia, Poznań 2015,Vol. 3, Issue 1, p. 5. 38 M. Nowakowski, Ocena wiarygodności informacji w serwisach internetowych, Research Papers of the University of Szczecin, Szczecin 2015, Issue 863, pp. 103–​104. 39 Cf.: N. Wiener, Cybernetyka a społeczeństwo, PWN, Warsaw 1961; J. Seidler Nauka informacji: podstawy, modele źródeł i wstępne przetwarzanie informacji,Vol. 1,Wydawnictwo Naukowo-​Techniczne, Warsaw 1983. 40 J. Błażyńska, Jakość informacji o sytuacji finansowej jednostek gospodarczych, op. cit., pp. 42–​43. 41 J. Błażyńska, Atrybuty jakościowe współczesnych sprawozdań finansowych, op. cit., p. 12.

Quality of earnings  111 42 G. Świderska, Wyzwania dla ekspertów rachunkowości wobec nowych koncepcji raportowania, [in:] T. Cebrowska, A. Kowalik, R. Stępień (eds.), Rachunkowość wczoraj, dziś, jutro, SKwP, Centralny Ośrodek Szkolenia Zawodowego, Warsaw 2007, p. 321. 43 B. Micherda, Analityczna funkcja rachunkowości w okresie przejściowym do gospodarki rynkowej, Research Papers of the Cracow University of Economics, ‘Monografie’ Series, Kraków 1997, p. 43; A. Rashad Abdel-​Khalik, The Entropy Law, Accounting Data, and Relevance to Decision-​Making, The Accounting Review 1974,Vol. 49, Issue 2, April, p. 272; T. J. Mock, T. L. Estrin, M. A. Vasarhely, Learning Patterns, Decision Approach and Value of Information, Journal of Accounting Research 1972, Spring, p. 129; B. Nadolna, Jakość informacji na potrzeby analizy decyzyjnej z wykorzystaniem kosztów relewantnych, Finanse, Rynki Finansowe, Ubezpieczenia, Issue 61, Research Papers of the University of Szczecin, Issue 765, Szczecin 2013, p. 452. 44 S. Forlicz, Informacja w biznesie, PWE, Warsaw 2008, p. 47; cited after: B. Nadolna, Jakość informacji na potrzeby analizy decyzyjnej z wykorzystaniem kosztów relewantnych, op. cit., pp. 452–​453. 45 B. Iwasieczko, Ocena użyteczności informacji sprawozdawczych, Finanse, Rynki Finansowe, Ubezpieczenia, Issue 6/​2016 (84), p. 296. 46 J. Błażyńska, Użyteczność informacji finansowych sprawozdań finansowych, Publishing House of the Poznań University of Economics and Business, Poznań 2015, p. 40. 47 B. Stefanowicz, Informacja, Oficyna Wydawnicza SGH, Warsaw 2010, p. 101. 48 L. Bukowski, J. Feliks, Ocena wartości użytkowej informacji logistycznych w warunkach niepewności oraz turbulentnych zmian otoczenia, Research Papers of the Wrocław University of Economics and Business, Wrocław 2015, Issue 283, p. 267. 49 B. Iwasieczko, Ocena użyteczności informacji sprawozdawczych, op. cit., pp. 297–​298. 50 Cf.: A. Adamus-​Matuszyńska, Wykorzystanie SNA w pomiarze efektywności instytucji publicznych, [in:] A. Frączkiewicz-​Wronka (ed.), Efektywność zarządzania organizacjami publicznymi i jej pomiar, Publishing House of the University of Economics in Katowice, Katowice 2013, pp. 13–​24. 51 Cf.: M. Morzy, A. Ławrynowicz, Wprowadzenie do analizy sieci społecznych, Poznan University of Technology Institute of Computer Science, Poznań 2015. 52 L. Bukowski, J. Feliks, Ocena wartości użytkowej informacji logistycznych w warunkach niepewności oraz turbulentnych zmian otoczenia, op. cit., p. 267. 53 J. Błażyńska, Użyteczność informacji finansowych sprawozdań finansowych, op. cit., p. 41. 54 J. Błażyńska, Użyteczność informacji finansowych sprawozdań finansowych, op. cit., p. 241. 55 B. Iwasieczko, Ocena użyteczności informacji sprawozdawczych, op. cit., pp. 296–​298. 56 B. Nadolna, Jakość informacji na potrzeby analizy decyzyjnej z wykorzystaniem kosztów relewantnych, op. cit., p. 453. 57 Cf.: R. R. Sterling, Theory of the Measurement of Enterprise Income, Lawrence, KS:The University Press of Kansas 1970; M. N. Greenball, The Predictive-​Ability Criterion: Its relevance in Evaluating Accounting Data, Abacus 1971, Vol. 7, Issue 1; Z. Gackowski, Projektowanie systemów informacyjnych zarządzania, WNT, Warsaw 1974, p. 236; J. L. Kuligowski, Informacja i świat, w którym żyjemy, Wiedza Powszechna, Warsaw 1978, p. 335; W. Flakiewicz, Systemy informowania kierownictwa. Aspekty semantyczne, PWN, Warsaw 1978; T. Kiziukiewicz, Problemy dostosowania rachunkowości do informacyjnych wymagań zarządzania, Research Papers of Szczecin University of Technology, Issue 261, Accounting Department Papers, Szczecin 1984, Issue 2, p. 37. 58 Cf.: M. J. Eppler, Managing Information Quality, Springer, Heidelberg 2006. 59 Cf.: F. Naumann, C. Rolker, Assessment Methods for Information Quality Criteria, International Conference on Information Quality, October 2000.

112  Quality of earnings 60 Cf.: E. Kolbusz, Analiza potrzeb informacyjnych przedsiębiorstwa. Podstawy metodologiczne, Scientific Publishing House of the University of Szczecin, Szczecin 1993. 61 Ł. Grudzień, Koncepcja oceny jakości informacji o procesach w systemach zarządzania, [in:] R. Knosola (ed.), Innowacje w Zarządzaniu i Inżynierii Produkcji, Oficyna Wydawnicza Polskiego Towarzystwa Zarządzania Produkcją, Opole 2012, pp. 638–​639. 62 Quality refers to a set of properties that determine the value of an evaluated object or phenomenon. 63 J. Błażyńska, Atrybuty jakościowe współczesnych sprawozdań finansowych, op. cit., pp. 11–​12. 64 B. Bednarek-​Michalska, Ocena jakości informacji elektronicznej. Pułapki sieci, Biuletyn EBIB, Issue 5/​2007, www.ebib.pl/​2007/​86/​a.php?bedna​rek (09.08.2018 r.). 65 The qualitative characteristics of information had been the subject of theoretical considerations only. The first empirical study was conducted in the years 1974–​1975 by H. D. Grove. His research was used to verify the author’s concept of a decision procedure, aimed to determine the appropriate scale of measurement for decision parameters under given conditions and constraints and to evaluate the costs and benefits of decision alternatives. The research project involved conducting interviews and surveys among managers of different levels. The obtained findings indicated that managers considered the most important feature of information to be its relevance in terms of its ability to solve a given decision-​related problem. See: H. G. Grove, T. J. Mock, Measurement, Accounting and Organizational Information, John Wiley & Sons Inc., March 1979, pp. 45–​102; J. E. Butterworth, The Accounting System as an Information Function, Journal of Accounting Research 1972, Vol. 10, Issue 1, p. 12. 66 B. Nadolna, Jakość informacji na potrzeby analizy decyzyjnej z wykorzystaniem kosztów relewantnych, op. cit., pp. 454–​455. 67 W. Flakiewicz, Systemy informacyjne w zarządzaniu. Uwarunkowania, technologie, rodzaje, C. H. Beck, Warsaw 2002, p. 58. 68 Cf.: J. Krasodomska, Informacje niefinansowe w sprawozdawczości spółek, Publishing House of the Cracow University of Economics, Kraków 2014, pp. 15–​ 102; J. Michalak, Wskaźniki finansowe i niefinansowe w raportach strategicznych spółek zWielkiej Brytanii –​analiza z perspektywy oceny spółek przez inwestorów odpowiedzialnych społecznie, Acta Universitatis Lodziensis Folia Oeconomica, 2017, Issue 1 (327), pp. 59–​73. 69 K. Grabiński, M. Kędzior, Ocena opracowanego przez ISAB i FASB projektu założeń koncepcyjnych sprawozdawczości finansowej, op. cit., pp. 62–​63. 70 S. Hońko, Podstawy wyceny aktywów i zobowiązań według założeń koncepcyjnych IASB –​ stan obecny i propozycje zmian, Studia Oeconomica Posnaniensia 2014,Vol. 2, Issue 4 (265), p. 41. 71 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, [in:] K. Grabiński, M. Kędzior, J. Krasodomska, Współczesna rachunkowość na rynkach kapitałowych, PWN, Warsaw 2014, pp. 203–​204. 72 Ch. Laux, Ch. Leuz, The Crisis of Fair-​Value Accounting: Making Sense of the Recent Debate, Accounting, Organizations and Society 2009, Issue 34, p. 826; cited after: K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., pp. 204–​205. 73 Cf.: J. Czekaj (ed.), Rynki, instrumenty i instytucje finansowe, PWN, Warsaw 2017, pp. 77–​119.

Quality of earnings  113 74 A. Kuciński, Jakość sprawozdania finansowego w kontekście rynku kapitałowego, op. cit., p. 170. 75 Z. Messner, J. Pfaff, Podstawy rachunkowości, SKwP, Zarząd Główny, Warsaw 2001, p. 40.; A. Jaruga (red), Międzynarodowe regulacje rachunkowości-​wpływ na rozwiązania krajowe, C. H. Beck, Warsaw 2002, p. 81; cited after: J. Pfaff, Wpływ rewizji finansowej na wiarygodność sprawozdania finansowego, op. cit., p. 66. 76 J. Gierusz, Koszty i przychody w świetle nadrzędnych zasad rachunkowości. Pojęcia, klasyfikacja, zakres ujawnień, op. cit., p. 17. 77 J. Samelak, Determinanty sprawozdawczości finansowej przedsiębiorstwa oraz kierunki jej dalszego rozwoju, op. cit., p. 64. 78 D. A. Niedziółka, Relacje inwestorskie, PWN, Warsaw 2008, pp. 29–​40.; cited after: A. Kuciński, Jakość sprawozdania finansowego w kontekście rynku kapitałowego, op. cit., pp. 170–​172. 79 I. Olchowicz, A. Tłaczała, Sprawozdawczość finansowa, Difin, Warsaw 2002, pp. 16–​18. 80 I. Olchowicz, A. Tłaczała, Sprawozdawczość finansowa, op. cit., pp. 17–​18. 81 K. Rajzer, Znajomość sprawozdawczości i rewizji finansowej wśród studentów-​przyszłych menadżerów (refleksje własne), [in:] B. Micherda (ed.), Sprawozdawczość i rewizja finansowa w procesie podnoszenia kwalifikacji kadry menadżerskiej, Cracow University of Economics, Kraków 2003, p. 594. 82 J. Pfaff, Wpływ rewizji finansowej na wiarygodność sprawozdania finansowego, op. cit., pp. 67–​69. 83 J. Turyna, Standardy rachunkowości-​MSR-​US GAAP-​Polskie Ustawodawstwo, Difin, Warsaw 2003, p. 43. 84 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., p. 205. 85 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., pp. 205–​206. 86 S. P. Kothari, Capital Markets Research in Accounting, Journal of Accounting and Economics 2001,Vol. 31, Issue 1–​3, pp. 107–​108. 87 Cf.: B. Graham, D. L. Dodd, Security Analysis, 1st edition, Whittlesey House, New York 1934; B. Graham, D. L. Dodd, S. Cottle, Security Analysis, 4th edition, McGraw-​Hill, New York 1962. 88 S. P. Kothari, Capital Markets Research in Accounting, op. cit., pp. 107–​108. 89 S. P. Kothari, Capital Markets Research in Accounting, op. cit., p. 109. 90 T. Copeland, J. Weston, K. Shastri, Financial Theory and Corporate Policy, Pearson Education, London 2005, p. 381. 91 C. Deegan, J. Unerman, Financial Accounting Theory, McGraw-​Hill, London 2006, p. 385; cited after: K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., p. 207. 92 B. Lev, T. Sougiannis, Penetrating the Book-​to-​Market Black Box: The R&D Effect, Journal of Business, Finance & Accounting 1999,Vol. 26, Issue 3–​4, pp. 419–​449. 93 B. Grabińska, K. Grabiński, Wpływ nakładów na badania i rozwój na rentowność przedsiębiorstw, Zeszyty Teoretyczne Rachunkowości,Vol. 96 (152), SKwP 2018, p. 49. 94 E. F. Fama, Efficient Capital Markets: II,The Journal of Finance 1991,Vol. XLVI, Issue 5, November, p. 1575. 95 H. Wolk, J. Dodd, J. Rozycki, Accounting Theory: Conceptual Issues in a Political and Economic Environment, Sage Publications, London 2008, p. 234. 96 W. H. Beaver, The Information Content of Annual Earnings Announcements, op. cit., p. 69.

114  Quality of earnings 97 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., pp. 207–​214. 98 T. Warfield, J. Wild, Accounting Recognition and the Relevance of Earnings as an Explanatory Variable for Returns, The Accounting Review 1992, Vol. 67, Issue 4, October, pp. 839–​840. 99 M. Firth, The Impact of Earnings Announcements on the Share Price Behaviour of Similar Type Firms, Economic Journal, June 1976,Vol. 86, Issue 342, pp. 305–​306. 100 P. Dumontier, P. Mendes, B. Raffournier, Accounting and Capital Markets: A Survey of the European Evidence, The European Accounting Review 2002,Vol. 1, Issue 11, p. 120.; cited after: K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., p. 215. 101 T. R.Archibald, Stock Market Reaction to the Depreciation Switch-​Bach,The Accounting Review, January 1972, pp. 22–​30. 102 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., pp. 214–​215. 103 K. Grabiński, Użyteczność informacji księgowej dla uczestników rynku kapitałowego, op. cit., pp. 216–​218. 104 A. Kuciński, Jakość sprawozdania finansowego w kontekście rynku kapitałowego, op. cit., pp. 171–​172.

4 Measures of earnings quality in accounting theory and in empirical research in accounting

4.1  Earnings management The literature on the subject offers many definitions of earnings management.1 A particularly noteworthy classification of definitions of earnings management is offered by J. Ronen and V.Yaari.2 They classify the definitions adopted in the literature according to the criterion of transparency and quality of financial statements. They speak of: ‘white’ earnings management, showing the beneficial consequences of these processes; ‘grey’ earnings management, indicating the benefits that can be obtained as a result of the process of earnings management while showing the negative consequences thereof at the same time; and ‘black’ earnings management, emphasising the negative consequences caused by earnings management and by reducing the transparency of financial statements, which can result in private gains.3 P. M. Dechow and D. J. Skinner4 noticed that earnings management is related to the matching and accrual principles of accounting.5 There appeared descriptions of the negative effects of earnings management as early as in the 1980s. K. Schipper6 claims that reporting entities managing their earnings enter the realm of creation of financial statements, which is an act aiming at achieving own benefits –​as opposed to statements prepared following a neutral approach. P. M. Healy and J. M. Wahlen7 have proven, in turn, that earnings management occurs when managers use professional judgement when creating and classifying transactions in order to change the information contained in the financial statements of the entity they manage. This modification is not only to mislead some stakeholders who need information about the entity’s basic economic and financial performance but also to influence contractual outcomes that depend on the reported accounting figures.8 Estimates include economic useful lives, valuation of employee benefits, or residual value of assets. The tools of earnings management include methods used in accounting, i.e. the depreciation method or the inventory (COGS) valuation method. The structuring of business transactions makes it possible to estimate the development of the effects of transactions in the accounting books in advance.9 DOI: 10.4324/9781003280088-5

116  Measures of earnings quality P. B. W. Miller and P. R. Bahson10 argue that the economic practice of earnings management takes the form of arriving at the results that are predicted by financial analysts. The research on earnings management is very often carried out on listed companies,11 where it is expected to see strong incentives affecting the value of the reported earnings –​for example, to increase executive compensation. Researchers focus on two aspects: earnings manipulation and earnings management. They argue that the concept of earnings management does not fully capture the processes observed and studied. J. C. Bedard and K. M. Johnstone12 believe that earnings manipulation is an act of entering the domain of financial reporting with the aim to present an economic entity’s position in a biased manner. According to E. N. Asien,13 the term ‘accounts manipulation’ positions the processes subject to analysis as acts of earnings management in their proper context. This researcher claims that an important element of manipulation may be manipulating other elements of the report –​including publishing falsified information in the appendices or overstating the number of employees. A. Piosik14 defines the manipulation of accounts as a situation where an economic entity’s managers mislead other stakeholders of the entity by not disclosing the actual situation of the entity in the financial statements. Many researchers15 claim that earnings management begins with the departure from the principles and standards of accounting. M. D. Beneish considers two perspectives on earnings management: an opportunistic perspective and an informational perspective. According to T. H. McKee,16 earnings management is a reasonable, moderate, and lawful decision-​making process aimed to achieve predictable financial results.The process identified is confused with illegal activities intended to manipulate results that do not give a true view of facts and reality. Fraudulent accounting should be classified outside of legal activities and therefore outside the scope of the concept of earnings management. Accrual adjustments is the most frequently used measure of earnings, which is applied in measuring the phenomenon of earnings management. Accrual adjustments can be divided into normal and non-​discretionary adjustments, which reflect the distortions in true earnings, which result from the imperfections of the reporting process. Any change in the value of a balance sheet item and the subsequent cash flow affecting the value of earnings is considered an accrual adjustment. Empirical studies make use of statistical methods to measure the level of accrual adjustments.17 J. Ronen and V. Yaari emphasise the weakness of P. M. Healy and J. M. Wahlen’s definition.18 They mention, e.g. the lack of a clear distinction between the management of balance sheet results and ordinary activities that result in certain balance sheet results. Another thing is that earnings management does not always have to be misleading.19 J. Ronen and V.Yaari suggest a different definition of earnings management, stating that it is a result of managers’ decision not to report true short-​term and value maximising earnings that they know of. Earnings management is related in a specific way with balance sheet policies and accounting policies. It should be stressed that the Polish literature on the

Measures of earnings quality  117 subject defines these terms very differently.20 This observation was made by K. Stępień21 and T. Cebrowska.22 The discussions on the equivalence and divergence of these terms are irrelevant to accounting practice. K. Stępień argues that these concepts are equivalent. Policies are considered at the microeconomic and macroeconomic levels. On a microeconomic scale, accounting policy is formed by a set of rules, opinions, accounting standards, interpretations, and regulations used by business entities to prepare financial statements in line with selected accounting principles, by higher tier institutions.23 In macroeconomic terms, accounting policy encompasses all activities of tax authorities and institutions established by national and international accounting organisations.24 The differences that exist between these terms have arisen because of the past events. At present, there is a strong tendency in the literature on the subject to converge these concepts. Equating balance sheet policy with accounting policy is a challenge nowadays because the problem is to identify which activities can be determined as a balance sheet policy and which as an accounting policy. A. Karmańska25 proposes two groups of activities: financial reporting objectives and managerial objectives, and points to the hierarchy of practising this policy. An accounting policy is therefore a ‘modus operandi’ of managers and involves prioritising objectives making it possible prepare financial statements. On the other hand, accounting policies provide detailed ways of implementing balance sheet policies. The issue of balance sheet policy vs. accounting policy has been addressed by many Polish researchers in recent years.26 It appears that A. Piosik and M. Strojek-​Filus27 are right in claiming that earnings management has certain common elements and is affected by the balance sheet policy and accounting policy, especially in the area related to the value of the reported earnings.28 Earnings management is defined as the actions of an economic entity’s management –​who is ultimately responsible for the content of the published financial statements –​taken with the aim to present the entity’s financial and asset position and, in particular, its performance and achievements. Earnings management is viewed in different ways by practitioners and researchers. Research suggests that earnings management phenomena have had a major impact on reported earnings and this should be of concern to investors.29 Practitioners are more likely to focus on earnings management in the context of forecasting earnings and manipulating earnings to meet forecasts. Academics, in turn, follow the assumption of investor rationality,30 which is set to moderate the effects of earnings management. Several research approaches to earnings management processes and their measurement can be found in the literature on the subject: • • • •

analysis of changes in non-​cash net current assets, particularly analysis of discretionary changes, analysis of the reported earnings, analysis of selected performance measurement indicators, analysis of the quality of earnings,

118  Measures of earnings quality • • • • •

comparative analysis of reports of reporting entities simultaneously, following different reporting systems, analysis of deviations from financial law standards and scandal analysis, analysis of the effects of changes in accounting methods, analysis of shaping transactions and estimates, and creating ‘aggregate’ indices of the level (size) of earnings management.31

An important indicator used to assess the quality of non-​cash net current assets (accruals)32 is the strength of the correlative relationship between accruals from a given period with changes in cash flows from operations in that period or the next period.33 The early stage of development of research on the quality of reports of public companies is also related to the diversity of Polish nomenclature in this research area, which makes it difficult to discuss the qualitative characteristics of information contained in reports.The term abnormal accruals is defined as operational and intentional differences, discretionary and non-​discretionary transactions, discretionary and non-​discretionary expense settlements, normal (non-​discretionary) accrual adjustments, and above-​normal (discretionary) accrual adjustments.34 Adjustments reflecting the value of accrual differences between net income and net operating cash flows can be divided into two categories. The first of them includes the so-​called non-​discretionary accrual differences, which are the so-​called operational accrual differences (normal accruals –​NACC, non-​ discretionary accruals) and intentional accrual differences (abnormal accruals, discretionary accruals –​AACC). The value of the operational differences in accruals depends on the size and profile of the business entity.35 This is because operational accrual differences are derived from both sales generated and investments made in fixed assets. Intentional accrual differences, on the other hand, result from subjective accounting choices (e.g. accounting estimates, discretionary approach) and represent the aggregate result of activities referred to as accounting earnings management.36 The relationships described can be determined using the following formula37: TACCt = ​NDACCt + ​DACCt

[F 4. 1]

where TACCt –​value of total accruals in year t, NDACCt –​value of non-​discretionary (operational) accruals in year t, and DACCt –​value of discretionary (intentional) accruals in year t. It is important to notice that a number of studies dealing with the issue in question determine the category of TACC (total accruals) in various ways using different models.They take into account both balance sheet categories and cash flow statement items. The discrepancy that occurs in the recognition of absolute values of the net profit adjustment ratio can lead to fundamental disparities

Measures of earnings quality  119 within the estimated values of DACC (discretionary/​intentional accruals) –​an incorrect estimate of the magnitude of an entity’s profit management.38 The literature on the subject often cites J. J. Jones’ research39 in the approach considering changes in non-​cash current assets to study earnings management. J. J. Jones analyses discretionary changes in non-​cash net current assets with the aim to study the development of earnings management among companies that file petitions for state protection against importers. The researcher investigated whether management boards intentionally managed their companies’ earnings downwards due to import-​related petitions during the study period.40 To measure the level of earnings management, an estimate of discretionary changes in non-​cash net current assets has been applied. They are part of the changes in working capital, called total changes in net current assets or total accruals (TA), which include41: TA = (​ Δ current assets –​Δ cash and short term investments) – ​(Δ short term liabilities) – ​depreciation [F 4. 2] where Δ –​indicates the change of the item during the analysed periods. The relationship of expected total changes in current assets (TA) has also been analysed42:  ∆REVit   1   PPEit  TA it + β1i  +β 2 i  = ai     + ε it A  A it −1   A it −1   A it −1  it −1

