Earnings Management Behavior Research Articles

Investigating the role of theory of planned behavior and Machiavellianism in earnings management intentions

PurposeThe purpose of this study is to develop and empirically test the earnings management (EM) behavior model to investigate the personal psychological factors that influence individuals’ intentions to engage in EM.Design/methodology/approachFollowing a review of literature, personal-psychological factors influencing EM intentions were identified within the scope of the theory of planned behavior (TPB) and a dark triad of personality theory. The survey data from 153 MBA students were analyzed using partial least square-structural equation modeling.FindingsThe results revealed perceived behavior control is significant in influencing individuals’ EM intentions followed by attitude toward behavior and subjective norms. The results, however, do not support the relationship between moral obligation and intentions to engage in EM and also reported a negative relationship between Machiavellianism and individuals’ EM intentions.Practical implicationsThe proposed model will enable organizations to develop focused training programs for managers to reduce EM behavior. It will also help educators in training students to positively shape their ethical behavior and make them more reciprocal toward others and their work environment.Originality/valueThe study develops the EM behavior model and suggests that TPB and Machiavellianism personality traits provide a useful framework to identify the personal psychological factors influencing individuals’ EM intentions. Further, the empirical testing of the model documents and contributes toward a better understanding of the personal psychological factors significantly influencing individuals’ EM intentions.

Analysis and Suggestions on the Applicability of ST System Under the Impact of Earnings Management Behavior

In order to adapt to the development and management of China's stock market, Shanghai and Shenzhen Stock Exchange put forward the delisting system with Chinese characteristics in 1998—ST system. However, with the introduction and application of earnings management in China, many * ST listed companies choose to use earnings management to temporarily inflate profits when facing delisting pressure, so as to avoid delisting, which has a certain impact on the actual operation of ST system. Through data screening and analysis, this paper analyzes the data of ten listed companies that successfully lifted the delisting early warning crisis in 2016 to verify the practical applicability of China's ST system under the impact of earnings management behavior and put forward relevant suggestions.

The monitoring role of the media: Evidence from earnings management

AbstractIn response to the recent debate on the media, this paper examines the effect of media coverage on firm earnings management. Even if prior studies (Dyck et al., 2010; Miller, 2006) have documented the media's role in detecting and deterring accounting fraud (or extreme earnings management), it is unclear ex ante whether the media amplifies or curbs less egregious earnings management. Our results show that media coverage is negatively associated with both accrual‐based and real earnings management, suggesting that the media serves as an external monitor that curbs managers’ opportunistic earnings management behaviors. Further analyses show that the effect of media coverage on earnings management is more pronounced when monitoring from auditors is weak and when the other information intermediaries are active. Overall, the findings suggest a monitoring role of the media in firm financial reporting practices.

Multilevel optimal managerial incentives and audit fees to limit earnings management practices

The main objective of this study is to design an optimal managerial compensation scheme and optimal auditor fees to counter income-increasing earnings management behavior. This study draws on game theory with three players: the shareholders, managers and auditors. It considers the possibility of collusion between the manager and auditor and analyzes the different scenarios that may exist between the three players. The results of our study prove that it is possible to establish an optimal managerial compensation contract and optimal auditor fees which will limit earnings management manipulation and guarantee high audit quality. We found that the optimal managerial compensation scheme depends on the firm situation. Moreover, we illustrated how the auditor is motivated by improving audit effort in all possible scenarios. This paper can be considered a tentative effort to provide systematic evidence for designing optimal contracts that align divergent interests between managers and shareholders.

Corporate governance and earnings management: A quantile regression approach

AbstractThe effects of corporate governance (CG) on earnings management (EM) have been debated for many years. Thus, this paper explores this issue in a novel way that utilizes a quantile regression to revisit the association between CG mechanisms and EM. We find that a non‐uniform relation between CG mechanisms and EM for non‐financial U.S. firms does exist from 2007 to 2015. Specifically, the empirical evidence documents that CG mechanisms can effectively constrain earning manipulation among firms with higher discretionary accruals (High EM). However, this effect becomes insignificant for firms with medium and low levels of discretionary accruals (Low EM). The quantile‐varying results provide further support for the theoretical viewpoint that the CG mechanism can serve as an effective tool for supervising management in the financial accounting process but only in the case of firms with aggressive EM behaviour.

