Real Earnings Management Activities Research Articles

How does divergence of control and cash-flow rights influence cost stickiness?

This study investigates whether the degree of cost stickiness depends on the divergence between control and cash-flow rights of ultimate owners using data from 22 countries. Firms with a large divergence between control and cash-flow rights are known to take more opportunistic actions at the expense of minority shareholders. The empirical results show that the magnitude of cost stickiness decreases as the divergence between control and cash-flow rights increases due to the greater incentives to manipulate earnings. Firms use both accruals earnings management (AEM) and real-activities earnings management (REM), and among REM, they adjust production activity and discretionary expense to affect cost. Additional tests show that the negative relationship between the divergence between control and cash-flow rights and cost stickiness is more pronounced in countries with weak economic, legal, and social factors. This paper, by examining the effect of ownership structure on cost behavior as well as its underlying mechanism, broadens the understanding of sticky cost behavior and contributes to the growing body of literature on the convergence of financial and managerial accounting.

The real effects of M&As on targets’ peers

AbstractThis paper studies the real effects of targets’ acquisitions on their peers through investigating the real earnings management (REM) behavior of the targets’ rivals following the mergers and acquisitions (M&As). Using a difference‐in‐differences design, we find that, on average, rivals of acquisition targets would engage in more REM after M&A announcements. We further find that within rivals of the target, the post‐announcement increase in REM is more pronounced when: (1) the rival is relatively less similar to the target; (2) the rival serves as the targets’ rival more than once within a year; (3) the target earns a higher bidding premium or positive abnormal returns; or (4) the rival has the higher institutional ownership or more analyst following. Additional analyses reveal that rivals engaging in more REM would have a higher likelihood of being acquired in subsequent years and would be sold at higher premiums. We also find that targets’ rivals boost their short‐term performance by engaging in REM activities at the cost of their long‐term performance. Our results are robust to various robustness checks. Overall, our evidence suggests that an acquisition activity could have a real effect on the target's industry, i.e., the effect on the accounting choices of the whole industry.

Differences in the influence of the board of directors and the board of commissioners on real earnings management: empirical evidence from Indonesia

Purpose – This research investigates the influence of the Board of Directors (BOD) and the Board of Commissioners (BOC) on real earnings management (REM) practices in Indonesian manufacturing companies. Real earnings management involves genuine alterations to operational decisions that affect financial reporting.Design/methodology/approach – The research uses a sample of manufacturing firm listed on Indonesia Stock Exchange (BEI) from 2016 to 2022 and uses panel data regression techniques, including the Pooled Least Square (PLS) and Fixed Effect Model (FEM), to examine the effects of BOD and BOC characteristics on REM. The empirical analysis considers multiple proxies for BOD and BOC attributes, such as board size, independence, meeting frequency, and expertise. Additionally, control variables including leverage, firm size, and growth indicators are incorporated into the analysis.Findings – The findings reveal a significant positive relationship between the presence of BOD and REM activities. In contrast, the presence of BOC demonstrates a non-significant but negatively associated impact on REM. Furthermore, the research identifies the moderating role of BOC in strengthening the relationship between BOD and REM.Research limitations/implications – The research contributes to the existing literature by providing empirical insights into the roles of BOD and BOC in shaping REM practices within the Indonesian manufacturing context. These findings highlight the importance of board characteristics in influencing financial reporting decisions and emphasize the need for effective corporate governance mechanisms to mitigate opportunistic behaviors related to earnings management.Practical implications – Enhancing corporate governance practices, provide an input for more effective board composition, increase the investor confidence and transparency, enhance policy implications and provide advice for company’s long-term performance focus.Originality/value – This research addresses a gap in the literature by focusing on the Indonesian context. Use the BOC to moderate the relationship between BOD and REM may be less common in the context of Indonesia and even in regional focus.

