Discretionary Expenditures Research Articles

An examination of real activities management and corporate cash holdings

I examine the relation between aggressive income increasing real activities management (RAM) and corporate cash holdings. Motivated by Jensen's (1986) concerns about free cash flows, I investigate whether aggressive cuts in discretionary expenditures are associated with higher levels and changes of cash holdings. Using empirical models from prior research, I document that aggressive income increasing RAM is associated with higher cash holdings and this positive association is stronger in weakly governed firms. I also find that weakly governed firms with aggressive income increasing RAM and high levels of cash tend to spend more on future investments, suggesting an effort to reduce accumulated cash and increase real assets under control. My results are robust to endogeneity, additional control variables, and alternative design choices. Evidence in this study provides a link between corporate cash holdings and aggressive cuts in discretionary expenses that allow managers to report higher earnings, indicating that efforts to achieve financial reporting objectives have implications for cash management.

The Role of Overbilling in Hospitals’ Earnings Management Decisions

This paper examines the role of overbilling in hospitals’ earnings management choices. Overbilling by hospitals is a form of revenue manipulation that involves misclassifying a patient into a diagnosis-related group that yields higher reimbursement. As overbilling allows hospitals to increase revenues without altering operations, affecting costs, or having to reverse such behavior in the future, I propose and find that overbilling reduces hospitals’ use of managing accruals or cutting discretionary expenditures. Next, I find that hospital managers prefer overbilling to managing accruals (cutting discretionary expenditures) when cutting discretionary expenditures (managing accruals) is constrained, and vice versa. Collectively, my findings suggest that overbilling is an important alternative manipulation tool in hospitals.

Debt Strategy Trends of Emerging Market Firms

Different industry sectors have high degree of variation with respect to financial leverage. The excessive use of financial leverage by firms had played a paramount role in the 2008 financial crisis. This study examines the average debt intensity of different industrial sectors during different time period. The study was based on a sample of approximately 20,000 companies representing 19 different industry sectors. The study explores whether there exist persistent differences in leverage ratios across different industry sectors in India. The study examines whether the leverage measures of the Indian firms have changed during different period of analysis. The study also examines the determinants of an optimal capital structure. Electricity sector is the most debt intensive sector among the different industry sectors. Communication, construction and real estate sectors were the next debt intensive sectors among the Indian industrial sectors. The average debt equity ratio of all the industry sectors was 16.57 reflecting the high debt intensity characteristics of Indian Industry. The mean debt equity ratio ranged from 1.45 (Machinery & Transport) to 85.64(Electricity) during the period 2005-2016. The average return on capital employed was negative for all the sectors during the period 2000-2016 except for electricity sector. The average leverage of 10 industry sectors increased in the period 2010-2016 compared to the period 2000-2009. The study document statistically significant variation in mean leverage ratio for industry sectors like communication, construction and real estate, electricity and miscellaneous manufacturing. The most leverage intensive sector construction and real estate sector was the only sector with positive average return on capital and had highest cash flow intensity during the period 2010-2016. Regression results finds statistically significant negative relationship between profitability and leverage. Less profitable firms tend to use more financial leverage. Firms that have more profits tend to have lower leverage. This result is in line with pecking order theory. Some evidence suggest that debt ratio is inversely related to the costs of financial distress. Firms with higher discretionary expenditures tend to have higher cash flows and hence lower costs of bankruptcy. Textile, metal, financial services, electricity and consumer goods are highly debt intensive industries.

The Role of Overbilling in Hospitalss Earnings Management Decisions

This paper examines the role of overbilling in hospitals’ earnings management choices. Overbilling by hospitals is a form of revenue manipulation that involves misclassifying a patient into a diagnosis-related group that yields higher reimbursement. As overbilling allows hospitals to increase revenues without altering operations, affecting costs, or having to reverse such behavior in the future, I propose and find that overbilling reduces hospitals’ use of managing accruals or cutting discretionary expenditures. Next, I find that hospital managers prefer overbilling to managing accruals (cutting discretionary expenditures) when cutting discretionary expenditures (managing accruals) is constrained, and vice versa. Collectively, my findings suggest that overbilling is an important alternative manipulation tool in hospitals.

