Financial Information and Earnings Quality: A Literature Review

Abstract

Earnings quality and the quality of financial reporting in general are subjects that, since a few years, receive more and more attention and are the centre of debate for investors, regulators as well as researchers. This heightened attention to the subject of earnings quality is in part due to the wave of accounting scandals of the early 2000s (manipulation of accounting numbers). The objective of this literature review is to give an overview of the recent studies devoted to the topic of earnings quality.

Although my attention goes primarily to papers that investigate the link between earnings quality and external audit related elements, I do not only focus on this kind of research. I take into account a broader panel of studies on earnings quality. The reason for this is that I want to obtain the most complete possible overview of earnings quality (and more precisely of earnings quality definitions and measurement methods). As for the finance literature however, I only consider the literature related to earnings quality and the capital market. Summarized, I focus on earnings quality studies related to the external audit (principal objective) as well as earnings quality studies with a focus on the capital market.

The literature review is divided in two broad groups. The first one considers earnings quality studies related to external audit. The second one regroups the other studies. No papers that deal exclusively with earnings management have been taken into account. Each of those two groups is structured following the study of Schipper and Vincent (2003), which appears to offer the most significant typology of research in this field. The subject of earnings quality is a complex area and no researcher has thus far been able to provide a unique definition of earnings quality, neither to find an adequate measure for it. According to Balsam e.a. (2003), there exist various measures of earnings quality in literature but those different measures capture diverse manifestations of earnings quality.

Keywords: earnings quality, external audit, capital market

JEL Classification: M41, M43, M49