Increase In Earnings Management Research Articles

Can Corporate Social Responsibility Decrease the Negative Influence of Financial Distress on Accounting Quality?

This study aimed to test how corporate social responsibility (CSR) can affect the impact of corporate financial distress on earnings management. Based on the existing literature, distressed firms tend to hide their financial crises through earnings manipulation. However, as CSR can positively affect companies in terms of performance, risk reduction, and market response, the better a firm’s CSR is the less managers will attempt earnings management even if they experience temporary distress. Consistent with the literature, test results using Korean-listed companies show that distress increased earnings management, and we confirmed that CSR weakened the positive effect of distress on earnings management. After testing each of the CSR subcategories, significant results were found mainly on environmental performance, reflecting the globally increasing interest in environmental issues. This study contributes to the literature on distress and earnings management, which rarely considers CSR as a moderating factor.

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.

Hiring Auditors with a Part II Quality Control Report: An Opportunity for Increased Earnings Management or Lower Audit Fees?

ABSTRACT The Public Company Accounting Oversight Board's (PCAOB) Part II inspection reports, which disclose systemic quality control issues that auditors fail to remediate, signal poor audit quality for triennially inspected audit firms. Auditors that receive a Part II inspection report typically experience a decrease in clients, which demonstrates a general demand for audit quality. However, some companies hire auditors that receive Part II inspection reports. We examine potential reasons for hiring these audit firms. We find that relative to companies that switch to auditors without Part II reports, companies that switch to auditors with Part II reports have higher discretionary accruals in the first fiscal year after the switch, which indicates lower audit quality and a heightened risk for future fraud. We find no difference in audit fees. Our results suggest that PCAOB Part II inspection reports may signal low-quality auditors to companies that desire low-quality audits. Data Availability: Data are available from the public sources cited in the text.

EFEITO DA COMPLEXIDADE EMPRESARIAL NO GERENCIAMENTO DE RESULTADOS DE EMPRESAS BRASILEIRAS

O objetivo do estudo foi analisar o efeito da complexidade empresarial no gerenciamento de resultados de empresas brasileiras. A metodologia pode ser caracterizada como descritiva, documental e quantitativa. A amostra foi composta por 110 empresas listadas na B3, no período compreendido entre os anos de 2010 a 2013. A coleta de dados foi realizada pela base de dados Thomson, formulários de referências das empresas, notas explicativas e dados cadastrais. Para a análise dos dados utilizou-se de técnicas estatísticas, tais como: regressão linear múltipla, estatística descritiva, entropia da informação, método TOPSIS e regressão de dados em painel, por meio dos softwares SPSS e STATA. Os resultados demonstraram que a experiência de mercado das empresas e a rentabilidade do patrimônio líquido aumentaram o nível de gerenciamento de resultados das empresas analisadas. Por outro lado, as dívidas de longo prazo e a complexidade total auxiliaram na redução desta prática oportunista dos gestores. Conclui-se que a complexidade de empresas aumenta a prática oportunista de gestores, quando na empesa apresentam-se formas de complexidade de forma individualizada, mas também pode contribuir para a sua diminuição, principalmente quando a empresa possui de forma conjunta várias medidas de complexidade.

The effect of CEO friendship and perceived pay equity on the earnings management behavior of business-unit managers

PurposeThe purpose of this study is to examine the possibility of adverse consequences regarding the recently enacted Dodd–Frank Act (DFA) pay-equity disclosure requirement in the USA, which will likely lead to lower levels of perceived Chief Executive Officer (CEO) pay fairness by subordinates. Specifically, the study examines whether the pay-equity disclosure leads to increased earnings management when business-unit managers have friendship ties with the CEO.Design/methodology/approachAn experiment is conducted wherein participants assume the role of a business-unit manager and are asked to provide an estimate for future warranty expense, which is used as a proxy for earnings management. The study manipulates friendship between the CEO and a business-unit manager and the saliency of CEO compensation pay-equity.FindingsCEO friendship ties, which are associated with lower levels of social distance, result in less earning management in the absence of the DFA CEO pay-equity ratio disclosure. However, CEO friendship may result in negative repercussions in terms of higher earnings management in the post-DFA environment when managers are provided with the pay-equity disclosure.Research limitations/implicationsFuture research may expand this study by examining how the adverse consequences of the CEO compensation saliency disclosure can be mitigated.Practical implicationsManagement, audit committees and internal auditors should consider the possibility of unintended consequences of the increased transparency of CEO pay-equity while designing management control systems.Social implicationsThis study highlights the importance of understanding how employees’ social relationships with leaders may influence their behavior.Originality/valueUnlike prior research, which focuses on senior executives’ direct incentives to manipulate earnings and subsequently increase their compensation, this study provides evidence regarding the earnings management behavior of business-unit managers.

