Earnings Management Decisions Research Articles

Do socially responsible firms demonstrate a preference for using classification shifting to manage earnings?

Prior research finds socially responsible firms are less likely to engage in earnings management, suggesting that socially responsible firms seek to provide more transparent financial reports (Hong and Anderson 2011; Kim, Park, and Wier 2012; Hwang, Choi, Choi, and Lee 2022). We investigate whether managers of CSR firms demonstrate a preference for classification shifting when making trade-off decisions among earnings management methods. First, our results support prior studies that find the overall extent of earnings management is lower for CSR firms. However, this study focuses on the use of classification shifting relative to other forms of earnings management. We find a robust positive relation between CSR performance and the relative use of classification shifting. Our results suggest that while CSR firms engage in lower levels of earnings management they demonstrate a preference to choose classification shifting when engaging in earnings management. These findings are consistent with managers perceiving classification shifting as a less unethical tool relative to accruals earnings management or real activities manipulation. Subsequent analyses reveal that our results are most pronounced for firms with lower external monitoring where managers have the most freedom to make trade-off decisions among earnings management methods based on ethical considerations. Overall, by demonstrating a preference for classification shifting relative to other earnings management tools our study furthers our understanding of the role of ethical considerations in earnings management decisions.

Analyst coverage and real earnings management: Does IFRS adoption matter? UK evidence

This study examines the impact of analysts coverage on real earnings management (REM) decisions. The study further investigates the effect of mandatory IFRS adoption on the relationship between analyst coverage and REM. We constructed a sample of UK non-financial listed firms for the period 1997–2021. The results demonstrate that firms followed by a large number of financial analysts record higher levels of earnings management. This result supports the contention that high intensity of analyst coverage imposes extra pressure on firms' managers to meet analysts' earnings per share (EPS) expectations, motivating a higher level of earnings management. Contrary to expectations, the introduction of IFRS fails to strengthen the monitoring role of security analysts on firms' management: rather, managers utilize the inherent flexibility and available discretion in the principles-based IFRS to meet analysts’ benchmarks by means of REM activities. These results are robust after controlling endogeneity.

Earnings management: the influence of peer group and the corporate governance intervention

PurposeOur study investigates the influence of peer performance on the earnings management decisions within publicly traded Indian companies. There is mixed evidence in the literature, with the impact of peer performance on earnings management in emerging markets being notably underexplored. Additionally, the study explores whether robust corporate governance mechanisms can mitigate earnings management practices. Our study offers policy insights into these areas.Design/methodology/approachOur study used a longitudinal panel dataset from 2011 to 2020, utilising idiosyncratic returns of peer firms as an external measure of peer performance. This approach is further enhanced by the usage of alternative discretionary accrual metrics, which could be a robust measure for both market leaders and followers.FindingsOur study employs two distinct methods, accrual and real earnings management, to assess earnings management. The findings indicate that peer performance triggers earnings management within peer groups, showcasing managerial opportunism in financial reporting to align with peer achievements. Furthermore, the evidence suggests that robust corporate governance effectively curtails earnings management, especially in industries where peer influence is significant.Practical implicationsOur study offers valuable insights for regulators, highlighting that enhancing the institutional framework with stringent corporate governance mechanisms can effectively reduce earnings management in companies within emerging markets.Originality/valueThe paper is a novel attempt in emerging markets to show that managers engage in opportunistic reporting to align with the performance of their peers and that governance strategies effectively mitigate these practices in such markets.

Targets’ earnings management and ownership decisions in M&A: Can less be more ?

In a sample of 1,097 European merger and acquisitions (M&A) deals, we find that the targets exhibiting higher levels of accruals earnings management (AEM) relate to lower ownership stakes offered by acquirers. Real earnings management (REM) measures do not relate to ownership decisions. This research contributes to broadening our knowledge about accounting information's role in the intricacies of M&A negotiations.

Earnings management and financial distress or soundness determining CEOs’ future over- and under-investment decisions

This study investigates the association between CEOs’ over-confidence in experiencing financial distress or soundness, future earnings management, and over and under-investment decisions. Specifically, it makes deeper the association between financial distress (soundness), requiring to increase (decrease) earnings management and over (under)-investment decisions. Methodologically, the authors demonstrate the CEOs’ aggressive behaviour in managing their firms’ earnings in developing countries. In other words, it shows a literature gap in some extant research that most CEOs in developing countries would intentionally manage future earnings for constructing future investment decisions. Then, it highlights that CEOs in developing countries tend to be over-confident because of cognitive distortion, assembling the earnings management to improve future performance. Finally, this study presents a newness with three critical reasoning arguments. First, this study uses the prospect theory, framing, conservatism and psychological projection to explain the CEOs’ future investment decisions due to past earnings information, which causes their behaviour to be more optimistic. Second, this research considers that financial distress or soundness influences the association between earnings management and future over(under) investment decisions. Third, this study investigates CEOs’ over-confidence using an international setting due to characteristic differentiation between advanced and developing countries, influencing this association.

