Earnings Management Techniques Research Articles

Accounting and Financial Reporting during a Pandemic

In this paper, I discuss how a pandemic affects the nature of financial reporting especially for financial and non-financial institutions that were deeply affected by the 2020 coronavirus (COVID-19) pandemic. I show that accounting practices or techniques such as fair value accounting, big bath earnings management, loss avoidance and income smoothing techniques can help to dampen the effect of a pandemic on firm performance. Some implications about the merits and risks of accounting during a pandemic are highlighted and discussed.

Earnings Management and Corporate Performance: An Empirical Evidence from Ghana

This study aimed at assessing the impact earnings management has on corporate performance of firms on the Ghana Stock Exchange. The study used discretionary accruals of the modified jones model, abnormal cashflow from operations, abnormal discretionary expenses and abnormal production cost to measure earnings management whiles corporate performance was measured using return on assets. The study used a sample of 14 listed companies on the Ghana Stock Exchange (GSE) for the period of 2008 to 2018. We applied multiple linear regression for hypothesis testing. The findings of the study indicate that firm listed on the GSE engages earnings management and manages earnings upwards. Our results indicate earnings management through both accrual earnings and real earnings management techniques have a significant positive effect on corporate performance. Therefore, we recommend an intensive evaluation by the users of financial statements to make competent decisions. Keywords : Accrual Earnings Management, Real Earnings Management, Discretionary Accruals, Corporate Performance DOI: 10.7176/RJFA/11-10-01 Publication date: May 31 st 2020

Big Bath Charges and Shareholders’ Wealth in Nigeria

Big bath accounting is an earnings management technique whereby a one-time charge is taken against income in order to reduce assets to lower expenses in the future. This type of voodoo accounting technique is used by companies to deceive shareholders’ in reporting an unrealistic financial report. This study examined the effect of big bath accounting on shareholders’ wealth in Nigeria. Survey research design was adopted. Primary data was used in obtaining information through a well-structured questionnaire that was administered to the supervisory department of the National Deposit Insurance Corporation and Central Bank (NDIC) of Nigeria (CBN). The result showed that big bath charges had a negative significant effect of shareholders’ wealth in Nigeria. This means that the more organizations apply big bath charges into their system, it will later on affect negatively the shareholders’ wealth. The study recommended that other analytical model can be employed in detecting earnings manipulations in the account and also the recommendations made by the supervisory departments of regulatory bodies like NDIC and CBN to companies should be adopted by this organizations in order to protect the interest of the shareholders.

CEO TENURE AND EARNING MANAGEMENT

The action raises earnings management accounting reporting scandal in the business world. Research on management of profit made by the CEO at the beginning of the year working period and at the end of his tenure is comprehensive regarding the CEO incentive to undertake earnings management. Several previous studies have focused on the accrual-based earnings management techniques. But in this study earnings management is also measured by the real earnings management to get more comprehensive results. This study predicts that the CEO in the early years of operation will increase the earnings management earnings (income-increasing) which can be explained by the theory of career concerns.

Kar Yönetimi Uygulamalarında İhtiyari Tahakkuklar ve Tahakkuk İptallerinin Etkisi: Bankacılık Sektörü Üzerine Bir Uygulama1 (Earnings Management Practices in terms of Discretionary Accruals and Accrual Reversals: An Empirical Study on Banking Sector )

Purpose – The main purpose of this paper is to determine “income smoothing” behavior of banking sector as an earnings management technique. Design/methodology/approach – In this context, 10.793 cross-country bank-year data (28 countries within 2000-2013 time period) have been analyzed in terms of earnings before tax and provisions, discretionary accruals and accrual reversal to investigate earnings management in banking sector. Panel Regression Analysisi techniques are used for model testing. Findings – According to the results, banks use both loan loss allowances and loan los provisions to smooth income. Earnings management behavior of banks is supported both for balance sheet and income stataement perspectives. Discussion – Throughout the accounting literature, modelling issues are still controversial in frame of earnings management studies. Thus, this study focuses on accrual reversals, which is currently argued hot topic in empirical modelling, and determines the effect of accrual reversals on earnings management behavior. As a result, a new model which incorporating accrual reversals, come up with statistically more significant results.