[F 4. 3]

where TAit –​total changes in net current assets of i-​st/​nd/​rd/​th company in year t, Ait–​1 –​total assets according to opening balance sheet of the i-​st/​nd/​rd/​th company, ΔREVit –​change in sales revenue relative to year t -​ 1 for the i-​st/​nd/​rd/​th company, and PPEit –​gross value of property, plant, and equipment of the i-​st/​nd/​rd/​th company. The changes made were intended to enable the control of changes in nett current assets resulting from the dynamics of operating conditions as well as the size of the business. An equation was created for each company analysed, and the results obtained were as expected. The approach to defining total changes in non-​cash net current assets has changed over the years. J. J. Jones’ research was refined by P. M. Dechow, R. G. Sloan, and A. P. Sweeney.43 They proposed a modification of J. J. Jones’ approach to modelling changes in non-​discretionary non-​cash net current assets based on

120  Measures of earnings quality companies’ time series, which involved estimating non-​discretionary accounts as follows:  1   PPEit  + a 2 [ ∆REVt − ∆RECt ] + a 3  + ε it [F 4. 4] NDA t = a1   A t-1  A it −1    where ΔREC –​change in accounts receivable. This approach was criticised by J. Ronen and V. Yaari, who deductively proved the effects of earnings management by increasing revenues due to an increase in the share of credit sales and underestimating the cost of bad debts. A different research approach was put forward by P. M. Dechow and I. D. Dichev, who used the relationships that exist between the effects of accruals recognised in working capital, the financial result, and the cash revenues. The proposed empirical measure of current asset quality is based on the residuals of the regression equations that were created for each company. The formula adopted is as follows44: ∆WCt = b0 + b1CFOt-1 + b2CFOt + b3CFOt +1 + ε it

[F 4. 5]

ΔWCt –​change in working capital and CFOt –​cash flows from operations over time t. The residual values of the regression equation represent changes in working capital that are unrelated to the realisation of operating cash flows, and the standard deviation of the model residuals is an indicator of the quality of working capital changes. P. M. Dechow and I. D. Dichev’s research confirmed the existence of correlational relationships between the variables.45 The literature on the subject offers two approaches to defining the quality of the reported earnings. The first is connected with earnings management. It argues that high-​quality returns result from an unbiased, objective, and neutral accounting approach. This results in a reduction of earnings (big bath),46 excessively aggressive earnings management, or a too conservative approach. The second approach, in turn, refers to analysing the informational value of earnings. It concentrates on the relationship between earnings for a given period to earnings for future periods. D. Burgstahler and I. D. Dichev47 studied the persistence of earnings of companies characterised by different levels of standard deviation of the residuals obtained from the built predictive model of earnings. In contrast, K. Schipper and L.Vincent assumed that earnings quality is the degree to which the reported earnings represent income as understood by J. R. Hicks. Researchers use a variety of methods to study the quality of earnings48:

Measures of earnings quality  121 • • • •

analysis of the time series of earnings; selected qualitative characteristics of the standards used; relationships between earnings, changes in non-​cash net current assets, and cash flows; and effects of decisions to implement certain regulations.

On the basis of time series, the literature on the subject has identified several characteristics. Persistence can be measured by modelling regression relationships of share returns as a function of changes in financial performance or earnings size. Another approach to measuring the quality of earnings overlaps with smoothing analysis. Predictability means the ability to forecast future earnings based on historical earnings and other elements of financial statements. Research into the management of earnings and of the quality of earnings should take into account the specific economic conditions under which public companies operate. A statement quality analysis focuses on the incremental value of information that results from changes in non-​cash net current assets and cash flows.The study considered the net income before extraordinary items (NIBEI). Working capital from operations (WCFO), in turn, was defined as the difference between NIBEI and adjustments to NIBEI for such items that could not be linked to working capital. When cash flows from operating activities were estimated, they were derived from WCFO adjustments and changes in current assets and short-​term liabilities. A research project by R. M. Bowen, D. Burgstahler, and L. A. Daley49 has shown that unexpected earnings50 and operating cash flow are marked by a relative change in the value of an item compared to the item’s value in the prior period. The econometric analysis conducted showed that unexpected rates of return generate functions of incremental earnings before extraordinary items, of incremental investment and operating cash flows. A range of studies on the trend towards increasingly strong relationships between earnings and market response was conducted by J. Francis, K. Schipper, and L.Vincent between 1980 and 1999.Their studies revealed an increase in the M/​BV ratio and a systematic increase in the level of assets, a reduction in ROA, and a decrease in the persistence of profits.51 Earnings management in Poland has so far been the subject of only a dozen or so publications, the majority of which have been theoretical studies.52 An important Polish-​language monograph, addressing the issue of balance sheet management in a comprehensive manner, is the work of P. Wójtowicz.53 The researcher questions the applicability of a ‘neutral’ approach to the preparation of reports, pointing out that the processes of balance sheet management can have both positive and negative consequences. Two interesting publications have been published recently. More recent Polish studies address many aspects of earnings management.These studies focus mainly on small loss avoidance, significant earnings reduction (big bath), and earnings smoothing. A. Piosik’s extensive monograph54 offers a comprehensive

122  Measures of earnings quality review of incentives and methods of earnings management in the Polish reality, discussing cases of both listed and non-​listed companies. Another Polish monograph, by K. Grabiński,55 as well as said monograph by A. Piosik, do not focus on the issue of managing earnings in order to achieve the values predicted by analysts. Instead, they offer comprehensive studies of the determinants of earnings management in the international perspective. K. Grabiński argues that the scope of this phenomenon is affected by factors defining the company itself, by cultural, institutional, and legal conditions, and by macroeconomic circumstances. In this research, earnings management has been treated inclusively and comprehensively, without distinguishing its various purposes.56 There are different approaches used in the literature on the subject to defining earnings management. Major differences between the approaches to defining earnings management occur when evaluating the processes of earnings management, considering it from the point of view of the quality of financial statements of the reporting economic entities. Some definitions emphasise managerial actions which are legal and intend to offer a specific view of the financial position of a given business entity with the use of appropriate accounting instruments. Other definitions highlight managers’ manipulation of data included in financial statements. These acts of manipulation (or interference) are the result of personal and individual interests, which are not always in line with those of shareholders –​which is closely related to the agency cost theory.

4.2  Earnings predictability Predictive value is defined as the ability to predict future earnings based on current earnings. According to this theory, the more the predictive value increases, the more the utility value of the current earnings grows. This is expected to translate into lower share price volatility and a stronger capital market response to a possible unexpected portion of the reported earnings. Two approaches to measuring predictability are proposed in the literature on the subject. The first –​simpler –​is based on historical data referring to the persistence model. The second approach takes the average absolute value of the earnings forecast error as a benchmark. The measure of persistence is β , and the measure of predictability is the root of the standard deviation of the estimation error of the above regression equation, which can be expressed as follows: P = σ2 ( εt )

[F 4. 6]

Predictability of earnings can only be established in developed capital markets. Stock analysts monitor and follow emerging public information and seek other additional information if necessary. K. Schipper refers to them as demanding and experienced consumers of financial statements. The acquired

Measures of earnings quality  123 data is processed and then produces information about the expected financial performance. The methodological problem is the very large number of earnings forecasts, which translates into one standardised forecast value for a given company. Valuable information is confidential information, which is not available to the public as it could be used to gain a competitive advantage. The source of this type of information is management board members. Such information, especially in the case of companies where earnings are unpredictable, is very important. Stock analysts, in order not to lose good relations with management boards, tend to often present results in line with the latter’s expectations. The consequence is bias and the publication of overly optimistic forecasts. A study by S. Das, C. Levine, and K. Sivaramakrishnan57 showed that in the case of companies with unpredictable financial performance, analysts’ forecasts were highly optimistic. In contrast, M. J. Eames and S. M. Glover58 increased the sample from 239 companies to 1,335 companies in their study. The researchers found no statistical relationship between the distribution of forecast error and the predictability of earnings.59 The research on the relationship between earnings management and the level of interest in the reporting company among independent analysts is connected with the claim that stock market analysts who produce forecasts of the earnings of listed companies act as guardians of the mechanism of the market. Studies show that the effectiveness of analysts in this area grows with the degree of advancement of the financial system in a given state. In developed countries, the increase in the number of analysts following a company and producing forecasts appeared to be associated with a decrease in the scope of earnings management. No such correlation was observed in the case of underdeveloped countries.60 The obtained results of the conducted empirical research prove that reporting predictable earnings lets business entities gain additional benefits. A study by I. Hasan, J. C. Park, and Q. Wu showed that companies reporting earnings with high predictive value were offered more advantageous contracting terms. According to the findings of the study, banks take the predictive value of their clients’ earnings into serious consideration. The capital market response coefficient is positively correlated with the persistence and predictability of earnings.Although they are determined in different ways, they have the same effect on public companies –​especially in the area of market response to the reported earnings. In the case of companies which make predictions of their earnings, their market valuation is more correct. The publishing of earnings close to expectations does not translate into a leap in the trading volume or share price. Also, the market response is less abrupt. The sources of predictability of earnings may lie in the essential characteristics of the reporting entity, which include: organisational culture, management, level of innovation, or resistance to adverse changes. F. Schiemann and T. Guenther have conducted a study where they put forward a thesis that human capital is an important resource of businesses, which has a significant impact on

124  Measures of earnings quality their operations and performance. A total of 938 UK companies and 5,039 observations from the years 1999 to 2010 have been examined. The findings indicate that the predictability of earnings is related to the persistence of payroll costs over time. The research has identified no statistical relationship between the average employee pay and the predictability of earnings. The predictability of earnings is also considered from the perspective of changing financial reporting regulations.The most important regulatory change is the abolishment of the requirement to report earnings and other material information by geographic area or sector affiliation. The new regulations make it possible to apply a different allocation criterion, which enables considering earnings from a management board’s perspective. O. K. Hope, W. B. Thomas, and G. Winterbotham61 posed the question of whether a managerial approach or a sector-​wide approach to segment reporting provides better information, i.e. information that is more useful in accurately predicting earnings.The study sample was defined as transnational corporations that earn at least 10% of their revenues abroad. The study examined 688 public companies. A total of 509 companies, i.e. those where reporting based on geolocation was discontinued, were excluded. The results obtained do not determine which of the approaches is useful for financial analysts to predict financial performance.62 In order for a presentation of information to be useful in predicting future earnings, it should: be recipient-​oriented, provide reliable, detailed, and reproducible data, be valid, be economical, make it possible to obtain information in a quick manner, and guarantee the timeliness and comparability of the presented information.63 The purpose of reporting earnings is to provide capital market actors with all the information (including internal information) that they can use to predict the future financial performance of a business entity and –​in particular –​to estimate its value.

4.3  Earnings persistence Persistence, defined as the ability to sustain a certain feature over time, should be considered a measure of the quality of the financial result. This concept is linked to the application of the time regression method to earnings, providing a way to predict the future value of earnings and other relevant data. This model makes it possible to estimate the economic value of a business based on cash flows that cannot be observed at the time of valuation using available information. Predicting and estimating future earnings finds application in practice, particularly in business valuation models and investment decisions. Earnings persistence models take into account other components of financial statements and other types of information that may be important in future earnings management. This can be expressed in the form of the following formula64: Et+​1 = α ​ +β ​ 1Et +​ β2FSCt + β ​ 3OTHER +​ εt

[F 4. 7]

Measures of earnings quality  125 where E –​earnings, FSC –​financial statement components, and OTHER –​other information. R. G. Sloan65 argues that investors evaluate earnings holistically and do not distinguish between the persistence of earnings covered by cash flows and the persistence of the rest of earnings. Investors tend to misinterpret the entity’s profitability that results from an increase in net long-​term operating assets. A ‘decomposition’ of earnings makes it possible to study them as smaller components. Earnings considered from this angle should be treated as a set of elements with different persistence. Therefore, we can distinguish here persistent earnings and transitory earnings. The literature on the subject mentions a third component, which is related to accrual estimation error.66 Empirical studies focus on individual components of earnings. Based on an experiment, researchers want to determine which of these parts is marked by persistence –​and which is transient. Transitory earnings are, for instance, the gain/​loss on securities held for sale, or the result on foreign exchange differences. Based on the above, it can be concluded that the components of earnings that are transitory have a negative effect on their persistence. The general approach makes it possible to establish a persistent element of earnings, which enables, in turn, estimating future earnings. From the methodological perspective, there is a difficulty in determining how the persistence of fundamental efficiency impacts the persistence of the reported earnings. It can be therefore assumed that the financial performance and its performance both decrease at the same time, and the management of the affected entity takes measures all measures to offset this process. This kind of circumstance is a temptation for managers not to signal difficulties but to present financial results that can be considered persistent. In consequence, this leads to earnings management and, in marginal situations, to the falsification of the financial statements of business entities.67 Following this line of thought, it can be assumed that business entities that have managed to gain a privileged position in the market and created barriers to entry for potential competitors will be characterised by more persistent financial performance. Empirical studies show that business units that go for technology, the objective of which is to manufacture products at a lower cost from the point of view of the persistence of earnings, do better than those, the strategy of which focuses on the development of an original product –​at a lower turnover.68 According to F. Li,69 there exists a relationship between the readability, legibility of reports, and the persistence of earnings. The most common measures of financial statement readability are the Fog index70 and the length of the financial statement. It is assumed that the longer the report, the less readable and understandable it is to the target audience. Two conclusions can

126  Measures of earnings quality be drawn from the study. First, the lower the earnings, the less readable the report. Second, in companies where earnings are reported and earnings are marked by lower persistence, the reports presenting the financial information are less readable. A statistical negative/​positive relationship was discovered between the extent to which managers used phrases denoting positive/​negative emotions, conditional phrases, and expressions referring to the past and present in the commentary and the persistence of earnings. Research shows that the persistence of earnings is inextricably linked to the market’s perception of earnings. An important area of research on the persistence of earnings is outcome analysis. It refers to the impact on capital markets. It is possible to statistically link the persistence of earnings to a strong investor response. Many researchers71 have proven this relationship to be true. From this point of view, this measure is undoubtedly important when considering the valuation of an enterprise.72 The persistence of earnings and its decomposition into cash flows and accrual adjustments may lead to the impression that accrual adjustments are not a useful part of a financial statement. Studies prove that earnings reconciled on an accrual basis are more persistent over time than cash flows and less volatile than cash flows. Also, they produce smaller estimation errors in valuation models. The relationship between the persistence of earnings and the quality of earnings is debatable. A greater persistence of earnings means that such earnings are more predictable. On the other hand, persistence of earnings can also be the result of earnings smoothing, which may be a strategy aiming to manipulate the amount of or changes to such earnings.

4.4  Decision relevance of earnings The dynamics and, at the same time, the complexity of the processes taking place in the environment of modern businesses have given rise to empirical studies conducted where capital market science and accounting science meet. This is because it is impossible to make the right decision without having access to up-​to-​date and reliable financial information.73 In the information system of a business entity, collected data are transformed into information, provided in the form of various types of reports, useful to their recipients.74 When considering the research on the quality of earnings, an important aspect in this context is the response of the capital market to the financial information reported in financial statements.The discussion in this area should begin with the theory of capital market efficiency, formulated by E. F. Fama in the early 1960s. According to this theory, the capital market fully represents the available information in share prices. An important element of the capital market efficiency theory is the concept of information asymmetry. When investors are in possession of material but undisclosed information, it gives them information advantage, which ultimately leads to undue profits. Information asymmetry is a significant element of the agency cost theory.75

Measures of earnings quality  127 Assuming a semi-​strong form efficiency of information in capital markets, it is possible to assume that the reported financial information has a decision value. Such value is expressed in particular by earnings. R. Kormendi and R. Lipe76 argued for studying the relationship between capital market behaviour and reporting information. Their proposal was not just to find links between reporting information and market response but also to measure the strength of that link. Market response is most often considered from the point of view of earnings but it may also sometimes affect other items included in financial statements. According to P. D. Easton and M. E. Zmijewski,77 information on financial performance made public leads to an adjustment in investor expectations. The degree of share price changes is determined by changes in investors’ expectations of future earnings. R. Kormendi and R. Lipe argue that the effect of so-​called earnings innovation on share return is equal to the relation [1+​PVR].78 Expected future earnings surprises are discounted using the rate of return-​cost of equity. As a result, the larger the discount rate, the smaller the present value of the adjustments, which this translates into a smaller impact of market response. In a market model, a change in the share price can not only be affected by general market information, but also by information specific to a particular company. Two methodological problems arise here. The first problem concerns separating the impact of market-​wide information from the impact of specific information on share prices. The second problem concerns separating the impact of a single piece of information from the impact of company-​specific information on share prices. Researchers have attempted to address this issue by transforming the market model as follows79: Ri,t = α ​i+β ​ i(Rm,t) + μ ​ i,t

[F 4. 8]

where Ri,t –​daily return of company i over t, αi –​constant average daily return on company i’s shares, equal to R f (1 − βi ) , βi –​estimation of the β coefficient for company i, Rm,t –​daily market return over time t, and μi,t –​estimation error of the regression equation over time t. This transformation gave rise to a new methodological approach called event study. In this approach, the research period is divided into so-​called research windows: • • •

before execution (used to estimate a and β parameters for the subject studied), moment of execution (publication of financial statements), and after execution.

128  Measures of earnings quality Parameters a and β are estimated based on 60 months of company share returns. The estimation error should be explained, in turn, as the part of the share return that is a response to the new information, called the abnormal return (AR). In general, the AR rate is calculated for short time periods. For longer periods, the so-​called cumulative abnormal return (CAR) is applied. The measure of market response can be both AR and CAR, depending on the time horizon, as well as the level of volatility of AR and CAR.80 A coefficient defined by W. R. Scott,81 the earnings response coefficient (ERC) ratio, measures how strongly the market responds to surprises included in the reported earnings. The measure was suggested by R. Kormendi and R. Lipe.82 It can be explained as a measure of the effect of one dollar of innovation effort in earnings on share returns, using the following formula: ARi,t + a ​i+β ​ iNWFi,t + e​ t

[F 4. 9]

where ARi,t –​abnormal rate of return on investment of company i over time t and NWFi,t–​earnings surprise of company i at time t, βi–​market response factor –​also referred to as ERC –​for company i. At present, the so-​called valuation model seems to be a very popular concept. It is consistent with J. A. Ohlson’s model and refers to the valuation of a business entity using the book value of equity, as described by the following formula: ARi,t = a ​i+β ​ 1iNAi +​ β2iNWFi,t + e​ t

[F 4. 10]

where NAi –​net assets of entity i and NWFi,t–​earnings surprise of company i at time t. The ERC market response is measured as the sum of the values of parameters β1i and β2i . An additional independent variable is the carrying value of the entity’s net assets. Today, it is the carrying value of nett assets that is more important in interpreting changes in share prices and market value of public companies than earnings. The most important determinants of ERC ratio variation according to S. P. Kothari83 are: the predictive value and the persistence of earnings, entity-​specific risk, risk-​free rate, and the level of growth of the company in question. There are also additional determinants such as the size of the company, the degree of debt, or the quality of corporate governance. Empirical evidence proving that the strength of market response is a function of the persistence of earnings, the

Measures of earnings quality  129 value of the prediction and the discount rate, reflecting the cost of capital, has been provided by R. Lipe in his research.84 J. Godfrey et al. provide empirical evidence proving that an increase in the level of coefficient β reduces the strength of capital market response.85 They indicate that a higher level of risk to which an entity is exposed is marked by a higher discount rate. From this point of view, the risk-​free rate interacts with the strength of the market response. This relationship has been verified to be true by P. D. Easton and M. E. Zmijewski,86 and D.W. Collins and S. P. Kothari87 in their research.88 An important contribution to the area of decision value research is the work of E. Amir, T. E. Harris, and K.Venuti.89 Their research was conducted on a sample of 101 foreign companies that issued securities in the US capital market. In the period 1981–​1991, the SEC recognised reports of foreign companies prepared under their home country regulations.The condition was to convert the amount of profit or loss and equity according to the US Generally Accepted Accounting Standards Board (US GAAP) regulations and present them on Form 20-​F. It was a costly process for foreign issuers to determine profit and loss according to domestic regulations and the US GAAP at the same time, which called into question the rationality of the profit and loss restatements. It was agreed that the result produced following different domestic regulations was as good as that produced in accordance with the US regulations.The researchers set out to analyse the information content from two obtainable variants of earnings. It was concluded that results prepared according to the US GAAP were more useful than those prepared in line with particular national regulations.90 P. F. Pope91 believes that the research results obtained are not as important to accounting as the emergence of a new methodology. This concerns mainly the relative and additional decision content. Relative decision value is calculated as coefficient R 2 from regression models, where earnings obtained under other accounting regulations relative to the same regulation are considered. Regression models are used with additional information content. The result is considered as an independent variable and the other –​as a control variable. Additional decision value can be measured using f and t statistics. This approach makes it possible to examine not only the information content of two outcomes but also the decision value of earnings and another component of the financial check.92 Studies conducted by A. Ali and L. S. Hwang93 over the period of 1986–​1995 showed that the market response was weaker in countries: •

•

where the system of establishing accounting regulations is subject to the legislative authority, and auditors and professional organisations of accountants have no influence on the process of the creation of these regulations; the role of accounting is reduced to settling economic entities’ accounts with tax authorities and their environment, where the banking system is the primary provider of capital; the role of financial reporting is marginalised as banks acquire the necessary –​relevant –​information more quickly than their clients,

130  Measures of earnings quality • •

which belong to the continental system, and where the tax system has major impact on the nature of accounting regulations.

