Lower Earnings Management Research Articles

Earnings management behaviour of Shariah-compliant firms and non-Shariah-compliant firms

Purpose – This paper aims to answer the following questions by using the data from the MENA region (Morocco, Egypt, Saudi Arabia, United Arab Emirates, Jordan, Kuwait and Bahrain): Do Shariah-compliant firms differ from other firms in the quality of information disclosure? and Can investors consider information disclosed by Shariah-compliant firms more truthful than information disclosed by other firms? Design/methodology/approach – Using regression analysis, this paper examines the relationship between earnings management and Shariah compliance during the period between 2005 and 2009. Findings – Results show that Shariah-compliant firms engage in lower earnings management than non-Shariah-compliant firms. This paper argues that financial characteristics of Shariah-compliant firms (i.e. low leverage, low account receivables and low cash) provide lower chances to managers to misreport earnings. It is also shown that external conditions can minimize the difference in earnings management between the two groups. Results show no significant difference between earnings management of Shariah-compliant firms and earnings management of non-Shariah-compliant firms in the common law countries and during the crisis period. This paper considers high risk of litigation in common law countries and enhanced monitoring of stock market participants during the crisis period main factors behind these results. This paper argues that external governance mechanisms can result in improving disclosure practices of non-Shariah-compliant firms to a level that minimizes the impact of Shariah compliance on earnings management. Practical implications – Results have implications for investors and regulators functioning in the MENA region. These results indicate that non-Shariah-compliant firms, being more prone to earnings misreporting, need more scrutiny from regulators than Shariah-compliant firms. Originality/value – The authors believe that this paper is the first attempt to argue that it is the financial characteristics of Shariah-compliant firms (i.e. low leverage, low account receivables and low cash) that result in better disclosure of reported earnings.

Competing Reporting Objectives and Financial Reporting Quality

We examine two sources of reporting incentives, contracts that use reported accounting information and transactions with capital markets, and investigate whether the type of reporting incentive impacts the earnings management and disclosure strategies managers employ. The primary difference between contract and market incentives is that the benefits of the former are obtained even if the counter party is aware of (or anticipates) the earnings management. In contrast, a market-motivated strategy can only be successful in the presence of information asymmetry. Consistent with our hypotheses, we find that when the reporting strategy does not require information asymmetry, managers use lower cost earnings management methods and increase disclosure to offset the negative impact of earnings management on financial reporting quality. Thus, this study provides evidence on how managers trade off the incentive to maintain their commitment to a particular level of financial reporting quality with competing incentives that require earnings management.

Earnings Management, Country Governance, and Cross-listing

We investigate whether Latin American firms cross-listed in the United States are associated with improved earnings quality and reduced information asymmetry. We find a negative relation between earnings management and cross-listing. We also find that firms from countries with stronger governance have lower earnings management. In contrast, the relationship between cross-listing and information asymmetry is not significant. Thus, local investors are not better protected when the firm is cross-listed abroad. They are, however, better protected when their home country has stronger governance. Our results evidence the importance of country governance on the information and trading environment of Latin American firms. From a policy-making standpoint, our results indicate that efforts and resources are well spent when pursuing an enhanced governance environment at home.

Earnings management under Polish GAAP versus IFRS: evidence from an emerging market

Our empirical paper examines the impact of IFRS on the quality of accounting information within Polish accounting setting, addressing the question whether IFRS implementation is associated with lower earnings management compared to domestic GAAPs. Using a sample of non-financial companies listed in the Warsaw Stock Exchange for a period of nine years (2005 to 2013), we document a positive impact of IFRS in curbing earnings management as measured by discretionary accruals. Our findings contribute to the debate whether IFRS are sufficient to override managers' incentives to manipulate earnings compared to local GAAPs in emerging countries with weak investor protection rights. Limits of the research conducted and potential directions of future research are also approached.

Corporate Goverance Determinants of Earnings Management: Evidence from Nigerian Quoted Companies

The aim of this study was to classify Nigerian quoted companies into high and low earnings management levels and also to investigate how corporate governance mechanisms relate to these categories of earnings management levels. A sample of 130 companies were drawn from quoted companies on the Nigerian stock exchange over the period of 2005 to 2010 and to identify the unique firm’s corporate governance characteristics and control variables that influence firms’ decision to engage in earnings management, we conducted descriptive statistics, correlation matrix, diagnostic test and binary regressions analyses of the data. The study revealed that, quoted companies in Nigeria prefer to use high earnings management practices; Board independence had a positive and significant influence on the probability of Nigerian companies adopting absolute high earnings management, Audit committee independence had a negative and significant influence on the probability of Nigerian companies adopting absolute high earnings management, Board gender representation had a negative and significant influence on the probability of Nigerian firms adopting absolute high earnings management and Also Board size and CEO shareholding were found to be statistically not significant in influencing the likelihood of Nigerian quoted companies adopting high earnings management levels. The control variables; firm size, auditors type and industry class were found to be positive and statistically significant in determining absolute high earnings management levels of Nigeria quoted companies.. This study recommended that stakeholders in quoted companies in Nigeria should promote sound audit independence, intensify the independence of board composition and encourage more female representation on the board. DOI: 10.5901/mjss.2014.v5n23p553

