Accrual-based Earnings Management Research Articles

Relationship between Earnings Management and large shareholder in Chinese listed companies

The essay aims to find the relationship between earnings management (including accrual-based earnings management and real earnings management) and the large shareholder. The database of the survey is based on the data of listed companies in China between 2014 and 2018. The relationship will be found by testing the moderate effect between the large shareholder and the degree of real earnings management and accrual-based earnings management in the enterprises in the database. The study can help us have a better understanding of the manipulation of accrual-based and real earnings management among listed companies with the shareholder concentration degree and its economic consequences. It can also help users of accounting information and external benefits stakeholders have a better understanding of the financial information of listed companies.

Do socially responsible companies use earnings management more rarely and (or) less aggressively? Evidence from Lithuania

This paper examines the problem of (in)compatibility between the performance of socially responsible enterprises and the use of earnings management, as well as the extent to which earnings management is likely prevalent in Lithuanian socially responsible enterprises. Although it seems that socially responsible companies make value-based commitments, the use of earnings management is incompatible with them, and various research studies have produced contradictory results. In Lithuania, there has been no research conducted on accounting manipulation in socially responsible enterprises, so it has not been possible to evaluate whether and how Lithuanian socially responsible enterprises manipulate financial information. Therefore, this study aims to compare the spread of earnings management’s use among Lithuanian socially responsible companies and other companies in order to reveal the prevalence of opportunistic or conceptual approaches to social responsibility in these companies. The study compared two groups of companies for the period 2017-2021: one group of companies that disclose information on socially responsible performance in their reports and a control group of companies that do not disclose information on socially responsible performance. The Jones (1991) model, modified by Dechow et al, chosen to investigate whether companies use accrual-based earnings management, is the most commonly adopted one for such studies. In order to determine if companies use real earnings management, Roychowdhury's (2016) model, which consists of three elements: sales manipulation, overproduction, and reduction of discretionary expenditures, was applied. The results showed that Lithuanian socially responsible companies use both accrual-based and real earnings management less frequently and/or less aggressively than other companies do. Therefore, it can be concluded that they follow a conceptual approach and pursue social responsibility for the sake of the idea and the concept, not to gain an advantage and to be able to influence the decisions of stakeholders in the market.

Corporate earnings management strategy under environmental regulation: Evidence from China

In response to external adverse factors affecting corporate performance, managers may be motivated to engage in earnings manipulation. Environmental regulation as an institutional factor threatens normal earnings for heavy-polluting firms. This paper discusses corporate earnings management strategy under an environmental regulation policy. A multistage difference-in-differences (DID) estimation is performed, based on the central environmental protection inspection (CEPI) that is widely acknowledged as China's most stringent environmental policy. The results show that heavy-polluting firms significantly adjust their earnings management strategy after CEPI. Managers tend to adopt real activities manipulation with the effects of CEPI, while reducing their reliance on accrual-based earnings management. CEPI stimulates heavy-polluting firms to increase environmental investment, which makes their managers more likely to manage earnings through real activity manipulation, simultaneously resulting in the reduction of discretionary accruals. This earnings management strategy only appears in firms inspected in 2016 or non-state-owned enterprises or firms located in the regions with low environmental pressure. Our findings show that managers could use the chances provided by exogenous shocks to manipulate earnings.