It is possible to notice the strong correlation between reported earnings and taxable income. In this case, there is a strong temptation to manipulate the level of earnings in order to reduce the tax burden. Also, the usefulness and content of the information is negligible. Researchers believe94 that the market responds stronger to the reporting activity of companies that pay a higher audit price.95 Research on the market response to the reported accounting results highlights a dilemma concerning the discrepancies existing between the real ERC value results and the expected results. B. Lev96 claims that the earnings reported in financial statements explain 2%–​5% of a share’s price change over the short term and 4%–​7% over the long term. S. P. Kothari believes that empirical studies of ERC97 values are within the range of 1–​3. Assuming that the rate of return expected by investors is 10%, the value of the coefficient should oscillate at the level of 11% (=​1+​1/​0.1). This phenomenon can be explained by the appearance of ‘new’ information that has already been partially identified. This unexpected part of earnings is determined by the projections of financial analysts, who have access to more specific, detailed information. Another argument provided by S. P. Kothari is the poor information efficiency of capital markets. The market takes time to consume and analyse the information coming from the published reports, and based on the information acquired from these reports, it ‘determines’ the price of shares. The next argument explaining the low level of market responsiveness is the imperfection of accounting regulations in presenting the correct economic results of business entities. The last point to consider when analysing the low level of market response to reported financial results is the transitory nature of the earnings surprise. Market response studies have most often been conducted in the US capital market and on samples of the US-​listed companies. It has been discovered that market response depends on country-​level conditions and on the specific characteristics of a given economic entity. Studies carried out by S. F. Cahan, D. Emanuell, and J. Sun98 prove that market response depends on country-​level factors: law enforcement effectiveness, institutional environment, level of minority shareholder protection, number of financial analysts, and speed of the transmission of financial information. These researchers noticed that the strength of the relationship between accounting performance and share prices depends not only on the quality of share prices but also on the quality of the reported financial results. In the adopted research methodology, other measures of the quality of earnings were used as control variables. It was found that the characteristic high quality of the reported earnings in a given country is not important as there may be a weak market response due to the low level of institutional development of the capital market.99

Measures of earnings quality  131 The past decades have seen a growing interest in the issue of how market response affects decision-​making processes. The market responds to a wide variety of information, not just to information originating from financial reports. Assessing the decision usefulness of reporting information can be the final step in an information audit, the role of which is to provide methods to identify, evaluate, and manage the information resources of any business entity. Stock market investors find information about the general condition of the economy, including announcements of the level of central bank key interest rates, particularly important.

4.5  Earnings smoothing The last method used to examine the quality of earnings described is income smoothing. S. H. Hepworth100 described the increasing role of earnings reporting as well as the factors behind earnings smoothing as early as in the 1950s. In 1964, M. J. Gordon found that managers’ potential to affect the choice of the adopted accounting approach would result in smoother reported financial results and growth rates.101 The literature on the subject offers many studies on smoothing instruments. One such instrument is the assignment of events into specific segments of earnings. This instrument does not affect the value of the financial result in a given period or in subsequent periods. In their study, J. Ronen and S. Sadan102 attributed the effects of selected transactions to business activities or to extraordinary gains and losses. Studies also mention other smoothing instruments, i.e. allocation of costs over time or choice of when to recognise operations. A. Belkaoui and R. D. Picur103 noticed that earnings smoothing is the conscious and intentional reduction of fluctuations in net income or segment performance.They identified three motivators for earnings smoothing: tax benefits, increasing the reliability of earnings predictions, and reducing the cost of capital.104 Their research was continued by D. W. Albrecht and F. M. Richardson,105 but they adopted a different research methodology. They classified business entities into those that smooth their earnings and those that do not smooth them. They applied the coefficient of variation of earnings to the coefficient of variation of sales revenue. They conducted their research with the use of statistics x 2 and analysed the reported earnings by examining the net result and the operating result at different levels. However, there was no significant difference in the frequency of earnings smoothing among the business entities in the two types of sectors considered.106 The instruments used in earnings smoothing are accounting methods, transactions, and estimates. Accounting methods examine the changes in the methods used by business entities. A range of studies on the use of the LIFO method in the valuation of inventories and changes in non-​cash net current assets intended to smooth earnings have been reviewed by A. Hunt, S. E. Moyer, and T. Shelvin.107 Their findings are confirmed by the conducted statistical analyses.

132  Measures of earnings quality Other researchers108 have examined the relationship between earnings smoothing and changes in accounting policies. Using the O. D. Moses indicator,109 they have found that there is no positive correlation between the size of a business entity and the smoothing of its earnings. Many researchers110 over the years have conducted empirical studies on earnings smoothing –​from a variety of possible angles, able to demonstrate the phenomenon’s impact on a more accurate market valuation of public companies. Earnings smoothing tools include also transactions. R. Craig and P. Walsh111 carried out a study in the area of extraordinary earnings, exploring the smoothing of net earnings among listed companies in Australia.Their analysis revealed that companies used extraordinary earnings to smooth the reported earnings and that this process was correlated with the size of the business entity.112 C. R. Beidleman mentions many different possibilities to smooth earnings, especially the significant margin of freedom in the recognition of revenues and expensed costs and managing discretionary costs. This applies to the more favourable and less favourable periods analysed.113 According to C. R. Beidleman’s definition,114 earnings smoothing means an attempt to intentionally reduce the fluctuations of the achieved financial result. It is important to bear in mind that the nature of contemporary accounting, especially the accrual principle, makes income smoothing possible. In a very general way, it can be concluded that the accrued results are marked by a lower volatility with respect to cash flows. By default, they should be more reliable in reflecting an entity’s fundamental performance –​which is not always true, as research proves.115 The literature on the subject offers measures of income smoothing expressed by the following formula116: δ ( EARN ) or ES = Cor ( ∆ACC, ∆CFO) ES = δ (CFO)

[F 4. 11]

where ES –​an indicator denoting the level of smoothing of earnings/​financial results, δ (EARN) –​standard deviation (variability) of earnings, δ (CFO) –​standard deviation (volatility) of cash flows from operations, ΔACC year-​over-​yr change in the amount of accrual adjustments, and ΔCFO year-​over-​year change in the amount of cash flows from operations. J.W.Tucker and P.A. Zarowin,117 in turn, use a measure of earnings smoothing in the form of the correlation between the change in discretionary accrual adjustments and earnings not managed, which can be expressed as follows: ES = Cor ( ∆DACC ′ ∆ ( NI − DACC ) )

[F 4. 12]

Measures of earnings quality  133 where ∆DACC’ –​year-​over-​year change in the amount of accrual adjustments and ∆ ( NI − DACC ) –​year-​over-​year change in the net income minus discretionary accrual adjustments. J. W. Tucker and P. A. Zarowin’s research shows that the current prices of shares which generate earnings that are smoothed reflect a business entity’s future earnings more accurately compared to entities, the earnings of which are smoothed to a smaller extent. Meanwhile, V. Beattie, S. Brown, D. Ewers, B. John, S. Manson, D. Thomas, and M.Tuner118 considered after-​tax earnings smoothing factors before extraordinary results. To this end, they used different components of earnings (decomposition), derived from income statements. They examined factors such as market risk, political costs, agency costs, and ownership structure. Additionally, they created a smoothing index SI: max E − EE − RE − EE SI = where ≤ SI ≤ 1 max Ei − EE − min E − EE

[F 4. 13]

where RE –​reported earnings after tax, before extraordinary results, Ei –​potential after-​tax earnings, taking into account DCIs, representing the financial impact in terms of classification, EE –​expected earnings based on the adopted forecast model, max Ei − EE –​maximum deviation from the expected earnings that could have been achieved, and DCIs – items reported separately in the income statement, for which there is no reporting requirement. The findings of the conducted research show that the smoothing of earnings before extraordinary events is positively correlated with the volatility of earnings (before taking into account the effects of smoothing) and with the occurrence of managerial options.There is also a negative correlation of earnings smoothing with dividend coverage (earnings to dividend ratio) and ownership concentration by outside owners.119 Smoothed earnings increase the credibility of listed companies in their relationships with prospective business partners or customers.The most common reasons for income smoothing include company reputation, predictability, positive impact on public company market valuation, and maintenance of credit rating. Q. Cheng and T. D. Warfield120 have found that managers are susceptible to share price-​related motivators. By not disclosing unexpected values of earnings, they form a reserve for future financial performance. S. Matsuura121 argues in his

134  Measures of earnings quality research that managers use material (tangible) and accounting instruments to smooth earnings. The former include decisions regarding investment and production features.The latter, in turn, include the choice of methods and estimates adopted in accounting. His research findings prove that material methods of earnings smoothing come before accounting instruments. The main research problem here is the information content of earnings from the point of view of earnings smoothing. In the signalling theory, it is assumed that investment policy always predetermined. The selection of funding sources is therefore seen as a vehicle for conveying information about the quality of a business entity. Moreover, people from within a given organisation have access to more information regarding the organisation’s future cash flows compared to outsiders.122 Two opposing theses must be considered in this regard. According to the first, the motive behind earnings smoothing is to provide knowledge and judgement to let managers manage earnings accordingly. In light of the above, it can be assumed that smoothed earnings mean a better quality of the reported earnings. The second thesis, in turn, implies that smoothed earnings translate into distorted information about earnings in general and give a false image of the real situation of the economic entity, and this has negative consequences on the quality of earnings. P. M. Dechow, W. Ge, and C. Schrand123 believe that in the case of a study focusing on a single country, earnings smoothing is considered a sign of higher quality earnings. In contrast, when it comes to studies that encompass different countries –​with different cultural backgrounds, accounting systems, etc. a higher level of smoothing of earnings is considered to be a sign of poorer financial performance. The studies concern not business entities but the institutional and legal environments of particular countries. This can be linked to a poor quality of corporate governance, weaker minority shareholder protection, and other characteristics.124 S. F. Cahan, L. Guoping, and J. Sun125 have examined the significance of the relationships between the smoothing and the information value of earnings, taking into account countries with different levels of investor protection. The analysis has shown that earnings smoothing increases the information value of earnings in the countries that offer strong investor protection. It can be concluded from the research that countries with weaker protection mechanisms, earnings smoothing processes used for opportunistic purposes are more frequent.126 J. McInnis127 begs to differ, claiming that earnings smoothing was treated as a proper feature of earnings in studies conducted before 2000. In contrast, later findings can be interpreted as a negative characteristic that affects the quality of the reported earnings.128 To conclude, earnings smoothing has been studied to a great extent since the 1950s. The strategy of smoothing applies to various aspects of financial performance. To smooth earnings, two primary instruments (material and accounting) are used. There are many studies of earnings smoothing that raise questions about the role of auditors who analyse accounts.

Measures of earnings quality  135 It is also important to stress that in connection with earnings smoothing, the role of auditors is to analyse the instruments and the estimates related thereto. It is important that they pay particular attention to the use of accounting instruments involved in working capital valuation. It is more difficult to address the outcomes of auditors’ efforts in the area of the effects of earnings smoothing when the process of smoothing involves taking advantage of material instruments. Another important aspect to consider is the increasing requirements of auditing standards for estimates since 2009. These procedures are very generally defined in Krajowy Standard Rewizji Finansowej nr 1 –​Polish National Auditing Standard 1.129 Great emphasis is put on the audit of estimated values in the International Standards on Auditing,130 which address this problem in separate standard no. 540 –​ Auditing accounting estimates, including fair value accounting estimates, and related disclosures. References to these values are also included in other standards, including, among others131: ISA 315. –​identifying and assessing the risks of material misstatement through understanding the entity and its environment and ISA 330. –​The auditor’s response to assessed risks.132

Notes 1 A. Piosik, M. Strojek-​Filus, Procesy kształtowania wyników bilansowych, [in:] A. Piosik (ed.), Kształtowanie zysków podmiotów sprawozdawczych w Polsce. MSR/​ MSSF a ustawa o rachunkowości, C. H. Beck, Warsaw 2013, pp. 11–​20. 2 J. Ronen, V. Yaari, Earnings Management. Emerging Insights in Theory, Practice and Research, Springer, New York, NY 2008, pp. 24–​26. 3 K. Schipper, Commentary on Earnings Management, Accounting Horizons, December 1989,Vol. 3, Issue 4, pp. 91–​92. 4 P. M. Dechow, D. J. Skinner, Earnings Management. Reconciling the Views of Accounting Academics, Practitioners and Regulators, Accounting Horizons 2000, Vol. 16, Issue 2, pp. 235–​250. 5 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, Publishing House of the University of Economics in Katowice, Katowice 2016, p. 17. 6 K. Schipper, Commentary on Earnings Management, op. cit., p. 92. 7 P. M. Healy, J. M. Wahlen, A Review of Earnings Management Literature and Its Implications for Standard Setting, Accounting Horizons, December 1999,Vol. 4, Issue 13, pp. 365–​383. 8 M. Chraścina, Kształtowanie wyniku finansowego netto w celu stosowania strategii “wielkich kąpieli” (big bath) na przykładzie spółek notowanych na giełdzie papierów wartościowych w Warszawie, Research Papers of the University of Economics in Katowice, Issue 284, Katowice 2016, p. 163. 9 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 17–​18. 10 P. B. W. Miller, P. R. Bahson, Quality Financial Reporting, McGraw-​Hill, New York, NY 2002, p. 184. 11 The terms ‘listed companies’ and ‘public companies’ will be used interchangeably in the book.

136  Measures of earnings quality 12 J. C. Bedard, K. M. Johnstone, Earnings Manipulation Risk, Corporate Governance Risk, and Auditors, Planning and Pricing Decisions, Accounting Review 2004, Vol. 27, Issue 12, pp. 277–​304. 13 E. N. Asien, It Is Not “Earnings Management” If It Is Not Earnings Management an Epistemological Dialectic, Autumn, Journal of Theoretical Accounting Research 2012, Vol. 24, Issue 1, pp. 73–​89. 14 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 19–​20. 15 Cf.: M. D. Beneish, Incentives and Penalties Related to Earnings Overstatements that Violate GAAP, Accounting Review 1999, Vol. 77, Issue 4, pp. 755–​791; R. L. Rosner, Earnings Manipulation in Failing Firms, Contemporary Accounting Research 2003,Vol. 20, Issue 2, pp. 361–​408; T. H. McKee, Earnings Management An Executive Perspective, South-​Western Division of Thomson Learning, Stamford, CT 2005, pp. 1–​187. 16 T. H. McKee, Earnings Management an Executive Perspective, op. cit., p. 1. 17 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 56–​79. 18 P. M. Healy, J. M. Wahlen, A Review of the Earnings Management Literature and Its Implications for Standard Setting, op. cit., pp. 365–​383. 19 A. Piosik, M. Strojek-​Filus, Procesy kształtowania wyników, op. cit., p. 13. 20 This concerns the terms ‘accounting policy’ and ‘balance sheet policy.’ 21 K. Stępień, Polityka rachunkowości w teorii i w prawnych regulacjach rachunkowości, [in:] B. Micherda (ed.), Teoria rachunkowości a jej współczesne regulacje, Difin, Warsaw 2014, pp. 58–​60. 22 T. Cebrowska, Polityka bilansowa, [in:] T. Cebrowska (red.), Rachunkowość finansowa i podatkowa, PWN, Warsaw 2006, p. 225. 23 P. Kabalski, Polityka rachunkowości w spółce stosującej MSFF, SKwP,Warsaw 2009, p. 11; cited after: A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 23. 24 W. Brzezin, Nauka, polityka i praktyka rachunkowości, Zeszyty Teoretyczne Rady Naukowej Stowarzyszenia Księgowych w Polsce, Issue 32, Warsaw 1995, p. 32. 25 A. Karmańska, Wartość ekonomiczna w systemie informacyjnym rachunkowości finansowej, Difin, Warsaw 2009, pp. 46–​55. 26 Cf.: H. Litwińczuk, Prawo bilansowe i podatkowe podmiotów gospodarczych,Wydawnictwo Konieczny i Kruszewski, Warsaw 1993; J. Weber, M. Kufel (eds.), Wprowadzenie do rachunkowości spółek. Bilansowanie majątku i kapitałów, Wydawnictwo Park, Bielsko-​ Biała 1993; R. Kamiński, Polityka bilansowa a ocena działalności przedsiębiorstwa, Wydawnictwo Ars Boni Et Aequi, Poznań 2003; K. Sawicki, Polityka bilansowa jako element polityki ekonomicznej w zarządzaniu przedsiębiorstwem, [in:] K. Sawicki (ed.), Wykorzystanie polityki bilansowej i analizy finansowej w zarządzaniu przedsiębiorstwem, EKSPERT Wydawnictwo i Doradztwo, Wrocław 2009; E. Walińska, Polityka rachunkowości, błędy lat poprzednich i zmiany szacunków, [in:] E. Walińska (ed.), Rachunkowość finansowa –​ujęcie sprawozdawcze i ewidencyjne, Oficyna Wolter Kluwer Business, Warsaw 2010. 27 A. Piosik, M. Strojek-​Filus, As Assessment of the Application of Earnings Management Objectives and Instruments in Financial Reporting –​Evidence of Survey Research Results, Scientific Annals of the Alexandru Ioan Cuza University of Iasi, Economic Sciences 2013,Vol. 60, Issue 2, pp. 331–​356. 28 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 21–​26.

Measures of earnings quality  137 29 P. M. Dechow, D. J. Skinner, Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators, op. cit., pp. 235–​250. 30 A rational investor interprets the information coming from the environment correctly and uses it to estimate the probability of future events. A. Sławiński, in turn, points to another interpretation of rationality in finance. In financial theory, the expression ‘rationality of investor behaviour’ is narrower than in everyday language. Rational decisions in the common understanding are decisions based on the knowledge available to the individual, determined by certain specific factors in the environment. In contrast, stock market investors’ rationality involves making decisions based on their expectations of the future development of fundamental factors. (Source: A. Sławiński, Rynki finansowe, PWE, Warsaw 2006, p. 159.) 31 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 47–​74. 32 In Polish literature, the term accruals is understood as non-​cash net assets or, more broadly, as accrual adjustments. 33 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 126; 174. 34 J. Michalak, Metody pomiaru i determinanty jakości informacji w raportach spółek giełdowych, Publishing House of the University of Lodz, Łódź 2019, p. 13. 35 Cf. S. A. Richardson, R. G. Solan, M. T. Soliman, I. Tuna, Accrual Reliability, Earnings Persistence and Stock Prices, Journal of Accounting and Economics 2005,Vol. 39, Issue 3, pp. 437–​485. 36 M. Comporek, Determinanty efektywności ekonomicznej aktywów obrotowych przemysłowych spółek giełdowych, Publishing House of the University of Lodz, Łódź 2016, pp. 142–​143; S. A. Richardson, Earnings Quality and Short Sellers, Accounting Horizons 2003,Vol. 17, pp. 41–​69. 37 M. Comporek, Możliwości i ograniczenia wykorzystania modeli memoriałowych korekt zysku netto w detekcji zarządzania zyskiem, Zeszyty Teoretyczne Rachunkowości, SKwP 2018,Vol. 100, Issue 156, p. 56. 38 M. Comporek, Możliwości i ograniczenia wykorzystania modeli memoriałowych korekt zysku netto w detekcji zarządzania zyskiem, op. cit., p. 56. 39 J. J. Jones, Earnings Management during Import Relief Investigations, Journal of Accounting Research 1991,Vol. 29, Issue 2, Autumn, pp. 193–​228. 40 J. J. Jones, Earnings Management during Import Relief Investigations, op. cit., p. 206. 41 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 49. 42 J. J. Jones, Earnings Management during Import Relief Investigations, op. cit., p. 221. 43 P. M. Dechow, R. G. Sloan, A. P. Sweeney, Detecting Earnings Management, The Accounting Review 1995,Vol. 70, Issue 2, April, pp. 193–​225. 44 P. M. Dechow, I. D. Dichev, The Quality of Accruals and Earnings: The Role of Accruals Estimation Errors, The Accounting Review 2002, Supplement: Quality of Earnings Conference,Vol. 77, pp. 35–​59. 45 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 59. 46 Big bath involves intentionally increasing the reported loss in order to show an increase in earnings in future reporting periods. (Source: A. Piosik, Analiza związku wdrożenia MSR/​MSSF z kształtowaniem wyników bilansowych. Badania empiryczne, [in:] A. Piosik (ed.), Kształtowanie zysków podmiotów sprawozdawczych w Polsce. MSR/​ MSSF a ustawa o rachunkowości, C.H. Beck, Warsaw 2013, p. 20.).

138  Measures of earnings quality 47 D. Burgstahler, I. D. Dichev, Earnings Management to Avoid Earnings Decreases and Losses, Journal of Accounting and Economics, 1997,Vol. 24, Issue 1, pp. 99–​126. 48 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 49–​51. 49 R. M. Bowen, D. Burgstahler, L.A. Daley, The Incremental Information Content of Accrual versus Cash Flows, The Accounting Review 1987,Vol. LXII, Issue 4, pp. 723–​747. 50 Earnings provide some information on the level of increment. Estimating unexpected earnings is not based on historical data. Rather, it involves making use of the forecasts provided by financial analysts who have more information content. (Source: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 90.) 51 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 58–​63. 52 P. Wójtowicz, Earnings Management to Achieve Positive Earnings Surprises in Case of Medium Size Companies Listed in Poland, International Journal of Accounting and Economics Studies 2015,Vol. 3, Issue 2, pp. 141–​147. 53 Cf.: P.Wójtowicz, Wiarygodność sprawozdań finansowych wobec aktywnego kształtowania wyniku finansowego, Publishing House of the Cracow University of Economics, Kraków 2010. 54 Cf.: A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, Publishing House of the University of Economics in Katowice, Katowice 2016. 55 Cf.: K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, Publishing House of the Cracow University of Economics, Kraków 2016. 56 P. Wójtowicz, Czy trafność prognoz wyników finansowych spółek notowanych na GPW ma znaczenie, Oficyna Wydawnicza SGH, Zeszyt Naukowy 157, Warsaw 2017, p. 166. 57 S. Das, C. Levine, K. Sivaramakrishnan, Earnings Predictability and Bias in Analysts’ Earnings Forecasts, The Accounting Review 1998,Vol. 73, Issue 2, pp. 277–​294. 58 M. J. Eames, S. M. Glover, Earnings Predictability and the Direction of Analysts’ Earnings Forecast Errors, The Accounting Review 2003,Vol. 78, Issue 3, pp. 749–​780. 59 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 67–​71. 60 F. Degeorge,Y. Ding, T. Jeanjean, H. Stolowy, Analyst Coverage, Earnings Management and Financial Development: An International Study, Journal of Accounting & Public Policy 2013,Vol. 32, Issue 1, pp. 1–​25; cited after: P. Wójtowicz, Czy trafność prognoz wyników finansowych spółek notowanych na GPW ma znaczenie, op. cit., p. 166. 61 O. K. Hope,W. B.Thomas, G.Winterbotham, The Impact of Nondisclosure of Geographic Segment Earnings on Earnings Predictability, Journal of Accounting, Auditing and Finance 2006,Vol. 21, Issue 3, pp. 323–​346. 62 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 72–​74. 63 A. Sajnóg, Siła predykcji zysku całkowitego w kształtowaniu przepływów pieniężnych przedsiębiorstwa, op. cit., p. 188. 64 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 62–​65. 65 R. G. Sloan, Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?, The Accounting Review 1996,Vol. 71, Issue 3, July, pp. 289–​315.

