Earnings Management In Firms Research Articles

The historical origins of earnings management: a geographical discontinuity design based on the Great Wall

PurposeDoes the history of the bureaucratic system, along with the establishment of the Great Wall during the Ming and Qing dynasties (1368–1911), affect firm behavior across the borderlands of the Great Wall?Design/methodology/approachThe Ming and Qing dynasties built a centralized administrative system in the borderlands on the south side of the Great Wall, in contrast to the “feudal lordship” system on the north side. Employing a regression discontinuity analysis framework with the Great Wall as a geographical discontinuity, we examine the long-run effects of the Great Wall on firms’ earnings management.FindingsUsing a large sample of nonlisted firms in the central core frontier region, we show that the earnings management of firms in the region south of the Great Wall is significantly curtailed compared with firms in the north of it, and this effect is more pronounced for non-SOEs. Our findings are robust to a battery of tests to account for alternative explanations.Practical implicationsOverall, by emphasizing the role of institutions, like legal system, shaped in history on firms’ earnings management, this study sheds new light on institutional determinants of firms’ behaviors in earnings information disclosure.Originality/valueFirst, we enrich our understanding of the institutional determinants of firms’ financial reporting outcomes. Second, our findings shed new light on the long-term effects of historical ruling styles on modern corporate behavior.

Internationalization of enterprises and quality of financial reports in China: Moderating roles of audit committee characteristics

In the process of seeking sustainable development, enterprises have chosen international business strategy. The purpose of this study is to examine the relationship between the degree of internationalization of Chinese listed firms and financial reporting quality, as well as whether audit committees can moderate the impact of enterprise internationalization on financial reporting quality. The empirical analysis results of Chinese listed manufacturing firms from 2014 to 2018 show that: the degree of corporate internationalization has a significant U-shaped relationship with earnings management. This new finding solves the problem that scholars have inconsistent views on the internationalization of enterprises and the quality of financial reporting. The study also found that audit committees with experience working in accounting firms can inhibit firm earnings management behavior in the early stage of internationalization; audit committees with experience working overseas can inhibit firm earnings management behavior in the later stage of internationalization; the higher the remuneration of audit committee experts, the more it can inhibit firm earnings management behavior in the early stage of internationalization. In the later stage of internationalization, the higher the remuneration of audit committee experts, it helps the earnings management behavior of firms. This provides new evidence on the functioning of the audit committee’s role; however, the independence of the audit committee and the proportion of financial experts do not have a significant effect on the inhibition of earnings management.

Policy uncertainty and real activities manipulation: evidence from Brexit

AbstractBrexit exposed the UK to substantial policy uncertainty that could affect the performance and behavior of British firms. We examine the impact of Brexit as an exogenous shock to policy uncertainty on real activities manipulation by British firms. Using several measures of real activities manipulation and a difference-in-differences design, we compare the earnings management of firms most adversely affected by Brexit uncertainty (affected firms) to other firms. Our results indicate that the affected firms exhibit higher real activities manipulation after the Brexit vote and we also find that they demonstrate similarly higher accruals management. Our findings suggesting that policy uncertainty induces the costly practice of real activities manipulation are relevant to various stakeholders including policymakers and financial statements users.

Stock market liberalization and earnings management: Evidence from the China–Hong Kong Stock Connects

In this paper, we use the China-Hong Kong Stock Connects (the connects) as exogenous shocks of the liberalization of Chinese stock markets to examine the effects of the connects on firm earnings management. We find that the stock market liberalization of capital market significantly reduces firms’ earnings management. The decrease of asymmetric information is the underlying driving force behind our findings. Overall, this study provides policy implication that the stock market liberalization reduces the earnings management.