Equity incentives, earnings management and corporate governance: Empirical evidence using UK panel data

Using a UK panel data set drawn from 1675 Chief Executive Officer (CEO) year observations and 1540 Chief Financial Officer (CFO) year observations, we examine the relationship between CEO and CFO equity incentives and earnings management. In addition, we examine the moderation effect of corporate governance mechanisms on the relationship between executives’ equity incentives and earnings management. We use multivariate regression models to test our hypotheses. We find that CEO equity incentives are related to higher absolute and income increasing earnings management. These results support the managerial power theory argument that CEOs exploit equity-linked compensation to obtain more personal benefits without causing public anger. Contrary to CEO equity incentives, we could not find any significant relationship between CFO equity incentives and any of the earnings management proxies. In addition, we find that corporate governance quality (measured by individual mechanisms and overall index) has no effect on the relationship between executives’ equity incentives and earnings management. This result indicates that whereas some corporate governance mechanisms can reduce earnings management in general, they do not affect wealth driven incentives to manipulate accruals. In total, results question the effectiveness of the corporate governance system in mitigating opportunistic behavior motivated by executives’ compensation structures

Short-term management earnings forecasts and earnings management through real activities manipulation

PurposeThe purpose of this paper is to investigate the association between managers’ short-term, quarterly earnings forecast characteristics and earnings management through real activities manipulation.Design/methodology/approachUsing a propensity-score matched sample from 2000 to 2015, the author examines whether, compared to non-issuers, firms issuing short-term earnings forecasts exhibit abnormal levels of earnings management through the manipulation of real activities such as acceleration of sales, changes in shipment schedules and delaying R&D and maintenance expenditures.FindingsThe finding of this study suggests that firms actually engage in less real activities manipulation when they provide short-term management earnings forecasts. This result does not support the practitioners’ criticism that providing short-term management earnings forecasts increases earnings management. Instead, it suggests that providing management earnings forecasts can reduce information asymmetry between managers and external shareholders, thereby constraining managers’ opportunistic behaviors.Originality/valuePractitioners have expressed concerns that issuing earnings forecasts may foster managerial myopia, therefore, increasing earnings management. However, recent empirical study found evidence that management earnings forecast mitigates accrual-based earnings management, which is inconsistent with practitioners’ view. This study hence aims to provide timely evidence to this debate by examining the relation between management earnings forecasts and real activities manipulation.

Stock pledging and earnings management: an empirical analysis

PurposeThe purpose of this paper is to investigate the impact of agency risk implied in case of personal debt obtained by promoters through pledging of their stock on accrual and real earnings management practices.Design/methodology/approachIn this paper abnormal accruals, as suggested in Dechow et al. (1995), and the real earnings management proxies as indicated in Dechow et al. (1998) and Roychowdhury (2006) are used. OLS regression is run over 29,054 firm-years of Indian companies starting from the year 2008 to 2016. Then the occurrence of earnings management is tested in firms in year t where promoters pledge/release their holdings from the pledge in year t+1.FindingsThe findings suggest that earnings management increases in the prior year with an increase in the proportion of promoters’ stock pledge in the subsequent year. The authors find evidence for increased earnings management through accruals and also for real earnings management using abnormal cash flows and abnormal discretionary expenses. However, the authors do not find real earnings management using abnormal production cost as a measure.Practical implicationsThe paper has considerable implications on managerial behavior toward earnings management because of the flexibility managers have in applying accounting policies and authority in operating decisions under domestic GAAP, and IFRS and earnings are prone to management tactics, fostering agency risk when they relate to the welfare of decision makers.Originality/valueThis paper addresses the consequences of individual borrowing of promoters collateralized by their stake in the firm, which is a global phenomenon, on reporting quality.