Keys to reduce earnings management in emerging markets

This paper examines earnings quality adapted to International Financial Reporting Standards in Mexican emerging capital market and how investor protection and audit quality to override managers’ incentives to engage in earnings management. We evidence that the new accounting regulation could be considered of high quality financial reporting standard because it is associated with lower earnings management. The analyses also suggest that cross-listed firms have higher quality local generally accepted accounting principles accounting information as measured by earnings management. There is also evidence that earnings of Mexican companies with Big 4 auditors are of higher quality. The results contribute to the ongoing debate on whether high standards are sufficient and effective in countries with weaker investor protection rights.

Religiosity and Earnings Management: International Evidence from the Banking Industry

Using an international sample of banks and country-level measures for several dimensions of religion, we study how differences in religiosity across countries affect earnings management. Given that religiosity is a major source of morality and ethical behavior, it may reduce excessive risk taking and act as deterrence for earnings manipulations. Therefore, we predict lower earnings management in societies that have higher religiosity. Consistent with expectations, our cross-country analysis indicates that religiosity is negatively related to income-increasing earnings management for loss avoidance and just-meeting-or-beating prior year’s earnings. We also find that religiosity is negatively related to income-smoothing behavior of banks. In additional tests, we document that religiosity greatly increases the information value of bank earnings, with both earnings persistence and cash flow predictability being enhanced by higher religiosity. For the crisis period analysis (i.e., 2007-2009), our evidence shows that banks in countries with higher religiosity exhibit lower probability of reporting asset deterioration and lower probability of having poor performance.

Research on Decision-Making Behavior of Analysts Coverage and Real and Accrual Earnings Management Based on SPSS Software Technology

The paper researches if decision-making behavior of analysts coverage can influence the earnings management of companies. The study selected 3727 samples and used SPSS software regression technology. The results indicate that a higher level of analysts coverage is related to lower accrual earnings management and real earnings management,which suggests that analysts have supervisory function to companies and can play an efficient external governance role to investor protection.The results also indicates that the larger companies eager to adopt real earnings management whereas the smaller companies would like to use accrual earnings management, and the enterprises with higher cash flow volatility are eager to adopt earnings management due to unstable operation .

Are Capitalized Software Development Costs Informative About Audit Risk?

SYNOPSISCapitalization of software research and development costs (SDC) under SFAS No. 86 is the only exception to SFAS No. 2 that calls for immediate expensing of R&D costs. Although intangible assets have become increasingly relevant for firm valuation, they remain largely unexplored in audit research. This is an important topic because intangible assets, especially those that are internally developed, pose greater challenges in assessing audit risk relative to tangible assets. Capitalization of SDC offers a unique opportunity to study how auditors assess audit risk associated with the recognition of this intangible asset. While capitalized SDC could shed light on software products' potential commercial success and inform the auditor about the client's business risk, the accounting flexibility allowed by SFAS No. 86 also increases the risk of earnings management, and thus implies higher audit risk. Using audit fees as a proxy for audit risk, our results indicate that capitalized SDC are negatively associated with audit fees for firms where capitalization is inconsequential to beating analysts' forecasts, and also for firms with low analysts' following. These results support the notion that capitalized SDC signal lower business risk, especially for firms with low earnings management risk or high private information.

Does investor protection regime affect the effectiveness of outside directorship on the board?

Since the Sarbanes-Oxley Act was enacted in U.S., there has been a general tendency to globally harmonize regulations and practices of board governance. The purpose of this study is to compare among countries how well the board of directors constrains earnings management. Using a sample of firms from 23 countries, we document some evidence that higher outside directorship on the board is associated with lower earnings management in the international context. We also find that there is no significant difference in the effectiveness of board outside directorship in constraining earnings management between high and low investor protection countries. Our findings mitigate a concern that harmonized corporate governance in low investor protection countries may not work.

