Discretionary Accounting Accruals Research Articles

Valuation and underpricing of initial public offerings: The role of discretionary accounting accruals

This study examines the role of pre-IPO (pre-initial public offering) discretionary accruals in the valuation and underpricing of IPOs. We find that the underwriter offer price is unaffected while the market closing price is positively associated with the levels of pre-IPO discretionary accruals for issuers with aggressively reported earnings. We also find that this relative over-valuation of managed earnings by the markets explains a portion of the initial return that is not explained by other known determinants. For issuers with conservatively reported pre-IPO earnings, there is no relation between discretionary accruals and the offer price or the market price, and the discretionary accruals do not explain any IPO underpricing. Our subsequent analysis shows that lower stock retention is a screen and a signal of entrepreneurs’ credibility to the markets. There seems to be a higher degree of earnings scrutiny by both the markets and the underwriters for IPOs with low insider retention. However, markets tend to assign a higher weight to aggressively reported earnings of issuers with higher insider retention, presumably because of perceived incentive alignment. Underwriters, with relatively lesser information asymmetry than the markets, tend to see through the distortions caused by earnings manipulations in the valuation of IPOs, regardless of the levels of issuers’ stock retention.

Earnings Management and Company Characteristics: Empirical Evidence from Algerian Companies

Abstract This paper attempts to analyze the impact of some Algerian companies’ characteristics (size, activity sector, property, listing, and nature of financial statements) on the level of earnings management. The research employed 117 observations for 26 Algerian companies from 2016 to 2020 and used a multiple linear regression model and discretionary accounting accruals to measure earnings management. According to the findings, earnings management in Algeria is explained by the companies’ sizes, activity sectors, and stock market listing. However, the nature of financial statements and the ownership of the companies do not affect earnings management. These results are beneficial for regulators and auditors since they provide empirical evidence about the characteristics of companies that manipulate earnings. Consequently, they can enable them to take appropriate actions to enhance the quality of financial reports, whether when developing and reviewing accounting standards by regulators or when examining financial information by auditors.

The impact CSR Disclosure on Earnings Quality: Analytical Study on Saudi Basic Materials Sector: أثر الإفصاح عن المسؤولية الاجتماعية على جودة الأرباح دراسة تحليلية في قطاع المواد الأساسية السعودي 2015-2017م

The current study aims to gain insight on the effect of social responsibility disclosure on the quality of earnings in (42) Saudi Basic Materials companies listed in the Saudi Financial Market. The extrapolation approach has been used to achieve the goals of the study. Also, the descriptive analytical approach has been employed to analyze the content of the financial reports of the sample companies for the period (2015 – 2017) in order to determine the level of disclosure of social responsibility. The quality of earnings has been measured by using the Modified Jones Model. The most significant study findings show that 92.5% of the sample companies disclosed their social responsibility using descriptive disclosure methods. The study findings also show that there is a statistically significant relationship between disclosure of social responsibility and between the improvement of the quality of earnings in the Basic Materials sector due to the strong positive correlation between discretionary accounting accruals and disclosure of social responsibility. The study has also found that there is a statistically significant relationship between social responsibility and between the effectiveness of the accruals method in measuring the quality of earnings in the Saudi Basic Materials sector, where the accruals quality method proved to be efficient in measuring the quality of earnings. In view of the findings, the study recommends to actively promote the role of the organizations that regulate social responsibility in order to increase the level of social responsibility, and to promote the role of monitoring which will in turn improve the quality and level of earnings.

The Influence of Cost Stickiness on Earnings Management through Discretionary Accounting Accruals

The Influence of Cost Stickiness on Earnings Management through Discretionary Accounting Accruals

Does there prevail momentum in earnings management for seasoned equity offering firms?

This study investigates the relationship between current and past period earnings manipulations for multiple seasoned equity offering (SEO) firms. These firms' discretionary accounting accruals (DAs) increase with the extent of cumulative prior DAs accompanying prior equity offers, consistent with the notion that prior earnings manipulators' continually inflate the earnings around SEOs. The prior manipulators appear to both engage in real activities as well as use accounting accruals to alter reported earnings. Nevertheless, the portfolio with the greatest allegedly cumulative manipulation and current income-increasing DAs in the issuance year generates significantly deteriorating post-issue stock returns.

Playing for keeps: local government distortion of depreciation accruals in response to high-stakes public policy-making

Use of discretionary accounting accruals has long been recognized as a vehicle for earnings management in the private sector. More recently, evidence has emerged suggesting that public officials may similarly manipulate discretionary accruals in order to achieve ‘balanced’ operating results. This paper extends the previous literature on the manipulation of depreciation accruals to the realm of high-stakes public policy-making.

