Income-increasing Earnings Management Research Articles

Institutional Imprints and Corporate Misconduct: Unravelling the Interplay of Economic History and Firm Choices on Earnings Manipulation in an Emerging Economy

This study investigates the impact of firms’ legacy institutional imprints on its engagement in corporate misconduct. We discover that a closed economic regime’s protectionist policies inscribe imprints in the form of opaque organizational routines and cause incumbent firms to develop competitive limitations. Utilizing the theoretical principles of the organizational imprinting theory, this research attests to the endurance of corruptive routines and argues that the degree of closed economy imprints increases firms’ engagement in income-increasing earnings management in the post-liberalization period. Furthermore, we find that the impact of imprints is weakened by firms’ choices on international exposure and internal innovation. By utilizing the historical data on Indian economic policies from 1956 to 1991 and analyzing a sample of 18,432 firm-year observations for 2,396 listed Indian manufacturing firms from 1997 to 2007, we find support for our hypotheses.

How does local debt expansion affect earnings management? Evidence from China

ABSTRACT This paper explores the impacts of local government debts (LGD) on earnings management strategy and moderation effects of internal control. Using a purpose-build database incorporating Chinese LGD and listed firms, we find that firms engage in income-increasing earnings management in response to local debt expansion. The results remain stable to endogeneity tests and various robustness checks. Furthermore, the impacts of LGD are markedly pronounced in non-SOEs, firms audited by Big 4 auditors, young and declining firms, and firms located in less-marketized regions. Moreover, this study reveals that internal control exerts moderation effects on the relation between LGD and earnings management.

The Impact of Dividend and Tax Avoidance on Earning Management of Companies

Using a sample covering practically all dividend-paying oil and gas companies companies in Pakistan during 2011–2020, we document that earnings management in these companies is driven by two concurrent forces: the willingness to pay (tax-exempt) dividends and avoiding unnecessary company income tax. Moreover, we show that the need for income increasing earnings management enabling current dividend distribution is mitigated by the amount of retained earnings from prior years. This article adds to the existing literature by providing empirical evidence for dividend and tax-driven earnings management in private oil and gas companies facing neither political pressures nor capital market incentives for earnings disclosures.

Carbon Emissions Accounting Disclosure: An Empirical Analysis during the Covid-19 Pandemic Period in a Developing Country

Carbon emissions accounting disclosure (CEAD) is an interesting research area that is related to the increase in global warming that is being caused by the use of non-renewable energy. However, there has been no research that has tested the disclosure of carbon emissions during the COVID-19 pandemic using a comprehensive model. Apart from that, there is still limited previous research that focuses on developing countries where the use of fossil-based energy has become an important issue at the moment. In this sense, this study aims to contribute to CEAD by analyzing earnings management, corporate governance, and media exposure as determinants of CEAD in Indonesia, a developing country. The sample consists of 244 firm-year manufacturing companies listed on the Indonesia Stock Exchange (IDX) during the 2020-2022 period. The test results, using partial least squares-structural equation modeling (PLS-SEM), indicate support for legitimacy theory, namely the view that corporate governance and media exposure have a positive effect on the level of CEAD. Drawn from the COVID-19 pandemic period, the empirical evidence from this study shows that the sample of manufacturing companies tended to carry out income-increasing earnings management and the disclosure of carbon emissions tended to be low.

Growth in revenue and earnings management practices in Nigeria pre- and post-IFRS adoption periods

The purpose of the study is to examine the revenue growth and association with earnings management practices of firms in Nigeria pre- and post-International Financial Reporting Standards (IFRS) adoption years. The study uses 87 nonfinancial firms over 19 years, nine years pre-IFRS (2003 to 2011), and nine years post-IFRS (2012-2020) for a total of 1566 firm-year observations. The panel regression estimate (fixed effect and random effect) was used to test the association between revenue growth and discretionary accruals, while the paired sample t-test was used to test the effect of IFRS adoption. The finding shows that decreasing growth rates resulted in increasing earnings management practices, probably due to the desire to maintain steady published performance figures in the pre-IFRS era, while decreasing growth rates resulted in income-decreasing earnings management practices in post-IFRS years, a rather surprising result. The finding also suggests that the practice of earnings manipulation is higher post-IFRS, indicating lower earnings quality. While managers engaged in income-increasing earnings management practices pre-IFRS, surprisingly, income-decreasing earnings management practices were detected post-IFRS. The finding deviates from norms and popular assumptions and suggests that the adoption of global standards might not necessarily mean limiting the abilities of managers to manipulate the earnings of companies. While changing standards may affect the nature of earnings manipulation, it is unlikely to prevent or deter the practice in general. The implication is that the application of IFRS will not deter earnings management practices.

