Accrual-based Earnings Management Research Articles

The Impact of Earnings Management on CEO Equity Incentives

This paper investigates whether firms adjust CEO equity incentives in response to prior earnings management. I show that the risk-taking incentives from new equity grants are lower for firms with higher prior real earnings management (REM), but not for firms with higher prior accruals-based earnings management (AEM). These adjustments are associated with sustained earnings management over the three years before the grant, but not with transitory earnings management. Additionally, I show that firms with higher institutional ownership primarily drive the negative relationship between REM and AEM and risk-taking incentives from new equity grants. My results are consistent with firms altering compensation incentives to restrain managers’ value-reducing behavior, in part, due to the monitoring of institutional investors.

Playing it ethical or safe? Examining the effects of executive military experience on earnings management

Purpose This study aims to investigate whether and how the executive military experience influences accrual-based earnings management and real earnings management. Design/methodology/approach Based on a sample of 4,392 listed firms in China between 2006 and 2022, this study examines the theoretical hypotheses by performing multiple regressions with fixed effects and a battery of robustness tests. Findings With a focus on executives’ decisions on the choice between two earning management methods, this paper find military executives reduce accrual-based earnings management but increase real earnings management. The mechanism of risk-aversion is verified in the post hoc analysis. Originality/value Most studies argue that military experience, which represents a strong sense of duty and self-discipline, can help to reduce corporate unethical behaviors. The study extends the existing literature on executives’ military experience by identifying risk-aversion rather than ethical values as the potential mechanism through which executives’ military experience affects earnings management.

The Impact of Corporate ESG Performance on Earnings Management

This paper selects listed companies from the Shanghai and Shenzhen A-share markets between 2009 and 2020 as the sample to empirically analyze the impact of corporate performance in ESG (Environmental, Social, and Governance) on the level of their earnings management activities. The study finds that the better the ESG performance, the lower the company's tendency to engage in real earnings management, significantly reducing the level of real earnings management. In contrast, the improvement in ESG performance increases accrual-based earnings management. Further analysis reveals that for non-state-owned enterprises, the restraining effect of ESG performance is more pronounced. All three dimensionsenvironment, social, and governancecan significantly increase corporate accrual-based earnings management. Compared to environmental responsibility, social responsibility and corporate governance are more effective in significantly reducing real earnings management.

Does integrated reporting offer firms more legitimacy?

PurposeThe study delves into the impact of integrating reporting (IR) on three earnings management tools, namely classification shifting (CS), real-based earnings management (REM) and accrual-based earnings management (AEM) under the Indian institutional settings.Design/methodology/approachThe data analysis involved the application of panel data regression models. Our dataset comprises 2,244 firm-years listed on the Bombay Stock Exchange spanning over financial years from March 2015 to 2021. To address endogeneity and self-selection bias concerns, a propensity score matching technique has been employed.FindingsOur empirical results exhibit that IR-adopting firms are engaged in earnings management. Further, we find that IR-adopting firms have reduced their engagement in AEM and REM, however, their CS practices have been increased, indicating the substitution relationship between earnings management tools after the adoption of IR. It implies that firms shift their preference from more to less observable earnings management tools after the adoption of the IR, which aligns with the idea that firms adopt IR to gain legitimacy, however, their intention to deceive stakeholders through earnings management remains unchanged. The inclination of firms toward CS can be ascribed to its cost-effectiveness, as it leaves net profit unchanged, hence less likelihood of being detected by auditors. Overall, our results align with the principle of legitimacy theory.Research limitations/implicationsThe study focuses exclusively on three primary forms of accounting manipulation and assesses IR holistically, rather than investigating the influence of each capital individually within IR.Practical implicationsWith a shift towards less detectable methods like CS, auditors must adapt their scrutiny and be mindful of their clients' IR adoption. Investors should scrutinize IR-adopting firms' financial disclosures, especially line items, as CS does not impact the net profits.Originality/valueIt is the pioneering research to thoroughly explore the impact of IR on different earnings management tools and strengthen the conceptual frameworks of legitimacy theory by documenting that firms adopt IR to gain legitimacy, however their intention to engage in earnings management remains intact.

