In this paper, we examine the role of incentives stemming from capital market pressures and legal institutions to report earnings that accurately reflect a firm’s economic performance. Reporting incentives have been given little attention in the international accounting debate. Much of the discussion has focused on accounting standards per se, which are viewed as the primary input for high quality accounting (e.g., Levitt, 1998). Consistent with this view, several countries have adopted or plan to adopt International Financial Reporting Standards (IFRS) in an attempt to improve accounting quality. Similarly, harmonization efforts within the European Union (EU) have largely focused on eliminating differences in accounting standards across countries (e.g., Van Hulle, 2004).

Accounting standards generally grant substantial flexibility to firms. Measurements are often based on private information and the application of standards involves judgment. Corporate insiders can use the resulting discretion in reporting to convey information about the firm’s economic performance, but they may also abuse discretion when it is in their interest. For this reason, reporting incentives are likely to play an integral role in determining the informativeness of reported accounting numbers. While this general insight is not new (e.g., Watts and Zimmerman, 1986), it is often overlooked in international standard setting. As Ball (2001) notes, the global debate focuses too much on the standards and too little on the role of institutional factors and market forces in shaping firms’ incentives to report informative earnings.