Measures of earnings quality  139 66 P. O. Christensen, G. A. Feltham, F. Sabac, A Contracting Perspective on Earnings Quality, Journal of Accounting and Economics,Vol. 39, Issue 2, p. 270. 67 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 65–​66. 68 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies,Their Determinants and Their Consequences, op. cit., p. 353. 69 F. Li, Annual Report Readability, Current Earnings and Earnings Persistence, Journal of Accounting and Economics 2008,Vol. 45, Issue 2–​3, pp. 221–​247. 70 The Fog index –​measures the number of syllables in each word as well as the number of words in a sentence. The more syllables and words in a sentence, the less readable an entity’s financial statements are. 71 Cf.: B. Lev, R.Thiagarajan, D.W. Collins, S. P. Kothari, An Analysis of Intertemporal and Cross-​sectional Determinants of Earnings Response Coefficients, Journal of Accounting and Economics 1989,Vol. 11, Issue 2–​3, July, pp. 143–​181. 72 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 66–​67. 73 A. Kamela-​Sowińska, Wprowadzenie, [in:] P. Gut (ed.), Kreatywna księgowość a fałszowanie sprawozdań finansowych, C. H. Beck, Warsaw 2006, p. 9. 74 A. Spoz, System informacyjny rachunkowości jako podstawowe źródło informacji do prowadzenia gospodarki finansowej i system generowania informacji o przedsiębiorstwie, [in:] H. Żukowska, A. Spoz, G. Zasuwa (eds.), Sprawozdawczość w procesie zarządzania i oceny działalności przedsiębiorstwa, Publishing House of John Paul II Catholic University of Lublin, Lublin 2016, p. 13. 75 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 80–​81. 76 R. Kormendi, R. Lipe, Earnings Innovation, Earnings Persistence, and Stock Returns, op. cit., pp. 323–​345. 77 P. D. Easton, M. E. Zmijewski, Cross –​Sectional Variation in the Stock-​Market Response to Accounting Earnings Announcements, Journal of Accounting and Economics 1989, Vol. 11, Issue 2–​3, July, p. 118. 78 PVR –​represents the present value ratio of expectation adjustments to the entity’s future earnings. 79 J. Godfrey, A. Hodgson, A. Tarca, J. Hamilton, S. Holmes, Accounting Theory, op. cit., p. 410. 80 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 82–​85. 81 Cf.: W. R. Scott, Financial Accounting Theory, 5th ed., Pearson Education Canada, Toronto 2009. 82 R. Kormendi, R. Lipe, Earnings Innovations, Earnings, Persistence, and Stock Returns, op. cit., p. 326. 83 S. P. Kothari, Capital Markets Research in Accounting, op. cit., pp. 105–​231. 84 R. Lipe, The Relation between Stock Returns and Accounting Earnings Given Alternative Information, The Accounting Review 1990,Vol. 65, Issue 1, January, p. 65. 85 J. Godfrey, A. Hodgson, A. Tarca, J. Hamilton, S. Holmes, Accounting Theory, op. cit., p. 418. 86 P. D. Easton, M. E. Zmijewski, Cross –​Sectional Variation in the Stock-​Market Response to Accounting Earnings Announcements, op. cit., 137. 87 D.W. Collins, S. P. Kothari, An Analysis of Intertemporal and Cross-​Sectional Determinants of Earnings Response Coefficients, op. cit., p. 178.

140  Measures of earnings quality 88 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 86–​87. 89 E. Amir, T. E. Harris, K. Venuti, A Comparison of the Value-​Relevance of U.S. versus Non-​ U.S. GAAP Accounting Measures Using Form 20-​ F Reconciliations, Journal of Accounting Research 1993, Studies on International Accounting, Vol. 31, pp. 230–​264. 90 E. Amir, T. E. Harris, K. Venuti, A Comparison of the Value-​Relevance of U.S. versus Non-​U.S. GAAP Accounting Measures Using Form 20-​F Reconciliations, op. cit., p. 262. 91 P. F. Pope, Discussion of a Comparison of the Value-​Relevance of U.S. versus Non-​U.S. GAAP Accounting Measures Using Form 20-​F Reconciliations, Journal of Accounting Research 1993,Vol. 31, pp. 264–​275. 92 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 88. 93 A. Ali, L. S. Hwang, Country-​Specific Factors Related to Financial Reporting and the Value Relevance of Accounting Data, Journal of Accounting Research 2000, Vol. 38, Issue 1, pp. 1–​2. 94 A. Ali, L. S. Hwang, Country-​Specific Factors Related to Financial Reporting and the Value Relevance of Accounting Data, op. cit., pp. 1–​2. 95 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 91–​92. 96 B. Lev, On the Usefulness of Earnings and Earnings Research: Lessons and Directions from Two Decades of Empirical Research, op. cit., p. 163. 97 The high and positive value of this coefficient means that accounting profit has a big impact on the share valuation process. Comparing the level of this coefficient at different periods can be the basis for evaluating the change in the decision usefulness of profit over time. 98 S. F. Cahan, D. Emanuel, J. Sun, The Effect of Earnings Quality and Country-​Level Institutions on the Value Relevance of Earnings, Review of Quantitative Finance and Accounting 2009,Vol. 33, November, pp. 371–​391. 99 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 90–​92. 100 S. H. Hepworth, Smoothing Periodic Income, Accounting Review 1953, January, Vol. 28, Issue 1, pp. 32–​39. 101 M. J. Gordon, Postulates, Principles and Research in Accounting, Accounting Review 1964,Vol. 39, Issue 2, April, p. 262. 102 J. Ronen, S. Sadan, Do Corporation Use Their Discretion in Classifying Accounting Items to Smooth Reported Income?, Financial Analysis Journal 1975, Vol. 31, Issue 5, September–​October, pp. 62–​68. 103 A. Belkaoui, R. D. Picur, The Smoothing of Income Numbers: Some Empirical Evidence on Systematic Differences between Core and Periphery Industrial Sectors, Journal of Business Finance and Accounting 1984,Vol. 11, Issue 4, Winter, pp. 527–​545. 104 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 27–​28. 105 D. W. Albrecht, F. M. Richardson, Income Smoothing by Economy Sector, Journal of Business Finance and Accounting 1990,Vol. 17, Issue 5, Winter, pp. 713–​730. 106 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 30.

Measures of earnings quality  141 107 A. Hunt, S. E. Moyer, T. Shevlin, Managing Interacting Accounting Measures to Meet Multiple Objectives: A Study of LIFO Firms, Journal of Accounting and Economics 1996,Vol. 21, Issue 3, June, pp. 339–​374. 108 S. M. Saudagaran, J. F. Sepe, Replication of Moses’ Income Smoothing Test with Canadian and UK Data. A Note, Journal Business Finance and Accounting 1996,Vol. 23, Issue 8, October, pp. 1219–​1222. 109 O. D. Moses, Income Smoothing and Incentives: Empirical Tests Using Accounting Changes, The Accounting Review 1987,Vol. LXII, Issue 2, pp. 358–​377. 110 Cf.: L. Bitner, R. C. Dolan, Assessing the Relationship between Income Smoothing and the Value of the Firm, Quarterly Journal of Business and Economics 1996,Vol. 35, Issue 1, Winter, pp. 16–​35; G. G. Booth, J. Kallunki, T. Martikainen, Post-​Announcement Drift and Income Smoothing: Finnish Evidence, Journal of Business Finance and Accounting 1996, Issue 23, October, pp. 1197–​1211;W. N.Wan-​Hussin, N. Ripain, IPO Profit Guarantees and Income Smoothing, Journal Analysis 2003,Vol. 10, Issue 2, pp. 119–​137; J. Grant, G. Markarian, A. Parbonetti, CEO Risk-​Related Incentives and Income Smoothing, Contemporary Accounting Research 2009, Vol. 26, Issue 4, Winter, pp. 1029–​1065. 111 R. Craig, P. Walsh, Adjustments for “Extraordinary Items” in Smoothing Reported Profit of Listed Australian Companies: Some Empirical Evidence, Journal of Business Finance and Accounting 1989, Spring,Vol. 16, Issue 2, pp. 229–​245. 112 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., pp. 28–​29. 113 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 27 and K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 77. 114 C. R. Beidleman, Income Smoothing: The Role of Management, The Accounting Review 1973,Vol. 48, Issue 4, pp. 653–​667. 115 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., pp. 56–​79. 116 D. C. Burgstahler, L. Hail, Ch. Leuz, The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms,The Accounting Review 2006,Vol. 81, Issue 5, p. 1007; F. Ecker, J. Francis, I. Kim, P. Olsson, K. Schipper, A Returns-​ Based Representation of Earnings Quality, The Accounting Review 2006, Vol. 81, Issue 4, p. 760; P. M. Dechow, R. G. Sloan, A. P. Sweeney, Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences, op. cit., p. 362. 117 J. W Tucker, P. A. Zarowin, Does Income Smoothing Improve Earnings Informativeness?, The Accounting Review 2006,Vol. 81, Issue 1, p. 254. 118 V. Beattie, S. Brown, D. Ewers, B. John, S. Manson, D. Thomas, M. Tuner, Extraordinary Items and Income Smoothing: A Positive Accounting Approach, Journal of Business Finance and Accounting 1994,Vol. 21, Issue 6, September, pp. 791–​811. 119 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 31. 120 Q. Cheng, T. D. Warfield, Equity Incentives and Earnings Management, Accounting Review 2005,Vol. 80, Issue 2, pp. 441–​476. 121 S. Matsuura, On the Relation between Real Earnings Management and Accounting Earnings Management: Income Smoothing Perspective, Journal of International Business Research 2008, Supplement 3,Vol. 7, Issue 3, June, pp. 63–​77.

142  Measures of earnings quality 122 J. E. Stiglitz, A. Weiss, Credit Rationing in Markets with Imperfect Information, The American Economic Review 1981,Vol. 71, Issue 3, pp. 393–​410; C. Mróz, Wpływ asymetrii informacji na strukturę kapitału, Inżynieria Mineralna 2016, R. 17, Issue 2, p. 40. 123 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies,Their Determinants and Their Consequences, op. cit., pp. 361–​362. 124 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 78. 125 S. F. Cahan, L. Guoping, J. Sun, Investor Protection, Income Smoothing and Earnings Informativeness, Journal of International Accounting Research 2008,Vol. 7, Issue 1, pp. 1–​24. 126 A. Piosik, Kształtowanie wyniku finansowego przez podmioty sprawozdawcze w Polsce, op. cit., p. 36. 127 J. McInnis, Earnings Smoothness, Average Returns, and Implied Cost of Equity Capital, The Accounting Review 2010,Vol. 85, Issue 1, p. 317. 128 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 78. 129 Krajowy Standard Rewizji Finansowej 1. Ogólne zasady badania sprawozdań finansowych, Resolution no. 1608/​38/​2010 of the National Council of Statutory Auditors of 16 February 2010 on national auditing standards. 130 Międzynarodowe Standardy Rewizji Finansowej i Kontroli Jakości, SKwP, KIBR, IFAC, Warsaw 2009. 131 J. Pfaff, Wartości szacunkowe w kosztach przedsiębiorstwa oraz procedury ich badania zgodnie z międzynarodowymi standardami rewizji finansowej, Research Papers of the Częstochowa University of Technology, Zarządzanie 2016, Vol. 2, Issue 23, pp. 95–​105. 132 International Standards on Auditing will replace Polish National Auditing Standards and will apply for the first time in Poland to the audit of financial statements prepared for the year 2016.

5 Analysis of the impact of cultural determinants on the quality of earnings illustrated with the example of European public companies 5.1  Purpose of the study, research hypotheses, and research methodology The research area analysed is the impact of cultural factors on the quality of earnings of public companies. The level of earnings management can be interpreted in different ways. Both theoretical considerations and empirical studies show that there is a correlation between the level of management, profits, and managerial motivation in the institutional and legal environment, which affects corporate governance. In light of the nature of the decision-​making process, there is a need for correct and reliable information on earnings. Decisions made on the basis of unreliable information raise questions and are interpreted as a given entity’s managers’ attempt to manipulate the reported results. Because of the limitation of financial resources, the continuous increase in the expenses borne by economic units and the emphasis on efficiency and rational use of resources, the interest of participants of decision-​making processes at various levels of management in economic and statistical information is growing. The authorities that shape the institutional environment of the capital market and the quality of the reported earnings play a crucial part in the provision of efficient information –​information that enables its users to make sound and reasonable decisions. Stock exchanges want to attract as many investors as possible, especially foreign investors, providing a sense of security, which surely translates into a high quality of reporting information. The phenomenon of earnings management is an important tool, used effectively to control and limit the financial performance. Identifying the motives behind earnings management offers a way to predict managerial behaviour. Cultural determinants have an impact on the level of earnings management in different countries. Even though certain factors can be controlled, it is the institutional and cultural environment that plays a significant role in making accounting what it is. The research conducted so far has taken into account the impact of cultural determinants on the level of earnings management. It has been, however, limited to the four cultural dimensions developed by G. Hofstede. In recent years, the said range of dimensions has come to include two more dimensions, associated with pragmatic long-​term orientation and DOI: 10.4324/9781003280088-6

144  Analysis of the impact indulgence. The studies conducted have generally addressed the impact of cultural determinants on the management of earnings, while much less research has dealt with other attributes of the quality of earnings –​persistence, predictability, and smoothing. This book aims to fill the existing research gap. The main objective of this study is to analyse the impact of cultural determinants on the quality of earnings illustrated with the example of selected public companies according to G. Hofstede’s model, which will be used as a measure of cultural determinants.The tools applied to verify the determinants of the quality of earnings are parametric methods: Ward’s method and cross-​ sectional regression analysis. The methodological objective has been developed by means of a methodology of studying and evaluating the quality of earnings in public companies in the cultural dimension, using G. Hofstede’s model. To verify the research hypotheses, the values of the following dimensions have been adopted as independent variables (as factors affecting the quality of earnings): • • • • • •

PDI –​power distance (large power distance vs small power distance), IDV –​individualism vs collectivism, MAS –​masculinity vs femininity, UAI –​uncertainty avoidance (strong uncertainty vs weak uncertainty), LTO –​long-​term orientation vs short-​term normative orientation, and IAR –​indulgence vs restraint.

In empirical studies, the quality of earnings is considered as one of the determinants of obtaining reliable information enabling managers to make good decisions. The proper selection of diagnostic characteristics consisted of two stages: substantive selection and formal selection. In many empirical studies, authors provide sets of features based on substantive or formal criteria without a broader discussion of the problem investigated. From the set of the control variables, the author has selected those whose impact on the quality of earnings has been confirmed in other empirical studies. These include: company size (SIZE), return on equity (ROE), total debt ratio (DR), sector affiliation according to NACE classification, accounting regulations (PRA), solvency ratio (RAT), and country wealth calculated as GDP per capita (GDPper) as a tool to assess the effectiveness of object discrimination and parametric method of feature selection. The approaches used most commonly in the literature on the subject have been used to measure the quality of earnings –​especially those that focus on the following earnings quality attributes: accrual adjustments, persistence, predictability, and income smoothing. In order to determine the particular interdependencies between the independent variables, a correlation analysis and a cluster analysis based on Ward’s method have been performed. Inference has been performed using statistical method, including a cross-​sectional regression analysis.

Analysis of the impact  145 The main objective of this study is to analyse the impact of culture-​ specific factors on the quality of earnings using the example of public companies drawing up consolidated financial statements according to International Accounting Standards (IAS)/​ International Financial Reporting Standards (IFRS). The dimensions featured in G. Hofstede’s model have been used as measures of cultural conditions. The purpose of the book has been defined in both theoretical and practical terms.The theoretical area of the book includes an analysis of domestic and foreign literature sources addressing the issue of the quality of earnings in different countries. The practical aim of the book is to identify the determinants –​the cultural factors that have a statistically significant impact (be it positive or negative) on the various attributes of the quality of financial performance of public companies. Research to date has not been able to clearly answer the question of the problem of the impact of the different cultural dimensions on the particular attributes of the quality of earnings. The efforts aimed at the pursuit and achievement of the objective adopted in the study require a verification of the main hypothesis, according to which: H. Cultural determinants significantly affect the quality of earnings in public companies. To verify the main hypothesis to be correct or wrong, the following specific hypotheses have been adopted: H1 Cultural determinants significantly affect the management of earnings public companies; H2 Cultural determinants significantly affect the predictability of earnings public companies; H3 Cultural determinants significantly affect the persistence of earnings public companies; and H4 Cultural determinants significantly affect the smoothing of earnings public companies.

in in in in

The above research hypotheses will be verified using research samples of varying composition –​which is due to the fact that different methodologies are used to measure the various attributes of the quality of earnings and because of the limitations related to the availability of source data. The following section will present important methodological aspects of the measurement of the quality of earnings, which have been applied in the empirical verification of the adopted research hypotheses. There are three different methodological approaches to measuring the phenomenon of earnings in empirical studies. The most commonly used methods are those based on accrual adjustments. These adjustments represent the difference between earnings and cash flow from operating activities. In their research, J. Ronen and V. Yaari1 argue that accrual adjustments occur because of the divergence of transactions over time and the realisation of cash flows associated therewith. For reasons related to access to data, an income statement

146  Analysis of the impact approach has been adopted. This method is less commonly used on account of the unavailability of source data. When considering the measurement of the extent of earnings management at the reporting entity level, the starting point is the determination of so-​called total accruals. The concept, the scope, and the methodology of calculation of accrual adjustments have evolved over time. Choosing the right measurement method is not an easy task because of the significant number of models proposed. Given the availability of the source data for the study, an income statement approach has been used whereby total accrual adjustments have been expressed as: TACCt = ​Nt – ​CFOt

[F 5. 1]

where TACCt –​value of total accrual adjustments to net income in year t, Nt –​net income (earnings) in year t, and CFOt –​cash flows from operations in year t. In such a model, the reported value of accrual differences in the net income, calculated for the i-​st/​nd/​rd/​th entity, should not be directly compared with the value of adjustments reported by other entities –​even if they operate in the same industry. This is because larger scale businesses will report higher net income adjustments. Therefore, in order to make data comparable to at least some degree, the literature on the subject suggests relating the value of net income adjustments to the size of the total assets of the economic entity, which can then provide information on the scale of its business activity.2 This way, the following formula has been used to determine the total accrual differences: TACC’t =

TACCt TA t

[F 5. 2]

where TACC′t –​index of total accrual adjustments to net income in year t, TA t –​value of total assets at the beginning of the year t, and TACCt –​value of total accrual adjustments to net income in year t. The next step in the study is to separate the discretionary accruals portion of the component from the total accrual adjustments. In the structure of the total adjustments to net income, there are both non-​discretionary accruals, representing the so-​called operating adjustments to net income –​NDACC, and discretionary/​abnormal accruals, concerning the non-​operating adjustments to

Analysis of the impact  147 net income –​DACC. This relationship has been expressed by the following formula: TACCt = ​NDACCt + ​DACCt

[F 5. 3]

where TACCt –​value of total accruals in year t, NDACCt –​value of non-​discretionary (operational) accruals in year t, and DACCt –​value of discretionary/​abnormal (intentional) accruals in year t. Many models have been used in the literature on the subject to estimate operating values and intentional (discretionary) adjustments to nett income. For the purposes of this study, the model proposed by J. J. Jones, later modificatied by P. M. Dechow, R. G. Sloan, and A. P. Sweeney (1995), has been used to predict the value of operating and intentional adjustments to net income. On account of data availability and comparability of study results, the following formula has been applied:  1   ∆REVt − ∆RECt   PPEi,t  NDA t = a 1  ε i,t [F 5. 4]  + a2   + a3   + ⏟ A i,t-1  A i,t-1 A i,t -1  NDACC     tDechow ⎭⎥⎥⎥⎥⎥⎥⎥⎥⎥⎨⎥⎥⎥⎥⎥⎥⎥⎥⎥ ⎩ DACCt Dechow where NDAt – ​non-​discretionary portion of accrual adjustments over time t, Ai,t–​1 –​total assets according to the opening balance sheet of the i-​st/​nd/​rd/​th company, ΔREVi,t –​change in sales revenue relative to year t -​ 1 for the i-​st/​nd/​rd/​th company, PPEi,t –​gross value of property, plant, and equipment of the i-​st/​nd/​rd/​th company, and ΔREC –​change in accounts receivable. The model has been applied in the study sample as follows: a cross-​sectional regression was performed for groups of similar companies. The groups were distinguished based on similarities, i.e. company size or sector affiliation. This produced a regression parameter, applied to the i-​st/​nd/​rd/​th company. The result of the calculation is the mismatch value of the model, which is a measure of the extent of earnings management of the i-​st/​nd/​rd/​th company.The size of groups in such studies ranges from 10 to 11 companies, and for each i-​st/​nd/​rd/​ th company in a given year, a group of 9–​10 similar companies is selected and a regression analysis is performed based on this.

148  Analysis of the impact In the study, the quality of earnings is defined as the entirety of features and characteristics of accounting earnings, which determine the usefulness of these earnings for economic decision-​making. The focus here is on three other accounting attributes, which are referred to in the literature on the subject as follows3: • • •

earnings persistence, earnings predictability, and earnings smoothing (also referred to as income smoothing).

A review of the literature on assessing earnings predictability and persistence points to two main approaches usually applied in this area. According to the first approach, parameter persistence estimation is based on a time series analysis of historical data concerning financial performance.4 The second approach involves estimating the persistence of earnings with the use of accounting data essential to assessing the economic health of the reporting entity.5 Under the first approach, earnings persistence is assessed by means of a comparison of the current period’s earnings with the past results. If the difference identified is positive and if this relationship is observed over a longer time horizon, then it is possible to assume and predict that such a trend will continue in the future.6 Hence, to determine the predictability and persistence of earnings, the study has made use of the approach proposed by: J. Francis, R. LaFond, P. M. Olsson, K. Schipper7 Y i,t = β0,i + β1,i *X i,t −1 + ε i,t

[F 5. 5]

where X i ,t −1 –​is net income excluding one-​time and extraordinary events for company i and year t weighted by the total assets the entity had at the beginning of year t. An equation was estimated for each entity in year t. The equation involved using a maximum likelihood calculation relating to a ten-​year time window. Profit predictability is a characteristic related to the usefulness of earnings in predicting their future value. It is a characteristic specific to the individual forecasts made by users of financial information. The high persistence of earnings increases their predictive utility in forecasting the future performance of a business entity, which should translate into lower volatility of a given company’s share prices and a stronger capital market response to any unexpected part of the reported earnings.8 The measure of persistence is β, and the measure of predictability is the root of the standard deviation of the estimation error of the above regression equation9: P = σ 2 ( ε i ,t )

[F 5. 6]

Analysis of the impact  149 These values are determined on the basis of time series regression. An estimation error of the equation can be interpreted as the impact of all other factors –​ other than current period earnings –​on future period earnings. High values of this measure mean low quality of financial performance, while low values of this measure indicate the opposite.10 Earnings persistence is determined by linear regression coefficient β1,i . A value of β1,i close to unity is interpreted as high-​quality earnings. If this value is close to zero, then the earnings will be marked by high volatility.11 To assess earnings smoothing, C. Leuz, D. Nanda, and P. Wysocki12 used cash flow from operations (CFO) as a counterpart to non-​smoothed earnings, measuring smoothing as an indicator that described the relationship of earnings volatility to cash flow volatility. R. M. Bowen, S. Rajgopal, and M. Venkatachalam13 measured earnings smoothing as the ratio of the standard deviation of operating cash flow to the standard deviation of earnings. Also, J. Francis, R. LaFond, P. M. Olsson, and K. Schipper14 measured earnings smoothing as the standard deviation relationship of net income minus one-​ time and extraordinary events, but preserved the comparability of the data analysed by dividing the parameters by beginning-​of-​year assets.15 The study uses the approach proposed by J. Francis, R. LaFond, P. M. Olsson, K. Schipper, expressed by the following formula: WZ =

(

δ EARN j,t

(

δ CFO j,t

)

)

[F 5. 7]

where

δ ( EARN j,t ) –​is net income excluding one-​time and extraordinary events for company i and year t weighted by the total assets the entity had at the beginning of year t and δ (CFO j,t ) –​standard deviation of operating cash flows of company j in year t. Although the study employs an earnings quality assessment methodology described at length in the literature on the subject and proven in other studies, it is important to highlight some interpretative problems associated with it. This is true for one of the earnings quality attributes analysed –​earnings smoothing, the result of which can be interpreted in many different ways. On the one hand, smoothed earnings may imply that it has been intentionally designed to look as it does by the managers of the reporting company. This is typical of low-​quality earnings. On the other hand, it may mean that earnings are marked by a high level of decision usefulness.16 P. M. Dechow, W. Ge, and C. Schrand have found that in the case of a study focusing on a single country, earnings smoothing is considered a sign of higher quality earnings. In cross-​ country comparative studies, a higher level of earnings smoothing implies

150  Analysis of the impact a poorer quality of earnings.17 Therefore, the study assumes that a high quality of earnings is equated with low levels of all indicators. Evaluating the impact of earnings quality on cultural determinants involves two steps. In step one, four measures of earnings quality, i.e. accrual adjustments, earnings persistence, earnings predictability, and earnings smoothing, were calculated for each i-​st/​nd/​rd/​th company included in the study in each year –​using the methodologies described above. The value of each of the three indicators was estimated using a time series of nine years of data. The second step of the study was to create regression models to examine the relationship between the response variable and the explanatory variables.

