Subordinates as the First Line of Defense against Biased Financial Reporting

Abstract

Managers who generate financial reports often rely on subordinates who possess private information to provide inputs. When managers have incentives to manipulate reports, they may request biased inputs from subordinates. However, subordinates can act as informal controls and constrain managers' opportunism. We experimentally examine two potential determinants of subordinates' willingness to serve as informal controls: their perception of the subordinate-manager relationship quality and their beliefs about the ethical nature of the task. Subordinates who perceive a high-quality relationship with their manager provide more bias, despite a compensation scheme that makes compliance costly. This result suggests that managers who cultivate close working relationships with subordinates may undermine the control system. Subordinates' beliefs about the ethical nature of the task also reduce compliance, but more so when the manager requests income-increasing estimates. Our findings contribute to the management accounting literature by providing insights into the role of subordinate employees as informal controls.

Trust and Financial Reporting Quality

“…Information production and information sharing are important to producing high‐quality financial statements because of the inherent difficulty in making required estimates, judgments, and evaluations (e.g., fair‐value accounting, accounting for derivatives—see Stowe and Jeffery []), combined with the dependency of managers, who are responsible for generating financial reports, on subordinates who possess private information (Jollineau, Vance, and Webb []). For example, if personnel involved in operations have little trust in the controller, they may be less open or honest in proposing forecasts and budgets or in reporting actual results, fearing that honest proposals and reports may unfairly be used in ways that harm their interests.…”

“…Despite its importance, the role of trust has been relatively unexplored in the accounting literature, and even less so in the specific context of financial reporting quality (FRQ) . However, there is reason to believe that trust, in particular, employees’ trust of their managers, might have a positive influence on FRQ, because “managers who generate financial reports often rely on subordinates who possess private information to provide inputs” (Jollineau, Vance, and Webb [, p. 1]), and the level of trust between managers and subordinates can influence the extent to which private information is objectively produced (Bart []) and openly and accurately shared (Mayer and Gavin [], Roberts and O'Reilly [], Zand []).…”

Do differences in national cultures affect cross-country financial statement comparability under IFRS?

“…Accounting researchers have also examined the effect of trust on managers and auditors (Rose, 2007;Garrett et al, 2014). Garrett et al (2014) document that when employees trust their management, they communicate their private information to management more frequently and accurately, which is crucial in making managerial evaluations and judgments (Jollineau, Vance, and Webb, 2012). Consistent with their argument, the authors find that firms with stronger trust between employees and management have higher accrual quality and lower likelihoods of misstatements and material internal control weakness disclosures.…”

The Effect of a Leader's Emotional Intelligence on the Subordinate's Intention to Whistleblow

“…As previously argued, effective leadership and high LMX can lead to many different consequences, such as subordinate effort on accounting work (Vance 2010), accounting reporting behavior (Jollineau et al 2012), and OCB (Dulebohn et al 2012). OCB is "individual behavior that is discretionary, not directly or explicitly recognized by the formal reward system, and that in the aggregate promotes the effective functioning of the organization" (Organ 1988, p. 4), and it could be classified into two subtypes: Organizational Citizenship Behavior-Organization (OCBO)behaviors that could benefit the organization as a whole (e.g., follow informal rules to maintain everything in order) and Organizational Citizenship Behavior -Individual (OCBI)behaviors that immediately benefit specific individuals (e.g., help other employees who cannot come to work even if it is not required by the organization to help the absent employee) (Williams and Anderson 1991;Smith et al 1983).…”

“…Moreover, as Jollineau et al (2012) argue, allowing subordinates to interact with manager confederates could introduce confounding factors that impair internal validity. Therefore, some dynamic constructs that may develop over time, such as LMX, is experimentally manipulated successfully in accounting studies by descriptive scenarios (e.g., Jollineau et al 2012;Vance 2010).…”