Does financial reporting quality vary across firm life cycle?

Abstract

This study provides empirical evidence that across firm life cycle there is considerable variation in financial reporting quality. Specifically, the focus is on matching quality captured by the contemporaneous correlation between revenues and expenses and on the likelihood of material misstatements in financial statements. On balance, we observe an inverted U-shaped pattern of financial reporting quality, that is, lower quality during the introduction, growth, and decline stages, compared to the mature stage of firm life cycle. First, we find poor matching of expenses with revenues in the introduction, growth, and decline stages. This implies conservative or aggressive recognition of expenses, leading to less informative earnings, and hence lower financial reporting quality. Then, we examine the likelihood of material misstatements, measured by weaknesses in internal control over financial reporting, financial statement restatements, Securities and Exchange Commission's (SEC) accounting and auditing enforcement releases (AAER), and financial statement divergence (FSD) scores. We find clear indications that firms in the introduction, growth, and decline stages are significantly more likely to have misstatements in their financial statements compared to firms in the mature stage. Overall, the findings of this study enhance our understanding of the role of life-cycle stages in causing variation in financial reporting quality.