5.2  Study sample characteristics and study period The empirical material consists of financial data of public companies and of macroeconomic data for selected countries of the world. The sample selection involved choosing between public and other companies. Public companies tend to have higher accounting quality, so the empirical material provided by such companies should be more extensive and of better quality. The financial information of public companies is made available to the general public in the form of annual reports. It should be stressed that the more entities verifying the financial and accounting data of public companies, the higher the quality of accounting and financial decisions made. Public companies are subject to strict and demanding financial and non-​financial disclosure regulations. The size of the study sample varies depending on the measure of earnings quality, i.e.: accrual adjustments, earnings persistence, earnings predictability, and earnings smoothing. The research data for individual companies consist of balance sheets, income statements, and cash flow statements. The main value of the empirical material collected is the universality and accessibility of the data. Another important feature of the empirical material in question in this study is its comparability. IAS/​ IFRS impose an obligation to present comparable data, the effect of which is empirical material produced with the use of similar methods of measurement and presentation of balance sheet and earnings items.The challenge in analysing data in international studies, when a study sample is composed of thousands of companies from different countries, with an average period of six to eight years, is to acquire accounting data directly from financial statements.The Orbis database was used to this end. Entities that met certain criteria were selected from the database (Table 5.1). In contrast, the data on the GDPper dynamics come from the Eurostat database and from the World Bank’s Statistics Office. Due to the lack of financial data and the incomparability of the countries included in the study, the number of companies analysed was reduced further. Countries characterised by an unstable political situation, poor infrastructure development, and low level of people’s professional qualifications were excluded because the least developed countries attract relatively little direct economic investment. The final number of companies analysed –​presented

Analysis of the impact  151 Table 5.1 Size and characteristics of the study sample –​initial stage Selected criteria

Specification of choice

Company status Active Size classification Very large, large, medium, small Part of the world/​ North America, Western Europe, country/​region Eastern Europe, Scandinavia, Baltic within a country states, Balkan countries, Middle East, Far East and Central Asia, South and Central America, Africa, Oceania Application of IAS/​IFRS accounting Consolidation C1 (Consolidated accounts without code an unconsolidated companion) Accounting Corporate governance Total companies searched

Total number Search results of companies 240,632,230 240,632,230 319,042,847 240,632,230 316,883,336 238,493,417

2,745,646

2,398,047

1,865,378

82,641

318,903,512

81,625 81,625

Source: Author’s own work.

Figure 5.1 Study sample by country. Source: Author’s own work.

according to NACE classification –​is shown in Table 5.2. Figure 5.1 shows the different geographic regions of the public companies included in the study. The study was conducted on a sample of consolidated reports of public companies, prepared in line with IAS/​IFRS and covering a period of nine

152  Analysis of the impact Table 5.2 Number of companies by sector classification based on search criteria No.

NACE

Sector

1 2 3 4 5

A B C D E

6 7

F G

8 9 10 11 12 13 14 15

H I J K L M N O

16 17 18 19 20

P Q R S T

21

U In total

Agriculture, forestry, and fishing Mining and quarrying Manufacturing Electricity, gas, steam, and air conditioning supply Water supply; sewerage, waste management, and remediation activities Construction Wholesale and retail trade; repair of motor vehicles and motorcycles Transporting and storage Accommodation and food service activities Information and communication Financial and insurance activities Real estate activities Professional, scientific, and technical activities Administrative and support service activities Public administration and defence; compulsory social security Education Health and social work activities Arts, entertainment, and recreation Other service activities Activities of households as employers; undifferentiated goods –​and services –​producing activities of households for own use Activities of extraterritorial organisations and bodies

Total 288 2,040 7,294 458 123 616 1,349 514 330 1,558 3,011 874 1,110 567 60 84 267 165 606 1 1 21,316

Source: Author’s own work.

years –​from 2010 to 2018. The data for the study were obtained from the Orbis database, which contains a dataset for 69 countries. The observations are company-​year observations. In subsequent phases of the study, the baseline sample will be adjusted for those observations for which there are no sufficient data required to estimate the particular attributes of earnings quality. As a result of the analysis of the information listed above, companies that did not meet the accrual adjustment guidelines used for the study were excluded from the sample. Observations for which it was not possible to estimate the discretionary accrual adjustments were excluded from the study. Another limitation on the number of observations comes from the lack of data to use regression analysis. After taking these limitations into account, the final sample amounted to 68,077 observations at the company and year level for the accrual adjustments quality characteristic (Table 5.3). Table 5.4 presents the size of the study sample by country, listing countries included in the empirical analysis.

Analysis of the impact  153 Table 5.3 Sample size for the study of accrual adjustments Specification

Adjustment

Study sample

Initial sample size Exclusion of observations for which it was not possible to estimate the J. J. Jones model Exclusion of data for which it was not possible to estimate a regression equation from the study

–​ (110,275)

191,844 81,569

(13,492)

68,077

Source: Author’s own work.

Confucian Asian culture 7.28%

South Asian culture 22.97%

Latin European culture 10.41%

Eastern European culture 10.59%

Latin American culture 7.37%

Nordic culture 8.00% Middle Eastern culture 0.46% Germanic culture 4.73% English culture 28.18%

Figure 5.2 Structure of the study sample by cultural circle –​accrual adjustments. Source: Author’s own work.

Figure 5.2 shows the structure of the study sample by cultural circle for accrual adjustments. The study sample for the persistence attribute was developed based on the data that met the set criteria (see Tables 5.1 and 5.2). Due to the lack of financial data for which it was not possible to estimate the persistence characteristic, the number of companies studied was reduced. Another portion of observations was excluded due to the lack of data to use regression analysis (Table 5.5). The final number of companies from each country is shown in Table 5.6. The study sample consisted of 79,964 observations from 69 countries around the world. Figure 5.3 shows the structure of the study sample by cultural circle.

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No.

Country

Cultural circle

2011

2012

2013

2014

2015

2016

2017

2018

In total

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Saudi Arabia Argentina Armenia Australia Austria Belgium Bosnia and Herzegovina Brazil Bulgaria Chile China Croatia Cyprus Montenegro Denmark Egypt Ecuador Estonia Russian Federation Finland France Greece Georgia Spain The Netherlands India Ireland Iceland

South Asian culture Latin American culture Middle Eastern culture English culture Germanic culture Nordic culture Eastern European culture Latin American culture Eastern European culture Latin American culture Confucian Asian culture Eastern European culture Eastern European culture Eastern European culture Nordic culture Middle Eastern culture Latin American culture Eastern European culture Eastern European culture Nordic culture Latin European culture Eastern European culture Eastern European culture Latin European culture Germanic culture South Asian culture English culture English culture

96 49 0 605 41 78 3 206 8 141 92 46 34 0 80 2 0 8 5 90 354 141 3 7 79 1,778 29 11

103 51 0 614 43 81 7 213 9 151 98 49 43 0 79 2 0 8 6 90 363 130 3 8 78 1,839 27 12

109 55 5 621 43 87 14 221 13 157 109 59 54 7 83 1 0 8 7 94 368 129 3 11 86 1,968 28 11

114 38 5 649 43 83 26 220 23 163 114 69 56 7 84 2 1 8 7 98 377 128 3 89 95 2,051 30 13

118 52 5 685 45 85 81 203 23 159 117 72 58 8 87 3 2 12 7 103 386 120 3 102 93 2,158 31 14

121 79 6 693 44 93 119 214 22 167 129 73 54 8 88 3 2 12 7 111 385 113 3 130 97 2,279 33 14

119 85 6 728 45 94 133 220 23 169 127 70 53 8 93 3 3 12 7 115 399 108 2 145 100 2,219 33 15

112 95 5 765 40 87 43 216 24 155 124 61 34 5 97 2 3 11 5 115 370 101 1 149 99 64 31 16

892 504 32 5,360 344 688 426 1,713 145 1,262 910 499 386 43 691 18 11 79 51 816 3,002 970 21 641 727 14,356 242 106

154  Analysis of the impact

Table 5.4 Study sample size by country and year-​accrual adjustments

Israel Japan Cayman Islands Canada Qatar Kazakhstan Colombia Kuwait Liechtenstein Lithuania Luxembourg Latvia Macedonia Malta Morocco Mexico Monaco Germany Norway New Zealand Panama Peru Poland Portugal Czech Republic Republic of Korea Romania Serbia Singapore Slovakia Slovenia

Latin European culture Confucian Asian culture English culture English culture Middle Eastern culture Eastern European culture Latin American culture Middle Eastern culture Nordic culture Eastern European culture Nordic culture Eastern European culture Eastern European culture Latin European culture Middle Eastern culture Latin American culture Latin European culture Germanic culture Nordic culture English culture Latin American culture Latin American culture Eastern European culture Latin European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture

271 0 0 893 0 0 3 0 0 17 28 10 9 13 11 99 0 192 80 78 10 24 164 38 6 3 7 3 477 2 6

273 1 0 843 0 0 2 0 0 18 29 10 9 13 11 102 0 196 85 85 14 30 202 36 6 3 8 4 497 2 7

263 1 0 802 0 0 8 0 0 19 31 10 25 14 10 102 0 195 93 96 20 34 228 38 8 3 32 12 511 2 17

265 1 0 761 0 0 29 0 0 23 31 11 46 17 12 104 0 196 94 101 21 44 263 36 8 1 34 95 522 2 20

256 1 0 740 0 0 30 0 0 25 32 11 46 19 12 107 0 212 100 104 20 47 283 39 8 0 36 101 525 3 22

255 1 0 718 0 0 32 0 0 25 37 11 44 19 11 117 0 215 101 111 20 53 292 39 10 0 36 141 528 3 20

249 1 0 702 0 0 35 0 0 25 38 11 44 18 11 115 0 214 107 113 25 52 288 41 10 0 35 141 522 2 18

183 1 0 638 0 0 37 0 0 22 38 9 23 21 12 113 0 200 85 110 30 51 271 38 8 0 33 104 449 2 14

2,015 7 0 6,097 0 0 176 0 0 174 264 83 246 134 90 859 0 1,620 745 798 160 335 1,991 305 64 10 221 601 4,031 18 124 (continued)

Analysis of the impact  155

29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59

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No.

Country

60 USA 61 Switzerland 62 Sweden 63 Turkey 64 Ukraine 65 Hungary 66 Great Britain 67 Italy 68 Virgin Islands (British) 69 United Arab Emirates In total Source: Author’s own work.

Cultural circle

2011

2012

2013

2014

2015

2016

2017

2018

In total

English culture Germanic culture Nordic culture Middle Eastern culture Eastern European culture Eastern European culture English culture Latin European culture English culture South Asian culture

7 62 224 27 3 10 701 10 0 49 7,523

6 66 245 26 3 10 733 11 0 48 7,741

3 68 269 25 7 17 758 21 0 47 8,140

4 66 285 22 200 16 809 163 0 48 8,946

4 68 310 19 185 20 869 173 0 49 9,308

4 67 333 17 187 19 918 194 0 52 9,729

4 68 343 18 185 19 942 208 0 47 9,785

3 66 236 20 169 18 813 210 0 48 6,905

35 531 2,245 174 939 129 6,543 990 0 388 68,077

156  Analysis of the impact

Table 5.4 Cont.

Analysis of the impact  157 Table 5.5 Study sample size in the persistence study Specification

Adjustment

Study sample

Initial sample size Exclusion of observations for which it was not possible to estimate persistence Exclusion of data for which it was not possible to estimate a regression equation from the study

–​ (96,871)

191,844 94,973

(15,009)

79,964

Source: Author’s own work. Confucian Asian culture 6.03% Eastern European culture 7.27%

Latin European culture 9.93%

South Asian culture 20.75%

Nordic culture 6.60% English culture 40.37%

Latin American culture 4.57% Middle Eastern culture 0.34%

Germanic culture 4.15%

Figure 5.3 Structure of the study sample by cultural circle –​persistence. Source: Author’s own work.

In order to verify the specific hypothesis H2, it was necessary to calculate the qualitative characteristic of predictability. The result obtained was referred to the initial data that met the set criteria (see Tables 5.1 and 5.2). The lack of financial data necessary to conduct the study for some of the explanatory variables translated into a reduced number of public companies under consideration. In light of the lack of data to use regression analysis, the study sample was further reduced (Table 5.7). Table 5.8 presents the study sample size by country and year. Figure 5.4 shows the structure of the study sample by cultural circle. The study sample for the earnings smoothing attribute was developed based on the data that met the set criteria (see Tables 5.1 and 5.2). Due to the lack of financial data to estimate the earnings smoothing attribute, the number of companies studied was reduced. Another portion of observations was excluded

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No. Country

Cultural circle

2010

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

South Asian culture Latin American culture Middle Eastern culture English culture Germanic culture Nordic culture Eastern European culture Latin American culture Eastern European culture Latin American culture Confucian Asian culture Eastern European culture Eastern European culture Eastern European culture Nordic culture Middle Eastern culture Latin American culture Eastern European culture Eastern European culture Nordic culture Latin European culture Eastern European culture Eastern European culture Latin European culture Germanic culture South Asian culture English culture English culture

79 86 88 98 100 105 29 29 31 31 30 30 0 0 0 0 0 0 840 967 1,062 1,085 1,117 1,132 34 38 41 41 41 42 79 78 80 79 81 84 0 1 2 5 9 13 128 146 156 161 166 164 4 9 11 13 19 27 89 97 101 98 98 101 71 73 77 81 84 91 17 46 46 53 61 66 65 66 70 68 71 72 0 0 0 0 0 0 68 78 77 78 84 84 2 2 2 1 1 2 0 0 0 0 0 0 10 12 12 12 12 12 2 2 4 5 5 5 82 86 84 85 92 97 327 337 352 351 362 371 135 134 126 123 120 115 0 0 0 0 0 0 81 84 78 74 83 90 68 68 69 72 75 81 1,678 1,773 1,848 1,887 1,922 1,961 20 22 25 28 31 36 7 7 7 8 8 9

Saudi Arabia Argentina Armenia Australia Austria Belgium Bosnia and Herzegovina Brazil Bulgaria Chile China Croatia Cyprus Montenegro Denmark Egypt Ecuador Estonia Russian Federation Finland France Greece Georgia Spain The Netherlands India Ireland Iceland

2011

2012

2013

2014

2015

2016 109 30 0 1,210 42 89 21 162 26 99 105 64 71 0 88 3 0 12 6 104 385 112 0 96 89 2,063 38 11

2017

2018

111 110 33 38 1 1 1,278 1,371 43 40 92 90 23 9 168 179 27 27 102 105 109 111 60 54 70 48 0 0 92 95 3 2 0 0 12 11 6 7 111 115 391 372 113 107 0 0 99 138 100 103 2,120 66 40 36 14 15

Overall 886 281 2 10,062 362 752 83 1,430 163 890 802 467 601 0 744 18 0 105 42 856 3,248 1,085 0 823 725 15,318 276 86

158  Analysis of the impact

Table 5.6 Study sample size by country and year-​persistence

Israel Japan Cayman Islands Canada Qatar Kazakhstan Colombia Kuwait Liechtenstein Lithuania Luxembourg Latvia Macedonia Malta Morocco Mexico Monaco Germany Norway New Zealand Panama Peru Poland Portugal Czech Republic Republic of Korea Romania Serbia Singapore Slovakia Slovenia USA

Latin European culture Confucian Asian culture English culture English culture Middle Eastern culture Eastern European culture Latin American culture Middle Eastern culture Nordic culture Eastern European culture Nordic culture Eastern European culture Eastern European culture Latin European culture Middle Eastern culture Latin American culture Latin European culture Germanic culture Nordic culture English culture Latin American culture Latin American culture Eastern European culture Latin European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture English culture

229 236 245 250 245 251 0 0 0 0 0 1 0 0 0 0 0 0 1,107 1,302 1,482 1,511 1,529 1,485 0 0 0 0 0 0 0 0 0 0 0 0 1 2 4 8 18 17 0 0 0 0 0 0 0 0 0 0 0 0 0 16 17 19 21 22 17 17 25 26 24 27 10 10 10 10 11 11 8 10 10 20 37 37 8 9 10 11 12 14 10 12 12 12 12 11 57 61 63 65 68 71 0 0 0 0 0 0 156 165 167 169 180 187 61 67 71 74 74 81 72 77 84 88 94 102 6 6 6 7 9 9 15 18 23 23 29 31 139 158 199 225 253 277 33 33 32 34 33 36 3 3 3 7 7 7 0 0 0 2 3 1 5 5 7 32 33 35 2 3 4 8 7 7 352 407 425 447 463 475 1 2 2 2 2 2 7 7 7 15 18 18 6 5 6 4 6 6

258 1 0 1,623 0 0 21 0 0 23 32 11 37 15 13 78 0 197 89 105 10 33 284 36 7 1 33 19 492 2 17 7

258 202 1 1 0 0 1,732 1,486 0 0 0 0 19 19 0 0 0 0 23 22 33 32 11 9 36 19 17 17 13 13 83 84 0 0 203 198 93 77 138 117 11 11 35 30 287 276 36 32 8 7 1 1 34 32 14 8 504 442 2 2 17 15 8 11

2,174 4 0 13,257 0 0 109 0 0 163 233 93 214 113 108 630 0 1,622 687 877 75 237 2,098 305 52 9 216 72 4,007 17 121 59 (continued)

Analysis of the impact  159

29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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No. Country

Cultural circle

2010

61 Switzerland 62 Sweden 63 Turkey 64 Ukraine 65 Hungary 66 Great Britain 67 Italy 68 Virgin Islands (British) 69 United Arab Emirates In total

Germanic culture Nordic culture Middle Eastern culture Eastern European culture Eastern European culture English culture Latin European culture English culture South Asian culture

61 63 66 68 68 69 70 72 71 171 185 196 200 208 233 266 309 234 16 16 16 16 16 16 16 17 18 1 2 2 3 23 13 10 7 9 12 12 12 19 18 19 18 19 19 625 674 708 745 806 915 971 1,041 919 119 122 122 130 137 145 150 174 182 12 16 25 29 35 34 38 39 30 41 41 40 38 39 44 46 49 49 7,278 8,003 8,550 8,854 9,210 9,499 10,064 10,562 7,944

Source: Author’s own work.

2011

2012

2013

2014

2015

2016

2017

2018

Overall 608 2,002 147 70 148 7,404 1,281 258 387 79,964

160  Analysis of the impact

Table 5.6 Cont.

Analysis of the impact  161 Table 5.7 Study sample size in the predictability study Specification

Adjustment

Study sample

Initial sample size Exclusion of observations for which it was not possible to estimate predictability Exclusion of data for which it was not possible to estimate a regression equation from the study

–​ (96,884)

191,844 94,960

(15,007)

79,953

Source: Author’s own work

Confucian Asian culture 7.28%

South Asian culture 22.97% Latin European culture 10.41%

Eastern European culture 10.59%

Latin American culture 7.37%

Nordic culture 8.00% Middle Eastern culture 0.46%

Germanic culture 4.73% English culture 28.18%

Figure 5.4 Structure of the study sample by cultural circle for the predictability attribute. Source: Author’s own work.

due to the lack of data to use regression analysis (Table 5.9). The final number of companies from each country is shown in Table 5.10. The study sample consisted of 8,678 response variables from 69 countries. Figure 5.5 shows the structure of the study sample by cultural circle.

