Human Development and the Quality of Financial Reporting among the Local

Governments in Indonesia

Abstract
We investigate whether a local government's level of human development is associated with its
financial reporting quality. We employ audit opinion and accruals management to capture financial
reporting quality and manually collected data from our sample of 4,254 financial reports of
Indonesian local governments from 2010 to 2018. We find that local governments whose citizens
have a higher Human Development Index (HDI) and each dimension of human development are
more likely to receive an unqualified audit opinion on their financial reports. However, we find
that local governments with a higher development index are more likely to use accruals
management through revenue overestimation or expense underestimation in preparing the
statement of operations. Our results suggest that employees of higher quality, as indicated by a
higher HDI, have a greater ability to follow accounting rules resulting in a cleaner audit opinion.
However, they might opportunistically use their judgments in making accounting estimates.
Finally, our study contributes to the literature by providing insight into how human development
and its dimensions are associated with the quality of financial reporting, especially in the public
sector in developing countries.

Keywords: quality of financial reporting, human development, local government, life expectancy,
education, the standard of living.

1
1. Introduction

We investigate whether human capital is associated with the quality of the financial reporting of
local governments, specifically in Indonesia. Our study is motivated by the United Nations
Sustainable Development Goals (the U.N. SDGs), which encourage every government worldwide
to prioritize both the development of human capital (SDG No. 4 quality education) and financial
reporting quality (SDG No 16 accountable institutions). Indonesia is a member of the G20
countries and is expected to contribute substantially to achieving the U.N. SDGs through quality
education and institutional accountability. From the perspective of quality education, it is believed
that higher-quality education potentially diminishes corruption. Since corruption has been a severe
challenge to Indonesia (Lewis & Hendrawan, 2019; McLeod & Harun, 2014), addressing human
capital becomes essential. From the institutional accountability perspective, Indonesia's central
government has made substantial efforts to promote better transparency and accountability among
local governments.1 Our study investigates how human capital is associated with the quality of
financial reporting in the unique institutional environment of Indonesia.
Prior studies suggest that human capital is a source of a region’s development (e.g., Florida,
Mellander, & Stolarick, 2016) and an organization’s competitive advantages (Minbaeva, 2018).
Human capital is often reflected in the level of education of managers and employees as well as
citizens and society. Existing studies have shown how the educational backgrounds of top
executives (Plöckinger et al., 2016; Yao et al., 2020), employees (Call et al., 2017; Liu, Lin, &
Shu, 2017), and auditors (Du, Yin, & Hou, 2018) affect financial reporting quality in the corporate
setting.2 While many studies have examined the association between human capital and financial
reporting quality in the corporate setting, limited empirical evidence has been documented about
such an association in the public sector context. Following the private sector literature, we expect
to find a positive association between human capital and the quality of financial reporting, which
will be reflected in a clean audit opinion on their financial reports.

1
As part of the Indonesian government’s public sector reforms under the Law No. 17 on State Finance issued in 2003,
almost 500 local governments have been required mandatorily to prepare and submit annual financial reports since
2004. The annual financial reports must be audited by Badan Pemeriksa Keuangan (BPK), the Supreme Audit Board.
2
Beck, Francis, & Gunn (2018) suggested that audit quality is affected by labor characteristics. While investments in
human capital increase auditor quality (Cheng, Liu, & Chien, 2009), better audit education reduces audit report lags
(Siddiqui, Nasreen, & Choudhury‐Lema, 2009).

2
 Information asymmetry, agency problems, contracting, governance, and regulation create
demand for accounting information and provide motives and opportunities for financial disclosure
management (Hofmann & McSwain, 2013; Mogues & Olofinbiyi, 2020).3 The demand is greater
in a country such as Indonesia, with its decentralized government system and characterized by
high levels of corruption on the part of government officials at both the central and local levels
(Lewis & Hendrawan, 2019; McLeod & Harun, 2014) and inadequate law enforcement (Enomoto,
Kimura, & Yamaguchi, 2015).4 In the collectivist culture of Indonesia (Hofstede, 2021), people
are more receptive and tend to compromise with controversial behavior (Zhang, Liang, & Sun,
2013). In the context of these formal and informal institutional backgrounds, we argue that
although local governments receive a clean opinion on their financial reports, the managers of
local governments may engage in financial-disclosure management. This financial-disclosure
management will be reflected in high accruals management resulting from revenue-increasing or
expense-decreasing activities. A positive association between human capital development and
accruals management is expected.
To investigate the association between financial reporting quality and the level of human
development, we employ the cleanliness of the audit opinion and accruals management (e.g., Arcas
& Martí, 2016; Cohen, Bisogno, & Malkogianni, 2019; Ferreira, Carvalho, & Pinho, 2013) as
proxies for reporting quality. The level of human development in this study is proxied by the
Indonesian Human Development Index (HDI) released by the Indonesian Central Bureau of
Statistics (BPS, 2020). Given that HDI dimensions include life expectancy, education, and
standard of living, we investigate further the association between each dimension of HDI and
financial reporting quality. They are examined to get insights into which dimensions of HDI are
dominant and how they influence the quality of financial reports in the public sector. The data to
determine the audit opinion and accruals management are manually collected from local
government financial reports. The control variables used in our study’s model include the size,
local revenues, regencies and municipalities, geographic location, mayors’ experience, age of the
mayor, budget realization, and mayors’ gender.

3
Similar to earnings management in a corporate setting (Hofmann & McSwain, 2013).
4
Managers of private firms are part of the corruption process in Indonesia, and they are often involved in the bribery
of government officers (Lingga, 2018).

3
 We find that the level of human development is positively associated with the quality of
financial reporting. More specifically, local governments with a higher HDI are more likely to
have a higher quality of financial reporting as measured by a cleaner audit opinion on their
financial reports. The results hold when each dimension of human capital is used as a predictor
variable and after controlling for factors such as the local governments' geographic location, size,
and revenue. Overall, we conclude that better human development and its dimensions lead to a
better quality of the financial reporting of local government in Indonesia. Interestingly, in
additional analyses, we find a positive association between human capital development and
accruals management. These results imply that local government managers with better human
capital are more likely to engage in financial disclosure management. Yet, they are more likely to
receive a clean audit opinion. Without strong formal and informal institutional environments, local
governments with better human capital will engage in accruals management practices and will still
be able to get clean audit opinions on their financial reports.
Our study contributes to the literature by showing how the level of human development
and its dimensions affect the quality of the financial reporting of local governments in Indonesia.
Only a few studies examine the association between human capital and the quality of financial
reporting in developing countries. Prior studies have examined this issue in the context of the U.S.
(Call et al., 2017; Call, Kedia, & Rajgopal, 2016; Demerjian et al., 2013) or other countries such
as China (Du, Jian, & Lai, 2017; Du et al., 2018), and Taiwan (Lin, Lin, & Fang, 2020).
Additionally, it has been investigated in corporate settings but not in public sector settings. Indeed,
Rakhman and Wijayana (2019) have examined determinants of the quality of financial reporting
in Indonesia’s public sector. However, they did not consider human capital as a factor that affects
financial reporting quality or examine accruals management practices. Our study’s results have
implications for government policies related to continuously improving life expectancy, the
education system, and the standard of living in Indonesia, supporting U.N. SDG No. 3 on good
health and well-being, No. 4. on quality education, No. 11 on sustainable communities, and No.
16 on peace, justice, and strong institutions. Studies that examine the link between the U.N. SDGs
and financial reporting are still sorely needed (Bebbington & Unerman, 2018; Salvia et al., 2019).
The next sections are arranged and presented as follows. Section 2 discusses the
background of human development and financial reporting in local governments in Indonesia.
Section 3 presents the theoretical background, literature review, and hypotheses development. The

4
research methodology, including data, sample selection, model, and measurement, is explained in
Section 4. Section 5 provides the results of hypotheses testing, and Section 6 concludes the
research findings and implications and discusses some limitations of our study.

2. Background: Human Development and Financial Reporting of Local Government in

Indonesia
The central government of Indonesia has committed to supporting the 2030 UN Agenda for SDGs,
as formally enacted and stated under Government Regulation No. 59 of 2017, signed by the
President of Indonesia. In particular, SDG No. 4 and SDG No. 16 are relevant in the context of our
study. SDG No. 4 concerns quality education by promoting opportunities for lifelong learning and
ensuring equitable and inclusive quality education. The other SDG goal (No. 16) concerns justice,
peace, and strong institutions to promote inclusive and peaceful societies for sustainable
development. This shall be done by building accountable, inclusive, and effective institutions at
all levels and providing access to justice for all. The central government of Indonesia has
incorporated both agendas in its medium- and long-term development planning.
We investigate how human capital is associated with the quality of financial reporting in
the unique institutional environments of Indonesia. Indonesia is still plagued with corruption by
government officials at both central and local levels. Indonesia is also characterized by a
collectivist culture where people are more receptive and tend to compromise with controversial
behavior (Zhang et al., 2013). Transparency International reports that Indonesia is in the 2 nd
quartile of the most corrupt countries (Transparency International, 2021).5 Among 180 countries,
Indonesia was ranked 89th and 85th in 2018 and 2019, respectively. Moreover, managers of private
firms in Indonesia are part of the corruption process in Indonesia. To gain access to markets or to
beat rivals, they are often involved in bribery or make corrupt payments to government officers
(Lingga, 2018). Prior studies also show that politically connected firms use related party loans to
tunnel resources and manage earnings to conceal tunneling activities (Habib, Muhammadi, &
Jiang, 2017).
The level of human capital development in Indonesia is still between “worst” and
“moderate” performance (Lim et al., 2018). In 2016, it was ranked 131 out of 195 countries

5
With a maximum score of 100, the Corruption Perception Index (CPI) is 38 in 2008 and 40 in 2019.

5
worldwide. Based on four major dimensions for human capital: 1) life expectancy; 2) functional
health status; 3) educational attainment; and 4) learning (education quality), Indonesia was ranked
130 in 1990 and 131 in 2016 out of 195 countries worldwide (Lim et al., 2018). While the rank
has fallen by one position, all scores for the individual dimension have slightly increased over
time. These data indicate no major change in the level of human capital in Indonesia over those 26
years, increasing the need for an education system and policy framework to upgrade human
resources and improve the country’s competitiveness. This need has increased with the current
digital disruption, the fourth industrial revolution, and the 2030 target of U.N. SDGs. Indeed, at
the subnational level, human capital has become the main driver for economic growth across
regions in Indonesia (Affandi, Anugrah, & Bary, 2018). They suggest that school enrollment, high-
quality educational infrastructure, and a curriculum that enhances cognitive skills are essential for
higher economic growth.
Indonesia has experienced changes in the economic structure where the manufacturing
sector overtook the agricultural sector in the early 1990s in terms of contribution to economic
growth. The contribution of the services sector has remained consistently high (Indrawati &
Kuncoro, 2021). Consequently, Indonesia needs to advance its infrastructure and human resources.
Indrawati and Kuncoro (2021) suggest that Indonesia’s education system and policy framework
need to upgrade human resources and improve the country’s competitiveness by focusing on five
areas: access to education, quality of education, synergies between government, industry, and
higher education, industry linkages, and incentives. To be relevant to the labor market, Indonesia’s
education system and policy framework shall be applied to the secondary vocational and tertiary
(higher) education systems (Indrawati & Kuncoro, 2021).
Regarding the accountability of local government’s financial reporting, as mandated by the
Local Government Act No. 32 issued in 2003 and following the governmental reporting standards
of the country, almost 500 local governments in Indonesia have been mandatorily required to
prepare financial reports since 2004. All governmental financial reports must be audited by the
Supreme Audit Board of Indonesia (BPK), the designated auditor for financial reports of all
government offices in the country. Local governments have until the end of March of the following
year to submit their annual financial report to the BPK, which then examines the financial reports
and issues an opinion, audit findings, and recommendations on each report that requires a follow-
up by the respective local government within 60 days.

