The Effects of Macroeconomic Business Cycle on Earnings Management: Evidence from Korean Companies

Earnings management is the practice of deriving certain benefits by intervening in external financial reporting or misleading certain stakeholders through adjustments to accruals without cash flow involvement or with affecting cash flows through real activities. Using the models of Kothari et al. (2005) and Cohen et al. (2008) for accrual-based earnings management (AEM) and real activities earnings management (REM), respectively, we examined whether relationships exist between key financial indicators, such as cash flows from operations, operating income, and debt dependency level, and AEM and REM in the ready mixed concrete (RMC) industry in Korea. This study is the first to investigate earnings management in Korea’s RMC sector. Results showed that operating income and cash flows from operations are significantly negatively related to AEM and REM, consistent with the findings of previous research. By contrast, debt dependency exhibits no significant relationship with AEM and REM, contradicting the findings of most previous studies. As a moderating variable, operating income affects the relationship between cash flows from operations and earnings management with only REM. On these bases, we can infer that earnings management in the Korean RMC industry responds differently to key financial indicators with regards to AEM and REM practice. Overall, companies in the industry implement aggressive earnings management depending on operating income and cash generation ability level rather than debt dependency level. These findings provide important insights for people who are interested in accounting information on the RMC industry in Korea.

Objective - The purpose of this research is to examine the consequences of accrual based earnings management and real earnings management on future operating performance.The firms studied engage in accrual-based earnings management with discretionary accrual measures using the modified Jones model and some of the following real earnings management activities: (1) Sales manipulation that accelerates the timing of sales through increased price discounts or cutting prices to boost sales in the current period; and/or (2) cutting of discretionary expenditures to increase income in the current period. Furthermore, the study examines the extent to which discretionary accrual and real earnings management affects subsequent operating performance (as measured by both return on assets and operating cash flows). Methodology/Technique - The sample manufacturing firms that engage in financial statement were listed on the Indonesian Stock Exchange between 2012 and 2014. The hypothesis testing method used in this research is multiple regression linear. Findings - The results suggest that accrual-based earnings management, with discretionary accrual measures, and real earnings management through sales manipulation and discretionary expenditures are positively associated with return on assets after one and two years. Meanwhile, accrual-based earnings management and real earnings management through sales manipulation enhances subsequent operating cash flows. However, real earnings management through discretionary expenditures does not influence operating cash flows. Novelty - This research contributes to the existing literature on the subsequent impact of accrual-based earnings management and real earnings management Type of Paper: Empirical Keywords: Discretionary Accrual; Sales Manipulation; Discretionary Expenditure; Return on Assets; Operating Cash Flows JEL Classification: M21, M41.

This paper provides evidence on the impact of regulatory environment on financial reporting quality of transitional economies. This study compares the financial reporting quality of Hong Kong firms which are cross-listed in mainland China with those of Hong Kong firms cross-listed in China using specific earnings management metrics (earnings smoothing, timely loss recognition, value relevance and managing towards earnings targets) under pre- and post-IFRS regimes. The financial reporting quality of Chinese A-share companies and Hong Kong listed companies are examined using earnings management measures. Using 2007 as base year, the study used a cumulative of −5 and +5 years of convergence experience which provide a total of 3,000 firm-year observations. In addition to regression analyses, we used the difference-in-difference analysis to check for the impact of regulatory environments on earnings management. Through the lens of contingency theory, our results indicate that the adoption of the new substantially IFRS-convergent accounting standards in China results in better financial reporting quality evidenced by less earning management. The empirical results further shows that accounting data are more value relevant for Hong Kong listed firms, and that firms listed in China are more likely to engage in accrual-based earnings management than in real earnings management activities. We established that different earnings management practices that are seemingly tolerable in one country may not be tolerable in another due to level of differences in the regulatory environments. The findings show that Hong Kong listed companies’ exhibit higher level of financial reporting quality than Chinese listed companies, which implies that the financial reporting quality under IFRS can be significantly different in regions with different institutional, economic and regulatory environments. The results imply that contingent factors such as country’s institutional structures, its extent of regulation and the strength of its investor protection environments impact on financial reporting quality particularly in transitional and emerging economies. As such, these factors need to be given appropriate considerations by financial reporting regulators and policy-makers interested in controlling earnings management practices among their corporations. This study is a high impact study considering that China plays a significant role in today’s globalised economy. This study is unique as it the first, that we are aware of, to compare real earnings activities against accrual-based earnings management in pre- and post-IFRS adoption periods within the Chinese and Hong Kong financial reporting environments, distinguishing between cross-listed and non-cross-listed firms.

