How does real earnings management respond to the 2007-2008 financial crisis?

Abstract

PurposeThis paper aims to investigate the dynamics of repurchase-based earnings management vis-à-vis other real activities manipulations during the 2007–2008 financial crisis.Design/methodology/approachThis paper adopts a Probit model to regress alternate real earnings management (REM) methods on a dummy variable indicating whether a firm falls in the crisis event window or not, during our 15-year sample period. This paper also detects switches made by suspected firms from repurchasing to other REM tools such as reducing discretionary expenditures.FindingsThis paper provides solid evidence indicating that firms suspected of earnings management have the tendency to decrease accretive share repurchases after the onset of the crisis. Conversely, the above pattern is neither observed in non-suspect firms nor over non-crisis periods. A further investigation documents that firms that switch REM during crisis can be characterized by less cash holding, smaller size, more severe liquidity shortage and/or tighter financial constraint.Originality/valueThis paper contributes to the literature on understanding the respective and interactive implications of both share repurchases and global financial crisis on firms’ REM activities.