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Alexandra B

agaeva

OULU 2010

G 42

Alexandra Bagaeva

THE QUALITY OF PUBLISHED ACCOUNTING INFORMATION IN RUSSIA

FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION,DEPARTMENT OF ACCOUNTING,UNIVERSITY OF OULU

A C T A U N I V E R S I T A T I S O U L U E N S I SG O e c o n o m i c a 4 2

ALEXANDRA BAGAEVA

THE QUALITY OF PUBLISHED ACCOUNTING INFORMATIONIN RUSSIA

Academic dissertation to be presented with the assent ofthe Faculty of Economics and Business Administration ofthe University of Oulu for public defence in AuditoriumTA105, Linnanmaa, on 2 June 2010, at 12 noon

UNIVERSITY OF OULU, OULU 2010

Copyright © 2010Acta Univ. Oul. G 42, 2010

Supervised byProfessor Juha-Pekka Kallunki

Reviewed byProfessor Lars HasselAssistant Professor Henrik Nilsson

ISBN 978-951-42-6197-8 (Paperback)ISBN 978-951-42-6198-5 (PDF)http://herkules.oulu.fi/isbn9789514261985/ISSN 1455-2647 (Printed)ISSN 1796-2269 (Online)http://herkules.oulu.fi/issn14552647/

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JUVENES PRINTTAMPERE 2010

Bagaeva, Alexandra, The quality of published accounting information in Russia Faculty of Economics and Business Administration, Department of Accounting, University ofOulu, P.O.Box 4600, FI-90014 University of Oulu, Finland Acta Univ. Oul. G 42, 2010Oulu, Finland

AbstractSince the collapse of the Soviet Union Russia has undergone a number of reforms towardsdeveloping market economy. Accounting has encountered dramatic changes over the last twodecades. Despite attractive investment opportunities in Russia, investors are often faced withuncertainty, which makes it very important to explore the quality of accounting informationpublished in Russia. The purpose of this thesis is to investigate the quality of published accountinginformation in Russia. The thesis consists of four essays, each of them addressing the question ofthe quality of accounting information published in Russia by incorporating the specific Russianinstitutional environment. Special attention is paid to the role of International FinancialAccounting Standards (IFRS) and foreign investors.

The quality of published accounting information is conceptualized by such accountingconstructs as conservatism, earnings management and value relevance. This first essayinvestigates the earnings quality of both listed and non-listed Russian firms and explores whetherforeign ownership affects the quality of earnings published by non-listed Russian firms. Thesecond essay examines whether emphasis on international investors is associated with theadoption of or intention to adopt IFRS in Russian firms. The third essay addresses the question ofIFRS and Russian Accounting Standards (RAS) accounting quality by using the methodologyproposed by Barth et al. (2008) and by value relevance constructs of accounting quality. Thefourth essay investigates the value relevance of firms’ integral environmental impact, i.e. a proxyfor environmental performance, following the stream of non-financial information value relevancein accounting research.

This thesis provides evidence that the quality of published accounting information publishedin Russia depends on many factors, the most influential of these being listing on the stockexchange, IFRS and foreign investors. The results of the thesis demonstrate that the institutionalcharacteristics of the country shape accounting numbers and influence the incentives of thosepreparing financial statements. The findings of the thesis include information valuable forregulators and investors.

Keywords: accounting quality, environmental performance, financial reporting, IFRS,RAS, Russia, transitional economies

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Acknowledgements

Entering the world of science by means of writing a PhD thesis was a major event

in my life and I have gained a lot of valuable experience while studying and

conducting research at the University of Oulu. I would like to express my

sincerest gratitude to the supervisor of my PhD thesis, Professor Juha-Pekka

Kallunki. His guidance and support during my PhD were invaluable. I would also

like to thank my reviewers, Professor Lars Hassel of Åbo Akademi University

and Assistant Professor Henrik Nilsson of Umeå University as their comments

helped substantially improve this work.

My work has benefited from numerous presentations at our Faculty Research

Seminars. I am deeply indebted to all staff members and PhD students from the

University of Oulu who commented on my work. My participations in Doctoral

Tutorial in Accounting in Finland were also very useful, from which I received

lots of constructive comments. Special thanks for academic contribution to my

work are addressed to Hanna Silvola PhD and Henry Jarva MSc. Participation in

European Accounting Association Congresses in 2008 and 2009 has likewise

played an important role in improving the quality of my work.

I would like also to express thanks to foundations and organizations that

supported my research: the Wihuri Foundation, the Oulu University, the Marie

Curie Fellowship and Graduate School of Accounting. Moreover, I am thankful to

all the people from administrative department of our Faculty for their help and

support. I wish to express my thanks also to Dr. Seppo Eriksson for the editorial

advice and to Virginia Mattila for her careful revision of the language. I have

enjoyed the working atmosphere in our department where I have made lots of

friends. Finally, I want to say thanks and send love to my family.

Oulu 25th April 2010 Alexandra Bagaeva

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List of original publications

The thesis consists of an introductory chapter and the following essays:

I Bagaeva A, Kallunki J-P & Silvola H (2008) Can Investors Rely on the Quality of Earnings Figures Published by Listed and Non-listed Russian Firms? International Journal of Accounting, Auditing and Performance Evaluation 5(1): 30–49.

II Bagaeva A (2008) An Examination of the Effect of International Investors on Accounting Information Quality in Russia. Advances in Accounting 24(2): 157–161.

III Bagaeva A (2009) The International Financial Reporting Standards (IFRS) and Accounting Quality in the Transitional Economy: The Case of Russia. Manuscript.

IV Bagaeva A (2009) The Value Relevance of Firms’ Integral Environmental Impact: Evidence from Russia. Manuscript.

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Table of contents

Abstract

Acknowledgements 5 List of original publications 7 Table of contents 9 1 Introduction 11 2 Constructs of accounting quality 15

2.1 Conservatism ........................................................................................... 15 2.2 Earnings management ............................................................................. 18 2.3 Value relevance ....................................................................................... 20

3 The Russian institutional environment 23 3.1 Development of accounting in Russia ..................................................... 23

3.1.1 Role of foreign investors .............................................................. 25 3.1.2 The Role of International Financial Accounting Standards

(IFRS) in Russia ........................................................................... 27 3.2 Legal system ........................................................................................... 28 3.3 The Stock Market .................................................................................... 29

4 Overview of the essays 33 4.1 Data and methods .................................................................................... 33 4.2 Essay 1: Can Investors Rely on the Quality of Earnings Figures

Published by Listed and Non-listed Russian Firms? ............................... 35 4.3 Essay 2: An Examination of the Effect of International Investors

on Accounting Information Quality in Russia ......................................... 35 4.4 Essay 3: The International Financial Reporting Standards (IFRS)

and Accounting Quality in a Transitional Economy: The Case of

Russia ...................................................................................................... 36 4.5 Essay 4: The Value Relevance of Firms’ Integral Environmental

Impact: Evidence from Russia ................................................................ 37 4.6 Contributions ........................................................................................... 38

5 Conclusions 41 References 43 Original articles 49

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1 Introduction

“Not with the mind is Russia comprehended,

The common yardstick will deceive

In gauging her: so singular her nature

In Russia you must just believe.”