The purpose of this paper is to investigate whether a CEOs stock-based compensation incentive, that is one of the main corporate governance dimensions, has different impacts on accruals-based earnings management (AEM) and real activities earnings management (REM) which have different economic costs. Empirical results show that CEOs stock-based compensation incentive has a positive impact on AEM but a negative impact on REM, implying stock-based compensation incentive leads executives to use more AEM but less REM. Given that the SOX places additional compensation risk on executives, the stock-based compensation is an incentive to significantly encourage managers for using more AEM during the pre-SOX period and less REM during the post-SOX period. The evidence implies that managers change their risk perceptions for AEM and REM after the enactment of SOX, and then their earnings management behaviors indeed change for avoiding wealth-destroying pitfalls. These results bring a new insight into the ability to prevent managers from increasing personal wealth at shareholders' expense.

Purpose This paper aims to investigate the impact of the separation between control and cash flow rights (control-ownership disparity) on the earnings management practices of Chinese firms. The notable features of Chinese firms are those of concentrated ownership and the severe disparity that exists between the control and cash flow rights of controlling shareholders. Design/methodology/approach This study measures the level of Chinese firms’ earnings management by adopting two different methods of measurement: accrual-based earnings management (AEM) and real activity earnings management (REM). The authors also consider the possible trade-off effects between these two types of measurements. The data set in this study encompasses over 2,000 Chinese firms, using data from 2003 to 2015. Findings The results indicate that controlling shareholders are more likely to engage in AEM as their cash flow rights are more concentrated, while they are less likely to use REM as the disparity of control-cash flow rights increases. Further, this inverse relationship between REM and control-cash flow rights disparity becomes more pronounced in the case of a low cash flow rights group. As REM generally causes distortions in firms’ operations, it is possible that the controlling shareholders are more likely to constrain the use of REM as the disparity is perceived to grow. This result may indicate a reduced agency problem between controlling and minority shareholders due to the developing and/or existing ownership dispersions, which are mainly driven by recent reforms applied to Chinese capital markets. However, we do not entirely exclude the possibility of other types of expropriations by the controlling shareholders. It appears that the controlling shareholders are still able to exert a significant level of control, even following a substantial ownership dispersion, and they may seek alternative expropriation methods, including but not limited to intercorporate loan or related party transactions as the disparity of control-cash flow rights increases. Originality/value Although the Chinese economy is experiencing a series of reforms to infuse market forces into capital markets, little has been known about the effects of ownership-control disparity in Chinese firms. Our findings highlight the importance of the country specific context in this vein of research.

Background: Economic value added (EVA) may reflect true performance compared with other conventional accounting indices, it is still measured through financial statements. It is highly probable that EVA motivates managers to manipulate earnings.Aim: The main contribution of this study is the analysis of the association between earnings management and EVA. This study provides shareholders, lenders and creditors (or other categories of investors) with a method for analysing the value of enterprises.Setting: We analyse the association between earnings management through real earnings management (REM) or discretionary accrual (DA) activities and the EVA by African and the Group of Twenty (G20) nations.Methods: The sample for this study was obtained from the COMPUSTAT database between 2009 and 2013. This study also adopted the ordinary least squares (OLS) method.Results: The results indicate that a significantly positive relationship exists between earnings management through DA items and EVA in African nations. In addition, a significantly negative relationship exists between earnings management through DA items or REM activities and EVA in G20 nations.Conclusion: Our results provide critical implications for managers, researchers, investors and regulators of various nations; for example, managers may determine whether to increase the EVA through earnings management, researchers may analyse varying degrees of REM activities and DAs existing in the same nation groups or regulators may determine how to establish laws or rules to prevent earnings management because it is likely that differences in national development, culture or politics exist in these nations.