Earnings management: Who do managers consider and what is the relative importance of ethics?

Using responses from Australian CFOs and CEOs to a case-based survey and interviews, we provide insights into managers’ earnings management (EM) decisions. Ethics has the greatest explanatory power for our participants’ EM assessments. Ethical concerns about EM deter EM, but surprisingly, ethical concerns about not managing earnings and missing market expectations motivate EM. The primary economic motivation for EM is shielding current shareholders from the short-term costs of missing market expectations. We find considerable heterogeneity regarding the extent to which CFOs and CEOs believe EM is lying. Finally, CFOs and CEOs believe that each are significantly involved in initiating EM. JEL Classification: M40, M41, M48

Investor institusional dan keinformatifan laba di Indonesia dan Jepang

This study examines the existence of institutional investors who can play a role in increasing earnings informativeness through income increasing-earnings management and income smoothing. The hypothesis was developed on the basis of the view that the motivation behind earnings management decisions is to increase the informativeness of earnings reports. The study employs sample of manufacturing companies listed on the Indonesia Stock Exchange and the Japan Stock Exchange for the period of 2010-2018. Ordinary least square and weighted least square regression models are used in cross-sectional statistical testing, which is carried out annually throughout the 2014-2018 observation period. In Japan, institutional ownership has a positive and significant effect on income increasing- earnings management, and on reverse income smoothing, as well, while these are not the case in Indonesia. This study reveals that in Japan, the institutional investors play a role of monitoring that can encourage managers to increase earnings informativeness through earnings management-income increasing followed by reverse income smoothing. This condition is not found in Indonesia. It is possible that in Indonesia, the institutional investors play a role of controlling, that may promote managerial opportunistic behavior.

Playing it Ethical or Safe? Exploring Earnings Management by Military Executives

The majority of studies argue that military experience makes executives more ethical and then reduces firms’ misconducts. What remains unclear is whether this is due to higher ethical values of ex-military executives or their preference in “playing it safe”. We propose that executives depend more on risk-aversion preference than their ethical values when making earnings management decisions. This is because the ethicality of earnings management is ambiguous and thus military executives may not perceive it as unethical. By examining a sample of 2,135 listed firms in China, a risk-avoidance culture (2006?2018), our results find military executives reduce higher-risk method (i.e., accrual-based earnings management) but increase lower-risk method (i.e., real earnings management). In a post-hoc test, we find that this risk-aversion characteristic is still significant when the external environment is subject to less litigation or auditing risk, and corporate risk-taking level mediates the effects of military experience on earnings management.

Does oil price uncertainty affect earnings management? Evidence from GCC markets

PurposeSince it is believed that economic growth in oil-rich countries is highly influenced by oil price movements, this study aims to explore the relationship between oil price volatility (uncertainty) and earnings-management decisions.Design/methodology/approachFinancial data from oil-exporting countries were used to explore the relationship between oil price volatility and earnings-management decisions. The study used univariate and multivariate analysis. The modified Jones model is the proxy accrual earnings management. Further, the standard deviation of daily oil price returns is used to proxy annualised oil price volatility.FindingsThe results show that there is an association between oil price volatility and accrual earnings management. Specifically, there is a positive and significant relationship between negative accruals and oil price volatility, indicating that firms are inclined to conduct income-decreasing earnings management in periods of high oil price volatility.Research limitations/implicationsThis study’s findings have important implications for regulators and investors because they indicate that the uncertainty of oil price volatility has an influence on earnings quality in oil-dependent economies. This is especially important considering the ongoing debate on transparency issues.Originality/valueTo the best of the authors’ knowledge, this study is the first to investigate the relationship between oil prices volatility and earning management behaviour for non-financial firms. Further, the study uses unique data of oil-dependent economies.