Institutional Ownership and Earnings Management in India

Influence of institutional ownership has been hypothesised to efficiently monitor the managerial decisions especially discretionary role of managers in reporting earnings. The managers have been found to misrepresent the quality of earnings for a dividend declaration; new issue; takeovers and for affirming debt holders of their financial position. Panel data methodology focusing on firms listed in CNX 500 in National Stock Exchange empirically examines the impact of institutional ownership on the earnings management practices in India. Earnings management is measured using discretionary accounting accruals. Firms with higher institutional holdings are found to have higher earnings quality thus restricting managers from using their discretionary powers to report earnings. Institutional ownership has a negative relationship with earnings management for larger and matured firms. Growing firms are found to be having higher earnings management. Institutional investors monitor the firms and hence reduce aggressive earnings management practices within the firm. Foreign institutional ownership also has a negative relationship with earnings management.

Institutional Ownership Composition and Earnings Management

This paper examines the impact of outside block-holders on earnings management, using discretionary accounting accruals as the measure of earnings management. For the income-decreasing earnings management scenario, we do not find significant results. This may be attributable to the different natures and time horizons of outside block-holders. Since the majority of outside block-holders are institutional investors, we then investigate the relationship between ownership by institutional investors with different natures and earnings management. Specifically, we find a significant positive relationship between ownership by transient institutional investors (holding diversified portfolios with high turnover) and discretionary accounting accruals. However, we do not find a significant relationship between ownership by dedicated institutional investors (holding concentrated portfolios with low turnover) and discretionary accounting accruals. Therefore, due to the differing natures of institutional investors, we may not treat them as a homogeneous group.

Earnings Management from the Bottom Up: An Analysis of Managerial Incentives Below the CEO

Performance-based pay is an important instrument to align the interests of managers with the interests of shareholders. However, recent evidence suggests that high-powered incentives also provide managers with incentives to manipulate the firm's reported earnings. The previous literature has focused primarily on Chief Executive Officers, but managers further down in the firm hierarchy — division managers and Chief Financial Officers — are likely to have similar incentives, and perhaps even greater opportunity to influence reported earnings in a manner that maximizes these managers’ personal income. Moreover, previous research focuses on equity incentives and largely ignores other elements of incentive pay. We contribute to this literature by analyzing all forms of incentive pay for several types of managerial positions and include additional measures of earnings manipulation — end-of-year excess sales and class action litigation — in addition to the standard measure of discretionary accounting accruals. We find that the association between high-powered incentives and earnings manipulation varies by both type of incentive pay and position. Our findings have important policy implications and suggest that compensation committees should review pay policies of other managerial positions in addition to CEOs. Importantly, if the committees wanted to weaken incentive pay to get more truthful reporting, diluting the CFO’s bonus and stock options would be one place to start.

Takeovers And Incentives For Earnings Management: An Empirical Analysis

This study tests the hypothesis that managers of firms that are targets of takeovers systematically increase reported earnings in the quarters immediately preceding and following initiation of the takeover attempt. Using both a modified version of the Jones method and the DeAngelo method, discretionary accounting accruals are examined for a sample of 100 firms that were targets of tender offers between 1985 and 1989, inclusive, and for a control group of nontargets. Results for the quarter ended prior to initiation support the hypothesis. Additional tests performed on the sub-samples of hostile and friendly takeover targets indicate that the results obtained for the sample as a whole are primarily due to the hostile takeover targets. No evidence of earnings management is found in the quarter ended subsequent to initiation.