Information Technology, Revenues, and Profits: Exploring the Role of Foreign and Domestic Operations

How does information technology (IT) enable firms to globalize their operations and achieve higher foreign profits? We use archival data for multinational firms publicly traded in the United States for the years 1999–2006, and find indirect evidence for the role of IT to help firms achieve higher foreign profits through revenue growth rather than cost reduction. Our findings suggest that foreign responsiveness plays a more important role in generating foreign profits than does value chain structure. Our exploratory analyses for the effect of IT on domestic revenues and profits suggest some evidence for equalization of returns across foreign and domestic operations. Among additional results, we find that research and development is positively associated with foreign revenues and foreign profits with an effect greater than that of IT, and advertising is positively associated with foreign revenues with an effect greater than that of IT. By documenting how IT creates value for firms through globalization, we extend the business value of IT and international business literatures that have so far touched on firm-level globalization benefits from IT only in passing. The findings can help managers decide how to allocate discretionary expenditures to achieve strategic objectives such as foreign and domestic revenues and profits, and the role of revenue versus cost mechanisms. The online appendix is available at https://doi.org/10.1287/isre.2017.0689 .

Earnings Management: An Advantage or Disadvantage?

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

Short term real earnings management prior to stock repurchases

This study examines whether firms engage in income-decreasing real earnings management before open market stock repurchases to reduce the cost of stock buybacks. In the short run, managers have the ability to underproduce inventory and increase discretionary expenditures, thus decreasing current period earnings. We find that managers engage in both of these activities before repurchasing their firms’ shares, especially the latter. Also, companies increase their discretionary spending before making repurchases to a greater extent following the passage of the Sarbanes–Oxley Act of 2002 as well as when they are financially healthy and have high marginal tax rates. Finally, we document that firms with the most income-decreasing real earnings management experience the largest positive abnormal returns during the subsequent period. Our findings highlight the importance of considering firms’ use of real operating decisions, as opposed to just opportunistic disclosure practices, around significant corporate events, such as the repurchase of their own stock.

Target ownership plans and earnings management

We examine the effect of target ownership plans (TOPs) on earnings management, after controlling for self-selection bias originating from firm characteristics underlying the determinants of TOPs. Our analyses show that firms engage in less accruals management for up to two years following plan adoption. Additionally, we find that the reduction in accruals management is concentrated in adopting firms whose CEOs' ownership levels are increasing because they have not yet met the ownership requirements. Interestingly, we find that TOPs are associated with less use of income-increasing accruals and less real earnings management, particularly through manipulation of discretionary expenditures. Finally, our results suggest that firms adopt TOPs not only in response to poor performance as documented by prior research, but also as a means to mitigate moral hazard concerns and in response to peer pressure. Our findings support the argument that TOPs align CEOs' incentives with shareholders' in that these plans result in reduced management short-termism. Data availabilityAll data used in the study are available from the public sources identified in the text.

Aggressive Real Earnings Management and the Value of Firm Cash Holdings

I examine whether aggressive income-increasing real earnings management (REM) influences the value of firm cash holdings. Motivated by agency problems of REM and free cash flows, I predict that aggressive cuts in discretionary expenditures have a negative effect on the marginal value of cash holdings. Using an abnormal returns model, my analysis documents that investors place a lower value on cash holdings of aggressive income-increasing REM firms. Economically, these results indicate that the marginal value of cash holdings is 16 cents lower in aggressive REM firms relative to non-aggressive REM firms. I also examine subsamples with positive abnormal cash holdings, higher incentives for REM, and different investment environments and find evidence consistent with my main results. Findings in my study contribute to two lines of research by documenting that REM influences the value that investors place on firm cash holdings.

The Impact of the Eurozone Crisis on European Banks Stocks Contagion or Interdependence?