CEO early-life experience and corporate accounting conservatism: Insights from the socio-political context

Using China's Cultural Revolution as a shock to risk attitude, this study investigates the effect of CEOs' early-life experience on corporate accounting conservatism. We find that CEOs who experienced the Cultural Revolution in their early life are more risk-averse and conservative, and thereby are associated with a higher level of accounting conservatism. Such a positive relationship is more pronounced in provinces with higher political risks, e.g., where the provincial leadership changes and where high-profile provincial bureaucratic corruption cases occur. Also, the positive effect of CEOs' early-life experience is stronger in SOEs where CEOs' political career concerns are more pronounced. Additional analysis suggests that CEOs with early-life Cultural Revolution experience are more likely to adopt conservative accounting practice, such as increasing firm's provisions for liabilities and reducing accrual-based earnings management. Our results add new evidence to support the upper echelons theory and imprinting theory by highlighting the enduring impact of influential socio-political events during early life on the decision-making processes of CEOs.

Political sentiment and abnormal accruals

ABSTRACT Firms exhibiting high political sentiment can be desirable for investors as a hedging tool, which increases the demand for their stocks due to the mispricing related to manger’s sentiment and intertemporal hedging demand. A long-short portfolio of firms corresponding to the quintiles of political sentiment has a positive alpha spread. We document a positive relationship between political sentiment and abnormal accruals, which implies that corporate executives who engage in accruals-based earnings management also discuss political risk more frequently during earnings calls. Some managers tend to portray their firms as politically sensitive to mitigate the risks of high accruals. Indeed, our distance-to-default analyses suggest that political sentiment ameliorates the negative effects of high accruals. Double-sorted portfolios on political sentiment and abnormal accruals earn significant positive alphas in the month/quarter of earnings call.

Do the specific characteristics of female directors work as alternative governance mechanisms to restrict earnings management in a developing country?

AbstractThis inquiry probes whether or not female directors and their specific characteristics effectively restrict earnings management (EM) measured by accrual‐based earnings management (AEM) and real‐based earnings management (REM) in a sample of 217 Pakistani companies from 2016 to 2021. The outcomes of the ordinary least squares with panel corrected standard errors demonstrated that boards with female directors are more effective in restricting EM than others. The results also explain that the proportion of female directors on the board and audit committee and the experience of the former are significantly and inversely associated with AEM and REM. However, women directors should be at least two or more on the board to effectively control AEM and REM since the role of a lone female director is insignificant in their mitigation. The positive effect of the female directors' master's or above qualification is slightly higher than their bachelor's or below education in opposing AEM and REM. Furthermore, the business education of female directors significantly, while their non‐business education insignificantly reduces AEM and REM. The findings are consistent and reliable for being validated by the generalised method of moments as an alternative estimator. Overall, the inquiry complements the literature, theory, practice, and policy in several ways.

The impact of the JOBS act on the costs of going public: evidence from long-term audit costs

The Jumpstart Our Business Startups (JOBS) Act (2012) allows reduced compliance costs for IPOs with less than $1 billion in revenues. While prior research has focused on the Act’s ability to reduce short-term IPO compliance costs, we investigate how the Act affected key observable compliance costs – audit fees – over the five years the issuing firm is eligible for this reduced level of disclosure/compliance. In contrast to prior findings of increased short-term audit costs, we find that long-term audit costs decreased by 16.6 percent, or $172,000 for IPO firms following JOBS, relative to the change fees for in control firms unaffected by the regulation. After investigating other consequences of the Act, we find greater information uncertainty for affected firms following JOBS. However, we find lower accrual-based earnings management as responses to these information frictions. We find the reductions in earnings management is driven by firms with the greatest information uncertainty with investors, suggesting that affected firms take additional steps to mitigate the information risks in light of their inherently riskier IPOs. Overall, we present a fuller picture of the costs/benefits and risk mitigation in post-JOBS IPOs.

