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Effect of Companys size and leverage Features on the Quality of Financial Reporting of
Companies Listed in Tehran Stock Exchange
Afshar Karami
Department of Accounting,sanandajBranch, Islamic Azad University, sanandaj, Iran
Mohammadomid Akhgar
Assistant professor in accounting university of Kurdistan,Kurdistan,iran
Abstract
This study aimed to investigate the effects of companys size and leverage features on the quality
of financial reporting of companies listed in Tehran stock exchange. For this reason, using
systematic elimination sampling method, 120 active companies in Tehran stock exchange during
the period of 2003 2012 were selected as the sample of the study. In order to evaluate the model
by panel data method, first F test of Limer and Hausman was used to select the best model
among the panel data, fixed effects and random effects. In this study the effects of two factors of
companys structural features (size of company and leverage) was investigated. The results of
this study show that the variables of company size and leverage have negative and significant and
positive and significant relationships with financial reporting quality, respectively.
Keywords: Quality of financial reporting, Structural features of the company, Size of the
company, leverage.
1. Introduction
Accounting formation is so effective that can affect the decision makers. Financial reporting
should always provide users with reliable information to help them in their decision-making.
Financial report should contain the related, reliable, comparable and understandable data
(Kamaruzman, et al, 2009). Reliability is related to the quality of information and ensures that
information is logically free of fault and bias and suggests what is expected, honestly. But,
Johnson (2005) argues that an annual report never can be free of bias, because the economic
status provided in annual reports is continuously provided under the conditions that can not to be
completely free of bias. Many evaluations and hypotheses are entered into the report. Even if the
complete lack of bias is not accessible, but if these data are to be useful in decision makings, it is
essential to have a certain level of accuracy for reported financial data (International Accounting
Standards Board, 2008). The more the companies become clearer about the figures of financial
reports, the more transparency will exist. The quality of financial report is developing
transparency and publishing a high-quality annual report through complete and comprehensive
disclosing. The quality of financial reports is and has always been the interested topic of the
board of directors, stockholders, researchers and the professional accountants themselves. In
recent years, the accounting scandals occurred in international financial community, have led to
increased questions and concerns about the quality of financial reporting (Agraval and Chadha,
2005; Brown and Falaschetti and Orlando, 2010). Several prominent companies like and Enron,
Worldcom, Marconi, Parmalat, Cadbury and Bank Oceanichave participated in financial fraud.
This results in weakening of trust of investors to the managerial teem and financial reports
(Biddel, Hillary and Verdi, 2009). The quality is a necessity in financial reporting and disclosing.
The quality of financial reporting results in better prediction of future cash flows of the
companies for investors and other users of financial statements. Its clear that the lawmakers and
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investors have the same idea about providing a high-quality financial reporting. Because the
dominant notion is that the quality of financial reporting directly affects capital markets (Levitt,
1998). Every company has a set of features that are greatly related to its kind and nature.
Different commercial activities have different difficulties, operational cycle, risk, return, capital,
financial resources, objectives and assignments and it is clear that the reporting and information
environment is significantly affected by the type of commercial activity and its dominant
characteristics. This study tries to investigate the effects of two factors of structural features (size
of the company and leverage) on financial reporting quality.
2. Literature and background
Based on theoretical foundations, the quality of financial reporting may be affected by some of
the features of the company. The power of managers in using the principles of utilization and
comparison, evaluation and prediction are some of the factors that affect the quality of financial
reporting in general and the quality of earnings, in particular. On the one hand, due to more
information of managers of companys affairs, it is expected that they provide and represent the
information that reflects the status of company in its best conditions. On the other hand, due to
companys survival, receiving rewards and other factors, the management may represent a
desirable financial status for the company through earnings management process. Therefore, the
quality of financial reporting of companies is altered and declined due to the effects of measures
and discretion of the management to show a better financial status. It is clear that the first
objective of information of financial reporting in capital markets is supporting certain judgments
and decisions; therefore the quality of financial reporting is primarily considered due to the
viewpoint that high-quality information leads to better judgments and decisions. This means that,
the high-quality financial reporting are more beneficial in decision-making than low quality
information (Francis et al, 2006). The capital structure has been defined as the most important
effective parameter on valuing and orientation of economic enterprises in capital markets.
Belkaoui (1999) defines the capital structure as a general claim over companys assets. He
suggests that the capital structure is comprised of public released securities, private investment,
banking that, commercial debts, leasing contracts etc. that is usually measured by ratios like the
ratio of debts to total assets, the ratio of rights of stockholders to the total assets and the ratio of
debts to the rights of stockholders. The size of company is one of the structural variables of the
company. A group of studies shows that the size of company has a positive effect on financial
reporting and some of the reasons are considered as establishment of an effective internal control
system, the relationship with great auditory institutions and observing the cost of creditability and
reputation. Cohen (2004) found a positive relationship between size of the company and the
quality of financial reporting. One of the other structural variables of investment is the ratio of
debts to capital. The agency theory is also greatly used to explain the relationship between the
ratio of debt to capital of the company and the quality of financial reporting. It has been argued
that when the ratio of debt to capital increases, the transfer of wealth is carried out from the fixed
claimants (creditors, owners of bonds and privileged shares of the company) to the rest of
claimants (stockholders of the company). Cohen (2004) concluded that the companies with a
higher leverage, probably provides higher quality financial information. Very extensive research
has been carried out in the world with regard to internal and external factors affecting the quality
of financial reporting. But, given the investigation of literature, it seems that there are few studies
regarding the probable effect of structural features of the company (the size of company and
leverage) on the quality of financial reporting in stock exchange companies in Iran.