The impact of terrorist attacks and mass shootings on earnings management

This study investigates the role of salient events on accrual-based and real earnings management activities. For people using availability heuristics, the salience of an event may temporarily increase perceived risk even though the actual risk does not change, and individuals making decisions by availability heuristics are subsequently more likely to assign a higher probability to unrelated negative future events. I use terrorist attacks and mass shootings as salient events and conjecture that the negative effects of terrorist attacks and mass shootings spill over and lead to pessimistic risk assessments of financial reporting choices. The findings show a decrease in accrual-based and real earnings management for firms located in the impacted regions. The documented effects are driven by firms with high information asymmetry levels and pessimistic annual reports. Additional analysis reveals that affected firms decrease the readability of their annual reports, suggesting affected firms engage in a more complex narrative disclosure. The findings of this paper support the argument that managers exhibit a cognitive bias which affects their financial reporting choices.

Ill‐intentioned or well‐intentioned: earnings management and trade credit

The use of trade credit as important short‐term financing for firms is increasing. This study explores the differential impact of firm earnings management on trade credit financing under different motives, using A‐share listed firms in China from 2009 to 2020. The results show that accrued and real earnings management reduce a firm's trade credit. On the other hand, the classification shifting earnings management increases a firm's trade credit. Accrued and real earnings management are opportunistically motivated, while classification shifting earnings management is non‐opportunistically motivated. Moreover, external audits weaken the negative effect of accrued and real earnings management on trade credit and enhance the positive effect of classification shifting earnings management on trade credit, indicating the ‘bilateral matching effect’ between external audits and firms. Finally, financing constraints weaken the impact of earnings management on trade credit.

Women on boards, firm earnings management (EM) and performance nexus: does gender diversity moderate the EM–performance relationship?

PurposeThis paper aims to shed light on an essential role that “female directors” on boards of companies in sub-Saharan Africa play towards corporate financial performance enhancement. The study observes how board gender diversity moderates the relationship between earnings management (EM) and financial performance of firms in sub-Saharan Africa from a dynamic perspective.Design/methodology/approachThe study’s sample comprises 105 companies listed on the respective stock markets of nine sub-Saharan African countries. The data are collected from annual reports over the period 2007–2019, a total of 1,166 firm-year observations. Panel data models are used in the analyses.FindingsThe study finds that the performance effect of EM is contingent on board diversity and this finding persists even after controlling for dynamic endogeneity, simultaneity and unobserved time-invariant heterogeneity inherent in the EM and performance relationship.Research limitations/implicationsThe findings should be understood within the context that, only available annual reports and audited financial statements that were filed with respective capital markets of the nine surveyed countries are used as source of information.Originality/valueThe current study is unique, in that, it is the first panel multi-cross-country investigation within Africa to introduce gender diversity in the study of the relationship between EM and firm performance. It therefore extends the agency theory by using gender diversity as a moderating variable in the EM–firm performance nexus.

Internationalization and earnings management: Evidence from China

Firm internationalization is an important strategy for enhancing competitive advantage. This study investigates the effects of internationalization on firm earnings management behavior by detecting multinational corporations’ earnings manipulation. No substitute effect of accrual earnings management and real earnings management is observed in the multinational operating enterprises’ earnings management activities. We find that internationalization increases firms’ motivation to manage accrual earnings. The higher the degree of multinational operation, the more inclined the firm is to manipulate accrual income to achieve its goals.

The Impact of Retail Investor Attention on Earnings Management: Evidence from China

The paper investigates the impact of change in retail investor attention on earnings management in this article. The result indicates that retail investor attention is positively correlated with earnings management. The relation with the two variables is tenable to multiple panel regressions containing alternative measurements and grouped regression models. The further analysis illustrates the positive impact of the increase in retail investor attention on earnings management is more salient in firms who are not state-owned, with small capitalization and audited by non-Big4. Moreover, it indicates that an increase in retail investor attention leads to more active earnings management in firms with less supervision and exposure. Finally, it leads to conclusion that retail investor attention appears to motivate earnings management.

