Earnings Management Motivation Research Articles

EVIDENCE OF EARNINGS MANAGEMENT FROM THE MEASUREMENT OF THE DEFERRED TAX ALLOWANCE ACCOUNT

Positive accounting literature has provided empirical evidence regarding firms' characteristics that cause their managers to make particular accounting decisions. The purpose of this study is to extend this line of research to the area of accounting for income taxes. The research is designed to identify accounting choice variables that influence managers' decisions to change the level of the deferred tax asset valuation allowance under SFAS No. 109. Specifically, the study presents an empirical examination of whether managerial discretion over the valuation allowance appears to be used for earnings management purposes. Evidence of earnings management motivations can provide insights into whether it is an appropriate accounting policy to give management considerable discretion to choose the level of the valuation allowance.

The Effect of Investment Opportunity Set and Debt Level on Earnings-Returns Relationship and the Pricing of Discretionary Accruals

This study examines whether the informativeness of earnings and the pricing of discretionary accruals by the market are associated with investment opportunity set (IOS) and debt levels. We show that the earnings-returns relationship is impacted positively by IOS but negatively by debt after controlling for other confounding variables such as size, beta, persistence of earnings and regulatory environment. We then show that the market prices discretionary accruals at a higher level for high-IOS firms than for low-IOS firms. The evidence on the effect of debt on the pricing of discretionary accruals is weaker but negative. We show further that the positive association of discretionary accruals with future profits is further improved in high-IOS firms but weakened in high-debt firms. This is consistent with the view that managers use discretionary accruals as a means to signal future opportunities for growth. In effect, this efficient earnings management can be significant, especially in high-IOS firms. More interestingly, opportunistic earnings management is not the only motivation for earnings management under all circumstances. Key Words: Earnings management; Investment opportunity set; Capital markets; Valuation; Discretionary accruals

Discussion of Evidence of Earnings Management from the Provision for Bad Debts

This paper is an empirical study of the provision for bad debts by firms in three industries (publishing, business services, and nondurable wholesalers) selected from Compustat as having especially high (i) accounts receivable to total assets and (ii) bad debts expense to net income. The authors' objective is to model the provision for bad debts in the absence of earnings management and to use the expected provision from that model to test for earnings management. The authors posit two underlying motivations for earnings management, income smoothing and a variant of the prediction developed by Healy [1985] that managers of firms with explicit bonus plans will manage earnings consistent with the incentives engendered by specific plan parameters. The authors argue that the latter prediction can be generalized to firms without explicit bonus plans so that managers of all firms with unusually high or low income have incentives to choose income-decreasing accounting accruals. The authors partition 906 firm-year observations for 106 sample firms into deciles based on deviations from (i) the average ratio of earnings to total assets (labeled ROA) over the sample period and (ii) the firm's prior year ROA.1 They consider firms in the top (bottom) decile as firms with unusually high (low) earnings, and their statistical tests compare observations in deciles 1 and 10 to those in deciles 2-9. Both hypothesized motivations for earnings management imply an income-decreasing measure of earnings discretion in the top decile, assuming that sample firms' managerial compensation plans have formal or implicit upper bounds, as