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 aims to examine the impact of national culture on classification shifting in Eastern European Member States of EU Eastern European countries (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 the authors 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 – This study uses a panel data set of firm year observations from 1996 and 2020 that covers the full transition of EEU. This empirical analysis is based on fixed effects panel regression analysis where the authors report a plethora of identifications. Findings – This 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. This study also notices that cultural factors are associated with classification shifting across all Member States of the EU. This study further examines the impact of interactions between cultural characteristics and special items and reveal variability between WEU and EEU. As part of the robustness analysis, this study also tests 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. 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 policymaking. Social implications – The findings show that cultural differences between EEU and the “old” Member States of the EU could explain classification shifting. Originality/value – To the best of the authors’ knowledge, this is the first study that sheds light on the impact of national culture on classification shifting in EEU of EU vis-a-vis the “old” WEU of EU.