We examine earnings management behavior around SEOs, focusing on both real activities and accrual-based manipulation. Although research has addressed the issues of earnings management around SEOs and earnings management via real activities manipulation, ours is the first paper to put these two issues together. We make three contributions to the literature. First, we document that firms use real, as well as accrual-based, earnings management tools around SEOs. Second, we show how the tendency for firms to tradeoff real versus accrual-based earnings management activities around SEOs varies cross-sectionally. We find that firms choices vary predictably as a function of the firms ability to use accrual management and the costs of doing so. Our model is a first step in examining how firms tradeoff between real versus accrual methods of earnings management. Third, we compare the economic costs of accrual versus real earnings management around SEOs, by examining the effect of each type of earnings management on the firms future performance. We provide the first evidence on this important issue by showing that the costs of real earnings management are likely greater than the costs of accrual earnings management, at least in the SEO context.

This study analyzed the effects of firm life cycle stages (LCS) and their changes on the level of adoption of earnings management strategies. Gaps were identified regarding the effects of the transition between various life cycle stages and the propensity for accrual-based earnings management (AEM) and real activities earnings management (REM), as well as the impacts on the trade-off or complementarity relationship between them. The findings reinforce the need for auditors, financial analysts, investors, and regulators to consider company context and specific characteristics, such as firm cycle stage, when analyzing earnings management. The results suggest a greater propensity for all earnings management strategies, in order to hide financial difficulties, at the beginning of the decline stage. A total of 185 companies listed on the Brazilian capital market were analyzed for the period from 2011 to 2022, with data collected from Refinitiv®. Park and Chen’s (2006) model has been adopted to classify firm life cycle stages, and the models were estimated by the system generalized method of moments (system GMM). Growth stage firms use overproduction and avoid discretionary expense cuts as REM strategies. However, when transitioning from the growth stage to the mature stage, they are more likely to cut discretionary expenses as an REM strategy. The use of AEM is more prevalent in the decline stage, when compared to mature stage companies. The findings add evidence to the literature that the trade-off or complementarity relationship between AEM and REM is influenced by firm LCS and their transitions.

Considering the voluminous published research confirming and extending the original findings of Cohen, Dey, and Lys (2008), we conclude that Pincus, Wu, and Hwang (2022) make a modest contribution to the earnings management literature. Specifically, their analysis does not incorporate recent advances in the earnings management literature, especially the measurement and estimation of real earnings management activities and the incorporation of the changing information environment. As a result, we conclude that the Pincus et al. (2022) results and conclusions with regards to the substitution between accrual-based and real earnings management activities should be interpreted with caution. JEL Classifications: G10; M4.

Prior research suggests that the presence of high-quality auditors (i.e. proxied by audit firm characteristics) constrains accrual-based earnings management, but it inadvertently leads to higher real activities manipulation. We investigate whether such trade-off exists between accrual-based and real earnings management activities in the presence of female or male auditors. We use a sample of UK firms for the period 2009 to 2016 and find that firms audited by female auditors do not resort to a higher-level real activities manipulation when their ability to engage in accruals management is constrained. Overall, our results suggest that the benefits of hiring female auditors (i.e. less accrual-based earnings management) are overwhelmingly higher than the costs they might bring to the client firms (i.e. higher real activities manipulation).

Purpose: Using a sample of firms selected in a pilot program of the SEC Regulation SHO, we investigate whether managers make trade-off decisions between accrual-based earnings management and real activities manipulation over the period 2000-2015.Design/methodology/approach: Real activities manipulation is computed based on Roychowdhury (2006), and discretionary accruals are measured by modified Jones (1991) model. To examine trade-off decisions, we follow models developed by Zang (2012). Findings: We find that managers of pilot firms do not make strong sequential decisions about the use of accrual-based earnings management (ABEM) versus real activities earnings management (RAEM) and their decisions are not fully dependent on the relative costliness of earnings management.Originality: While prior studies provide evidence on short-selling firms and accrual management, no prior study has examined trade-off decisions between RAEM and ABEM for pilot firms, particularly during the pilot program.