Effect of Earnings Management on Earnings Quality and Sustainability: Evidence from Gulf Cooperation Council Distressed and Non-Distressed Companies

This study evaluates the effect of earnings management on earnings quality and sustainability in the GCC region, particularly in distressed and non-distressed companies. Studies on earnings quality and sustainability have mostly concentrated on developed markets, with little attention paid to emerging markets like the GCC region. This research is the first to examine how manipulating earnings impacts the quality and sustainability of earnings in distressed and non-distressed companies. This study utilized a unique dataset that represents the GCC region, which has a specific socio-cultural context. We collected data from 839 publicly listed companies in the GCC region between 2011 and 2022 using DataStream®, WorldScope (WS), and Refinitiv Eikon. To test our hypotheses and ensure accuracy, we used three types of regressions (the fixed effects model, OLS, and 2SLS) and conducted robustness and endogeneity tests. The results of this study indicate that accruals-based earnings management has a negative impact on earnings quality for distressed and non-distressed firms but a positive effect on earnings sustainability for both types of companies. The results of this study also find variations in earnings management practices across industries. These findings provide valuable guidance for auditors, investors, and other stakeholders to evaluate the earnings quality and sustainability of distressed and non-distressed companies, benefiting the GCC economy and similar economies.

EARNINGS MANAGEMENT: A LITERATURE REVIEW

Earning is an important component in financial statements that can be modified by management policies. Managers have the opportunity to present profits according to their wishes because managers have more information so they are free to do this which is called earnings management. In our study, the researchers attempt to review the literature studies that provide an analysis of earnings management impact from two perspectives. The researcher attempts to review existing research/literatures that provide an analysis of earnings management from two perspectives. The articles used in this study consist of 50 articles on earnings management that have been published in international journals and were obtained from Google Scholar using the keyword "earnings management". The research findings indicate that the majority of the articles are quantitative studies utilizing the accrual-based earnings management approach and possess an opportunistic perspective towards earnings management. Research on earnings management has been extensively conducted, but only a few have explored earnings management from a signal perspective. The study aims to examine two different point of view from earnings management article.

Debt Maturity Structure and Earning Management: Evidence from Emerging Markets

This study aims to examine the non-linear impact of debt maturity structure on earnings management (EM) in international data settings. Panel dataset of 5129 non-financial listed firms from 9 Asian Emerging Economies (AEE) is analyzed covering the period from 2000 to 2021. EM is measured using Accrual-Based Earnings Management (AEM) and Real Activity-Based Earnings Management (REM). Debt is categorized into Total Financial Debt (TFD), Short-Term Debt (STD), and Long-Term Debt (LTD). Based on fixed effect regression model, results clearly reveal presence of non-linear relationship between debt maturities and EM. The study provides the evidence that firms of AEEs are engaged in accrual as well as real earnings management to report their earnings.TFD and STD have positive where as LTD has negative impact on AEM at low debt level. In the similar vein, TFD and STD have negative where as LTD has no impact on REM. The findings also demonstrate substitution of REM for AEM at varying debt levels. This study offer valuable insight for investors, creditors, policy makers, auditors and researchers.

EARNINGS QUALITY AND NATIONAL IPO: REM PRACTICES OF CENTRAL ASIA

Abstract. The study aims to assess the impact of the National IPO/SPO Program on Earnings quality in KASE-listed companies and provide recommendations to the investor community. KASE Stock Exchange sample population is 52 local companies, 26 state and 26 private, across different industries excluding financial institutions and investment holdings. Time horizon is 13 years during 2009-2021period totaling 572 unbalanced panel firm-year observations. To estimate Earnings quality, we follow Kasznik cash flow model for accrual-based Earnings management jointly with real activity Roychowdhury aggregate model. We found that the National IPO/SPO process creates partial state-owned enterprises and improve their key investment indicators. Partially state-owned companies outperform private ones and thus become the preferable investment strategy based on Earnings quality risk, cash generation, profitability and leverage-based risk. To strengthen our analysis we compare main results with another popular measurement of accrual-based Earnings management based on the Shivakumar 1996 model. We also winsorised key investment indicators to estimate the impact of outliers on the main results. Theoretically, this study is the first to analyze Earnings management from the National IPO/SPO perspective and the first to relate Earnings quality with structure ownership in case of Kazakhstan. Practically, results and discussion are useful for investors of KASE-listed companies in investment decision-making. Keywords: Earnings quality, Ownership structure, Earnings management, Kazakhstan, National IPO/SPO, KASE

Revisiting corporate governance mechanisms and real earnings management activities in emerging economies