The Influence of Audit-Committee Characteristics on the Association between Corporate Social Responsibility and Earnings Quality

Corporate social responsibility (CSR) activities are affected by the national system, and the social and cultural environment to which a firm belongs. This study investigates whether the characteristics of an audit committee (AC) such as independence, expertise, activity, or power influence the relation between CSR and earnings quality for Korean firms. Multivariate regression analysis is used to identify the effect of AC characteristics on the relation between CSR and the earnings management of firms with CSR excellence, as well as whether their contribution enhances the quality of earnings of firms that actively engage in CSR practices. The results show that when ACs are active, earnings management using the discretionary accruals of firms that participate in CSR activities with an ethical motive is more tightly constrained. ACs are more effective when they have independent directors, accounting expertise, active participation, and relative power. The findings suggest that ACs have a positive effect on the financial reporting quality of firms with high levels of CSR. Furthermore, active ACs are crucial for improving the quality of earnings, which is further enhanced when ACs have a variety of superior characteristics.

The Factors Impact On Earnings Management On Indonesia Mining Company

This purpose of this research to analyze the impact of size, age, profitability, and leverage on earnings management of the company. The data sampling was selected using a purposive sampling technique to obtain 20 mining companies listed on the Indonesia Stock Exchange IDX that can meet the criteria. The analysis in this study was binary logistic regression analysis through SPSS 26. The analysis found that firm size insignificant effect on earnings management. Company age has a negative and significant impact, profitability has no significant effect, and leverage insignificant effect on firm earnings management.

Under watchful eyes: Analyst site visits and firm earnings management

This paper investigates whether analyst site visits, where sell-side analysts visit corporate sites and interact with management, reduce earnings management by host firms. Taking advantage of the disclosure of analyst site visits by Chinese listed firms, we find that the intensity of analyst site visits is negatively associated with discretionary accruals, and this relation is robust to controlling for endogeneity. Furthermore, we find that site visits attended by star analysts and including factory tours are associated with lower levels of discretionary accruals than those without these features. We also report that the number and coverage of questions posed during site visits are negatively associated with discretionary accruals. Our results demonstrate that site visits by sell-side analysts perform a vital monitoring role and exert significant constraints on firms' opportunistic financial reporting.

The effect of debt maturity structure on earnings management strategies

PurposeThe aim of this study is to investigate whether debt maturity matters for the choice of earnings management strategy (i.e. accruals earnings management and real earnings management).Design/methodology/approachThe sample involves 486 American listed firms extracted from fortune 1,000 over the period 2006–2014. Panel data regression models are employed to empirically test the impact of short-term debt and long-term debt on manager's choice of earnings management form. The generalized least square technique is applied to estimate the parameters of the regression models.FindingsThe results show that managers are more likely to manage earnings through real activities and reduce their use of accruals earnings management once short debt is increasing because the latter induces heavy lender's scrutiny. The managers move hence to real earnings management due to a lower possibility of being discovered. Moreover, the results reveal a simultaneous use of accruals earnings management and real earnings management for firms with high long-term debt. This finding highlights that long-term debt does not produce regular lender's enforcement allowing managers to use both earnings management techniques to reach earnings targets.Research limitations/implicationsThis research has two limitations. Like many other studies, the measure of discretionary accruals is subject to measurement errors. Moreover, the sample exclusively involves large firms extracted from Fortune 1,000. Therefore, the attained results may be not available for small and medium firms.Practical implicationsThe findings have implications for both researchers and lenders. For researchers, the present work points out that the decision about the debt maturity structure is crucial for all managers because they establish their earnings management policy accordingly. For lenders, the findings imply that increasing scrutiny effectively constrains accounting manipulations but does not eliminate earnings management activities altogether. The managers move to another earnings management strategy (i.e. real earnings management). This evidence may support the lenders and the creditors in their decision-making processes.Originality/valueThis paper adds to the accounting literature by providing new and interesting evidence on the role of debt maturity on the trade-off between the earnings management tools. Prior studies provided mixed finding for the issue of earnings management in levered firms. The findings of this study should be viewed as a first step to understand the mixed results on this issue. While most papers focus on one earnings management form when they examine the earnings management in levered firms, the authors highlight the impact of debt on both accruals and real earnings management simultaneously.

