Earnings Management Behavior Research Articles

The effect of CEO friendship and perceived pay equity on the earnings management behavior of business-unit managers

PurposeThe purpose of this study is to examine the possibility of adverse consequences regarding the recently enacted Dodd–Frank Act (DFA) pay-equity disclosure requirement in the USA, which will likely lead to lower levels of perceived Chief Executive Officer (CEO) pay fairness by subordinates. Specifically, the study examines whether the pay-equity disclosure leads to increased earnings management when business-unit managers have friendship ties with the CEO.Design/methodology/approachAn experiment is conducted wherein participants assume the role of a business-unit manager and are asked to provide an estimate for future warranty expense, which is used as a proxy for earnings management. The study manipulates friendship between the CEO and a business-unit manager and the saliency of CEO compensation pay-equity.FindingsCEO friendship ties, which are associated with lower levels of social distance, result in less earning management in the absence of the DFA CEO pay-equity ratio disclosure. However, CEO friendship may result in negative repercussions in terms of higher earnings management in the post-DFA environment when managers are provided with the pay-equity disclosure.Research limitations/implicationsFuture research may expand this study by examining how the adverse consequences of the CEO compensation saliency disclosure can be mitigated.Practical implicationsManagement, audit committees and internal auditors should consider the possibility of unintended consequences of the increased transparency of CEO pay-equity while designing management control systems.Social implicationsThis study highlights the importance of understanding how employees’ social relationships with leaders may influence their behavior.Originality/valueUnlike prior research, which focuses on senior executives’ direct incentives to manipulate earnings and subsequently increase their compensation, this study provides evidence regarding the earnings management behavior of business-unit managers.

Unemployment governance, labour cost and earnings management: Evidence from China

AbstractThis study investigates the effect of labour cost on earnings management based on the panel data of listed firms in China. We use the average wage of employees in firm level as the proxy for labour cost. Firms with rising labour cost become more likely to engage in negative earnings management to conceal profits or report losses. The effect becomes more significant in state‐owned enterprises, labour‐intensive enterprises, firms in high unemployment‐rate regions and firms with political connections. Further research finds that, under the institutional background of Chinese unemployment governance, firms get more government subsidies and tax preferences and reduce the excessive employment through negative earnings management. To a certain extent, this weakens the policy effect of unemployment governance. Overall, our conclusions are meaningful to the reform of unemployment governance, the standardisation of earnings management behaviour, the improvement of the government subsidy policies and the improvement of the efficiency of public resource allocation.

Political stability, political rights and earnings management: some international evidence

PurposeThis study aims to examine the impact of political stability and political rights on firm-level earnings (both accrual-based and real) management.Design/methodology/approachThe authors develop models that link political stability, political rights, and the interplay between the two and earnings (both accrual-based and real) management. The authors analyze 63,872 firm-year observations of publicly listed, non-financial, firms drawn from 39 countries, for the period 1995 to 2016.FindingsThe authors find that political stability (political rights) attenuates (accentuates) accrual-based earnings management; political rights (political stability) accentuates (have no effect on) real earnings management; and the association between political rights and real earnings management is more pronounced in countries with better political stability.Practical implicationsThe findings imply that users of financial statements should take cognizance of a country’s ambient political environment in assessing the potential for earnings management by firms.Originality/valueNo prior research examined the role of political forces in shaping firm-level earnings management behavior in a cross-country setting.