PurposeThis study aims to investigate the effects of main corporate governance (CG) mechanisms used in Iran on the relationship between managers’ rewards and real earnings management activities.Design/methodology/approachPanel data analysis is performed on 101 companies listed on the Tehran Stock Exchange during the past seven years (from 2015 to 2021).FindingsThe percentage of non-executive members of the company’s board of directors and the percentage of acquisition of the company’s largest shareholders have a negative significant effect on the relationship between abnormal operating cash flows and managers’ remuneration. Moreover, the separation of the CEO from the chairman and vice chairman of the board has also a negative significant effect on this relationship. However, concentration of ownership does not have a significant effect on the relationship between abnormal operating cash flows and managers’ rewards.Practical implicationsThe study provides policymakers and governing bodies with a better understanding of the effects of the percentage of non-executive board members, concentration of ownership, percentage of major shareholders and duality of the role of CEO (or president) from the chairman and vice chairman of the board on the relationship between managers’ rewards and earnings management.Originality/valuePrevious studies focus mainly on accrual-based earnings management. This study investigates real earnings management and provides empirical evidence on the most effective and significant CG dimensions in Iran. It embraces the fact that CG may have the same principal concept in different markets, but the mechanisms may vary significantly, thus opening the door for more comparative future research.

BOARD FINANCIAL EXPERIENCE AND EFFICIENCY-BASED EARNINGS MANAGEMENT IN PRE- AND POST-INTERNATIONAL FINANCIAL REPORTING STANDARDS

The study examines whether the board of directors with financial experience can effectively constrain earnings management pre- and post-International Financial Reporting Standards (IFRS). For a large balanced panel dataset of Taiwanese electronics companies over 2007–2017, we replace returns on assets in an augmented modified Jones model with efficiency scores derived using data envelopment analysis (DEA). Using DEA as an innovative adaptation in the accrual-based earnings management model, we aim to provide an accurate measure of earnings management. The results of our panel-estimated generalized least square (EGLS) regression models, which account for heteroskedasticity and auto-correlation problems, indicate that the proportion of board of directors with financial and/or accounting experiences reduces earnings management pre-IFRS. However, their ability turns weaker post-IFRS. Overall, this study thus not only has important theoretical significance in that a board of directors with financial experience might and might not curb earnings management but also has an important practical contribution to decision-makers in companies regarding the effectiveness of board financial experiences in the IFRS era.

Reconnecting sustainability reporting with earnings management: empirical evidence from Kuwait

PurposeThis study aims to examine the impact of environmental, social and governance (ESG) reporting on accruals-based earnings management (AEM) activities in Kuwait.Design/methodology/approachBased on a random-effects regression analysis, this study examines the relationship between sustainability reporting (SR), as determined by the intensity degree method and EM, as measured by AEM, using panel data from 37 listed Kuwaiti companies on the Kuwait Stock Exchange between 2017 and 2021.FindingsEmpirical results reveal that SR affects EM in Kuwait. It appears that socially responsible Kuwaiti firms concentrate their efforts on fostering transparency and integrity in their interactions with stakeholders rather than engaging in misleading practices.Practical implicationsThis study suggests a range of practical implications in Kuwait and similar economies. The findings highlight that SR can be advantageous for individuals, policymakers and corporations by promoting positive impact, addressing sustainability targets, building stakeholder confidence, reducing the risk of exposure to environmental, social and ethical liabilities and enhancing public well-being.Originality/valueThis study creates a unique ESG data set for Kuwait, unavailable in academic research. Building upon previous study that focused only on the environmental aspect (Gerged et al., 2020), this research, however, adopts a broader approach by investigating the overall impact of ESG reporting on EM in Kuwait, making it the first study to explore this relationship in this country.

Transfer pricing, earnings management and corporate governance among listed firms: Evidence from Ghana