Paradox of Familiness: Evidence from Earnings Management in Korean Family Firms

Extant literature offers that the alignment of ownership and controls presumably resolves the agency problem. However, traditional governance mechanisms are limited to resolve agency problems in family firms where interests of family owners and managers are aligned but conflicting with those of other shareholders. Drawing on the principal-principal perspective and the social embeddedness, we develop a theoretical framework to address the agency problems in family firms. Specifically, we theorize different earnings management behaviors between non-family and family firms, and under what conditions family owners and managers engage in earnings management. We also propose a business group, independent board, and dissimilarity in top manager functional backgrounds as governance mechanisms to monitor earnings management in family firms. We investigate the earnings management practices of 570 Korean family and non-family firms from 2002 to 2010. We find that, in general, family firms are less likely to engage in earnings management than non-family firms. However, we also find that the higher the level of family embeddedness through ownership, the more earnings management a family firm will commit. In addition, we confirm that business group affiliations and independent boards attenuate the effect of family embeddedness through ownership on earnings management. Our study contributes to corporate governance and family business research by suggesting governance mechanisms to solve socially embedded agency problems in family firms.

Does an item change trigger earnings management? Evidence from asset disposal income in China

AbstractWe explore a unique regulatory change in 2017 in China that requires firms to move the non‐current assets disposal income in the income statement from below the line of operating income to above it. We find that firms that have incentives to avoid losses conduct upward earnings management using the non‐current assets disposal income after the regulatory change. We also find that this earnings management behaviour is more pronounced for firms in the growth and decline stages, and for firms with weak market competition power. In addition, such behaviour damages firm’s operating performance and innovation in the next year.

Earnings Management in Companies that Missed and Beat Analyst Consensus

The aim of this study is to analyze the differences of earnings management between companies that missed and beat analyst consensus. Nonfinancial companies listed in the Indonesia Stock Exchange in 2017–2018 and have analyst consensus data available are used as the research sample, which consist of 28 companies observed for four quarters. The final sample in the analysis consists of 94 observations (firm-quarters). The independent sample t-test is used for data analysis. Results show that companies that missed analyst consensus have greater discretionary accrual than the group of companies that beat analyst consensus. Therefore, differences in earnings management between companies that missed and beat analyst consensus exist. Companies that missed analyst consensus are more inclined to conduct earnings management in the following period. This finding opens the possibility to develop a new hypothesis in the positive accounting research framework.
 Keywords: Analyst Consensus; Missed and Beat; Earnings Management.

Influence of financial indicators on earnings management behavior: evidence from Vietnamese commercial banks

The quality of financial disclosures is of great importance than ever, as Vietnam’s international economic integration has been accelerating recently. This issue is currently particularly worrying for the banking sector in Vietnam, as banks play a vital role in economic development. However, there is a growing concern that managers tend to manipulate financial information using earnings management techniques to meet analyst expectations and to enhance the firm value in the short term. Such behavior can lead to inappropriateness in the decision-making process of financial statement users, as well as impair firm value in the long term. Therefore, this study examines the impact of factors related to financial indicators on earnings management of Vietnamese commercial banks to give more insight into the issue. The data of this study was collected from a sample of 30 Vietnamese commercial banks during a 5-year period from 2015 to 2019. By using the Ordinary Least Square (OLS) regression method through Eviews 10.0, the findings revealed that financial leverage and loan loss provision have a positive and significant impact on earnings management. Also, bank size and profitability were negatively associated with earnings management. Based on these findings, in the context of Vietnam, the study proposed policy suggestions to improve the quality of accounting information and to assist users of financial statements in recognizing and restricting earnings management in commercial banks.

Real Earnings Management and Industry Differences: Based on Empirical Evidence From Listed Companies in China

This article examines the industry differences in the real earnings management behavior of listed companies in China. The study finds that listed companies in the health and social work industries have the highest degree of real earnings management, and the electricity, heat, gas and water production and supply industries has the lowest level of real earnings management, and there are obvious industry differences in real earnings management among Chinese listed companies. The empirical evidence in this paper shows that there are industry differences in the real earnings management of Chinese listed companies.