6
 The House of Representatives selects the BPK leadership, which comprises nine members
that work for five years. The selection process is designed to safeguard their independence from
the government. The BPK has representative offices in 34 provinces responsible for auditing local
governments’ financial reports. Unlike in the corporate setting, where auditors receive audit fees
from the auditee, auditors from the BPK do not charge the local governments any audit fees. Thus,
they are expected to be more independent in issuing an audit opinion compared to the audit
practices in corporate settings. Such independence enables them to express their candid opinions
on the reports. If they believe the report does not deserve an unqualified opinion, they will not be
reluctant to issue a less-than-clean audit opinion.
The BPK is also protected by law. In cases such as when auditees express dissatisfaction
with the BPK’s opinion, the law protects the auditor from being terminated as an auditor for the
local governments and allows them to present objective views and issue audit opinions
independently. Correspondingly, we consider that the types of audit opinions on local
government’s financial reports are less noisy and a valid measure of the quality of financial reports
in the context of Indonesia’s governmental institutions. Law No. 15, issued in 2004, indicates that
the BPK states the audit opinions on financial reports based on four aspects: 1) the effectiveness
of internal control; 2) compliance with the accounting standards; 3) compliance with regulations
and laws; and 4) disclosures adequacy.
Indonesia’s central government strongly requires high-quality financial reporting among
governmental institutions, including the local governments. Since 2010, financial incentives have
been provided to push for improving the quality of financial reporting in the governmental sector.
The timeliness of submission and the cleanliness of the audit opinions on financial reports are
included as the incentives' criteria. Their importance has increased because of the enactment of
Local Government Law No. 23 of 2014, which gives greater autonomy to local governments to
govern their regions. With this decentralized to local government, the annual reports are considered
an important document to support and develop mechanisms to report the local government’s
accountability to the central government and society in the regions. From the perspective of
accountability in financial reporting, the need for accountable institutions is greater because
Indonesia is a large, newly democratic, and decentralized country. Indonesia has a low level of
law enforcement (Enomoto et al., 2015). This lower level of legal enforcement potentially opens
opportunities for government officials to engage in financial disclosure management.

7
3. Theoretical Background, Literature Review, and Hypotheses Development
3.1 Theoretical Background and Literature Review
The human capital theory suggests that education increases an individual’s earnings and
productivity; thus, education is considered an investment (Becker, 1962). It is developed based on
rational choice theory, which states that individuals maximize their interests/utility by making
optimal decisions. Investment in education is crucial for individuals and the economic growth of
a region or country (Lim et al., 2018).6 Further, theoretical and empirical studies in the literature
on urban economics suggest that a city’s aggregate human capital affects productivity and the
economic growth of cities (Beck et al., 2018; Cinnirella & Streb, 2017). The influence of aggregate
human capital on productivity and economic growth is applied in the context of U.S. cities (Florida
et al., 2016; Turner, Tamura, & Mulholland, 2013), Latin American (Hanushek & Woessmann,
2012), U.K. cities (Simon & Nardinelli, 1996), South Korea (Lee, 2005), India (Vijaya & Balu,
2023), Africa (Ogundari & Awokuse, 2018), China (Li & Wang, 2018), Taiwan (Chang, Wang, &
Liu, 2016), and developing countries (Hanushek, 2013).7
The higher the average level of human capital is, the higher the likelihood of having
meetings to exchange ideas and, therefore, contribute to more rapid diffusion and growth of
knowledge (Santos & Halkias, 2021). They suggest that if knowledge development contributes to
innovations of new products, processes, or markets, then human capital affects not only
productivity factors but also makes external factors and aspects rely on both the individuals and
the average level of human capital. In addition, human capital in cities and suburbs plays a
fundamental role in regional economic development. Highly talented, skilled, ambitious, and
entrepreneurial people become engines for economic growth, generate knowledge spillovers
(Chang et al., 2016) and attract businesses and firms to locate near well-developed regions (Florida
et al., 2016; Lucas, 1988).
Analogous to the above theoretical and empirical literature, prior studies in the context of
corporate financial reporting have documented that the top-level executive is associated with

6
Human capital is considered an important determinant of economic growth (Lim et al., 2018). It reflects the level of
health and education in a population.
7
Geographic variations in human capital affect service firm formation rates (Acs & Armington, 2004). Hanushek
(2013) suggests that the quality of education is a fundamental factor to close the gaps with developed countries and
improve long-run economic performance.

8
financial reporting quality (Demerjian et al., 2013; Du et al., 2017). This empirical evidence is
explained by the upper echelons theory, which states that a manager’s education is likely to affect
managerial styles (Plöckinger et al., 2016). Firms with board chairpersons with stronger
qualifications (education and training, certification, experience, and integrity) lead to better
internal control (Lu & Cao, 2018) and, thus, a better quality of financial reporting. Indeed, firms
with higher managerial ability can maintain and control the underlying financial information of
the company (Abernathy, Kubick, & Masli, 2018), as well as make better judgments and estimates
in preparing financial reports (Demerjian et al., 2013).
Beyond the evidence from the top-level executive perspective, Call et al. (2017) argue that
the entire staff of firms participates in both the preparation of accounting information and the
provision of raw internal data used in the executives’ reporting. A firm’s employees do not have
to be knowledgeable about accounting standards to improve reporting outcomes. The information
they provide is relevant enough to the final reporting decision made by the higher-level
management (Call et al., 2017). Based on these arguments, the association between an average
employee’s (human capital) quality and the quality of corporate financial reporting can be
expected. A highly educated employee can improve financial reporting quality for the following
reasons (Call et al., 2017; Liu et al., 2017).8 First, employees can make fewer unintentional errors
when recording transactions in the accounting system or generating data processed into financial
information, leading to higher-quality information. Second, a higher-educated employee is more
likely to recognize possible fraudulent and abnormal transactions, informing the top management
about these before the final reporting. Lastly, a higher-educated employee exerting internal control
plays an essential role in designing and implementing internal control, resulting in high internal
control and financial reporting quality.
Prior studies suggest that the credibility of management disclosures is enhanced by auditors
(Hofmann & McSwain, 2013; Rich et al., 2021). The credibility is measured by the cleanliness of
the audit opinion, which means the financial report receives an unqualified opinion (Rakhman &
Wijayana, 2019). Furthermore, prior empirical studies also suggest that the education level of a
signing auditor is negatively associated with the likelihood of misstatements in financial reports

8
Employee quality is measured by the average workforce education level. Higher quality of financial reporting is
indicated by higher accrual quality, fewer internal control violations, and fewer restatements (Call et al., 2017). They
also find that higher employee quality produces better management forecasts regarding frequency, accuracy,
timeliness, bias, and precision.

9
(Du et al., 2018). They indicate that highly educated auditors tend to have higher ethics and
independence and, thus, mitigate financial misstatements. Beck et al. (2018) present another
example of auditors’ effectiveness in increasing the credibility of financial reporting through
human capital. They show that, through the increased ability to conduct high-quality audits, audit
firms in cities with higher human capital are more likely to have better audit quality.
While the above theoretical and literature discussion is presented from the supply side (the
preparers of financial statements), the demand side (the users of financial statements) has also
suggested that stakeholders demand higher reporting quality as a means of uncovering financial
misconduct or misreporting to discourage whistleblowing (Bowen, Call, & Rajgopal, 2010; Hope,
Thomas, & Vyas, 2017). The demand for financial statements is influenced by the characteristics
of the owners, such as education and experience (Call et al., 2017; Dauth, Pronobis, & Schmid,
2017).
The demand for higher reporting quality as a monitoring mechanism is also influenced by
equity investors, lenders, and suppliers (Hope et al., 2017). In addition, Ball and Shivakumar
(2008) suggest that the report of an initial public offering firm is more conservative because the
users of financial statements demand higher quality reporting and consequentially demand higher
monitoring by boards, rating agencies, analysts, litigants, and the press. Firms with board
chairpersons with stronger qualifications also demand higher reporting quality through the
reduction of internal control weaknesses (Lu & Cao, 2018).
The underlying arguments for the demand for financial information relay the opportunistic
behavior hypothesis versus the demand hypothesis (Hope, Thomas, & Vyas, 2013; Hope et al.,
2017). The “demand” hypothesis in the corporate setting holds that stronger demand by creditors
and shareholders for public-listed firms than that for private firms, leading to higher earnings
quality of public-listed firms than earnings quality of private firms. 9 Managers are more likely to
engage in financial misconduct in a region with weak external monitoring (Bowen et al., 2010).
From a cross-countries study perspective, managers tend to engage in earnings management10
when the level of investor protection or legal enforcement is low (e.g., Leuz, Nanda, & Wysocki,

9
In contrast, the opportunistic (behavior) hypothesis states that managers of public-listed firms have a greater incentive
to manage earnings than private firms, resulting to lower earnings quality of public-listed firms than earnings quality
of private firms (Hope et al., 2013, 2017).
10
This higher earnings management is related to lower quality of financial reporting (Dechow, Ge, & Schrand, 2010).

10
2003; Wijayana & Gray, 2019). This investor protection or legal enforcement, as a formal
institutional (external) factor, affects the accountability of institutions or entities.
The demand for higher reporting quality as a monitoring mechanism is expected to be higher
in the local government. In the public sector, mayors as local government managers tend to have
more information about program service expenses and the financial conditions than outsiders,
which leads to higher information asymmetry. It creates an opportunity for (financial) disclosure
management and a demand for a higher quality of financial reporting (Hofmann & McSwain, 2013;
Rich et al., 2021). The link between the beneficiaries of the government’s goods and services and
funding sources (tax revenues) cannot be recognized clearly (Hofmann & McSwain, 2013; Rich
et al., 2021). For example, the central government supplies funding to the local government for
providing free goods and services, but then the local government sometimes requires payments
from, or does not act in the interest of, society. This asymmetry creates opportunities to engage in
financial disclosure management and to mislead concerning financial conditions (Hofmann &
McSwain, 2013; Mogues & Olofinbiyi, 2020). This opportunistic behavior might be manifested in
the form of budgeting by overestimating expense and/or revenue (Anessi-Pessina & Sicilia, 2015)
and deciding debt levels in times of slow economic growth (e.g., Chen et al., 2016) or during
electoral cycles (Bastida, Beyaert, & Benito, 2013). As a consequence, stakeholders of local
government demand a better quality of financial reporting as a monitoring mechanism.
Overall, this literature suggests a strong positive association between human capital and the
quality of financial information. The supporting arguments can be derived from the literature on
either supply or demand for high-quality financial reporting.

