Do cultural differences affect the quality of financial reporting in the EU? An analysis of Western EU countries vis a vis Eastern EU countries

Purpose: This study examines the impact of national culture on classification shifting in Eastern European Member States of EU (EEU) vis a vis the Western Member States of EU (WEU). The EEU provides a unique sample to study the quality of financial reporting that we measure with classification shifting given that for more than five decades they were following the model of a centrally planned economy, where market-based financial reporting was absent. Yet, the EEU transitioned to a market-based economy and completed its accession to the EU. Design/methodology/approach: We employ a panel data set of firm year observations from 1996 and 2020 that covers the full transition of EEU. Our empirical analysis is based on fixed effects panel regression analysis where we report a plethora of identifications. Findings: Our study finds classification shifting in the EEU countries since their transition to the market-based economy, though they have no long record of market-based financial reporting. Our study also notices that cultural factors are associated with classification shifting across all Member States of the EU. We further examine the impact of interactions between cultural characteristics and special items and reveal variability between WEU and EEU. As part of the robustness analysis, we also test the impact of culture on real earnings management measures for both WEU vs EEU confirming the variability of the impact of culture on earnings management. Originality: This is the first study, to the best of our knowledge, that sheds light on the impact of national culture on classification shifting in EEU of EU vis a vis the “old” WEU of EU. Research limitations/implications: Future research could explore the role of religion differences in WEU vis a vis EEU states as they are also subject to cultural differences. Practical implications: The findings are important for regulators, external monitors, and investors, as they show that cultural factors affect earnings management with some variability across countries in the EU, and they should be acknowledged in policy making