Earnings Management Literature Research Articles

Market power, competition and earnings management: accrual-based activities

Purpose This study aims to understand the impact of market power and competition on earnings management, particularly discretionary accruals, in the Chinese and Taiwanese tourism industries. China and Taiwan differ not only in their political and social systems but also in their economic systems. The research aims to provide managers and investors with stock selection strategy in the decision-making process. Design/methodology/approach Accounting data consisted of 60 publicly traded travel companies in China and Taiwan from 2000 to 2014. Methodology included correlation matrix for the variables, univariate and multivariate regression and competition analysis. Findings Based on empirical results, the authors found a significant negative correlation between market power and discretionary accruals and market concentration (or lower market competition) and discretionary accruals in both the Chinese or Taiwanese markets. Although the Chinese travel companies enjoyed higher market power and market concentration, they engaged in less earnings manipulation than their Taiwanese counterparts as a result of the Chinese Government regulation. Research limitations/implications Based on listed travel companies, generalization of the research results to entire tourism industry is limited. This study compares the travel companies’ practices of smoothing out earnings between China and Taiwan, thus helping managers and investors in making their financing, investment decisions. Originality/value This research contributes to the earnings management literature by examining a specific industry of tourism. This paper is original in two ways. The authors linked market power and market competition with earnings management simultaneously and then compared the Chinese and Taiwanese tourism industries in manipulating earnings.

Voting with hands, earnings management and corporate governance

PurposeMotivated by managers’ intentions to pursue private interests by engaging in earnings management, this paper aims to investigate whether voting with hands (shareholders cast votes on shareholder proposals) by shareholders acts as an external disciplining mechanism over earnings management relative to corporate governance. Also, as corporate governance can scrutinize managers’ behavior, this study also examines whether there is a substitutive relation between shareholder proposals and corporate governance mechanism.Design/methodology/approachFirst, this paper uses ordinary least squares (OLS) regressions of discrepancy accruals on the percentage of “For” votes for shareholder proposals to test the incremental effect of shareholder proposals on earnings management. Second, firms receiving shareholder proposals are matched with those not receiving proposals by propensity scores, and the levels of earnings management and corporate governance between these two groups are compared by univariate analysis and OLS regressions. In addition, six portfolios are created based on whether firms receive shareholder proposals, as well as on the levels of corporate governance, to assess whether external control from shareholder proposals can substitute internal control for corporate governance in disciplining earnings management. Regressions of earnings management on corporate governance (shareholder proposals) are conducted in the sub-samples formed on shareholder proposals (corporate governance) to further explore the above substitution effects.FindingsBased on a sample of 2,041 firm-year observations from 2001 to 2010, this paper finds that the “For” votes received from the shareholder proposals have a significant negative relationship with the practice of earnings management, even when corporate governance is controlled. The negative relationship between shareholder proposal and magnitude of earnings management is also found to be stronger when firms have weak corporate governance. The overall evidence suggests that the external control from “voting-with-hand” shareholders has a significant impact on earnings management. In addition, shareholder proposals can substitute the monitoring mechanism for corporate governance in constraining managers’ myopic behavior.Originality/valueThis paper contributes to the extant literature by using the percentage of “For” votes for shareholder proposals as a proxy for shareholder pressure and concerns. This study contributes to the earnings management literature by showing the disciplinary effect of outside shareholders on managers’ reporting behavior. Also, it contributes to the corporate governance research by presenting that shareholder proposals can substitute for the internal control of corporate governance in decreasing earnings management. This paper should be of interest to investors and standard setters.

