Earnings management and the role of MOSAL in co-ops

Abstract

• Consumer co-ops drive their annual earnings toward zero earnings based on their prior expectations of the level of pre-managed earnings. • Co-ops manipulate sales up, increase COGS, and reduce SG&A discretionary expenses when observed pre-managed earnings fall below zero earnings. • If pre-managed earnings exceed zero and attract regulators’ attention, co-ops reduce sales and COGS, and increase SG&A discretionary expenses. • Co-ops with small losses engage in real activities manipulation to avoid reporting losses and to make small profits. • Real activities manipulation and accrual-based earnings management have decreased following the passage of the 2013 MOSAL regulation. This study provides evidence that consumer co-operative societies (co-ops) drive reported earnings toward zero profit by adjusting sales, discretionary expenses, and costs of goods sold. Evidence also indicates that co-ops with small losses manage earnings up to avoid reporting losses and make small profits. Furthermore, earnings management tends to decrease after the 2013 MOSAL (Ministry of Social Affairs and Labor) regulation. This paper examines a highly significant and currently unresearched segment of the economy using a unique and comprehensive dataset of annual information on Kuwaiti co-ops. It also provides new insights on the role of government regulations in curbing the accounting practices co-ops managers use to misreport financial statements.