3.2. Hypotheses Development

3.2.1 Human Development and the Quality of Financial Reporting
As previously stated, from the supply side, it is expected that local governments with higher human
capital development are more likely to deliver higher reporting quality. In line with corporate
literature which suggests higher financial reporting quality is related to higher employee quality
for both the top-level executives (Demerjian et al., 2013; Du et al., 2017) and average employees
(Call et al., 2017; Liu et al., 2017), it is believed that both higher-educated mayors and average
local government officers tend to be associated with a higher quality of local government reporting.
Many employees at lower levels in different departments are involved in producing financial

11
reports. Afterward, it is consolidated by the treasurer and signed by the mayor of a local
government. These employees, especially those with higher quality, in internal control (e.g., Liu
et al., 2017) and each department (e.g., Call et al., 2017), produce fewer unintentional errors and
more accurate information, leading to higher reporting quality. They tend to have more ability to
detect errors and make the necessary corrections before submitting the reports. These factors lower
the probability of the errors showing up as audit findings by the auditors.
Prior studies in the corporate setting have documented the demand for higher financial
reporting and stronger external parties. They include equity investors, lenders (banks), and
suppliers (Hope et al., 2017); stakeholders monitoring (Bowen et al., 2010); regulators (Hairston
& Brooks, 2019); investor protection (Chen et al., 2018; Wijayana & Gray, 2019); boards, rating
agencies, analysts, litigants, and the press/media (Ball & Shivakumar, 2008) and the education and
experience profiles (Call et al., 2017; Dauth et al., 2017).
We expect a similar association in the governmental public sector setting. The demand for
information may come directly from the citizens/society or indirectly through the role of
academicians and media in the local government’s context. Information asymmetry in the public
sector is likely to be greater than in the corporate setting because the link between sources of
funding (tax revenues) and the beneficiaries of the government’s goods and services are not direct
(Hofmann & McSwain, 2013; Mogues & Olofinbiyi, 2020). The agency problem exists between
the board of trustees and nonprofit management, as the board of trustees’ goal is service
maximization, while the management’s goal is budget maximization (Ardanaz, Otálvaro-Ramírez,
& Scartascini, 2023; Mitchell, Hughes, & Campbell, 2013).11 As part of the governance
mechanism, the board of trustees uses accounting information to monitor the stewardship of
management. Creditors and other resource providers incorporate accounting information in
making implicit and explicit contracts with management. The potential for nonprofits to abuse
their tax-exempt status or to channel donated funds for the benefit of insiders makes the
government’s auditors and regulatory agencies demand accounting information from nonprofit
organizations (Desai & Yetman, 2015).
Local governments with higher human development tend to have more or better education
institutions whose academicians have a greater ability to digest financial reporting information

11
Management may wish to disclose information that they have been successful in providing services, but they have
incentives to manage financial disclosures in such a way as to encourage more funding from the central government.

12
and, thus, are more likely to demand better financial reporting (e.g., Gebreiter & Nunung, 2019).
A highly educated society is negatively associated with the level of political corruption of the states
in the United States (Brown et al., 2021; Glaeser & Saks, 2006). In addition, academic institutions
play roles through political accountability for implementation, better governance, policy research,
knowledge sharing, and joint learning in speeding up the SDGs' progress (Ihlebaek, Ese, &
Zambon, 2019). The media and local government parliament are also other sources of demands
for better financial reporting. Local governments with higher human development are more likely
to have stronger roles of the media and local government parliament, which represent the interest
of the citizens and society in demanding accountability (e.g., Dhanani & Connolly, 2015).
Human development, both at an individual level (Magnac, Pistolesi, & Roux, 2018) and
aggregate level (Beck et al., 2018), contributes significantly to productivity, economic growth in
cities, and more rapid diffusion and growth of knowledge. In line with this idea, better human
capital as measured by HDI is expected to lead to stronger external parties of local government
and, thus, demand better accountability and quality of the financial reporting of local government.
Since citizens of local governments with a higher level of human development are expected to be
more active in decision-making and have a greater ability to monitor the affairs of the local
government, including its financial reporting, they tend to demand higher reporting quality.
Existing studies in corporate settings imply that human capital improves financial reporting
quality through both the supply and demand sides. We expect to observe the same positive
association between human capital development and the quality of financial reporting in local
governments in Indonesia. The hypothesis is stated as follows.
H1: The level of human development in a local government region is positively associated with
financial reporting quality.

Given that prior literature has employed different measures of human capital, our study
further explores how each dimension of United Nation Development Program (UNDP) human
capital is associated with the quality of financial reporting in Indonesia’s public sector (e.g., Lim
et al., 2018; UNDP, 2020).

13
3.2.2 Life Expectancy and the Quality of Financial Reporting
Only a limited number of studies have examined the association between the quality of financial
reporting and life expectancy. Consequently, we develop a hypothesis analogously on the
influence of life expectancy and the quality of financial reporting based on other streams of
literature. Indeed, cross-countries literature on the quality of financial reporting has documented
that societies with a long-term orientation are likely to avoid uncertainty and be more conservative,
leading to a better quality of financial reporting (Chen et al., 2018; Wijayana & Gray, 2018;
Wijayana & Gray, 2019). Theoretical and empirical studies suggest that cultural values influence
accounting measurement and thus affect earnings management practices and the quality of
financial reporting (Gray, 1988; Han et al., 2010). Managers in a society characterized by long-
term orientation are less likely to engage in earnings management practices in corporate settings
or disclosure management practices in the public sector (Hofmann & McSwain, 2013; Wijayana
& Gray, 2019).12
In the public sector, the agency problem arises when the supervisory board encourages
local government managers to maximize services, but the manager focuses on maximizing the
budget (Ardanaz et al., 2023; Mitchell et al., 2013; Mogues & Olofinbiyi, 2020). Managers of local
governments tend to disclose information about how they have been successful in providing
services, but they also have incentives to manage financial disclosures in such a way as to
encourage more funding from the central government. Higher financial disclosure management
has been used to show performance opportunistically, leading to lower-quality financial reports
issued by public sector entities. To prevent this, the supervisory board uses accounting information
to monitor the stewardship of the management of local governments. Contracts between resource
providers or creditors and management of local government require accounting information.
Government auditors and regulatory agencies demand accounting information to remove the
potential misuse of government funds for the benefit of the management of local government
(Desai & Yetman, 2015).
It is important to consider the socio-economic in health care and in planning public health
interventions (Zhang, Zhang, & Su, 2022). Specifically, life expectancy is positively correlated

12
For not-for-profit entities, prior studies employ the term “financial disclosure management” or “disclosure
management” rather than “earnings management” because they do not focus on earnings or profit. This is done to
describe the opportunistic behavior of managers in reporting financial performance to affect stakeholders’ perceptions
(Hofmann & McSwain, 2013).

14
with public health interventions. Life expectancy is affected by the central government funding,
markets, and contracting motivations (e.g., Bhattacharya & Tinkelman, 2009; Keating, Parsons, &
Roberts, 2008) and political costs, regulatory, and tax motivations (Eldenburg et al., 2011;
Krishnan & Yetman, 2011). In addition, life expectancy significantly improves education (Alam
et al., 2021; Restuccia & Vandenbroucke, 2013). Given that higher education is associated with
better quality of financial reporting, a higher long-term orientation consecutively contributes to
longer life expectancy and better education and consequently leads to a better quality of reporting.
Assuming that a society with long-term orientation tends to have longer life expectancy
because, for example, they care more about health, food, education, and medication, we expect the
mayor and average local government officer is likely to produce a higher quality of financial
reporting. While long-term orientation in health is reflected in life expectancy, long-term
orientation in disclosure management is reflected in a higher quality of the financial report.
Correspondingly, we state the following hypothesis:
H2a: The life expectancy in a local government region is positively associated with financial
reporting quality.

3.2.3 Education and the Quality of Financial Reporting

Since one dimension of human development is the citizens' education level (i.e., mean years of
schooling), local governments with better education systems are expected to have higher employee
quality. Schooling is expected to result in better quality financial reporting by the local government
for the following reasons. An individual and average local government employee’s higher profile
in terms of schooling and experience is expected to result in school quality that comes with
improved economic conditions. A better quality of education leads to productivity at both
individual and aggregate levels. In addition, with a better schooling profile, better internal control
and mechanism are created because more educated employees can better digest financial reporting
information and uncover financial misconduct or misreporting. Furthermore, top-level local
government officials with a better schooling background make better judgments and estimates in
preparing the financial report. These supply-side arguments are derived and consistent with those
from the perspective of the corporate setting.
In the Indonesian governmental public sector, Rakhman and Wijayana (2019) suggest that
sources of demand for the quality financial reports of local governments include the central

15
government, banks, and the Indonesian Ministry of Finance. The central government ensures that
local governments use the allocated funds as intended and report them in compliance with the
existing standards and rules. As alternative sources of financing, the local governments are
permitted to take loans from local banks or foreign loans with the supervision of the Ministry of
Finance. The existence of the debt in most local governments in Indonesia creates a demand for
higher financial quality reporting by the banks and the Ministry of Finance. As previously
mentioned, the schooling of other stakeholders, such as academicians, media, society, regulators,
and taxpayers, is also expected to be positively associated with the quality of financial reporting.
Local governments with higher human development are less likely to have lower-quality education
systems. This schooling system supplies the local governments with a high-quality workforce on
the one side and strengthens the demand for higher-quality reporting through the involvement of
the academicians, society, and media on the other side. Similarly, we also expect that strong
schooling of the external parties produces better financial reporting quality.
Prior studies have found a positive impact of schooling (quality) on productivity and
economic growth (Hanushek, 2013; Hanushek & Woessmann, 2012; Ogundari & Awokuse, 2018).
Schooling has been largely employed as a measure of human capital in the literature (e.g., Kroch
& Sjoblom, 1994; Magnac et al., 2018). Nonetheless, some studies argue that schooling may not
transform automatically into better human capital as it depends on the quality of educational
institutions (Ahsan & Haque, 2017). They also argue that schooling cannot be linked to
productivity because of the country’s deficiency in terms of its economy. Similarly, Hanushek
(2013) suggests that expanding schooling without attention to its quality will not improve
economic conditions. Interest in local governance accountability is likely to increase in periods of
economic slowdown (Chen et al., 2016) or elections (Bastida et al., 2013). In particular, the
institutional efficiency and quality of educational institutions tend to increase in line with the level
of economic development (Ahsan & Haque, 2017). The positive effect of schooling can only be
gained after a country’s level of development reaches above the economic threshold.
As discussed previously, Indonesia has experienced economic growth due to a shift in the
economic structure from the agricultural sector to the manufacturing sector in the early 1990s and
the major contribution of the services sector (Indrawati & Kuncoro, 2021). Consequently,
schooling quality in Indonesia is expected to improve in line with economic conditions. Schooling
quality in Indonesia is also expected to improve in line with its commitment to support the 2030

16
U.N. agenda for SDGs and as a member of G20 countries. These improvements are likely to vary
across local governments. From the demand perspective, the role of academicians and researchers
in pushing for public accountability and better governance of the local government through policy
research, knowledge sharing, and joint learning is also expected to increase (Ihlebaek et al., 2019).
Correspondingly, local governments with better education institutions are more likely to demand
better financial reporting (e.g., Gebreiter & Nunung, 2019). Similarly, local governments with a
better quality of schooling are more likely to have stronger roles played by the media to represent
the interests of the citizens and society, including interest in local governance accountability (e.g.,
Dhanani & Connolly, 2015). Correspondingly, the hypothesis is presented as follows.
H2b: The level of education in a local government region is positively associated with financial
reporting quality.

