The Effect of Managerial Ability on the Timeliness of Financial Reporting: The Role of Audit Firm and Company Size

The objective of this study is to investigate whether managers' ability impacts the timeliness of financial reporting. The timeliness of financial reports is a topic that has been receiving increasing attention from regulators, standard setters, and academics [1], [2]. The US Securities and Exchange Commission (SEC) has set deadlines for various corporate filings, including periodic accounting reports [3]. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) also emphasize the importance of timely financial reporting, considering it a primary characteristic of relevant financial information. Additionally, empirical study has long emphasized the significance of timely financial reporting.

While previous study has studied various economic and auditor characteristics related to the timeliness of financial reporting [4], [5], [6], the influence of management characteristics, such as human capital, has not been thoroughly examined. This lack of evidence regarding managers' impact on financial reporting and auditing has been highlighted since the implementation of laws such as the Sarbanes-Oxley Act. Therefore, this study uses a management ability measure introduced by Demerjian et al. [1] to investigate the relationship between managers' ability and the timeliness of financial reporting. We hypothesize that managers' abilities affect the timeliness of financial reporting. The audit report lag (ARL) measures how efficiently management facilitates the audit process and negotiates with auditors. Abernathy et al. [7] suggest that ARL is shorter when managers are more capable.

Given the significance of timely financial reporting for investors, regulators, and researchers, this study can have a substantial impact. Managers' ability to disclose confirmed financial information to the market earlier plays a crucial role in reducing information asymmetry. As emphasized by Abernathy et al. [4], capital markets in emerging economies must provide audited financial statements. Our findings suggest that managerial ability is related to timely financial information, which is beneficial for auditors, boards, investors, and regulators.

The results of this study contribute to the literature on management ability by highlighting that managers' ability to report timely financial information about companies is a crucial aspect of decision usefulness. Demerjian et al. [1] quantify managers' ability empirically with a metric that has generated an emerging field of research examining how managers' ability influences accounting and disclosure practices. Improving financial reporting timeliness can help reduce information asymmetry and benefit shareholders.

According to Kor [8], managerial ability is derived from a manager's knowledge, experiences, and skills, including their understanding of markets, corporate strategies, and technology. The power of managers and their effect on financial and non-financial indicators has become a popular research area in recent years. Timely information is critical in making economic decisions and financial forecasts, and it is considered one of the main components of an efficient capital market. Financial reports indicate that the time value of information significantly influences users' financial and economic decisions. Therefore, managers who can manage resources effectively are more likely to achieve their goals, including the timely release of financial statements [1].

Timely information must be available to decision-makers before it loses its ability to influence decisions. Accounting research suggests that financial information should be available at the right time as the availability of timely information is a significant factor in influencing decision-makers' decisions and expected returns. Delayed earnings announcements have been found to have a positive association with lower abnormal returns [9], [10], [11]. Timely financial information improves financial statements by reducing asymmetric releases of financial information [12].

Abernathy et al. [13] point out that accounting information disclosure is done in several steps. Many companies publish their earnings before the audit report date, and the audit report confirms the management profit's publication [14]. Managers' abilities are expected to play a significant role at each stage; executives with a more extraordinary capability of handling resources efficiently are more likely to achieve their goals, including financial reporting timeliness.

While previous research has identified audit reporting lag (ARL) as the significant financial reporting timeliness determinant, the relationship between managerial ability and ARL in the capital market has not been investigated [6]. An auditing and financial reporting process is facilitated by management. Managers with high managerial ability are expected to have a shorter ARL since they are more knowledgeable about the firm and the industry. Consequently, a shorter ARL can be achieved because the information can be verified more quickly, enabling better financial reporting and auditing due to more capable managers. The audit process is facilitated by facilitating communication between the auditor and management. By reducing ARL, the managerial ability is believed to minimize time spent discussing, understanding, and evaluating effective accounting procedures with the auditor [15]. According to Krishnan and Wang [16], audit engagement risk is lower for clients with higher managerial abilities than those with lower managerial abilities.

Therefore, the role of business unit managers in management ability and financial reporting is significant [17]. It is important to measure the accuracy and efficiency of an organization's audited financial statements using the ARL since it is an objective and publicly available metric.

H1: There is a positive and significant relationship between managerial ability and financial reporting timeliness (according to the audit report delay criterion).

According to Uygur [18], larger companies face various political costs and must perform properly due to their attractiveness to investors. However, larger companies have lower disclosure quality than small companies, despite their highly competitive power. The CEO of a company knows that the market evaluates their capabilities through the company's characteristics, such as performance, investment success, or decisions related to research and development policies. Numerous studies have shown a significant relationship between the ability of company managers and their company's performance [19], [20], [21]. Executives with high ability are expected to bring better company performance to their shareholders.