Refinement of the FCF motive for stock repurchases

PurposeThe purpose of this paper is to investigate factors that influence the free cash flow (FCF) motive for stock repurchases. Specifically, it examines whether the positive association between FCF and open-market repurchases is partially driven by abnormal cash flows, and whether external analyst monitor and financial crisis influence the association.Design/methodology/approachThe study employs a tobit regression model to test the hypotheses.FindingsFirst, the results suggest that the positive association between FCF and stock repurchases is partially driven by abnormal cash flows. Second, the association between pre-managed FCF and stock repurchases is strengthened as more analyst following the firms. Third, firms repurchase less when they report more negative abnormal cash flows, and that tendency is more pronounced during the 2008 financial crisis period. Further analysis shows that during the crisis period, the effect of negative abnormal cash flows on operating performance gets stronger.Originality/valueThe study makes several contributions to the literature. This paper is the first to show that managers use abnormal cash flows to fulfill the share buy-backs. In addition, it shows that analysts provide effective external monitoring by strengthening the association between pre-managed FCF and repurchases. Furthermore, it finds that firms adjust their strategy in times of financial crisis period in response to the increased risk. Finally, it contributes to the earnings management literature by showing the differential effects of accruals management and cash flow management on earnings performance.

Earnings Management, Managerial Ability, and the Role of Competition

I contribute to the extensive earnings management literature by examining the effect of market competition on the relationship between managerial ability and earnings management. The results show that in the face of increased competition, high quality managers manipulate earnings via accruals rather than more costly real earnings management. As a result, competition amplifies accrual earnings management by superior managers, but does not result in greater amounts of real earnings management. This reaction to the pressure of competition reflects the optimal contracting between firms and more able managers that creates mutual benefits to both parties. The results emphasize the importance of understanding how industry level factors influence managerial decisions at the firm level.

A New Perspective on Earnings Management in Emerging European Countries: Investigation on Environmental Factors that Explain Differences in Earnings Management

This paper presents a new perspective on earnings management analyzing and comparing emerging European countries in the presence of environmental factors of developing countries. We provide empirical evidence on differences in the extent of earnings management across countries. Developing Eastern European countries experienced important changes. They have been in transition over the past decade, and remain making great strides to overcome the drag exerted by their communist heritage. Nevertheless, the studies on earnings management based on emerging economies are rare and hardly pursued due to the presence of institutional and regulatory differences between developed and emerging economies. Therefore, the present study fulfils the important gap in earnings management literature related to developing countries. Our results confirm that managers from different emerging European countries manage earnings differently. Additionally, we identify that there is not a sole reason affecting the managers’ decisions, but a significant number of circumstances and characteristics. Whether a firm’s environment offers more protection or is characterized by a higher level of development, higher foreign investments, it helps to limit the earnings management. In addition, when accounting and tax are not as strongly aligned with market approach as expected, it also limits the earnings management behaviour of managers.

Does corporate governance influence earnings management in listed companies in Bahrain Bourse?

PurposeThis paper aims to consider data for listed companies in Bahrain Bourse to determine whether companies practice earnings management (EM). Further, the effect of a set of corporate governance characteristics on EM practices is examined.Design/methodology/approachThe EM level was measured using discretionary accruals (DA) [calculated using the Modified Jones (1995) Model]. The study sample consisted of 20 companies listed during the period 2011-2015. Panel regression model was used to test the study hypotheses and achieve the study aims.FindingsEM is negatively correlated with board size, confirming that a larger board is associated with a lower level of EM practices. Further, board independence is positively correlated with EM, suggesting that the larger the number of independent directors, the higher the level of EM practices. In addition, internal ownership is positively related to EM, confirming that the higher level of internal ownership increases EM practices. CEO duality does not appear to have any effect on EM in Bahrain Bourse. More interestingly, the findings reveal that companies practice EM through income-increasing DA.Research limitations/implicationsFinancial data and data related to other corporate governance characteristics are lacking.Practical implicationsThe results of this study provide empirical support for the development of new regulations and amendments and necessary corrective decisions regarding the effectiveness of applying corporate governance code in Bahrain Bourse. More specifically, this study reveals an urgent need for new amendments to restrict EM practices in Bahrain Bourse.Originality/valueThis study enriches the EM literature by covering Bahrain as an Asian country, which has not been sufficiently examined in relation to this topic. Further, this study provides a clear picture of the level of EM practices in Bahrain Bourse to multiple parties.

