Income-decreasing Discretionary Accruals Research Articles

Air pollution, political costs, and earnings management

This paper examines how firms that pollute the air react to political costs induced by air pollution. We use detailed data on accounting, air pollution and meteorological factors to investigate earnings management activities of the firms. We find that the firms engage in income-decreasing earnings management in response to air pollution. A one standard deviation increase in Air Quality Index (19.4) causes an increase in income-decreasing discretionary accruals equal to 1.20% of total assets. We observe that income-decreasing earnings management activities are only induced when air pollution reaches the “lightly polluted” level. We also find evidence that the firms are particularly sensitive to political costs around the release of annual reports. This paper contributes to a more accurate assessment of the undesirable impacts of air pollution, and adds to the existing body of literature on political cost hypothesis as well.

Anticipated Reductions in Tax Rates and Earning Management of Listed Companies: Evidence from China

The effects of tax rate changes on corporations’ earning management are not fully understood. As a transitional economy, China has listed companies with different ownership and special regulatory rules. We explore under the expectation of tax reduction whether there are differences in the way and degree of earnings management implemented by different types of companies. Our study shows that firms under the anticipation of tax reduction make use of earning management, including delaying sales, taking unusual income-decreasing discretionary accruals, and so on, which leads to lower income in higher tax rate period. We find that private enterprises have more attention to reduce earning in the higher tax rate period than state-owned enterprises (SOEs), indicating that the ownership has effect on the extent of earning management. Moreover, under the specific regulations in Chinese stock market, we find that for those listed companies with negative net profit in the previous year, the priority is how to reverse losses rather than tax saving.

Financial Crisis and Earnings Management Under U.S. GAAP and IFRS

This paper examines the effects of the global financial crisis of 2008 on real and accrual-based earnings management activities of foreign companies listed in the United States as American Depositary Receipts (ADRs). The ADR firms are classified according to whether they report under U.S. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). Accrual-based earnings management is measured using the absolute value of performance-matched discretionary accruals. We also use the positive and negative values of performance-matched discretionary accruals to examine income-increasing and income-decreasing earnings management, respectively. Real earnings management proxies are measured using performance-matched measures of the abnormal levels of cash flow from operations, production costs, and discretionary expenses. In summary, our findings indicate no difference in accrual-based earnings management for ADRs reporting under IFRS and U.S. GAAP but suggest that ADRs reporting under IFRS are more likely to manage earnings using income-decreasing discretionary accruals and aggregate real earnings management than ADRs reporting under U.S. GAAP during the financial crisis.

The Determinants and Consequences of Tax Audits: Some Evidence from China

ABSTRACT Using data obtained from a local tax office in China, we examine the determinants of corporate tax audits and the consequences of those audits. We find that the tax authority is more likely to select a firm for an audit when the firm has a lower effective tax rate, a higher book-tax difference, and more income-decreasing discretionary accruals. Applying a difference-in-differences research design, we find that after firms have been audited, they significantly increase their effective tax rates, reduce their book-tax differences, and reduce their income-decreasing discretionary accruals. Our study provides important insights on the determinants of the tax authority's decision on whether to initiate an audit and the impact of tax audits on both tax reporting and financial reporting. JEL Classifications: H26; L51; M41.

The impact of firm-specific characteristics on earnings management: evidence from GCC countries

This study aims to decide whether listed companies in GCC countries practice earnings management (EM). Further, effect of a set of firm-specific characteristics on EM practices is examined. The study sample consists of 332 listed companies during the period 2010–2015. The study estimates the discretionary accruals (DAs) using the modified Jones (1995) model as a proxy for EM to reveal EM activities. Multiple regression analysis is used to test the study hypotheses and achieve the study aims. The results reveal that companies are engaged in EM practices except for Oman and they are practicing downward EM activities (income-decreasing). The results show that the company size and leverage have an insignificant impact on EM practices in GCC countries. Company's losses affect EM for GCC countries except for Bahrain. This further evidence confirms that most GCC countries are engaged in EM and practice EM through income-decreasing discretionary accruals.

PENGARUH REAKSI PASAR ATAS PENGUMUMAN INFORMASI LABA PERUSAHAAN BERKAITAN DENGAN MANAJEMEN LABA PADA PERUSAHAAN MANUFAKTUR DI BURSA EFEK INDONESIA

<p>Financial report is an important factor for inventors to make investment decision in capital market. Publicly financial report which has relevant information will be reacted by market player. Many investors and other users of financial report do not pay attention to the process of publishing financial report, so it pushes the emergence of dysfunctional behaviours like earning management practices.<br />The research aims to analyze the difference of market reaction between:1) earning management companies and non-earning management companies; 2) income-decreasing discretionary accruals companies and income-increasing discretionary accruals companies.Population of this research is 130 manufactured companies listed in JSX during 2009-2010. Using convenience sampling method, 49 companies were taken to become final samples for each period. The result with two independent samples test Kruskal Walles χ (sign 5%) shows that there was no difference of market reaction between earning management companies and non-earning management companies (χ 0,58989 dan 0,03137), and neither was there between income-decreasing discretionary accruals companies and income-increasing discretionary accruals companies (χ 0,735 dan 2,82767).<br />Keywords : Earning Management, Market Reaction.</p>