Does the covid-19 pandemic create an incentive for firms to manage earnings? The role of board independence and corporate social responsibility

It is argued that managers took advantage of Covid-19 pandemic lockdowns and remote auditing and used earnings management (EM) practices extensively. Furthermore, the Covid-19 pandemic created new unsearched crisis-related incentives. This study, therefore, tests whether Covid-19 created a new incentive for managers to manipulate earnings. It also examines the association between corporate social responsibility (CSR) and board independence and EM during Covid-19. A data set of 384 firm-year observations from 2018 to 2021 of non-financial firms listed on the Amman Stock Exchange (ASE) was investigated. Results indicate that Jordanian firms engaged in EM during Covid-19 considerably more than when compared to pre-Covid-19, suggesting that Covid-19 created a new incentive for managers to manipulate earnings. Furthermore, Jordanian firms used income-increasing EM much more when compared to income-decreasing EM. However, when taking Covid-19 into account, no significant association was found between board independence and EM. In addition, the ability of CSR to constrain EM decreased. This adds to the current debate in the literature that even well-established monitoring mechanisms like board independence and CSR are unable to constrain EM practices in a unique business environment caused by Covid-19.

Does Income-Increasing Earnings Management Enhance Tax Aggressiveness? The Moderating Role of The Corporate Governance Mechanism

Purpose — This study examines and analyzes the effect of income-increasing accrual and natural earnings management on tax aggressiveness with institutional ownership as a moderating variable. Design/methodology/approach — The research population is manufacturing companies listed on the Indonesia Stock Exchange (IDX) from 2017 to 2019. The research sample selection method used is the purposive sampling method. There are 84 observations (firm-year) for income-increasing accrual earnings management and 81 observations (firm-year) for income-increasing natural earnings management. Data analysis is conducted using Moderated Regression Analysis (MRA). Findings — As predicted, this study finds a positive effect of income-increasing accrual earnings management and a negative effect of income-increasing natural earnings management on tax aggressiveness. However, this study cannot prove that institutional ownership moderates the relationship between income-increasing accrual and income-increasing natural earnings management on tax aggressiveness. Practical implications — Our study can be used as evidence for the Directorate General of Taxes and the Financial Services Authority that implementing good corporate governance in companies may not necessarily reduce the practice of tax and financial reporting aggressiveness. This can be used as a reference for improving Indonesia's tax and accounting regulations and policies. Originality/value — This study presents income-increasing accrual and natural earnings management activities as well as corporate tax aggressiveness activities in manufacturing companies in Indonesia. Hopefully, this can be used as an evaluation to improve existing tax and accounting regulations and policies in Indonesia.

When are busy boards beneficial?

Whether busy boards contribute positively to firm value is inconclusive. I examine whether the effectiveness of busy boards varies with firms’ demands for specific board functions: advising and monitoring. I find that the positive effects of busy boards on advising quality, including corporate innovation and acquisition returns, are enhanced when firms have higher advising needs. I also show that the negative effects of busy boards on monitoring quality, including forced CEO turnover-performance sensitivity and income-increasing earnings management, are mitigated when firms have lower monitoring needs. Taken together, firm value results suggest that the positive effect through improved advising is more likely to outweigh the mitigated negative effect through monitoring when firms have higher advising needs but lower monitoring needs.

Investor institusional dan keinformatifan laba di Indonesia dan Jepang

This study examines the existence of institutional investors who can play a role in increasing earnings informativeness through income increasing-earnings management and income smoothing. The hypothesis was developed on the basis of the view that the motivation behind earnings management decisions is to increase the informativeness of earnings reports. The study employs sample of manufacturing companies listed on the Indonesia Stock Exchange and the Japan Stock Exchange for the period of 2010-2018. Ordinary least square and weighted least square regression models are used in cross-sectional statistical testing, which is carried out annually throughout the 2014-2018 observation period. In Japan, institutional ownership has a positive and significant effect on income increasing- earnings management, and on reverse income smoothing, as well, while these are not the case in Indonesia. This study reveals that in Japan, the institutional investors play a role of monitoring that can encourage managers to increase earnings informativeness through earnings management-income increasing followed by reverse income smoothing. This condition is not found in Indonesia. It is possible that in Indonesia, the institutional investors play a role of controlling, that may promote managerial opportunistic behavior.

CEO Regulatory Focus, Earnings Management, and Analyst Recommendations

Drawing on regulatory focus theory and impression management literature, we examine the influences of CEO regulatory focus on earnings management. Furthermore, we show how the analyst recommendations differentially moderate the relationship between CEO promotion and prevention foci and earnings management. Based on U.S. public firms from 2003 to 2019, our findings indicate that CEO promotion focus is positively related to the magnitude of income-increasing earnings management, and CEO prevention focus is negatively related to the magnitude of income-increasing earnings management. In the context of positive analyst recommendations, the positive relationship between CEO promotion focus and income-increasing earnings management is strengthened, and the negative relationship between CEO prevention focus and income-increasing earnings management is weakened.