Shareholder activism, earnings management and Market performance consequences: French case

PurposeThe purpose of this study is to investigate the impact of the relationship between shareholder activism and earnings management on the market performance of French companies.Design/methodology/approachThis study used 385 firm-year observations drawn from a sample of French companies belonging to the SBF 120 index from 2008 to 2012. Data was collected from annual reports of sample companies. To measure earnings management, this study used the model of Raman and Shahrur (2008). The relationship between shareholder activism, earnings management and market performance using the panel data regression model was empirically examined.FindingsThe results prove that shareholder activism, as indicated by shareholder proposals, has no impact on market performance. However, the existence of shareholder activism affects the market performance positively. In fact, a minimum of proposals proves that shareholder activism plays an appropriate and effective role in creating value. Thus, several activists would resort to “a private activism” which could be the best and the least expensive form. This form of activism is called “behind the scenes.” Findings also show that earnings management has a negative impact on market performance. As a matter of fact, these findings allow to conclude that the firm performance decreases whenever managers undertake to earnings management. Also, earnings management behavior is mainly opportunistic. Finally, the relationship between shareholder activism and earnings management has no impact on market performance. This result reveals that shareholder activism proves to be an ineffective mechanism that does not alter the accounting choices, particularly in relation to earnings management. This result shows the inability of active shareholders to define and implement strategies across their proposals, namely, “the lack of monitoring competence.”Research limitations/implicationsIt is important in future research to evaluate the impact of behind the scenes interventions on corporate governance. Also, this paper gives a larger dimension to the effect of shareholder activism on the market performance in the specific context of earnings management, thus justifying the need to expand this study using other methodologies to deepen and better understand this relationship in this context.Practical implicationsThe paper's evidence contributes to an understanding of corporate governance. The finding of this study will help in monitoring and controlling fraudulent earnings management practices that effect on market performance. Further, this study is important to investors, academics and policymakers, as it demonstrates that governance reforms that encourage firms to adopt better governance practices that reduce the likelihood of earnings management.Originality/valueTo the best of the author’s knowledge, this paper pioneers in focusing on the impact of the shareholder activism and earnings management on the market performance because previous studies put more emphasis on pair-wise relations (Shareholder activism-earnings management, earnings management-market performance and shareholder activism-market performance). This study provides empirical evidence on the effectiveness of the relationship between shareholder activism and earnings management on market performance.

EARNINGS MANAGEMENT ANALYSIS ON SERVICE INDUSTRIES THAT SUPPORT TOURISM SECTOR AFTER THE EARTHQUAKE OF LOMBOK AND PALU

Earnings management practices in corporate financial statement continues to be an issue of debate in the financial accounting realm. Earnings management is done by the management of a company for various reasons. Information disclosed in the financial statement ideally must reflect the condition and performance of a company. Extraordinary events such as natural disaster surely will affect the performance of a company that is impacted by the event. A decline in corporate financial performance will affect the corporate stakeholders. This research aims to detect earnings management practices that might be conducted by service companies that support tourism industries affected by the earthquake that occurred in Lombok and Palu. Using the equation formulated by Stubben (2009) to detect earnings management practices by observing the change in discretionary revenues, this research has found that the natural disaster that hit Lombok and Palu was not a powerful enough extraordinary event that might have driven the management to conduct earnings management practices.

The Impact of Political Connection on Earnings Management in China’s Private Enterprises

Earnings management behaviour lowers the quality of accounting information of private enterprises to a certain extent. Hence, it is necessary to study the relationship between political connection and earnings management of private enterprises. Through the investigation and statistics of the private companies in China’s Small and Medium-sized Enterprise Board Market from 2013 to 2017, this paper performs empirical analysis to verify the relationship between political connection and earnings management. It shows that political connection can weaken accrual-based earnings management level, which helps private firms obtain more preferential policies and financing help. Based on the above conclusions, this paper puts forward the corresponding policy recommendations, which provide reference for the governance of private enterprises and the capital market.