Fundamental performance and earnings quality in private firms

PurposeThe purpose of this paper is to examine the effect on earnings quality in private firms caused by a negative shock to fundamental performance, while simultaneously addressing methodological challenges measuring fundamental performance present in prior accrual-based earnings management literature.Design/methodology/approachFundamental performance is unobservable and, therefore, difficult to measure. Existing research has used proxies that are subject to estimation errors and endogeneity concerns (e.g. DeFond and Park, 1997, Balsam et al., 1995). This study attempts to overcome these issues by taking advantage of the exogenous shock in oil price which occurred in 2014 and by using a difference-in-differences approach to investigate the effect on earnings management caused by a negative shift in fundamental performance.FindingsThe results suggest that a negative shock in fundamental performance, indicated by the oil price shock in 2014, reduces earnings quality. This result holds for various robustness tests such as the use of propensity score matching, and the inclusion of firm fixed effects. Additional analysis suggests that the reduction in earnings quality is driven by an increase in positive discretionary accruals, suggesting that managers of private firms experiencing poor performance manage earnings upwards to conceal true performance.Originality/valueThis study contributes to the literature by examining the effect of a negative shock to performance in a setting of private firms and by addressing methodological challenges in prior literature. Private firms are fundamentally different from public firms, with the consequence that results from public firms may not be generalizable to private firms (e.g. Hope et al., 2012, Burghstahler et al., 2006, Ball and Shivakumar, 2005).

High-speed rail network and earnings management techniques usage trade-off: the moderating effects of governance and religion

PurposeThis study aims to investigate the impact of the development of high-speed rail (HSR) network on earnings management, especially on the trade-off between the usage of accruals-based earnings management (AM) and real earnings management (RM) techniques, and consequently, examines the extent to which the HSR network–earnings management nexus is moderated by governance and religion factors.Design/methodology/approachUsing a sample of Chinese A-listed firms over an 11-year period, this study uses regression techniques as the baseline methodology while controlling for industry and year-fixed effects. The authors also use endogeneity tests (including instrumental variable method, Generalized Methods of Moments estimation and difference-in-difference) and different robustness checks.FindingsThe key findings are threefold. First, the HSR network development reduces AM. This suggests that the presence of HSR network is effective in reducing information asymmetry. Second, the use of RM technique increases with the HSR network development. This indicates that managers do not seem to engage in less earnings management with the HSR network development but instead appear to switch from the easy-to-detect AM to the more costly RM approach. Finally, the HSR network and earnings management nexus is moderated by governance and religion factors.Originality/valueThis study provides new evidence on the trade-off between AM and RM by managers and pioneers in examining the impacts of governance and religion factors on the relationship between the HSR network and the trade-off of earnings management techniques.

Overlapping institutional ownership along the supply chain and earnings management of supplier firms

We explore the impact of overlapping institutional ownership (OIO) within supply chains on the earnings management practices of supplier firms. Utilizing a dataset of U.S. publicly traded supplier firms from 1988 to 2016, we discover that suppliers with institutional ownership overlapping with their major customers exhibit reduced levels of discretionary accruals. This finding implies that such overlap discourages suppliers from engaging in upward earnings management through the manipulation of discretionary accruals. We also find that OIO curtails accrual-based earnings management by enhancing the relationship between supply chain partners and bolstering external monitoring. Additionally, we find that OIO also mitigates the extent of real earnings management undertaken by the supplier firm. These findings remain robust after addressing potential endogeneity concerns. Our results underscore the significant role of OIO within supply chains in curbing both accrual-based and real earnings management by supplier firms.

Capital structure and practices of accrual-based earnings management among non-financial Vietnamese listed firms

This paper’s primary goal is to examine the influence of a firm’s capital structures on practices of accrual-based earnings management by doing empirical research covering 51 non-financial Vietnamese listed companies during a period from 2013 to 2022. To estimate accrual-based earnings management practices, the modified Dechow and Dichev (2002) model was mobilized. Then, a regression between earnings management estimated values based on accruals and a group of capital structure variables and control variables that are hypothesized to influence earnings management practices is performed. The feasible generalized least square model is used to address econometric issues. Empirical results reveal that activities for managing accrual-based earnings indicate a considerable adverse influence from institutional ownership. However, other hypothesized variables that are management ownership, ownership concentration, foreign ownership, and leverage do not have a determinant sign as expected. ROA, one of five control factors, has a favorable impact on accrual-based earnings management practices, whereas company size has a negative impact. The study provides useful information to investors and stakeholders for their making investment decisions in Vietnam. The empirical findings are also based for recommendations to control earnings management practices at Vietnamese listed enterprises to enhance accounting information quality, thus contributing to the sustainable development of the Vietnam Stock Exchange.