The Relationship between Labor Union Strikes and Earnings Management from Korean Evidence

This paper investigates whether labor union strikes have an effect on earnings management. Most prior studies have concluded that companies with labor unions are less engaged in earnings management than companies without labor unions. For the agency cost perspective, Jensen and Meckling (1976) insist that labor unions monitor management. Because union members have considerable information about companies, labor unions play a governance role to diminish management behavior pursuing private wealth. On the different view, labor unions intend to raise wages in negotiation if the company reports higher earnings. Therefore, management is motivated to reduce earnings to minimize wage increases when they negotiate with labor unions (Liberty and Zimmerman, 1986; Mora and Sabater, 2008). Chen et al. (2012) show that companies in the industry with higher labor force unionized rate have more positive response in the bond market. They posit that unionized workers have strong incentive to monitor management’s actions to ensure the firm’s health and that the market reacts positively. Lee et al. (2013) show that management engages in more conservative accounting when labor unions join stronger federations of unions. Kim et al. (2016), however, suggest that management is incentivized to increase earnings in firms with union strikes. They conclude that firms that experience labor strikes are engaged in upward earnings management because management tries to recover poor financial performance and bad reputation in the market due to strike. As for labor union strength and earnings management, different perspectives of management incentive to manage earnings stand opposed to each other, and the empirical results are not consistent. It is therefore important to investigate empirically whether earnings management varies according to labor union strength and whether the effect of labor union strength on earnings management is different from the effect of labor union presence on earnings management. Unlike the prior research, we use union strike as a proxy of union strength to investigate the effect of labor union strength on earnings management. Union activity such as strike is a better proxy because strike is occurred by the union when the union has strong bargaining power (Myers and Saretto, 2010). We conjecture that managements have complicated motivations to manage reported earnings according to union strikes. On the one hand, they have incentive to manage earnings downward for negotiations with labor unions. Managements lower the upper limit of future wage increase by reducing reported earnings. On the other hand, managements would manage earnings upward to recover from bad financial performance and declining stock prices caused by union strikes because shareholders regard strikes costly events. To examine our research question, we use union strikes as a proxy for unions, while prior research used unionized rate or federation of unions to capture union strength. Using Korean listed firms from survey data from 2005 to 2013, we find that union strikes relate to increased earnings management. We observe earnings management increase in strike years compared to the prior year. This result is robust after controlling for the presence of union, which has a negative coefficient. This suggests that management has complicated incentives regarding union and union strike, while prior research insists that management reduces earnings management by union monitoring. Management intends to increase reported earnings since strikes negatively affect firm financial performance and market reaction, while they intend to reduce earnings due to union monitoring. We suggest management incentive to increase reported earnings during a striking period by demonstrating a different perspective from previous studies on the relationship between labor union and earnings management. We suggest that union strike is also a factor affecting earnings management, and that management incentive among union firms is not homogeneous. We use nationwide data in our study, different from prior research. Our results offer implications to investors of Korean companies because Korean labor dispute is relatively stronger than other countries. Investors should consider union status and union strikes of Korean companies when they make investment decisions.

Board Quality and Earnings Management: Evidence from India

This article examines whether board qualities influence the earnings management behaviour of firms in a large emerging market set-up by using panel data of 783 Indian private manufacturing firms over a period of 7 years (April 2009–March 2016). The study finds that it is board quality that helps in curbing earnings manipulation and not just board independence. Results reveal that diligent and busy boards help in reducing earnings management, CEO duality affects the quality of reported earnings and promoters’ influence on boards increases earnings management. Domestic or foreign institutional investors do not have any independent impact on earnings management. However, domestic institutional ownership reduces earnings management when promoters’ influence exists. The article contributes to the literature by focusing on whether corporate governance (CG) mechanisms are important in curbing earnings management in an emerging market context. The findings are expected to be helpful to policymakers and regulators while framing appropriate CG policies and regulations.

Unintended consequences of regulation FD: a natural experiment from China

ABSTRACT The aim of Regulation Fair Disclosure (Reg FD) is to prohibit selected disclosure and improve the information environment of capital markets. Using a natural experiment from China and applying a difference-in-differences design, we find that Reg FD constrains private communication between firms and analysts but has the unintended consequence of increasing earnings management, which deteriorates accounting information quality. Furthermore, the effect of Reg FD on earnings management is concentrated in firms without public management earnings forecasts (MFs), firms with strong incentives to meet or beat analysts’ targets, and firms with poor corporate governance. Overall, this study sheds light on the effect of Reg FD on the methods that managers use to meet analysts’ expectations and on how this effect varies with underlying firm characteristics.

