The impact of COVID-19 on accrual-based earnings management: Evidence from South Africa

PurposeThe purpose of this paper is to examine whether firms use different earnings management approaches when facing financial difficulties and the effects of industry-specialist auditors in constraining those choices. The empirical results suggest that (1) firms with lower risk of business failure but with stronger incentives to adjust earnings upward tend to use real earnings management (REM) income-increasing approaches while (2) at the same time, using discretionary accruals for income-decreasing earnings management, due to constraints imposed by specialist auditors on the use of accrual-based earnings management (AEM). This is consistent with the findings of Chi et al., and the authors do not find similar evidence for the firms with higher risk of failure. Also, (3) regardless of the level of failure risk, firms turn to REM while interestingly, such REM behavior is effectively curbed by industry-leading specialist auditors (specialist auditors with the highest client market share) on financially distressed firms. These results extend the findings of Chi et al. (2011), suggesting that industry-specialist auditors have different tolerance levels for earnings management approaches by firms with different levels of business failure risk. That is, when auditing clients with higher risk of failure, specialist auditors are more likely to maintain higher audit quality through more stringent audit testing and use of more audit staff time to prevent an occurrence of audit failure.Design/methodology/approachThe authors examine earnings management behavior across firms in Taiwan with different levels of business failure risk and the effects of audit partner industry specialization in constraining that behavior. Chi et al. (2011) studied low-risk firms with incentives to adjust earnings upward and found firms use REM when the auditors constrain AEM. The authors extend the work of Chi et al. and observe firms with different levels of failure risk.FindingsThe authors find (1) lower risk firms may use discretionary accruals to adjust earnings downward while the authors find no similar evidence for financially distressed firms, (2) lower risk firms may use REM when their industry-specialist auditors curb AEM and (3) the industry leaders among specialist auditors do the same for the financially distressed firms. The results demonstrate the extent to which industry-specialist auditors apply different tolerance levels for earnings management behaviors across firms with different levels of failure risk.Originality/valueThe study contributes to the literature in the following three ways: first, the authors fill a gap in the existing literature by comparing firms with higher risk of business failure to firms with lower risk of business failure to explore the possible difference in the two different kinds of earnings management behavior; second, the authors extend the findings of Chi et al. (2011) and examine whether specialist auditors, when auditing firms with higher risk of business failure, will input more audit effort to constrain their clients' use of REM and third, since business failures have a significant impact on the capital markets and any associated audit failures can have an even greater negative impact on investor confidence, the study provides information useful to auditors and regulators in the formation of salient policy regarding the use of REM by firms experiencing high risk of business failure.

PurposeThis study aims to investigate the earnings management practices of the listed manufacturing firms in Bangladesh and assess the impact of corporate governance mechanisms on such earnings management behavior.Design/methodology/approachThe study applies the real earnings management (REM) model developed by Dechow et al. (1998) and implemented by Roychowdhury (2006) and modified Jones model (1991) for the proxy of accrual-based earnings management (AEM). It uses a pooled ordinary least square regression model corrected with robust standard errors for empirical analysis.FindingsThe study finds that firms with small positive earnings per share are engaged in AEM to avoid losses. Also, firm managers craft discretionary expenses to manage real earnings. For governance factors, the institutional shareholders tend to play a significant role in limiting both REM and AEM embedded in generally accepted accounting principles or International Financial Reporting Standards. Also, factors such as foreign ownership and board size significantly restrict REM, whereas director ownership encourages the same. The paper does not reveal any significant monitoring role for other governance factors in curbing either REM or AEM practices by Bangladeshi firms.Research limitations/implicationsThe paper studies the monitoring role of governance mechanisms on listed manufacturing firms’ earnings management. A study of separating the listed firms into family and non-family ones could be interesting for future research.Practical implicationsThe paper unveils earning management techniques used by firms in Bangladesh and provides critical policy implications to the corporate governance mechanisms that effectively limit earnings management practice.Social implicationsThe social significance is to aware constituents of financial reporting about the earnings management behavior by firms in emerging economies.Originality/valueThe study adds to evidence that the manufacturing firms in Bangladesh adopt both REM and AEM techniques to avoid losses. Simultaneously, the paper highlights some critical governance factors that can restrict misleading earnings management behavior by firms in an emerging economy to assist in policymaking.

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.

Geography, business strategy and accruals-based earnings management

The Switch Up: An Examination of Changes in Earnings Management after Receiving SEC Comment Letters

The objective of this study is to examine the effect of the international financial reporting standards (IFRS) implementation on earnings management behavior in countries with high investor protection and strong legal enforcement. It does this by looking at a sample of 199 public listed companies from seven selected countries over a period of 15 years (before and after IFRS adoption). The results of this study suggest that in high investor protection countries, earnings management in general and accrual-based earnings management (AEM) in particular are more implemented during the IFRS application period than during the national generally accepted accounting principles (GAAP) application period. The study also suggests that earnings reports are more manipulated when firms face financial distress. However, it does not have enough evidence to conclude that real earnings management (REM) is more or less practiced after the transition to IFRS and whether there is a substitutional relationship between REM and AEM.