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Frost and Pownall(1994) studied the quality of financial reporting in USA and UK. For this
reason, they studied financial reports ending on December 1989 of 107 companies. Among these
companies, 33 companies were listed in the UK stock exchange, 33 companies were listed in the
USA stock exchange and the rest of them were listed in both the stock exchanges. After their
study, they concluded that the financial reporting quality in the mentioned countries is associated
with the size of companies.
Hung and Song (2006), after investigation of 1200 Chinese companies in the period of 1994 to
2003 concluded that leverage in Chinese companies is directly related to the variable of size of
company and fixed assets but it is inversely related to profitability, development opportunities
and managerial ownership.
Suhaila and wan Mansor(2007) investigated the relationship between the companys features and
capital structure (leverage) in Malaysian companies. The results have shown that all the three
variables (size, coverage of interest and growth) had a positive and significant relationship with
the capital structure.
Shehu (2012) investigated the effect of features of company on the quality of financial reporting
of productive companies in Nigeria. The results of a study showed that liquidity has an inverse
and significant relationship on the earning quality, but the other features of size of the company,
leverage, the combination of board of directors, institutional stockholders, profitability and
growth of the company had a significant and positive effect on the quality of financial report of
studied Nigerian productive companies.
3. Research hypotheses
In order to investigate the concerned relationships and answering the main questions of the
research, the one mail hypothesis and two sub-hypotheses were developed.
The capital structure has been considered as the most important parameter that affects valuing
and orientation of economic enterprises in capital markets. Belkaoui (1999) introduces the capital
structure as a general claim over assets of company. The topic of capital structure was first raised
by Modigliani and Miller in 1960s. Ibrahim (2009) investigated the relationship between capital
structure and the operation of companies listed in stock exchange of Egypt during the period of
1997 2005. The results of his study showed that there is a significant but weak relationship
between capital structure and operation in normal conditions. Therefore the hypothesis of
research can be defined as follows:
Main hypothesis: there is a significant relationship between companys structure features and the
quality of financial report.
The size of company is one of the structural features of the company. A group of studies shows
that the size of company has a positive effect on financial reporting and some of the reasons are
considered as establishment of an effective internal control system, the relationship with great
auditory institutions and observing the cost of creditability and reputation. Frost and Panal(1994)
studied the quality of financial reporting in USA and UK. The result of their study showed that
financial reporting quality has a relationship with the size of companies in the mentioned
countries. According to the mentioned issues, one of the hypotheses of the research can be raised
as follows:
Sub-hypothesis 1: there is a significant relationship between the size of company and financial
reporting quality.
The agency theory is also greatly used to explain the relationship between the ratio of debt to
capital of the company and the quality of financial reporting. It has been argued that when the
ratio of debt to capital increases, the transfer of wealth is carried out from the fixed claimants
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(creditors, owners of bonds and privileged shares of the company) to the rest of claimants
(stockholders of the company). Leftwitch et al (1981) suggest that the companies with a high
leverage have a higher representative cost and thereby more demand for supervision and
therefore it seems that the quality of financial reporting is related to the funding structure of the
company (ibid, 24). According to the mentioned issues, one of the hypotheses of the research can
be raised as follows:
Sub-hypothesis 2: there is a significant relationship between the leverage of company and
financial reporting quality.
4. Statistical population and sample
The statistical population of this study includes all companies listed in the Tehran stock
exchange. In this research, in order to have a representative statistical sample of the statistical
population, systematic elimination was used. For this reason, the following five criteria were
considered and if a company fulfilled all the criteria, it was selected as the sample of research and
the others were eliminated.
The companies should be listed in the stock exchange since 2003 and they should be
active in the stock exchange of the 2012.

