Earnings management to avoid losses: Evidence in non-listed Colombian companies

Abstract

This paper studies the manipulation of the profits reported by non-listed Colombian companies. First, we examine whether the distribution of profits shows a discontinuity around zero earnings, an empirical fact evident in other countries. Second, we investigate whether this discontinuity results from opportunistic management behavior in manipulating the profit figures to avoid reporting losses or if, on the contrary, it is the result of accounting conservatism in recognizing extraordinary items or the asymmetric effect of the expense of income tax. Moreover, frequency analysis identifies a discontinuity around zero in all analyzed earnings measurements. Additional evidence suggests that while companies use non-operating items discretionarily to exceed the zero-profit threshold, the discontinuity generated by tax expenditure results from its asymmetrical effect.