(Tyutchev 1866, in Yarmolinsky 1949:88)

The accounting phenomenon in Russia has been under the influence of the major

historical changes in the last century. It was marked by the advent and the rule of

the Soviet party for almost 75 years in Russian history, followed by the collapse

of the Soviet Union and the pursuit of a market economy. The period in the most

recent history of Russia starting from 1991 up to the present day has witnessed a

number of economic reforms, the development of the stock market, the formation

of a whole new accounting system and the initiation of the accounting and

auditing profession (Bailey 1995). Russia is still undergoing a transition process

from a command economy to a market economy, which necessitates economic

reforms and the establishment of a new institutional and legal framework.

It is generally known that accounting information from financial reports has a

great impact on the behaviour and decision-making of its users, namely investors,

managers and the state. In accounting studies covering a wide range of topics

starting from management and ending with financial accounting, one may find

examples of the usefulness and relevance of accounting information in most

European countries, Australia, Asia and in the USA (e.g. Kothari 2001, Verrecchia

2001). At the same time accounting in Russia remains one of the most under-

researched areas in the accounting literature. Despite a handful of studies dealing

with accounting in Russia (Enthoven et al. 2001, McGee & Preobragenskaya

2006, Goncharov & Zimmerman 2006), there is no solid research on the most

common attributes of accounting quality, such as value relevance, conservatism

and earnings management. This absence of scientific research can be partly

explained by the complexities of the accounting phenomenon in Russia and its

cultural embeddedness in the Russian past and present.

While Russia is considered to be an attractive country to foreign investors,

because of its qualified labour supply, vast natural resources and its geographical

proximity to Europe, its transitional nature involves a high degree of uncertainty.

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This has been reflected in considerably lower foreign direct investment (FDI)

levels in Russia than, e.g. in China. The accounting information provided by

Russian firms needs to be scrutinised. Using financial accounting quality concepts,

this thesis investigates the quality of accounting information in Russia relying on

such factors as the role of foreign investors and International Financial

Accounting Standards (IFRS). Major emphasis is placed on the incentives of

those involved in the financial accounting statements preparation. Furthermore,

the Russian transitional context is intensively incorporated into the study.

Taking into consideration the transitional state of the economy in Russia, the

purpose of this study is to examine the quality of accounting information

published in the nascent Russian market economy, while paying attention to the

development of accounting in Russia and keeping in mind the most influential

forces in this process, such as the role of foreign investors and IFRS. The topic of

this thesis is in line with accounting studies emphasising the role of institutional

environment influencing the properties of published accounting information and

the incentives of managers and auditors (e.g. Ali & Hwang 2000, Ball et al. 2000,

Fan & Wong 2001, Leuz et al. 2003, Bushman & Piotroski 2006, Barth et al.

2008 etc.). Therefore, this work continues this research tradition by investigating

the quality of accounting information in Russia and reflecting on the impact

thereon of the institutional environment. Moreover, looking at the incentives of

those preparing financial statements, it is possible to see how such incentives

permeate the quality of accounting information in Russia. For, example, keeping

everything fixed, the Russian firm in need of foreign equity capital is more likely

to begin acting more proactively by improving the quality of the published

accounting information and by adopting IFRS, because these are the ways to

demonstrate commitment and increase transparency.

The thesis is composed of four independent essays, with three common

themes running through all of them: accounting quality in Russia, the role of

international investors and the role of IFRS. All these themes are very much

interrelated, however, there is no search for a causal relationship. The role of

foreign investors and IFRS serve as anchors uniting the thesis into an entity

allowing for a multi-angle coverage of the research topic.

The contribution of the thesis relates to the literature on the role of incentives

in the quality of accounting information (Ball & Shivakumar 2005, Barth et al.

2008, Christensen et al. 2008) by expanding models used in earlier research and

providing empirical evidence from the Russian transitional economy. The thesis

also contributes to the discussion on the influence of institutional country

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characteristics on the quality of accounting information (Ball et al. 2000, Ball et

al. 2003) by using the Russian institutional setting as an example. It provides new

evidence on the impact of IFRS on the quality of accounting information

internationally (e.g. Barth et al. 2008, Bartov et al. 2005; Hung & Subramanyam

2007). The thesis contributes to the discussion on the valuation properties of

environmental performance (Jaggi & Freedman 1992, Dowell et al. 2000, Hassel

et al. 2005) by introducing the measure of integral environmental impact and adds

to the to the literature on the impact of ownership on environmental disclosure

and performance (Magness 2006, Cormier & Gordon 2001, Cormier & Magnan

2003). The respective contributions of the individual essays are discussed in

greater detail in subsequent chapters.

The remainder of this introductory chapter is organized as follows.

Accounting quality constructs and previous research thereon are reviewed in

Section 2. Section 3 deals with accounting in Russia, summarising the most

important development stages of accounting in Russia and drawing upon the legal

framework as well as reviewing the situation on the stock market. Section 4

focuses on the research framework by outlining the research questions, research

structure and drawing on research contributions. Sections 5 concludes.

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2 Constructs of accounting quality

The quality of accounting information derived from financial reporting is a

widely used term in financial accounting research. However, there is no

consensus on the definition of accounting quality in general. There are different

approaches that attempt to capture the phenomenon of accounting quality from

financial reports by evoking accounting earnings and its characteristics such as

earnings persistence, predictive ability and variability of earnings (Schipper &

Vincent 2003) and other information from the financial statements. Accounting

information quality can be described in terms of decision usefulness and

reliability for the users. As accounting information becomes less reliable, it

becomes more difficult for equity investors to evaluate a firm’s true performance.

While it is difficult to formulate an exact definition of accounting information

quality, one might understand that, for instance, manager manipulation and

earnings management could serve as primary cause of impaired information

quality.

The accounting literature uses different approaches and concepts to

conventionalise accounting information quality to be measured or tested

empirically. For the purposes of this thesis the following constructs measuring

accounting information quality have been chosen: conservatism, value relevance

and earnings management. The rationale behind choosing these constructs is

based on their versatility and applicability, meaning that they have been employed

in many studies worldwide (Kothari 2001), as well as by the existence of a fully

articulated theory on these constructs. Furthermore, by incorporating

conservatism, value relevance and earnings management into the examination of

accounting information quality it is possible to achieve a more holistic picture on

the state of accounting in Russia. The use of these constructs moreover makes it

possible to extend the existing research by shedding light on the state of these

issues in the transitional Russian economy. In the following subchapter each of

the accounting information quality constructs used in this thesis will be examined

in more detail.

2.1 Conservatism

Conservatism has a history of long and significant influence on accounting

practice and, thus, on accounting research. The most common definition of

conservatism identifies it as “the accountant’s tendency to require a higher

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degree of verification to recognise good news as gains than to recognize bad news

as losses” (Basu 1997, 7). Therefore, conservatism requires an asymmetrical

degree of verification for gains versus losses. According to Watts (2003)

conservatism originated and has persisted because of contracting, litigation,

taxation and regulation considerations. The same factors triggering conservatism

have also been documented by Ball (2001), Ball & Shivakumar (2005) and Basu

(2005). Conservatism also serves as a mechanism for reducing information

asymmetry between firm insiders and outside equity investors by reducing the

manager’s incentives to manipulate accounting numbers (LaFond & Watts 2008).

In investigating conservatism it is important to pay attention to two different

types of conservatism: unconditional and conditional conservatism.

