The effect of non-financial disclosure regulation on earnings management: information symmetry, signalling or political costs?

Acknowledging the scarce literature examining the effect of non-financial disclosure regulation on earnings management (EM), this study aims to investigate whether the narrative reporting regulation prompts or prevents EM.

This study uses the difference-in-differences research design using the UK narrative reporting regulation 2013 as an exogenous shock. The sample comprises of 417 firms, incorporating both treated firms listed on the London Stock Exchange and control firms from STOXX600 Europe during the period from 2010 to 2016.

The results indicate that, following the implementation of the UK narrative reporting regulation, treated firms exhibited an increase in EM compared to control firms. Furthermore, the study findings reveal a preference among firms for conservative EM practices, as opposed to engaging in aggressive strategies. Drawing on the political cost hypothesis, the results suggest that managers were motivated to downwardly adjust their reported earnings in response to regulatory pressures, particularly those stemming from political costs and uncertainty associated with the narrative reporting regulation.

In particular, the author recommends that regulations concerning both financial and non-financial disclosures should be interconnected, ensuring that subsequent disclosures offer a comprehensive and precise representation of the firm’s performance.

Through this analysis, the author offers policy-relevant insights that can be valuable for policymakers and regulators in shaping effective regulations in this domain.