Analisis Faktor Yang Mempengaruhi Perencanaan Pajak Terhadap Manajemen Laba Pada Perusahaan Manufaktur Yang Terdaftar Di Bursa Efek Indonesia Pada Tahun 2015 - 2017

The preparation of financial statements by management aims to convey information about the financial condition and size of the company's performance in a certain period. One of the parameters used to measure company performance is information about earnings. Information about earnings is an important element used by users of financial statements both internal and external parties in decision making. Earnings information must reflect the company's actual economic and financial situation, but in reality often management manipulates the financial statements by raising profits to maximize their own satisfaction.
 Tax planning is related to reporting higher corporate profits. Therefore, company management will use various earnings management techniques to achieve the target. Tax planning and earnings management are related in one another, because they both aim to achieve profit targets by manipulating earnings figures in the financial statements. Various actions taken by the company to show that tax planning is done by manipulating the company's operating activities

Shareholder litigation risk and real earnings management: a causal inference

PurposeThe authors study how shareholder litigation risk impacts a firm’s decision of real earnings management (REM). This paper aims to shed light on how shareholder litigation risk impacts REM. The authors further explore how the intensifying effect varies systematically conditioning on the degree of information asymmetry and the strength of internal corporate governance.Design/methodology/approachIn this study, the authors use the 1999 Ninth Circuit Court ruling as a quasi-experiment that reduces shareholder litigation risk to address endogeneity and establish a causal inference.FindingsThe difference-in-difference tests suggest lower shareholder litigation risk intensifies REM. In other words, higher litigation risk mitigates REM. Cross-sectional test results suggest the negative effect of decreased shareholder litigation is more pronounced when monitoring difficulty is higher, when information environment is more impoverished and when internal corporate governance is weaker. The negative effect is also stronger in firms with higher sensitivity to legal threats.Originality/valueProtection of investors’ interest is the focus of corporate governance. Designed as an important corporate governance mechanism, shareholder litigation enables investors to pursue legal actions to recover their losses in the event of corporate misbehaviors. However, whether shareholder litigation is an effective corporate governance tool and beneficial to shareholders and firms is not without controversy. The authors contribute to the debate by providing evidence that supports the argument that shareholder litigation threat significantly disciplines REM, a form of costlier earnings management technique and myopic investment behavior.

The Impact of Financial Covenants in Private Loan Contracts on Classification Shifting

This study examines whether firms with private loan contracts that contain debt covenants based on earnings before interest, taxes, depreciation, and amortization (EBITDA) are more likely to misclassify core expenses as special items (i.e., classification shift). Misclassifying core expenses as income-decreasing special items allows the firm to increase EBITDA and thereby potentially avoid debt covenant violations. Consistent with our expectation, firms misclassify core expenses as special items when at least one EBITDA-related financial covenant is close to being violated. In addition, classification shifting is more prominent when financially distressed firms are close to violating at least one EBITDA-related covenant. Whereas prior research on classification shifting focuses primarily on equity market incentives (e.g., meeting analysts’ earnings forecasts), our study extends this research to private loan contracts to highlight that creditors also affect classification shifting. Classification shifting appears to be an additional earnings management technique used by managers to avoid debt covenant violations. This paper was accepted by Shivaram Rajgopal, accounting.

The Role of Corporate Diversification, Capital Structure Determinant, And Structure of Ownership on Earning Management with Information Asymmetry as Moderating Variable

Along with the development of the economy and technology, companies are expanding their businesses to be able to defend in the competition in the industry by diversification. In the diversified companies with high complexity, manager’s motivation to use various earnings management techniques is increase. Apart from diversification, there are various factors that influence earnings management, including capital structure and ownership, and also information asymmetry. The major objective of this study was to discusses a comprehensive understanding of earnings management and the factors that influence it, namely business diversification, capital structure, ownership structure, and information asymmetry; and second is to empirically investigate the effect of diversification, capital structure, ownership structure and asymmetry of information to earnings management, and to clarify whether information asymmetry can moderate the influence of the three other factors on earnings management as measured by the approach of Stubben (2010). The study used the Total Asset control, Growth Opportunity, ROA, ROE, and Leverage. Data obtained from observations 165 Financial Statements of Manufacturing Companies in the chemical, pharmaceutical, and consumer goods sectors in 2015-2017. These results indicate that diversification does not relation with earnings management, but the other three factors namely capital structure, ownership structure, and information asymmetry are proven to significantly affect earnings management. Information asymmetry variables can moderate the affect of capital structure and ownership structure on earnings management. Keywords: Earning Management, Capital Structure, Ownership Structure, as information asymmetry DOI : 10.7176/RJFA/10-14-05 Publication date :July 31 st 2019