Is there One Pattern of Earnings Management Motivations Fit all Contexts? An Empirical Study

This paper aims at exploring the effect of the Egyptian context on shaping executives' motives to manage earnings; and identifying the most influential managerial motives: managerial self-interests and external environmental factors. The research adopts an interpretative methodology and interview methods. Interviewees were conducted with twenty managers representing five different companies within industrial and service sectors of the Egyptian economy. The findings of this research suggest that a firm’s context has an influence on shaping managers’ self-interests and that in Egypt the job market is a powerful motive for managing the financial reports, followed by cash bonuses; however, stock-based compensation lacks the power to motivate managers into making such financial improvements. In addition, this paper concludes that environmental motives are more important than motives related to managers’ self-interests, because managers cannot achieve their own interests without complying with the external pressures or motives to manage the financial reports. The principal contribution of this paper is to build on the previous earnings management literature to consider the firms' context while studying managers' motives. It pairs the economic factors with institutional factors to form the main reasons behind: 1) managers’ engagement in earnings management; and 2) the superiority of environmental factors over the managerial self-interests motives. It also sheds light on, there is no one pattern of earning management motivations fit all contexts. This paper also contributes to the new institutional sociology literature by bringing managers’ interests and power into the centre of the conceptual framework.

An examination of SEC revenue recognition comments and IPO earnings management

PurposeThe purpose of this study is to examine the association between revenue-based earnings management in the periods immediately before and after firms’ initial public offerings (IPOs) and regulatory scrutiny by the United States Securities and Exchange Commission (SEC) during review of IPO firms’ registration statements.Design/methodology/approachThis paper uses conditional discretionary revenues (Stubben, 2010) as its measure of earnings management, and revenue recognition comments delivered by the SEC as its measure of regulatory scrutiny. The authors use ordinary least squares regression (OLS) models, as well as a supplemental count model, to assess the association between conditional discretionary revenues and revenue recognition comments delivered by the SEC.FindingsThis study finds evidence of a positive association between earnings management measures in the pre-IPO period and the number of revenue recognition comments received by those firms during the SEC’s review. Furthermore, this study provides evidence that greater numbers of comments are associated with declining earnings management measures in the post-IPO period. However, the evidence suggests that these associations apply only to income-decreasing earnings management.Originality/valueThis paper extends the IPO earnings management literature by using conditional discretionary revenues as the measure of earnings management, and contributes to a nascent research stream in the accounting literature by investigating the SEC’s comment letter process and its association with, and impact upon, earnings management in the IPO process.

Earnings management in the aftermath of the zero-earnings discontinuity disappearance

Purpose The purpose of this paper is to investigate earnings management by firms reporting a small profit or a small loss after the recent evidence that the discontinuity around zero earnings has disappeared. Design/methodology/approach Using a large sample of US firms for the period 2002–2011, regression analysis and earnings distribution approach are employed to examine the earnings management of small-profit and small-loss firms in terms of both accruals management and real activities manipulation. Findings The results suggest that both small-profit and small-loss firms are engaged in upward manipulation of accruals and real activities. This implies that failure to document a difference between firms to the right and left of zero by prior studies is not due to small-profit firms not managing earnings, but rather this is more attributable to loss firms engaging in upward manipulation. Furthermore, it is indicated that the discontinuity around the distribution of earnings change has also recently disappeared as firms reporting a small earnings decrease demonstrate similar earnings management behaviour to those reporting a small earnings increase. Research limitations/implications This study is subject to the measurement error which is a common limitation in the earnings management literature. Practical implications The results suggest that the users should be aware that, in addition to firms that meet benchmarks by a slight margin, firms narrowly missing benchmarks are also involved in earnings management. Originality/value This study shows that the disappearance of the discontinuity around zero earnings and zero change in earnings should not be interpreted as a sign of no earnings management. It also explains how earnings management could have contributed to the disappearance of the discontinuities in earnings distribution.