PurposeThis study aims to examine the prevalence of transfer pricing and earnings management activities, and how they are impacted by corporate governance mechanisms.Design/methodology/approachUsing the political cost theory, the study provides insights into how opportunistic managerial behaviours which have a strong link to profit shifting and tax evasion are driven by corporate governance using data from 16 listed firms for the period 2008–2020.FindingsThe results reveal that the transaction-based transfer pricing model is better than the index-based model and the accrual-based earnings management model suits the political cost theory more than the real earnings management metric. Board size and female CEO increase transfer pricing aggressiveness but board independence, CEO tenure, CEO nationality and female Board Chairwomanship reduce transfer pricing aggressiveness. The findings also reveal the role of multinational enterprise status, private ownership, industry type, firm size, financial leverage, asset tangibility and firm age. For accrual-based earnings management, board independence, CEO tenure, and female Board Chairwomanship significantly decrease earnings management. Other factors include private ownership, firm size, and firm age.Practical implicationsThe findings of the study are relevant for shaping industry-level policies on earning management, transfer pricing and related-party transactions. Since these opportunistic managerial behaviours are the foremost drivers of tax avoidance and profit shifting, the findings of this study provide relevant insights for practitioners, tax and other regulatory authorities, policymakers and the academic community alike.Originality/valueThis is among the premier studies on the transfer pricing and earnings management nexus with corporate governance factors using the political cost theory, especially in the developing country context. It also reveals the significant impact of gender and suggests the need for gender diversity in corporate management.

Manipuliacinė apskaita, jos taikymo motyvai ir tendencijos apskaitos teorijų raidos kontekste

The paper examines the concept of earnings management, including its characteristics and motives for use as presented in scientific literature. A matrix of firm and managerial motive clusters is presented in the light of the opportunistic behaviour hypotheses of positive accounting theory. The paper analyses the various types of earnings management practices and discusses profit-reducing and profit-enhancing accounting methods. It also explores the trends in the use of different types of earnings management and the reasons behind them, which can be divided into three phases. The normative period of accounting theories was characterised by the widespread use of accrual-based earnings management. During the positive period of accounting theory development, there was an increase in the practice of real earnings management. The evolution of accounting theories, improvements in auditing practices, and changes in accounting policies led to shift away from accrual-based to real earnings management.

International trade, mandatory IFRS adoption and financial reporting quality

Purpose This study examines how bilateral international trade among mandatory International Financial Reporting Standards (IFRS) adopter countries moderates the relation between IFRS adoption and firms’ financial reporting quality. Design/methodology/approach The authors use data from 2007 to 2015 and focus on publicly listed firms from non-European Union countries that adopted IFRS on a mandatory basis. Findings The authors find that the interaction between mandatory IFRS adoption and a country’s bilateral trade with other countries using IFRS is negatively and significantly related to accruals-based earnings management, which is an inverse measure of financial reporting quality. This result is driven by firms in less developed countries. The improvement in accounting quality is for firms located in countries that both fully and partially adopt IFRS. The authors also find a significant and negative coefficient for the relation between real earnings management and the interaction between mandatory IFRS adoption and a country’s bilateral trade with other IFRS countries in the post-global financial crisis period. Originality/value Overall, the authors’ results are consistent with the notion that the mandatory adoption of IFRS creates a positive externality where firms improve their accounting quality because increased financial statement comparability means that foreign customers and suppliers can monitor the quality of earnings more easily.

Cultural tightness and financial reporting behavior around the world

This study examines the effect of cultural tightness on earnings management globally through an institutional economics perspective. We find that managers are less (more) likely to use accrual-based (real) earnings management in countries with tight cultures, consistent with the notion that managers switch to real earnings management when accrual-based earnings management is constrained in tight cultures. Our findings are robust to several endogeneity and sensitivity tests. Additionally, our results show that the strength of investor protection attenuates the effect of cultural tightness on earnings management, suggesting a substitutive relationship between this effect and the legal regime. The results also show that transactions with other countries (i.e., more imports and exports or foreign sales) weaken the effect of cultural tightness. Thus, by focusing on norm-based cultural tightness rather than Hofstede’s value-based cultural dimensions, this study advances the understanding of how culture affects corporate reporting practices.

Noncontrolling shareholders' network centrality and corporate earnings management: Governance or conspiracy?

Corporate governance is undermined by the tunneling of controlling shareholders. Social networks play a positive role in corporate governance; hence, the question is whether noncontrolling shareholders can take advantage of their network position to participate in corporate governance and subsequently influence earnings management. Our findings indicate that noncontrolling shareholders' network centrality can impede positive accrual-based earnings management and primarily functions as a governance mechanism via external governance. Also influencing the relationship between positive accrual-based earnings management and noncontrolling shareholders' network centrality are the religious culture in different regions and the nature of corporate property rights. Our study contributes to the debate about the role of noncontrolling shareholders by providing direct evidence that the network centrality of noncontrolling shareholders plays an active role in enhancing corporate governance and accounting information quality.