Interaction between securitization gains and abnormal loan loss provisions: Credit risk retention and fair value accounting

AbstractThis study investigates whether managers use asset securitization gains to substitute loan loss provision (LLP) management for earnings management, and, if so, whether the percentage of credit risk retained affects such a relationship. The literature provides evidence that managers have used securitization transactions to boost earnings. Using 2001‒2014 data for a sample of bank holding companies, I find that managers use securitization gains and LLPs as partial substitutes and that earnings management from securitization gains grows at an increasing rate to substitute income increasing LLP management as the level of risk retention increases. These findings are consistent with the argument that the higher the level of risk retention, the greater the potential impact on achieving earnings targets, given banks’ exercise of discretion over securitization gains through estimation of fair value of retained interest. In addition, I document that the substitution effect between the two tools is non‐existent in the post‐SFAS 166/167 period. Taken together, the findings have timely implications for accounting standards by informing the effect of risk retention that I measure through earnings management techniques. Moreover, my findings provide additional support for improved disclosures on assets‐backed securities.

The Deliberate Engagement of Narcissistic CEOs in Earnings Management

Corroborating upper echelons theory, this study picks up the notion that narcissistic chief executive officers (CEOs) take advantage of accounting choices to enhance their firms’—and inherently their own—personal track records. Using a set of 15 indicators, reflecting the narcissistic trait of 1126 CEOs for the period 1992 to 2012, we find evidence of highly narcissistic CEOs engaging in accrual-based earnings management (ABEM). In contrast to prior research, the results show evidence not only for income-increasing but also for income-decreasing ABEM. This indicates that highly narcissistic CEOs not only strive to influence stakeholders’ perception of current performance. We conclude that they also assess their potential to influence perception of current and future earnings. The results imply that highly narcissistic CEOs’ accounting choices are driven by self-serving behavior rather than by the intention to provide additional information to the market. When earnings management techniques are used to derive personal advantage from the presentation of a firm’s earnings, the literature refers to this as a case of low earnings quality reflecting unethical behavior. Accordingly, this study contributes to the field of business ethics by showing that CEO narcissism is related to low earnings quality in that it is associated to discretionarily decreasing accruals.

Does late 10K filing impact companies’ financial reporting strategy? Evidence from discretionary accruals and real transaction management

AbstractThe study investigates how late 10K filers adapt their financial reporting strategy in the post‐late filing period in their response to bad publicity, negative market sentiment, and higher stakeholders’ scrutiny resulting from reporting delays. Both the level and change regressions show that late 10K filers significantly reduce the use of discretionary accruals from pre‐ to post‐late filing year. However, they simultaneously increase real transaction management over the same time period. The trade‐offs between the two earnings management techniques are more prominent when the late filers have a strong incentive to meet or beat earnings benchmarks. Our primary results are robust when late filings are caused by accounting, auditing, and internal control issues, and when the late filers cited no meaningful reason for late 10K filings. It is further evident that late filers with material internal control weaknesses and late filers that subsequently restate their financial statements make relatively higher trade‐offs than the matched non‐late filers. Finally, the trade‐offs between reduced accruals and increased real transaction management are stronger for the accelerated filers, and for the late filers audited by Big 4 auditors.