Unconditional conservatism refers to accounting policies that consistently

underestimate net assets, for instance, such procedures as full expensing of R&D,

accelerated depreciation and avoiding the recognition of self-originated

intangibles. In light of Watts & Zimmerman’s (1986) discussion, unconditional

conservatism means that the accountant should report the lowest value among the

possible alternative for assets and the highest value for liabilities. Another

definition of unconditional conservatism by Beaver & Ryan (2005) states that

unconditional conservatism is ex ante in nature or news independent, meaning

that this type of conservatism only utilizes information known at the inception of

the asset’s life. Conditional conservatism refers to more timely recognition of loss

events and delayed recognition of gains, generating earnings that reflect bad news

in a timelier fashion than good news (Basu 1997). Conditional conservatism can

be viewed as ex post or news dependent conservatism (Beaver & Ryan 2005). The

examples of this type of conservatism may be lowering of cost or market

accounting for inventory and impairment accounting for long-lived tangible and

intangible assets. Starting with Basu (1997) a body of research has investigated

the association between share returns and earnings finding a stronger association

when returns are negative, hence demonstrating the asymmetry.

In empirical studies researchers use different constructs for measuring

conservatism, which as in (Watts 2003) can be divided into the following

categories: book-to-market measures, valuation model measures, earnings/accrual

measures and earnings and stock returns relation measures. Book-to-market and

valuation model measures are used for investigating unconditional conservatism,

as they make it possible to obtain the understatement of net assets caused by

unconditional conservatism (Ahmed et al. 2000, Beaver & Ryan 2000).

Meanwhile earnings and accrual measures, as well as earnings and stock returns

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relation measures capture the impact of conditional conservatism due to the

asymmetrical treatment of gains and losses under conditional conservatism.

Both types of conservatism serve many of the same purposes, including

reducing information asymmetry, minimizing firms’ litigation risk, tax, or

regulatory costs. In contracting agreements conservatism by requiring asymmetric

verifiability of gains and losses constrains managerial opportunistic behaviour. By

means of conditional conservatism contracting efficiency can be improved, given

general managers’ tendency to report upward-biased accounting numbers (Beaver

& Ryan 2005), if one looks at debt contracts, which are commonly written in

terms of variables reported in the financial statements, such as interest coverage

or financial leverage. Monitoring of debt contracts is facilitated if conditional

conservatism is applied, as debt-covenant violations are triggered faster. Also,

timely loss recognition gives managers less incentives to undertake ex ante

negative-NPV projects (Ball & Shivakumar 2005). Consistent with the

contracting explanation of conditional conservatism Ball et al. (2008) find that

conservative accounting limits the opportunities available for manipulation of the

reported variables included in debt contracts by restricting decisions made by

loss-making managers that could further erode debt quality. Regarding taxation

and regulation, Ball (2001), Ball and Shivakumar (2005) and Basu (2005) argue

that they are likely to induce only conservatism in its unconditional form.

Moreover, based on the studies by Ball and Shivakumar (2005) and Basu (2005)

it is possible to conclude that contracting and litigation are the reasons for

conditional conservatism. To conclude, both types of conservatism are likely to

reduce income and equity, but the timing of these reductions is different, since

only conditional conservatism provides new information that generates

contracting responses.

In the last two decades research on conservatism has attracted great attention

in accounting. There are large cross-country studies such as that by Bushman &

Piotroski (2006) examining the influence of legal and political institutions on

incentives for conservative accounting. Raonic et al. (2004) focuses on set of

European countries in investigating interrelation between country-level disclosure

regimes, legal enforcement and importance of equity markets on conservatism.

Furthermore, the issues of the country institutional background and forces have

been incorporated into the research by Ball et al. (2000) and Ball et al. (2003).

Depending on the demand for accounting income in each given country, Ball et al.

(2000) find that accounting income properties vary across countries. In four East

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Asian countries Ball et al. (2003) observe various levels of conditional

conservatism depending on the country’s institutional framework.

For the purposes of this thesis a conditional conservatism measure by Ball

and Shivakumar (2005) is applied. The rationale behind choosing this approach

lies in the applicability of their conservatism measurement for investigating

conservatism in both public and private firms, because the measure of timeliness

is based on the transitory nature of economic income and does not require stock

returns. Moreover, it is possible to examine how incentives for providing high

quality accounting information differ in Russian private and public firms as well

as to see what impact foreign ownership has on conservatism in Russia.

2.2 Earnings management

The most common definition of earnings management is the manipulation of a

company's financial earnings either directly or through indirect accounting

methods. This happens when a company is unable to meet investor expectations

or in periods of volatile earnings. Earnings management is often viewed as a

misleading and fraudulent activity.

Researchers have classified the incentives for earnings management into:

stock market purposes, contracting and regulatory motivations (Healy & Palepu

1999). In stock market purposes managers are likely to manage earnings before

equity offers, e.g. (Dechow et al. 1996), or to meet the expectations of financial

analysts or management (Burgstahler & Eames 1998). For contracting

motivations earnings management is likely to produce misleading financial

statements which could affect resource allocation (Healy & Wahlen 1999), this

suggests that compensation and lending contracts induce at least some firms to

manage earnings to increase bonuses, improve job security, and mitigate potential

violation of debt covenants. First, earnings management for any reason can

potentially lead to misleading financial statements and affect resource allocation.

Second, financial reporting is used for communicating management information

not only to stock investors, but also to debt investors and to investors'

representatives on boards of directors. It has been documented that regulatory

considerations induce firms to manage earnings, for instance to manage industry-

specific regulatory constrains. Adding to the existing motivations for earnings

management this thesis incorporates the Russian institutional environment and

builds on the notion of tax incentives and attracting foreign investors as

considerations for or against earnings management.

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Empirical constructs for measuring earnings management vary from study to

study. However, according to McNichols (2000), they can be classified into

aggregate accruals models, specific accruals models and the frequency

distribution approach. Aggregate accruals models include studies by Jones (1991),

where a model of discretionary accruals is employed, Dechow et al. (1995),

specific accruals models focus on industry settings in which a single accrual is

sizable and requires substantial judgement, e.g. Beaver & McNichols (1998),

Nelson (2000) and Petroni et al. (2000). The reason for investigating

discretionary accruals is that managers may exploit their discretion over

accounting decisions to enhance reported earnings. Accruals quality can be

measured in terms of discretionary accruals using a variant of the Jones (1991)

model, the modified Jones model (Dechow et al. 1995), or performance-matched

discretionary accruals (Kothari et al. 2005). The third group of measures

examines statistical properties of earnings to identify behaviour that influences

earnings (Burgstahler & Dichev 1997).

Earnings management can be also detected in the form of earnings smoothing,

documented by Defond & Park (1997), Lang et al. (2003) etc. This particular type

of earnings management is scrutinized in this thesis. It has been observed that in

countries with weak rule of law there is a tendency for managers to smooth

earnings (Leuz et al. 2003). In their study Leuz et al. (2003) use four measures of

earnings management: earnings smoothing using accruals, the correlation

between changes in accounting accruals and operating cash flows, magnitude of

accruals and small loss avoidance. Existing research suggests that tax incentives

have a stronger influence on financial statements in countries where accounting

practice is aligned with tax considerations (Ball et al. 2000, Herrmann & Inoue

1996).