Gerenciamento de resultados nos diferentes níveis de governança corporativa

The article investigates the correlation between adherence to different levels of Bovespa corporate governance and earnings management. We take the hypothesis that firms with higher standard of corporate governance have lower earnings management. After a review of the literature on conceptual aspects of accruals, discretionary and non-discretionary accruals, earnings management and its relationship to the levels of Bovespa corporate governance, a research is promoted by applying the model developed by Kang and Silvaramkrishnan (1995) to identify discretionary accruals at different levels of corporate governance. The survey is characterized as descriptive and documentary, with a quantitative approach. We analyzed the companies listed on Bovespa in different governance levels: Level 1, Level 2 and Novo Mercado, in the period between 2000 and 2007. Unlike the results reported in international studies, mercaresearch has not allowed us to infer that a higher level of governance necessarily mean a lower degree of earnings management. It is also concluded that the behavior of firms in earnings management is similar between the different levels of governance of the Bovespa, especially those found in two groups of positive profitability described in this study. This suggests that the level of governance does not interfere in such behavior of managers.

The Effect of External Monitoring on Accrual‐Based and Real Earnings Management: Evidence from Venture‐Backed Initial Public Offerings*

This paper investigates the effect of venture capitalist (VC) quality on earnings management in firms conducting initial public offerings of their equity stock, focusing on manipulation of both accruals and real activities. I develop a measure of VC quality based on a principal components factor analysis using data that are obtainable for virtually all VC firms. This metric is highly correlated with VC funds’ financial returns, and with the likelihood of successful exits through initial public offerings or trade sales. After going public, companies backed by higher quality VCs have lower abnormal accruals, lower earnings management through real activities manipulation, and a lower likelihood of financial restatement. Companies backed by top‐quartile VCs do not appear to engage in real activities manipulation as a substitute for accruals manipulation. Companies backed by lower‐tier VCs exhibit earnings management behaviors which are indistinguishable from those of non‐VC‐backed companies. The results continue to hold when controlling for endogeneity. Overall, the results suggest that higher quality VCs are better able to constrain opportunistic financial reporting by their portfolio companies going public.

The effectiveness of audit committees for low‐ and mid‐cap firms

PurposeThe purpose of this paper is to investigate the effectiveness of recommendations made by the Australian Stock Exchange (ASX) relating to audit committees in Australia, and whether they have improved financial reporting quality for low‐ and mid‐cap listed firms.Design/methodology/approachThe authors examine the relation between characteristics of the audit committee and financial reporting quality for listed companies not mandated to comply with these requirements, i.e. low‐ and mid‐cap firms. For a sample of 288 firms, the authors regress measures of audit committee independence, expertise and activity and size on alternative measures of earnings management.FindingsA significant association is found between all three characteristics and lower earnings management. The significant measure for independence is the proportion of independent directors on the audit committee; for expertise, it is that at least one member of the audit committee has an accounting qualification; and for activity and size, it is the frequency of audit committee meetings.Practical implicationsThe results provide support for the mandatory establishment of audit committees for the top 500 (high‐ and mid‐cap) firms introduced by the ASX and suggest those audit committee characteristics which could improve financial reporting quality for low‐ and mid‐cap firms.Originality/valueThe paper examines low‐ and mid‐cap firms in order to complement previous similar studies done for high‐cap firms. It identifies the effects on financial reporting quality of voluntarily choosing to have an audit committee and of the choice of audit committee characteristics, in the period after substantial corporate governance reform. It includes a new measure among audit committee characteristics, industry expertise, which is required in Australia and is new to the literature.

Monitoring of earnings management by independent directors and the impact of regulation: evidence from the People's Republic of China

Alarmed by escalating volatility in international financial markets and the uncovering of numerous accounting scandals, national regulators worldwide responded by introducing new regulations on corporate governance. To shed light on the debate over the merit of such regulations, this study examines the effectiveness of independent directors in constraining earnings management behaviour in the PRC around the time when the Chinese regulators issued a mandate requiring minimum representation of independent directors in listed firms. The results show that while board independence significantly reduces earnings management when adoption of independent directors is voluntary, a higher degree of board independence is not associated with lower earnings management when adoption of independent directors is made mandatory. This suggests that board independence could be effective in monitoring earnings management even in an institutional environment like that of the PRC, but regulation could distort conditions in the market of independent directors, which renders such governance mechanism ineffective.

Family ownership control and earnings management: Evidence from Hong Kong firms

This study examines the impact of family ownership control on earnings management for firms operating in Hong Kong. We find evidence that family-controlled firms are less likely to engage in earnings management activities in the earnings management settings to avoid reporting an earnings decline and to avoid reporting a loss than non-family-controlled firms. Additionally, we observe that deferred tax expense is useful in detecting earnings management in the earnings management settings to avoid reporting an earnings decline, to avoid reporting a loss, and to avoid failing to meet or beat the consensus analysts’ earnings forecast. Moreover, we find that the positive association between deferred tax expense and earnings management is weakened significantly by family ownership control. Overall, the empirical evidence indicates that lower earnings management is more prevalent in family-controlled firms compared to non-family-controlled firms. This finding is consistent with a greater alignment of interest between controlling and outside owners, rather than the expropriation by the controlling families which can be achieved by managing reported earnings.