Revisiting corporate governance mechanisms and real earnings management activities in emerging economies

PurposeThis study aims to investigate the effects of main corporate governance (CG) mechanisms used in Iran on the relationship between managers’ rewards and real earnings management activities.Design/methodology/approachPanel data analysis is performed on 101 companies listed on the Tehran Stock Exchange during the past seven years (from 2015 to 2021).FindingsThe percentage of non-executive members of the company’s board of directors and the percentage of acquisition of the company’s largest shareholders have a negative significant effect on the relationship between abnormal operating cash flows and managers’ remuneration. Moreover, the separation of the CEO from the chairman and vice chairman of the board has also a negative significant effect on this relationship. However, concentration of ownership does not have a significant effect on the relationship between abnormal operating cash flows and managers’ rewards.Practical implicationsThe study provides policymakers and governing bodies with a better understanding of the effects of the percentage of non-executive board members, concentration of ownership, percentage of major shareholders and duality of the role of CEO (or president) from the chairman and vice chairman of the board on the relationship between managers’ rewards and earnings management.Originality/valuePrevious studies focus mainly on accrual-based earnings management. This study investigates real earnings management and provides empirical evidence on the most effective and significant CG dimensions in Iran. It embraces the fact that CG may have the same principal concept in different markets, but the mechanisms may vary significantly, thus opening the door for more comparative future research.

Analyst coverage and real earnings management: Does IFRS adoption matter? UK evidence

This study examines the impact of analysts coverage on real earnings management (REM) decisions. The study further investigates the effect of mandatory IFRS adoption on the relationship between analyst coverage and REM. We constructed a sample of UK non-financial listed firms for the period 1997–2021. The results demonstrate that firms followed by a large number of financial analysts record higher levels of earnings management. This result supports the contention that high intensity of analyst coverage imposes extra pressure on firms' managers to meet analysts' earnings per share (EPS) expectations, motivating a higher level of earnings management. Contrary to expectations, the introduction of IFRS fails to strengthen the monitoring role of security analysts on firms' management: rather, managers utilize the inherent flexibility and available discretion in the principles-based IFRS to meet analysts’ benchmarks by means of REM activities. These results are robust after controlling endogeneity.

EARNINGS QUALITY DURING COVID-19: CENTRAL ASIAN CASE

The purpose of this research. In 2021 Gong & Choi investigated the eff ect of State ownership on Accounting quality. Positive relationship between State ownership and Earnings management has weakened in recent years, which is the result of the eff ective mixed-ownership reform [1]. Our research is an event study to assess the impact of COVID-19 on the National IPO/SPO Program results in terms of Earnings quality changes in partial state-owned enterprises.Methodology. We analyze 572 unbalanced panel fi rm-year observations during 2009-2021period. Sample data is extracted from KASE Stock Exchange population across diff erent industries excluding fi nancial institutions and investment holdings. To estimate Earnings quality, we combine Kasznik cash fl ow model for accrual-based Earnings management and Roychowdhury aggregate model for real activity Earnings management [2; 3].Findings. We found that COVID-19 positively aff ected Earnings quality in partially state-owned companies and its eff ect was stronger compared to Earnings quality in 100 % owned private and state enterprises. Despite such the immediate and positive reaction, in post COVID-19 2021 year, Earnings quality deteriorated in partial state-owned companies (with 50-99 % Government ownership) up to the level of 100 % private/state companies.Originality / value of the research. Our study is among the fi rst attempts to analyze Earnings quality dynamics over 2009-2021 horizon in Kazakhstan with the assessment of COVID-19 impact. As a practical recommendation, our research fi ndings could be integrated into the National IPO/SPO Program as a red fl ag to impact Earnings quality trend in partial state-owned enterprises.