Clawback adoptions, managerial compensation incentives, capital investment mix and efficiency

We present evidence that clawback adoptions, by dissuading accruals management, motivate managers to shift capital investment mix from R&D to capex to preserve earnings-based compensation, thereby lowering capital investment efficiency. These effects are more pronounced for firms prone to financial misreporting, which is consistent with board incentives to adopt clawbacks, and with managerial incentives to substitute real for accruals-based earnings management to preserve performance-based compensation. Path analyses lend support to performance-based compensation serving as a channel through which clawback adoptions influence capital investment mix and efficiency. These findings extend and reinterpret prior findings and are timely given the Security and Exchange Commission's newly issued Rule 10D-1 that makes clawback provision adoptions a condition for U.S. exchange listings and explicitly requested “comment on any effect the proposed requirements may have on efficiency, competition, and capital formation.”

Accrual-Based Earnings Management and the COVID-19 Pandemic

In this study, we document the accrual-based earnings management of Old Economy firms and New Economy firms (firms in the technology industry) and loss-making firms (firms with negative earnings in the pre-pandemic year, 2019) and profit firms in each economy, respectively, before, during, and in the recovery year of the COVID-19 pandemic. Using both univariate and difference-in-difference regression analyses, we find that old and new economy firms adopt different accrual-based earnings management, and Old Economy Loss firms changed their accrual-based earnings management the most during and in the recovery of the pandemic. During the 2020 pandemic, Old Economy Loss reported the lowest amount of accrual-based discretionary accruals. This suggests that Old Economy Loss firms are engaged in the most conservative approach to reporting their earnings, consistent with the big bath proposition. In the recovery year of the pandemic, 2021, we find that accrual-based earnings management reversed, with the old economy losing firms reporting the highest amounts of discretionary accruals. However, we do not find that the explanatory power of earnings on the variance of stock prices for the old economy loss firms is affected by their discretionary change in accounting accruals.

Institutional ownership, earnings management and earnings surprises: evidence from 39 years of U.S. data

PurposeAs the influence of institutional investors over managerial decision-making grows, so does the importance of understanding the effect of institutional investor ownership (IO) on firm outcomes. The authors take a comprehensive approach to studying the effect of IO on earnings management (EM).Design/methodology/approach The authors study the relation between IO and EM using a sample of 59,503 listed U.S. firm-year observations from 1981–2019. The authors proxy EM with earnings surprises and with accrual-based and real activity measures. The authors test for nonlinear relations and analyze changes resulting from the passage of the Sarbanes–Oxley Act.FindingsThe findings support a positive IO-EM relation overall, but show that the relation is dynamic and heavily context-dependent with evidence of nonlinearity. The authors also find evidence that IO positively affects accrual-based EM and real activities EM negatively.Originality/valueTo the authors’ knowledge, this is the first study of the IO-EM relation to consider evidence of nonlinearity in the U.S. context, measuring changes to the relation over time, and with the use of several measures of EM.

Related party transactions, accrual-based earnings management and real activities earnings management in emerging market

Purpose The purpose of this study is to examine the association between related party transactions (RPTs) in terms of sales and purchases and earnings management (EM). Design/methodology/approach The authors use the estimation method of system generalized method of moments (Sys-GMM) on a sample of 413 non-financial firms in Vietnam in the period from 2015 to 2019, totaling 1,638 firm-year observations. Multiple proxies for RPTs and EM are used to provide a comprehensive assessment of the relationship between the two factors. Findings There is a positive association between RPTs and EM, suggesting that both types of RPTs could reduce financial reporting quality and allow firms to be more engaged in earnings manipulation. Originality/value There are a number of studies investigating the above link, but they tend to use aggregate values (the sum of both sales and purchases with related parties) or just either accruals-based earnings or real EM. This study is the first to extend the literature on the relationship between RPTs and EM by examining both sales-based and purchases-based RPTs on both real and accruals-based earnings manipulation. This approach helps uncover the differences in the effect of the two types of RPTs on both types of upward EM.