When dealing with earnings smoothing, it is important to remember that

earnings smoothing may on the one hand be beneficial if managers use their

knowledge to communicate information about future earnings. As Russian

financial statements are very much affected by tax considerations, it is more

likely that earnings smoothing is used to create a smooth stream of earnings for

the tax authorities to ensure risk-free relations with them. This thesis strives to

disentangle different incentives for earnings smoothing in Russian firms, by

investigating earnings smoothing in Russian firms using either Russian

Accounting Standards (RAS), IFRS or firms using both sets of standards

simultaneously.

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2.3 Value relevance

The issue of financial accounting usefulness is crucial in determining the quality

of accounting information. Until the 1960s accounting research concentrated

mostly on normative, policy-oriented research. Value relevance studies in

accounting originated from an article by Ball & Brown (1968), which first

endeavoured to quantitatively measure the usefulness of earnings to investors.

Further accounting thinking has developed towards examining the extent to which

the information conveyed by earnings is consistent with that reflected in security

returns (Lev 1989).

The value relevance stream in accounting has a large pool of studies with

findings that information content of earnings merely captures some economic

events that are reflected in stock prices. The most basic classification of value

relevance studies falls into the categories of event and association type of studies.

While event studies investigate if any event conveys new information reflected in

security returns (Ball & Kothari 1991), association type of studies are aimed at

testing for a relation between an accounting measure, e.g. earnings, cash flows

with stock returns over a longer time window, usually one year (Collins &

Kothari 1987, Easton & Harris 1991, Dechow 1994 etc.).

A few decades after the first studies on the value relevance of accounting

earnings for stock prices, Lev (1989) pointed out that the correlation between

earnings and stock research was very low. This discussion initiated a search for

new models, incorporating information from both income statement and balance

sheet for valuation purposes. One of the most-widely used models based on

combining information from income statement and balance sheet is the residual

income model by Ohlson (1995), which uses net income of earnings and book

value of equity for valuation purposes. In the third essay this model is employed

for examining whether accounting information prepared in accordance with RAS

or with IFRS is more value relevant.

Recently value relevance research has been used to a large extent for the

evaluation of accounting standards as well as for the investigation of the

economic consequences of new accounting standards (Holthausen & Watts 2001,

Healy & Palepu 2001). The impact of the adoption of IFRS in Europe has been

researched extensively in a number of studies, e.g. Hung and Subramanian (2007),

Bartov et al. (2005), Callao et al. (2007), Morrais & Curto (2009). There are

likewise several studies investigating the value relevance of IFRS in transitional

economies, e.g. (Eccher & Healy 2003), but no studies on Russia. Earlier studies

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document that accounting information in countries with a strong link between tax

and financial accounting is less value relevant (Joos & Lang 1994, Ali & Hwang

2000). In Russia there persists a gap on the value relevance of accounting

information from financial statements, despite the importance of such information

for investors. Thus, in this thesis the difference between the value relevance of

Russian Accounting Standards (RAS) and IFRS is investigated.

The value relevance metric is moreover used in examining how relevant non-

financial information is for investors and other groups of users (Amir & Lev

1996), in other words, what incremental value relevance non-financial

information conveys in conjunction with net income and book value of equity. In

the fourth essay of this thesis, the value relevance of environmental performance

in Russian firms is investigated providing new evidence on the impact of non-

financial information for value relevance in the Russian firms.

Value relevance studies are grounded on the assumption of market efficiency,

meaning that all public information is reflected in prices. Due to the novelty of

the stock market in Russia evidence of its efficiency or inefficiency is unavailable.

However, earlier studies (e.g. Aboody et al. 2002, Wang et al. 2006) modelling

value relevance on a possibly inefficient market conclude that although the

relevance of accounting numbers would be considerably lowered if it were

measured in an inefficient market, the difference is not big enough to alter the

conclusions of earlier value relevance studies. Therefore, the possible inefficiency

of Russian market does not prevent us from investigating the value relevance of

accounting information and non-financial information.

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3 The Russian institutional environment

Russia is one of the most important players in the world economy, by size its

economy is ranked seventh largest in the world with the GDP growth levels

averaging 7% per year in 2000–2007 (Nabiullina 2008). Russia is the largest

exporter of natural gas and a country with a rich natural resource base. However,

the transitional situation of Russia is reflected in the state of the Russian

institutional environment. For instance, the accession of Russia to the World

Trade Organization (WTO) has been delayed due to the non-conformity of the

Russian legislation with WTO requirements. After the collapse of the Soviet

Union, Russia had to face major economic shocks such as price liberalization,

stabilization and privatization (Shleifer 1997). It had to develop a whole new set

of institutions fundamental for a market economy, such as private property,

convertible currency, banking system and a system for regulating the stock market

(Gaidar 2007). Therefore, when investigating published accounting information

quality in Russia it is essential to review the institutional environment in Russia

pertinent to the accounting phenomenon, such as stages of accounting

development in Russia, the role of institutional investors and IFRS, the legal

system and the situation on the stock market.

3.1 Development of accounting in Russia

The evolution of accounting Russia has undergone some major changes and

phases since the collapse of the Soviet Union in 1991. It is of pivotal importance

to understand the influences that Russian accounting inherited from the Soviet era

and what major forces formed accounting in Russia. Thereafter, the most

distinctive features of Soviet accounting and Russian accounting will be

examined.

In accounting terminology one may come across a term Soviet accounting

(Bailey 1995), which characterises a set of methods and rules developed during

more than seventy years of communist rule in the history of Russia (Fig.1.). In

Soviet era of accounting from 1917 to 1990 accounting was used as a tool for

control over the implementation of the state plan. Accounting became neutralised,

meaning that it was unusable for purposes of taking economic action. Basically,

accounting was reduced to book-keeping functions and the value of the

accounting profession was degraded. The State served as the only source of

accounting regulation in the Soviet Union. Starting from 1990 accounting in

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Russia has entered a new epoch, because the transformation from a planned

economy to a market economy required a completely new accounting system. The

goals of accounting reform were to introduce market economy concepts into

accounting following a gradual, evolutionary approach. The Ministry of Finance

was responsible for the development of the new Russian Accounting Standards

(RAS), which would be based on the principles of IFRS, but still preserving

distinctive Russian features. In 1991 a new Chart of Accounts corresponding to

those in developed market economies was introduced, followed by a “Law on

Accounting” in 1996 which still serves as the main legislative document outlining

the scope of accounting in Russia.

Fig. 1. Development of accounting in Russia from 1917 to 2010.

The Programme for the “Reformation of Accounting in Accordance with

International Accounting Standards” was approved by the government in 1998.

The Programme delineated the new direction of accounting development which

would be concentrated on users’ needs. The development of Russian Accounting

Standards (RAS), which would be based on IFRS, was launched at the same time.