Confucian culture and executive compensation: Evidence from China

AbstractResearch Question/IssueThis study investigates how traditional Confucian culture affects executive compensation from three dimensions: CEO compensation level, CEO pay gap (the pay gap between CEO and other management members), and the gender pay gap.Research Findings/InsightsWe find that firms' exposure to stronger Confucianism is associated with less CEO compensation, a smaller CEO pay gap, and a larger gender pay gap in China. These findings are consistent with the core values of moderatism, collectivism, and patriarchalism rooted in the Confucian culture. Our findings are robust to different firms' exposure to Confucian culture measures. Endogeneity concerns are further addressed with a subsample of firms that experienced headquarters relocation. Cross‐sectional analyses show that the influence of traditional Confucian culture is more pronounced for firms facing less industry competition, owned by the state, or with a higher concentration of power. Additional analyses show that the Confucian culture also reduces the CEO's pay‐for‐performance sensitivity, weakens pay incentives, and leads to lower firm risk‐taking; however, it also mitigates firm agency problems by reducing firm earnings management and managerial perk consumption. The combination of these positive and negative effects reduces the firm's overall value.Theoretical/Academic ImplicationsThis study expands our understanding of the role of informal institutions in corporate behavior. Corporate governance is embedded in the market's formal institutions, which, in turn, are embedded in local informal institutions. Academically, our study suggests further corporate governance research on informal institutions, especially in emerging markets where institutional development is not yet complete and informal institutions play a particularly important role.Practitioner/Policy ImplicationsThis study could help practitioners better understand the business culture and compensation contract design in Confucian nations. It also suggests that policymakers consider the effect of informal institutions when designing formal institutions.

The context of earnings management and its ability to predict future stock returns

This paper constructs a signal-based composite index, namely ESCORE, which captures the context of earnings management. Specifically, ESCORE aggregates 15 individual signals related to both accrual and real earnings management based on prior relevant literature. After establishing that ESCORE is capable of capturing the context in which earnings management is more likely to occur, the study finds that low ESCORE firms outperform those with high ESCORE by an average of 1.37% per month after controlling for risk loadings on the market, size, book-to-market and momentum factors up to one year after portfolio formation in the UK. This finding implies that investors tend to ignore the observable context of earnings management. In addition, with ESCORE model, investors do not need to estimate the magnitude of earnings management, rather it is sufficient to look at the surrounding context to differentiate between low and high earnings management firms. Finally, when tested using the US data, most of the main results of the study appear to hold.

The Role of Institutional Ownership Structure on Real Earnings Management in Growth Firms

The objective of the study was to examine the role of institutional ownership structure on real earnings management on firms in growth stage. The real earnings management was indicated by three proxy such as abnormal CFO, abnormal discretionary expenses, and abnormal production costs. The sample of the study was the manufacturing firms listed in the Indonesia Stock Exchange. The data observation period was 5 years (2016-2020). Total samples are 600 firm-years. The samples are classified into various life cycle using dividend payout, sales growth, capital expenditure value, and age. The empirical results indicate concentration of institutional ownership affect the real earnings management through cash flow operating activities but this study cannot prove that the concentration of institutional ownership affects the real earnings management in firms that are in the growth stage. The findings prove the firms choose real earnings management through cash flow operating activities even though the cost is more in the long term.