Sentiment and Accruals Earnings Management: Does Governance and Regulatory Environment Matter?

This paper examines the implications of firm-level governance mechanisms and the regulatory environment on the relationship between investor sentiment and accrual-based earnings management. Our findings confirm the positive impact of sentiment on earnings management through accruals. Our results confirm that in the presence of a stringent regulatory environment, the likelihood of abnormal accruals following a positive sentiment environment is low. We document that a stringent regulatory environment reduces the likelihood of abnormal accruals following a positive sentiment environment. Results further confirm that improved governance characteristics like larger board, increased board independence, and stringent related party transaction norms help to monitor corporate behaviour and mitigates opportunistic earnings management activity of managers with an exogeneous effect of market sentiment. Thus, our results have important implications for regulators and policymakers for strengthening the regulatory and monitoring environment. Investors may also use earnings announcement news during an optimistic market sentiment scenario in a more informative way.

The Effect of Religion in European Financial Statement Disclosures: A Real Earnings’ Management Case

Prior research has extensively examined the relationship between religion and accrual-based earnings management. However, there is currently little research on the relationship between religion and real (non-accrual) earnings management, especially in Europe. This paper aims to fill this research gap and examines whether and how the effect of religion could be linked with firms’ real earnings management activities. Four hypotheses are developed and tested, with our results providing indications that the degree of overall religiosity is negatively and significantly associated with real earnings management. Furthermore, when investigating the effects of different religions in Europe, Christianity and Islam have the opposite impact on firms’ real earnings management activities. Overall, our paper indicates that in European countries, the religious environment can mitigate firms’ manipulations on earnings.

Real Earnings Management during Economic Downturns

ABSTRACT This study examines the impact of economic downturns on real earnings management activities in an international setting. Using a sample of 27 countries between 1988 and 2016, I find that the extent of real earnings management increases and that the substitution relation between real earnings management and accrual-based earnings management becomes stronger during economic downturns. Managers tend to rely on real earnings management to avoid the threat of greater scrutiny during economic downturns. The effect of an economic downturn on real earnings management is stronger for firms with high earnings management incentives, such as to avoid reporting earnings decreases and losses, to just meet or beat analysts’ earnings forecasts, and to facilitate the success of seasonal equity offerings. The findings suggest that real earnings management comes at a high cost. Firms sacrifice future performance when engaging in real earnings management. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G14; G28; G39; M41.

The School-ties Between Top Management Executive and Audit Partner: Exploring From Earnings Management in Indonesia

The objective of this study is to investigate the impact of school ties between top management executives, such as the Chief Executive Officer and Chief Financial Officer, and external parties, including auditors, on a company’s earnings management practices. This study uses fixed effect regression method to test the hypotheses, whether school ties between top management executives and audit partner will affect on the practical earnings management. The authors obtained sample from Indonesia Stock Exchange Commission during 2010 to 2022 and includes several causality tests to robust the empirical result from current study. Our findings suggest a noteworthy positive association between school-ties linking the Chief Executive Officer (CEO) and the Auditor with Earnings Management. However, our analysis reveals that other combinations of school ties exhibit an opposite effect. The findings of this study suggest that ties between internal and external parties within a company may be a factor that investors should carefully consider when evaluating the accuracy and reliability of financial reports. As such, it may be prudent to avoid investing in such companies. Despite prior research extensively examining the measurement of accrual-based earnings management, the literature lacks discussion regarding its association with the potential influence of ties. Thus, this study aims to fill this gap by investigating the relationship between top management school ties and earnings management.