Institutional investors and earnings management associated with controlling shareholders' promises: Evidence from the split share structure reform in China

We examine the effectiveness of institutional investors in constraining aggressive earnings management induced by strong contractual incentives. To this end we focus on the consequences of earnings-related promises (covenants) negotiated between corporate controlling shareholders and minority shareholders during China’s split-share structure reform, wherein failure to achieve profit benchmarks had the potential to transfer significant wealth from controlling to minority shareholders. Our initial analysis provides evidence that profit-promised firm-years are, on average, associated with income-increasing earnings management, and that this association is stronger for: (i) firm-years in which the profit-promise was satisfied, and (ii) firm-years in which proxies for the level of unmanaged earnings suggest that earnings management was needed to satisfy the promise. However, such benchmark-beating behavior is weaker for firms with higher levels of institutional ownership. Further analysis documents that the exit threat of institutional shareholders can discipline earnings management associated with profit promises. We also show that the effect of institutional shareholders in reducing earnings management associated with profit promises is greater for domestic mutual funds and for privately controlled firms. Interestingly, our evidence suggests that institutional investors only play an effective monitoring role over earnings management when their incentives are strongly aligned with those of other minority owners. In other cases, our evidence suggests that these investors may exacerbate the level of earnings management.

Exploring the Relationship between New Bank Debt and Earnings Management: Evidence from Italian SMEs

This paper investigates the relationship between bank debt and earnings management in private SMEs in a bank-oriented economy. In this study, we leverage a sample of 4866 Italian private SMEs from 2005 to 2012 and propose a new metric to isolate the annual increase in bank debt. The results of our OLS regression suggest that, even though bank monitoring is an effective mechanism to constrain firms’ earnings management, firms engage in higher income-increasing earnings management, as proxied by discretionary accruals, in the fiscal year prior to a new bank loan application. The results are robust to different econometric specifications and are not affected by endogeneity.

Financial distress, earnings management and Big 4 auditors in emerging markets

PurposeThe purpose of this study is to examine the association between financial distress and accruals-based earnings management in emerging markets, and the role that auditors play in that association.Design/methodology/approachThis study relies on a sample of 33,455 firm-year observations from 20 emerging markets, covering a large period of analysis of 20 years. A multivariate analysis is performed by considering the level of financial distress as the dependent variable, and the accruals-based earnings management and dummies for the type of auditor as the main independent ones.FindingsThe authors predict and find empirical evidence that firms facing greater financial distress engage in income-increasing accruals-based earnings management in emerging markets, and that such engagement is lower in firms audited by Big 4 firms compared to those audited by non-Big 4 auditors. The authors also find significant differences across Big 4 audit firms in their role of constraining income-increasing earnings management strategies in firms with high levels of financial distress.Originality/valueThe study adds to previous literature by investigating the association between financial distress and accruals-based earnings management in a comprehensive sample of 20 emerging markets, by providing important overall cross-country empirical evidence that has not been addressed by previous literature. The authors also bring new knowledge by discussing the role played by the Big 4 audit firms in limiting earnings management practices by firms with high levels of financial distress. Such a limitation serves as an important external corporate governance mechanism to restrain managers’ opportunistic behaviour in firms facing financial distress – especially in emerging economies characterized overall by institutional voids.

Impact of COVID-19 Pandemic on Earnings Management: An Evidence from Financial Reporting in European Firms

The aim of this study is to determine the impact of COVID-19 pandemic on earnings management practices. Focusing on a sample of 2,031 firms listed in 15 European countries, the study uses three discretionary accrual metrics as a proxy for earnings management ( Dechow et al., 1995 ; Kothari et al., 2005 ; McNichols, 2002 ) models. To this end, ordinary least squares (OLS) regressions are applied to compare earnings management during the pre-pandemic period (2017q1–2019q4) and the pandemic period (2020q1–2020q4). The results indicate that the sample firms tend to manage earnings during the pandemic period than during the preceding period. This finding implies a reduced reliability of the financial reports during the COVID-19 pandemic. Further analysis provides evidence of significant income-increasing earnings management during 2020. This finding suggests that firms manage earnings upward by alleviating the level of reported losses to rebuild investor and stakeholder confidence needed to support the economic recovery.

David versus Goliath: The Relation between Auditor Size and Audit Quality for U.K. Private Firms

We examine the relation between auditor size and audit quality for a sample of U.K. private firms. Private firms prioritize tax considerations over reducing information asymmetry in their financial reporting. We find that Big 4’s private clients exhibit higher levels of discretionary accruals and lower precision of accrual estimates than non-Big 4’s private clients. Although Big 4 auditors are less tolerant of income-increasing earnings management, they leave more room for downward earnings management and their private clients are able to engage in greater tax avoidance. These results are stronger for standalone firms than for business groups as the latter’s greater demand for stakeholder communication motivates Big 4 auditors to increase audit quality. Collectively, our evidence suggests that Big 4 auditors adjust audit quality in a more competitive segment of the audit market where client firms generally perceive the benefit from tax minimization to outweigh the cost of reduced earnings informativeness.