Since 2005 all Russian listed firms have been required to issue financial

statements that comply with IFRS or US GAAP, the banks already had to file

IFRS financial statements starting in 2004. In 2004 a Concept of Accounting and

Reporting Development in the Russian Federation for the medium term was

approved by the Ministry of Finance, which encapsulated the strategy for mid-

term development. The main goals of this strategy for mid-term accounting

development for the period 2004–2010 are improving the quality of accounting

information, creating the infrastructure for IFRS implementation, change in the

accounting regulations and improving the professionalism and skills of

accountants and auditors. In 2007 a draft law On Accounting was introduced

20101990State centralised planning

Control of the planNeutralization of accounting

1996Law on

Accounting

2000Russian

AccountingStandards

(PBU)

2005 2007Planned

transition to IFRS

Listed firmsrequired

IFRS or US GAAP

financialrepots

Draft lawon new

”Law onAccounting”

1991 1998 2004

Soviet accounting Post-soviet accounting, transitional period

New chart of accounts

Accounting reform

Strategy for mid-term

1917 20101990State centralised planning


1996Law on

Accounting

2000Russian

AccountingStandards

(PBU)

2005 2007Planned

transition to IFRS


IFRS or US GAAP

financialrepots

Draft lawon new


20101990State centralised planning


1996Law on

Accounting

2000Russian

AccountingStandards

(PBU)

2005 2007Planned

transition to IFRS


IFRS or US GAAP

financialrepots

Draft lawon new


1991 1998 2004



Accounting reform


1917

1991 1998 2004



Accounting reform


1917



Accounting reform


1917



Accounting reform


1917

25

since the acting Law on accounting dates back to 1996, meaning that it lost its

relevance and requires major amendment. However, the draft is still in the making.

To sum up, accounting reforms took a longer time in Russia than initially planned

and the timetable for RAS development was not adhered to. Nevertheless many

economic categories are missing in the RAS and, hence, financial statements

prepared in accordance with RAS are likely to lack the information needed by

investors.

One of the most distinctive features in the post-soviet accounting in Russia is

the tax orientation of accounting. The role of accounting was deemed to

communicate tax information to the state in the Soviet Union, while in

transitional Russia the state was replaced by the tax inspectorate. The main user

of accounting information is still considered to be the tax inspectorate. Although

in 2004 financial and tax accounting were legally separated with the introduction

of Chapter 25 of the Tax Code, still due to the cost and complexity considerations

in many instances only one set of financial statements was still being prepared,

the one which complies with the tax law and based on RAS.

3.1.1 Role of foreign investors

In the Soviet Union all sources of finance originated from the State. After the

collapse of the Soviet Union the role of foreign investors as providers of external

finance has become very important for the Russian economy. The amount of

foreign direct investments (FDI) grew steadily from 1995 to 2008, and GDP

growth has averaged out at 5.5% (see Table 1).

Table 1. Russia’s FDI inflows in US$ billion and GDP growth for the years 1995–2008.

Variable 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

FDI 2.0 2.4 5.3 3.4 4.3 4.4 4.0 4.0 6.8 9.4 13.1 13.7 27.8 27.0

GDP

growth

- -3.6 1.4 -5.3 6.4 10.0 5.1 4.7 7.3 7.2 6.4 7.7 8.1 5.6

Notes: FDI is foreign direct investments made by legal entities or individuals wholly owning the enterprise

or controlling not less than 10% of shares of its charter capital. Source: Federal State Statistics Service of

the Russian Federation

The Russian stock market remains an attractive target for international investors

for several reasons, e.g. stable oil prices, investors’ beliefs that the share prices of

the Russian companies are undervalued. Unfortunately, there is no complete

26

statistics on the numbers of individuals investors engaged in stock market

activities in Russia. 1 The Russian stock market is of growing interest to

international foreign investment funds. According to the Interfax Business Service

statistics, the dynamics of foreign fund investments to Russia is as follows, 2005 -

1200 funds, 2006–1520 funds, 2007–1942 funds, 2008–2406 funds, showing a

steady 25% growth (see Table 2). Based on the information available it is possible

to conclude that about 25% of the foreign investments of foreign investments

funds are made through Russian stock exchanges, while 75% is made through

foreign stock exchanges. Apart from foreign investment funds, foreign hedge

funds also invest in the Russian stock market, but there is no information

available on them.

Table 2. Investments of foreign investment funds to Russia.

Variable 2005 2006 2007 2008

Number of foreign

investment funds

investing in the

Russian market

1200 1520 1942 2406

Volume of

investment funds

investing in the

Russian stock

market in

US$ billion

22.8 49.5 73.4 76.4

Source: “Russian Capital Market” reports published in 2007 and 2008 by the National Association of

Securities Market Participants (NAUFOR) and Skolkovo School of Management.

Enthoven et al. (2001) document that foreign investors have completely different

needs as users of financial information than the State had during the Soviet era.

When investing in Russian firms foreign investors are faced with much

uncertainty regarding what determines the firm value. It has been outlined in

earlier studies that without overseas investors or a large group of local interested

financially literate investors, the key user of published financial reports is the tax

inspectorate (Krylova 2003, Sucher & Jindrichovska 2004). Foreign investors are

likely to create incentives for the firms to provide world-class comparable

accounting information. Without the presence of foreign investors financial

1Based on the reports “Russian Capital Market” published in 2007 and 2008 by NAUFOR and Moscow Management School Skolkovo

27

information is very likely to be targeted at the needs of the tax inspectorate and,

thus, lack the properties important for decision-making. Moreover, it is very

likely that accounting information that is reliable for tax calculation is not always

relevant for other investors.

Therefore, the role of foreign investors in the transitional Russian economy is

viewed throughout this thesis a stimulus for providing better quality accounting

information useful for decision-making and for the implementation of IFRS. As

documented by Barth et al. (1999) foreign investors are at a disadvantage when

extracting information from the domestic GAAP report. Foreign investors are

likely to demand high quality and transparent financial statements prepared in

accordance with IFRS, because they are familiar with IFRS principles.

Furthermore, prior research suggests that institutional investors exhibit a

preference for high quality financial information when making international

investments (Barth et al. 1999).

3.1.2 The Role of International Financial Accounting Standards (IFRS) in Russia

In the transformation of accounting in Russia the role of IFRS has been of

paramount importance right from the outset. In order to be recognized as a serious

player in world financial markets Russia had to acquire a great deal of overseas

knowledge and expertise, which is encapsulated in IFRS. Prior research suggests

that foreign investors would not invest in firms which do not publish IFRS reports.

IFRS is believed to improve financial transparency, attract a greater share of

equity capital and serve as an aid in decision-making. McGee & Preobragenskaya

(2004) classify driving factors to IFRS transformation into external and internal.

External factors include the needs of creditors and investors interested in the

company’s transparency, which can be achieved by means of IFRS

implementation. Internally, IFRS financial statements serve as a better source of

decision making than RAS. Furthermore, IFRS are likely to strengthen corporate

governance and increase confidence between managers and shareholders (McGee

& Preobragenskaya 2004).

The role of IFRS is especially emphasized when compared to the existing set

of RAS. IFRS are based on substance over form principles, while RAS adhere

strictly to the form and to Russian Civil Law. RAS are regulated by the

government. IFRS is aimed primarily at investors’ needs, while RAS continues to

be targeted at tax authorities (Preobragensakaya & McGee 2004). RAS does not

28

have guidance for reporting in hyperinflationary economies. RAS are based on

strict compliance with legal norms and requirements. RAS apply both cash and

accrual cost accounting schemes. The cash basis is still quite often used in

financial reports prepared in accordance with RAS because in many instances a

transaction can be recognized only if all the documentation is available; in IFRS

this would equal untimely recognition of transactions because IFRS require an

accrual basis for transactions recognition. The greatest disadvantage of RAS that

it does not provide guidance for consolidations and business combinations as well

as for the impairment of assets. Fixed assets are deducted according to their

acquisition price, less amortization, usually calculated according to tax norms,

which does not reflect the real value of the assets. IFRS takes into consideration

appraised value, which in most cases reflects market value. Depreciation of assets

according to RAS is mostly done using the straight-line method because it is the

one most-widely used as it stipulated by the Tax Code. The main difference

between IFRS and RAS is that the concept of impairment is not applied under the

Russian system. IFRS also require more disclosure in relation to assets valuation.2

Apart from the advantages associated with IFRS adoption there are some

drawbacks as well, according to Moody’s Global Report (2008) reporting in

compliance with IFRS may involve inconsistent interpretations, false volatility

and undue complexity. Due to its complexity and the absence of many economic

categories in Russia, the adoption of IFRS is not so easy. Implementation of IFRS

requires accountants’ professional judgment, which was absent during the Soviet

period of accounting in Russia and it takes time to acquire such a skill. The main

obstacle to IFRS adoption is the absence of a legally approved right to use IFRS,

due its non-conformity with the Civil Law. Banks were obliged to report in

accordance with IFRS in 2004, followed by public companies, which from 2005

had to submit either US GAAP or IFRS financial reports. It has been documented

that the implementation of IFRS is not so straightforward in other post-soviet

countries, either, e.g. Sucher & Alexander (2002), Sucher & Jindrichovska (2004).