Ting et al. [22] argue that the ability of managers to create, develop, and achieve company success is important, measured by efficiency, investment decisions, compensation, and overall performance. Therefore, companies seek to hire managers with high ability. Firm size significantly affects managers' perceptions of production flexibility and market requirements [23]. Capable managers can simplify the financial reporting and auditing process effectively. Hence, the company's size is expected to affect the relationship between managers' ability and their timely financial reporting. Large companies are more likely to hire higher-ability managers than small ones.

Therefore, it is hypothesized that company size affects the relationship between managers' ability and financial reporting timeliness.

H₂: Company size affects the relationship between managers' ability and financial reporting timeliness.

It has been shown that delaying the audit report can have a negative impact on capital market transactions and the company's value, as it reduces the quality and timely availability of financial information [24], [25]. Timely financial reporting is considered critical in reducing the misuse of a company's information by insiders in developing countries' capital markets [26]. Providing timely information enables investors to analyze it correctly and make logical and predictable investments, leading to improved decision-making and reduced uncertainty, ultimately positively affecting the company's value and the market.

The timeliness of the audit process is essential in ensuring timely financial reporting [26]. Companies must pay attention to the audit process for their financial statements to be timely. The annual audit duration is the most crucial factor determining companies' timely presentation of financial reports [27]. Audit report delay refers to the number of days between the end of the company's financial year and the date of presentation of the independent auditor's report [28].

Significant and reliable audit institutions are equipped to complete the audit process with higher efficiency, effectiveness, and speed, due to their ability to employ and hire expert staff [29], [30], [31]. These auditing institutions can perform audits effectively and efficiently using superior and advanced auditing technologies and have more flexibility in implementing their audit program. Large audit institutions usually use professional and highly experienced audit staff, who spend less time identifying their clients' financial systems and the complexity of information processing systems, which will not lead to a delay in submitting the audit report. Therefore, the negative relationship between the size of the audit firm and the delay in the audit report is considered a symbol of the timeliness of financial reporting.

However, some argue that large audit institutions act more cautiously and carefully to maintain their credibility and reputation and use more extensive audit procedures, which can increase the audit work time and, as a result, increase the delay of the audit report. Thus, there may be a positive relationship between the size and credibility of the auditing firm and audit delay [32], [33], [34].

In light of the above, it can be concluded that managers with high ability seek timely financial reporting and may choose to engage large auditing firms to achieve this goal by utilizing the professional team of such firms. Hence, the following hypothesis is proposed:

H3: The size of the audit firm affects the relationship between managers' ability and the timeliness of financial reporting.

For a period of 10 years (2012-2021), the statistical sample for this study includes companies listed on the Tehran Stock Exchange that meet the following criteria:

- Have maintained consistency in their financial year leading up to 29/12 to increase comparability.

- Have not changed their activity or financial year during the study period.

- Engage in production activities, with financial institutions, investments, and banks excluded from the sample.

Overall, there are 115 companies that meet these criteria, providing a sample size of 1150 observations for the study.

To test the first hypothesis, the following model is used:

Based on the results of the first hypothesis, the second hypothesis is tested using the following model:

To test the third hypothesis, the following model is used:

In current models

Timeliness of financial reporting (Timeliness): The ARL (audit report lag) criterion is used as a measure of this variable. ARL is calculated as the number of days between the end of the company's financial year and the date of the independent auditor's report. The lower the ARL, the more timely the financial reporting.

Imeni et al. [35].

Company size (CSIZE): This variable is measured as the natural logarithm of the company’s sales value. To control for industry and year effects, a dummy variable is created for each year-industry combination, taking a value of 1 if the company’s sales value is above the median for that year-industry and 0 otherwise.

Profitability (ROA): This variable measures the company’s ability to generate profits from its assets and is calculated as the ratio of net income to total assets.

Company loss (LOSS): This is a binary variable that takes a value of 1 if the company has a loss in a financial year, and 0 otherwise. It is used to control for the effect of loss-making companies on the relationship between managerial ability and the timeliness of financial reporting.

Leverage (LEV): This variable is measured as the ratio of total liabilities to total assets and provides an indication of the company’s financial leverage and risk [36].

Inherent risk (Inherent): This variable measures the company’s risk exposure due to its current assets and is calculated as the ratio of total accounts receivable and inventory to total assets.

Audit Fee (AUFEE): This variable measures the audit fee charged by the independent auditor as a percentage of the company’s total assets.

Internal controls weakness (IC WEAKNESS): This variable is a binary variable that takes a value of 1 if the company discloses weaknesses in its internal controls, and 0 otherwise.