3.2.4 Standard of Living and the Quality of Financial Reporting

Prior studies suggest that human capital affects productivity and economic growth in cities (Beck
et al., 2018). Better human capital will likely be better at maintaining systems and controlling and
preparing financial reports (Abernathy et al., 2018; Demerjian et al., 2013; Lu & Cao, 2018).
Nonetheless, it is unclear how the standard of living is associated with economic growth or
productivity, such as firm performance and quality of the financial report. The standard of living
is a complex phenomenon because it goes beyond existing multidimensional poverty indicators. It
must comprehensively address living conditions and the means of social participation (Rao & Min,
2018). The standard of living refers to wealth, the comfort of everyday life, material goods and
services, and necessities available to a certain geographic area or socioeconomic class and is
measured by gross national income per capita (UNDP, 2020).
Prior studies suggest that managers or mayors in a society with a better standard of living
are less motivated to engage in earnings management because they have a better living wage and
level of wealth, and they live comfortably and have enough in terms of their need for goods and
services (Yao et al., 2017). People who already have a decent job and sufficient standard of living
are more likely to show good performance and achievement at work rather than pursue bonuses or
other opportunistic benefits (Gibb & Ishaq, 2020). As suggested by the theory and literature
regarding urban economics, cities with greater human capital are associated with various positive
economic outcomes, including the work quality of the employees and high quality of financial

17
reporting outcomes (Beck et al., 2018). These positive outcomes can be at an individual level
(Magnac et al., 2018) and an aggregate level (Beck et al., 2018).
In addition to the perspective of the supply side, we argue from a demand perspective that
a society with a better standard of living is likely to have better access to education and a local
government’s financial information about its performance. They are more aware of the
environment and society as they are used to having a comfortable life and enough in terms of their
need for goods and services. With higher living wages and a better level of wealth, they pay more
tax and, thus, expect to receive more benefits and services and greater accountability from the local
government. Given the above arguments on how standards of living are associated with the quality
of financial reporting, we state the following hypothesis:
H2c: The standard of living in a local government region is positively associated with financial
reporting quality.

4. Research Methodology
4.1. Data and Sample
For our sample, we used more than 500 local/regency governments in Indonesia from 2010–2018.
Because of the release of the UNDP’s new method of measuring the HDI in 2010, our study’s
sample begins with that year. Financial reporting data were manually collected from the financial
reports issued by local governments, which the Indonesian Supreme Audit Board had audited. Data
on the characteristics of mayors were collected from various sources. The HDI and its dimensions
were gathered from the Indonesian Central Bureau of Statistics, which releases HDI scores
annually. Since the Indonesian Central Bureau of Statistics used a different method in calculating
the HDI and its dimensions before 2010, observations from before 2010 are not included in the
sample because of data incompatibility. After eliminating observations with incomplete
information, we obtained a total of 4,254 local government years as our sample.

4.2. Model and Measurements

We investigated whether there is an association between human development in a local
government and the quality of a local government’s financial reports. The logistic regression
models were employed to test separately for aggregated human capital (HDI) and the individual

18
dimensions of human capital (LEX, MYS, and EXPD). The following regression model was used
to test the hypotheses.

𝐹𝑅𝑄𝑗,𝑡 = 𝜇0 + 𝜇1 𝐻𝐷𝐼𝑗,𝑡 + 𝜇2 𝑆𝐼𝑍𝐸𝑗,𝑡 + 𝜇3 𝐿𝑂𝐶𝑅𝐸𝑉𝑗,𝑡 + 𝜇4 𝐶𝐼𝑇𝑌𝑗 + 𝜇5 𝐽𝐴𝑉𝐴𝑗 + 𝜇6 𝐸𝑋𝑃𝑅𝑗,𝑡 +

𝜇7 𝐴𝐺𝐸𝑗,𝑡 + 𝜇8 𝑅𝐸𝐴𝐿𝑗,𝑡 + 𝜇9 𝐺𝑁𝐷𝑅𝑗,𝑡 + 𝑦𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡 + 𝑒𝑗,𝑡 (1)

where,
FRQj,t = the financial reporting quality of local government j for period t.
HDIj,t = the HDI of local government j for period t.13 To test H2a, H2b, and H2c, we replace
the HDI variable with the following individual dimension of HDI and regress each
separately.
LEXj,t = the life expectancy at birth in local government j for period t.
MYSj,t = the mean years of schooling in local government j for period t.
EXPDj,t = the per capita expenditure in local government j for period t.
SIZEj,t = the natural log of the total assets of local government j for period t.
LOCREVj,t = the local revenues divided by the total revenues of local government j for
period t.
CITYj = a dummy variable, 1 if local government j is a city, and 0 otherwise. 14
JAVAj = a dummy variable, 1 if local government j is located in Java Island, and 0
otherwise.
EXPRj,t = the number of years the mayor had stayed as mayor of local government j for
period t.
AGEj,t = the age of the mayor of local government j for period t.
REALj,t = the budget realization ratio (the actual spending divided by the total budget) of
local government j for period t, measuring managerial ability.
GNDRj,t = a dummy variable, 1 if the mayor of local government j for period t is a male,
and 0 otherwise.

13According to the UNDP, the HDI is calculated as follows: HDI = (LEI × EI × II)1/3 where LEI = life expectancy
index, EI = education index, and II = income index. The EI is the average value of the mean years of schooling (MYS)
index and the expected years of schooling (EYS) index.
14A local government in each province in Indonesia is either a city or a regency. A city is generally more developed,
more highly populated, and has more educated citizens than a regency.

19
 ej,t = error term.

We used the types of audit opinion (Rakhman & Wijayana, 2019) to measure variable FRQ. The
cleanliness of the audit opinion is a dummy variable set to 1 if the financial report receives an
unqualified opinion, and 0 otherwise. We used the HDI, which employed a methodology used by
the UNDP. It was calculated as follows: HDI = (LEI × EI × II)1/3; where LEI = life expectancy
index, EI = education index, and II = income index. The EI is the average value of the mean years
of schooling (MYS) index and the expected years of schooling (EYS) index (UNDP, 2020).
Following Rakhman and Wijayana (2019), the size of the local government (SIZE), the wealth of
the local government (LOCREV), whether the status of the local government is as a municipality
or a regency (CITY), and whether the location of the government is on Java island (JAVA)—which
is where the capital city (i.e., Jakarta) is located—is controlled for in this study. Citizens living in
cities and larger communities are more likely to participate in local governments’ affairs (Rakhman
& Wijayana, 2019). Our analysis also controls for age (Huang, Rose-Green, & Lee, 2012; Xu,
Fernando, & Tam, 2018) and budget realization as a proxy for managerial ability (Demerjian et
al., 2013). The definition and measurement of variables are presented in Table 1 below.

Insert Table 1 about Here

5. Results and Discussions

5.1. Descriptive Statistics
Table 2 presents the descriptive statistics of our sample. The results show that 45% of the financial
reports obtain an unqualified opinion. The mean (median) value of the HDI is 66.65 (66.46), with
a minimum value of 23.07 and a maximum value of 86.11. The variable life expectancy (LEX) has
a mean (median) value of 68.70 (69.02), with a minimum value of 53.42 and a maximum value of
77.54. The mean years of schooling variable (MYS) have a mean (median) value of 7.67 (7.53).
The highest and the lowest mean years of schooling are 12.6 and 0.49, respectively. The variable
per capita expenditure (EXPD), as presented in thousands of rupiah (IDR), has an average of
9,358.55 (mean) and 9,179.33 (median). The maximum value of EXPD (IDR 19,698.00) is more
than five times bigger than the minimum value (IDR 3,405.67). The size of the local governments’

20
total assets varies from a minimum of IDR 71.42 billion to a maximum of IDR 42.76 trillion.15 In
general, the local governments in Indonesia are very dependent financially on the central
government. On average, the local revenues constitute only 9% (mean) or 7% (median) of the total
revenues of local governments. The rest of the revenues are transferred mainly from the central
government. The average age of the mayors is 52.93 years, and they have held the position, on
average, for 4.76 years.

Insert Table 2 about Here

5.2. Correlation Analyses

Table 3 presents the correlations among the variables used in this study. Results show that
the cleanliness of the financial report (CLEAN) is correlated positively with the HDI (r= 0.337),
MYS (r=0.250), LEX (r= 0.208), and EXPD (r= 0.303). The variables HDI and its dimensions are
highly correlated to MYS (r = 0.881), LEX (r = 0.677), and EXPD (r = 0.861). As expected, HDI
is highly correlated with SIZE (r = 0.393), LOCREV (r = 0.574), and CITY (r = 0.578), indicating
that larger-sized and wealthier local governments and those with the status of a municipality (as
opposed to a regency) tend to have a higher HDI. Strong correlations are also found between the
variable LOCREV and variables SIZE (r = 0.577), CITY (r = 0.391), and JAVA (r = 0.437). This
indicates that larger-sized local governments, those with municipal status, and those on Java Island
tend to be wealthier or less dependent on transfer from the central government. Table 3 shows that
none of the coefficients are higher than 0.70, thus unlikely to cause any potential collinearity
problems or influence our results.

Insert Table 3 about Here

5.3. Regression Analyses

Our first hypothesis investigates whether a local government's level of human development is
positively associated with financial reporting quality. Table 4 presents the results of the regression

15 The exchange rate was around IDR 14,500 per US$1, as of December 2021.

21
analyses. The proxy for the FRQ is the variable CLEAN, which is the dummy variable set to 1 if
the financial report receives an unqualified opinion and 0 otherwise. Using the logistic regression
model, we find that a higher HDI is associated with a higher probability of receiving an unqualified
opinion on the financial reports (t = 9.32). This result is in line with corporate literature, which
suggests that higher financial reporting quality is related to higher employee quality for both top-
level executives (Demerjian et al., 2013; Du et al., 2017) and average employees (Call et al., 2017;
Liu et al., 2017). This result is also consistent with Beck et al. (2018) who suggest that human
capital should improve the work quality of the employees.