3.2 Legal system

The uncertainty associated with investing in Russia is also reflected in by the state

of the legal system in Russia. Russia has to a great extent inherited its legal

2 Based on information from E&Y report (2008) “IFRS, US GAAP & RAP: comparison and basic”, Preobragenskaya & McGee (2004), Suvorov (2007).

29

system from the Soviet era (Gustafson 1999). The reforms in post-Soviet Russia

have been vital in all spheres, especially in legislation. In order to enter the path

towards building a new market economy, Russia had to transform its legal system

to meet the expectations of the world business community. The post-Soviet

Russian legal system is different from both common law and code law systems,

yet closer to code law (Nysten-Haarala 2001). According to Pistor (2000), e.g.

Russian Corporate law has been transplanted from the Anglo-American corporate

law. In 2002 Russia introduced a Corporate Governance Code, however, in the

absence of effective legal institutes and law enforcement mechanisms the good

law on the books does not carry out its function. The problem lies in the weak

institutions and in the lack of understanding of new laws (Pistor et al. 2000). As a

result, one may observe weak law enforcement in Russia (Gustafson 1999).

Liberman and Eidinov (1995) point out that during the transitional period the

creation of all components of the legal and economic framework required for

smooth functioning of market economy is not feasible. Therefore, the transitional

nature of the legal system in Russia affects the quality of accounting information

as well, because in the absence of a well functioning enforcement system, the

greater emphasis is on the financial statement preparers’ incentives. It is expected

that the incentives to provide more reliable and transparent information would be

in those firms which are listed on the stock exchange and are keen to attract

foreign capital.

3.3 The Stock Market

A well-functioning stock market plays an important role in the transformation to a

market economy, as it initiates raising money from abroad and improves

corporate governance. There are two major stock exchanges in Russia: the

Russian Trading System (RTS) and the Moscow Interbank Currency Exchange

(MICEX), with MICEX being the largest securities trading, clearing and

settlement infrastructure complex in Russia.

The development of the stock market in Russia can be traced to 1995 (see

Fig.2.), when the RTS trading platform was launched, followed by the MICEX

index in 1997. The MICEX Index is a capital-weighted price index of the 30

major and most liquid Russian stocks traded on the MICEX Stock Exchange the

initial value of the index is 100 points), which covers nearly 80% of the market

capitalization of the Russian equity market. The RTS Index, calculated by the

open joint-stock company “Russian Trading System” Stock Exchange, is the

30

leading indicator of the Russian securities market. The RTS Index is calculated on

the basis of the prices of the 50 liquid shares of the most highly capitalized

Russian companies. The growth of the stock market was consolidated in 1997,

when the RTS Index reached the value of 500 and since then it has continued

growing steadily up to 2008, both RTS and MICEX indices having the same

magnitude in growth. The peak value of the RTS Index was achieved in 2008,

when it reached 2500 points, thus it grew 25-fold since its incipience in 1995.

Fig. 2. Micex and RTS indices 1995–2009 (Source: MICEX RTS).

The total amount of market capitalization of all Russian firms had amounted to

US$500 billion by the end of 2005, making it around 70% of GDP (Noel et al.

2006) and according to experts it has good potential for growth. During the years

2005–2006 the capitalization of the Russian stock market has grown more than

3.5-fold. The turnover rate is rather low, however it tends to grow, rising from 3.3

percent in 2005 to 5.1 in 2007. Initial public offerings increased in Russia during

2005–2007; 13 companies in 2005, 24 companies in 2006, and 25 companies in

2007 went public. The trading volumes have grown substantially during the last

few years, for instance, taking into account that on both RTS and MICEX trading

platforms the trading volumes increased from 186.0 US$ in 2005 billion to

1233.2 US$ billion in 2007 (report by NAUFOR & Skolkovo School of

Management 2008).

One of the distinctive characteristics of the Russian stock market is that it is

largely dominated by the natural resources sector, especially by the oil and gas

0

500

1000

1500

2000

2500

3000

1.9.

1995

1.9.

1996

1.9.

1997

1.9.

1998

1.9.

1999

1.9.

2000

1.9.

2001

1.9.

2002

1.9.

2003

1.9.

2004

1.9.

2005

1.9.

2006

1.9.

2007

1.9.

2008

RTS MICEX

31

sector. Moreover, the number of firms which are traded on a regular basis is rather

small, for instance in 2006 almost 85% of the total capitalization was represented

by the biggest 20 companies (Lazareva et al. 2007). The branch structure of the

Russian stock market capitalization is dominated by the oil and gas industry; in

2005 it accounted for 68% of all capitalization and in 2008 for 57%. However,

lately other sectors of the Russian economy have significantly strengthened their

positions. A considerable share in the RTS Index is now taken up by metals,

financials, and electric utilities. Thus in general, although on a positive

development track, the Russian stock market remains fragmented and

undercapitalized (Noel et al. 2006).

Listing on the stock exchange serves as a good mechanism for improving

corporate finance in Russian firms, because they have to comply with disclosure

and reporting requirements (McCarthy & Puffer 2003). According to the report by

the National Association of Securities Market Participants (NAUFOR) &

Skolkovo Management School (2008) more than 2000 foreign investment funds

are investing their money in Russian stocks and American Depository Receipts

(ADRs) and the money inflow is increasing over time. Throughout this thesis

listing on one of the Russian stock exchanges is viewed as a factor improving

financial accounting quality, due to the disclosure and listing requirements and the

use of either IFRS or US GAAP standards for financial reporting.

32

33

4 Overview of the essays

The research comprising this thesis was undertaken in the form of four

independent essays. Published accounting information quality is conceptualised in

terms of conservatism, earnings management and value relevance. All four essays

are grounded on the notion of the accounting information being influenced by the

country’s institutional make-up. Therefore, the transitional nature of Russia is

incorporated into the essays. Russian environment here serves as interplay

between accounting quality and forces that are most likely to affect it in the

Russian case, namely foreign investors and IFRS. A great deal of attention is also

paid to the role of IFRS in influencing the quality of accounting information in

Russia.

4.1 Data and methods

The four essays comprising this thesis utilise Russian data. Data collection in

Russia is often difficult, as noted in earlier studies (Michailova 2004), due to the

reluctance of Russian firms to disclose accounting information to outsiders.

Therefore, the data collected for the purposes of this thesis are decidedly unique

in nature, because it necessitated a great deal of manual data collection.