An analysis of the effect of mandatory adoption of IAS/IFRS on earnings management

This paper examines whether mandatory adoption of international accounting standards, IAS/IFRS, by French companies is associated with lower earnings management. In addition, the impact of six factors that may be related to earnings management level are also considered: the independence and the efficiency of the board of directors, the separation of roles of CEO and Chairman of the board, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets. Based on a sample of 353 French listed groups relating to the period 2003–2006, our results show that the mandatory adoption of IAS/IFRS is associated with a reduction in the earnings management level. In addition, the independence and the efficiency of the board of directors, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets are important factors for enforcement of IAS/IFRS in France. Mandatory adoption of IAS/IFRS has decreased earnings management level for companies with good corporate governance and those that depend on foreign financial markets.

The Effects of Board Independence, Board Diversity and Corporate Social Responsibility on Earnings Management

This study extends earlier research on corporate governance by examining whether the interaction between independent directors, women directors, minority directors and corporate social responsibility practices is effective to mitigate earnings management. Using panel data from Malaysian firms for the financial years 2005-07, this study finds that only minority director has main effect on earnings management. This result suggests that firms which have board diversity tend to have lower earnings management. There is no interaction effect between corporate social responsibility and corporate governance variables on earnings management.

The association between non-financial performance measures in executive compensation contracts and earnings management

Executive compensation, especially cash bonus compensation, has come under fire by the Securities and Exchange Commission (SEC), the US Federal government, and the media for its role in the current economic crisis. Specifically, the SEC has argued that some compensation packages provide incentives for risk-taking that may undermine shareholder value over the long-term. Short-term incentive payments to executives in the form of cash bonuses are mostly contingent on reaching targets of accounting-related measures or financial performance measures (FPMs). However, the incentives from these payments may lead to accrual manipulation and earnings management (EM). Alternative measures are non-financial performance measures (NFPMs). We expect that firms that employ NFPMs in bonus contracts will have a lower prevalence of EM, since these measures tend to focus executives on the long-term. In this paper, we examine the type of performance measures used by firms in the S&P 500 index in their cash bonus compensation. We find that firms that use both FPMs and NFPMs have lower discretionary accruals compared to firms that use only FPMs, consistent with lower income-increasing EM. However, we do not find evidence of a reduction in EM behavior using the incidence of meeting or just beating analyst earnings benchmarks, another common EM proxy. In additional tests on a subset of firms with equity offerings, in which incentives for income-increasing manipulation are likely high, we find that firms with NFPMs have lower discretionary accruals. The implication is that NFPMs can be used in compensation contracts to reduce EM behavior and mitigate erroneous executive compensation. This is important to investors as well as regulators, especially in light of the recent debate on compensation reform.

PENGARUH EARNINGS MANAGEMENT TERHADAP EARNINGS QUALITY

This research objective is to axamine empirically the influence of earnings management on earnings quality. The study motivated by the controversy of previous study about earnings management and earnings quality. Earnings management was measured by Discretionary Accrual and earnings quality was measured by Earnings Response Coefficient (ERC). The units were 128 (16x8) Quartal financial report in manufacturing companies listed in the Jakarta Stock Exchange, started from the year 2005 up to 2006. The data was collected using purposive sampling method. Statistical method used to test the hypotheses was multiple regressions. The result of the research showed that: the influence of earnings management on earnings quality was negative, sig 0.049. It means that the lower earnings management will be followed by higher earnings quality. This study supported the result of Fetham and Pae (2000), Nelson et al. (2000), Scott (2000), Lobo and Zhou (2001), also Teixeira (2002), Pudjiastuti (2006).

International Investor Protection Regime and the Effectiveness of Outside Directorship on the Board: An Empirical Essay

We empirically identify exploratory evidence suggesting the potential for establishing an international corporate governance law protecting investors in relation to the outside directors on the board. Our conclusions are consistent with the principles proposed by OECD in 2004. Our study motivates by the institutionalizing aspects of laws pertaining to the governance of firms in international perspective. We obtain motivation from the published literature in accounting and finance domain to identify the answer to our research question. Existing evidence regarding whether outside directors on the board of directors can effectively constrain earnings management by firms leaves unaddressed the international context. We document international evidence that higher outside directorship on the board is associated with lower earnings management. We also find evidence that investor protection law does not affect the association between earnings management and board outside directorship. The results suggest that outside directors can play a similar role in monitoring the financial reporting process irrespective of whether they sit on the board in strong or weak investor protection law countries. Our findings support the internationalization of corporate regulations and practices on board governance as evinced in the OECD study.