The articles have explored different aspects of financial reporting enforcement, materiality, the
enforcement of auditors, auditors’ auditing efforts and auditors’ liability. The findings of these explorations are summarised below.
8.1 Enforcement
To explore how enforcement varies among the European countries, it has been necessary to develop three enforcement indices that capture the various enforcement strategies4. Six key characteristics are identified as important for effective financial reporting enforcement, and the three enforcement indices are modelled based on these six key characteristics. The six characteristics5 are as follows: Independence, scope of enforcement, enforcement approach, sanctions and the ability to impose these sanctions on non-performers, publishing of guidance and decisions, and interaction with stakeholders. The applied enforcement may emphasise different aspects of the six characteristics. Consequently, three enforcement
4 The three enforcement strategies are the deterrence strategy, the persuasion strategy and a mix of the deterrence and the persuasion enforcement strategies (total enforcement).
5 Independence aims to ensure that the enforcers are independent from the stakeholders (for example, governments, auditors, market participants, preparers and users of financial reports, etc.). Scope of enforcement is needed because it clarifies and defines what the enforcers must enforce.
The enforcement approach helps ensure consistent enforcement with regard to performing the actual enforcement (the enforcement follows similar principles) and evaluation of infringements and imposed sanctions.
Sanctions and the ability to impose them on non-performers make it possible for enforcers to punish non-compliers using various sanctions and penalties.
Publishing of guidance and decision refers to the need for enforcers to publish information about their activities, guidance and decisions.
Interaction with stakeholders enables enforcers to dialogue with the enforced entities and provide pre-clearance.
indices have been created that capture different enforcement strategies. Two of the enforcement indices are based on the two archetypes of enforcement strategy (deterrence and persuasion), whereas the third is based on a mix of the two (responsive enforcement).
The analysis finds variation in the strictness of financial reporting enforcement across the European countries and that the countries emphasise different aspects of enforcement, which is expected because of differences in institutional settings. However, some countries consistently engage in stricter enforcement, disregarding the chosen enforcement strategy, which indicates a generally strict enforcement environment of financial reporting. The three enforcement indices do not generally correlate with existing enforcement indices. This is not entirely surprising, as many of the existing indices are created for purposes other than the enforcement of financial reporting. However, it is surprising that indices specifically created to measure financial reporting enforcement (Brown et al. 2014) exhibit a similar lack of correlation. The reason for the lack of correlation between the three enforcement indices and the Brown et al. (2014) enforcement index is that Brown et al. (2014) capture the breadth and depth of actual enforcement only to a limited extent.
8.2 Enforcement and materiality assessments on mandatory disclosure decisions
In article two, the three enforcement indices created are used to analyse the effect of financial reporting enforcement on the materiality assessment and the disclosure decisions for mandatory disclosures. The results show that the strictness of the enforcement has both a positive and a significant influence on the level of compliance with mandatory disclosures if the applied enforcement strategy is either a mix of the deterrence and the persuasion strategies or the deterrence strategy only. Enforcement based on a persuasion strategy appears ineffective in securing compliance with mandatory disclosures. Furthermore, the results show that the level of disclosures is significantly lower when goodwill is immaterial, whereas the level of disclosures is insignificantly different once goodwill is material. In other words, the absolute and
relative size of goodwill does not influence the level of disclosures once goodwill is material. This result provides a clear indication that firms perform a materiality assessment when they decide to disclose mandatory disclosures. Finally, this study finds that strict enforcement does not influence the materiality assessment of the firms, which means that financial reporting enforcement does not influence the firms’
materiality assessments.
8.3 Financial reporting enforcement, enforcement of auditors and limitations on the auditor’s liability
The enforcement index created is also used to investigate how the strictness of enforcement impacts the audit efforts of the auditor while considering possible limitations on the auditor’s liability. The analysis finds that strict financial reporting enforcement has a negative and significant influence on the audit efforts, disregarding the applied enforcement strategy. This indicates that auditors apply less audit effort when financial reporting is strict because strict enforcement causes preparers to deliver a higher-quality financial report. Consequently, the auditor must perform fewer audits before he has achieved the desired level of assurance. However, strict enforcement of auditors (proxied by a modified Brown et al. 2014 audit measure) causes them to make significantly more auditing efforts if the enforcement of auditors is weak.
These additional auditing efforts are most likely caused by the auditor’s attempt to hedge against the increased risk of penalties and/or reputational losses derived from the increased strictness of enforcement.
Prior studies have found mixed results on how limitations on the auditor’s liability impact the applied audit efforts but provide an overall conclusion indicating that liability limitations reduce the audit efforts of the auditor. This thesis finds that limitations on the auditor’s liability significantly reduce the efforts of the auditor. However, robustness tests indicate that the effects of limitations on the auditor’s liability are highly susceptible to the enforcement environment of financial reporting because financial reporting enforcement based on an enforcement strategy of either deterrence or persuasion reduces the effect from
significant to insignificant, i.e., limitations on the auditor’s liability do not impact the applied auditing efforts. Consequently, it appears that the impact of limitations on the auditor’s liability depends upon the enforcement strategy applied.