Does stock market liberalisation reduce earnings management? Evidence from China

ABSTRACT This paper employs the Stock Connect programme to examine the impact of stock market liberalisation on the earnings management activities of listed firms in China. Using the time-varying difference-in-difference model, we find that both accrual-based and real earnings management activities decrease after firms join the Stock Connect programme. This reduction effect disappears once the firms leave the programme. These firms may even resume their earnings management activities. We further find that the participation of international investors, the improvement of the information environment, and the strengthening of monitoring power are potential transmission channels for this reduction effect.

The Effect of Religion in European Financial Statement Disclosures: A Real Earnings’ Management Case

Prior research has extensively examined the relationship between religion and accrual-based earnings management. However, there is currently little research on the relationship between religion and real (non-accrual) earnings management, especially in Europe. This paper aims to fill this research gap and examines whether and how the effect of religion could be linked with firms’ real earnings management activities. Four hypotheses are developed and tested, with our results providing indications that the degree of overall religiosity is negatively and significantly associated with real earnings management. Furthermore, when investigating the effects of different religions in Europe, Christianity and Islam have the opposite impact on firms’ real earnings management activities. Overall, our paper indicates that in European countries, the religious environment can mitigate firms’ manipulations on earnings.

Real Earnings Management during Economic Downturns

ABSTRACT This study examines the impact of economic downturns on real earnings management activities in an international setting. Using a sample of 27 countries between 1988 and 2016, I find that the extent of real earnings management increases and that the substitution relation between real earnings management and accrual-based earnings management becomes stronger during economic downturns. Managers tend to rely on real earnings management to avoid the threat of greater scrutiny during economic downturns. The effect of an economic downturn on real earnings management is stronger for firms with high earnings management incentives, such as to avoid reporting earnings decreases and losses, to just meet or beat analysts’ earnings forecasts, and to facilitate the success of seasonal equity offerings. The findings suggest that real earnings management comes at a high cost. Firms sacrifice future performance when engaging in real earnings management. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G14; G28; G39; M41.

Boundaries of the firm and real earnings management

Despite harmful effects, Real Earnings Management (REM) is increasingly becoming a more popular method of earnings management than Accruals based Earnings Management (AEM) (Cohen et al., 2008; Commerford et al., 2018). We argue that when a firm’s organizational structure has extended boundaries with other firms, the benefits due to REM can outweigh the costs. We use family business groups, that extend firm boundaries with other affiliated firms, for testing our conjecture. Using a large dataset of 11,417 firm-year observations of Indian firms, we show that REM is significantly higher in business group affiliated firms compared to standalone firms. Further, intra-group transactions, in the form of purchases, sales, and cash flows from operating activities, contribute to higher REM activities. More importantly, when group affiliated firms engage in intragroup transactions and report higher REM, mainly in the form of abnormal production, they experience an increase in their future profitability and a decrease in their cost of equity.

Real earnings management and the strategic release of new products: evidence from the motion picture industry

Prior studies on real earnings management (REM) focus mainly on estimating abnormal operating and investing activities at the firm level. We extend this literature by providing micro-level evidence regarding how financial reporting pressures influence new product release decisions, or product-level REM. Specifically, we compare how public and private studios differentially time the release of their movies. We find that, faced with pressure to boost quarterly revenues and earnings, public studios are more likely to release movies with high expected revenues in the last month of a fiscal quarter, compared to private studios. This documented result is stronger for firms with recent poor past performance, but is not present for movies in genres with a more targeted release window (e.g., romance and horror movies) and those using directors who have a history of collaboration with the studio. These results suggest that studios choose REM activities that have a lower impact on consumer demand and that minimize conflict with talent, consistent with choosing less costly activities to achieve financial reporting goals. A negative consequence of this financial reporting–driven product release strategy is that movies released in the last month of a quarter have lower international box office revenues. Taken together, these results provide evidence of the existence and consequences of product-level REM.

