Higher Earnings Management Research Articles

Information Risk and Debtholders’ Mispricing by Considering Audit Quality*

AbstractWe examine how audit quality perceptions impact debt mispricing in the presence of earnings management. The Big Four auditors (BFAs) and auditor tenure are used as proxies for perceptions of higher quality audits. Debt mispricing means that debtholders charge a lower (higher) cost of debt to a firm with low (high) accrual earnings management (AEM) and high (low) real earnings management (REM). We find that debt mispricing is accentuated (attenuated) by considering the BFA and auditor tenure because debtholders fixate on quality audits curving AEM. For low AEM and REM firms, debt investors place a premium on low AEM with the BFAs/long‐tenured auditors, worsening the mispricing. For high AEM and low REM firms, debt investors impose a “smaller discount” on high AEM with the BFAs/long‐tenured auditors. This study demonstrates that the accentuation (attenuation) of debt mispricing when considering the BFA and auditor tenure occurs mainly if the firm raised only private debt rather than both private and public debt.

Military reform, militarily-connected firms and auditor choice

PurposeOne of the strongest connections in politics in developing countries is through military links. This study aims to examine the auditor choice preference of the militarily-connected firms in Indonesia, an emerging country where there is a strong influence from the military on political decision-making.Design/methodology/approachThe analysis used 3,473 firms-year observations listed on the Indonesian Stock Exchange spanning from 2003 to 2017 using regression and other statistical tests.FindingsThe results reveal that firms with a militarily-connected director are less likely to appoint one of the Big 4 auditors. Using the military reform as a natural experiment, the finding shows that militarily-connected firms did not change their auditor choice preference even after the military reform. Interestingly, I find that connected firms are associated with high earnings management. In addition, the different retirement position level and military affiliations of the connected directors generate different outcomes related to the auditor choice decision. Overall, the results indicate that militarily-connected firms were less likely to appoint one of the Big 4 auditors both before and after the military reforms. These results are robust, even after the author controlled for political connections, year fixed effects and industry fixed effects.Research limitations/implicationsBecause of the limitations of the prior literature on military connections, this study is developed based on the assumption that the militarily-connected directors have identical behavior whether they serve in either public or private companies. However, this assumption could be invalid which potentially affects the interpretation of some of the results in this study.Originality/valueThis paper provides direct evidence of the auditor choice preference of firms with a military connection. The evidence builds on the existing literature on the difference in auditor choice preference between politically and militarily-connected firms.

Testing the role of independent supervisory board characteristics on the relationship between earnings management and quality of corporate social reporting disclosure

This research aims to examine whether a company with high earnings management discloses high quality Corporate Social Reporting (CSR) information to obscure the stakeholders’ view related to earnings management practice within the company. The characteristics of independent supervisory board as formal supervisor is predicted to weaken the relation between earnings management and quality of CSR disclosure. Using Thompson Reuters and Osiris databases, 242 samples consist of 36 companies from 5 countries, namely Indonesia, Malaysia, Singapore, Thailand and Philippines were obtained. The results show that the proportion of independent supervisory board has negative role in moderating the relationship between earnings management and quality of CSR disclosure. The larger the proportion of independent supervisory board, the more effective the supervisory board in conducting supervision so the earnings management decreases. Companies with low earnings management do not have tendency in disclosing the CSR information with better quality as an effort to obscure the earnings management, so CSR information is revealed truthfully or even lower than expected.

Short-sale refinancing and price adjustment speed to bad news: Evidence from a quasi-natural experiment in China

Short selling may accelerate stock price adjustment to negative news. However, the literature provides mixed evidence for this prediction. Using short-sale refinancing and a staggered difference-in-differences (DID) model, this paper explores the effect of short selling on stock price adjustment. Our results show that (1) short-sale refinancing improves the speed of stock price adjustment to negative news. This result holds after we control for endogeneity. (2) The positive relationship between short-sale refinancing and stock price adjustment speed is significant in subsamples of stocks with higher earnings management or lower accuracy of analyst forecasts, indicating that firms with more opaque information are more likely to be targeted by short sellers. In subsamples of stocks with a higher ownership concentration or lower ownership by institutional investors, short selling is more likely to increase the speed of stock price adjustment, indicating that ownership structure may influence negative news mining. (3) As short-sale refinancing exacerbates the absorption of bad news by stock prices, it increases crash risk. This study enriches the research on the economic consequences of short selling and provides empirical evidence supporting regulations on short selling in China.