Income Smoothing Using Reserve Accounts By Japanese Companies

<p class="MsoBodyText3" style="line-height: normal; margin: 0in 34.2pt 0pt 0.5in;"><span style="font-family: Times New Roman;"><span style="font-size: 10pt; mso-bidi-font-style: italic;">This paper </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">examines</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">income-smoothing </span><span style="font-size: 10pt; mso-bidi-font-style: italic;">by Japanese firms using several reserve accounts. </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">Previous</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> studies investigate</span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">d</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> the incentives for Japanese managers to smooth income using sales of assets</span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">, discretionary </span><span style="font-size: 10pt; mso-bidi-font-style: italic;">accounting accruals </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">or </span><span style="font-size: 10pt; mso-bidi-font-style: italic;">depreciation charges under different operating environments</span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">.</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">Discretion</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">in</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> reserve accounts </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">as a means of income-smoothing, however, </span><span style="font-size: 10pt; mso-bidi-font-style: italic;">has not yet been investigated</span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">.</span><span style="font-size: 10pt; mso-bidi-font-style: italic;"> </span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;">Understanding Japanese </span><span style="font-size: 10pt; mso-bidi-font-style: italic;">managers’ earnings management</span><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;"> via reserve accounts is particularly interesting because of the unique legal environment for reserve accounts. We find that income-smoothing via reserve accounts is associated with size, tax, capital intensity, operating deviations, leverage, earnings variability, and securities offerings. When we partition the sample to take into account the substantial structural changes in Japan in 1990, the effects of several variables appear to be different over the two periods</span><span style="font-size: 10pt; mso-bidi-font-style: italic;">.</span></span><strong><span style="font-size: 10pt; mso-fareast-font-family: Batang; mso-bidi-font-style: italic; mso-fareast-language: KO;"></span></strong></p>

Valuation and Underpricing of Initial Public Offerings: Role of Discretionary Accounting Accruals

This study examines the role of pre-IPO discretionary accruals in the valuation and underpricing of IPOs. We find that the underwriter offer price is unaffected whereas the market closing price is positively associated with the levels of pre-IPO discretionary accruals for issuers with aggressively reported earnings. We also find that this relative over-valuation of managed earnings by the markets explains a portion of the initial return that is not explained by other known determinants. For issuers with conservatively reported pre-IPO earnings, there is no relation between discretionary accruals and the offer price or the market price, and that the discretionary accruals do not explain any IPO underpricing. Our subsequent analysis shows that lower stock retention appears to be a screen and a signal of entrepreneurs’ credibility to the markets. There seems to be a higher degree of earnings scrutiny by both the markets and the underwriters for IPOs with low insider retention. However, markets tend to assign higher weight to aggressively reported earnings of issuers with higher insider retention, presumably because of perceived incentive alignment. Underwriters, with relatively lesser information asymmetry than the markets, tend to see through the distortions caused by earnings manipulations in the valuation of IPOs, regardless of the levels of issuers’ stock retention.

Accounting Responses to Hedge-Fund Activism

We examine changes in firms’ discretionary accounting accruals around the commencement of activism by hedge funds. We argue that hedge funds have the potential to provide increased monitoring of earnings management behavior and we predict and find empirically that average discretionary accruals decrease around the commencement of hedge fund activism. We find in both univariate and multivariate tests that discretionary accruals decline significantly after commencement of hedge fund activism, suggesting activist hedge funds do provide at least some incremental monitoring of accounting and reporting in addition to their focus on the governance, operations and financing of target firms. However, we find no cross-sectional relationship between changes in earnings management and analyst following, institutional ownership or other factors, suggesting that the accounting improvements are not conditional on these factors but are instead a general benefit resulting from the intervention of activist hedge funds.

Auditor conservatism following audit failures

PurposeThe purpose of this paper is to examine the effects of audit failure on Big 4 audit firm monitoring activities. The paper analyzes changes in discretionary accruals (DAs) among clients of firms implicated in audit failure events and examines whether these DAs decline in the period following the event.Design/methodology/approachThe paper uses archival data and regression analyses to test whether DAs for clients of implicated audit firms decline in the period following the audit failure as compared to clients of other Big 4 firms. Audit failures are identified during the years 1996‐2004 based on significant lawsuit settlements. The paper focuses on an office‐level analysis to control for audit quality differences which may vary across firm geographic locations as suggested by recent research.FindingsEmpirical results indicate that auditor response to audit failure has changed over time. Auditors implicated in audit failure events occurring in the post‐Enron and Sarbanes‐Oxley period enforce more conservative accounting choices in the year following the event. Specifically, clients of the implicated firm's office report a significant decline in discretionary accounting accruals relative to clients of other auditors in the same city location. However, a significant change in client discretionary accounting accruals is not found following audit failures that occurred prior to 2001, the year of the Enron bankruptcy.Originality/valueThe results of this paper extend the knowledge of the effects of litigation pressure on audit quality. Additionally, this paper helps address the question of how large‐scale audit failures witnessed at the beginning of the century have impacted audit firm conservatism.