Insert Table 4 about Here

Given that our study’s measure of human capital does not specifically address the level of
human development of top-level executives (mayors as governmental managers), we interpret the
results to indicate that a mean level of human development of a local government’s average
employee affects the quality of financial reporting. Our results imply that the higher level of human
development of local government officers is associated with a higher quality of local government
reporting. The production of a financial report involves the role of employees in a local
government, especially in internal control positions (e.g., Liu et al., 2017) and in each department
(e.g., Call et al., 2017). Their higher level of human development produces fewer unintentional
errors and more accurate information; thus, there is a lower probability of the errors showing up
as audit findings.
Similarly, from the demand perspective, it is implied that a higher HDI reflects a higher
life expectancy, education, and standard of living of the society/citizens and, thus, the quality of
financial reporting. The results imply that the society/citizens of local governments with a higher
level of human development are expected to be more active in decision-making and have a greater
ability to monitor the local government’s financial reporting through media or local government
parliament. Prior studies have suggested that this monitoring mechanism may be used both at an
individual level (Magnac et al., 2018) and at an aggregate level (Beck et al., 2018). It suggests that
the higher the human development, as indicated by the HDI, the more it contributes to productivity,
cities’ economic growth, and more rapid diffusion and growth of knowledge. They demand better

22
accountability and quality of financial reporting since they actively participate in the decision-
making and have a greater ability to monitor local government affairs.
Regarding the control variables, the size of a local government (SIZE), its local revenues
(LOCREV), the experience of mayors (EXPR), and their managerial ability (REAL) improve FRQ.
They are significant and mostly consistent with the expected signs.

Table 5 shows the results of the regression analyses on the effect of the dimensions of the
HDI (i.e., life expectancy, mean years of schooling, and per capita expenditure) on financial
reporting quality. The results show that all the dimensions of HDI affect the financial reporting
quality of local governments. The variables LEX (t= 5.86), MYS (t= 8.13), and EXPD (t= 9.51) are
positively associated with financial reporting quality. All variables are significant at less than 1
percent level.

Insert Table 5 about Here

As for the argument that a society with a long-term orientation tends to have a longer life
expectancy (because people care more about health, food, education, and medication), we can
provide empirical evidence that mayors and local government officers produce a higher quality of
financial reporting. These results are analogously similar to cross-countries literature which has
documented that societies with a long-term orientation are likely to avoid uncertainty, be more
conservative, and thus, will have a better quality of financial reporting (Chen et al., 2018; Wijayana
& Gray, 2018; Wijayana & Gray, 2019). As reflected in life expectancy, long-term orientation is
associated with a higher quality of financial reports as a means of long-term orientation in
disclosure management.
For the dimension of education (MYS), our results support the arguments that higher-profile
schooling and educational experience lead to better productivity, internal control mechanism, and
better judgments and estimates in preparing the financial report. It supports the idea that better
education leads to a greater ability to digest financial reporting information and uncover financial
misconduct or misreporting. In Indonesia, commitment to support the 2030 U.N. agenda for SDGs
and economic growth (Indrawati & Kuncoro, 2021) drives improved schooling quality and
education institutions. Although at the country level, the level of human capital development in
Indonesia is still between the “worst” and a “moderate” performance (Lim et al., 2018), evidence
23
of variation in average years of education across local governments explains the quality of financial
reporting is found in this study. We interpret these results as evidence of the increased role of
education in pushing public accountability and demanding better financial reporting of the local
government. This is in line with prior studies which suggest public accountability and governance
are improved through policy research, knowledge sharing, joint learning (Ihlebaek et al., 2019),
and demand for better financial reporting (e.g., Gebreiter & Nunung, 2019). In addition, our study
supports the idea that a better quality of schooling results from stronger roles of the media to
represent the interests of the citizens and society, including interest in local governance
accountability (e.g., Dhanani & Connolly, 2015).
For the standard of living variable, our study’s results support the argument that mayors in
a society with a better standard of living engage less in earnings management as they preside over
a better living wage, level of wealth, live comfortably, and have enough goods and services (Yao
et al., 2017). The results also imply that a society with decent jobs and a sufficient standard of
living focuses more on performance and achievement at work rather than pursuing bonuses or
other opportunistic benefits (Gibb & Ishaq, 2020). Our empirical results suggest that a society with
a better standard of living has better access to education. Consequently, its citizens have more
knowledge to be aware of, and review critically, the local government’s financial information and
performance and the environment and society around them. Their awareness increases with better
levels of wages and wealth as they pay more tax, and thus, they expect to receive more benefits
and services and greater accountability from the local government.

5.4. Additional Tests

In the previous section, we used the type of audit opinions on local governments' financial reports
as a broad measure of financial reporting quality. In this section, we follow the literature and use
accruals quality to measure financial reporting quality, as it is commonly used in corporations to
detect earnings management and recently has been used in local government settings (e.g., Arcas
& Martí, 2016; Cohen et al., 2019; Ferreira et al., 2013). We use the sample from 2015 to 2018 as
local governments in Indonesia started preparing the accrual-based statement of operation only in
2015, resulting in 1,471 observations (local government years). Our study uses the term “accruals
management” to capture income-increasing accruals in local government’s financial reporting.

24
 Following Hribar and Collins (2002), we calculate total accruals (TACC) as the difference
between earnings before extraordinary items (EXBI) and cash flows from operations (CFO):

TACCi,t = EXBIi,t - CFOi,t (2)

where TACCi,t = the total accruals of local government i at year t, EXBIi,t = the earnings before
extraordinary items of local government i at year t, and CFOi,t = the cash flows from operations of
local government i at year t. We use the pooled ordinary least square (OLS) regression that was
used in the Jones (1991) model to estimate the discretionary accruals as follows:

TACCi,t/TAi,t-1 = α0 (1/TA i,t-1) + α1(ΔREVi,t / TA i,t-1) + α2(PPEi,t/TAi,t-1) + ε i,t (3)

where ΔREVi,t= changes in total revenues of local government i at year t, and PPEi,t = property,
plant, and equipment of local government i at year t and TAi,t-1 = total assets of local government i
at year t-1. The nondiscretionary components of accruals are calculated using the following
equation:

NDAi,t = α0 (1/TA i,t-1) + α1(ΔREVi,t / TA i,t-1) + α2(PPEi,t/TAi,t-1) (4)

The discretionary component of accruals (accruals management) is captured in the error term of
model (3) and is calculated as follows:

DAi,t = (TACCi,t/TAi,t-1) - NDAi,t (5)

We use the following equation to investigate the effect of the human development index and its
components on the accruals management of local government financial statements.

DAi,t = β0 + β1HDIi,t + β2SIZEi,t + β3ROAi,t + β4GROWTHi,t + β5LOSSi,t + β6LEVi,t

+ β7POPi,t + +εi,t (6)

25
where ROAi,t = income before extraordinary items of local government i at year t divided by total
asset at year t-1, GROWTHi,t = revenue growth of local government i at year t, LOSS = a dummy
variable equals 1 if the income before extraordinary items is negative, and zero otherwise, LEVi,t
= total liabilities divided by total assets of local government i at year t, and POPi,t = the natural log
of the population of local government i. All other variables are previously defined. Following
Wang (2006), the model controls for size, return on assets (ROA), revenue growth, loss dummy,
and leverage. Additionally, we also control for the population size.
In Indonesia, local governments are highly dependent on the central government because,
on average, local revenues comprise only 9 percent of total revenues (see Table 2), and the rest are
transferred from higher levels of government. Therefore, concerning the Jones model used in this
study, we expect depreciation to affect accruals management more than revenue changes. Our data
shows that more than 90 percent of the sample has negative accruals or TACC (i.e., cash flows
from operation being greater than income from operations) due to the negative impact of
depreciation expenses being more significant than the positive impact of changes to balance sheet
items (i.e., increases in account receivables, increases in inventories) on accruals. Table 6 below
presents the regression results on the effect of HDI on accruals management.

Insert Table 6 about Here

The regression results show that the human development index (HDI) is associated with the
tendency to use income-increasing accruals (t=7.39) in the statement of operation among the local
governments in the sample. The results hold when we use the components of the HDI. Life
expectancy (t=4.71), mean years of schooling (t=7.51), and per capita expenditures (t=5.17) are
all associated with the use of income-increasing accruals in financial reporting. Local governments
with higher human development use their judgment to make accounting adjustments and estimates,
resulting in smaller depreciation expenses and less negative accruals. This view is consistent with
Pilcher and Van Der Zahn (2010) who found that Australian local governments report unexpected
levels of depreciation expenses to maximize capital contribution.

26
6. Conclusions and Limitations
Many recent studies have examined how human capital affects the quality of financial reporting
and auditing. However, most studies in this area have been conducted in corporate settings. Our
study investigates the association between human development and the quality of financial
reporting in the public sector. Using 4,254 manually collected data from financial reports from
over 500 local/regency governments in Indonesia, we find that FRQ is better for local governments
with a higher level of human development as measured by the HDI. Local governments with a
higher HDI score are more likely to receive a clean audit opinion from the Indonesian Supreme
Audit Board. Our study’s results imply that providing citizens with better human development can
improve reporting quality among local governments.
We further examine the human capital dimensions and provide insights into how each
dimension is associated with the quality of financial reporting. We hypothesize that local
governments with better life expectancy, education, and living standards are more likely to receive
clean audit opinions. We find that the results hold when each dimension of HDI is used as the
predictor variable. Our study confirms that all HDI dimensions, as measured by life expectancy,
education, and living standards, are significantly positively associated with the quality of financial
reporting by local governments in Indonesia. Indeed, compared with the other two dimensions,
education has been documented relatively better in terms of its association with productivity or
performance and quality of financial reporting in a corporate setting. Our results confirm that
education affects the quality of financial reporting more strongly than the other two HDI
dimensions.
Evidence from our additional analyses indicates that higher human capital leads to higher
accruals management activities which intuitively contradicts the results of our primary analyses.
Beyond the formal audit opinion, interestingly, we found indications that local governments with
higher human capital tend to engage in accruals management more than those with lower human
capital. Prior literature suggests that without strong formal and informal institutional
environments, earnings management practices tend to be high (e.g., Leuz et al., 2003; Wijayana &
Gray, 2019). Analogously, empirical evidence from these additional analyses may be explained
by institutional environments in Indonesia, which are characterized by high levels of corruption
among government officials (Lewis & Hendrawan, 2019; McLeod & Harun, 2014), low levels of
law enforcement (Enomoto et al., 2015), bribery of government officers (Lingga, 2018), and

27
compromising with controversial behavior (Zhang et al., 2013). With such a strong culture of
corruption, unfortunately, human capital can be used to opportunistically manage accruals, which
will mask the true financial performance of local governments.
Overall, the results suggest that human development and all three dimensions substantially
impact financial reporting outcomes. Investments in long-term orientation development, such as
health care and planning public health interventions, education quality, and living standards as part
of developing human capital, directly and indirectly affect the FRQ. This substantial impact of
human capital, and all its dimensions, on the quality of financial reporting indicates the need for
better human capital to result in a cleaner audit opinion on financial reports. However, with a weak
institutional environment and a culture of corruption, human capital can instead be used to conduct
accruals management, which will create opacity.
Our study contributes to the financial reporting literature by providing evidence that human
development and its dimensions increase the likelihood of obtaining a clean audit opinion on the
one hand but might hurt the quality of accounting estimates on the other hand. Policymakers such
as the Supreme Audit Board should benefit from this study by performing audit procedures beyond
compliance with accounting rules and substantively examining how employees’ judgment affects
accounting estimates, especially with the use of accrual-based accounting in the public sector
starting in 2015. Further, this study provides policymakers with insights, especially in the public
sector, that providing citizens with better access to public facilities, education, and living standards
will improve FRQ. But a more substantive improvement in FRQ should be obtained by
strengthening institutional factors and eliminating the country's corruption culture.
One limitation of our study is the inability to control for cross-border employment—where
some employees may work for a neighboring local government—as this would reduce the strength
of the relationships between human development and FRQ for that local government. This
phenomenon is more pronounced in large cities where more job opportunities are available and
advanced transportation systems are present, increasing the mobility of their employees.
Unfortunately, the data on cross-border employment are not available, and thus, this study cannot
control for such an issue. However, eliminating cities with significant cross-border employment
from the sample, if possible, should only strengthen the results of our study.

