An Exploratory Analysis of Earnings Management Before and after the Governance and Disclosure Regulatory Changes in Australia and New Zealand

Abstract

This study examines the effect of regulatory changes and corporate governance reforms on firms’ earnings management practices in Australia and New Zealand. Using a sample of 3,966 firm-year observations including all ASX and NZX listed firms from the period 2001 to 2006, we find that the magnitude of earnings management did not decline after the introduction of new regulations to reform corporate governance. In fact, we observe a positive time trend suggesting that earnings management has been growing over time. We also perform Chow test and the results indicate a structural change has occurred in earnings management practice before and after the new regulation was introduced in Australia. The results reveal that managers tend to reduce earnings before the introduction of corporate law and economic reform program, companies with high reported earnings may be targeted by the regulators and attracted more public inquiry during the reform movement and therefore managers would have incentive to engage in downward earnings management to reduce such political exposure. We also find that subsequently following the reform action, managers are more likely to show a smooth and growing earnings string to prove that firm performance has benefited from the reform. As such, upward earning management severs a role of information signalling in the period after the introduction of corporate law and economic reform program to convince investors the better shaped and improved financial performance after the regulatory change. These findings taken together can lead regulatory authorities considering appropriate measures to promote earnings quality in corporate financial reporting from a long-run decision usefulness context.