Contemporary financial reporting and intangible resources: Implications for corporate governance

The key question of this paper is what are the implications for corporate governance from the emergence of contemporary financial reporting and intangible resources? Going beyond traditional financial reporting, Boards of Directors and corporate executives should investigate the intangible resources of contemporary financial reporting. What intangible resources are causing the huge price to earnings (PE) ratio gap and the huge market to book (M/B) ratio gap for their companies? Possibly such gaps are driven by global brand names, global licensing, customer loyalty, product quality, and product innovation. Unfortunately, the short-term focus upon traditional financial reporting by both Wall Street and corporate executives to “make the numbers”, i.e. short-term (quarterly), predicted numbers, has damaged firms’ competitiveness. Such damages include postponing or cutting expenditures on emerging technologies, advertising, research and development, employee training, and maintenance expenses. Research has shown that such earnings management techniques are relatively futile efforts since a consensus earnings miss by a company generally produces an insignificant 1.5% to 2% share price drop. Boards of Directors should inform corporate executives accordingly. To offer solutions to these issues and implications for corporate governance, this paper is divided into the following sections: the emergence of contemporary financial reporting; asset value migration: the power of intangibles; top five future business value drivers: all intangibles; forward looking measures for intangible resources; market gaps: “old economy” versus “new economy” companies; global brands and global licensing; hidden intangible values made visible; international perspectives on contemporary financial reporting; and conclusions.

Did we Constrain Managers’ Attempts to Manipulate Earnings: Insights from the Relevant Literature

Since the numbers game speech by Levitt (1998), earnings management is becoming one of the most cited accounting research areas. The objective of this paper is to review the main themes highlighted in the relevant literature. Studies provided some contradicting points of views regarding earnings management definition, incentives, and techniques. Earnings management, in general, tends to be undesirable as it distorts the financial reporting process and subsequently leads to lower earnings quality. Therefore, regulators have invested time and effort seeking solutions to this problem (Examples include regulations regarding auditor independence, audit firm tenure, auditing standards, and accounting standards). In addition, accounting and auditing research investigated factors and mechanisms, which lead to mitigate or constrain earnings management. Earnings management is classified into accruals earnings management, real earnings management, and classification shifting earnings management. The focus of this paper is on earnings management mitigation. Different studies provided some evidence on the role of each of investor protection, corporate governance, external auditing, and accounting standards in mitigating earnings management.

Female CEOs and Core Earnings Quality: New Evidence on the Ethics Versus Risk-Aversion Puzzle

The question of whether females tend to act more ethically or risk-averse compared to males is an interesting ethical puzzle. Using a large sample of US firms over the 1992–2014 period, we investigate the effect that the gender of a chief executive officer (CEO) has on earnings management using classification shifting. We find that the pre-Sarbanes–Oxley (SOX) Act period was characterized by high levels of classification shifting by both female and male CEOs, but the magnitude of such practices is, surprisingly, significantly higher in firms with female CEOs than in those with male CEOs. By contrast, our results suggest that following the passage of the punitive SOX Act, classification shifting by female CEOs declined significantly, whilst it remained pervasive in firms with male CEOs. This suggests that the observable differences in financial reporting behavior between male and female CEOs seem to be because female CEOs are more risk-averse, but not necessarily more ethically sensitive than their male counterparts are. The central tenets of our findings remain unchanged after several additional checks, including controlling for alternative earnings management techniques, corporate governance mechanisms, CEO and chief financial officer characteristics and propensity score-matching.

TREND AND TRADEOFF BETWEEN ACCRUAL EARNINGS MANAGEMENT AND REAL EARNINGS MANAGEMENT IN INDONESIA

This research was carried out to test trend of earnings management in Indonesia. By understanding the trend of earnings management, it can be found out what scheme of earnings management practice in Indonesia. The sample used were 31 (thirty one) non financial, hotel, travel, transportation and real estate companies that listed in Indonesia Stocks Exchange from 1991 to 2014. The time of observation was from 1993 to 2013. Research model was using multiple regression method. The result showed there was no trend increasing of accrual earnings management during research period. Practice of accrual earnings management in Indonesia that tends fluctuate shows there is a tradeoff or substitution of earnings management technique from accrual to real earnings management.