The Determinants and Consequences of Tax Audits: Some Evidence from China

Using proprietary data obtained from a local tax office in China, we examine the determinants of corporate tax audits and the consequences of those audits. We find that the tax authority is more likely to select a firm for an audit when the firm has a lower effective tax rate, a higher book-tax difference, and more income-decreasing discretionary accruals. In addition, the tax office imposes larger tax payments on the audited firms that have lower effective tax rates, higher book-tax differences, and more income-decreasing discretionary accruals. Applying a difference-in-difference and matching research design, we find that after firms have been audited they significantly increase their effective tax rates, reduce their book-tax differences, and reduce their income-decreasing discretionary accruals. Our study provides important insights on the determinants of the tax authority’s decision on whether to initiate an audit and the impact of tax audits on both tax reporting and financial reporting.

Dual audit, audit firm independence, and auditor conservatism

Purpose– This study aims to examine whether China's unique dual audit policy affects one specific aspect of audit quality: auditor conservatism. In China, listed companies issuing B/H-shares in addition to A-shares must release two financial reports – one based on Chinese accounting standards and the other based on international accounting standards (ISA). The China Securities Regulatory Commission (CSRC) further requires that the financial reports following Chinese accounting standards should be audited by a domestic CPA firm, and the financial reports following ISA should be audited by an approved overseas CPA firm. This study investigates whether the dual audit requirement induces more auditor conservatism.Design/methodology/approach– Based on a sample of 7,046 firm-year observations that issue A-shares from 2001 to 2006, the authors empirically test whether the dual audit requirement induces more auditor conservatism, measured by the level of discretionary accruals.Findings– The authors find the dual audit requirement significantly restricts the use of income-increasing discretionary accruals but not income-decreasing discretionary accruals. Moreover, financial reporting becomes most conservative when two auditors are from two un-affiliated audit firms. Nevertheless, the difference-in-difference analysis fails to show a significant decrease in auditor conservatism after the revocation of the dual audit rule for the treatment group with dual audit before but no dual audit after 2007 comparing to the control group that experience no change in 2007.Originality/value– First, the previous studies examine issues regarding the effects of supervision pressure through experimental setting. The authors extend the literature by examining empirically the impact of perceived peer pressure on auditor conservatism. Second, the findings from China regarding the effect of the dual audit system on auditor conservatism serve as a reference for other emerging markets that have not yet established sound audit systems.

Does Audit Quality Influence the Relation between Earnings Management and Internal Control Weakness in the Post –SOX Period

Material weaknesses in the internal control system of a company create more opportunities for managers to engage in opportunistic earnings management. In this study the authors investigate the relation between earnings management and disclosed material weaknesses in the internal controls, both under SOX 302 and SOX 404, and examine whether audit quality, measured as being audited by a Big Four auditor, has an effect on that relation. The results suggest that material weakness firms have more absolute discretionary accruals and greater income-decreasing discretionary accruals. So evidence is provided that material weakness firms engage in more earnings management, however not in opportunistic income-increasing earnings management. When audit quality is high, measured as being audited by a Big Four auditor, the disclosed material weaknesses are lower just as total and absolute discretionary accruals are. It is also interesting in our findings that when material weakness firms are audited by a Big Four auditor a positive relationship seems to exist with discretionary accruals, suggesting that when a firm is audited by a Big Four auditor, material weaknesses in the internal controls will lead to opportunistic earnings management.

Fenomena Manajemen Laba dalam IPO (Initial Public Offering); Studi dengan Menggunakan Model Aharony dan Friedlan

The research was done on PT Multistrada Arah Sarana, during 2002 to 2007, using modified- Jones Model. The research used two means differentiation tests. Based on the result of two means differentiation test, it can be said that there was no income increasing discretionary accruals one year before initial public offering (on 2004). Issuers also did not do income-decreasing discretionary accruals on one year after initial public offering and two years after initial public offering. Hipotesis 1 and hipotesis 2 a and 2 b were refused, or can not be accepted. So, it can be concluded that PT Multisrada Arah Sarana did not do income smoothing before and after initial public offering on Indonesia Stock Exchange. Keywords: income smoothing, income increasing discretionary accruals, income decreasing discretionary accruals, initial public offering.