The data and data analysis methods used in this thesis are presented in Table

1. In Essay 1 and Essay 3 data from the SPARK-Interfax database are utilised.

The SPARK-Interfax database contains uniform information on all legal entities

registered in Russia. The data come from more than ten of the most reliable

official sources. Every piece of information has a reference to the source (the

Federal State Statistics Service, the Federal Tax Service, the Federal Financial

Markets Service etc.). All financial statement data are prepared according to

Russian accounting standards.

In Essay 2 the sample of firms selected for the study was drawn from firms in

the Saint Petersburg region. The candidate firms were randomly selected from the

INFOWAVE Database. Next, firms were contacted and their participation was

solicited. Altogether 100 firms agreed to participate in the survey, which yields an

18% response rate. The survey was conducted in the form of structured face-to-

face interviews. The face-to-face method of survey was chosen because earlier

studies dealing with data collection in Russia have documented that it is difficult

to otherwise to gain access to reliable data (e.g. Daniels & Cannice 2004;

Michailova 2004). Questionnaire design involved several stages during which

34

items included in the questionnaire were refined and several pilot tests were

conducted (in Finland and in Russia) in order to ensure the clarity and

comprehensibility of the questions. Pilot tests were conducted with people

employed in academia and in the business sector. The Russian context was taken

into consideration by conducting pilot testing with native speakers of Russian.

Table 3. Data and methods used in the study

Contents Data source Methods

Essay 1 SPARK-Interfax database Regression analysis

Essay 2 Data gathered by structured face-

to-face interviews

Mann–Whitney U-test

Essay 3 Thomson WorldScope database,

SPARK-Interfax database, hand

collected data

Regression analysis

Essay 4 Thomson WorldScope database,

NERA Rating agency, hand

collected data

Univariate analysis

Regression analysis

In Essay 3 and Essay 4 the Thomson WorldScope database was used to obtain

data on the Russian listed firms, which was then complemented by manual data

collection. In Essay 3 the manually collected data concerned firms publishing

IFRS reports. These IFRS-related data were collected from firms’ websites’

financial reports. In Essay 4 manually collected data comprised NERA

environmental impact ratings.

One of the limitations of the study is related to the inaccessibility of the

Russian data and reluctance of the Russian companies to disclose any proprietary

information as documented by earlier research (e.g. Daniels & Cannice 2004;

Michailova 2004). This problem was addressed by extensive manual data

collection, nevertheless, for instance in Essay 3 and Essay 4 unavailability of the

data resulted in a small number of observations in the samples. Since the adoption

of IFRS is a new phenomenon, even in Europe studies have been compelled to

restrict themselves in their analyses to low sample sizes (Van Tandeloo &

Vanstraelen 2005, Hung & Subramanyam 2007). Keeping in mind the data

restrictions, the generalizability of the findings from the studies included to this

thesis is limited.

35

4.2 Essay 1: Can Investors Rely on the Quality of Earnings Figures Published by Listed and Non-listed Russian Firms?

This essay investigates earnings quality of both listed and non-listed Russian

firms and explores whether foreign ownership affects the quality of earnings

published by non-listed Russian firms. Following earlier studies (e.g. Ball &

Shivakumar 2005), accounting earnings quality is defined based on the timely

recognition of economic losses in earnings figures (accounting conservatism).

Attention is also paid to timely recognition of economic gains as they may be an

important part of efficient accounting reporting (Guay 2006). Foreign investors’

impact on the quality of accounting earnings information disclosed by different

types of Russian firms is the focus in this essay. Foreign investors are believed to

have a positive impact on quality as the firms’ need to attract and retain foreign

capital increases. More specifically, the two following empirically testable

hypotheses are maintained: firstly, Russian firms listed on a stock exchange

disclose earnings of good quality and, secondly, non-listed Russian firms co-

owned by foreign investors disclose earning of better quality than solely Russian-

owned private firms.

The empirical results show that Russian firms listed on a stock exchange

report earnings of relatively good quality, which corroborates the notion that firms

listed on a stock exchange are faced with disclosure requirements and are more

likely to have incentives to provide timely and reliable information to investors.

However, no support is found for the hypothesis that non-listed Russian firms co-

owned by foreign investors report earnings of better quality than do exclusively

Russian-owned non-listed firms. Moreover, non-listed Russian firms with foreign

ownership report earnings with more timely recognition of economic gains than

exclusively Russian-owned non-listed firms do, which might indicate that there

are differences in the demand for timely recognition of economic gains in firms

with and without foreign investors.

4.3 Essay 2: An Examination of the Effect of International Investors on Accounting Information Quality in Russia

This essay examines whether emphasis on international investors is associated

with the adoption of or intention to adopt IFRS in Russian firms. IFRS clearly

requires higher quality reporting than existing Russian standards. The existing

literature on IFRS convergence is focused almost exclusively on factors

36

influencing corporate compliance with IFRS in European countries (e.g.

Dumontier & Raffournier 1998; Street & Larson 2004), while the literature on

IFRS adoption in emerging countries is scarce (Abd-Elsalam & Weetman 2003).

It is widely believed that the use of IFRS in Russia will promote enhanced

international investment in Russia, due to its familiarity to investors and due to

the fact that IFRS serves as the global language of business. The results of this

essay confirm that there is a positive association between international ownership

of a company and the company’s willingness and intention to implement IFRS.

Improving a firm’s status among foreign customers and investors is viewed as the

most important reason to adopt international reports. Firms with international

investors also have reasons to adopt IFRS because they are more user-friendly,

help to attract international investors and improve the firm’s status among

Russian customers. Along with the strong evidence on the reasons for IFRS

adoption and IFRS use, the results show that the influence of international

investors is conducive to change towards more transparent financial reports

achieved by implementing IFRS. This result also indirectly shows that

international investors demand more transparent IFRS financial reports rather

than financial reports prepared in compliance with Russian accounting standards.

4.4 Essay 3: The International Financial Reporting Standards (IFRS) and Accounting Quality in a Transitional Economy: The Case of

Russia

As noted by McGee and Preobragenskaya (2004), international investors demand

preparation of IFRS or US GAAP reports if they intend to invest in a Russian

company, meaning that listed firms would have higher incentives to provide better

quality financial reports in accordance with IFRS as means of attracting

international investors. The financial reports prepared according to RAS are

considered to be of poorer quality than those prepared according to IFRS. This

essay addresses the question of IFRS and RAS accounting quality by using the

methodology proposed by Barth et al. (2008) and by value relevance constructs of

accounting quality. Furthermore, value relevance analyses as in Hung and

Subramanyam (2007) using a sample of firms reporting both IFRS and RAS

financial reports are conducted.

The rationale behind this study lies in the assumption that accounting with

RAS suffers from a lack of economic categories widely accepted and used with

IFRS. This can be explained by the transitional nature of the Russian economy

37

and, thus, the transitional nature of RAS. In Russia one may predict better

accounting quality provided by IFRS financial statements due to the fact that they

are targeted at investors’, not the tax authorities’ needs. At the same time the

application of IFRS is not so straightforward due to the transitional situation of

the Russian economy.

The results of this essay demonstrate that firms using IFRS exhibit higher

accounting quality measured as earnings smoothing than firms using RAS.