Exploring the Family Effect on Innovative Capacity and Earnings Management

Purpose: This study examines whether family businesses (FBs) differ from non-FBs with regard to innovative strategies, and whether their innovation is a reflection of earnings management behavior. Design/methodology/approach: This study extended research into the issue of FBs by investigating innovation capacity and earnings management. We adopted the electronics industry in Taiwan (between 2010 and 2015) as a research sample to determine (1) whether family effects influence innovation performance at the firm level; (2) whether the innovation performance of FBs is an indication of earnings management behavior; and (3) the effects of family involvement and CEO-duality in FBs. Finding: Our results show that FBs are less likely than non-FBs to devote resources to increasing innovation. However, managerial participation of family members and a uniform CEO-duality leadership was shown to strengthen efficiency and flexibility in decision-making, thereby enhancing innovation capacity. We also found that FBs with higher innovation capacity are less likely to window-dress earnings. This association is more pronounced in cases of CEO-duality leadership, which implies that FBs’ innovative ambitions and duality leadership had greatly advanced in operating performance and corporate governance, and thus restrain managerial self-interested behavior. Research limitations/implications: This study had a number of limitations. First is the measure of innovative capacity. There are a number of ways of measuring innovation, and we posit that patents are superior to RD however, this does not necessarily reflect actual practices of earnings management. Although such proxies have been consistently used in previous research, may provide rich insights into earnings management behavior. Despite the noted limitations, our evidence clearly suggests the following: (1) FBs with strong family involvement in management and CEO-duality leadership tend to have higher innovation capacity; and (2) FBs with quality innovation capacity are less likely to engage in earnings management. Originality/value: This study fills a gap in the research on FBs by providing evidence concerning the effects of family on innovation and earnings management. Our findings have important implications for future research as well as the establishment of regulations and standards. Our findings provide evidence of a positive association between family effects and innovation capacity, which depends on the degree of family involvement in management and leadership structure. We found that family governance has a significantly positive impact on the competitive advantage of FBs. We also found that the innovation capacity of FBs is negatively associated with earnings management behavior. This study also re-examines the apparent contradictions in previous findings related to earnings management among FBs, while contributing to the literature linking family effects and governance mechanisms to earnings management behavior.

Financial Crisis: Time to Manage Earnings?

Previous research on how financial crisis affects managers’ earnings management behavior has resulted in different scenarios with inconclusive results. To address the ambiguity in the findings in the literature, the present study presents critical realism as an alternative to the positivist mainstream approach. The study argues against the existence of a causal law based on a constant conjunction model (i.e., whenever a financial crisis happens, earnings management happens) and concludes that financial crisis cannot be seen as the cause of earnings management. Finally, it suggests exploring other structures at work that might be responsible for earnings management.

Language in Economics and Accounting Research: The Role of Linguistic History

This paper investigates whether a consideration of linguistic history is important when studying the relationship between economic and linguistic behaviours. Several recent economic studies have suggested that differences between languages can affect the way people think and behave (the linguistic relativity or Sapir-Whorf hypothesis). For example, the way a language allows one to talk about the future might influence future-oriented decisions (Chen, 2013), such as a company’s earnings management (Kim et al., 2017; Cheng et al. 2019). However, languages have historical relations which lead to shared features, meaning that they do not constitute independent observations. This can inflate correlations between variables if not dealt with appropriately (Galton’s problem). We discuss this problem and provide an overview of the latest methods for controlling for linguistic history. We then provide an empirical demonstration of how the Galton’s problem can bias results in an investigation of whether a company’s earnings management behaviour is predicted by structural features of the language of its employees. We find a strong relationship when not controlling for linguistic history, but the relationship disappears when controls are applied. In contrast, economic predictors of earnings management remain robust. Overall, our results suggest that a careful consideration of linguistic history is important for distinguishing true causes from spurious correlations in economic behaviors.

Can the Ethical Orientation Mitigate the Manager’s Earnings Management?

Research aims : This study investigates the role of the ethical orientation of management in the relationship of asymmetry information and management status toward an individual’s decision-making with respect to earnings management behaviors. Design / Methodology / Approach : This methodology is an experimental method with 2x2 between-subject designs. 55 Accounting students from three private universities participated in 4 scenarios of cases (permanent and contractual management status, high and low asymmetry information) individually. Other side, the ethical orientation is measured, relativist and idealist. The Hypothesis was analyzed by ANOVA. Research findings : The ethical orientation influence managers’ earnings management decisions. It can mitigate the influence of asymmetry information toward manager earning management decisions. Theoretical contribution / Originality : This research explains that earnings management behavior also can be explained by ethical approach, not only by using agency theory. Decision-makers will use ethical considerations when they are faced by the earnings management practices. Practitioner/Policy implication : The results support pro-social theory that ethical orientation can influence the decision making when individuals are exposed to ethical dilemmas to make earning management. Research limitation/Implication : Participants in this study used students, so they did not have experience. future studies can use professional participants and consider management status in more detail.