Does CEO power moderate the link between corporate social responsibility and bank earnings management

PurposeThis paper aims to investigate the relationship between corporate social responsibility (CSR) and earnings management (EM) in US commercial banks and examines whether the chief executive officer (CEO) power can moderate this relationship.Design/methodology/approachFor a sample of American commercial banks covering 2009–2018, several equations and regressions are used to measure the main proxies for bank EM. The authors use the fixed effects model and generalized method of moment to investigate the CSR–EM relationship.FindingsThe authors find a significant positive relation between CSR and EM. Moreover, the authors find that CEO power moderates the CSR–EM relationship. This study also suggests a bidirectional relationship between CSR and EM.Research limitations/implicationsThe findings of this paper have important policy implications for policymakers, regulators and investors in their attempts to constrain EM practices and enhance the quality of financial reporting in US commercial banks.Originality/valueThe study contributes to the literature by exploring the relationship between CSR practices and firm EM by particularly focusing on banking. This study offers new insights into whether the association between CSR practices and EM is moderated by the CEO power. To the best of the knowledge, the relationship between CSR and EM is not studied yet with the moderating role of CEO power.

Short Seller, Firm, and Auditor Behavior

Purpose: Although a small part of arbitrage trading, short selling has a significant impact on capital markets. This study empirically examines relationships among short selling, earnings managements, and auditor behaviors. Design/methodology/approach: We employed short selling and abnormal short selling as independent variables. Audit hours, audit fees, and (absolute) value of discretionary accruals as dependent variables. In this study, we basically include ordinary least-squares regression analyses using panel data and interaction analyses. Findings: This study verifies the relationship among short selling, firm earnings management, and auditor behavior, showing positive relationships between short selling and current and future audit fees, audit hours, and current audit quality. Further, higher audit risk, caused by the interaction between abnormal short selling and aggressive earnings management, is reflected in future audit fees and hours. Research limitations/implications: Due to the financial data provided on an annual basis, the daily short selling data was aggregated on an annual basis. This study suggests that short selling is related to firm earnings management behavior, as well as to the auditor behaviors. Therefore, regulators should consider the impacts of short selling on company and auditors as well as investors. Originality/value: This study provides evidence that the positive relationship between short selling and audit fee is not only caused by risk-premium channels, but also by audit-effort channels. Furthermore, we find that the interaction effects of short selling and earnings managements occur only in abnormal short selling. This seemed to impose penalties on short selling exceeding forecasts when auditors considered earnings managements and short selling at the same time.

Environmental regulation and real earnings management—Evidence from the SO2 emissions trading system in China

This study investigates the effect of environmental regulations on the real earnings management and accrual earnings management of firms. Based on China's sulfur dioxide(SO2) emissions trading program, we adopt a difference-in-difference approach and find that the emissions trading program is negatively associated with real earnings management. The negative relation is stronger for firms with high information asymmetry and firms with poor corporate governance. Our findings suggest that market-based environmental regulations such as the cap-and-trade program can indeed incentivize firms to provide better earnings quality even in a weak institutional environment.

National culture and earnings management in developed and emerging countries

PurposeThis study investigates how the association between national culture and earnings management compares between developed and emerging countries.Design/methodology/approachThe empirical analysis relies on a sample of 6,313 firm-year observations from 11 emerging markets and 27,605 firm-year observations from 22 developed countries. The authors use ordinary least squares regression methods to test the hypotheses of the study.FindingsBased on Hofstede's (2011) cultural dimensions, the authors find that firms from countries with a higher level of uncertainty avoidance and individualism are less likely to engage in earnings management, but the effect of uncertainty avoidance (individualism) is more (less) pronounced in the emerging countries. Moreover, the authors demonstrate that firms from emerging (developed) countries with higher levels of power distance and masculinity are less (more) likely to engage in earnings management. Finally, the authors find evidence of a trade-off between accruals-based and real earnings management in firms from countries with greater long-term orientation and an indulgence cultural dimension.Originality/valueThis paper adds to the literature by theoretically discussing and empirically analysing the role that developed and emerging countries' development plays on the effect of national culture on earnings management.