"This paper aims to empirically investigate firms’ earnings management (EM) behaviour, representing an issue in the realm of corporate financial reporting. Specifically, it explores the strategic roles of two common governance elements of ownership (managerial, institutional and family) and external audit in shaping the firms’ EM behaviour based on the two common EM attributes of Discretionary Accruals (DA) and Real Activities EM (REM). The analyses based on 227 survived Malaysian listed firms throughout the sixteen-year period from 2001 to 2016 (3,632 firm-year observations) indicate a dynamic EM behaviour depending on the presence of different ownership structures. Whilst a high percentage of family and institutional ownership mitigates DA, it however does not hold true for REM. Further, this paper also shows that the external control mechanism of audit quality is not significant in mitigating both EM attributes. The empirical results suggest that firms facing different challenges would affect the firms’ financial reporting behaviours in their choice of EM. The paper adds to the growing body of empirical knowledge dealing with the determinants of DA and REM from the lens of an emerging economy like Malaysia. KEYWORDS: Earnings management, discretionary accruals, real earnings management, accrual earnings management, financial reporting quality."

The purpose of this paper is to empirically test whether firms substitute accruals-based earnings management with real activities-based earnings management or complement the two methods in the MENA region. Further, this paper seeks to investigate the impact of IFRS adoption on accruals-based earnings management. To test the research hypotheses, this paper employs a panel fixed-effects regression model for a sample of 798 non-financial listed MENA region firms over the period 2008-2015, inclusively. The research findings provide evidence that firms complement accruals-based and real activities-based earnings management methods rather than substituting one earnings management method for the other, which suggests that MENA firms conduct both methods concurrently to achieve earnings targets and are not constrained by the relative costs of employing a particular method. Furthermore, a significant positive association between GDP growth and accruals-based earnings management is found, which provides evidence that economic growth leads to a greater degree of accruals-based earnings management behavior in MENA region firms.

Environmental, social and governance performance and earnings management – The moderating role of law code and creditor's rights

This paper aims to empirically investigate firms’ earnings management (EM) behaviour, representing an issue in the realm of corporate financial reporting. Specifically, it explores the strategic roles of two common governance elements of ownership (managerial, institutional and family) and external audit in shaping the firms’ EM behaviour based on the two common EM attributes of Discretionary Accruals (DA) and Real Activities EM (REM). The analyses based on 227 survived Malaysian listed firms throughout the sixteen-year period from 2001 to 2016 (3,632 firm-year observations) indicate a dynamic EM behaviour depending on the presence of different ownership structure. Whilst a high percentage of family and institutional ownership mitigates DA, it however does not hold true for REM. Further, this paper also finds that the external control mechanism of audit quality is not significant in mitigating both EM attributes. The empirical results suggest that firms facing different challenges would affect the firms' financial reporting behaviours in their choice of EM. The paper adds to the growing body of empirical knowledge dealing with the determinants of DA and REM from the lens of an emerging economy of Malaysia. Keywords: Earnings management, discretionary accruals, real earnings management, accrual earnings management, financial reporting quality.

The purpose of this paper is to examine whether executive stock-based compensation incentives induce the relation between accrual-based earnings management (AEM) and real earnings management (REM) to become asymmetric. The empirical results show that there is the substitute relation between AEM and REM when CEOs have the lowest degree of stock-based compensation incentives. However, there is the complementary relation between AEM and REM when CEOs have the median degree of stock-based compensation incentives. Moreover, the results also present a trade-off relation exists in the highest degree financial incentives during the post-SOX period, but this relation does not exist in the same regime during the pre-SOX period. These findings provide new insight into executive compensation mechanism for shareholders, investors, and regulators, resulting in the efficiency to prevent managers from obtaining private gains at shareholders’ expense.

