External monitoring and financial reporting quality: Evidence from universities

In this paper we exploit the complementarities between agency theory and resource dependence theory to investigate the influence of regulatory monitoring on financial reporting quality in the higher education sector. Our... [ view full abstract ]

In this paper we exploit the complementarities between agency theory and resource dependence theory to investigate the influence of regulatory monitoring on financial reporting quality in the higher education sector. Our setting is English universities. Using ten years of data over the period 2002-2011, we find that financial reporting quality, proxied by discretionary accruals, improves with the intensity of monitoring, proxied by dependence on funding from the sector regulator, the Higher Education Funding Council for England (HEFCE). However, this positive influence is moderated in the presence of a small pre-discretionary loss, a proxy for the threat of regulatory intervention. A net benefit from monitoring remains for those universities with low levels of regulated funding but in those where there is high dependence the monitoring benefit is reversed and a pre-discretionary loss is reported as a small surplus. Both agency and resource dependence theories offer explanations for these findings. Agency theory predicts increased financial reporting quality with increased monitoring and also a reduction in financial reporting quality to avoid costly regulatory intervention. Resource dependence theory predicts that both these effects will increase with increased dependence on resources from a key provider. These findings extend our theoretical understanding of financial reporting quality in the not-for-profit and public sectors, contribute to the limited literature on the financial governance of universities, and provide an early exploration of the complementarity of alternative theoretical frameworks in the domain of public sector accounting.