JEL Classification: E6; F3; G2 1. Introduction The 2007-2009 crisis began by intense tensions in the financial systems of advanced economies and unraveled into a dramatic contraction in global growth. To prevent a larger collapse in economic activity, governments and central banks intervened massively in order to support aggregate demand--via automatic stabilizers and discretionary expenditures--and to bailout financial institutions. As a result, public finance experienced a marked degradation, leading to the emergence of the Eurozone sovereign debt crisis as a new phase of the global crisis. (1) According to the IMF Fiscal Monitor, the fiscal deficit in advanced countries (2) moves from 1.3% of the GDP in 2006 to 8.9% in 2009 while the public debt in percentage of the GDP climbed from 75.8 to 93.7 over the same period. The degradation in public finance has been more dramatic in the euro area, and more specifically in its peripheral countries. Thus, the average fiscal deficit in Greece, Ireland, Italy, Portugal, and Spain (GUPS-group) increased from 1.6% of the GDP in 2006 to 11.2% in 2009, while their public debt surged from 68.4% to 89.6% (with a projected peak at 130.5 percent of the GDP). Any drop in the market value of European sovereign debt has a negative impact on the balance sheets of European banks. Banks hold large amounts of government bonds to satisfy multiple purposes. First, investing in government bonds allows financial institutions to diversify their portfolio into low risk assets. The European prudential regulation has encouraged banks to hold such safe and liquid securities that may help to cushion losses on riskier assets. Second, holding government bonds is crucial for banks to access the central bank liquidity, insofar as the refinancing operations of the central bank are based on highly rated securities. Besides, interbank loans and repos rely heavily on the use of public bonds as collaterals. Therefore, when the value of sovereign bonds plummets it reduces both the market value of these assets in banks' balance sheets and banks' access to funding. These large holdings of Eurozone government bonds by European banks have led to a growing concern about possible spillovers from the sovereigns to the banks and a second round of spillovers from banks to sovereigns. Caruana and Avdjiev (2012) identify various channels of transmission from sovereign risks to the financial sector. First, they stress the impact of direct portfolio exposures. The Committee on the Global Finance System estimates that, for a sample of 21 advanced economies (3) at the end-2010, the banks' exposures to the domestic sovereign, measured as a percentage of banks' equities, have been above 30 percent in all countries except Austria, Ireland, and the United Kingdom (CGFS, 2011). On average, 85 percent of this exposure is held in the banking book. It is important to stress that the holding of government bonds is characterized by a strong home bias. Second, as sovereign bonds are used by banks as collaterals, a decrease in the quality of government debt may lead to a significant deterioration of funding conditions for financial institutions. (4). A third channel of transmission from sovereigns to banks resides in the fact that a marked increase in sovereign credit risk may trigger doubts on the ability of the governments to offer a credible guarantee to banks and / or financial supports in case of distress. In other terms a sovereign domestic debt crisis decreases the value of the explicit and implicit government guarantees that benefit banks that are considered too big or too interconnected (TBTF) to be allowed to fail. As these guarantees amount to very significant government subsidies (Schich and Lindh, 2012) their impairment may have a large negative impact on TBTF banks' balance sheets. This paper contributes to the growing literature on the European sovereign debt crisis by focusing on the impact of the successive crises on banks' equity returns over the period 2007-2013. …

CEO Risk Incentives and Real Earnings Management

<p>Previous research shows that companies use option compensation to motivate managers to accept risk (Jensen & Meckling, 1976). Indeed, risk adverse CEOs are likely to accept less risk than that accepted by diversified shareholders (Fama & French, 1992). Nonetheless, not all risks produce the expected benefits and risk has an intrinsic cost, such as potential large losses, that cannot be eliminated. Therefore, given CEO risk incentives, real earnings management can be viewed as a mechanism used to avoid the undesirable consequences of risk on reported earnings. However, engaging in real earnings management requires cutting investments, such as R&D, that have a well-documented association with firm’s future risk profile (Comin & Philippon, 2005). As a consequence, the use of real earnings management by CEOs with high-risk incentives as a tool for mitigating the intrinsic costs of risk is an empirical question that we tackle in this paper. Using a sample of quarterly observations from US firms over the period 2003-2010, and an instrumental variable approach to overcome endogeneity concerns, we show that CEOs with high risk-related incentives engage less in real activity manipulations that encompass cutting discretionary expenditures than do executives with low incentives. These findings are consistent with the idea that CEOs incentivized on risk avoid engaging in real management activities that can decrease firm’s future risk profile.</p>

Fiscal Rules, Fiscal Space, and the Procyclicality of Fiscal Policy

We analyze the interaction of fiscal rules and fiscal space. We find strong evidence for fiscal rules being associated with higher fiscal space for the EU27 countries for the period 1990-2014. Furthermore, the analysis shows that countries with more fiscal space tend to have higher discretionary expenditures, but that this effect is significantly reduced if fiscal rules are in place. Moreover, we find support for the hypothesis that the procyclicality of fiscal policy is significantly higher in an environment of ample fiscal space and that fiscal rules can help lowering this procyclicality.

