Do firms substitute earnings management methods? The case of the MENA region

Tarek Elkalla

doi:10.30585/jrems.v3i1.568

Abstract

The purpose of this paper is to empirically test whether firms substitute accruals-based earnings management with real activities-based earnings management or complement the two methods in the MENA region. Further, this paper seeks to investigate the impact of IFRS adoption on accruals-based earnings management. To test the research hypotheses, this paper employs a panel fixed-effects regression model for a sample of 798 non-financial listed MENA region firms over the period 2008-2015, inclusively. The research findings provide evidence that firms complement accruals-based and real activities-based earnings management methods rather than substituting one earnings management method for the other, which suggests that MENA firms conduct both methods concurrently to achieve earnings targets and are not constrained by the relative costs of employing a particular method. Furthermore, a significant positive association between GDP growth and accruals-based earnings management is found, which provides evidence that economic growth leads to a greater degree of accruals-based earnings management behavior in MENA region firms.

Highlights

Earnings management has become a significant issue as evidenced by an extensive body of literature
This paper seeks to address two research questions: (i) what is the impact of IFRS adoption on accrualsbased earnings management for Middle East and North Africa (MENA) firms? and (ii) are earnings management methods used as substitutes or complements by firms? By addressing these research questions, this paper provides significant contributions to the earnings management literature
This study addresses two research questions: (i) are earnings management methods used as substitutes or complements by firms? and (ii) what is the impact of IFRS adoption on accruals-based earnings management? The research findings provide evidence that MENA firms employ both accruals-based earnings management and real earnings management methods concurrently, which is likely conducted to achieve earnings targets

Summary

Introduction

Earnings management has become a significant issue as evidenced by an extensive body of literature. Schipper (1989, p.92) defines earnings management as the “purposeful intervention in the external financial reporting process with the intent of obtaining some private gain.”. On the other hand, according to Healy and Wahlen (1999, p.368), “earnings management occurs when managers use judgement in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers.”. Opportunistic earnings management occurs when accounting choices are selected in ways that are intentionally misleading to stakeholders with regard to the underlying economic performance of the firm (Healy and Wahlen, 1999). Managers could opportunistically bring forward reported earnings from the future to a current accounting period if a bonus award plan exists (Watts and Zimmerman, 1978)

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