They should not be among investment companies, financial broker offices, holdings,
banks and/or leasing companies.

The financial year of companies should end March 20th and during the period of 2003
2012 they should have no change their activities or their financial year.

The stocks of companies should be traded at least one time during the year.

Financial formation of companies should be available.

After observing all the above criteria, 120 companies were remaining as the screened population,
all of which were selected as the sample of the study. Therefore, our observations were 1200 year
company.

5. The variables of study

5.1. Independent variables
The company features: Every company has a set of characteristics that is mostly related to its type
and the nature of its activity. Different commercial activities have different difficulties,
operational cycle, risk, return, capital, financial resources, objectives and assignments and it is
clear that the reporting and information environment is significantly affected by the type of
commercial activity and its dominant characteristics. Based on theoretical basics, the quality of
financial reporting may be influenced by company features. This study investigates the
companys structural features (size of the company and leverage). Here, the two mentioned
features are explained respectively and their method of measurement will be described:
Size of company: A group of studies shows that the size of company has a positive effect on
financial reporting and some of the reasons are considered as establishment of an effective
internal control system, the relationship with great auditory institutions and observing the cost of
creditability and reputation. Hossein et al (1995) in support of a positive relationship between
size of company and financial information quality argue that the potential benefits of disclosure
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increases with costs of representatives. On this basis, according to the inflammatory conditions
and irrelevant date figures of assets, in this study the value of stock market is finally used as the
basis for determining the value of company and finally its logarithm is used as the variable of
company size.
Leverage: Leftwitch et al (1981) suggest that the companies with a high leverage have a higher
representative cost and thereby more demand for supervision and therefore it seems that the
quality of financial reporting is related to the funding structure of the company (ibid, 24). In this
study, the leverage of company is measured as the ratio of all long-term debts to total rights of
stockholders.
5.2. Dependent variable
Quality of financial reporting is dependent variable of the study. In order to evaluate the quality
of financial reporting, the accruals quality model of Kaznick (1999) was used. The reason for this
selection (the accruals quality) for evaluation of quality of financial reporting is the fact that the
accruals are the main factor of predicting the future cash flows and if there is lower fault in their
evaluation, the earnings are a better sign of future cash flows (Bidel et al., 2009). Also the other
reason for selection of this model for this research is that akhgar et al (2012) investigated 4
models and Yaghoobnezhad et al (2011) investigated 6 models of the accruals model that were
separated for each industry in terms of significance and predictability and the Kaznick model was
selected as the optimal model in Iran.
Kaznickmodel (1999)
By adding changes in net operational cash, this model and just adjusts the model of Jones. Model
of Kaznick is as follows:
=
+
[
]+
+
+
which:
is all the accruals,
is change in selling income of year t compared to previous year,
is changes in net rceivable accounts of year t compared to previous year,
is the
finished cost of properties, machineries and equipment,
is changes in cash flows of year t
compared to previous year and the rest of factors that is .
6. Data analysis method
In this analysis, Multivariate linear regression was used to test the hypotheses. The statistical
method used in this study was panel data method. In this method, a series of section unit (like
companies) will be considered for some years. Using this method which has been used many
times in research of recent years, the number of observations is increased to the desirable number.
Since, the merged observations cause more variability, less multi-collinearity between
explanatory variables, more degrees of freedom and higher efficiency of evaluators, combined
methods are more advantageous than section studies and time series (Beltaji, 1995, 3-6).
7. Model specifications:
The first phase of evaluation of panel data model is determining the constraints of the model. In
fact it can be determined that the regression in the studied sample has inhomogeneous abscissa
and homogenous inclination or the hypothesis of shared abscissa and shared inclination is
accepted (Ashrafzadeh and Mehregan). For this reason, F-test of Limear is used. Based on this
test, first we evaluate the model as constrained and in the general form with the shared abscissas
and shared inclinations and obtain the total squared unconstrained remaining. After performing
the test was following results are obtained:
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Table 1: F-test of Limear

