As firms embrace greater cultural diversity, managing transparent financial reporting becomes increasingly complex, with classification shifting posing a significant risk to earnings quality. This research aims to analyze how environmental, social and governance (ESG) performance impacts the nexus between board cultural diversity and classification shifting in a developed market, such as the UK.
This study used panel data of 67 UK firms listed in the FTSE 100 index between 2019 and 2023. The authors employed the feasible generalized least squares method, estimated on panel data.
The regression results demonstrate a positive relationship between unexpected core earnings and non-recurring items, confirming that UK companies engage in classification shifting. They also reveal that board cultural diversity can significantly inhibit classification shifting practices. In addition, ESG performance mediates this relationship significantly.
For stakeholders, policymakers and regulatory bodies, this study highlights how ESG performance and board cultural diversity can improve financial reporting quality, providing actionable insights for strategic decision-making. It sheds light on the significance of firms enhancing their ESG initiatives as a tool to reduce risks of financial reporting manipulation due to cultural diversity. Proper ESG frameworks have the potential to increase transparency and ethical conduct to improve stakeholder trust and corporate reputation.
This study contributes to the literature by investigating how firms mitigate classification shifting – a specific form of earnings manipulation – through ESG initiatives and cultural diversity, a relationship that remains underexplored in prior research.
