**2. Literature review and hypotheses development**

#### **2.1. Accounting and sustainable development**

Traditional accounting tools do not provide information tailored to the specific needs of environmental issues. Environmental information is often embedded in aggregates of costs and revenues, which do not allow the benefits and losses inherent in this area to be identified. This inefficient allocation of costs complicates the decision-making process.

The occurrence of environmental accounting is consistent with the improvement of environmental awareness that started in the 1970s. The unawareness of different leaders about environmental concerns has given way to rebuff. Increasingly, the focus of firms progressed toward mindfulness, and the appearance of a commitment vis-à-vis the protection of the environment emerged [1].

The need to integrate environmental considerations into decision-making is one of the basic strategies for sustainable development. Sustainability requires taking greater responsibility for decisions, which calls for changes in the legal and institutional frameworks to emphasize the public interest. The law alone cannot impose the public interest; this requires broad public participation in decision-making that affects the environment. When the environmental impacts of the proposed project are high, it requires that there be mandatory public scrutiny of such projects [2].

Income smoothing is one of the most common forms of earnings management, and managers try to maintain the stability of net income by influencing the timing of certain financial events or by selecting specific accounting methods or both. Companies generally prefer to show a stable trend in income growth and do not want to show the volatility of profits, the rise in some periods, and decline in others. To achieve this balance, companies try to maintain income stability.

this area. Then, in 2002, the United Nations Conference in Johannesburg stressed the importance of adopting adequate environmental controls and information systems at different levels in countries that can be used as a basis for political decisions, mainly through the Global

The World Bank is not far behind; it has published recommendations and offers courses to raise corporate social responsibility (CSR) awareness among companies. The Organization for Economic Co-operation and Development (OECD) has made simple recommendations but is a forerunner with papers dating back to 1976. Environmental accounting provides more information and promotes transparency and accountability for political action for the envi-

On another hand, green or universal accounting is slowly entering the world of finance. Global warming, biodiversity, pollution, water consumption, noise pollution, employability, and the fight against discrimination are beginning to be integrated into accounting plans. The objective, in addition to financial performance, is the company's ability to live in harmony with its physical and social environment. An important change in the economic model was evident, and the subject is taken very seriously by a handful of auditors, experts, and researchers.

Traditional accounting tools do not provide information tailored to the specific needs of environmental issues. Environmental information is often embedded in aggregates of costs and revenues, which do not allow the benefits and losses inherent in this area to be identified. This

The occurrence of environmental accounting is consistent with the improvement of environmental awareness that started in the 1970s. The unawareness of different leaders about environmental concerns has given way to rebuff. Increasingly, the focus of firms progressed toward mindfulness, and the appearance of a commitment vis-à-vis the protection of the envi-

The need to integrate environmental considerations into decision-making is one of the basic strategies for sustainable development. Sustainability requires taking greater responsibility for decisions, which calls for changes in the legal and institutional frameworks to emphasize the public interest. The law alone cannot impose the public interest; this requires broad public participation in decision-making that affects the environment. When the environmental impacts of the proposed project are high, it requires that there be mandatory public scrutiny

Income smoothing is one of the most common forms of earnings management, and managers try to maintain the stability of net income by influencing the timing of certain financial events or by selecting specific accounting methods or both. Companies generally prefer to show

ronment by bringing the economy and the environment closer together.

**2. Literature review and hypotheses development**

inefficient allocation of costs complicates the decision-making process.

**2.1. Accounting and sustainable development**

ronment emerged [1].

of such projects [2].

Reporting Initiative (GRI) and the Global Compact.

18 Sustainability Assessment and Reporting

Management is based on the relative performance of the company now and in the future. When current profits are low and expected future profits are strong, the manager borrows profits from the future period for use in the current period. When current profits are good, management tends to save them for potential use in the future.

Several studies have dealt with the concept of preparing income for study and analysis. Fudenberg and Tirole [3] referred to the concept of income as all the methods and processes are used by management in business organizations to reduce income to reduce the degree of risk in the company's investments. Ashari et al. [4] referred to the introduction of income as a set of mechanisms whereby profits are reduced in periods of a significant increase in income and they increase in periods where income falls significantly.

## **2.2. Relation between sustainability reporting and income smoothing: hypothesis development**

A growing number of organizations are making sustainable development a major focus of communication. If sustainable development is designated as the ideal new structure or "skeleton" of a society going through a global crisis, communication is the blood that feeds it. I know the magnitude of the operational challenges that companies face when trying to understand and use this new approach. However, developing an integrated approach to sustainability based communication is an equally difficult challenge. There are perceptions of issues of concern: understanding stakeholder expectations varies, and traditional structures are firmly established.

Indeed, accounting allows the aggregation of all the financial information of the firm and communicating it to stakeholders with interest in the financial management of the company. Accounting can also be used to measure other types of financial information about the company's environmental and social performance, helping managers to make strategic decisions [5]. Several concepts have appeared in parallel with this concern for sustainability, for example, eco-accounting, the "green economy," the carbon footprint among others.