HETEROGENEITY IN EARNING MANAGEMENT OF LISTED COMPANIES FOLLOWING INTERNATIONAL FINANCIAL REPORTING STANDARDS CONVERGENCE: A DEVELOPING COUNTRY EXPERIENCES

This study examines the earning management behavior of Sri Lankan firms following IFRS convergence. Moreover, we investigate whether the earning management following IFRS convergence is similar across different companies. We separately evaluate the companies based on size, auditor type, and performance to see whether these factors can moderate earning management behavior. We collected the data from a sample of 160 companies that are listed on the Colombo Stock Exchange (CSE) for the period spanning from 2008 to 2015. The period from 2008 to 2011 was the pre-IFRS convergence and the period after 2012 was the post-IFRS period. Following prior studies, we used several measures to capture the earning management around IFRS convergence. Especially, our measures aim to identify earning smoothing and managing towards earning target and thereby determining whether the firms have engaged in earning management and its increase and decrease. The results show that the earning management, in overall, has not decreased following IFRS convergence. However, our results indicate that the post-IFRS earning management is vary between companies. That is, large companies and companies with big four auditors experienced a decrease in earning management following IFRS convergence. Similarly, certain aspects of earning management of high performing companies is also found to have decreased in post-IFRS convergence. Finally, our findings provide important implications for regulators, investors and other corporate stakeholders.Keywords: Earnings Management, IFRS Convergence, Sri Lankan FirmsJEL Classifications: M410, M480, C2, C3DOI: https://doi.org/10.32479/ijefi.8872

Goodwill impairment tests as a device for earnings management: Evidence from Germany

This study investigates whether goodwill impairments are influenced by earnings management incentives. It is motivated by the International Accounting Standards Board’s (IASB) post-implementation review on business combinations, the ongoing debate on the reliability of impairment testing, and the high practical relevance of this topic. The sample consists of 2,127 firm-year observations from German listed firms for the periods 2006 to 2013. The results show that the likelihood to recognize goodwill impairments and the magnitude of impairment losses are not only determined by economic and other relevant factors but also influenced by earnings management incentives like beating an earnings target, conservative smoothing, big bath accounting, changes in senior management, and the firms’ general earnings management behavior. Hence, goodwill impairment tests seem to be used by management as a device for earnings management. The results do not change over time, i.e., between the period before, during, and after the financial crisis.

Earnings management prior to mergers and acquisitions: The role of acquirers’ ownership structures. Evidence from Poland

Abstract The purpose of the study is to identify earnings management behaviour prior to mergers and acquisitions with a particular emphasis on the role of acquirers’ ownership structures. We build panel regression models describing the associations between earnings management proxies and measures of mergers and acquisitions with additional variables describing elements of acquirers’ ownership structures. In the study, we confirm that acquirers do not engage in upward management prior to mergers and acquisitions. We find, however, that managerial ownership reduces magnitudes of total upward real earnings management. The presence of institutional investors diminishes accrual-based upward earnings management prior to mergers and acquisitions.

Effects of Audit Quality and Audit Committee Characteristics on Earnings Management During the Global Financial Crisis – Evidence from Australia

Purpose: We examine the earnings management behaviour of Australian firms during the Global Financial Crisis (GFC) and the effectiveness of audit quality and audit committee characteristics in mitigating such behaviour. Design/methodology/approach: The sample consists of 503 firm-year -observations spanning from 2006 to 2009. The years 2008 and 2009 are considered as the global financial crisis period. Discretionary accruals have been used as the proxy for earnings management. To test the hypothesis, we apply multivariate fixed effect regression to test the hypothesis. As the robustness test, we use propensity matching score, to find out comparable clients audited by Big-4 and Non-Big-4 audit firms to control observations to mitigate the effect of selection bias. Findings: We find that the sampled firms engage in a significantly higher level of earnings management during the GFC compared to the pre-crisis period (PCP). We find that audit quality, in terms of being audited by Big4 auditors, constrains earnings management during the PCP, but not during the GFC. Audit committee independence has a significant mitigating effect on firms' earnings management, while audit committee members' accounting and finance expertise do not constrain earnings management. Research limitations/implications: Future research can include a larger sample and examine the effects of other corporate governance variables on earnings management during periods of macroscopic shocks. Practical implications: Our findings support the importance of having independent directors in the audit committee. Moreover, the fact that Big4 auditors do not constrain earnings management during the GFC although constraining it during the PCP implies that regulators and policy makers should concentrate more on the audit committee for effective mitigation of earnings management during periods of macroeconomic shock. Originality/value: A key policy implication of the findings is that regulators and standard setters may need to shift their focus from the quality of a firm's auditor to encouraging well-functioning audit committees. The specific action to promote audit committee effectiveness includes mandating independence.