Model
F - statistic

43.24
(0.0000)

Source:ResultsResearch
According to the values of F for the model and the relevant statistic, different and
inhomogeneous abscissas can be considered between groups. The studied regressions contain two
dimensions of time and space. The time dimension was 10 years (that is the period of 2003
2012) and the space dimension was 120 items. Therefore, the number of observations for each
variable has been 1200 issues. In the next studied regressions, the time dimension is very smaller
than the space dimension. Therefore, evaluation of reliability of variables used and the problem is
not important and the regression can be evaluated directly through the least combined squares
(Zaranejad and Anvari, 2005). Before evaluation of the model, Hausman F-tests have been
carried out and its results are provided in table 2.
Table 2: Hausman F-tests results.
Name of test
Chi-square
probe
value

Hausman

test

0.0000

1.0000

model
Source: FindingsResearch
The Hausman F-tests results showed that the models have no fixed effects. Therefore, regressions
have been evaluated with random effects. Then, we evaluate the study model using random
effects.
8. Findings obtained by testing the study hypotheses
In this part, first the model of the study is evaluated and then after evaluation of regression
assumptions, we interpreted the findings of each of hypotheses, separately.
8.1. Evaluation of the study model
In this study, the research hypotheses are tested using the following model which is a regression
model and will be evaluated using panel data:
+
+
+
FRQ = Financial Reporting Quality0 = Intercept1-2 = Coefficient of the independent variables
FSIZE = Firm SizeLEV = Leverage = Residual or error term
The results of evaluation of model are provided in the following table.
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Table 3: Model estimation results

A regression
Variable
C

Coefficients
11.119

T-statistics
28.475
(0.0000)

Fsize

-0.966

-30.210
(0.0000)

lev

5.025

80.135
(0.0000)

R2

.89

4752.784

No .Obs

1200

No.