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No. Country

Cultural circle

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

South Asian culture Latin American culture Middle Eastern culture English culture Germanic culture Nordic culture Eastern European culture Latin American culture Eastern European culture Latin American culture Confucian Asian culture Eastern European culture Eastern European culture Eastern European culture Nordic culture Middle Eastern culture Latin American culture Eastern European culture Eastern European culture Nordic culture Latin European culture Eastern European culture Eastern European culture Latin European culture Germanic culture South Asian culture English culture English culture

Saudi Arabia Argentina Armenia Australia Austria Belgium Bosnia and Herzegovina Brazil Bulgaria Chile China Croatia Cyprus Montenegro Denmark Egypt Ecuador Estonia Russian Federation Finland France Greece Georgia Spain The Netherlands India Ireland Iceland

2010 79 29 0 840 34 79 0 128 4 89 71 17 65 0 68 2 0 10 2 82 326 135 0 81 67 1,675 20 7

2011 86 29 0 967 38 78 1 146 9 97 73 46 66 0 78 2 0 12 2 86 337 134 0 84 68 1,774 22 7

2012 88 31 0 1,062 41 80 2 156 11 101 77 46 70 0 77 2 0 12 4 84 352 126 0 78 69 1,848 25 7

2013 98 31 0 1,085 41 79 5 161 13 98 81 53 68 0 78 1 0 12 5 85 351 123 0 74 72 1,887 28 8

2014 100 30 0 1,117 41 81 9 166 19 98 84 61 71 0 84 1 0 12 5 92 362 120 0 83 75 1,922 31 8

2015 105 30 0 1,132 42 84 13 164 27 101 91 66 72 0 84 2 0 12 5 97 371 115 0 90 81 1,961 36 9

2016 109 30 0 1,210 42 89 21 162 26 99 105 64 71 0 88 3 0 12 6 104 385 112 0 96 89 2,063 38 11

2017 111 33 1 1,278 43 92 23 168 27 102 109 60 70 0 92 3 0 12 6 111 391 113 0 99 100 2,120 40 14

2018

Overall

110 886 38 281 1 2 1,371 10,062 40 362 90 752 9 83 179 1,430 27 163 105 890 111 802 54 467 48 601 0 0 95 744 2 18 0 0 11 105 7 42 115 856 372 3,247 107 1,085 0 0 138 823 103 724 66 15,316 36 276 15 86

162  Analysis of the impact

Table 5.8 Study sample size by country and year-​predictability

Israel Japan Cayman Islands Canada Qatar Kazakhstan Colombia Kuwait Liechtenstein Lithuania Luxembourg Latvia Macedonia Malta Morocco Mexico Monaco Germany Norway New Zealand Panama Peru Poland Portugal Czech Republic Republic of Korea Romania Serbia Singapore Slovakia Slovenia

Latin European culture Confucian Asian culture English culture English culture Middle Eastern culture Eastern European culture Latin American culture Middle Eastern culture Nordic culture Eastern European culture Nordic culture Eastern European culture Eastern European culture Latin European culture Middle Eastern culture Latin American culture Latin European culture Germanic culture Nordic culture English culture Latin American culture Latin American culture Eastern European culture Latin European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture

229 0 0 1,107 0 0 1 0 0 0 17 10 8 8 10 57 0 156 61 67 6 15 138 33 3 0 5 2 351 1 7

236 0 0 1,302 0 0 2 0 0 16 17 10 10 9 12 61 0 165 67 77 6 18 158 33 3 0 5 3 407 2 7

245 0 0 1,482 0 0 4 0 0 17 25 10 10 10 12 63 0 167 71 84 6 23 199 32 3 0 7 4 425 2 7

250 0 0 1,511 0 0 8 0 0 19 26 10 20 11 12 65 0 169 74 88 7 23 225 34 7 2 32 8 447 2 15

245 0 0 1,529 0 0 18 0 0 21 24 11 37 12 12 68 0 180 74 94 9 29 253 33 7 3 33 7 463 2 18

251 1 0 1,485 0 0 17 0 0 22 27 11 37 14 11 71 0 187 81 102 9 31 277 36 7 1 35 7 475 2 18

258 1 0 1,623 0 0 21 0 0 23 32 11 37 15 13 78 0 197 89 105 10 33 284 36 7 1 33 19 492 2 17

258 1 0 1,732 0 0 19 0 0 23 33 11 36 17 13 83 0 203 93 138 11 35 287 36 8 1 34 14 504 2 17

202 2,174 1 4 0 0 1,486 13,257 0 0 0 0 19 109 0 0 0 0 22 163 32 233 9 93 19 214 17 113 13 108 84 630 0 0 198 1,622 77 687 117 872 11 75 30 237 276 2,097 32 305 7 52 1 9 32 216 8 72 442 4,006 2 17 15 121 (continued)

Analysis of the impact  163

29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59

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No. Country

Cultural circle

2010

2011

2012

2013

2014

2015

2016

2017

2018

Overall

60 USA 61 Switzerland 62 Sweden 63 Turkey 64 Ukraine 65 Hungary 66 Great Britain 67 Italy 68 Virgin Islands (British) 69 United Arab Emirates In total

English culture Germanic culture Nordic culture Middle Eastern culture Eastern European culture Eastern European culture English culture Latin European culture English culture South Asian culture

6 5 6 4 6 6 7 8 11 59 61 63 66 68 68 69 70 72 71 608 171 185 196 200 208 233 266 309 234 2,002 16 16 16 16 16 16 16 17 18 147 1 2 2 3 23 13 10 7 9 70 12 12 12 19 18 19 18 19 19 148 625 674 708 745 806 915 971 1,041 919 7,404 119 122 122 130 137 145 150 174 182 1,281 12 16 25 29 35 34 38 39 30 258 41 41 40 38 39 44 46 49 49 387 7,266 8,004 8,550 8,854 9,210 9,499 10,064 10,562 7,944 79,953

164  Analysis of the impact

Table 5.8 Cont.

Analysis of the impact  165 Table 5.9 Sample size for the study of earnings smoothing Specification

Adjustment

Study sample

Initial sample size Exclusion of observations for which it was not possible to estimate earnings smoothing Exclusion of data for which it was not possible to estimate a regression equation from the study

–​ (5,279)

21,316 16,037

(7,359)

8,678

Source: Author’s own work.

Confucian Asian culture 6.82% Eastern European culture 9.77%

South Asian culture 2.85%

Latin American culture 8.03% Middle Eastern culture 0.43%

Latin European culture 11.86%

Nordic culture 8.11%

English culture 47.17%

Germanic culture 4.97%

Figure 5.5 Structure of the study sample by cultural circle for the earnings smoothing attribute. Source: Author’s own work.

Table 5.10 Study sample size by country and year-​earnings smoothing No.

Country

Cultural circle

1 2 3 4 5 6 7 8 9 10

Saudi Arabia Argentina Armenia Australia Austria Belgium Bosnia and Herzegovina Brazil Bulgaria Chile

South Asian culture Latin American culture Middle Eastern culture English culture Germanic culture Nordic culture Eastern European culture Latin American culture Eastern European culture Latin American culture

Overall 121 81 3 1,467 42 94 15 220 24 167 (continued)

166  Analysis of the impact Table 5.10 Cont. No.

Country

Cultural circle

Overall

11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58

China Croatia Cyprus Montenegro Denmark Egypt Ecuador Estonia Russian Federation Finland France Greece Georgia Spain The Netherlands India Ireland Iceland Israel Japan Cayman Islands Canada Qatar Kazakhstan Colombia Kuwait Liechtenstein Lithuania Luxembourg Latvia Macedonia Malta Morocco Mexico Monaco Germany Norway New Zealand Panama Peru Poland Portugal Czech Republic Republic of Korea Romania Serbia Singapore Slovakia

Confucian Asian culture Eastern European culture Eastern European culture Eastern European culture Nordic culture Middle Eastern culture Latin American culture Eastern European culture Eastern European culture Nordic culture Latin European culture Eastern European culture Eastern European culture Latin European culture Germanic culture South Asian culture English culture English culture Latin European culture Confucian Asian culture English culture English culture Middle Eastern culture Eastern European culture Latin American culture Middle Eastern culture Nordic culture Eastern European culture Nordic culture Eastern European culture Eastern European culture Latin European culture Middle Eastern culture Latin American culture Latin European culture Germanic culture Nordic culture English culture Latin American culture Latin American culture Eastern European culture Latin European culture Eastern European culture Confucian Asian culture Eastern European culture Eastern European culture Confucian Asian culture Eastern European culture

127 59 57 5 106 2 2 10 6 120 387 121 1 145 109 66 38 15 234 1 0 1,447 0 0 38 0 0 21 40 8 16 30 13 114 0 204 89 131 25 50 270 39 8 3 33 51 461 2

Analysis of the impact 167 Table 5.7 Cont. No.

Country

Cultural circle

Overall

59 60 61 62 63 64 65 66 67 68 69 In total

Slovenia USA Switzerland Sweden Turkey Ukraine Hungary Great Britain Italy Virgin Islands (British) United Arab Emirates

Eastern European culture English culture Germanic culture Nordic culture Middle Eastern culture Eastern European culture Eastern European culture English culture Latin European culture English culture South Asian culture

14 2 76 255 19 109 18 955 194 38 60 8,678

Source: Author’s own work.

5.3  Study results The first step in the verification of the set research hypotheses is to determine the independent variables that affect the level of earnings. They shall be treated as control variables in the adopted models. In the regression equation, the research model will be as follows: Y =​ β  0 +​ β1SIZE +​ β2PRA +​ β3ROE +​ β4DR +​ β5RAT +​ β6Sector +​ β7GDPper

[F 5. 8]

where Y –​the level of earnings management according to the J. J. Jones model, SIZE –​size of the company (calculated on the basis of the sum of total assets), Sector –​sector affiliation (1 –​Sector; 0 –​no sector), PRA –​accounting regulations (1 –​IFRS/​IAS; 0 –​US GAAP, local), ROE –​profitability calculated as return on equity, GDPper –​the wealth of a country calculated as GDP per capita, DR –​general debt ratio, and RAT –​solvency ratio. To determine the interdependence of the individual variables used in the model, a correlation matrix was created (Table 5.11). Correlation coefficients take values in the range and are a measure of the strength of the linear relationship between individual variables. Using the results obtained, it is possible to determine the direction of the relationship between the response variable and the explanatory variables. Positive coefficient values indicate a positive correlation between the variables, while negative coefficient values mean a negative correlation. The significance of the correlation is determined by

168  Analysis of the impact Table 5.11 Correlation matrix of the variables in the model absAEM~S ROE absAEM_​JONES ROE SIZE DR PRA GDPper RAT

1.0000 -​0.1488 -​0.2768 -​0.0608 -​0.0182 0.0294 0.0612

SIZE

1.0000 0.1625 1.0000 -​0.1056 0.2518 -​0.0413 0.2468 -​0.0578 0.1761 0.1105 -​0.2490

DR

PRA

GDPper RAT

1.0000 -​0.0430 1.0000 -​0.0710 0.5069 1.0000 -​0.9720 0.0468 0.0769 1.0000

Source: Authors’ own work.

means of the absolute values of the correlation coefficients. Calculating the correlation between two variables produces a value whose absolute value is called the strength of correlation or the strength of the relationship between two variables. In statistical analyses, the following classification is adopted18: • • • • • •

below 0.2 –​weak correlation (virtually no relationship), 0.2–​0.4 –​low correlation (definite relationship), 0.4–​0.6 –​moderate correlation (substantial relationship), 0.6–​0.8 –​high correlation (strong relationship), 0.8–​0.9 –​very high correlation (very strong relationship), and 0.9–​1.0 –​practically absolute relationship.

The results presented make it possible to conclude that there is no significant correlation between the response variable and the explanatory variables. In order to investigate the interdependence between the explanatory variables for a given unit, a cluster analysis was conducted using Ward’s method (Figure 5.6). The analysis shows that the variables ROE and RAT are relatively independent of each other and completely independent of the other variables. Moreover, the SIZE variable is related to DR, and the PRA variable is related to GDPper. It is assumed that the higher the efficiency of equity of an economic entity, the greater the possibility for this entity to achieve a higher level of financial surplus and –​therefore –​to produce higher dividends. The less profitable the company, the greater the level of earnings management. The usual practice has been to assume that share capital is like a guarantee, i.e. its purpose is to safeguard the interest of creditors in case of insolvency of the company. A link can be drawn between profitability and solvency and actions bearing traces of earnings management. Any actions taken in this field are aimed at showing the economic condition of the reporting business entity in a positive light. When considering the results for the SIZE and DR variables, they can be explained as follows: the larger the company, the greater the interest of external

Analysis of the impact  169 Tree diagram Ward's method 1- Pearson's r ROE RAT SIZE DR PRA PKBper 0,0

0,5

1,0

1,5

2,0

2,5

Linkage distance

Figure 5.6 Cluster analysis of explanatory variable parameters for a reporting entity using Ward’s method. Source: Author’s own work developed using the Statistica suite.

parties in the information about its financial status, which may translate into a lower level of earnings management. Subsequently, the more indebted an entity is, the greater the temptation for its management to manage its earnings in order to offer a more favourable image of it. The scope of business entities’ activity is not limited only to the territories of the countries in which they primarily operate. Economic cooperation, exchange of goods and services, takes place also between entities operating globally. This gives rise to the need for certain and reliable information about the financial position of business entities. The estimator of the regression equation for accounting practice shows that companies following the IAS/​IFRS regulations are more likely to manage their earnings than those that act in accordance with local –​domestic –​regulations. The wealthier a country is –​with the wealth measured as GDPper, the more likely it is to find entities that apply IAS/​ IFRS regulations there. Statistically significant variables will be used as control variables in subsequent analyses. In the second step, to verify the first specific hypothesis, the following model will be subjected to regression analysis: EMi,t =​β  0 +​ β1PDIi +​ β2IDVi +​ β3MASi +​ β4UAIi +​ β5LTOi +​ β6IARi +​ β7ContVar

[F 5. 9]

170  Analysis of the impact where EMi,t –​the level of earnings management according to the J. J. Jones model, PDI –​power distance, IDV –​individualism vs collectivism, MAS –​masculinity vs femininity, UAI –​uncertainty avoidance, LTO –​long-​term orientation vs short-​term orientation, IAR –​indulgence vs restraint, and ContVar –​control variables such as sector affiliation, ROE, accounting regulations, country wealth calculated as GDPper, total DR, and solvency ratio. The analysis of the interdependence of the variables used in the model shows mostly no significant relationships (Table 5.12). Based on the results of the cluster analysis, conducted using Ward’s method, it appears the variables MAS and UAI are relatively independent of each other and completely independent of the other variables. The PDI variable is related, in turn, to LTO, and the IDV variable is related to IAR (Figure 5.7). Robust regression analysis –​a linear regression with robust estimators was performed using the STATA suite. The obtained results are shown in Table 5.13. The regression model analytically explains the evolution of the value of the response variable under the influence of the explanatory variables.The p values shown in the table define the significance of the factors determining the variability of the response variable EM (earnings management variable). p-​Value taking a value: • • •

within the range of 0.01–​0.05 means a strong relationship between the variables, between 0.05 and 0.10 –​indicates a weak relationship, and above 0.10 –​means no significant relationship.

The value of the F(30, 68,045) statistic and the corresponding probability level p(p < 0.000) imply that there is a statistical significance of the examined Table 5.12 Correlation matrix of G. Hofstede’s variables occurring in the J. J. Jones model

EM_J​ ONES PDI IDV MAS UAI LTO IAR

EM~S

PDI

IDV

MAS

UAI

LTO

IAR

1.0000 -​0.0143 0.0588 0.0308 -​0.0692 -​0.0557 0.0203

1.0000 -​0.2940 0.3706 0.2208 0.1871 -​0.3700

1.0000 0.3940 0.1710 -​0.2530 0.4008

1.0000 0.2550 -​0.0500 -​0.0230

1.0000 -​0.2145 -​0.0615

1.0000 -​0.3610

1.0000

Source: Author’s own work.

Analysis of the impact  171 Tree diagram Ward's method 1- Pearson's r

PDI LTO IDV IAR MAS UAI

0,0

0,5

1,0

1,5

2,0

2,5

3,0

Linkage distance

Figure 5.7 Cluster analysis of G. Hofstede’s cultural determinants using Ward’s method. Source: Author’s own work developed using the Statistica suite.

relationship (linear model). For the purpose of verification of the statistical hypothesis, a significance level of α =​0.05 was adopted.The obtained results of the conducted regression analysis imply that the cultural dimensions PDI, IDV, MAS, UAI, and LTO have an impact on the level of earnings management. No significant relationships were found for the explanatory variable IAR. The R2 coefficient, called the coefficient of determination in the literature on the subject, is a descriptive measure of the strength of the linear relationship between variables –​a measure of the fit of the regression line to the data.19 The result obtained should be interpreted as follows: 10.79% of the variation in the phenomenon of earnings management can be attributed to the impact of cultural determinants based on G. Hofstede’s dimensions and of control variables on this management. For statistically significant variables, a β coefficient taking values greater than 0 implies a positive direction of the relationship between the variables. An increase in the value of the explanatory variable affects the increase in the value of the response variable. In the case of a negative coefficient, an increase in the value of the explanatory variable affects a decrease in the value of the response variable.20 Table 5.14 describes the nature of the relationship between the dependent variable and the independent variables. The analysis shows that characteristics such as power distance, individualism and collectivism, and masculinity and femininity intensify the phenomenon of earnings management. Looking into the results, it was found that uncertainty

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172  Analysis of the impact

Table 5.13 Results of regression analysis with robust estimators for accrual adjustments absAEM_​JONES

PDI IDV MAS UAI LTO IAR ROE SIZE DR PRA GDPper RAT

Coefficient (β)

0.0001215 0.0000976 0.0000855 -​0.0001832 -​0.0001885 0.0000174 -​0.0001043 -​0.008767 0.0073929 0.0078474 0.000000096 0.0000295

Std. Err.

0.0000163 0.0000156 0.0000179 0.0000126 0.0000179 0.0000174 0.00000818 0.000158 0.0091126 0.0010945 0.00000002 0.000093

t

7.47 6.28 4.77 -​14.56 -​10.53 1.00 -​12.75 -​55.5 0.81 7.17 4.83 0.32

p>t

0.000 0.000 0.000 0.000 0.000 0.317 0.000 0.000 0.417 0.000 0.000 0.751

*** Variable significant at 1%, ** variable significant at 5%, * variable significant at 10%. Source: Author’s own work.

No. of observations =​68,077 F(30, 68,045) =​0.00 Prob. >F =​0.00 R-​squared =​ 0.1079 Root MSE =​0.07216 95% Confidence interval

Significance*

0.000896 0.0000672 0.0000504 -​0.0002029 -​0.0002235 -​0.0000167 -​0.0001204 -​0.0090767 -​0.0104677 0.0057022 0.000000074 -​0.0001528

*** *** *** *** ***

0.0001534 0.0001281 0.0001207 -​0.001585 -​0.0001534 0.0000514 -​0.0000883 -​0.0084574 0.0252536 0.0099925 0.000000136 0.0002117

*** *** *** ***

Analysis of the impact  173 Table 5.14  Nature of the relationship between cultural dimensions and earnings management

Earnings management

PDI

IDV

MAS

UAI

LTO

IAR

+​

+​

+​

-​

-​

None

Source: Author’s own work.

avoidance and long-​term orientation limit the magnitude of the phenomenon of earnings management. It should also be stressed that the analysis did not provide sufficient evidence to consider the characteristic of indulgence vs restraint as important in the process of earnings management in public companies. To summarise the above analyses, it can be concluded that five of the six dimensions are statistically significant factors affecting the phenomenon of earnings management. The obtained findings make it possible to verify the first specific hypothesis, concerning the influence of cultural factors on the level of earnings management in public companies, as true. In conclusion, it appears that specific hypothesis H1 is correct. The next step of the study will be to verify the second specific hypothesis, according to which cultural determinants significantly affect the predictability of earnings in public companies. In this part of the study, G. Hofstede’s cultural determinants will be considered as independent variables.To verify the research hypothesis, the following model has been analysed: PREDICTi,t =​β  0 +​ β1PDIi +​ β2IDVi +​ β3MASi +​ β4UAIi +​ β5LTOi +​ β6IARi +​ β7ContVar

[F 5. 10]

where PREDICTi,t –​level of prediction of earnings, PDI –​power distance, IDV –​individualism vs collectivism, MAS –​masculinity vs femininity, UAI –​uncertainty avoidance, LTO –​long-​term orientation vs short-​term orientation, IAR –​indulgence vs restraint, and ContVar –​control variables such as: company size, ROE, total DR. If the p-​value is lower than the adopted level of a =​0.05, the impact of the explanatory variable on the response variable is significant. Otherwise, there are no grounds to claim that there is a significant relationship between the variables. If the coefficient β > 0, the relationship between the variables is

174  Analysis of the impact positive. On the other hand, if the coefficient β < 0, the relationship between the variables is negative. The obtained results of the conducted regression analysis imply that the cultural dimensions PDI, IDV, MAS, IAR, and LTO have an impact on the predictability of earnings (Table 5.15). No significant relationships were found for the explanatory variable UAI. As a result of the conducted regression analysis, it was found that cultural determinants significantly affect the predictability of earnings and that the relationship is negative for independent variables: PDI, IDV, MAS, LTO. A positive relationship was discovered, in turn, for the variable IAR (Table 5.16). Upon analysis of the results, it was found that the characteristics: power distance, collectivism vs individualism, masculinity vs femininity, and long-​term orientation limit the phenomenon of predictability of earnings. No significant statistical relationships were found for the UAI dimension. The analysis did not provide sufficient evidence to consider the uncertainty avoidance dimension as important in predicting earnings in public companies. The analysis shows that the characteristic of indulgence vs restraint enhances the strength of the phenomenon of predictability of earnings. At the significance level of α =​0.05, it appears that cultural determinants significantly affect the predictability of earnings in public companies.The above analysis has proven that five of the six dimensions are statistically significant factors affecting the phenomenon of earnings predictability. In conclusion, it appears that specific hypothesis H2 is correct. The next step of the study will be to verify the third specific hypothesis, according to which cultural determinants significantly affect the persistence of earnings in public companies. In this part of the study, G. Hofstede’s cultural determinants will be considered as independent variables.To verify the research hypothesis, the following model has been analysed: PERSISTi,t =​β  0 +​ β1PDIi +​ β2IDVi +​ β3MASi +​ β4UAIi +​ β5LTOi +​ β6IARi +​ β7ContVar where PERSISTi,t –​level of earnings persistence, PDI –​power distance, IDV –​individualism vs collectivism, MAS –​masculinity vs femininity, UAI –​uncertainty avoidance, LTO –​long-​term orientation vs short-​term orientation, IAR –​indulgence vs restraint , and ContVar –​control variables such as: company size, ROE, total DR.

[F 5. 11]

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Table 5.15 Regression results with robust estimators –​earnings predictability Predict

-​0.239145 -​0.284238 -​0.0996013 -​0.0525837 -​0.258893 0.0516246 0.1104712 -​0.0165192 11.47734 45.31657

Std. err.

0.0781063 0.1156947 0.0207394 0.0372023 0.1054212 0.0309946 0.4391413 0.0171524 3.987384 16.41901

t

-​3.06 -​2.46 -​4.80 -​1.41 -​2.46 1.67 0.25 -​0.96 2.88 2.76

p>t

0.002 0.014 0.000 0.158 0.014 0.096 0.801 0.336 0.004 0.006

*** Variable significant at 1%, ** variable significant at 5%, * variable significant at 10%. Source: Author’s own work.

No. of observations =​79,953 F(9, 79,943) =​26.97 Prob. >F =​0.00 R-​squared =​ 0.0032 Root MSE =​165.61 95% Confidence interval

Significance*

-​0.3922329 -​0.5109988 -​0.1402504 -​0.1254999 -​0.4655178 -​0.0091245 -​0.750243 -​0.0501377 3.662088 13.13541

*** ** ***

-​0.0860571 -​0.0574773 -​0.0589522 0.0203325 -​0.0522682 0.1123738 0.9711853 0.0170994 19.29258 77.49773

** * ***

Analysis of the impact  175

PDI IDV MAS UAI LTO IAR SIZE ROE DR _​cons

Coefficient (β)

176  Analysis of the impact Table 5.16  Nature of the relationship between cultural dimensions and earnings predictability

Earnings predictability

PDI

IDV

MAS

UAI

LTO

-​

-​

-​

None

-​

IAR +​

Source: Author’s own work.