Restatement of Financial Statements (MISTATE): This variable is a binary variable that takes a value of 1 if the company has restated its financial statements, and 0 otherwise. It is used to control for the effect of financial reporting errors on the relationship between managerial ability and the timeliness of financial reporting [14].

In descriptive statistics, the status of data is often summarized using central tendency measures. Table 1 provides the following summary statistics for the data:

Based on the results of Table 1, it can be concluded that:

(1): The average delay in financial reporting is 74 days, indicating that, on average, companies take 74 days to prepare their financial statements and have them audited.

(2): The average leverage ratio is 65%, suggesting that companies tend to rely heavily on debt financing to fund their operations. The highest leverage ratio is observed for Farabi Petrochemical Company in 2017.

(3): The average sales growth rate for companies is approximately 14%, indicating that, on average, companies are experiencing moderate growth in their sales.

(4): The average operating cash flow ratio to the company's total assets is around 11%, indicating that companies have a moderate level of operating cash flow in relation to their total assets.

(5): The average growth rate of companies' assets is approximately 30%, suggesting that companies are experiencing relatively high growth in their assets.

(6): Approximately 13% of the companies had weak internal controls, indicating that there is room for improvement in the companies' internal control systems.

(7): Approximately 23% of the companies had an average loss for the financial year, suggesting that a significant portion of the companies are not generating profits from their operations.

Linear regression was used to test the first hypothesis of the research. The results are presented in Table 2:

Based on the results presented in Table 2, the F statistic value is 50.05, and its significance level is 0.000, indicating that the research model is statistically significant and has a good fit for the data. This means that the independent variables in the model collectively have a significant effect on the dependent variable, which is the timeliness of financial reporting.

Furthermore, the test results at a significance level of 5% revealed a significant negative relationship between managerial ability and timeliness of financial reporting, which supports the first hypothesis of the research. This suggests that companies with higher managerial ability tend to report their financial information more quickly than those with lower managerial ability.

Table 3 shows that the research model is overall statistically significant, with an F statistic value of 48.1119 and a significance level of 0.000. The results of the model test at a significance level of 5% indicate a significant and meaningful relationship between managerial ability, company size, and the interaction effect between these two variables with the timeliness of financial reporting. Specifically, the results suggest that companies with higher managerial ability tend to report their financial information more quickly, but this relationship is weaker for larger companies. Additionally, the results indicate that larger companies tend to report their financial information more slowly.

According to the results shown in Table 4, the F statistic value is 53.1515, and its significance level is 0.000, indicating that the research model is overall statistically significant.

The results of the model test at a significance level of 5%, as presented in Table 4, reveal a significant and positive relationship between managerial ability, the size of the auditing firm, and the interactive effect between these two variables with the timeliness of financial reporting.

Effective resource management by capable executive managers can help achieve timely financial reporting. When managers have confidence in their financial reporting system and possess knowledge about their business environment and industry, they are more motivated to publish financial statements quickly. Additionally, capable managers can handle complex issues efficiently, which can speed up the financial reporting and auditing process. Therefore, the relationship between managerial ability and financial reporting timeliness was examined for 115 listed companies in the Tehran Stock Exchange between 2012 and 2021.

Audit efficiency, which measures management's ability to facilitate audit processes and negotiate with auditors, is positively associated with higher managerial ability. According to Abernathy et al. [7], higher managerial ability is associated with shorter ARL, and management ability is positively and significantly related to the timeliness of financial reporting. Moreover, Mehrani et al. [9] found that qualified managers delay audits and profit announcements passively, leading to more timely disclosure of financial information.

The research by Abernathy et al. [7] and Mehrani et al. [9] also suggests a positive and significant relationship between the size of the audit firm and the timeliness of financial reporting. Larger audit firms, with greater expertise and experience, tend to have shorter delays in reporting, and capable managers use larger, more experienced, and well-known audit firms to reduce audit time.

Furthermore, the research model results show a positive and meaningful relationship between managerial ability, company size, and their interaction effect with the timeliness of financial reporting. According to Mehrani et al. [9], there is a positive and significant relationship between the size of the company and the timeliness of financial reporting based on the delay index in the auditor's report. This suggests that companies with larger size tend to hire more capable managers to handle complex issues, which can lead to improved financial reporting timeliness.

Based on these findings, it is recommended that legislators in the capital market provide a suitable information base for economic decision-making and changing the shareholding status by rating and disclosing companies' timeliness of financial reporting. This can help reduce information asymmetry, secret exchanges, rumors, and information leakage in the market, leading to efficient pricing of securities, attracting capital, and maintaining investors' confidence in the capital markets. Companies should pay attention to their reputation and rating when hiring auditing firms, and great attention should be paid to their abilities in hiring managers.