120

Firm
Source: FindingsResearch
Remarks: the variable of time has been included to eliminate the time trend.
2
Based on evaluation findings according to statistics R , F and t the evaluated model is an
appropriate model. Also the test of correlation of fault values shows the lack of correlation
2
between fourth elements. According to R model it can be said that the percentage of valuations
of dependent variable is explained by independent variables which means a good fitness. Also
according to F-statistic, the generality of regression is significant.
Results obtained by testing research hypothesis
In this study the effect of companies structures on financial reporting quality was evaluated.
Since, the structure of companies has been considered from two perspectives of size and leverage
ratio, therefore this hypothesis was tested in these two sub-hypotheses:
Sub-hypotheses 1: it evaluates the relationship between financial reporting quality and the size of
companies and its statistical hypothesis can be developed as the following:
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There is a significant relationship between the size of company and financial reporting quality.
Based on the results provided in table 3, the significance level (P-Value) of t-statistic related to
the variable of size of company is lower than 0.05 (0.0000) and its coefficient is negative (0.966). Therefore at 95% confidence level, it can be said that there is a significant and negative
relationship between the size of company and financial reporting quality, so that with the increase
of one unit in the size of company, financial reporting quality of companies also decreases
accordingly. Therefore, sub-hypotheses 1 is confirmed at 95% confidence level.
Sub-hypotheses 2: it investigates the relationship between financial reporting quality and
financial leverage of companies and its statistical hypothesis can be developed as follows:
There is a significant relationship between leverage of company and financial reporting quality.
Based on results provided in table 3, the significance level (P-Value) of t-statistics related to the
variable of financial leverage of company is lower than 0.05 (0.0000) and its coefficient is
positive(5.025). Therefore at 95% confidence level, it can be said that there is a significant and
positive relationship between the financial leverage of company and financial reporting quality,
so that with the increase of one unit in the financial leverage ratio of company, financial reporting
quality of companies also increased accordingly. Therefore, sub-hypothesis 2 is confirmed at
95% confidence level.
Interpretation of the results obtained by testing the study hypothesis
H 0 : There is no significant relationship between variables of companys structure and financial
reporting quality
H 1 : There is a significant relationship between variables of companys structure and financial
reporting quality
According to the results obtained for testing the sub-hypothesis 1 and 2 of this study, it can be
said there is a significant relationship between the variables of size of company and financial
leverage ratio as criteria of companys structure, and financial reporting quality at 95 %
confidence level, so that the increase in financial leverage of companies and/or decrease of their
sizes have an increasing effect on financial reporting quality. Therefore, the first hypothesis of
study is confirmed at both levels of the size of companies and financial leverage ratio and this
shows that improvement in the structure of companies has a positive effect on the quality of
financial reporting.
Conclusion
This study investigated the effect of features of company on financial reporting quality in
companies listed in the Tehran stock exchange. This study used a multivariate regression model
to explain and predict the behavior of earning quality due to changes in features of company,
experimentally. Using multivariate regression of panel data, the used model evaluated the effects
and relationships of two independent variables of the size of company, leverage on a dependent
variable, financial reporting quality.
In the first hypothesis, we investigated the relationship between the size of company and financial
reporting quality. The results obtained for size of company and its effect on reporting quality
showed that the size of company is 5% effective in explaining the quality of earnings of the
studied companies. This shows that the size of companies has a negative impact on quality of
financial reporting and there are various reasons for this claim. First, big companies are subjected
to more pressures than small companies; second, the big companies have higher negotiation
capabilities for dealing with auditors; and third, big companies have more facilities to use for the
extended range of accounting procedures. Jensen and Mc Ling (1976) argued that the stock
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companies are subjected to political attacks, social responsibilities and wealth redistribution
regulations and use the accounting procedures in such a way that reduces these threats. This
hypothesis was tested in studies by Watts and Zimmerman (1978) (Hagerman and Zmijewski,
1979, 142-143). Barton and Simcoe (2002) showed that the companies are under great pleasure to
realize the expectations of analysts (Kim et al, 2003, 5). These findings are completely consistent
with the findings of (Oyelere et al. 2000; Denis et al 2009; Adelopo, 2010 and Cristini, 2010).
The second hypothesis of study investigates the relationship between leverage and financial
reporting quality of studies companies. The results of regression showed that leverage has a
significant effect (5%) on the earnings quality of studied companies with a positive coefficient.
This shows that the more the leverage ratio of a company, its earnings quality higher will be. But
companies with higher leverage ratio improve the quality of receivable information from their
financial reporting. This positive correlation confirms the results of a study by Shiho (2012). But
since the leverage ratio of a company shows its capital structure, therefore its higher values
indicates that the company has sold its stocks to increase its capital greatly. Assets can be used to
maintain the long-term growth of the company and therefore, they can be profitable. This means
that the debts level of the company has not reached to confiscation of properties. This finding is
consistent with the findings of Schipper, 1981; Kamaruzaman et al, 2009; Adelopo, 2010 and
Cristini, 2010.
Suggestions of study
a.The users of financial reports: in economic decision makings, should consider leverage as the
positive factor and size of company as the negative factor affecting on financial reports quality.
b.Managers of companies: should use the economic sources under their control optimally to
maximize the interests of company.
c.The stock exchange organization: should identify and clarify the factors affecting financial
reporting quality and use it as an instrument for ratings of companies.
d.The committee of developing accounting standards: should be very careful about the sizes of
companies (small, medium and large) and differences between industries (high and low
investment requirement) in developing financial reporting requirements.
Suggestions for future research
Due to the importance of financial information quality and financial reporting, it seems that
performing more studies with regard to their conditions can help to clarify this issue. In this
regard the following suggestions are provided for the researchers and users:
1. investigation of the effect of independent audit quality and internal audit on quality of financial
reporting
2. investigation of the relationship between non-auditory services and financial reporting quality
3. investigation of relationship between basic risk indicators and financial reporting quality
4. investigation of financial dependencies on financial reporting quality of non-profit
organizations
5. Repetition of this study in different industries and separately for each industry.

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-Suhaila Mat Kila and Wan Mansor Wan Mahmood. (2007),Capital Structure and Firm
Characteristics: Some Evidencefrom Malaysian Companies, Department of Finance,
Faculty ofBusiness & Management, Malaysia.

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