Earnings Management Preferences of Family Firms and Its Impact on the Market Value of the Firm

In this paper we analyze the preference for earnings management techniques by the family firms and the impact of the same on the performance of the firm. Family firms contrary to non-family firms are driven by different objectives. Using socio emotional wealth theory, we hypothesize that family firms prefer an earnings management technique, which is less risky in the long term. Using the publicly available data on all the family firms listed on Bombay Stock Exchange (BSE), our analysis indicates prevalence both accrual based and real activity earnings management among Indian family firms. However, revenue based real activity earnings management was preferred by those family firms that have exhausted the possibility of accrual based earnings management. Our analysis of the impact of earnings management choice on market value indicates a short-term positive impact of the accrual based earnings management. Revenue based real activity earnings management was found to have long term positive impact but the cost based real activity earnings management had a long term negative impact on the value of the market value of the firm.

Stakeholders’ perceptions on earnings management motivations and techniques in Libyan commercial banks

The issue of earnings management has continued to be problematic in the financial reporting context. It has proved to be an important topic that concerns a wide range of stakeholders including regulators, investors and preparers. This paper examines the perceptions of Libyan Commercial Banks' (LCBs) stakeholders regarding earnings management (EM) motivations and techniques. The paper reports on a questionnaire survey of stakeholders which yielded 102 Responses (response rate 53%). It is found that LCBs’ managers are engaged in EM practices as a result of a number of motivations. In consistent with accounting literature on EM, LCBs’ managers tend to use Loan Loss Provision LLP as well as other techniques to manage their earnings. However, the research finding reveal some other “techniques” that are being used for EM. Some of them clearly lay out of GAAP and law framework which may be seen as an explicit breach to bank managers’ accountability. The importance of the banking sector for society has been amply demonstrated in recent years. The evidence provided by the questionnaire results refer to a serious problem to the accountability of LCBs’ managers. The existence of these motivations, which appear to be unavoidable, put pressure on the accountability process and expose it to a lack of trust and disrepute which therefore may have an adverse effect on the relationship between LCBs’ managers and their stakeholders. LCBs’ manager should be free from such motivations in order to produce unbiased and fair accounting information.

Classification shifting: impact of firm life cycle

PurposeThis paper aims to examine whether firms in the decline stage of lifecycle manipulate core or operating income through misclassification of operating expenses as income-decreasing special items.Design/methodology/approachThe sample comprises of firms from an emerging market, India with data from 1996 to 2011. The paper uses the methodology given in McVay’s (2006) work and multiple regressions.FindingsManagers of Indian firms also engage in classification shifting, primary incentive being the desire to avoid reporting of operating losses. Furthermore, the use of classification shifting is dependent upon the stage of lifecycle in which firm is in. Specifically, firms in the decline stage of lifecycle are more likely to use classification shifting to avoid reporting of operating losses.Practical implicationsThe paper sheds light on a critical phase of the firm lifecycle, decline, which increases the possibility of the use of classification shifting, an earnings management technique which is tough to detect. Firms in decline, thus, may be trying to fool the investors who are infusing capital to save the company from going bankrupt; regulators, who are likely to focus less on troubled firms; and auditors, who may not be expecting core income manipulation in such firms.Originality/valueThe paper extends the literature on classification shifting and presents first evidence that such shifting is more likely to take place during the decline phase of firm lifecycle.

Toomer's Energy Drinks: Fueling Earnings Management?

ABSTRACTCompanies around the world commonly engage in earnings management. Some earnings management techniques comply with U.S. GAAP and do not violate financial reporting standards (e.g., real earnings management techniques such as postponing research and development expenditures), other techniques clearly cross the line (e.g., misclassifying repair and maintenance expenses as capital expenditures), and some fall into a gray area (e.g., adjusting the allowance for bad debt). This case exposes students to an ethical dilemma that involves earnings management: toward the end of its fiscal year, the executive management team at Toomer's Energy Drinks' European division realize that they will fall just short of a short-term financial performance target, and consider ways in which they can manage earnings to generate sufficient performance to meet the target. The case exposes students to ways in which companies manage earnings, and encourages students to think critically about the extent to which these techniques are ethical by requiring them to apply the IMA's Statement of Ethical Professional Practice and the AICPA's Code of Professional Conduct to a realistic scenario.