Artificial and real income smoothing around corporate governance reforms: further evidence from Egypt

Awad Elsayed Awad Ibrahim,Khaled Hussainey,Tarek Abdelfattah

doi:10.1108/jaar-06-2019-0100

Awad Elsayed Awad Ibrahim, Khaled Hussainey + Show 1 more

Open Access

https://doi.org/10.1108/jaar-06-2019-0100

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Abstract

PurposeThe authors examine whether managers switch from artificial income smoothing using discretionary accruals to real income smoothing around corporate governance reform in Egypt.Design/methodology/approachThe sample comprises 61 non-financial companies listed on the Egyptian Stock Exchange for the years 2004–2011. The authors use discretionary accruals as a proxy for artificial income smoothing and income/loss from asset sales as a proxy for real income smoothing.FindingsThe authors offer a significant contribution to accounting literature by providing new empirical evidence on the trade-off between real smoothing technique (e.g. income/loss from asset sales) and discretionary accruals around governance reform in a developing country.Research limitations/implicationsThis study suffers from some limitations. First, the study sample is limited to only 338 observations. However, this is due to collecting the data manually and to the small number of listed firms during the study period. Second, the study period ended in 2011 due to the unprecedented political instability after the 2011 Egyptian people revolution. Third, although this study examines the effect of corporate governance, not all the governance aspects have been examined in the study models due to the lack of data.Practical implicationsFirst, the results of the total samples reveal that managers prefer real income smoothing than accruals income smoothing. This result may confirm the literature arguments on the advantages of REM methods over AEM methods. Cohenet al.(2008) find that firms switch to manage earnings using REM methods and explain that REM methods are harder to detect because they depend on operating decisions (Schipper, 1989). REM can be undertaken anytime during the year (Gunny, 2010). Besides, REM could not be deemed a violation of accounting standards or regulations (MyVay, 2006).Originality/valueThe authors offer a significant contribution to accounting literature by providing new empirical evidence on the trade-off between real smoothing technique (e.g. income/loss from asset sales) and discretionary accruals around governance reform in a developing country.

Highlights

This study investigates whether Egyptian managers switch from artificial income smoothing to real income smoothing around corporate governance reform
The results of the subsamples before and after the application of the ECGC in 2007 imply that the Egyptian governance reform is not productive, especially in mitigating real income-smoothing practices, where we find that real income smoothing still exists even after the governance reform in 2007, which may confirm the argument of McVay (2006) that Real Earnings Management (REM) could not be deemed a violation of the accounting standards or regulations
We examine accounting income smoothing using discretionary accruals and real income smoothing using income/loss from asset sales and determine whether managers substituted between the two techniques, before and after the first governance reform in Egypt

Summary

Introduction

This study investigates whether Egyptian managers switch from artificial income smoothing to real income smoothing around corporate governance reform. Egypt provides a unique country context to examine income smoothing behavior as it has paid attention to corporate governance (CG) early in 2000. It has experienced two waves of corporate governance reform, aiming at supporting economic reform programs and attracting direct foreign investments (Abdelfattah and Hussainey, 2019). Based on the method used, income smoothing could be classified as artificial, where techniques of accounting earnings management such as accruals manipulation could be implemented, or real, where methods of real earnings management could be applied such as sales of assets (Huang, Zhang, Dies, & Moffitt, 2009; Yang, Tan, & Ding, 2012; Khalil & Simon, 2014)

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