28
References
Abernathy, J. L., Kubick, T. R., & Masli, A. (2018). Evidence on the relation between managerial
ability and financial reporting timeliness. International Journal of Auditing, 22(2), 185-
196. doi: 10.1111/ijau.12112
Acs, Z. J., & Armington, C. (2004). The impact of geographic differences in human capital on
service firm formation rates. Journal of Urban Economics, 56(2), 244-278. doi:
https://doi.org/10.1016/j.jue.2004.03.008
Affandi, Y., Anugrah, D. F., & Bary, P. (2018). Human capital and economic growth across
regions: a case study in Indonesia. Eurasian economic review, 9(3), 331-347. doi:
10.1007/s40822-018-0114-4
Ahsan, H., & Haque, M. E. (2017). Threshold effects of human capital: Schooling and economic
growth. Economics Letters, 156, 48-52. doi:
https://doi.org/10.1016/j.econlet.2017.04.014
Alam, M. S., Islam, M. S., Shahzad, S. J. H., & Bilal, S. (2021). Rapid rise of life expectancy in
Bangladesh: Does financial development matter? International Journal of Finance &
Economics, 26(4), 4918-4931. doi: 10.1002/ijfe.2046
Anessi-Pessina, E., & Sicilia, M. (2015). Biased Budgeting in the Public Sector: Evidence from
Italian Local Governments. Local Government Studies, 41(6), 819-840. doi:
10.1080/03003930.2015.1012194
Arcas, M. J., & Martí, C. (2016). Financial Performance Adjustment in English Local
Governments. Australian Accounting Review, 26(2), 141-152. doi: 10.1111/auar.12094
Ardanaz, M., Otálvaro-Ramírez, S., & Scartascini, C. (2023). Does information about citizen
participation initiatives increase political trust? World Development, 162, 106132. doi:
https://doi.org/10.1016/j.worlddev.2022.106132
Ball, R., & Shivakumar, L. (2008). Earnings quality at initial public offerings. Journal of
Accounting and Economics, 45(2-3), 324-349.
Bastida, F., Beyaert, A., & Benito, B. (2013). Electoral Cycles and Local Government Debt
Management. Local Government Studies, 39(1), 107-132. doi:
10.1080/03003930.2012.683861
Bebbington, J., & Unerman, J. (2018). Achieving the united nations sustainable development
goals 31(1), 2-24. Accounting, Auditing & Accountability Journal, 31(1), 2-24.
Beck, M. J., Francis, J. R., & Gunn, J. L. (2018). Public Company Audits and City-Specific Labor
Characteristics. Contemporary Accounting Research, 35(1), 394-433. doi: 10.1111/1911-
3846.12344
Becker, G. S. (1962). Investment in Human Capital: A Theoretical Analysis. Journal of Political
Economy, 70(5), 9-49.
Bhattacharya, R., & Tinkelman, D. (2009). How tough are better business bureau/wise giving
alliance. Nonprofit and Voluntary Sector Quarterly, 38(3), 467-489. doi:
10.1177/0899764008316120
Bowen, R. M., Call, A. C., & Rajgopal, S. (2010). Whistle-Blowing: Target Firm Characteristics and
Economic Consequences. The Accounting Review, 85(4), 1239-1271.
BPS. (2020). Index Pembangunan Manusia menurut Provinsi, 2010-2018 (Metode Baru). Badan
Pusat Statistik-Indonesian Center Bureau of Statistics, Retrieved 11 January 2020, from

29
 https://www.bps.go.id/dynamictable/2016/06/16/1211/indeks-pembangunan-manusia-
menurut-provinsi-2010-2018-metode-baru-.html.
Brown, N. C., Smith, J. D., White, R. M., & Zutter, C. J. (2021). Political Corruption and Firm
Value in the U.S.: Do Rents and Monitoring Matter?: JBE. Journal of Business Ethics,
168(2), 335-351. doi: https://doi.org/10.1007/s10551-019-04181-0
Call, A. C., Campbell, J. L., Dhaliwal, D. S., & Moon, J. R. (2017). Employee quality and financial
reporting outcomes. Journal of Accounting and Economics, 64(1), 123-149. doi:
https://doi.org/10.1016/j.jacceco.2017.06.003
Call, A. C., Kedia, S., & Rajgopal, S. (2016). Rank and file employees and the discovery of
misreporting: The role of stock options. Journal of Accounting and Economics, 62(2),
277-300. doi: https://doi.org/10.1016/j.jacceco.2016.06.003
Chang, C.-F., Wang, P., & Liu, J.-T. (2016). Knowledge spillovers, human capital and productivity.
Journal of Macroeconomics, 47, 214-232. doi:
https://doi.org/10.1016/j.jmacro.2015.11.003
Chen, C., Gotti, G., Kang, T., & Wolfe, M. C. (2018). Corporate Codes of Ethics, National Culture,
and Earnings Discretion: International Evidence. Journal of Business Ethics, 151(1), 141-
163. doi: 10.1007/s10551-016-3210-y
Chen, Z., Pan, J., Wang, L., & Shen, X. (2016). Disclosure of government financial information
and the cost of local government’s debt financing—Empirical evidence from provincial
investment bonds for urban construction. China Journal of Accounting Research, 9(3),
191-206. doi: https://doi.org/10.1016/j.cjar.2016.02.001
Cheng, Y. S., Liu, Y. P., & Chien, C. Y. (2009). The association between auditor quality and human
capital. Managerial Auditing Journal, 24(6), 523-541. doi: 10.1108/02686900910966512
Cinnirella, F., & Streb, J. (2017). The role of human capital and innovation in economic
development: evidence from post-Malthusian Prussia. Journal of Economic Growth,
22(2), 193-227. doi: https://doi.org/10.1007/s10887-017-9141-3
Cohen, S., Bisogno, M., & Malkogianni, I. (2019). Earnings management in local governments:
the role of political factors. Journal of Applied Accounting Research, 20(3), 331-348. doi:
10.1108/JAAR-10-2018-0162
Dauth, T., Pronobis, P., & Schmid, S. (2017). Exploring the link between internationalization of
top management and accounting quality: The CFO’s international experience matters.
International Business Review, 26(1), 71-88. doi:
https://doi.org/10.1016/j.ibusrev.2016.05.007
Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the
proxies, their determinants and their consequences. Journal of Accounting and
Economics, 50(2–3), 344-401.
Demerjian, P. R., Lev, B., Lewis, M. F., & McVay, S. E. (2013). Managerial ability and earnings
quality. Accounting Review, 88(2), 463-498. doi: 10.2308/accr-50318
Desai, M. A., & Yetman, R. J. (2015). Constraining Managers without Owners: Governance of the
Not-for-Profit Enterprise. Journal of governmental & nonprofit accounting, 4(1), 53-72.
doi: 10.2308/ogna-51138
Dhanani, A., & Connolly, C. (2015). Non-governmental Organizational Accountability: Talking
the Talk and Walking the Walk?: JBE JBE. Journal of Business Ethics, 129(3), 613-637. doi:
http://dx.doi.org/10.1007/s10551-014-2172-1

30
Du, X., Jian, W., & Lai, S. (2017). Do Foreign Directors Mitigate Earnings Management? Evidence
From China. The International Journal of Accounting, 52(2), 142-177. doi:
https://doi.org/10.1016/j.intacc.2017.04.002
Du, X., Yin, J., & Hou, F. (2018). Auditor human capital and financial misstatement: Evidence
from China. China Journal of Accounting Research, 11(4), 279-305. doi:
https://doi.org/10.1016/j.cjar.2018.06.001
Eldenburg, L. G., Gunny, K. A., Hee, K. W., & Soderstrom, N. (2011). Earnings management using
real activities: Evidence from nonprofit hospitals. The Accounting Review, 86(5), 1605-
1630.
Enomoto, M., Kimura, F., & Yamaguchi, T. (2015). Accrual-based and real earnings
management: An international comparison for investor protection. Journal of
Contemporary Accounting & Economics, 11(3), 183-198. doi:
http://dx.doi.org/10.1016/j.jcae.2015.07.001
Ferreira, A., Carvalho, J., & Pinho, F. (2013). Earnings Management Around Zero: A motivation
to local politician signalling competence. Public management review, 15(5), 657-686.
doi: 10.1080/14719037.2012.707679
Florida, R., Mellander, C., & Stolarick, K. (2016). Human capital in cities and suburbs. The Annals
of Regional Science, 57(1), 91-123. doi: http://dx.doi.org/10.1007/s00168-016-0763-8
Gebreiter, F., & Nunung, N. H. (2019). Individual responses to competing accountability
pressures in hybrid organisations. Accounting, Auditing & Accountability Journal, 32(3),
727-749. doi: http://dx.doi.org/10.1108/AAAJ-08-2017-3098
Gibb, S., & Ishaq, M. (2020). Decent work: what matters most and who can make a difference?
Employee relations, 42(4), 845-861. doi: 10.1108/ER-04-2018-0099
Glaeser, E. L., & Saks, R. E. (2006). Corruption in America. Journal of Public Economics, 90(6),
1053-1072. doi: https://doi.org/10.1016/j.jpubeco.2005.08.007
Gray, S. J. (1988). Towards a theory of cultural influence on the development of accounting
systems internationally. Abacus, 24(1), 1-15. doi: 10.1111/j.1467-6281.1988.tb00200.x
Habib, A., Muhammadi, A. H., & Jiang, H. (2017). Political Connections and Related Party
Transactions: Evidence. International Journal of Accounting, 52(1), 45-63. doi:
10.1016/j.intacc.2017.01.004
Hairston, S. A., & Brooks, M. R. (2019). Derivative accounting and financial reporting quality: A
review of the literature. Advances in Accounting, 44, 81-94. doi:
https://doi.org/10.1016/j.adiac.2018.10.003
Han, S., Kang, T., Salter, S., & Yoo, Y. K. (2010). A cross-country study on the effects of national
culture on earnings management. Journal of International Business Studies, 41(1), 123-
141. doi: 10.2307/27752481
Hanushek, E. A. (2013). Economic growth in developing countries: The role of human capital.
Economics of Education Review, 37, 204-212. doi:
https://doi.org/10.1016/j.econedurev.2013.04.005
Hanushek, E. A., & Woessmann, L. (2012). Schooling, educational achievement, and the Latin
American growth puzzle. Journal of Development Economics, 99(2), 497-512. doi:
https://doi.org/10.1016/j.jdeveco.2012.06.004