Policy uncertainty and earnings management: International evidence

Policy uncertainty (PU) influences the financial and investment decisions of the firm. We use global data to extend the nascent empirical finance literature on policy uncertainty by examining corporate earnings management. We find overwhelming evidence that policy uncertainty is associated with earnings management. Firms increase (decrease) earnings management (EM) when policy uncertainty is high (low). Our results show that uncertainty induced earnings management is not influenced by national culture or other country-level institutional characteristics. Further, we find that policy uncertainty induced earnings management harms firm value. The observation implies that low-quality financial reporting impairs firm value. Our results withstand a battery of robustness tests, such as removing the effect of general economic uncertainty from the measure of PU and using other measures of earnings management.

Conformidade contábil-fiscal e gerenciamento de resultados contábeis no Brasil

Este estudo se propôs a examinar se uma maior conformidade contábil-fiscal restringe o gerenciamento de resultados em companhias de capital aberto, não financeiras, listadas na B3 no período de 2010 a 2016. A conformidade contábil-fiscal mensura o grau de aderência das normas da contabilidade societária e daquelas da contabilidade tributária. Metodologicamente, foram utilizados três modelos de regressões, em que os dois primeiros modelos têm o objetivo de fornecer, respectivamente, o grau de conformidade contábil-fiscal e os accruals discricionários, que serão utilizados no terceiro modelo, o qual é o foco principal de análise, em que se investigam associação entre a conformidade contábil-fiscal e o gerenciamento de resultados contábeis. Os resultados mostraram que quanto menor a conformidade contábil-fiscal, maior é a propensão ao gerenciamento de resultados. Adicionalmente, foi identificado que as empresas de menor tamanho e com menor rentabilidade tendem a gerenciar mais seus resultados contábeis. Os achados indicam que práticas contábeis que reduzem a conformidade das regras da contabilidade societária com aquelas da contabilidade tributária estimulam aumento do gerenciamento de resultados contábeis. Por sua vez, naquelas empresas com maior conformidade contábil-fiscal há uma menor propensão a gerenciamento de resultados contábeis. O grau de conformidade contábil-fiscal passa a ser, assim, um elemento determinante para compreender os incentivos econômicos ao gerenciamento de resultados contábeis no Brasil. Face as conclusões expostas, esta pesquisa é de significativo interesse para reguladores, profissionais e usuários da contabilidade, que podem identificar possíveis efeitos na qualidade da informação contábil de uma menor conformidade contábil-fiscal.

The effects of market power on stability: do diversification and earnings strategy matter

This paper examines whether the effect of the level of market power on bank soundness depends on the banks' decision to diversify and adopt a particular earnings strategy. We conduct the empirical approach in two stages. First, we estimate the Boone indicator, which is the measure for bank market power. We then regress this measure and other explanatory variables on the bank risk focusing on the role of earnings and diversification strategies. The results show that competition increases earnings management as the level of market power increases when banks diversify into non-interest income generating activities. The results also suggest that the relatively low insolvency risk among banks in Africa is attributed to the high degree of market power and the diversification strategy employed over the period.

Testing the Efficacy of Replacing the Incurred Credit Loss Model with the Expected Credit Loss Model

We use a controlled laboratory environment to provide evidence on the potential efficacy of the replacement of the Incurred Credit Loss (ICL) Model of International Accounting Standard (IAS 39) by the Expected Credit Loss (ECL) model of IFRS 9 to account for credit impairment losses. We focus on the simplified version of the ECL model using an uncertain production environment as the context. We induce incentives consistent with the existing rigid rule-based ICL model and the proposed forward-looking principle-based ECL model. Our primary finding is that the combined effects of eliminating the minimum ‘probable’ threshold condition together with allowing managers to incorporate forward-looking information increase both the amount and adequacy of periodic reserve decisions. In addition, we analyze the effects of increased flexibility under the new credit-loss model on earnings management using three different compensation schemes. We find that while the replacement of the ICL model with the ECL model facilitates higher reserves, the resulting increased earnings management varies across compensation schemes, is less than predicted, and does not offset the potential of the ECL model’s positive effects. The results provide ex ante evidence on the likely intended and unintended consequences of implementing the ECL model.

