Studies on accounting quality across public and private companies are listed below. Most of studies find that public companies have higher accounting quality than private companies (Beatty, Ke and Petroni, 2002; Ball and Shivakumar, 2005; Burgstahler, Hail and Leuz, 2006; Hope, Thomas and Vyas, 2012). However, Givoly et al (2010) find that public companies report more conservative but have more incentives to manage earnings than private companies.
Studies on comparability of accounting quality across different sizes of companies are mixed, that public companies tend to report more conservatively because of higher demand and tough regulations whereas private companies have lower accruals quality because of less market demand and less legal enforcement.
Beatty, Ke and Petroni (2002)
Findings: They examine the earnings quality of public banks and private banks. They find that public banks have a greater propensity to manage earnings than private banks.
Methods: (1) Target beating; (2) Discretionary Accounting Choice with financial variables in banking sector.
Ball and Shivakumar (2005)
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UK have poorer loss recognition timeliness than public companies. This is the effect of the financial market demand.
Methods: (1) Timely loss recognition (following Basu 1991); (2) Accrual based timely loss recognition (measures the contemporaneous relationship between accruals and cash flows).
Burgstahler, Hail and Leuz (2006)
Findings: Private companies (excluding small companies) in the EU have more earnings management than public companies. Earnings management is lower in countries with strong legal systems.
Methods: (1) Proxies of Earnings Management (including small profit relative to small losses, absolute values of accruals over cash flows, standard deviation of earnings over standard deviation of cash flows, correlation between changes in accruals and changes in cash flows)
Givoly, Hayn and Katz (2010)
Findings: They find that US private equity companies (with public debt) have better quality than public equity companies. This is the effect of earnings opportunism. Interestingly, on loss recognition timeliness they find similar to Ball and Shivakumar (2005), that public equity companies report more conservatively than private equity companies.
Methods: (1) Earnings persistence (expect coefficient in accruals component is larger, that accruals are more informative about future earnings); (2) Accruals model proposed by Dechow and Dichev (2002) and modified by McNichols (2002) and Francis et al (2005); (3) Small profit relative to small losses; (4) Accruals based timely loss recognition following Ball and Shivakumar (2005)
Hope, Thomas and Vyas, (2012)
Findings: They present clearer results than Givoly et al (2010). Private firms have lower financial reporting quality and are less conservative than public firms.
Methods: (1) Accruals estimation errors following McNichols (2002); (2) Absolute values of accruals over absolute values of cash flows following Burgstahler et al (2006); (2) Conservatism following Ball and Shivakumar (2005)
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4.3 Sample and Data
In order to be consistent with previous chapter, in this chapter, we use the same data as the previous chapter from FAME database under current financial reporting structure, which include public EU quoted companies are following full IFRS to prepare consolidated accounts, private non-small (medium) companies are following UK GAAP7 and small companies are following FRSSE.8
Under the definition of size of companies from sections 382 and 465 of the Companies Act 2006, we select active public companies for the years of 2008-2010, private medium companies with turnover greater than £6.5 million and balance sheet worth greater £3.26 million for the years of 2008-2010, and small companies with annual turnover of £6.5 million or less and have an annual balance sheet worth no more than £3.26 million for the years of 2008-2010. We therefore obtain three groups of companies-observations based on the size criteria from Companies Act, which are large companies (public companies), medium companies (private medium-sized companies) and small companies.
We exclude companies that are subsidiary as their reporting requirement is different. The criterion for subsidiary in FAME is that the minimum path of ultimate owner is 50.01%. We also screen out private firms whose legal form is not equal to the status of corporations such as legal forms like sole proprietorships or partnerships. We exclude banks, insurance companies and other financial institutions (SIC codes 6000-6799). We also exclude companies that without known value of total assets in the years of 2008, 2009 and 2010 in order to mitigate the data errors.
Each sample of companies (Large, medium and small companies) are then grouped into 10 major industry sectors based on UK SIC 2007, which include9: Primary, Manufacturing, Utility, Construction, Wholesale, Service, Transport, Telecom, Other service, Education & Health. The reason of using two digits SIC codes is to analyse the difference in accounting quality across different industry
7
UK GAAP is a mixture of Financial Reporting Standards (FRS), Statements of Standard Accounting Practice (SSAP) and IFRS-based standards.
8 There are still public companies following UK GAAP and private companies following IFRS, these
companies are excluded in our studies, given our intuition of this research is to compare three classes companies that are public quoted companies following IFRS, medium companies following UK GAAP and small companies following FRSSE respectively.
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groups in a broader range. Finer or detailed SIC codes may not present any significant difference in accounting quality across groups.
However, using broad two digits SIC codes may introduce noise in the results, we therefore control outliers using winsorizing. We winsorized accounting items needed in the calculation of our earnings quality proxies at the 5th and 95th percentile as in Barth et al (2008). We exclude those companies-observations where accounting items include profit, turnover, total assets and equity are exactly equal to zero since most likely they indicate missing data for the years of 2008-2010.
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