Female Executives and Earnings Management

Purpose – The purpose of this paper is to examine the association between earnings management and the gender of the firm’s executives. Design/methodology/approach – Panel regressions of discretionary accruals on a set of female executive dummies and firm-specific controls. Findings – The results provide considerable evidence to suggest that firms with female CFOs are associated with income-decreasing discretionary accruals, thereby implying that female CFOs are following more conservative earnings management strategies. Research limitations/implications – In general, the findings indicate that gender-based differences in conservatism, risk-aversion, and managerial opportunism may have important implications for financial reporting and corporate governance. Originality/value – This paper extends prior research by addressing the potential effects of female executives on earnings management. The findings reported in this paper provide novel insights to the empirical financial accounting literature.

Prominent Audit Clients and the Relation between Discretionary Accruals and Non-Audit Service Fees

Abstract Using a matched-pair design, we find that for SP however, this result is not robust to alternative fee measures. For a group of matching small firms, higher fees paid to auditors are associated with higher levels of income-decreasing discretionary accruals (i.e., lead to more negative discretionary accruals). We conclude that (1) the relation between discretionary accruals and fees paid to auditors differs for prominent and less-prominent audit clients, and (2) auditors appear to be more conservative with their less-prominent audit clients from whom they receive large fees.

Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

This study examines the association between audit fees and earnings management, using publicly available fee data. We hypothesize that, due to asymmetric litigation effects, audit fees decrease (increase) with a client's risk of income-decreasing (increasing) earnings management risk. We also hypothesize that the positive relation between income-increasing earnings management risk and audit fees is heightened for clients that are high-growth firms. We test our hypotheses with a sample of 429 public, non-regulated, Big 5 audited companies, using fee data for the year 2000. We find that downward earnings management risk, as estimated by negative (i.e., income-decreasing) discretionary accruals, is associated with lower audit fees. We also document that upward earnings management risk, as estimated by positive discretionary accruals, is associated with higher audit fees and that the interaction of this risk with an industry-adjusted price-earnings ratio has an incrementally significant, positive effect on fees. We interpret our findings as consistent with a conservative bias on the part of auditors. The conservative bias arises from asymmetric litigation risk in which income-increasing discretionary accruals exhibit greater expected litigation costs than income-decreasing discretionary accruals (Simunic and Stein 1996; Palmrose and Scholz 2004; Palmrose et al. 2004; Richardson et al. 2002; Heninger 2001).

Earnings Management Response to Debt Covenant Violations and Debt Restructuring

The study investigates whether the choice of income-increasing or income-decreasing discretionary accruals is related to the severity of financial distress and whether this choice is also influenced by the creditors' waivers of debt covenant violations. Financially distressed firms experiencing debt covenant violations and/or debt restructuring during the 1989–96 period are used to evaluate the management's choice of discretionary accruals. Discretionary accruals are calculated based on four different accrual models. The results show that managers of financial distressed firms use income-increasing discretionary accruals if they are able to obtain waivers for debt covenant violations, and use income-decreasing discretionary accruals if debt restructuring takes place or debts are renegotiated because waivers are denied. These findings thus provide support to the expectation that the choice of income-increasing or -decreasing discretionary accruals is influenced by the severity of financial distress. They also provide an explanation for divergence in the results of earlier studies on the use of income-increasing or -decreasing discretionary accruals by financially distressed firms.

Empirical tests of budget ratcheting and its effect on managers’ discretionary accrual choices

In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis.

The Relation Between Auditors' Fees for Non-Audit Services and Earnings Management

This paper examines whether auditor fees are associated with earnings management and the market reaction to the disclosure of auditor fees. Using data collected from proxy statements, we present evidence that non-audit fees are positively associated with small positive earnings surprises, the magnitude of absolute discretionary accruals, and the magnitude of income-increasing and income-decreasing discretionary accruals. In contrast, audit fees are negatively associated with these earnings management indicators. These results are robust to a variety of alternative variable definitions and model specifications. Specifically, contrary to the claims of Ashbaugh et al. (2002), the results are robust to the use of performance-matched discretionary accruals. Moreover, contrary to the claims of Francis and Ke (2002), the results for small positive earnings surprises are robust regardless of whether the comparison group is all other earnings surprises or small negative earnings surprises. Our final set of results provide evidence of a significant negative association between non-audit fees and share values on the date the fees were disclosed, although the effect is small in economic terms.

Earnings management in the electric utility industry

This study examines whether accounting earnings are systematically managed as a response to regulation regime (rate vs. incentive regulation) and relative performance (over- vs. under-perform- ance). Incentive regulation aims at mitigating efficiency problems arising from rate regulation under which managers have incentives to decrease accounting earnings to the extent that expenses are recoverable through a bargaining process at rate hearings. Specifically, income-managing incentives of electric utilities are assessed by hypothesising that income-decreasing accounting accruals are more pronounced (i) for rate-regulated firms than for incentive regulated firms and (ii) for overearning firms than for underearning firms. Empirical results generally support the expectation. In particular, income-decreasing discretionary accruals are the most negative for rate regulated overearning firms (i.e., firms that earn above allowed return) among others. © City University of Hong Kong.