How Do Financial Distress Risk and Related Party Transactions Affect Financial Reporting Quality? Empirical Evidence from Iran

Abstract

The paper aims to investigate the effects of financial distress risk (FDR) and related party transactions (RPT) on financial reporting quality (FRQ) in an emerging market called Iran. In this study, the ordinary least squares regression (OLS) method is employed to test the hypotheses; moreover, Jones’ discretionary accruals model is used to assess the financial reporting quality (FRQ). The results show financially distressed companies have a lower financial reporting quality because they try to mislead other stakeholders about the corporate actual performance to attract more investors and lenders. Consistent with the “tunneling” or “conflict of interests transaction” assumption, our findings confirm there is a positive association between related party transactions through loan and accrual-based profit management. In other words, Iranian managers participate in loan-related party transactions to expropriate their firm’s resources and then manipulate financial statements to mask such expropriation. Finally, additional analysis indicates that financial reporting quality is seen well among firms having higher sale growth and more institutional owners, whereas the variables of ROA and financial leverage negatively affect financial information quality.

The Way Financial Distress Affects Financial Reporting Delay

“…The sign of PD coefficient is positive, which indicated that if financial distress experienced by a company is getting heavier (the PD value is getting bigger), then there will be a tendency for the financial reporting quality published by the company to be lower (the M-Score value is getting bigger). The result of the effect of financial distress on financial reporting quality showed in this study is in line with the study conducted by Haji-Abdullah et al (2016), Tarighi et al (2022), and Yang et al (2016.…”

“…The efforts made by the management are intended to secure its interests, so it is necessary to distort financial statement information. Companies experiencing financial distress tend to produce financial reports with low information quality (Haji-Abdullah et al, 2016;Yang et al, 2016) because they try to mislead stakeholders regarding the company's actual performance in the hope of attracting more investors and creditors (Tarighi et al, 2022). A financial report containing information that does not accurately reflect the actual condition of the company's performance is considered poor quality because it gives an impression that the company has no financial issues.…”

Preempting fraud: a financial distress prediction perspective on combating financial crime

“…Research by Tarighi et al (2022) highlights the link between financial distress and fraudulent activities, the study found that financially distressed companies are more likely to engage in fraudulent financial reporting. Furthermore, Lokanan and Sharma (2022) studied investment fraud in Canada.…”

Pengaruh risiko litigasi, ketidakpercayaan investor, dan financial leverage terhadap kualitas pelaporan keuangan dengan komite audit berkeahlian hukum sebagai pemoderasi

“…Kualitas pelaporan keuangan dinilai dengan menggunakan sejumlah perspektif pada pendapatan dan kinerja masa depan (Ratu & Hermanto, 2020). Informasi kualitas pelaporan keuangan tidak hanya untuk kepentingan pasar, dimana informasi tersebut menjadi alat yang efektif untuk mengevaluasi kinerja keuangan perusahaan dan menganalisis keputusan manajemen (Tarighi et al, 2022). Menurut Kaawaase et al (2021) pelaporan keuangan sangat penting bagi perusahaan karena berguna dalam proses pengambilan keputusan yang valid, sehingga harus disajikan dengan tepat, relevan, dapat dipahami, dapat dibandingkan, tepat waktu, dan dapat diverifikasi.…”