Kar Yönetimi Uygulamalarında İhtiyari Tahakkuklar ve Tahakkuk İptallerinin Etkisi: Bankacılık Sektörü Üzerine Bir Uygulama1 (Earnings Management Practices in terms of Discretionary Accruals and Accrual Reversals: An Empirical Study on Banking Sector )

Purpose – The main purpose of this paper is to determine “income smoothing” behavior of banking sector as an earnings management technique. Design/methodology/approach – In this context, 10.793 cross-country bank-year data (28 countries within 2000-2013 time period) have been analyzed in terms of earnings before tax and provisions, discretionary accruals and accrual reversal to investigate earnings management in banking sector. Panel Regression Analysisi techniques are used for model testing. Findings – According to the results, banks use both loan loss allowances and loan los provisions to smooth income. Earnings management behavior of banks is supported both for balance sheet and income stataement perspectives. Discussion – Throughout the accounting literature, modelling issues are still controversial in frame of earnings management studies. Thus, this study focuses on accrual reversals, which is currently argued hot topic in empirical modelling, and determines the effect of accrual reversals on earnings management behavior. As a result, a new model which incorporating accrual reversals, come up with statistically more significant results.

Corporate social responsibility and earnings quality: do institutional features matter?

PurposeThis paper aims to examine whether corporate social responsibility (CSR) is associated with firms’ earnings quality (EQ) and how this association is context-specific. The authors consider specific institutional differences in strength of corporate governance (CG) attributes, quality of law enforcement and level of investor protection found between Anglo-American, European and South-Eastern Asian CG models to test the impact of above country-level factors on this association.Design/methodology/approachTo test the association between CSR and EQ, the authors consider EIRIS (Ethical Investment Research Service) (2018) CSR issues of sustainability indicators as proxy to capture CSR. Following Rezaee and Tuo’s (2019) study, the authors classify EQ into innate earnings quality (IEQ) and discretionary earnings quality (DEQ). The authors investigate the innate (discretionary) EQ as to refer to firm’s inherent operating uncertainty (earnings management). Several dependency models for panel data applying the generalized method of moment (GMM) estimator of Arellano and Bond (1991) are ruled based on archival data of 4,206 non-financial international listed firms over the period 2012-2017.FindingsUnivariate and GMM multivariate cross-country analyses show that CSR is positively associated with EQ and that this association is more pronounced for firms within countries where good CG tools and higher investor right protection are preserved. The authors interpret the findings as evidence that the CSR-EQ association is shaped by the degree of monitoring role played by institutional features at the country level. The results are robust to a battery of robustness tests.Originality/valueThe originality of this research is twice. On the one hand, it examines whether CSR is a reflection of manager’s ethical opportunistic behavior resultant on earnings quality derived from a firm’s innate traits. On the second hand, it tests whether CSR is a reflection of discretionary earnings quality manifested by earnings management behavior. This paper is the first to support that institutional features significantly matter when investigating the association between CSR and EQ.

Evaluasi Perataan Laba pada Kinerja Badan Usaha Milik Negara Sebelum dan Setelah Menjadi Perusahaan Terbuka di Indonesia

This study was investigated by using multiple regression analysis method. The sample of this research is purposive sampling with total 6 years observation. The result of the research shows that SOEs conduct earnings management policy in two years before IPO and two years after IPO by income increasing. In order to get generalized results future research can use all listed state-owned enterprises until 2016, which is 20 companies with five years-period before and after going public.

Relationship between Real Earnings Management and Cost Behavior

Purpose- This research aims to examine the relationship between real earnings management (REM) and sticky Selling General and Administrative (SG&A) costs in the case of a developing economy.
 Design/Methodology- The study employed a purposive sampling method. Fifteen firms listed on Ghana stock exchange were selected for the study. Data from the period of 2005 to 20014 were collected.
 Findings- The study finds Ghanaian listed firm's SG&A cost to be sticky and also see these firms to manipulate earnings through REM. This study finds that REM through discretionary expenses and production cost increases sticky SG&A cost, whereas REM through cash flow reduces sticky SG&A cost. Overall, the results imply that REM exhibit sticky cost.
 Practical Implications- The study informs managers that cost is not only fixed or variable but also behaves asymmetrically. The understanding of this concept could help managers to implement strategies that will lower the cost of doing business. Also, since some managers deliberately make decisions that lead to real earnings management and sticky cost, we, therefore, believe that this research will be of importance to regulatory bodies, policymakers, investors, and other stakeholders.

Does financial crisis impact earnings management? Evidence from Turkey

AbstractThis study attempts to display the impact of global financial crisis of 2008 on earnings management (EM) compare with the period before and after with the case of listed manufacturing firms in Borsa Istanbul for the period of 2007–2012. Furthermore, it deepens the EM literature by concentrating on an emerging economy. Discretionary accruals (DA) were computed using the modified Jones model as a measure of EM. Moreover, this study examines EM behavior by separating firms into firms with positive and negative DA. The results of this study registered a high level of EM in firms throughout the postcrisis period.

