Abstract
We enrich the research on income manipulation by establishing a link among companies’ price-setting control and the extent of real activities management. Examining three types of real activities management, the results reveal an interesting asymmetry in how companies employ income manipulation based on their pricing strength. We discover that companies with weaker price-setting clout employ larger manipulation of sales and production costs as a tool to manage income, while firms with more dominant pricing power prefer managing discretionary expenses.
Highlights
A key matter in income manipulation investigation is to detect firm characteristics that determine income manipulation
The analysis reveals an interesting asymmetry in how firms resort to income manipulations through real activities where firms with weak market positions favor engaging in manipulation of sales and manufacturing expenses as tools for income manipulation while companies with higher market power prefer managing discretionary expenses
We look at the relationship between competition and real activities management in multiple regression, adjusting for company features revealed in the past studies, like the growth rate of assets, firm size, market-to-book ratio, leverage and volatility that have bearing on income manipulation
Summary
A key matter in income manipulation investigation is to detect firm characteristics that determine income manipulation (see Healy & Wahlen, 1999). Datta, Iskandar-Datta, and Singh (2013) relate the product market power to income management, their focus was on accruals management This is the first paper to relate the pricing environment of a firm to its degree of real activities manipulation. It can be reasoned that managers of high market power firms are under relatively forgiving disciplinary environment, and enjoy greater discretion to manipulate income compared to their low market power firm counterparts These two competing arguments create an interesting tension, making the compelling central issue examined in this study an important empirical question. The analysis reveals that companies with low price-setting clout have greater tendency to utilize production costs in an effort to reduce their costs of goods sold This is in support of research that documents that management resort to manipulations since declaring worse than anticipated income is harshly punished by the Wall Street (Skinner & Sloan, 2002).
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