Co-opted directors, gender diversity, and crash risk: evidence from China

This study examines how the composition of the board of directors at Chinese firms affects crash risk. The results indicate that co-opted directors (i.e., directors appointed after the CEO assumed office) have a positive and significant effect on crash risk; the positive relation between board directors and crash risk is primarily driven by co-opted male directors, implying a gender difference on crash risk. Non-co-opted independent directors mitigate crash risk, but the negative relation between gender and crash risk is much stronger for female directors than for male directors. The results indicate that co-option/non-co-opted independence along with gender diversity on the board plays an important role in shaping crash risk behaviors. The director-crash risk linkage disappears at state-owned enterprises, suggesting that ownership structure affects board behaviors and board members play the role of rubber-stamp. Finally, the relation between gender and crash risk is more pronounced at crash-risk prone firms with high earnings management and high financial leverage.

What is earning management in sharia bank lower than conventional bank?

<p><strong>Purpose</strong> - This study is to examine the effect of sharia status on the level of earning management in Banking Companies in Indonesia.</p><p><strong>Method</strong> - This study use pooled data regression analysis and independent sample t-test to test the level of earning management between Islamic banks and non-Islamic banks. We use sample of Islamic banks and non-Islamic banks in Indonesia in the year 2009-2013.</p><p><strong>Result</strong> - We find the Islamic banks employ less earning management than non-Islamic banks. The results show that, as hypothesised, Islamic banks status has a significant negative association with earning management in regression model. This Suggest that Islamic banks have lower discressionary accrual than non-Islamic banks ans Islamic ethics palys monitoring role in reducing managerial opportunistic behaviors to manage earnings by discretionary accruals.</p><p><strong>Implication</strong> - At least the sample in this study was due to the limited number of Islamic banks and conventional banks in Indonesia. The discretionary accrual model used in this study may not be able to detect earnings management properly, so that there is a need to readjust other models related to earnings management.</p><p><strong>Originality</strong> - Earnings management has become a global issue, but for Islamic banking based on religious principles, the practice of earnings management can be minimized or eliminated. Then provide information about the high and low earnings management in banks, especially Islamic and conventional banking in Indonesia.</p>

Does internal board monitoring affect debt maturity?

Using the Sarbanes–Oxley Act (SOX) as an exogenous shock to board structure, we identify internal monitoring via board independence and estimate its impact on corporate debt maturity. We introduce a triple difference-in-difference approach. Additionally, we use a simultaneous equations model and address that decisions about leverage and debt maturity are simultaneous. We also incorporate new debt issuance in the model to ensure the causality in the relation is from internal monitoring towards the maturity of new debt. The findings provide support for agency theory. As board independence increases, internal monitoring becomes stronger, and good governance substitutes for external control over managers through short-term debt. Subsequently, firms have more long-maturity debt. The results are robust to controlling for other internal monitoring mechanisms, CEO characteristics, financial constraints, cash, bond ratings, yield, and debt seniority. The impact of increased board independence on debt maturity is more significant for conglomerates and cases where there is a greater need for internal control over managers, such as CEO duality, high GIM index, straight debt, less strict covenants, high intangibility, high free cash flow, no majority blockholders, high discretionary accruals, or high real earnings management. In further analyses, we rule out the concern that our results are due to better reporting of internal controls through SOX Section 404 or an increase in auditors’ liability after SOX, rather than increased board independence.

Does earnings management matter for firm leverage? An international analysis

ABSTRACT This paper examines the relation between corporate information environment and capital structure decisions, and whether this association changes with cross-country institutional environments. Using earnings management as a measure of the corporate information environment, we find that firms with higher earnings management activities have greater firm leverage ratios. We further document that the effect of earnings management on leverage is more pronounced in countries with weaker institutional environments. Overall, our study adds to the strand of research on imperfect factor markets and verifies the influence of information asymmetry on debt financing choices in a cross-country setting.