If the p-​value is lower than the adopted level of a =​0.05, the impact of the explanatory variable on the response variable is significant. Otherwise, there are no grounds to claim that there is a significant relationship between the variables. If the coefficient β > 0, the relationship between the variables is positive. On the other hand, if the coefficient β < 0, the relationship between the variables is negative. The obtained results of the conducted regression analysis imply that the cultural dimensions PDI, IDV, MAS, IAR, and LTO have an impact on the persistence of earnings (Table 5.17). No significant relationships were found for the explanatory variable UAI. As a result of the conducted regression analysis, it was found that cultural determinants significantly affect the persistence of earnings and that the relationship is negative for independent variables: PDI, IDV, MAS, IAR. A positive relationship was discovered, in turn, for the variable LTO (Table 5.18). Upon analysis of the results, it was found that the characteristics: power distance, collectivism vs individualism, masculinity vs femininity, and indulgence vs restraint limit the phenomenon of persistence of earnings. The study also shows that the LTO variable enhances the phenomenon of earnings persistence. The analysis did not provide sufficient evidence to consider the uncertainty avoidance dimension as important in the process of earnings persistence in public companies. The analysis shows that the characteristic of long-​term or short-​term orientation intensifies the magnitude of the phenomenon of earnings persistence. At the significance level of α =​0.05, it appears that there is a strong relationship between cultural determinants and the persistence of earnings in public companies. In conclusion, it appears that specific hypothesis H3 is correct. The last step of the study is to verify the fourth specific hypothesis, according to which cultural determinants significantly affect the phenomenon of earnings smoothing in public companies. In this part of the study, G. Hofstede’s cultural determinants will be considered as independent variables.To verify the research hypothesis, the following model has been analysed: EARN_​SMOOTHi =​ β0 +​ β1PDIi +​ β2IDVi +​ β3MASi +​ β4UAIi +​ β5LTOi +​ β6IARi +​ β7ContVar

[F 5. 12]

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Table 5.17 Regression results with robust estimators –​earnings predictability Persist

-​0.0091584 -​0.0075161 -​0.0023279 -​0.0010174 0.0043462 -​0.0019589 -​0.0756852 0.000297 0.2877175 1.355316

Std. err.

0.0038964 0.0027908 0.0008427 0.0010055 0.0017209 0.000433 0.0384478 0.00046 0.1110278 0.4156266

t

-​2.35 -​2.69 -​2.76 -​1.01 2.53 -​4.52 -​1.97 0.65 2.59 3.26

p>t

0.019 0.007 0.060 0.312 0.012 0.000 0.049 0.518 0.010 0.001

*** Variable significant at 1%, ** variable significant at 5%, * variable significant at 10%. Source: Author’s own work.

No. of observations =​79,964 F(9, 79,954) =​16.45 Prob. >F =​0.00 R-​squared =​ 0.0019 Root MSE =​5.7516 95% Confidence interval

Significance*

-​0.0167954 -​0.012986 -​0.0039796 -​0.0029883 0.0009733 -​0.0028075 -​0.1510427 -​0.0006046 0.0701037 0.5406907

** *** *

-​0.0015215 -​0.0020462 -​0.0006763 0.0009534 0.0077192 -​0.0011104 -​0.0003276 0.0011987 0.5053313 2.169942

** *** ** ***

Analysis of the impact  177

PDI IDV MAS UAI LTO IAR SIZE ROE DR _​cons

Coefficient (β)

178  Analysis of the impact Table 5.18  Nature of the relationship between cultural dimensions and earnings predictability

Earnings persistence

PDI

IDV

MAS

UAI

LTO

IAR

-​

-​

-​

None

+​

-​

Source: Author’s own work.

where EARN_​SMOOTHi –​level of earnings smoothing, PDI –​power distance, IDV –​individualism vs collectivism, MAS –​masculinity vs femininity, UAI –​uncertainty avoidance, LTO –​long-​term orientation vs short-​term orientation, IAR –​indulgence vs restraint, and ContVar –​control variables such as: ROE, total DR. The results of the conducted regression analysis suggest that cultural dimensions have an impact on earnings smoothing (Table 5.19). As a result of the conducted regression analysis, it was found that cultural determinants significantly affect the phenomenon of earnings smoothing and that the relationship is negative for independent variables: PDI, UAI. A positive relationship was discovered, in turn, for the variable IDV. No significant statistical relationships were found for the MAS and LTO explanatory variables.Yet, in the case of the independent variable IAR, the result is ambiguous; there occurs a weak relationship or no statistical relationship.The analysis did not provide sufficient evidence to consider these characteristics as important in the process of earnings smoothing in public companies (Table 5.20). The study implies that the characteristics of power distance and uncertainty avoidance curb the phenomenon of earnings smoothing. On analysing the results, it was found that the characteristic of individualism vs collectivism intensifies the phenomenon of earnings smoothing. At the significance level of α =​0.05, the above analysis suggests that there is a strong relationship between cultural determinants and earnings smoothing in public companies. In conclusion, it appears that specific hypothesis H4 is correct. The results of the conducted empirical study for the proposed models and the conducted statistical inference prove that the main hypothesis is true and correct. It can be therefore concluded that the results of the study support the claim that cultural determinants significantly affect the quality of earnings in public companies. The proposed measures of the quality of earnings measure different characteristics and cannot be considered as substitutes. The quality of earnings is also a criterion that is synonymous with the cognitive value and decision value

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Table 5.19 Regression results with robust estimators –​earnings smoothing EARN_​SMOOTH

-​0.0058832 0.0109892 0.0003585 -​0.0041254 0.0006484 0.005841 -​0.0016857 -​2.33884 2.39261

Std. err.

0.0032415 0.0037173 0.006735 0.0024503 0.0058202 0.0035698 0.0007651 0.4413711 0.4283252

t

-​1.81 2.96 0.05 -​1.68 0.11 1.64 -​2.20 -​5.30 5.59

*** Variable significant at 1%, ** variable significant at 5%, * variable significant at 10%. Source: Author’s own work.

p>t

0.070 0.003 0.958 0.092 0.911 0.102 0.028 0.000 0.000

No. of observations =​8,678 F(8, 8,669) =​8.41 Prob. >F =​0.00 R-​squared =​ 0.0091 Root MSE =​8.9971 95% Confidence interval

Significance*

-​0.0122373 0.0037025 -​0.0128437 -​0.0089285 -​0.0107606 -​0.0011568 -​0.0031856 -​3.204033 1.55299

* ***

0.0004708 0.0182759 0.0135607 0.0006777 0.120574 0.128387 -​0.0001859 -​1.473648 3.232229

* ** ***

Analysis of the impact  179

PDI IDV MAS UAI LTO IAR ROE DR _​cons

Coefficient (β)

180  Analysis of the impact Table 5.20  Nature of the relationship between cultural dimensions and earnings smoothing

Earnings smoothing

PDI

IDV

MAS

UAI

LTO

IAR

-​

+​

None

-​

None

None

Source: Author’s own work.

of the information originating from financial reports for its users. Considered the issue from this perspective, the quality of earnings can be identified by current profit’s ability to maintain the assumed level in the future. Higher persistence of earnings increases its predictive ability and its decision usefulness at the same time.The definition of ‘earnings quality’ is ambiguous. In the literature on the subject, the term is often equated with measures of: persistence, predictability, earnings smoothing, and earnings management. The regression models adopted in the study prove that cultural determinants have a significant impact on the quality of earnings for accounting measures. The regression analysis conducted for the studied measures of earnings quality reveals different directions of relationships and a varying statistical significance of the different cultural dimensions. According to research, cultural characteristics intensify or limit the phenomenon of the studied trait of quality. It also needs to be emphasised that there is potential for further research, which should lead to more detailed, in-​depth results. The presented results open the pathways for further research, covering a wider spectrum of economic entities and analysing longer periods of time.

5.4 Analysis of results and an economic interpretation thereof Financial statements are an important source of financial information, essential to the process of decision-​making in business entities. In line with the existing international arrangements, the objective of general purpose financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions. Moreover, financial statements also show the results of the management’s stewardship of the resources entrusted to it.21 This means that the information contained in financial statements must be marked by high quality to be useful to potential users. The research conducted on the phenomenon of earnings management presents the nature of the quality of earnings in capital markets. The results obtained should be interpreted taking into account other studies carried out in this area. It is questionable whether a higher level of earnings management means a higher or lower quality of the presented earnings. The management of earnings can have a positive effect and

Analysis of the impact 181 Table 5.21 Proposed and found relationships between cultural determinants and the level of earnings management Cultural dimension

Relationship

Author’s own Grabiński’s Doupnik’s research research results research results results (2008) (2016)

Power distance Individualism vs collectivism Masculinity vs femininity Uncertainty avoidance Long-​term orientation vs short-​term orientation Indulgence vs restraint

Yes (strong) Yes (strong)

+​ +​

-​ +​

+​ -​/​?

Yes (strong)

+​

-​

+​

Yes (strong)

-​

-​

+​

Yes (strong)

-​

+​

-​

No relationship X

+​

No proposition

Source: Author’s own work based on own study and studies by K. Grabiński and T. S. Doupnik.

Table 5.22 Relationship between cultural determinants and the level of earnings management in global studies Cultural dimension

The phenomenon of earnings management Positive relationship

Power distance

Individualism vs collectivism

Masculinity vs femininity

Negative relationship

• T. S. Doupnik (2008) • H. Nikoomaram, E. Kavousy, S. J. Kangarluei, A. Bayazidi (2010) • K. Mokrzycka-​Kogut (2020) • L. Guan, H. Pourjalali, P. Sengupta, J. Teruya (2005) • S. Han, T. Kang, S. Salter,Y. K. Yoo (2010) • S. J. Gray, T. Kang, Z. Lin, Q. Tang (2015) • K. Grabiński (2016) • K. Mokrzycka-​Kogut (2020) • T. S. Doupnik (2008) • H. Nikoomaram, E. Kavousy, S. J. Kangarluei, A. Bayazidi (2010) • K. Mokrzycka-​Kogut (2020) (continued)

182  Analysis of the impact Table 5.20 Cont. Cultural dimension

The phenomenon of earnings management Positive relationship

• L. Guan, H. Pourjalali, P. Sengupta, J. Teruya (2005) • S. Han, T. Kang, S. Salter,Y. K. Yoo (2010) • H. Nikoomaram, E. Kavousy, S. J. Kangarluei, A. Bayazidi (2010) • R. Riahi, A. Omri (2013) • S. J. Gray, T. Kang, Z. Lin, Q. Tang (2015) • K. Grabiński (2016) • K. Mokrzycka-​Kogut (2020) • T. S. Doupnik (2008) • K. Mokrzycka-​Kogut (2020)

Uncertainty avoidance

Long-​term orientation vs short-​term orientation Indulgence vs restraint

Negative relationship

• K. Grabiński (2016)

Source: Author’s own work based on own research.

involves e.g. signalling factors that affect value over the long term. But it can also be detrimental when ‘concealing’ factors that negatively affect the value of an entity in the long and short term. It is therefore impossible to give a clear answer. The main research hypothesis is that cultural determinants affect the quality of earnings in public companies. In the conducted study, the characteristics of a public company included: company size calculated as total assets, total DR, return on fixed assets, applied regulations, sector affiliation, country wealth calculated as GDPper, and solvency ratio. The regression results obtained suggested that these variables were statistically significant and were therefore used as control variables in further studies. The results of the analysis of the first specific hypothesis confirm the findings of both K. Grabiński and T. S. Doupnik (Table 5.21). It is important to stress that the nature of the relationships examined in this study coincides with the findings of other empirical studies in this area, as shown in Table 5.22. The first dimension –​power distance –​is positively correlated with the level of earnings management. Examples of countries with high power distance are: Malaysia, Guatemala, or Panama. On the opposite pole of this dimension there are countries such as: Austria, Denmark, and Israel. The power distance dimension explains how a society recognises power vested in its institutions and organisations. Countries with low power distance tend to have decentralised

Analysis of the impact  183 organisations. In the case of countries with high power distance, the usual preference is centralised authority. The results obtained can be interpreted as follows: in countries with a high power distance index, managers and other users of reporting information are ready to tolerate information asymmetry to a greater extent. In this case, power is the fact of possession of information, accepting the adopted hierarchical order. In countries with a low power distance index, shareholders and other users of reporting information seek to equalise and balance the distribution of power. They expect explanations and justifications if there is any inequality when it comes to power. Managers in high-​distance societies have no need to signal the information they have. As a result, countries with a high power distance index are those where earnings management occurs more frequently. The results for the second dimension show a positive relationship between individualism and earnings management. In cultures where collectivism is dominant, the good of the collective is prioritised over the good of the individual, and people belong to close-​knit and coherent internal groups from birth, which provide them with security and care in exchange for loyalty. In contrast, in individualistic cultures, the interest of the individual is more important than the interest of the group.Ties between individuals are loose, and the individual’s goal is their own well-​being and that of their immediate family members. When considering this issue on the grounds of managing a business entity, it can be linked with a higher level of earnings management. Individualistic or collectivistic attitudes seem also to have a significant impact on the behaviour of supervisors and subordinates in one workplace, especially when each of them have different cultural backgrounds. In more individualistic societies, managers and accountants have more decision-​making freedom. At the same time, there is more competition in the strive for better results. This behaviour translates into taking advantage of the opportunities offered by the accounting regulations in place, and this affects the accounting regulatory environment –​including the institutions that establish these regulations and the methods of application thereof. This leads to a higher level of earnings management. Individualistic countries include the USA, Australia, the Netherlands, or Anglo-​Saxon countries. Collectivist cultures, in turn, are typical of countries like Japan, Portugal, Greece,Venezuela, or Ecuador. When it comes to the third dimension, a positive relationship was found between masculinity and earnings management.This dimension refers to values that affect the motivation of individuals: ‘economic’ values (e.g. salary, promotion, professional achievements) or ‘social’ values (e.g. good atmosphere at work). For masculine countries, typical characteristics include activity, aggression, constant competition, or achievement. Achieving professional success involves being resolute, with the main driving force being ambition in this context. In contrast, in feminine societies, a focus on the other person and on building interpersonal bonds prevails. Such cultures prefer gentle, kind, non-​aggressive behaviours, and the primary motivator for action is service to others. Masculine societies are marked by a higher level of earnings management. Managers make

184  Analysis of the impact firm decisions, accept divisions, prefer independence, and are assertive in their pursuit of success. They are more likely to manage earnings to achieve their goals, which translate into a greater internal consent not to follow the rules and procedures –​and more tolerance for change. Countries where feminine cultures are the dominant pattern include, for example, Scandinavian countries, the Netherlands, and Belgium. In contrast, in countries where masculine characteristics predominate, strong male cultures have emerged. Such countries include: Japan, Austria, Hungary, or Venezuela. The dimension of uncertainty avoidance has already been identified in other empirical studies as statistically significant. Countries with high levels of uncertainty avoidance have strict rules governing the ways of acting and thinking. Societies from such countries do not accept behaviours or ideas that go beyond these principles. In contrast, societies with low levels of uncertainty avoidance tend to have a much more relaxed attitude. For them, practicality and function are much more important than principles. Speaking in accounting terms, this could mean applying the principle of economic content over legal content to a greater extent. Managers are willing to take risks and accept change. Rules and procedures can be modified if there is a good, well-​justified reason for it. This behaviour translates into a more discretionary approach to earnings management. The results obtained can be explained by the fact that the dimension of uncertainty avoidance has a negative impact on flexibility, transparency, and professionalism, which lead to a decrease in the level of earnings management. The countries with the highest uncertainty avoidance index values are Greece, Portugal, Russia, Ukraine, and Guatemala. The countries with the lowest levels of this index include, in turn, Singapore, Sweden, Ireland, Denmark, and the United Kingdom. Long-​ term vs short-​ term orientation is negatively correlated with the level of earnings management. Societies with a culture focused more on the long term are usually more practical. Basically, they make more investments in modern education. They do it because they see it as a way to prepare for the future. In contrast, societies with a short-​term orientation seek to maintain and uphold deep-​rooted traditions and principles. They are very suspicious of the social changes that take place. Considering the above in financial reporting terms, it can be said that societies with a long-​time orientation are more open-​minded, unafraid of changes in accounting regulations and new challenges. Short-​term oriented societies, on the other hand, are suspicious and apply stricter standards both to the design and establishment of financial statements and during the auditing process. Examples of the most long-​term oriented countries include China, Hong Kong, Germany, Belgium, Switzerland, South Korea, or Brazil. The countries that focus on the short term to the greatest extent are the Czech Republic, the Philippines, Ireland, Poland, Spain, Venezuela, Uruguay, and the United Arab Emirates. The last dimension analysed is indulgence vs restraint. No statistical significance was found in the case of this dimension.

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Table 5.23 Analysis of the relationships between cultural dimensions and quality attributes: earnings predictability, earnings persistence, and earnings smoothing Cultural dimension

Earnings persistence

Earnings smoothing

Relationship

Nature of relationship

Relationship

Nature of relationship

Relationship

Nature of relationship

Yes (strong) Yes (strong) Yes (strong) None Yes (strong)

-​ -​ -​ x -​

Yes (strong) Yes (strong) Weak None Yes (strong)

-​ -​ -​ x +​

Weak Yes (strong) None Weak None

-​ +​ x -​ x

Weak relationship

+​

Yes (strong)

-​

No or weak relationship

+​

Source: Author’s own work based on own research.

Analysis of the impact  185

Power distance Individualism vs collectivism Masculinity vs femininity Uncertainty avoidance Long-​term orientation vs short-​ term orientation Indulgence vs restraint

Earnings predictability

186  Analysis of the impact The next step in the verification of the study is the specific hypotheses, according to which cultural determinants affects accounting attributes: earnings persistence, earnings predictability, and earnings smoothing (Table 5.23). The cultural dimensions of a society can affect the decisions made by a business entity. Decisions that will have an impact on its financial results. Prediction is a characteristic of earnings, related to the usefulness of earnings in predicting their future value. It is a characteristic specific to the individual forecasts made by users of financial information. The results obtained prove that the higher the quality of earnings prediction, the smaller the impact of cultural determinants: power distance, individualism vs collectivism, masculinity vs femininity. The conducted analysis implies that managers who do not manage their company’s earnings to achieve their own personal goals tend to present non-​managed earnings. No statistical relationship was found for the uncertainty avoidance dimension. According to the analysis, the more long-​term goal oriented the managers are, the more the long-​term orientation dimension reduces the prediction phenomenon. The decisions made do not affect earnings management over the long term.The dimension of indulgence vs restraint enhances the phenomenon of earnings prediction. Managers striving for self-​fulfilment try to increase the value of their business entity through earnings management. Looking at it this way, from a moral standpoint, it can be interpreted as the right thing to do. One more aspect worth stressing is that the predictability of a public company’s financial performance is also important to the auditor and affects the type of the opinion given. A high level of persistence of earnings increases their predictive utility. The study results obtained prove that the higher the persistence level, the smaller the impact of cultural determinants: power distance, individualism vs collectivism, masculinity vs femininity, indulgence vs restraint. If managers are able to gain a sustainable competitive advantage in the marketplace or build effective barriers to entry, the results achieved will be marked by a higher level of persistence of earnings. Such a situation does not force or tempt managers to manipulate the earnings in a public company. Similarly, an analogy can be found here, in the case of a decrease in the persistence of earnings (usefulness). Managers may take corrective action, which can be considered close to earnings management. These types of activities may be developed over a longer period of time, as indicated by the long-​term or short-​term orientation dimension. Earnings smoothing can be defined as a process which involves intentionally affecting the volatility of earnings levels, resulting in a level of earnings that is considered normal for a given company and over a given period of time. The results obtained are consistent with the findings of M. J. Gordon, who found that investors favour companies whose results are smoothed. Such activity makes a company more credible in the eyes of its clients and business partners. The measures taken are designed to keep managers from losing their positions –​with their careers in mind. Managers who manage earnings must have the right knowledge and experience –​and should be committed to their

Analysis of the impact  187 job. Then, they will be well able to predict the performance of public companies in the future. Managers take steps to limit the fluctuations in the level of earnings so as not to distort their company’s market value or cause an increase in the company’s capital. The actions taken have a positive impact on maintaining the desired level of credit ratings and on the predictability of earnings. According to the research discussed, the power distance dimension reduces the extent of the earnings smoothing phenomenon. The statistical relationship for the indulgence vs restraint dimension is weak or not present at all, and it is difficult to estimate the impact of this dimension on the phenomenon of earnings smoothing. To conclude, both the existing theory and empirical evidence suggest that financial statement information made public is more frequently used in managerial interactions in countries with strong investors than in countries with poor investor protection mechanisms. The available findings suggest that even with comparability, the accounting choices made under uniform accounting principles may still differ across countries due to cultural differences. In other words, this means that a uniform reporting standard may not necessarily translate into uniform reporting practices. The results obtained prove that there is a positive impact of earnings management on approximating the value of the reported earnings to the economic value. The cultural values used to differentiate the economic environment across societies determine the characteristics and nature of accounting models. Their qualities are driven by accounting dimensions and –​indirectly –​by cultural factors. It needs to be said that societies cannot be assigned to one cultural dimension. It is only possible to determine the dominant characteristics that influence a given society and make it what it is. However, explorations involving a longer period of study may be especially important because of the slow rate of change in the environmental conditions, resulting in the development of a national culture.

Notes 1 J. Ronen, V. Yaari, Earnings Management. Emerging Insights in Theory, Practice, and Research, Springer, New York, NY, 2008, p. 371. 2 M. Comporek, Efektywność gospodarowania aktywami obrotowymi publicznych przemysłowych spółek akcyjnych w obrazie memoriałowych korekt zysku netto, Studies and Papers of the College of Management and Finance 2016, Issue 152, pp. 149–​150. 3 J. Francis, R. LaFond, P. M. Olsson, K. Schipper, Costs of Equity and Earnings Attributes, The Accounting Review 2004,Vol. 79, Issue 4, p. 980. 4 R. Kormendi, R. Lipe, Earnings Innovations, Earnings Persistence, and Stock Returns, Journal of Business 1987,Vol. 60, Issue 3, pp. 323–​345. 5 B. Lev, R. Thiagarajan, Fundamental Information Analysis, Journal of Accounting Research, Autumn 1993,Vol. 31, Issue 2, pp. 190–​215. 6 R. Cieślik, Wpływ jakości zysku na zależność pomiędzy zyskiem a stopą zwrotu z akcji na przykładzie GPW w Warszawie, Studia i Materiały 2/​2016, Issue 22, Part 2, pp. 64–​65. 7 J. Francis, R. LaFond, P. M. Olsson, K. Schipper, Costs of Equity and Earnings Attributes, op. cit., p. 980.

188  Analysis of the impact 8 R. Lipe, The Relation between Stock Returns and Accounting Earnings Given Alternative Information, op. cit., pp. 50–​51. 9 J. Francis, P. Olsson, K. Schipper, Earnings Quality, op. cit., p. 44; R. Lipe, The Relation between Stock Returns and Accounting Earnings Given Alternative Information, op. cit., pp. 50–​51. 10 K. Grabiński, Determinanty kształtowania wyniku finansowego w teorii i praktyce europejskich spółek giełdowych, op. cit., p. 69. 11 J. Francis, R. LaFond, P. M. Olsson, K. Schipper, Costs of Equity and Earnings Attributes, op. cit., p. 980. 12 C. Leuz, D. Nanda, P. Wysocki, Earnings Management and Investor Protection: An International Comparison, Journal of Financial Economics 2003, Issue 69, pp. 505–​527. 13 R. M. Bowen, S. Rajgopal, M. Venkatachalam, Accounting Discretion, Corporate Governance and Firm Performance, Contemporary Accounting Research 2003,Vol. 25, Issue 2, pp. 351–​405. 14 J. Francis, R. LaFond, P. M. Olsson, K. Schipper, Costs of Equity and Earnings Attributes, op. cit., pp. 967–​1010. 15 R. Cieślik, Wpływ jakości zysku na zależność pomiędzy zyskiem a stopą zwrotu z akcji na przykładzie GPW w Warszawie, op. cit., p. 65. 16 R. Cieślik, Wpływ jakości zysku na zależność pomiędzy zyskiem a stopą zwrotu z akcji na przykładzie GPW w Warszawie, op. cit., p. 66. 17 P. M. Dechow, W. Ge, C. Schrand, Understanding Earnings Quality: A Review of the Proxies,Their Determinants and Their Consequences, op. cit., pp. 361–​362. 18 www.naukow​iec.org/​wie​dza/​sta​tyst​yka/​sila-​korela​cji-​-​klasy​fika​cja_​512.html (25.10.2019). 19 A. D. Aczel, Statystyka w zarządzaniu, PWN, Warsaw 2000, p. 490. 20 A. D. Aczel, Statystyka w zarządzaniu, op. cit., pp. 456–​495. 21 IAS 1, para. 7.