Impact of the Independent Directors' Social Network on Earnings Management Before and During the COVID-19 Period

This study examines the impact of the independent directors' social network on earnings management before and during the COVID-19 pandemic. The COVID-19 pandemic increased uncertainty and pressure in the business environment, which led to intensified earnings management of listed companies worldwide. The research constructs centrality indexes of the independent director social network through the social network analysis method and conducts an empirical study on 1,167 A-share listed companies in China from 2009 to 2020. The relationship between independent directors' network centrality and accrual-based earnings management of companies is examined. Empirical results reveal that independent directors' network centrality is associated with higher accrued earnings management and undesirable corporate practices such as earnings management can be disseminated through directors' social networks. This research innovatively incorporates the research findings into the COVID-19 context, further indicating that independent directors' social network is associated with higher accrued earnings management during the COVID-19 period than before. This research will provide insights for regulators, specifically regulators in China, regarding the independent directors' composition and effectiveness.

Effect of accounting information manipulation on innovation: Evidence from China

This study focuses on the real effect of accounting information manipulation. We find that accrual-based earnings management (AEM) impairs corporate innovation in China and the mechanisms include formal (i.e., financing) and informal (i.e., trust) channels. First, AEM impedes access to equity and debt financing, and government technological subsidies. Second, firms with AEM are considered less trustworthy, leading to less collaborative innovation. Furthermore, AEM leads to less R&D input and lower innovation efficiency. Our study reveals the mechanisms through which accounting information quality affects corporate innovation in emerging markets and demonstrates how accounting information affects economic outputs by influencing mutual trust.

Does Investment Bankers’ Prior Experience in Public Accounting Reduce Earnings Management in IPO Firms?

SUMMARY We examine whether firms undertaking an initial public offering (IPO) exhibit less earnings management when individual investment bankers have prior experience in public accounting. Although auditors are primarily responsible for providing external monitoring of the financial reporting process, individual bankers also have strong incentives to improve accounting quality in firms going public. We predict a negative relation between public accounting experience and IPO firms’ earnings management because working in public practice fosters individual bankers’ accounting expertise and conservative personalities. In exploiting unique disclosures of investment bankers’ identities and characteristics in China, our analysis indicates that bankers with early-career public accounting experience constrain IPO firms’ accrual-based earnings management. Consistent with expectations, we find that this evidence is more pronounced if the accounting firm that employed the future investment banker is larger, is permitted to audit listed companies, and was previously subject to a regulatory sanction. Data Availability: Most data are publicly available from the sources identified in the paper. Hand-collected data from the Securities Association of China (SAC) can be made available upon request. JEL Classifications: G24; M41; M42.

Changes in Accounting Standards and Accrual-based Earnings Management: Evidence from CAS 14

This research aims to explore the relationship between changes in accounting standards and accrual-based earnings management in Chinese listed A-share firms. Specifically, this paper focuses on CAS 14, an accounting standards amendment closely related to revenue recognition under IFRS 15, introduced by the Ministry of Finance of the People’s Republic of China. By analyzing a comprehensive sample of 25,309 observations spanning the years 2014 to 2021, this paper reveals compelling evidence that Chinese firms exhibit reduced utilization of accrual-based earnings management after the adoption of CAS 14 in 2018.

Boundaries of the firm and real earnings management

Despite harmful effects, Real Earnings Management (REM) is increasingly becoming a more popular method of earnings management than Accruals based Earnings Management (AEM) (Cohen et al., 2008; Commerford et al., 2018). We argue that when a firm’s organizational structure has extended boundaries with other firms, the benefits due to REM can outweigh the costs. We use family business groups, that extend firm boundaries with other affiliated firms, for testing our conjecture. Using a large dataset of 11,417 firm-year observations of Indian firms, we show that REM is significantly higher in business group affiliated firms compared to standalone firms. Further, intra-group transactions, in the form of purchases, sales, and cash flows from operating activities, contribute to higher REM activities. More importantly, when group affiliated firms engage in intragroup transactions and report higher REM, mainly in the form of abnormal production, they experience an increase in their future profitability and a decrease in their cost of equity.