Listed companies face multiple earnings pressures from stakeholders in their operations. When normal operations cannot achieve earnings expectations or having opportunistic motivations, companies often choose to conduct earnings management under earnings pressure. With the enhancement of the recognition and supervision of accrual-based earnings management, real earnings management has gradually become the main earnings management tool for companies under earnings pressure. Due to the concealment of real earnings management and information asymmetry, it is difficult for the company’s external stakeholders to detect real earnings management. Meanwhile, the high degree of supply chain concentration is one of the important characteristics that distinguish the Chinese market from the West. It is also a typical scenario for relational transactions in China. Transactions with customers and suppliers can directly affect the company’s earnings, and long-term transactions provide the basis for forming relationship and conducting relational transactions. Therefore, whether the company will conduct earnings management based on the supply chain relationship is an important research question with Chinese characteristics. Our research on this problem can help to improve investors’ understanding of the company’s real earnings management, and improve the efficiency of capital market in information transmission and resource allocation.This paper uses A-share non-financial companies listed in Shanghai and Shenzhen stock exchanges from 2007 to 2019 as the main research sample to examine the impact of earnings pressure on the company’s supply chain real earnings management. The empirical results show that: Corporate earnings pressure has a positive effect on the company’s supply chain real earnings management, and bargaining power and executive shareholding of the company separately strengths and weakens this impact. Moreover, there is an alternative relationship between supply chain real earnings management and upward accrual-based earnings management under earnings pressure. This paper also further analyzes the implementation of supply chain real earnings management and its economic consequences. We mainly find that supply chain real earnings management is different from the company’s excess production, and is more pronounced when earnings pressure is positive; for economic consequences, the implementation of supply chain real earnings management can help the company meet or beat analysts’ forecasts, so as to increase the company’s market value and analysts’ coverage, but there will be a reversal of supply chain real earnings management in the following year.This paper makes two primary contributions: First, this paper enriches the literature on the impact of earnings pressure on corporate operation and accounting behaviors. It examines the company’s supply chain earnings management under earnings pressure, and proves that the company’s response to earnings pressure can be reflected in external cooperative earnings management, rather than be limited to the company’s internal environment. Second, this paper contributes to the relevant research on real earnings management. It studies the company’s real earnings management by supply chain under earnings pressure, and explores its specific implementation conditions, which enriches the existing research content of the company’s real earnings management methods. It also can help investors better understand the company’s earnings management approach under earnings pressure, and improve the effectiveness of the capital market signal mechanism.

Two tales of earnings management with short sales deregulation

Purpose This study investigates how firms responded to the compliance costs imposed by the US Nitrogen Oxides Budget Trading Program (NBP), a regulatory initiative aimed at reducing climate-related air pollution. Specifically, it examines whether affected firms used real and/or accrual-based earnings management to offset the adverse effects on financial reporting. Design/methodology/approach Using a difference-in-differences regression framework, the authors compare manufacturing firms headquartered in 11 NBP-compliant states with those in noncompliant states. The authors test for changes in earnings management behavior using ordinary least squares, Propensity Score Matching and the Generalized Method of Moments (GMM), ensuring robustness across methods. Findings Results show that the NBP led to significant increases in real earnings management, particularly through inventory overproduction and reductions in discretionary expenditures (Selling, General and Administrative Expenses and Research and Development Expenses). The impact on accrual-based earnings management was limited. Practical implications This study highlights that even well-designed environmental regulations can have unintended financial reporting consequences, as firms seek to preserve short-term profitability. Policymakers should account for such behavioral responses when designing compliance regimes. Originality/value This study makes a unique contribution to the literature on climate policy and earnings quality by demonstrating how compliance costs from environmental regulation prompt strategic financial reporting responses. It also contributes to understanding the substitution between real and accrual-based earnings management.

Purpose– The primary purpose of this paper is to investigate the motivations of earnings management in less-developed economy using Saudi listed companies.Design/methodology/approach– While numerous motivations for earnings management are proposed in the literature, many of these motivations have inconsistent empirical support. A number of studies report discontinuities in the distribution of earnings around benchmarks such as the zero profit level. However, the evidence regarding whether these discontinuities are associated with earnings management behaviour is still uncertain. In addition, evidence regarding the ability of various governance mechanisms to constrain earnings management is also mixed. These issues raise the necessity to investigate managers behaviour that incentivise earnings management practices through qualitative research approach. A questionnaire survey and interviews are mainly used to explore the motivations for earnings management in Saudi Arabia in order to obtain the different perceptions of respondents.Findings– The findings reveal that the four main incentives for Saudi managers to manage earnings are “to increase the amount of remuneration”, “to report a reasonable profit and avoid loss”, “to obtain a bank loan” and “to increase share price”.Research limitations/implications– Hence, agency-institutional theory may provide a sensible explanation for earnings management practices in Saudi Arabia.Practical implications– Previous findings could be helpful for external auditors and regulators and legislators in their attempts to constrain the incidence of earnings management and enhance the quality of monitoring mechanisms.Originality/value– While numerous motivations for earnings management are proposed in the literature, many of these motivations have inconsistent empirical support. A number of studies report discontinuities in the distribution of earnings around benchmarks such as the zero profit level. However, there is no evidence that these discontinuities are associated with earnings management behaviour. In addition, evidence regarding the ability of various governance mechanisms to constrain earnings management is also mixed. These issues raise the necessity to investigate managers behaviour that incentivise earnings management practices through qualitative research approach.