The impact of pyramid ownership on earnings management

PurposeUnlike firms listed in the USA, many large firms in Canada belong to business groups organized as pyramids. A pyramidal structure refers to a business group that consists of a set of enterprises or other entities and displays a top-down chain of control. The purpose of this paper is to investigate the relationship between pyramid ownership and earnings management.Design/methodology/approachThe paper is an empirical study using a sample of 165 Canadian listed firms from 2010 to 2015. The impact of pyramid ownership on both accrual-based and real earnings management is examined.FindingsThe findings show that pyramid-affiliated firms engage in less accrual-based and real earnings management than non-pyramid-affiliated firms. The results further show that the divergence between control rights and cash flow rights of the controlling shareholders in the pyramid-affiliated firms is positively related to real earnings management. Moreover, the results highlight that intra-group transactions (other than internal financing) among pyramid-affiliated firms lead to higher level of both accrual-based and real earnings management, but internal financing is negatively associated with real earnings management. Overall, this study provides the evidence which indicates that pyramid ownership structure and earnings management are related to each other.Originality/valueThe paper contributes to the earnings management literature by studying the impact of pyramid ownership structure on earnings management, especially real earnings management.

An exploratory analysis of earnings management practices in Australia and New Zealand

PurposeThis study aims to explore corporate earnings management practices in Australia and New Zealand before and after the regulatory changes and corporate governance reforms. The study argues that the effectiveness of regulatory reforms has to be reflected in constraining earnings management in post-reform period as compared to pre-reform period.Design/methodology/approachUsing a sample of 3,966 firm-year observations, including all ASX and NZX listed firms for the period 2001-2006, the study examines earnings management practices in both countries in pre- and post-reform periods with appropriate statistical methods.FindingsThe results indicate some interesting phenomenon: the magnitude of earnings management did not decline after the governance reform as a positive time trend is observed in the entire sample as well as in Australian and New Zealand sub-samples, suggesting that earnings management has been growing over time. Additional test indicates no structural change has occurred before and after the new regulations. The shifting from decreasing earnings management to increasing earnings management can be interpreted as an evidence that earnings become more ‘informative’ in a more transparent disclosure regime to capture short-run benefits from regulator reforms.Research limitations/implicationsThe shifting of earnings management behaviour from decreasing to increasing income can be interpreted as the outcome of more “informative”, rather than “deliberate”, earnings management in a more transparent disclosure regime to capture short-run benefits of regulatory reforms, which is worth further investigation. The findings of the study can lead regulatory authorities taking appropriate measures to promote earnings quality in corporate financial reporting from a long-run decision usefulness context. Any future reforms should be directed to protecting the interest of stakeholders as well as ensuring benefits outweighing costs for them.Practical implicationsThe findings of the study can lead regulatory authorities in taking appropriate measures to promote earnings quality in corporate financial reporting from a long-run decision usefulness context.Originality/valueThe study adds value to the existing earnings management literature as well as effectiveness of regulations for the benefit of wider stakeholder groups.

On the assessment of the performance in earnings management for the banking industry: the case of China’s banks

ABSTRACTEarnings management is popular in the banking industry. Earnings can be manipulated by discretionary loan loss provisions (DLLP). Analysing the trajectories of banks’ DLLP (i.e. their change in DLLP over time) is an effective way to assess the performance in earnings management for the banking industry, but seems not to have been addressed in the earnings management literature. In this study, we analyse the trajectories of DLLP with the yearly data from 2007 through 2012 for four types of banks in China. The results have indicated that state-owned banks, policy banks and city commercial banks seem to manage earnings well. Cautionary notes about bank risks are provided.

What can auditors tell us about accounting manipulations?