EARNINGS MANAGEMENT AND DIVIDEND POLICY OF SMALL AND MEDIUM ENTERPRISES IN THAILAND1

This study aims to examine earnings management of 51 small and medium enterprises listed inMarket for Alternative Investment (MAI) of Thailand during 2005 – 2012. Earnings managementin this study is measured by discretionary accruals based on Kasznik Model (Kasznik, 1999) andKothari Model (Kothari et al., 2005). Additionally, this study also investigates the influence ofearnings management on dividend policy of these companies which are measured bytwo indicators, including dividend payout ratio and dividend yield, by employing fixed andrandom effects regression analyses. The findings reveal that listed companies in MAI had highearnings management due to high average discretionary accruals in absolute term whichequalled 11.91 percent of total assets based on Kasznik Model and 12.55 percent of total assetsbased on Kothari Model. Moreover, earnings management is found to have the positive influenceon dividend yield of listed companies in MAI. That is, one percent increase in discretionaryaccruals in absolute term as percentage of total assets will lead to about 0.2 percent increasein dividend yield. In contrast, earnings management is found to have no influence on dividendpayout ratio.Keywords: Earnings Management; Earnings Quality; Dividend Policy; SMES; Market forAlternative Investment; Thailand.

Ex ante and ex post overvalued equities: The roles of corporate governance and product market competition

Abstract This paper examines equity overvaluation and the effects of corporate governance and product market competition on market valuation of potentially overvalued equities in an economy with high earnings management and weak investor protection (Taiwan). We follow Beneish and Nicholas (2009) to mimic Altman Z-Score and Beneish M-Score to compose an ex ante O-Score to measure overvaluation. We show that our ex ante overvaluation measure (O-Score) can effectively identify those that are likely to be overvalued by manipulation. Portfolios of longing stocks with high current O-Score and shorting stocks with low current O-Score earn abnormal returns. Portfolios of longing stocks with high one-year-ahead O-Score and shorting stocks with low one-year-ahead O-Score suffer losses. We also show that corporate governance reduces but product market competition raises managers’ incentive to manipulate market overvaluation. Moreover, product market competition reduces market valuation on currently overvalued equities. Corporate governance effectively reduces but product market competition reinforces the reverse effect of one-year-ahead overvaluation on current market valuation.

Ownership concentration, earnings management and stock market liquidity: evidence from Malaysia

PurposeThis paper aims to examine whether ownership concentration and earnings management affect the stock market liquidity of Malaysian firms.Design/methodology/approachThis study uses a sample of 2,020 yearly firm observations in Bursa Malaysia over the period 2009-2012. The ordinary least square regression is used to examine the relationships. The study undertakes a sensitivity test by regressing the main study variables by using different measurements. Another robustness test is then used, where a regression based on the change in variables and a one-year lag of the independent variables are used. Furthermore, to alleviate the concern of possible endogeneity, the simultaneity and reverse causality are checked using the lag of the dependent variable, fixed effect regression, two-stage least squares using the instrumental variables and the generalized method of moments using instrumental variables analysis.FindingsThe study finds that firms with a high level of ownership concentration have discrepancies in information between informed and uninformed traders, which impair the stock market liquidity. In addition, this study finds that firms with high earnings management experience greater liquidity. A possible explanation for this is that firms might manage earnings to convey private information to enhance the information content of the earnings. Overall, the evidence suggests that manipulating earnings signals information informatively, particularly in a country with a higher level of ownership concentration and a higher likelihood of expropriating minority shareholders.Originality/valueThis study enriches the limited empirical research devoted to the impact of earnings management and ownership concentration on stock market liquidity especially in the context of emerging economies. The findings of this study are robust to alternative liquidity measurements, to alternative estimation methods, and to endogeneity bias.