However, there is no any evidence that the use of IFRS jointly improves the value

relevance of book value of equity and net income accounting in listed Russian

firms, only partial support for the book value of equity value relevance

improvements with IFRS for firms reporting both IFRS and RAS financial reports

is found. Research evidence shows that the use of high quality accounting

standards, per se, does not translate into increased value relevance of accounting

figures, because numerous country specific factors, such as the level of law

enforcement, legal mechanisms and the incentives of those preparing accounting

information are likely to affect the final outcome of standards adoption, for

example, in the case of Spain (Callao et al. 2007) and in China (Eccher & Healy

2003). This may be explained by the transitional nature of the whole accounting

phenomenon in Russia. IFRS financial statements fail to provide more value

relevant results for the stock market because of the absence of many economic

categories in Russian reality which are inherent in IFRS; by the lack of expertise

in IFRS and inability to exercise professional judgment.

4.5 Essay 4: The Value Relevance of Firms’ Integral Environmental

Impact: Evidence from Russia

The fourth essay investigates the value relevance of firms’ integral environmental

impact, i.e. our proxy for environmental performance, following a stream of non-

financial information value relevance in accounting research. Despite a number of

studies addressing the issue of environmental performance value relevance

(Hassel et al. 2005, Cormier & Mangan 2007 etc), there has been no consensus

among researchers on the valuation properties of environmental performance.

In our study for the proxy of environmental performance we use the integral

environmental impact, which we construct based on the data provided by the

Russian Independent Ecological Rating Agency (NERA). We use a unique

measure of environmental performance directly addressing companies’ integral

environmental impacts, capturing use of fresh water, volume of polluted sewage,

38

volume of emission of polluting substances, emissions from vehicles, volume of

toxic waste and total area of used and polluted lands. The data allows us to

compare the value relevance of environmental performance across companies and

industries.

In this essay data from 74 Russian listed firms for the years 2005–2007 are

used. In our analysis, we extend the literature on the valuation properties of

environmental performance (Jaggi & Freedman 1992, Dowell et al. 2000, Hassel

et al. 2005) by introducing the measure of integral environmental impact. We also

address the question of legitimacy of environmental performance disclosure by

looking into differences between firms having different disclosure policies. The

results of the study indicate that environmental performance is valued positively

in Russia, meaning that lower environmental impact is valued positively by

investors, i.e. as investment.

4.6 Contributions

The first essay contributes to the existing research investigating the quality of

accounting information globally (e.g. Ball & Shivakumar 2005, Ball et al. 2003,

Bushman & Piotroski 2006, Givoly et al. 2007) in the following three ways.

Firstly, the sample covers various types of Russian firms from large listed firms to

small private firms, all of them open joint-stock companies. This allows a direct

comparison of the foreign owner’s influence on the quality of earnings disclosed

by firms with clearly different financial reporting incentives. Secondly, there are

some earlier papers investigating the earnings management of Russian firms

(Goncharov & Zimmerman 2006), but this essay, to the best of our knowledge, is

the first to report empirical evidence on the quality of accounting information

disclosed by listed and non-listed Russian firms.

The main contribution of the second essay is in identifying the impact of

international investors on the quality of accounting information in Russia.

Secondly, we contribute to the literature, e.g. Archer et al. (1995), by studying

differences in IFRS convergence between exclusively Russian-owned and part

foreign-owned firms. This study enhances our knowledge of accounting quality in

post-Soviet Russia bringing forward the importance of international investors'

impact on the quality of accounting information. The study also adds on a more

general level to our understanding of within country differences in firms in such

areas as the quality of accounting information, the use of capital finance sources

and the adoption of IFRS. On a practical level the implications of this study may

39

be useful for regulators in developing accounting policies in Russia for the

different types of firms as well as for the investors planning business activities in

Russia.

The key contribution of the third essay is in providing new evidence on the

impact of IFRS on the quality of accounting information internationally (e.g.

Barth et al. 2008, Bartov et al. 2005; Hung & Subramanyam 2007). We believe

that the results of our investigation of IFRS application in Russia will be of

interest to researchers, because we contribute new evidence on the consequences

of IFRS adoptions worldwide. Furthermore, the results of our research are very

topical and of great practical use for regulators in light of the imminent discussion

on the reform of the accounting system in Russia. We may conclude that the use

and the economic consequences of IFRS adoption in Russia are not so simple and

straightforward. Even though we include a number of control variables in our

analyses to mitigate the effect of economic environment and try to distinguish

between firms’ incentives, we cannot fully eliminate the impact of the Russian

transitional economic environment and the change in firms’ incentives to provide

financial reports of lower or higher quality.

The fourth essay contributes largely to the discussion on the valuation

properties of environmental performance (Jaggi & Freedman 1992, Dowell et al.

2000, Hassel et al. 2005) by introducing the measure of integral environmental

impact. Furthermore, the fourth essay adds to the literature on the impact of

ownership on environmental disclosure and performance (Magness 2006,

Cormier & Gordon 2001, Cormier & Magnan 2003) by examining how foreign

ownership affects environmental performance in Russian firms. Finally, the study

contributes to the literature on the valuation properties of environmental

performance by examining its cross-industry differences in valuation.

40

41

5 Conclusions

This thesis investigates the quality of published accounting information quality in

Russia. Since entering the path to market economy, the accounting system in

Russia has undergone major changes during the last two decades. In examining

the quality of published accounting information this thesis strives to account for

the major transformations occurring in the transitional Russian economy.

The thesis explores the most important facets of accounting quality through

companies’ financial reports. The thesis reports extensive research on such

characteristics of accounting quality as conservatism, earnings management and

value relevance. Moreover, the impact of IFRS on accounting quality is examined

in detail. This study follows the trend in accounting research incorporating a

country’s specific institutional features into the analysis, in the case of Russia

these factors are the tax orientation of accounting and the dominance of state

regulation inherited from the Soviet era.

The study presents evidence that the quality of published accounting

information in Russia depends on many factors, the most influential of those

having a positive impact on published accounting information quality are listing

on a stock exchange, IFRS and foreign investors. The results of the thesis

demonstrate that the institutional characteristics of the country shape accounting

numbers and influence the incentives of those preparing financial statements. The

findings moreover shed light on the current state of accounting quality that could

be used by investors and regulators.

Apart from providing country-specific information, the thesis contributes on a

larger scale to the accounting debate in such areas as the consequences of IFRS

adoption, the role of incentives in the quality of accounting information and value

relevance of environmental performance.

42

43

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49

Original articles

I Bagaeva A, Kallunki J-P & Silvola H (2008) Can Investors Rely on the Quality of Earnings Figures Published by Listed and Non-listed Russian Firms? International Journal of Accounting, Auditing and Performance Evaluation 5(1): 30–49.

II Bagaeva A (2008) An Examination of the Effect of International Investors on Accounting Information Quality in Russia. Advances in Accounting 24(2): 157–161.

III Bagaeva A (2009) The International Financial Reporting Standards (IFRS) and Accounting Quality in the Transitional Economy: The Case of Russia. Manuscript.

IV Bagaeva A (2009) The Value Relevance of Firms’ Integral Environmental Impact: Evidence from Russia. Manuscript.

Reprinted with permission from Inderscience (I) and Elsevier (II).

Original publications are not included in the electronic version of the dissertation.

50


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THE QUALITY OF PUBLISHED ACCOUNTING INFORMATION IN RUSSIA

FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION,DEPARTMENT OF ACCOUNTING,UNIVERSITY OF OULU

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