PurposeThis paper aims to examine the frequency and the nature of International Financial Reporting Standards/International Accounting Standards (IFRS/IAS) violations that resulted in modified audit opinions (MAOs); determinants of MAO decision; and underlying motives, targets and techniques of accounting manipulations.Design/methodology/approachDescriptive statistics and in-depth investigation on archival data collected from the published audit reports are used to analyse the frequency and the nature of IFRS violations that resulted in MAOs, while the logistic regression is applied to identify the possible determinants of MAO decisions. A survey instrument is used to identify the relative importance of different manipulation motives, targets and techniques from the perspective of an external auditor.FindingsResults from the archival research show that MAOs are expressed in 29% of audit reports of listed companies in Croatia. A majority of the qualifications refer to noncompliance with provisions of IAS 39, IAS 16, IAS 1, IAS 2 and IAS 36. The survey results show that manipulations are principally oriented towards creditors, tax authorities and suppliers with the intention to hide bad performance, get better terms of crediting and minimize fiscal and political costs. Results from the field study complement and confirm the archival research results in respect to the accounting areas and techniques used for manipulation purposes.Originality/valueThe analysis provides a rather robust estimation of the extent of accounting manipulations, compared to commonly used earnings management metrics. Application of multi-method research that integrates archival research and field study offers significant contribution to the existing earnings management literature in methodological approach. The results directly address particular provisions of the IFRS that are frequently violated and provide better understanding of the features of accounting manipulations in a specific institutional setting.

Ownership Concentration and Earnings Management Literature Review

This paper reviews the main literature of ownership concentration and earnings management research, comments the views development of this eare research from the large shareholders equity concentration, the identity of owner shareholder and institutional investors holding ratio according to the conclusion of literature and the logical relationships of the literatures respectively. It also discusses the research development of earnings management theory in equity structure. Expect to provide a reference for the future research of ownership structure and earnings management.

Earnings management in non-public companies: the case of for-profit hospice organizations

We examine earnings management in non-publicly listed companies, with a focus on for-profit (FP) hospice organizations, and extend the accounting earnings management literature to the hospice industry. FP hospice organizations file Medicare cost reports that include complete financial statements not otherwise publicly available. Managers of FP hospice organizations have incentives to manage earnings to increase performancebased bonuses, meet or beat bond covenant requirements, or avoid public scrutiny. We find total accruals are significantly positively associated with profitability, debt, and size factors. However, discretionary accruals are significantly negatively associated with debt and size, but not profitability. Thus, monitoring and political cost factors appear to effectively mitigate earnings management in this industry sector.

The impact of idiosyncratic risk on accrual management

PurposeThe purpose of this paper is to add an important new dimension to the earnings management literature by establishing a link between idiosyncratic risk and the degree of accrual management.Design/methodology/approachBased on a comprehensive sample of 44,599 firm-year observations during the period spanning 1987-2009, the study offers robust empirical evidence of the importance of firm-specific idiosyncratic volatility as a determinant of earnings manipulation. The authors use standard measures of earnings management and idiosyncratic volatility. The authors test the hypotheses with robust econometrics techniques.FindingsThe authors document a strong positive relationship between idiosyncratic risk and accruals management. Further, the authors find a positive association between residual volatility and discretionary accruals whether accruals are income inflationary or income deflationary. The findings are robust to alternate idiosyncratic risk proxies and variables associated with earnings management.Originality/valueOverall, the knowledge derived from this study provides additional tools to assess the degree of earnings management by firms, and hence the quality of the financial reporting. Thus the findings will enable standard setters, financial market regulators, analysts, and investors to make more informed legislative, regulatory, resource allocation, and investment decisions.

