Financial failure and managers' accounting responses: Finnish evidence

Abstract

This paper provides new evidence on the earnings management adopted by the managers of financially troubled Finnish firms. Data from Finland are used, because the Finnish accounting legislation provides extensive opportunities for firms to manage their reported earnings figures. Moreover, the extent of discretionary accruals can be directly measured from the published Finnish income statements. Supporting the hypothesis based on contracting theory, the results of this study indicate that firms use their accounting discretion to manage reported earnings upwards before financial failure. By recognizing this behaviour of the managers of failed firms, we can improve the predictability of financial failure using financial ratios.