Impact of Discretionary Expenditures on Profitability during Recession: Evidence from Manufacturing Sector in India

Advertisement and R & D expenditures are often considered as strategic variables which add value to the firm. During recession these expenses are often been compromised due to various reasons by the firms. This sometimes proves out to be costly for the firms in long run as they fail to catch up even after recession is over. Firms while taking these decisions often ignore the interaction effect of these variables with other variables in affecting profitability. This paper aims to show that Advertisement and R & D activities have moderated other variables in positively affecting performance especially during recession. Hence, firms must take into consideration the interaction effects of R & D and advertisement intensities with other important variables.

Behavioral economic predictors of brief alcohol intervention outcomes.

The present study attempted to determine whether behavioral economic indices of elevated alcohol reward value, measured before and immediately after a brief alcohol intervention, predict treatment response. Participants were 133 heavy drinking college students (49.6% female, 51.4% male; 64.3% Caucasian, 29.5% African American) who were randomized to 1 of 3 conditions: motivational interviewing plus personalized feedback (brief motivational interventions; BMI), computerized personalized feedback intervention (electronic check-up to go; e-CHUG), and assessment only. Baseline level of alcohol demand intensity (maximum consumption) significantly predicted drinks per week and alcohol problems at 1-month follow-up and baseline relative discretionary expenditures on alcohol significantly predicted drinks per week and alcohol problems at 6-month follow-up. BMI and e-CHUG were associated with an immediate postsession reduction in alcohol demand (p < .001, ηp2 = .29) that persisted at the 1-month follow-up, with greater postsession reductions in the BMI condition (p = .02, ηp2 = .06). Reductions in demand intensity and Omax (maximum expenditure) immediately postintervention significantly predicted drinking reductions at 1-month follow up (p = .04, ΔR2 = .02, and p = .01, ΔR2 = .03, respectively). Reductions in relative discretionary expenditures on alcohol at 1-month significantly predicted drinking (p = .002, ΔR2 = .06,) and alcohol problem (p < .001, ΔR2 = .13) reductions at the 6-month follow-up. These results suggest that behavioral economic reward value indices may function as risk factors for poor intervention response and as clinically relevant markers of change in heavy drinkers.

Under-performance of listed companies? Real earnings management and M&amp;A: Chinese empirical evidence

Purpose: The purpose of this paper is to examine whether acquiring firms attempt to adopt real earnings management strategy to upward reported earnings in the period of M&A announcement and provide an explanation for the underperformance of post-M&A in share payment M&A affairs occurring in China’s capital market from 2008-2010. Design/methodology/approach: The author uses Roychowdhury’s(2006) methodology to measure the magnitude of real earnings management of acquiring firms in stock for stock M&A by exploiting financial date from 2006 to 2011. The methodology includes three models, which are cash ?ow from operations, production costs and discretionary expenditures, respectively. Findings: It was found that firms using stock as a financing medium exhibit significant negative abnormal cash flows and abnormal discretionary expenses yet abnormal production costs significantly positive during the current period of M&A. Moreover, it was also documented that acquiring firms use real activities manipulation to overstate earnings for the purpose of improving market confidence. Finally, a negative association was found between REM and under-performance of post-M&A. Research limitations/implications: To some extent, these results explain the puzzle of performance decline over the following period of post-M&A. Meanwhile, our study adds to prior literature that capital market pressures induce acquiring firms inflate reported earnings by manipulating real activities in stock-financed M&A occurring in China’s capital market. Practical implications: The author’s result imply that investors, analysts and regulators cannot ignore more undetectable opportunism behaviors underlying reported earnings than accrual-based earnings management and the impact on the performance of post-M&A when they use financial statements to evaluate acquiring firms. Social implications: Our study plays important role in making public policies. Furthermore, it is necessary to improve outside supervisory mechanism and strengthen construction of honesty and faithfulness so as to realize the main purpose of value creation in M&A. Originality/value: The paper extends prior literature by taking a closer look at acquiring firms’ managerial myopia behavior in stock-financed M&A. The administrators of acquiring firms have strong incentives to manage earning upward by adopting a more subtle way which is a costly means because it has value-destroying effect on performance of post-M&A.