The Effect of Geographic Distance on Earnings Management Decisions

ABSTRACTPrior research has found evidence that country factors and management styles influence earnings management decisions in various geographic locations. Extending this research, we utilize an experimental setting to isolate the effect of geographic distance on the willingness to manage earnings in a near/distant location. In an initial experiment, we find less acceptable earnings management methods generate greater concerns about the method (ethicality and riskiness) leading to less willingness to manage earnings. Yet, greater geographic distance between the decision-maker and reporting location attenuates these concerns, resulting in increased willingness to use a less acceptable method. In contrast, individuals are willing to use a more acceptable method to manage earnings regardless of geographic distance. These findings are consistent with construal level theory (CLT) and are corroborated in a second experiment where we find that greater geographic distance reduces managers' focus on the means of earnings management, thereby reducing concerns about the method.Data Availability: Available upon request from the authors.

Does analyst coverage enhance or curb earnings management The impact of mandatory IFRS adoption

This study aims to investigate the effect of external corporate governance mechanisms on earnings management decisions. In particular, this study examines the effect of analyst coverage on the magnitude of discretionary accruals in the UK context. In addition, this study examines the moderating role of mandatory International Financial Reporting Standards (IFRS) adoption on the relationship between analyst coverage and earnings management. By using a sample of 9,165 observations collected from 1,401 specific UK firms from 1994-2013, it is found that a high level of analyst coverage can be considered as an external governance mechanism that controls managers' behaviours. The results suggest a significant negative effect of analyst coverage on earnings management. I also find some evidence that the mandatory adoption of IFRS does lead to lower earnings management levels. Contrary to expectations, IFRS fails to enhance the monitoring role of financial analysts in detecting and deterring earnings management.

Effect of CEO-executive Connections on Earnings Management and Detection

While the top management team is important in shaping the overall governance within the firm, there is limited research on how top management team relationships affect earnings management decisions. This study uses connections between the CEO and the top non-CEO executives to examine whether having previously formed relationships affect their earnings management activities and detection thereof. Using 6,582 S&P 1500 firms in the U.S. from 1999 to 2013, I find that as the percentage of executives with connections to the CEO increases, so do discretionary accruals. In contrast I do not find any association between connections and real earnings management. I also find that the greater the percentage of executives with connections to the CEO, the less likely accounting manipulation will be detected. This study should be useful to regulators and standard setters who are interested in assessing the likelihood of the firm engaging in accounting manipulations as this study documents that connections between the CEO and the non-CEO executives is an important determinant.

CEO Regulatory Focus, Decision Frames, and Earnings Management

Strategy scholars have increasingly noted the influence of the psychological characteristics of executives on corporate strategy and performance. Synthesizing theories on regulatory focus and framing effect, in this study we examine the role of CEO regulatory focus (i.e., promotion and prevention focus) and decision frames (i.e., gain and loss frames) reflected in earnings management decisions. Specifically, we predict that under two conditions, promotion focus under a gain frame and prevention focus under a loss frame, a CEO’s subjective utilities and probabilities of the attainable gains in earnings management become heightened. This, in turn, ultimately leads to his/her intensified tendency to manipulate earnings. Conversely, a CEO’s promotion (prevention) focus under a loss (gain) frame decreases his/her perceived utilities and probabilities of the attainable gains in earnings management, subsequently leading to diminished tendency to manipulate earnings. Using a seven-year panel data of U.S. manufacturing firms between 2011 and 2017, we find general support for our hypotheses. The results indicate that the psychological characteristics of CEOs, along with their framing of performance, have a significant impact on their earnings management decisions. Overall, our study highlights the importance of understanding the psychological underpinnings of the earnings management behavior.

The Career Imprint of the CEOs’ Previous Work Environment in Earnings Management Decisions

This paper examines how CEOs’ prior work experiences involving earnings management decisions continue to influence their financial reporting decisions despite their change of employers. Based on insights from the career imprint theory, we propose that firms are more likely to engage in earnings management when their newly appointed CEOs come from firms that were also involved in such practices. Empirical support was found by analyzing a dataset that tracks 855 CEO transitions. Additionally, we find that the strength of this effect is influenced by a number of factors such as the officers’ age when they joined the previous firm, the tenure length of the officers at their previous employers, the officers’ former firm size, as well as the strength of the officers’ current firm’s corporate governance. Furthermore, our results are robust after addressing for large sample, omitted variable and the self-selection biases.

