Modern slavery and financial reporting quality worldwide: the impact of institutional and legal environment

Purpose In this paper, the authors opt for an identification strategy to examine the moderating impact of the institutional environment on the association between modern slavery and financial reporting quality, as measured by classification shifting and real earnings management around the world. Design/methodology/approach Using panel data between 2010 and 2018, the authors perform various analyses and robustness tests on a sample consisting of 134, 205 firm-year observations in 63 countries. Findings The results, which are robust, show a positive association between modern slavery and expense misclassification and real activities earnings management, confirming that the institutional environment facilitates prolonged and endless concealment of unethical and illegal business practices. In addition, we find that the quality of the legal environment moderates illegal modern slavery practices, unethical expense misclassification and real activities earnings management. The negative impact is more pronounced in a strong legal environment than in a weak legal environment. Our results are robust after controlling for the impact of auditing, including financial auditors, social auditing, corporate social responsibilities, environmental, social and governance score and corporate governance. Research limitations/implications The study’s findings are limited to a lack of modern slavery data prior to 2010. In addition, some of the variables examined are studied at the firm level, while other variables are at the state or county level. Finally, the study establishes an association between the variables of interest, and this does not necessarily imply causation. Social implications The findings have several important social, practical, policy, practitioner and regulatory implications for all types of countries and businesses. First, senior and corporate management committed to socially responsible reporting should intensify their momentum to deal with modern slavery risks and practices in their supply chains. Second, auditors and external monitoring agencies should strengthen their social and financial audits to uncover hidden modern slavery crimes and illicit financial benefits. Third, regulators and governments around the world should mandate laws and severe sanctions against illegal and illegitimate modern slavery practices. Fourth, the internal governance mechanism should be strengthened and modern slavery reporting, sustainability reports and social audits should be enforced and made compulsory in the governance section of the annual report. Originality/value The study provides novel evidence of the impact of modern slavery practices on financial reporting quality in an institutional environment. Our study contributes to the ongoing policy debate by showing how institutional and legal environments influence firms’ behaviour regarding modern slavery and financial reporting. The findings reveal the importance of robust regulatory frameworks and ethical auditing practices in curbing modern slavery and promoting transparency. As firms continue to navigate these challenges, strengthening institutional and ethical standards could play a key role in reducing illegal and unethical practices, ultimately contributing to better financial transparency and accountability on a global scale.