Eco-accounting is a reworking of the traditional accounting system, integrating the internal and external environmental and social and economic costs inherent in the total life cycle of the product. This practice allows managers to review the profitability of their products by considering the environmental and social impacts. For example, an executive could recognize the cost of managing and disposing of waste by property or by department and thus review its profitability. The attribution of a specific cost to an environmental or social effect makes it possible to measure the inefficiency of current methods and to identify new sources of potential savings [6]. However, some costs are difficult to quantify. In this case, the company may allocate an approximate cost to them.

A majority of the sustainability literature relies on institutional theory, which states that firms establish actions for external legitimacy. Conferring to the legitimacy theory, firms attempt to justify their activities as reliable with the norms and values "required" by society because they are permitted to continue their actions through a social treaty. If a firm does not act according to society's rules, a legitimacy gap appears, affecting the firm's very durability [7]. Legitimacy is insight or postulation that the actions of an organization are needed or suitable within some focus on the norms, values, and beliefs in the social area. It increases when society and pertinent stakeholders enhance a company's behavior as correct and convenient; consequently, firms communicate to the relevant public that they work in tandem with norms and values of society. A firm may also report its envisioned objective in social matters along with the use of reporting to adjust the discernment of its actions or hide unethical comportment or the weak quality of its financial information to protect or enhance its legitimacy [8].

A final sample of 94 of the 146 nonfinancial listed companies was obtained (see Appendix 1).

Sustainability Reporting and Income Smoothing: Evidence from Saudi-Listed Companies

http://dx.doi.org/10.5772/intechopen.79219

21

In this section, I describe the variables of the study beginning with the principle variables

Sustainability reporting represents the dependent variable, which is measured by an index. The index includes many items related to CSR, economic, and environmental governance, updated to the new guidelines of the International Organization of Standardization (ISO) 26000. These items are measured via content analysis, grouped in dimensions that describe

In the field of management sciences, the most commonly used method in the analysis of qualitative data, especially interviews, is content analysis [5, 11, 12] as pointed out by [13], p.202: "The place of content analysis is becoming increasingly important in social research, particularly because it offers the possibility of methodically dealing with information and testimonies that have a certain degree of depth and complexity, such as semi-directive interviews." The sustainability reporting score is obtained after an analysis of the quality and quantity of published sustainability information. The assessment of the quality of the information content delivered by the company consists of coding the content delivered according to two modalities: quantitative information and general information. Quantitative information is of better quality and reliability than general information because it is considered to have better

To measure the sustainability reporting index, I evaluate the degree of firm communication by coding a grid of items relating to sustainability, assigning values from zero to four dependent on the quantity or quality of reported information in the firm's website. The rating of the grid of items related to sustainability reporting is based on a score from zero to three; three points are given for an item described in monetarily or quantitatively, two when an item is described precisely, one for an item discussed in general, and zero for no information about the item [15, 16]. Two persons made the valuation of items, and then I made a rapprochement

Regarding the explanatory variable, income smoothing, the firm is supposed to smooth its results if it presents low variability results as referenced to a level considered normal. From a methodological point of view, it is necessary to define the object of smoothing, the duration of study of the smoothing, and the statistical tool allowing evaluation of the variability of the

I use the ratio of cash flow volatility to earnings volatility to measure income smoothing. This measure presents the extent to which accrual accounting has smoothed out the underlying volatility of the firm's operations, which is reliable with previous research on income smoothing [8, 18]. Cash flow (earnings) volatility is the standard deviation of cash flows from

I discarded companies created after 2008 and those that do not have a website.

**3.2. Variables and measurement**

social and environmental areas.

informational influence [14].

between the two results [17].

result.

*3.2.1. Independent and explanatory variables*

(dependent and explanatory) and then the control variables.

According to the institutional theory, sustainability reporting is observed as one of the central concepts that organizations rely on to prove that they work with society's rules [9]. A company's legitimacy is influenced by its sustainability reputation, as well as by its financial situation; sustainability reporting and financial reporting are instruments that outline the stakeholders' insights of these two reputational features [10].

Firms use signaling of their qualities and then act dependably with ethical values. As stated by signaling theory, a pertinent signal should be noticeable to the community. Sustainability reporting is a visible signal to socially responsible behavior. Likewise, it is a costly behavior and cost rise with the volume of the given information.

Regarding the impact of CSR on financial performance, some studies in stakeholder theory suggest a positive link between the two concepts (social impact hypothesis) since it is supposed to improve the satisfaction of the whole. The company's stakeholders, and consequently, the reputation of the company, favor better economic and financial performance. Others, belonging to a liberal trend, establish a negative link (trade-off hypothesis), a socially responsible commitment of the company increasing costs and leading to misuse of capital, causing competitive disadvantages.

According to the signal theory, the incentives emanating from sustainability reporting and unethical comportment, such as income smoothing, have been well documented. Based on the following theories, propositions, and arguments, I can present the following hypothesis:

*Hypothesis:* The more companies disclose about sustainability, the more their managers are motivated to smooth income.