What's my target? Individual analyst forecasts and last-chance earnings management

Kirk, Reppenhagen, and Tucker (2014) find that investors use individual analyst forecasts as additional earnings benchmarks. We investigate whether executives manage earnings to beat these individual benchmarks. Using year-end effective tax rate (ETR) manipulation as our setting, we find that firms decrease ETRs from 3rd to 4th quarter to meet or beat a greater percentage of individual forecasts. We also find some evidence that firms use incremental ETR changes to meet forecasts by key analysts. After controlling for the distance to the nearest forecast, our evidence shows that firms are more likely to beat an incremental forecast with a decrease in ETR compared to missing an incremental forecast with an increase in ETR. Our study highlights the strategic nature of earnings management by providing evidence that managers consider individual forecasts to calibrate earnings management decisions.

What's My Target? Individual Analyst Forecasts and Last-Chance Earnings Management

Kirk, Reppenhagen, and Tucker (2014) find that investors use individual analyst forecasts as additional earnings benchmarks. We investigate whether executives manage earnings to beat these individual benchmarks. Using year-end effective tax rate (ETR) manipulation as our setting, we find that firms decrease ETRs from 3rd to 4th quarter to meet or beat a greater percentage of individual forecasts. We also find some evidence that firms use incremental ETR changes to meet forecasts by key analysts. After controlling for the distance to the nearest forecast, our evidence shows that firms are more likely to beat an incremental forecast with a decrease in ETR compared to missing an incremental forecast with an increase in ETR. Our study highlights the strategic nature of earnings management by providing evidence that managers consider individual forecasts to calibrate earnings management decisions.

The Influences Of Status Quo And Endowment Biases On Earnings Management

This study investigates the effects of status quo and endowment biases on earnings management behaviors. This research conducts a survey method in 2018. The sample comprises of 74 accounting students at a business school in Indonesia. The main variables are measured by questionnaires with 1 to 7 scale. The hypotheses are examined by multiple regression technique. The findings reveal that status quo and endowment biases positively influence earnings management actions. This research provides two contributions. This study attempts to link status quo and endowment biases to earnings management behaviors. This contributes additional theoretical explanations of earnings management behaviors among accountants. Research conclusions can be utilized to determine the suitable psychological aspects of accountants for earnings management decisions.

Does the executive labor market discipline? Labor market incentives and earnings management

This paper investigates the role of outside options in the executive labor market on earnings management decisions. To proxy for executives’ outside options, we use the number of times other firms cite the executive’s firm as a compensation peer. We find that executives with more citations conduct less earnings management. Exploiting the 2006 SEC requirement for compensation peer disclosure as a quasi-natural shock to executives’ awareness of outside options, we show that the executives who should be more responsive to outside options significantly reduce earnings management. Cross-sectional tests support a labor market discipline channel of outside options. Finally, we exploit state-level recognition of Inevitable Disclosure Doctrine and enforcement of non-compete agreements as cross-sectional restrictions on labor mobility and show that the impact of peer citations on reducing earnings management is stronger when there are fewer restrictions on mobility.

Controlling Shareholder’s Share Pledge, Earnings Management and Audit Decision—Based on Regression Method in Statistics

This article uses 2009-2019 Shanghai and Shenzhen A-share listed companies as a sample to study the impact of listed companies’ equity pledge behaviour on auditors’ decision-making. The empirical results show that if there is a pledge of large shareholder equity, the audit pricing will be higher than when it does not exist. At the same time, the greater the proportion of pledged equity is, the higher the audit pricing accordingly is. The study finds that the equity pledge behaviour would make auditors more likely to issue non-standard audit opinions. The state-owned nature has a positive regulating effect on the relationship between equity pledge and audit opinion. But it has a negative regulating effect on the relationship between equity pledge and audit pricing. In the study of the mechanism of action, it is found that the equity pledge affects the auditor’s decision-making by affecting the level of earnings management. The research in this article provides a reference for listed companies, auditor firms and regulatory authorities.

Air Quality Uncertainty and Earnings Management

We empirically examine the influence of rising political costs from the air quality uncertainty caused by regional air quality fluctuations on firms′ earnings management. The results indicate that when air quality uncertainty increases, firms tend to increase their degree of earnings management and are more willing to carry out downward earnings management. We also find that the relationship is more obvious in the bottom-ten cities according to air quality ranking. Further evidence shows that the effect is most pronounced for less market-oriented regions, northern regions, manufacturing industries and firms with high asset-liability ratio and high media attention. In addition, we find that air quality uncertainty affects earnings management through the intermediary effect of government environmental investment. We explore the influence of the external environmental uncertainty on earnings management decisions, and the results have significant reference value for improving firms’ earnings quality level.