31
Hofmann, M. A., & McSwain, D. (2013). Financial disclosure management in the nonprofit
sector: A framework for past and future research. Journal of Accounting Literature,
32(1), 61-87. doi: https://doi.org/10.1016/j.acclit.2013.10.003
Hofstede. (2021). Hofstede Insight: Country Comparison. Retrieved 12 November 2021, from
https://www.hofstede-insights.com/country-comparison/indonesia/.
Hope, O.-K., Thomas, W. B., & Vyas, D. (2013). Financial Reporting Quality of U.S. Private and
Public Firms. The Accounting Review, 88(5), 1715-1742.
Hope, O.-K., Thomas, W. B., & Vyas, D. (2017). Stakeholder demand for accounting quality and
economic usefulness of accounting in U.S. private firms. Journal of Accounting and
Public Policy, 36(1), 1-13. doi: https://doi.org/10.1016/j.jaccpubpol.2016.11.004
Hribar, P., & Collins, D. W. (2002). Errors in Estimating Accruals: Implications for Empirical
Research. Journal of Accounting Research, 40(1), 105-134. doi: 10.1111/1475-
679X.00041
Huang, H.-W., Rose-Green, E., & Lee, C.-C. (2012). CEO age and financial reporting quality.
Accounting Horizons, 26(4), 725-740.
Ihlebaek, C., Ese, J., & Zambon, F. (2019). Partnerships for public health between regional
governments and academic institutions – status quo in European regions. European
journal of public health, 29(Supplement_4). doi: 10.1093/eurpub/ckz185.559
Indrawati, S. M., & Kuncoro, A. (2021). Improving Competitiveness Through Vocational and
Higher Education: Indonesia’s Vision For Human Capital Development In 2019–2024.
Bulletin of Indonesian Economic Studies, 57(1), 29-59. doi:
10.1080/00074918.2021.1909692
Jones, J. J. (1991). Earnings management during import relief investigations. Journal of
Accounting Research, 29(2), 193-228.
Keating, E. K., Parsons, L. M., & Roberts, A. A. (2008). Misreporting fundraising: How do
nonprofit organizations account for telemarketing campaigns? The Accounting Review,
83(2), 417-446.
Krishnan, R., & Yetman, M. H. (2011). Institutional drivers of reporting decisions in nonprofit
hospitals. Journal of Accounting Research, 49(4), 1001-1039.
Kroch, E. A., & Sjoblom, K. (1994). Schooling as Human Capital or a Signal: Some Evidence. The
Journal of Human Resources, 29(1), 156-180. doi: 10.2307/146060
Lee, J.-W. (2005). Human capital and productivity for Korea's sustained economic growth.
Journal of Asian Economics, 16(4), 663-687. doi: 10.1016/j.asieco.2005.06.009
Leuz, C., Nanda, D., & Wysocki, P. D. (2003). Earnings management and investor protection: an
international comparison. Journal of Financial Economics, 69(3), 505-527.
Lewis, B. D., & Hendrawan, A. (2019). The impact of majority coalitions on local government
spending, service delivery, and corruption in Indonesia. European Journal of Political
Economy, 58, 178-191. doi: https://doi.org/10.1016/j.ejpoleco.2018.11.002
Li, T., & Wang, Y. (2018). Growth channels of human capital: A Chinese panel data study. China
Economic Review, 51, 309-322. doi: https://doi.org/10.1016/j.chieco.2016.11.002
Lim, S. S., Updike, R. L., Kaldjian, A. S., Barber, R. M., Cowling, K., Hunter, Y., ...., & Murray, C. J.
L. (2018). Measuring human capital: A systematic analysis of 195 countries and
territories, 1990–2016. . The Lancet, 392(392(10154)), 1217-1234. doi:
doi:http://dx.doi.org.ezproxy.ugm.ac.id/10.1016/S0140-6736(18)31941-X

32
Lin, F., Lin, S.-W., & Fang, W.-C. (2020). How CEO narcissism affects earnings management
behaviors. The North American Journal of Economics and Finance, 51, 101080. doi:
https://doi.org/10.1016/j.najef.2019.101080
Lingga, I. (2018). Corruption, Foreign Ownership Structure, and Productivity: Firm Level Evidence
from Manufacturing Industry in Indonesia. (13850648 Ph.D.), National University of
Singapore (Singapore), Ann Arbor. Retrieved from
https://www.proquest.com/dissertations-theses/corruption-foreign-ownership-
structure/docview/2189728634/se-2?accountid=13771 ABI/INFORM Collection
database.
Liu, C., Lin, B., & Shu, W. (2017). Employee quality, monitoring environment and internal
control. China Journal of Accounting Research, 10(1), 51-70. doi:
https://doi.org/10.1016/j.cjar.2016.12.002
Lu, Y., & Cao, Y. (2018). The individual characteristics of board members and internal control
weakness: Evidence from China. Pacific-Basin Finance Journal, 51, 75-94. doi:
https://doi.org/10.1016/j.pacfin.2018.05.013
Lucas, R. E. (1988). On the mechanics of economic development. Journal of Monetary
Economics, 22(1), 3-42. doi: https://doi.org/10.1016/0304-3932(88)90168-7
Magnac, T., Pistolesi, N., & Roux, S. (2018). Post-schooling human capital investments and the
life cycle of earnings. Journal of Political Economy, 126(3).
McLeod, R. H., & Harun, H. (2014). Public Sector Accounting Reform at Local Government Level
in Indonesia. Financial Accountability and Management, 30(2), 238-258. doi:
10.1111/faam.12035
Minbaeva, D. B. (2018). Building credible human capital analytics for organizational competitive
advantage: Building credible human capital analytics. Human resource management,
57(3), 701-713. doi: 10.1002/hrm.21848
Mitchell, D. T., Hughes, D. R., & Campbell, N. D. (2013). Are Powerful Majorities Inefficient for
Parties and Efficient for Taxpayers?: An Analysis of Budget Maximization in the United
States. Public Finance Review, 42(1), 117-138. doi: 10.1177/1091142113487009
Mogues, T., & Olofinbiyi, T. (2020). Budgetary influence under information asymmetries:
Evidence from Nigeria’s subnational agricultural investments. World Development, 129,
104902. doi: 10.1016/j.worlddev.2020.104902
Ogundari, K., & Awokuse, T. (2018). Human capital contribution to economic growth in Sub-
Saharan Africa: Does health status matter more than education? Economic Analysis and
Policy, 58, 131-140. doi: https://doi.org/10.1016/j.eap.2018.02.001
Pilcher, R., & Van Der Zahn, M. (2010). Local Governments, Unexpected Depreciation and
Financial Performance Adjustment: Local Governments and Financial Performance
Adjustment. Financial Accountability and Management, 26(3), 299-324. doi:
10.1111/j.1468-0408.2010.00503.x
Plöckinger, M., Aschauer, E., Hiebl, M. R. W., & Rohatschek, R. (2016). The influence of
individual executives on corporate financial reporting: A review and outlook from the
perspective of upper echelons theory. Journal of Accounting Literature, 37, 55-75. doi:
https://doi.org/10.1016/j.acclit.2016.09.002

33
Rakhman, F., & Wijayana, S. (2019). Determinants of Financial Reporting Quality in the Public
Sector: Evidence from Indonesia. The International Journal of Accounting, 54(03),
1950009. doi: https://doi.org/10.1142/S1094406019500094
Rao, N. D., & Min, J. (2018). Decent Living Standards: Material Prerequisites for Human
Wellbeing. Social Indicators Research, 138(1), 225-244. doi:
http://dx.doi.org/10.1007/s11205-017-1650-0
Restuccia, D., & Vandenbroucke, G. (2013). A Century of Human Capital and Hours. Economic
Inquiry, 51(3), 1849-1866. doi: 10.1111/j.1465-7295.2012.00497.x
Rich, K. T., Roberts, B. L., Wall, J. M., & Zhang, J. X. (2021). Toward an understanding of year-
over-year changes in municipal management discussion and analysis disclosures.
Advances in Accounting, 54, 100548. doi: 10.1016/j.adiac.2021.100548
Salvia, A. L., Leal Filho, W., Brandli, L. L., & Griebeler, J. S. (2019). Assessing research trends
related to Sustainable Development Goals: local and global issues. Journal of Cleaner
Production, 208, 841-849. doi: https://doi.org/10.1016/j.jclepro.2018.09.242
Santos, É., & Halkias, D. (2021). Diffusion of innovations and labor market challenges: a multiple
case study from Angola. Journal of enterprising communities., 15(2), 204-227. doi:
10.1108/JEC-12-2020-0198
Siddiqui, J., Nasreen, T., & Choudhury‐Lema, A. (2009). The audit expectations gap and the role
of audit education: the case of an emerging economy. Managerial Auditing Journal,
24(6), 564-583. doi: 10.1108/02686900910966530
Simon, C. J., & Nardinelli, C. (1996). The Talk of the Town: Human Capital, Information, and the
Growth of English Cities, 1861 to 1961. Explorations in Economic History, 33(3), 384-413.
doi: https://doi.org/10.1006/exeh.1996.0021
Turner, C., Tamura, R., & Mulholland, S. E. (2013). How important are human capital, physical
capital and total factor productivity for determining state economic growth in the
United States, 1840-2000? Journal of economic growth (Boston, Mass.), 18(4), 319-371.
doi: 10.1007/s10887-013-9090-4
UNDP. (2020). Human Development Index (HDI). United Nation Development Program,
Retrieved 11 January 2020, from http://hdr.undp.org/en/content/human-development-
index-hdi
Vijaya, K. M., & Balu, B. (2023). Estimating the Impact of Human Capital Underutilization on the
Productivity and Economic Growth in India. Journal of the Knowledge Economy, 1-25.
doi: 10.1007/s13132-023-01152-9
Wang, D. (2006). Founding Family Ownership and Earnings Quality. Journal of Accounting
Research, 44(3), 619-656.
Wijayana, S., & Gray, S. J. (2018). Capital market consequences of cultural influences on
earnings: The case of cross-listed firms in the U.S. stock market. International Review of
Financial Analysis, 57, 134-147. doi: https://doi.org/10.1016/j.irfa.2018.03.007
Wijayana, S., & Gray, S. J. (2019). Institutional factors and earnings management in the Asia-
Pacific: Is IFRS adoption making a difference? Management International Review, 59(2),
307-334. doi: 10.1007/s11575-018-0371-1
Xu, Q., Fernando, G. D., & Tam, K. (2018). Executive age and the readability of financial reports.
Advances in Accounting, 43, 70-81. doi: https://doi.org/10.1016/j.adiac.2018.09.004