Aggregate Discretionary Accruals and Future Market Returns: International Evidence

We conduct a cross-country analysis to provide further insight into the “lean-against-the-wind” hypothesis of aggregate discretionary accruals (Kang et al. 2010), i.e., opportunistic use of discretionary accruals in times of market undervaluation. We investigate whether the reversal of firm-level effect extends to non-U.S. firms and identify institutional factors that affect the association between aggregate discretionary accruals and future market returns. We find that the association between aggregate discretionary accruals and future market returns is less positive in countries with stronger disclosure requirements and more in countries with greater financial analysts, suggesting that aggregate discretionary accruals contain less garbling component in stronger legal/regulation environments and more garbling component in countries where the market incentive to manipulate earnings is high. We also use a K-median clustering to classify the sample countries into two clusters using seven country-level institutional variables. The results suggest that countries that have institutional features that lead to earnings management have greater coefficients on aggregate discretionary accruals, while countries that have institutional characteristics that mitigate earnings management behavior have smaller coefficients on aggregate discretionary accruals. In sum, our results are broadly consistent with the “lean-against-the-wind” hypothesis and highlight the role of institutional and socio-economic factors in understanding the phenomenon.

Accrual earnings management in response to an oil price shock

The aim of this study was to examine the relationship between the oil price shock of 2014 and earnings management of oil companies listed on the Oslo Stock Exchange. The results revealed a significant increase in earnings management following the oil price drop. Moreover, we found that companies adjusted their earnings and abnormal income-decreasing accruals were identified during the third and fourth quarters of 2014. We attribute this finding to the big bath strategy. The contribution of this study promotes the understanding of the effect of macroeconomic shocks on earnings management behaviour, and it supplements and expands the earnings management literature in this homogenous industry.

Accounting Standards, Reporting Incentives, and Earnings Management

In this study, we examine which factor, firms’ accounting standards or firms’ reporting incentives, has a greater impact on firms’ earnings management behavior. To answer this question, we utilize unique hand-collected data that consists of foreign firms cross-listed in the U.S. using U.S. GAAP. This interesting setting allows us to control for differing accounting standards and external monitoring from the SEC between foreign firms and their U.S. domestic counterparts. Therefore, if there is any observed difference in the level of firms’ earnings management, that difference can be mainly attributed to firms’ reporting incentives rather than firms’ accounting standards. Our findings suggest that cross-listed foreign firms using U.S. GAAP exhibit more accruals-based and real activities earnings management relative to domestic firms. The results suggest that accounting standards, regulations, and enforcement is not enough to eliminate opportunistic reporting behavior. Firm incentives will still impact the magnitude of earnings management. This finding is particularly important given the hot debate regarding whether the U.S should adopt IFRS or not. No matter what accounting standards firms choose, U.S GAAP or IFRS, firms’ earnings quality can still vary with differing reporting incentives.

The Switch‐Up: An Examination of Changes in Earnings Management after Receiving SEC Comment Letters

ABSTRACTThe SEC has long asserted that earnings management practices result in adverse consequences for investors. We examine whether SEC oversight affects firms' accounting quality in terms of earnings management trade‐offs. We expect that increased firm‐specific regulatory scrutiny, in the form of an SEC comment letter, will induce management to switch from accrual‐based earnings management (AEM), which is a main focus of the SEC, to real‐activities‐based earnings management (REM), which is not likely to be commented on in the SEC's review process. Consistent with our predictions, we find that AEM is lower and REM is higher following the receipt of a comment letter, relative to non‐comment‐letter years and a propensity‐score‐matched sample of non‐comment‐letter firms. However, we do not find a significant difference in total earnings management (i.e., the sum of AEM and REM), suggesting that the higher REM acts as a substitute for lower AEM activity. We further find that our results are driven by accounting comments relating to estimates and accruals and not by classification‐only comments, which suggests that a comment letter that does not question specific issues associated with estimates and accruals is not a strong enough signal to induce the firm to change earnings management behavior. Additionally, the shift to REM is attenuated for firms with high institutional ownership. These results collectively suggest that the comment letter process effectively constrains AEM but has the unintended consequence of firms, on average, switching to REM.