An exploratory analysis of earnings management practices in Australia and New Zealand

PurposeThis study aims to explore corporate earnings management practices in Australia and New Zealand before and after the regulatory changes and corporate governance reforms. The study argues that the effectiveness of regulatory reforms has to be reflected in constraining earnings management in post-reform period as compared to pre-reform period.Design/methodology/approachUsing a sample of 3,966 firm-year observations, including all ASX and NZX listed firms for the period 2001-2006, the study examines earnings management practices in both countries in pre- and post-reform periods with appropriate statistical methods.FindingsThe results indicate some interesting phenomenon: the magnitude of earnings management did not decline after the governance reform as a positive time trend is observed in the entire sample as well as in Australian and New Zealand sub-samples, suggesting that earnings management has been growing over time. Additional test indicates no structural change has occurred before and after the new regulations. The shifting from decreasing earnings management to increasing earnings management can be interpreted as an evidence that earnings become more ‘informative’ in a more transparent disclosure regime to capture short-run benefits from regulator reforms.Research limitations/implicationsThe shifting of earnings management behaviour from decreasing to increasing income can be interpreted as the outcome of more “informative”, rather than “deliberate”, earnings management in a more transparent disclosure regime to capture short-run benefits of regulatory reforms, which is worth further investigation. The findings of the study can lead regulatory authorities taking appropriate measures to promote earnings quality in corporate financial reporting from a long-run decision usefulness context. Any future reforms should be directed to protecting the interest of stakeholders as well as ensuring benefits outweighing costs for them.Practical implicationsThe findings of the study can lead regulatory authorities in taking appropriate measures to promote earnings quality in corporate financial reporting from a long-run decision usefulness context.Originality/valueThe study adds value to the existing earnings management literature as well as effectiveness of regulations for the benefit of wider stakeholder groups.

The effects of market power on stability: do diversification and earnings strategy matter?

This paper examines whether the effect of the level of market power on bank soundness depends on the banks' decision to diversify and adopt a particular earnings strategy. We conduct the empirical approach in two stages. First, we estimate the Boone indicator, which is the measure for bank market power. We then regress this measure and other explanatory variables on the bank risk focusing on the role of earnings and diversification strategies. The results show that competition increases earnings management as the level of market power increases when banks diversify into non-interest income generating activities. The results also suggest that the relatively low insolvency risk among banks in Africa is attributed to the high degree of market power and the diversification strategy employed over the period.

Earnings management in islamic and conventional banks: Does ownership structure matter? Evidence from the MENA region

The aim of this paper is to compare earnings management between conventional and Islamic banks and to examine whether ownership structure affects earnings management in the banking industry of emerging markets. Using a sample of Conventional and Islamic banks from Middle Eastern and North African (MENA) countries, we first found evidence that Islamic bank manage less their earnings than conventional banks. Second, both Islamic and conventional banks with more concentrated ownership use discretionary loan loss provisions to manage their earnings. Third, institutional owners encourage earnings management in Islamic banks and State participation increases earnings management in conventional banks. Finally, family owners reduce this practice in both types of banks.

How does competition affect real earnings management to meet or beat targets? Evidence from import tariff reductions

Targets provide incentives for earnings management, and a longstanding question is whether earnings management is undertaken opportunistically or to communicate private information about future firm value. To discriminate between these motivations, I follow analytical research showing that an increase in competition through a large decrease in tariffs disciplines managers and better aligns their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it signals future performance expectations, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management to avoid reporting negative earnings or a negative change in earnings. In addition, by showing that the lessening of trade barriers through import tariff reductions reduces the use of real earnings management to meet or beat earnings targets, I provide evidence on the role of macroeconomic conditions as a determinant of earnings quality.

Product Market Competition and Real Earnings Management to Meet or Beat Earnings Benchmarks

Targets provide incentives for earnings management, and a longstanding question is whether earnings management is undertaken opportunistically or to communicate private information about future firm value. To discriminate between these motivations, I follow analytical research showing that an increase in competition through a large decrease in tariffs disciplines managers and better aligns their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it signals future performance expectations, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management to avoid reporting negative earnings or a negative change in earnings. In addition, by showing that the lessening of trade barriers through import tariff reductions reduces the use of real earnings management to meet or beat earnings targets, I provide evidence on the role of macroeconomic conditions as a determinant of earnings quality.