Does the government’s anti-corruption storm improve the quality of corporate earnings? — Evidence from Chinese listed companies

ABSTRACT This paper uses A-share listed companies as a sample to examine the impact of the exogenous event of the 18th National Congress of the Communist Party of China(CPC) on the substitution effect of three types of earnings management behaviors. Under the impact of the anti-corruption storm, while reducing accrual earnings management behaviors, enterprises switch to more hidden earnings management behaviors,such as real earnings management and classification shifting earnings management. The substitution effect of three types of earnings management behaviors also exists in non-SOEs. However, compared with non-SOEs, the decline in accrual earnings management adopted by state-owned enterprises(SOEs), and the increase in real earnings management and classification shifting earnings management are significantly larger than those of non-SOEs. Further research finds that the significant reduction of corporate political connections after the anti-corruption storm is an important way to generate the substitution effect of earnings management behaviors.

How CEO narcissism affects earnings management behaviors

This study examined whether chief executive officers’ (CEOs) with narcissistic tendencies are more likely to execute earnings management behavior because of pressure to fulfill earnings thresholds. The results revealed that a CEO who exhibits high narcissism is more likely to be involved in earnings management to compensate for her/his performance. Our findings suggest that CEO narcissism directly influences financial decisions. Considering the earnings thresholds, firms with a more narcissistic CEO experience a regulatory effect on real earnings management behavior. Studies have indicated that CEOs manipulate earnings to satisfy three primary earnings thresholds: prior year’s reported earnings, zero earnings, and analysts’ forecasts. Our empirical results provide further evidence that CEOs engage in earnings management to fulfill positive earnings thresholds and analysts’ forecasts. We infer that CEOs use the abnormal production cost method as an underlying mechanism to increase reported earnings. Our findings help clarify the relationship between CEO personality traits and earnings manipulation to assist investors with decision-making.

Earnings Management during the Fourth Quarter: Evidence from Taiwan

ABSTRACTThis study aims to investigate earnings management during the fourth quarter and explains why there is a large kink in the distribution of annual earnings around zero. We use multinomial logistic regressions to investigate intra-year shifts in earnings distributions. Our empirical results support that managers of listed companies in Taiwan may manage earnings upward or keep their earnings during the fourth quarter to avoid small losses or decreases in earnings, when their earnings are slightly below or above zero after the first three quarters. Thus, auditors should pay more attention to the firms with cumulative earnings distribution surrounding zero at the end of the third quarter. However, we also demonstrate that some of the earnings maintenance or movement is due to the industry factor rather than earnings management. Meanwhile, the earnings management behavior seems less obvious since 2008, which may be due to the improvement of corporate governance.

Earnings management in local governments: the role of political factors

PurposeThe purpose of this paper is to examine earnings management practices in local governments (LGs). The implementation of accrual accounting in LGs opens the way for empirical research on the topic, as reporting high surpluses or high deficits can be negatively interpreted by the central government, monitoring authorities, citizens and political opponents. According to public choice theory, the conflicting interests between politicians, who pursue re-election, and voters, who observe politicians’ actions to assess their alignment with social welfare, create fertile ground for earnings management practices.Design/methodology/approachThe study calculates discretionary accruals, by using the Jones (1991) model, and relates them to several political variables. It employs a large sample of Greek and Italian LGs. The Greek database covers the period from 2002 to 2015 with about 4,300 observations, and the Italian database includes the period from 2008 to 2015 with about 1,130 observations.FindingsThe findings from the analysis give evidence that LGs engage in earnings management. The principal factor is the electoral cycle, as earnings management seems to be greater when the mayor is re-elected than when the mayor is elected for the first time. Furthermore, the period before elections create conditions that cultivate earnings management attitudes.Research limitations/implicationsPrevious studies have principally investigated earnings management in the private sector. Considering that many public-sector entities have implemented accrual accounting systems, this study intends to examine earnings management behaviour at the LG level, providing interesting findings for researchers and policy makers.Practical implicationsA better understanding of the political factors and the financial conditions, which act as obstacles or facilitators, should work hand in hand with the accounting reforms. The usefulness of financial statements for decision making and control presupposes that they are of high quality, an attribute that can be impaired by earnings management.Originality/valueThis study investigates the influence of political factors on earnings management behaviour in public-sector contexts where self-interest and accountability pressures coexist.