6 Conclusions

Modern business entities operate in a dynamically changing and highly complex environment, which makes identifying cultural determinants that affect the quality of the earnings quite challenging. Moreover, conducting cross-​ cultural empirical research faces a number of difficulties. There is no single definition of culture on which the majority of researchers would agree. Adding the cross-​cultural aspect to it makes the subject of research even more complicated. There are many typologies of culture, all of which point to its different dimensions. It is important to see that in most cross-​cultural studies, authors refer to the concept of G. Hofstede and his six dimensions of culture. Taking the above into account, the study conducted has made use of the measures proposed by the said researcher. Moreover, accounting, despite its many advantages, is imperfect in measuring real earnings. The reason for this can be found in new economic transactions, which make the measurement of the value of earnings problematic. Accounting practice has produced instruments used when the development of financial reporting regulations fails to keep pace with economic change. The conducted empirical study on the impact of cultural determinants on the quality of earnings was based on the attributes of earnings. Also, this is one of the research trends which has so far drawn the attention of researchers rather rarely, especially when considering the impact of particular cultural dimensions on various attributes of earnings quality (persistence, predictability, and earnings smoothing).The literature on the subject discusses a range of studies that aim to identify the key determinants of the quality of earnings, exploring the factors of earnings management at the level of characteristics of the reporting entity. Thus, taking into account that culture is a phenomenon in which people –​the most valuable organisational resource of businesses –​are involved, the impact of cultural determinants has been examined as a dimension that affects the quality of financial performance in public companies. Cultural determinants, in light of the research conducted, provide contradictory results regarding their impact on the quality of earnings. The cultural factor is certainly important –​and should be considered when auditing financial statements. DOI: 10.4324/9781003280088-7

190 Conclusions An example of the concept of accounting development based on cultural patterns is S. J. Gray’s theory of cultural values of accounting, taking into account G. Hofstede’s dimensions of cultural values. This theory considers accounting an element of national culture, drawing on and closely following the social values shared by particular groups of people. S. J. Gray believes that there is a close relationship between social values, the system of values and attitudes adopted by accounting professionals, and the nature and direction of the development of the model of accounting measurement and disclosure. The main problem in the study of earnings management is the interpretation of the obtained results. There is always a question whether the result achieved suggests a positive phenomenon (‘white’ earnings management) or rather a negative one (‘black’ earnings management) –​or perhaps a neutral one (‘grey’ earnings management). Both theoretical considerations and empirical studies show that there is a correlation between the level of management, profits, and managerial motivation in the institutional and legal environment, which affects corporate governance. There are many factors that can influence managers’ motivation, ranging from material incentives to cultural determinants. The process of decision-​making requires correct and reliable information about earnings in order to produce good outcomes. Decisions made on the basis of unreliable information raise questions and are interpreted as a given entity’s managers’ attempt to manipulate the reported results. On the other hand, there are numerous restrictions on earnings management, as seen in financial reporting requirements and other accounting solutions and mechanisms, aimed at protecting investors. The authorities that shape the institutional environment of the capital market and the quality of the reported earnings play a crucial part in the provision of efficient information –​information that enables its users to make sound and reasonable decisions. Stock exchanges want to attract as many investors as possible –​especially foreign investors, offering them a sense of security, which surely translates, in turn, into a high quality of reporting information. The studies conducted so far have generally addressed the impact of cultural determinants on the management of earnings, while much less research has dealt with other attributes of the quality of earnings –​persistence, predictability, and smoothing. The aim of this book was to fill the existing research gap. The book aimed to analyse the impact of culture-​specific factors on the quality of earnings using the example of public companies drawing up financial statements according to International Accounting Standards/​International Financial Reporting Standards. The measures featured in G. Hofstede’s model were used as measures of cultural conditions. The outcome of the research process was the achievement of both the main objective and the specific objectives set. Achieving the objectives of the study made it possible to confirm that all of the formulated research hypotheses were correct. The study is epistemological and applied in its nature. The pursuit of the objective involved the application

Conclusions  191 of research methods ranging from the analysis of Polish and global literature and current legal regulations to extensive empirical research. The purpose of this study was to explore the topic of the impact of cultural determinants on the quality of earnings. The conducted empirical research addresses the main objective of the book, which is the impact of cultural determinants on the quality of earnings reported by public companies. The study was conducted on source material in the form of financial statements from the reporting years 2010 to 2018, published by selected 21,316 public companies from 69 countries around the world, representing 21 different sectors. In the course of the analysis, the study sample varied due to the possibility or impossibility to calculate measures of earnings quality (accrual adjustments, persistence, predictability, and earnings smoothing), as indicated in Table 6.1. The main research hypothesis and four supporting hypotheses were formulated.The empirical-​analytical part of the study made it possible not only to achieve the main aim of the project but also to test the four specific hypotheses –​and confirm them to be true. The model adopted in the study has proven that cultural determinants have a significant impact on the quality of earnings, which means that the main hypothesis is correct. The first specific hypothesis implied that cultural determinants had a significantly impact on earnings management. G. Hofstede’s six cultural dimensions were analysed to verify that claim. The conducted study proves that five of the six dimensions are factors which are statistically significant in earnings management. In this regard, the results support the majority of findings of other empirical studies. The second specific hypothesis proposed that cultural determinants significantly affected the predictability of earnings in public companies. The findings suggest that five of the six cultural dimensions are statistically significant determinants of the predictability phenomenon.The results obtained prove that the higher the quality of earnings prediction, the smaller the impact of cultural determinants: power distance, individualism vs collectivism, masculinity vs femininity, and long-​term orientation vs short-​term orientation. In light of the conducted analysis, these dimensions reduce the extent of the phenomenon. The only dimension that enhances it is indulgence vs restraint.

Table 6.1 The size of the study sample in relation to the quality attributes of earnings

Sample size

Accrual adjustments to earnings

Earnings predictability

Earnings persistence

Earnings smoothing

68,077

79,953

79,964

8,678

Source: author’s own work.

192 Conclusions The third specific hypothesis proposed that cultural determinants significantly affected the persistence of earnings in public companies. The study has found that five of the six G. Hofstede’s dimensions are statistically significant determinants of earnings persistence. Like above, the said three dimensions (power distance, individualism vs collectivism, masculinity vs femininity) as well as the dimension of indulgence vs restraint limit the phenomenon. In contrast, the long-​term orientation vs short-​term orientation dimension intensifies the extent thereof. An important aspect to highlight here is that in both cases the uncertainty avoidance dimension is a statistically insignificant factor. The fourth specific hypothesis concerned the effect of cultural determinants on earnings smoothing in public companies. The analysis shows that three of the six dimensions are statistically significant determinants in the phenomenon of earnings smoothing. The dimensions of collectivism vs individualism and masculinity vs femininity intensify earnings smoothing, while the dimension of power distance reduces the intensity of this phenomenon. Past research has very rarely addressed other measures of earnings quality. Therefore, the results obtained for the three specific hypotheses should be considered as a major contribution to the science of finance. Studies conducted in the US market reveal that earnings management is linked to public companies’ investment-​related decisions. One of the main reasons behind earnings management as identified in the literature on the subject is the managers’ desire to acquiring external funding at a low cost in order to finance investments.1 Managers, wishing to pursue investment projects while having limited access to external funds, are more inclined to manage the earnings of their companies –​thus increasing the information asymmetry between the company and external capital providers.2 J. S. Linck, J. Netter, and T. Shu3 notice, in turn, that managers of business entities with limited access to external capital take deliberate actions aimed at earnings management. The actions taken intend to send a positive signal to the capital market, which will enable the sending company to attract and raise capital for investment more easily. The results of the above study suggest that earnings management may now be considered as a positive phenomenon. The quality of earnings is a function of the information needs of users of financial statements.These information needs are driven, in turn, by a variety of factors.According to research, managers running companies in developed countries are more likely to take advantage of earnings management. Management’s care for high-​quality financial statements affects the decisions made by company owners or investors and –​their perception of the reporting entity’s value. Investors prefer investments with the highest rate of return and the lowest rate of risk.The low persistence of reported earnings may affect the market’s perceived level of risk.The more developed the market, the stronger the market’s response to new information as it appears. Therefore, managers are aware of the need to create value for the entity they manage, compete effectively in the market, and raise new capital.

Conclusions  193 The author believes that there is a need to take cultural factors into account when developing various financial or economic models. The homogeneous image of economic man needs to additionally include knowledge from the domain of cultural finance. Incorporating cultural determinants into various economic analyses could translate into an in-​depth study of the phenomena that occur in the global economy, as well as into a better understanding of the decision-​making processes that occur. This study can be a contribution to further in-​depth research, covering a broader spectrum of business entities and analysing a longer time horizon.

Notes 1 P. M. Dechow, R. G. Sloan, A. P. Sweeney, Causes and Consequences of Earnings Manipulation:An Analysis of Firm Subject to Enforcement Action by the SEC, Contemporary Accounting Research 1996,Vol. 12, Issue 1, pp. 1–​36. 2 M. McNichols, S. Stubben, Does Earnings Management Affect Firms Investment Decisions? The Accounting Review 2008,Vol. 83, Issue 6, pp. 1571–​1603. 3 J. S. Linck, J. Netter, T. Shu, Can Managers Use Discretionary Accruals to Ease Financial Constraints? Evidence from Discretionary Accruals Prior to Investment, The Accounting Review 2013,Vol. 88, Issue 6, pp. 2117–​2143.

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Name index

Note: Figures are indicated by italics. Tables are indicated by bold. Amon, A. 10 Ball, R. 39 Bayazidi, A. 181–​2 Beaver, W. H. 39, 106 Beidleman, C. R. 132 Beneish, M. D. 116 Bernstein, P. L. 12 Błażyńska, J. 103 Bliss, C. 19 Böhm-​Bawerk, E. von 10, 15 Borker, D. R. 79 Bradley, F. 61 Brown, G. P. 79 Brown, P. 39 Carver, T. 10 Cassel, G. 10 Cateora, P. R. 61 Chaney, P. 107 Choi, F. 80 Cohen, A. J. 19 Cronin,V. 58 Czarnowski, S. 58 Czekaj, J. 12 Dechow, P. M. 120, 147, 149 Dichev, I. D. 120 Diehl, K. 10 Dobija, M. 9, 18 Doupnik, T. S. 181–​2 Dresler, Z. 12 Duliniec, A. 12, 35 Eddie, A. 79 Fama, E. F. 6, 126 Feltham, G. A. 101

Firth M. 107 Fisher, I. 12 Fogarty, T. J. 79 Francis, J. 121, 149 Frąckowiak, W. 6 Gawrońska, J. 23 Ge, W. 149 Ghauri, P. 61 Gierusz, J. 23 Goodenough, W. H. 58 Gordon, M. J. 186 Grabiński, B. 28 Grabiński, K. 28, 181–​2 Grabski, St. 10 Gray, S. J. 73, 76–​7, 79, 181–​2, 190 Gray’s: accounting 79; accounting values 78; hypotheses 79; output 78; research 79; theory of cultural values of accounting 190 Greenball, M. N. 101 Greenspan, A. 6 Guan, L. 181–​2 Guenther, T. 123 Hall, E. T. 58, 63 Hampden-​Turner, Ch. 82 Han, S. 181–​2 Hansen, A. 6 Hansen’s IS-​LM model 6 Harcourt, G. C. 19 Harris, M. 58 Hasan, I. 123 Heidhues, E. 79 Heller, W. 10 Herder, J. G. 58 Hicks, J. R. 6, 120 Hoebel, A. 58

Name index  219 Hofstede, G. 2, 59, 63–​4, 69, 73, 77, 79, 81, 143, 189 Hofstede’s: analysis 69; list of dimensions 68; research 60, 73; studies 74; cultural determinants 171, 173–​4, 176; cultural dimensions 78; data 68; dimensions 171, 190, 192; findings 76; model 3, 144–​145, 190; output 76, 78; six cultural dimensions 191; variables occurring 170 Hope, O. K. 79 House, R. J. 63, 73 House’s model 68 Hume, D. 14 Inkeles, A. 73 Jaggi, B. 79 Jain, S. C. 58 Jajuga, K. 12 Jeter D. 107 Jevons, W. S. 15 Jiambalvo, J. 101 Jones, J. J. 119, 147 Jones model 170, 153 Kahneman, D. 6 Kaldor, N. 17 Kang, T. 181–​2 Kangarluei, S. J. 181–​2 Karmańska, A. 101 Kavousy, E. 181–​2 Keynes, J. M. 14 Kisielnicki, J. 101 Kiziukiewicz, T. 101 Kłoskowska, A. 58 Kluckhohn, F. R. 63 Knies, K. 10 Knight, F. 6 Kolman, R. 101 Kothari, S. P. 130 LaFond, R. 149 Levinson, D. J. 73 Lin, Z. 181–​2 Linton, R. 58 Low, P.Y. 79 Markowitz, H. 6 Menger, C. 10 Mill, J. S. 10 Miller, M. H. 6 Mock, T. J. 101 Modigliani, F. 6

Mokrzycka-​Kogut, K. 181–​2 Motil, J. 101 Mueller, G. 80 Myers, S. C. 35 Nikoomaram, H. 181–​2 Niswander, F. 79 Nobes, C. 80 Ohlson’s model 128 Olsson, P. M. 149 Omri, A. 182 Pareto,V. 6, 10 Park, J. C. 123 Pasinetti, L. 17 Patel, C. 79 Piosik, A. 122 Pourjalali, H. 181–​2 Riahi, R. 182 Ricardo, D. 10 Robinson, J. 17 Rodriguez, R. P. 79 Ronen, J. 120 Saam, N. J. 31 Salter, S. 79, 181–​2 Samuelson, P. 17 Sarathy, R. 61 Say, J. B. 10, 14 Schiemann, F. 123 Schipper, K. 120–​2, 149 Schmoller, G. 10 Schrand, C. 149 Schumpeter, J. A. 6, 10, 16 Schwartz, S. H. 60, 71 Seligman, E. R. A. 10 Sengupta, P. 181–​2 Senior’s abstinence theory 15 Singer, H. 10 Skarbek, F. 10 Skrzypek, S. 10 Sloan, R. G. 147 Smith, A. 10, 12, 14–​15, 72 Smith’s: conclusions 15; views 14 Solow, R. M. 17 Sombart, W. 10 Sopińska, A. 101 Stefanowicz, B. 101 Sterling, R. R. 101 Strodtbeck, F. L. 63 Suchodolski’s concept 58

220  Name index Sudarwan, M. 79 Sweeney, A. P. 147 Szczepański, J. 58 Szychta, A. 7, 21 Szymański, K. G. 7–​8 Tang, Q. 181–​2 Taussig, F. W. 10 Taylor, E. 15 Terpstra,V. 61 Teruya, J. 181–​2 Throsby, A. 57 Trompenaars, F. 63, 82 Tucker, J. W. 133 Turgot, A. R. J. 10, 14 Turyna, J. 101 Tversky, A. 6 Tylor, E. B. 58

Vincent, L. 120–​1 Vint, H. M. 79 Wagner, R. 10 Walras, L. 6 Ward’s method 169, 171 Weber, M. 10 Weber’s output 72 Wingate, M. L. 79 Wójtowicz, P. 33 Wu, Q. 123 Yaari,V. 120 Yoo,Y. K. 181–​2 Zarowin’s research 133 Zarzeski, M. T. 79 Zimmerman, J. 101

Subject index

Note: Figures are indicated by italics. Tables are indicated by bold. abnormal accruals 118, 146 abnormal return 10, 128 accounting earnings management 118 accounting theory 3, 6–​8, 20–​2, 26, 28, 115 accounting values 2, 40, 78–​9 accrual estimation error 125 adverse selection 34, 52 agency costs theory 31 arbitrage pricing theory 31, 38, 40 assertiveness 60, 68–​9, 76 attributes of financial information 91, 101 autonomous leadership 70

cultural dimensions 2, 59–​60, 63–​4, 68–​70, 75–​6, 78, 81, 143, 145, 171, 173–​4, 176, 178, 180, 185–​6, 189, 191 culture 2–​3, 56–​64, 66–​9, 71–​5, 79–​84, 86, 123, 145, 153, 154–​6, 157, 158–​60, 162–​7, 183–​184, 187, 189–​90 culture typology 61 cumulative abnormal return 128 current operating performance 22, 26, 28

behavioural finance 1, 6 big bath 120–​1 bonding costs 31 book-​to-​market ratio 107 business effectiveness 30

earnings association coefficient 107 earnings management 2, 27–​8, 30–​1, 40, 79, 81, 115–​25, 143, 146–​7, 167–​71, 173, 180–​4, 186–​7, 189–​92 earnings quality in accounting 3, 115 earnings response coefficient 128 earnings smoothing 131–​5, 148–​50, 157, 165, 176, 178–​80, 185, 186–​7, 189, 191–​2 efficient capital market theory 40 eigenvector 99 event study 107, 127

capital asset pricing model 10, 31 capital market research in accounting 106 capital value 18 CAPM 31, 37–​8, 40–​1, 107 Chinese Value Survey 67 clean surplus 22, 26–​7 clustering coefficient 99 comparability 65, 92, 101, 108, 124, 147, 149–​50, 187 comprehensive income 7, 22–​30, 95 concept of culture 2, 56–​7, 64 conservatism vs. optimism 77 cultural categories 73, 74 cultural determinants 2, 3, 56, 59, 61–​2, 71–​3, 81, 104, 143–​4, 150, 171, 173–​4, 176, 178, 180–​2, 186, 189–​93

degree of centrality 99 dimensions of a national culture 63–​4 dirty surplus accounting 22 discretionary accruals 118, 146

faithful representation 92–​3, 95 financial performance 21–​2, 25, 29, 32, 39, 95, 115, 121, 123–​5, 127, 133–​4, 143, 145, 148–​9, 180, 186, 189 financial reporting 2, 20, 22, 28–​30, 32–​3, 37, 40–​1, 91–​3, 95–​7, 103–​4, 106, 108, 116–​17, 124, 129, 184, 189, 190 financial statements 1–​3, 9, 20–​2, 25, 27–​30, 33–​4, 38–​40, 50, 77, 91–​2, 94–​6, 103–​8,

222  Subject index 115–​17, 121–​2, 124–​7, 130, 139, 142, 145, 150, 180, 184, 189–​92 Fog index 125, 139 fraudulent accounting 116 future orientation 60, 68, 70, 76 gender egalitarianism 60, 68–​70, 76 GLOBE 56, 60, 63, 68–​71, 82, 84, 86–​7, 200, 203–​4, 206 Hofstede’s model 3, 69, 144–​5, 190 humane orientation 60, 68–​9, 76 impact of cultural determinants 3, 81, 143, 171, 186, 189–​91 individualism vs. collectivism 75, 144, 170, 173–​4, 178, 186, 191–​2 indulgence 3, 59, 67, 81, 144, 170, 173–​4, 176, 184, 186–​7, 191–​2 information asymmetry theory 31, 33, 40 information quality 97, 99–​103 in-​group collectivism 60, 68–​70, 76 institutional collectivism 60, 68–​9, 76 interest 6, 9, 11, 13, 15–​17, 31–​2, 34, 41, 63, 72–​3, 85, 103, 105, 122–​3, 131, 143, 168, 183 J. J. Jones model 153, 167, 170 judgements 7, 21, 24, 30, 59, 95, 115, 134 liquid capital 18 long-​term orientation 3, 59, 86, 143–​4, 170, 173–​4, 176, 178, 181–​2, 184–​6, 191–​2 managerial approach 124 masculinity vs. femininity 2, 144, 170, 173–​4, 176, 178, 186, 191–​2 minority shareholders 104 modern portfolio theory 38 monitoring costs 32 moral hazard 34 MPT 38 national culture 61, 63–​4, 66, 69, 71, 187, 190 non-​discretionary accruals 118, 146 non-​recurring earnings 37 Ohlson’s model 128 participative leadership 70 performance orientation 60, 68–​70, 76

persistence 2–​3, 28, 37, 40, 120–​6, 128, 144–​5, 148–​50, 153, 157–​8, 174, 176, 178, 180, 185, 186, 189–​92 persistent earnings 125 portfolio theory 31, 37–​8, 40–​1 power distance 2, 59–​60, 64–​5, 68–​70, 75–​6, 79, 144, 170–​1, 173–​4, 176, 178, 182–​3, 186–​7, 191–​2 power distance index 183 predictability 3, 27, 75, 94, 122–​4, 133, 144–​5, 148, 150, 157, 161–​2, 173–​4, 175–​8, 180, 185, 186–​7, 189–​91 price/​earnings ratio 107 professionalism vs. statutory control 76 profit 5–​6, 9–​10, 13, 15–​31, 35–​6, 44, 50, 52, 118, 119, 129, 140 profit and interest 15–​16 profitability 16, 33, 35, 105, 125, 167–​8 qualitative characteristics 3, 91–​7, 99–​100, 103–​4, 112, 118, 121 quality of earnings 1–​3, 34, 36–​7, 39–​40, 59, 115, 117, 120–​1, 126, 130–​1, 134, 143–​5, 148, 150, 152, 178, 180, 182, 186, 189–​92 quality of the financial result 124 quantitative measurement 63, 71–​2 real capital 14, 18 recurring earnings 37 residual loss 32 restraint 3, 59, 67, 75, 81, 144, 170, 173–​4, 176, 178, 181–​2, 184–​7, 191–​2 risk 6, 10, 18, 31–​2, 35, 37–​8, 41, 51, 77, 104–​5, 108, 128–​9, 133 secrecy vs. transparency 77 sector-​wide approach 124 shareholders 17, 25, 28, 31–​3, 104–​6, 122, 183 shareholder value 25, 30, 105 short-​term normative orientation 144 signalling theory 31, 34–​5, 40, 134 Social Network Analysis 99 stakeholder theory 104 strong uncertainty 66, 75, 144 timeliness 33, 92–​3, 95–​7, 101, 103, 108, 124 total accruals 118–​19, 146–​7 transitory earnings 125 true and fair view 9, 29, 50, 92, 95

Subject index  223 uncertainty avoidance 2, 59–​60, 64, 66–​70, 76, 79, 81, 86–​7, 144, 170, 173–​4, 176, 178, 184, 186, 192 understandability 92–​3, 95, 101 unexpected earnings 37, 121, 138 uniformity vs. flexibility 77

value-​based management 24 value maximising earnings 116 verifiability 92–​3, 95, 103 weak uncertainty 75, 144