Internal audit quality and earnings management: evidence from the UK

PurposeThis study aims to examine the association between internal audit quality and the involvement of UK companies in earnings management practices.Design/methodology/approachTo measure the internal audit quality, this study uses 115 responses for a postal questionnaire that was addressed to the heads of internal audit departments in a sample of non-financial listed companies in the UK context. The other financial and governance data for the respondent companies were collected from the Datastream and the companies’ annual reports. The present study uses the signed abnormal accruals as a proxy for earnings management and uses both logistic and ordinary least squares regression models to test the research hypothesis.FindingsThis study finds a negative relationship between the internal audit quality and the abnormal accruals, implying the prominent role of internal audit in reducing the upwards earnings management. The study also finds a significant impact of the internal audit competence on reducing the engagement of UK companies in income-increasing earnings management compared to the internal audit independence. This remarkable result suggests the companies need to focus more on enhancing the internal audit competence to reduce the opportunistic management’s behaviour.Practical implicationsThis study has important implications for the internal audit’s practice, regulation and research.Originality/valueThis is the first study that investigates the relationship between internal audit quality and earnings management in the UK context. Furthermore, it uses a comprehensive measure for the internal audit function (IAF) quality covering different aspects of IAF quality based on the global Institute of Internal Auditor standards and prior internal audit literature.

Standard precision and aggressive financial reporting: the influence of incentive horizon

The extant literature on precision in accounting standards suggests that financial statement preparers are less likely to make aggressive financial reporting decisions under less precise, principles-based accounting standards as compared to under more precise, rules-based accounting standards. We extend this line of research by examining how the incentive horizon of financial statement preparers influences earnings management behaviour. Consistent with prior literature, we find evidence that more precise standards lead to more income-increasing earnings management behaviour than do less precise standards when the incentive horizon is short-term in nature. However, when the incentive horizon is long-term, more precise standards are associated with financial reporting decisions that reduce current income relative to less precise standards. Importantly, the findings demonstrate that the effects of standard precision are changed by the incentive time horizon, and the effects of standard precision on financial decision makers cannot be fully understood when precision is studied without considering the timing of management incentive structures.

Asymmetric Monitoring of Quarterly Financial Statements by Big 4 Auditors and the SEC's Timely Review Requirement

SYNOPSIS We investigate if Big 4 firms are asymmetrically more effective than non-Big 4 firms in monitoring income-increasing versus income-decreasing quarterly earnings management. We also study the Securities and Exchange Commission's (SEC) 2000 requirement that audit firm reviews of quarterly financial statements be completed prior to their filing with the SEC (“timely reviews”). We find Big 4 firms are more effective than non-Big 4 firms in curbing income-increasing earnings management around seasoned equity offerings (SEOs), but not income-decreasing earnings management around open market repurchases (OMRs). In the post-2000 period, after the SEC's mandate for timely reviews began, we find income-increasing earnings management around SEOs declined significantly, and this decline is primarily driven by the clients of Big 4 firms. We provide evidence that timely quarterly reviews improve earnings quality, especially when companies have incentives to engage in income-increasing accruals and are reviewed by Big 4 firms.

Affiliated Mutual Fund Investments and Discretionary Accruals: Evidence from Korea

This paper examines the effect of mutual fund investments on financial reporting quality by focusing on their affiliation with firms. Using Korean public companies between 2008 and 2014, we find that firms tend to have greater discretionary accruals when they are invested by mutual funds that are in the same business group. We further show that investments from affiliated mutual funds increase the likelihood of income-increasing earnings management while decreasing income-decreasing earnings management. However, the results suggest that mutual fund investment itself does not affect financial reporting quality. Our findings are robust with various model specifications and to endogeneity concerns.

Manajemen Laba dan Nilai Perusahaan (Studi Empiris pada Perusahaan Manufaktur di Bursa Efek Indoensia)

The purpose of this study is to determine the effect of earnings management with income increasing and income decreasing patterns on firm value in manufacturing companies listed on the Indonesia Stock Exchange in 2014-2018. The population of this research are 167 companies. A total of 105 samples are selected using a purposive sampling technique. Total observations over the 5 years to 525 observations, then divided into two groups, 472 observations for increasing income management and 53 observations for decreasing earnings management. This study uses a simple linear regression analysis technique. The test results show that income increasing earnings management variable does not affect the value of the company, while earnings decreasing earnings management has a negative effect on firm value.
 Keywords: Firm Value; Earnings Management; Income Increasing; Income Decreasing.