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Financial Reporting Quality Impact on the Firm’s Capital Structure

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Carolina Pereira Reis (2210574).pdf1.32 MBAdobe PDF Download

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Past literature on capital structure has demonstrated that firms’ financing decisions play a crucial role in their performance and longevity. Accordingly, researchers have often addressed this subject to understand why firms opt for either debt or equity financing. Most research suggests that capital structure is predominantly determined by two elements: the firms’ internal and external characteristics. In this study, we investigate the possible impact of the quality of financial information that has been frequently neglected. Since financial reports are the principal basis for most financial decisions, their quality and information heavily influence capital structure choices. However, some managers have been known to resort to earnings management practices during times of financial hardship, to conceal difficulties and maintain a facade of growth and stability for stakeholders. Such practices compromise the quality of financial information, possibly hindering financial decisions. Therefore, this study aims to investigate the potential impact of financial reporting quality on firms’ capital structure. Our hypothesis is tested using an unbalanced panel sample of 414 firms from four European stock exchanges between 2013 and 2022. To evaluate capital structure, we employ total and maturity debt ratios, based on book and market values, to achieve a more comprehensive result. Financial reporting quality is also evaluated through multiple proxies, such as accruals quality, smoothness, timeliness, and accounting conservatism. Our empirical regressions were estimated through the fixed effects and the OLS models. The global analysis revealed mixed findings, with three variables of financial reporting quality exhibiting a positive impact on debt (accruals quality, smoothness, and accounting conservatism), while the remaining proxy presented a negative impact (timeliness). Further analysis also indicates that companies affected by Troika policies experienced a contrasting effect of timeliness on debt, while the other firms displayed results consistent with the global analysis. Moreover, both firm-specific and macroeconomic factors exhibited substantial statistical significance in influencing debt in all the estimated models. These conclusions broaden our knowledge on factors that define capital structure, as well as the relevance of financial reporting.

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Capital structure Financial reporting quality Listed companies European countries Troika

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