Foreign directors and corporate governance in Islamic banks

PurposeThe purpose of this paper is to examine whether foreign directors’ influence on opportunistic behavior among managers varies between Islamic banks (IBs) and conventional banks (CBs). It also examines how religious ethics and morals guide foreign directors to be better monitors.Design/methodology/approachA panel fixed effects regression is used to analyze the effect of foreign directors on opportunistic behavior among managers in IBs and CBs. The authors use different proxies such as loss avoidance, discretionary loan loss provision and expense preference behavior to measure management opportunistic behavior.FindingsBased on sample of 3,758 bank-year observations for 164 banks over the period 1993-2015, the authors show that the presence of foreign directors in IBs increases boards’ effectiveness in impeding management opportunistic behavior, whereas the presence of foreign directors in CBs reduces boards’ effectiveness in curbing management’s unethical acts. The authors also document that IBs (CBs) with foreign directors demonstrate less (more) earnings management and expense-preference behavior among managers. In addition, the authors’ evidence indicates that the existence of the Shari’ah supervisory boards helps foreign directors be more effective monitors.Research limitations/implicationsThe current study focuses on banks only which makes its results subject to sample bias; there are many other forms of financial institutions (e.g. investments, real-estates and mutual funds) complying to the Shari’ah law. Second, owing to the lack of foreign board directors characteristics, the authors cannot investigate the intensity of the specific characteristics that could have specific directions in affecting managerial behavior.Practical implicationsThe findings in this paper may help standards-setters, auditors, investors and regulators take appropriate measures and create better policies that reduce managers’ discretion. This could in turn improve information transparency decision-making, monitoring, advising and accounting quality.Originality/valueThe authors’ theoretical framework combines the agency, contingency, resource-dependence, stewardship and stakeholders’ theories and applies them to Shari’ah as an alternative ethical and internal governance mechanism. The authors find that the impact of foreign directors on management opportunistic behavior depends on the corporate religious norms within boards of directors, in particular, suggesting that religious values affect how foreign directors influence bank managers’ behavior.

Effects of superiors’ compensation structures on psychophysiological responses and real earnings management decisions of subordinate managers

This study examines the effects of executive compensation structures and research and development (R&D) reporting methods on subordinate managers’ psychophysiological responses and decisions to engage in real earnings management. Results from one 2 × 2 between-participants experiment indicate that when R&D expenditures are capitalized, relative to expensed, managers are less willing to abandon a failing project in favor of a superior project. Importantly, executive compensation structures can effectively reduce this form of real earnings management by subordinates. When executives are paid with restricted stock, relative to when executives are compensated with unrestricted stock, their subordinate managers are less willing to continue a failing R&D project when R&D expenses are capitalized. A second experiment that employs pupillometry, eye tracking and facial analysis in order to capture participants’ psychophysiological responses to incentive structures reveals that subordinates exhibit increased arousal and more intense negative emotions when they encounter supervisor pay structures that conflict with their personal incentives. Increases in negative emotion lead to reductions in earnings management behavior. The results indicate that compensation structures for superiors, such as executives, can significantly mitigate subordinate managers’ tendency to engage in real earnings management. In addition, from a methodological perspective, the second experiment indicates that hypothetical incentives are internalized by experiment participants, and hypothetical incentives lead to predictable psychophysiological responses and related decisions.

Earnings Management, Analyst Forecasts and Credit Rating of Corporate Bond: Empirical Evidences from Chinese Listed Companies

Bond credit rating is a comprehensive evaluation by credit rating agencies on the credit records, financial status and operating results of bond issuing companies. Because of information asymmetry, bond credit rating is influenced by information disclosed by companies through earnings management and information forecasted by analysts as an independent third party. Based on 311 samples of Chinese listed companies which issued bonds for the first time from 2011 to 2017, this paper studied the relationships among company earnings management, analyst forecasts and credit rating of corporate bonds. Our empirical results show that, in order to improve the bond credit rating, company managers do have some earnings management behaviors before bond issuing, and the extent of earnings management is positively correlated with its bond rating. We also find that the forecasted corporate rating by analysts is positively correlated with its bond rating, and analyst forecasts cannot restrain the impact of earnings management on bond rating and does not exclude the collusion with corporate management. Earnings management and analysts forecast and have certain mutual promotion effect on bond credit rating. The conclusions of this paper are conducive to information regulates and stakeholder decisions.