Stock Repurchases, Stock Options, and Earnings Management: An Empirical Analysis of US Firms

This paper examines the relationship between open market repurchases, stock options, and earnings management. Using a sample of firms in the S&P 500, S&P Midcap 400 and S&P Smallcap 600 indices during 1998-2004, we find that, after controlling for the traditional motives, managerial stock options affect positively the magnitude of actual repurchases. In addition, while both managerial options exercisable and unexercisable have a positive effect on actual repurchases, exercisable options have a larger effect than unexercisable options. We also find managers use stock repurchases as a substitute device for discretionary accounting accruals in their earnings management behavior. The evidence further shows that managerial stock options, especially managerial options exercisable, are positively associated with the magnitude of earnings management.

The IPO Derby: Are There Consistent Losers and Winners on This Track?

We examine the individual and joint relation of discretionary accounting accruals, underwriter reputation, and venture capital backing with the long‐run performance of initial public offerings (IPOs). We find that although correlated to some extent, these variables do not manifest the same underlying phenomena in their relation to IPOs' performance. The confluence of the variables is more important than using any one of them individually to identify IPOs that exhibit abnormal long‐run stock returns. The combination of their negative aspects helps identify extreme underperformers. We also identify a set of winner IPOs by combining the positive aspects of the three variables.

The Potential Impact of More Frequent Financial Reporting and Assurance: User, Preparer, and Auditor Assessments (Retracted)

The purpose of this study is to examine some of the potential impacts of more frequent financial reporting and concurrent assurance, as assessed by members of the assurer, preparer, and investor communities. Two hundred and fifteen participants (84 auditors, 30 controllers, 80 investors, as surrogated by MBA students, and 21 sell-side analysts) took part in an experiment where they received a case situation involving a company that was planning to voluntarily change from quarterly to monthly (daily) external financial statement reporting, without (with) assurance. After reading the case materials, the participants assessed the likely effects of such changes on the decision usefulness of financial statements, quality of earnings, financial reporting behavior, stock market price volatility, analysts' consensus forecasts, and cost of capital. The results indicate that monthly reporting without assurance would significantly enhance the decision usefulness of financial statements, improve the quality of earnings, and reduce managements' aggressiveness with respect to discretionary accounting accruals, estimates, and principles; further, the findings suggest stock price volatility would be lower, analyst consensus of future earnings estimates would increase, and cost of capital would decrease. Assessments of daily reporting were consistent with monthly reporting, yet significantly stronger. The inclusion of concurrent auditor assurance resulted in directionally consistent yet significantly pronounced results in both monthly and daily reporting conditions on all measures. Additionally, participants agreed that providing monthly reports would be technically and economically feasible at this time, while daily reporting would not be feasible.

Block-ownership and earnings management in Malaysian listed firms

This study examines the association between level of block ownership and earnings management activities in Malaysian listed companies. Agency theory suggests separation of ownership and control gives rise to manager’s incentives to select and apply accounting techniques opportunistically at the expense of the shareholders. The existence of block ownership may reduce the agency cost to shareholders since block-holders are in a better position and capacity to monitor the management. Our results indicate that there is no significant relationship between the level of block-ownership and the magnitude of discretionary accounting accruals. This indicates that block-ownership is not an effective mechanism in mitigating aggressive earnings management by firms. However, further analysis indicates that institutional and holding block-ownerships are negatively related to the discretionary accruals. This suggests that institutional block and controlling block ownerships have more incentives and possess more sophisticated mechanisms to entail better control toward managerial opportunistic behaviours

Discretionary Accounting Accruals, Managers' Incentives, and Audit Fees*

AbstractThis paper examines the linkages between discretionary accruals (DAs), managerial share ownership, management compensation, and audit fees. It draws on the theory that managers of firms with high management ownership are likely to use DAs to communicate value‐relevant information, while managers of firms with high accounting‐based compensation are likely to use DAs opportunistically to manage earnings to improve their compensation. OLS regression results of 648 Australian firms show that (1) there is a positive association between DAs and audit fees; (2) managerial ownership negatively affects the positive relationship between DAs and audit fees; and (3) this negative impact is further found to be weaker for firms with high accounting‐based management compensation.

The IPO Derby: Are There Consistent Losers and Winners on This Track?

Recent studies have documented that various factors such as discretionary accounting accruals, underwriter reputation, venture capital backing, and firm size will affect the long-run performance of IPOs. However, it is not clear whether the return predictability of these attributes are the manifestation of one phenomenon, or independent results. In this study, we use univariate and multivariate analyses on these factors to trace the sources of return predictability. We find that these previously identified effects are not the same phenomenon, though correlated to some extent. The results show that a confluence of these determinants is more important than any individual factor in explaining the IPO long-run performance. We also identify a subset of IPOs that outperform their benchmark and another subset that consistently underperforms.