In the name of others: an investigation of earnings management motives in Egypt

PurposePrevious literature on earnings management (EM) indicates that managers are motivated to adjust reported income to serve their own self-interests, and to try and influence capital markets. However, previous research has failed to provide an appropriate theoretical underpinning for EM and has ignored the effect of cultural and environmental factors on shaping managers’ motivations. Therefore the purpose of this paper is to draw on interpretive methodology and new institutional sociology (NIS) theory to identify the external factors that motivate managers of Egyptian companies to use EM to modify financial statements.Design/methodology/approachThe research adopted an interpretative methodology and interview methods. Interviewees were conducted with 34 participants, who were divided into four different categories; executives, financial analysts, auditors and stock exchanges’ authorities.FindingsThis paper provides empirical evidence on the range of external factors that motivate Egyptian corporate executives to adjust the earnings number in financial statements. These external factors include the expectations of investors, lenders and employees, the impact of stock exchange listing rules, beating an earnings target, and the privatisation of key state-owned companies.Research limitations/implicationsThe authors recognise that the paper has a number of limitations. The research is concerned solely with EM in Egypt and, therefore, it would not be safe to generalise the results to other contexts, even in the Middle East. Further research on the behaviour of managers towards EM in other countries would be useful to test validity of the results reported in this paper.Originality/valueThe principal contribution of this paper is to build on the previous EM literature to include external factors within the Egyptian context which motivate Egyptian managers to manage the earnings of companies in an upward direction. It adds additional EM motives to available literature including: employees, stock exchange’s rules, privatisation and meeting industrial norms. Also, the paper provides evidence of the effect of concentrated share ownership on managers’ likelihood to engage in EM behaviour. The paper also extends NIS theory to recognise the importance of the interplay between institutional and economic environment by including economic reform, and non-financial providers as factors that can explain the EM behaviour.

Viewing Discretionary and Non-Discretionary Accruals Through the Univariate Lens: A Conditional Heteroscedastic Mean-Variance Approach

Unlike no study in accounting literature, I do a firm-by-firm application of the univariate conditional heteroscedastic (UCH) mean-variance modeling technique –hereafter called ‘UCH Model’ –to propose a new way to decoupling a firm’s discretionary from non-discretionary accruals. What the UCH Model essentially does is it kills any linear dependence in accruals estimation errors to isolate firm-specific shocks to accruals reporting so that ‘model misspecification’ and ‘low test power’ concerns –known to have plagued existing accruals models –are completely eliminated. The UCH mechanism invokes an intuitive, but popular econometric time-series argument that for the same time series variable (e.g. stock return, earnings per share, accruals), each sample unit (i.e. firm) tends to have a unique behavior and should be modelled distinctively. I provide empirical evidence supporting this and conduct a series of validation tests on this new univariate measure of discretionary accruals to assess if it appeals to economic theories largely popularized in the earnings management literature. Specifically, I find that the UCH discretionary accruals measure –capturing managers’ opportunistic reporting of accruals –significantly and positively associates with the ‘smoothing’ incentive (i.e. managerial intents to report abnormally large accruals when current earnings is already above different types of earnings targets [industry profitability, prior-period earnings, and analysts’ forecasts]). Cross-sectional analyses also reveal that a number of other management intents (e.g. avoidance of debt covenant violation, large firms’ desire to minimize exposure to political costs, high operations uncertainty, etc.) affect the nature and extent to which managers report abnormally large accruals.

Effects of borrowing costs, firm size, and characteristics of board of directors on earnings management types: a study at Borsa Istanbul

Using data for firms at Borsa Istanbul in Turkey, this study determines how borrowing costs, firm size, and board size and independency affect choice of earnings management (EM) type (efficient or opportunistic), in an attempt to expand the somewhat limited EM literature. The results of the ordinary least squares hypothesis testing show that the firms practice efficient EM, and that highly leveraged firms and those with a high proportion of independent non-executive board members use EM less than those with a low proportion, while large firms and those with large boards use EM more than those with small boards do.

Spring-loading future performance when no one is looking? Earnings and cash flow management around acquisitions

We find evidence that performance—reflected in earnings and cash flows—is transferred from targets to acquirers around acquisitions. Using a sample of 2128 completed deals from 1985 to 2010, our results suggest that targets depress performance when investor attention declines once the deal parameters are set, and much of that performance understatement is transferred to boost post-acquisition acquirer performance. Evidence of variation across subsamples provides additional confirmation: transfers are more visible for large deals (with transfers large enough to be detected) and muted for pooling transactions (with lower incentives to transfer). We contribute to the earnings management literature by showing that earnings and cash flows are transferred not just within firms but also across firms, and to the mergers and acquisitions literature by documenting that performance is managed not only before but also after deals are announced.