CFO gender and earnings management: evidence from China

We study the effect of chief financial officer (CFO) gender on earnings management (EM) in China’s listed firms from 1999 to 2011. In the cross-sectional analysis, we find that female CFO firm-years exhibit significantly lower discretionary accruals, lower total accruals, lower abnormal production costs, and higher abnormal discretionary expenditures, than the male CFO firm-years. We further examine the relation between CFO gender and EM surrounding CFO transitions. We find that the departing male CFOs are more aggressive than the departing female CFOs in managing up earnings during their last year with the firm and the newly appointed male CFOs are more aggressive than the new female CFOs in managing down earnings during their first year on the job. The evidence surrounding CFO transitions suggests that male CFOs are more aggressive than female CFOs in manipulating earnings, either in the last attempt to save their jobs or to take bigger credit for any future performance gains. Overall, our empirical evidence suggests that female CFOs engage in less EM and are more conservative in financial reporting than their male counterparts.

Fiscal Rules, Fiscal Space and Procyclical Fiscal Policy

In this paper we analyse the interaction of fiscal rules and fiscal space. We find strong evidence for fiscal rules being associated with higher fiscal space. Furthermore, the analysis shows that countries with more fiscal space tend to have higher discretionary expenditures, but that this effect is significantly reduced if fiscal rules are in place. A similar effect can be observed for the procyclicality of fiscal policy, which is significantly higher in an environment of ample fiscal space, while this difference is reduced with fiscal rules. Regarding the different types of fiscal rules, we find the strongest results for expenditure rules and to a lesser extent for balanced budget rules, but none for debt rules.

Target Ownership Plan and Earnings Management

We examine the determinants of target ownership plans and their association with earnings management. We find that firms adopt target ownership plans not only in response to poor performance as documented by prior research, but also as a means to mitigate moral hazard concerns and in response to peer pressure. Our analyses show that firms engage in less accruals and real earnings management for up to two years following plan adoption. Additionally, we find that the reduction in accruals management is concentrated in adoption firms that have met the target ownership requirements, and in high probability adoption firms whose adoption decisions are driven by performance, moral hazard, governance, capital market, and peer-firm concerns. Our findings support the argument that target ownership plans align CEOs’ incentives with shareholders’ in that these plans result in reduced management short-termism as evidenced by more truthful earnings reporting and less real earnings management through production cost manipulation and discretionary expenditures.

Stable Shareholdings, the Decision Horizon Problem and Earnings Smoothing

AbstractPrior studies argue that stable shareholders do not encourage firm managers to manage their earnings to achieve short‐term earnings goals. They also state that firm managers with stable shareholders have an incentive to report smooth earnings to maintain long‐term relationships with such shareholders. We focus on cross‐shareholdings and stable shareholdings owned by financial institutions as stable shareholdings in Japan, and investigate the effect of these ownership structures on earnings management patterns. Specifically, we hypothesize that stable shareholdings are positively associated with the informational components of earnings smoothing. Consistent with our hypothesis, we first find that as stable shareholdings increase, managers are more likely to conduct earnings smoothing that provides useful information to stable shareholders. Further, our additional analysis shows that stable shareholdings reduce incentives for managers to cut discretionary expenditures to meet short‐term earnings benchmarks, implying that stable shareholdings could reduce the possibility of a myopic problem. These results suggest that managers with stable shareholdings tend to report smoother and less volatile earnings, and do not tend to pursue earnings management to attain short‐term earnings targets.

Introduction to Special Issue on the Property Tax and the Financing of K–12 Education

reschovsky@lafollette.wisc.edu The property tax is the mainstay of local K–12 education revenue. Public schools derive over 80 percent of their local own-source revenue from the property tax (Reschovsky 2014). At the same time, nearly half of total property tax dollars collected in the United States is used to finance public elementary and secondary education (U.S. Census Bureau 2013, 2014). This close link between property taxation and school finance is one motivation for this special issue. Another motivation is the state and local fiscal aftermath of the Great Recession. Over the past few years the financing of public elementary and secondary education has become particularly challenging. In real per pupil terms, total revenues devoted to public education fell by 6.2 percent between the 2008–09 and 2011–12 school years.2 Although comprehensive revenue data are not yet available for the most recent years, existing evidence points to a continued decline in financial support for public education. Data from the U.S. Census Bureau’s Quarterly Summary of State and Local Tax Revenue indicate that per capita real local government property tax revenues (for school and non-school purposes) declined by 3 percent between fiscal years 2011 and 2013 (Collins and Langley 2014). And a survey conducted by the Center on Budget and Policy Priorities found that in 33 states, real