The main objective of the study is to evaluate the effect of firm size and firm profitability on earning management among listed firms on Nigeria Exchange Group. This study specifically seeks to ascertain the effect of firm size and firm profitability on both accrual-based earnings management and real earnings management activities. The study focused on non-financial listed firms on Nigeria Exchange Group for the period of 2013 to 2023. The study adopted ex post facto research design and purposive sampling was used to select sample population. Secondary source of data was extracted from financial reports and accounts of sample firms from either companies’ corporate web site or Nigeria Exchange Group Factbooks. This study found that firm size and firm profitability affects both discretionary accruals management and real earnings management. the study recommends among others that since profitable firms tend to engage in both discretionary accruals management and real earnings management. Though profitability showed management’s ability to generate profit, financial regulators should encourage them to improve their financial reporting quality and reduce earning management practice.

In this study, I examine whether earnings management varies by a firm’s life-cycle stage relative to its industry life-cycle stage. This relationship, measured as Leaders, Match, or Laggards, concerns strategic groups with different operating strategies. Leaders (Laggards) employ a pioneering (an imperfect imitation) strategy. Overall, I find evidence that Leaders engage in less earnings management than do Match firms. Specifically, Leaders (Laggards) engage in less (more) accruals-based earnings management (AEM) than do Match firms, and Leaders engage in less real-activities earnings management (RAM) than do Match firms. Within firm life-cycle stages, I find additional evidence that Leaders engage in less RAM than do Match firms. This evidence of variation in earnings management suggests that incentives to manage earnings vary among strategic groups.

This paper examines the effects of the global financial crisis of 2008 on real and accrual-based earnings management activities of foreign companies listed in the United States as American Depositary Receipts (ADRs). The ADR firms are classified according to whether they report under U.S. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). Accrual-based earnings management is measured using the absolute value of performance-matched discretionary accruals. We also use the positive and negative values of performance-matched discretionary accruals to examine income-increasing and income-decreasing earnings management, respectively. Real earnings management proxies are measured using performance-matched measures of the abnormal levels of cash flow from operations, production costs, and discretionary expenses. In summary, our findings indicate no difference in accrual-based earnings management for ADRs reporting under IFRS and U.S. GAAP but suggest that ADRs reporting under IFRS are more likely to manage earnings using income-decreasing discretionary accruals and aggregate real earnings management than ADRs reporting under U.S. GAAP during the financial crisis.

PurposeManagers of defined-benefit (DB) firms have considerable discretion in deriving pension costs and flexibility in cash contributions to pension plans. Pension accruals occur when cash contributions differ from pension costs. The manipulable nature of pension costs and cash contributions allows managers of DB firms to manipulate pension accruals to achieve their desired earnings. We study whether DB firms with earnings management attributes (referred to as suspect DB firms) used more discretionary pension accruals (DPA) than non-suspect DB firms, especially after the passage of Sarbanes-Oxley (SOX).Design/methodology/approachThe authors develop an aggregate measure of DPA to capture overall earnings management in pension accounting. They then employ a multivariate regression model to study whether the suspect DB firms engage in more DPA than non-suspect firms and to assess the impact of SOX on DPA for all DB firms and for suspect DB firms.FindingsThe authors find evidence that suspect firms inflate DPA to achieve their earnings goals and also that all DB firms and the suspect firms use more DPA in the post-SOX era compared to the pre-SOX period. In contrast, they observe no significant difference in real activities earnings management (REM) between suspect and non-suspect firms. In addition, neither the entire sample of DB firms nor the suspect firms display a significant change in REM after SOX.Research limitations/implicationsThe samples in the study are limited to firms with defined pension plans; thus, the findings cannot be generalized to all firms. In addition, as in other empirical studies relying on models to estimate earnings management proxies, this study inherits estimation errors from Jones and Roychowdhury's models. Consequently, the impact of these estimation errors cannot be ruled out.Practical implicationsThe empirical findings of the study appear that instead of deterring DB firms from engaging in pension accruals earnings management, enacting the stringent anti-fraud SOX prompts these firms to rely more on accrual-based discretionary pension rather than switch to real activities manipulation to manage earnings.Originality/valueWhile many prior studies focus on the impact of managing individual pension assumptions on earnings, the authors study overall earnings management in pension accounting by developing a model to derive an aggregate measure of pension earnings management.