Multiple Audit Mechanism and Audit Quality: Some Preliminary Evidence

Purpose: This study focuses on the distinctive Egyptian setting, where firms could use multiple audit mechanism voluntarily or mandatory under certain circumstances. We investigate the effects on audit quality and cost of debt. Design/methodology/approach: A sample of 1699 firm-year observations of Egyptian listed firms for the 2009-2019 period is used. Abnormal accruals are employed as proxies of audit quality through abnormal working capital accruals and modified-Jones models. The multiple regression method is used to estimate the research model after controlling for firm and ownership specific factors that hypothetically influence the levels of both audit quality and cost of debt. Findings: Results suggest that joint audits are not associated with both proxies of audit quality. In contrast, the dual audit is positively associated with abnormal accruals leading to conclude that dual audits are not providing a high level of audit quality. But this result holds only in companies with income decreasing discretionary accruals. These results are in line with litigation and reputational risk fears offering motivations for auditors to favour conservative accounting alternatives (i.e., income decreasing discretionary accruals). This implies that firms opting to employ dual audits have a higher level of earnings conservatism. Our evidence also indicates that the choice of multiple audit mechanisms especially joint audits is related to significant increases in the cost of debt, implying a higher perceived level of risk. Further, dual audits decrease the cost of debt only in companies with high earnings management. Originality/value: This study adds to the literature on whether the preference of income-increasing or income decreasing discretionary accruals is related to multiple audit mechanism and consequently affected cost of debt. Together, our results support the view that voluntary joint audits are not related to audit quality in Egypt compared to mandatory dual audits, which consequently affect the pricing of debt. Our results have important implications for policymakers, audit firms and investors. .

STUDI HUBUNGAN SURPLUS FREE CASH FLOW TERHADAP KECENDERUNGAN MELAKUKAN EARNINGS MANAGEMENT PADA BADAN USAHA SEKTOR MANUFAKTUR DI BEI PERIODE 2010-2011

The purpose of this study is to examine the relationship between surplus freecash flow (SFCF) and earnings management. This study argues that managersin companies with low growth and high surplus free cash flow tend to usediscretionary accounting accrual (DAC) to offset negative earning related to their investments with negative net present value (NPV). Besides that, we expect that the positive relationship between surplus free cash flow (SFCF) and earnings management is moderated by audit quality and institutional shareholder. This research uses quantitative approach with 205 companies listed in Bursa Efek Indonesia for the year 2010 – 2011 as a sample. The findings of this research show that there is positive significant relationship between high SFCF in company that has low growth with earnings management. This study failed to proof that audit quality and institutional shareholder moderate the relationship between high SFCF and earnings management.

Empirical Evidence on Earnings Management Strategies and Their Consequences in Innovative Small and Medium Entities

We investigate innovative Small and Medium Entities’ (SMEs) earnings management strategies and their related economic consequences. Uncertainty and complexity surrounding innovative SMEs’ activities lead to high information asymmetries between managers and investors which facilitate earnings management strategies. Yet managers do not want to be penalized by market participants which could impair their innovative capacity and future performance. It is generally argued that real activities-based earnings management are more difficult to detect by outsiders than accrual-based earnings management. We examine SMEs listed on the AIM London stock exchange, an exchange for firms of smaller size, over the 1995-2014 period. We document that innovative SMEs engage less intensively in accrual-based earnings management and more intensively in real activities-based earnings management relative to non-innovative SMEs. Our evidence shows that innovative SMEs undertake earnings management strategies that are more difficult to detect externally. We find that the combination of low accruals earnings management and high real earnings management is done efficiently by focusing resources towards investments in R&D in the future years which lead to higher market value. We further examine the role of external monitoring on accounting quality, comparing innovative SMEs listed on stock exchanges with different regulatory requirements, i.e., the AIM London and the Nasdaq stock exchanges. We document that stricter rules reduce the level of accrual earnings management, while it leads to more use of real earnings management. This paper contributes to the literature on SMEs’ financial reporting quality and on the effect of regulation on financial reporting quality.

Executive Compensation, Corporate Governance and Earnings Management in an Emerging Market

We examine how compensation of chief executive officer (CEO) and corporate governance practices affect earnings management behavior in an emerging economy, Pakistan. Using 1836 firm-year observations from 260 firms listed in KSE for period 2005 to 2012, we do not find that CEO compensation has significant influence on earnings management behavior however weak evidence is found that CEOs in small firms do manage earnings to increase their compensation. Further, we find that CEO duality is related to improved earnings quality. However, larger boards appear to be related to higher earnings. Thus, larger boards reduce the quality of reported financial information. Furthermore, we find that concentrated ownership is related to higher earnings management. Sub-sample analysis shows that both concentrated and family ownerships are related to income decreasing earnings management. Overall, as policy implications, our findings suggest that earnings management behavior is likely to be conditioned to the contextual settings of the economy under examination.