34
Yao, C., Parker, J., Arrowsmith, J., & Carr, S. C. (2017). The living wage as an income range for
decent work and life. Employee relations, 39(6), 875-887. doi: 10.1108/ER-03-2017-0071
Yao, S., Wang, Z., Sun, M., Liao, J., & Cheng, F. (2020). Top executives’ early‐life experience and
financial disclosure quality: impact from the Great Chinese Famine. Accounting and
finance (Parkville), 60(5), 4757-4793. doi: 10.1111/acfi.12659
Zhang, X., Liang, X., & Sun, H. (2013). Individualism—Collectivism, Private Benefits of Control,
and Earnings Management: A Cross-Culture Comparison. Journal of Business Ethics,
114(4), 655-664. doi: 10.1007/s10551-013-1711-5
Zhang, Z., Zhang, G., & Su, B. (2022). The spatial impacts of air pollution and socio-economic
status on public health: Empirical evidence from China. Socio-Economic Planning
Sciences, 83, 101167. doi: 10.1016/j.seps.2021.101167

35
Table 1. Definition and measurement of variables
Variables Measurement Source of Data
Dependent Variable
CLEANj,t a dummy variable set to 1 if the financial report of local Local governments'
government j for period t obtains an unqualified opinion, and 0 financial reports
otherwise;
DAi,t The discretionary component of accruals (accruals management) Local governments'
is captured in the error term of model (3) and is calculated as financial reports
follows:

DAi,t = (TACCi,t/TAi,t-1) - NDAi,t

Following Hribar and Collins (2002), we calculate total accruals

(TACC) as the difference between earnings before extraordinary
items (EXBI) and cash flows from operations (CFO):

TACCi,t = EXBIi,t - CFOi,t

where TACCi,t = the total accruals of local government i at year t,

EXBIi,t = the earnings before extraordinary items of local
government i at year t, and CFOi,t = the cash flows from
operations of local government i at year t. We use the pooled
ordinary least square (OLS) regression that was used in the Jones
(1991) model to estimate the discretionary accruals as follows:

TACCi,t/TAi,t-1 = α0 (1/TA i,t-1) + α1(ΔREVi,t / TA i,t-1) +

α2(PPEi,t/TAi,t-1) + ε i,t
where ΔREVi,t= changes in total revenues of local government i
at year t, and PPEi,t = property, plant, and equipment of local
government i at year t and TAi,t-1 = total assets of local government
i at year t-1. The nondiscretionary components of accruals are
calculated using the following equation:

NDAi,t = α0 (1/TA i,t-1) + α1(ΔREVi,t / TA i,t-1) + α2(PPEi,t/TAi,t-

1)

Tested Variables
HDIj,t the human development index of local government j for period t. Central Bureau of
Statistics
LEXj,t the life expectancy at birth in local government j for period t. Central Bureau of
Statistics
MYSj,t the mean years of schooling in local government j for period t; Central Bureau of
Statistics
EXPDj,t the per capita expenditure in local government j for period t. Central Bureau of
Statistics
Control Variable
SIZEj,t the natural log of the local government j’s total assets for period Local governments'
t; financial reports
LOCREVj,t the local revenues divided by the local government j’s total Local governments'
revenues for period t; financial reports

36
Variables Measurement Source of Data
CITYj a dummy variable, 1 if the local government is a municipality, Ministry of Interior
and 0 otherwise;
JAVAj a dummy variable, 1 if the local government j is situated on Java Ministry of Interior
island, and 0 otherwise;
EXPRj,t the number of years the mayor had stayed as mayor of local Internet sources
government j for period t;
AGEj,t the age of the mayor of local government j in year t; Internet sources
REALj,t the budget realization ratio (the actual spending divided by the Local governments'
total budget) of local government j for period t, measuring financial reports
managerial ability;
GNDRj,t a dummy variable, 1 if the mayor of local government j for period Internet sources
t is a male, and 0 otherwise.
ROAi,t income before extraordinary items of local government i at year t Local governments'
divided by total asset at year t-1; financial reports
GROWTHi,t revenue growth of local government i at year t; Local governments'
financial reports
LOSSi,t a dummy variable equals 1 if the income before extraordinary Local governments'
items is negative, and zero otherwise; financial reports
LEVi,t total liabilities divided by total assets of local government i at year Local governments'
t; financial reports
POPi,t the natural log of the population of local government i. Central Bureau of
Statistics

37
Table 2 Descriptive Statistics
Variables N Mean Std. Min Q1 Med Q3 Max
Dev.
CLEANj,t 4,258 0.45 0.5 0 0 0 1 1
HDIj,t 4,258 66.65 6.81 23.07 63.19 66.46 70.32 86.11
LEXj,t 4,258 68.70 3.67 53.42 66.40 69.02 71.13 77.54
MYSj,t 4,258 7.67 1.68 0.49 6.72 7.53 8.58 12.6
EXPDj,t (thousand Rp) 4,258 9,358.55 2,400.02 3,405.67 7,685.89 9,179.33 10,697.55 19,698.00
SIZEj,t (billion Rp) 4,258 2,684.89 3,278.41 71.42 1,360.52 1,896.10 2,867.78 42,764.67
LOCREVj,t 4,258 0.09 0.08 0.00 0.04 0.07 0.12 0.84
CITYj 4,258 0.19 0.39 0 0 0 0 1
JAVAj 4,258 0.23 0.42 0 0 0 0 1
EXPRj,t 4,258 4.76 2.79 1 2 4 7 10
AGEj,t 4,258 52.93 8.08 27 48 54 59 79
REALj,t 4,258 0.89 0.06 0.53 0.87 0.90 0.93 1.63
GNDRj,t 4,258 0.95 0.22 0 1 1 1 1
Note: The definition and measurement of variables are presented in Table 1.

38
Table 3 Correlation Analysis
Variables CLEANj,t HDIj,t LEXj,t MYSj,t EXPDj,t SIZEj,t LOCREVj,t CITYj JAVAj EXPRj,t AGEj,t REALj,t GNDRj,t
CLEANj,t 1
HDI,t .337** 1
LEXj,t .208** .677** 1
MYS,t .250** .881** .413** 1
EXPDj,t .303** .861** .516** .686** 1
SIZEj,t .281** .393** .410** .240** .439** 1
LOCREVj,t .309** .574** .488** .424** .645** .577** 1
** ** ** ** ** ** **
CITYj .092 .578 .327 .653 .537 .117 .391 1
JAVAj .103** .201** .495** -.039* .174** .381** .437** .092** 1
EXPRj,t .047** .039* 0.018 0.016 .053** .080** .035* -0.001 .046** 1
AGEj,t .031* .100** .054** .100** .048** -0.002 0.004 0.030 -0.014 .293** 1
** ** ** ** ** ** ** **
REALj,t .041 -.049 -0.024 -.078 -.069 -.133 -.114 -.099 0.009 .042 0.010 1
GNDRj,t -.076** -.100** -.136** -0.027 -.117** -.144** -.187** -.031* -.209** .081** .118** 0.026 1
Notes: The definition and measurement of variables are presented in Table 1. (**) Correlation is significant at the 0.01 and (*) at the 0.05 levels.

39
Table 4 Regression Analyses of the HDI on FRQ
Variables Exp. CLEANj,t
Signs
Intercept ? −21.151 ***

(−13.04)
***
HDIj,t + 0.153
(9.32)
***
SIZEj,t + 0.332
(4.04)
***
LOCREVj,t + 1.986
(2.52)
CITYj ? −0.327 **

(−2.26)
JAVAj + 0.024
(0.20)
***
EXPRj,t + 0.055
(3.69)
AGEj,t ? −0.006
(−1.32)
***
REALj,t ? 5.098
(6.64)
GNDRj,t 0.085
(0.48)
Fixed effect Yes
N 4,258
Nagelkerke R2 0.468
Notes: The definition and measurement of variables are presented in Table 1. (***) The coefficient is significant at the
0.01 level and (**) at the 0.05 level.

40
Table 5 Regression Analyses of the Dimensions of HDI on FRQ

Variables Exp. Signs CLEAN

1 2 3
*** *** ***
Intercept ? -19.70 -16.29 -15.25
(-11,80) (-10,86) (-10,17)
***
LEXj,t + 0.081
(5.86)
***
MYSj,t + 0.288
(8.13)
***
EXPDj,t + 0.001
(9.51)
*** *** ***
SIZEj,t + 0.411 0.412 0.347
(5.07) (5.08) (4.24)
*** *** ***
LOCREVj,t + 4.835 4.186 2.069
(6.17) (5.33) (2.49)
***
CITYj ? 0.179 -0.369 -0.129
(1.56) (-2,62) (-1,05)
** *** **
JAVAj + -0.223 0.290 0.221
(-1,92) (2.53) (1.98)
*** *** ***
EXPRj,t + 0.052 0.053 0.046
(3.52) (3.58) (3.12)
AGEj,t ? -0.001 -0.004 -0.001
(-0,24) (-0,74) (-0,29)
*** *** ***
REALj,t ? 5.235 5.423 5.208
(6.97) (7.18) (6.87)
GNDRj,t ? 0.020 0.014 0.089
(0.12) (0.08) (0.50)
Fixed effect Yes Yes Yes
N 4,258 4,258 4,258
Nagelkerke R2 0.442 0.449 0.454
Notes: The definition and measurement of variables are presented in Table 1. (***) The coefficient is significant at the
0.01 level and (**) at the 0.05 level.

41
Table 6 Regression of the Effect of HDI on Accruals Management
Variables Discretionary Accruals (DAi,t)
***
Constant -0.464 -0.551 *** -0.436 *** -0.551 ***

(-20.13) (-19.48) (-19.39) (-16.29)

***
HDIi,t 0.001 - - -
(7.39)
***
LEXi,t - 0.001 - -
(4.71)
- ***
MYSi,t - - 0.004 -
(7.51)
- ***
EXPDi,t - - - 0.004
(5.17)
SIZEi,t 0.029 *** 0.029 *** 0.030 *** 0.030 ***

(15.87) (15.63) (16.34) (16.13)

*** *** *** ***
ROAi,t 0.267 0.265 0.253 0.263
(15.78) (15.72) (14.94) (15.38)
*** *** *** ***
GROWTHi,t -0.126 -0.126 -0.123 -0.126
(-10.37) (-10.36) (-10.03) (-10.25)
*** *** *** ***
LOSSi,t 0.039 -0.039 0.40 0.039
(-10.92) (-10.95) (-11.07) (-10.92)
*** *** *** ***
LEVi,t -0.100 -0.107 -0.101 -0.101
(-2.81) (-3.01) (-2.82) (-2.81)
*** *** *** ***
POPi,t -0.006 -0.004 -0.007 -0.006
(-5.6) (-3.71) (-5.82) (-5.55)

N 1,471 1,471 1,471 1,471

F-stat 130.35 130.75 123.09 124.10
Adj-R2 0.3841 0.3819 0.3676 0.3696
Notes: The definition and measurement of variables are presented in Table 1. (***) The coefficient is significant at
the 0.01 level.

42