Fatores determinantes da qualidade da informação contábil em empresas brasileiras listadas na BM&FBovespa

O estudo objetivou analisar os fatores determinantes da qualidade da informação contábil em companhias abertas listadas na BM&FBovespa. A qualidade da informação foi analisada por meio do gerenciamento de resultados e os fatores determinantes observados foram o nível de competição do mercado, maiores proporções de ativos intangíveis, concentração acionária e governança corporativa. Realizou-se pesquisa descritiva, documental e abordagem quantitativa. A amostra da pesquisa foi composta por 271 companhias em 2008, 278 em 2009, 285 em 2010, 290 em 2011, 294 em 2012, 296 em 2013 e 293 em 2014. Os resultados demostraram que, entre os fatores investigados no período de 2008 a 2014, somente dois se confirmaram. Um deles foi o fator competitividade, cujo coeficiente positivo e significativo indicou que menor competitividade estava relacionada com maior gerenciamento de resultados. O outro fator foi intangibilidade, que apresentou coeficiente negativo e significativo, sinalizando que as empresas que possuíam maiores proporções de ativos intangíveis nos seus ativos totais apresentavam menores índices de gerenciamento.

Earnings Management and Equity Issue Firms: A Study in Indian Context

The purpose of this paper is to empirically investigate about the engagement of firms in earnings management at the time of issuing equity. Furthermore, we examined if firms issuing domestic equity (IPO) indulge in higher earnings management than firms issuing overseas equity. To estimate the earnings management, accrual-based earnings management (Dechow et al., 1995) model and real earnings management (Roychowdhury, 2006) model are used respectively. The initial results suggest that Indian companies undertake both accrual-based earnings management and real earnings management. The empirical results find that equity issue firms indulge in both accrual-based earnings management and real earnings management during the time of offering equity. Moreover, we found that domestic equity issue firms manipulate more accrual-based earnings management as well as real earnings management than overseas equity issue firms.

Earnings management, capital structure, and the role of institutional environments

This paper examines the effect of earnings management on financial leverage and how this relation is influenced by institutional environments by employing a large panel of 25,777 firms across 37 countries spanning the years 1989–2009. We find that firms with high earnings management activities are associated with high financial leverage. More importantly, this positive relation is attenuated by strong institutional environments. Our results lend strong support to the notions that (1) both corporate debt and institutional environments can be served as external control mechanisms to alleviate the agency cost of free cash flow; and (2) it is less costly to rely on institutional environments than debt. After meticulously addressing the possible endogeneity issues and conducting various robustness tests, our main conclusions remain confirmed.

Determinants of earnings management in India: 2002-2011

The study examines and quantifies the extent of earnings management (EM) in India by studying a cohort of 1,150 publicly listed Indian companies (non-financial) during 2002-2011. The study shows that the average EM in the Indian non-financial corporate sector is 1.5% of the total assets of these firms in the previous year. The study also finds that EM has recorded a growth of 1.7% per annum during 2002-2011. The average discretionary accruals of small-sized firms at 3.7% were substantially higher than medium (1%) and large-sized firms (0.52%). The increases in earnings management (discretionary accruals) among small firms (4.3% per annum) were higher than those of medium (1.6% per annum) and large firms (decline of 0.5%). The empirical analysis also finds that the firm size and EM are negatively correlated. The study also finds relatively higher earnings management among agriculture, construction and services industries.

Institutional Ownership and Earnings Management in India

Influence of institutional ownership has been hypothesised to efficiently monitor the managerial decisions especially discretionary role of managers in reporting earnings. The managers have been found to misrepresent the quality of earnings for a dividend declaration; new issue; takeovers and for affirming debt holders of their financial position. Panel data methodology focusing on firms listed in CNX 500 in National Stock Exchange empirically examines the impact of institutional ownership on the earnings management practices in India. Earnings management is measured using discretionary accounting accruals. Firms with higher institutional holdings are found to have higher earnings quality thus restricting managers from using their discretionary powers to report earnings. Institutional ownership has a negative relationship with earnings management for larger and matured firms. Growing firms are found to be having higher earnings management. Institutional investors monitor the firms and hence reduce aggressive earnings management practices within the firm. Foreign institutional ownership also has a negative relationship with earnings management.