The impact of terrorist attacks and mass shootings on earnings management

This study investigates the role of salient events on accrual-based and real earnings management activities. For people using availability heuristics, the salience of an event may temporarily increase perceived risk even though the actual risk does not change, and individuals making decisions by availability heuristics are subsequently more likely to assign a higher probability to unrelated negative future events. I use terrorist attacks and mass shootings as salient events and conjecture that the negative effects of terrorist attacks and mass shootings spill over and lead to pessimistic risk assessments of financial reporting choices. The findings show a decrease in accrual-based and real earnings management for firms located in the impacted regions. The documented effects are driven by firms with high information asymmetry levels and pessimistic annual reports. Additional analysis reveals that affected firms decrease the readability of their annual reports, suggesting affected firms engage in a more complex narrative disclosure. The findings of this paper support the argument that managers exhibit a cognitive bias which affects their financial reporting choices.

Credit Default Swaps and Borrowers’ Real Earnings Management: Evidence From Credit Default Swap Initiation

In this study, we examine whether the initiation of credit default swap (CDS) trading alters borrowers’ real earnings management activities. Creditors increase debt supply and loosen loan contracts after CDS initiation, which in turn lessens borrowers’ pressure to resort to real earnings management as a way of lowering the cost of debt and increasing debt capacity. Consistent with this prediction, we find that borrowers reduce myopic real earnings management activities after CDS initiation. Furthermore, we show that this negative association between CDS initiation and real earnings management is more pronounced for borrowers with safer financial status and fewer debt covenants. Our findings remain robust to conducting a parallel trend analysis, employing the propensity score matching and the two-stage instrumental variable methods, using alternative measures of real earnings management, and controlling for accrual-based earnings management. Overall, our study suggests a potential “bright side” of CDS contracts by showing that the introduction of CDS contracts reduces, rather than exacerbates, borrowers’ myopic real earnings management behavior.

Real Earnings Management Sine Qua Non Book-Tax Differences in Tax Avoidance of Mining Sector Companies in Indonesia

This study aims to prove the effect of book income that can be manipulated through real earnings management activities on book-tax differences that appear to be interrelated but have not been widely studied. Researchers want to prove the coupling relationship (sine qua non) between real earnings management and book-tax differences based on rational choice theory as the main theory. Tests were conducted on 43 sample companies in the mining sector listed on the Indonesia Stock Exchange in 2018–2021. The analytical method used is panel data regression with the help of EViews (Econometric Views) version 12. The results prove that there is an effect of abnormal cash flow and abnormal discretionary expenses on book-tax differences, while abnormal production costs have no effect. Furthermore, the same result is also obtained when the reverse test is conducted, namely book-tax differences in real earnings management. The reciprocal test gives the result that book-tax differences affect abnormal operating cash flows and abnormal discretionary expenses but do not affect abnormal production cots. Meanwhile, the alignment of the reciprocal relationship between abnormal cash flow operations and abnormal discretionary expenses to book-tax differences shows the relationship (sine qua non) between real earnings management and book-tax differences. The contribution of this research proves that book-tax differences are the output of real earnings management, so the amount can be used as an indicator if a company manipulates earnings. Therefore, it is important for the government, especially the Directorate General of Taxes as a policymaker to start considering the amount of book-tax differences in a certain range that is permitted for companies. In addition, it can be followed up by issuing additional tax regulations if needed to minimize tax avoidance.

Modelling the Impact of Earnings Management on the Probability of Financial Statements Fraud

In the last decades, numerous financial scandals were reported, many related to earnings manipulation and fraud financial reporting. Analytical models were designed and estimation techniques were improved. However, current design of those models suffers from some limitations. The objective of our study is to bring improvements to the analytical models of detection of potential fraudulent financial reporting practices. Therefore, we separately evaluate the impact of real activities earnings management and innate accruals component on the probability of potential fraudulent financial reporting. The empirical analysis is made on a sample of firms with headquarters in G7 countries and the research methodology consists of time series analysis. The results show that, on a long term, the F score is negatively affected by real earnings management activities. Instead, the innate component of accruals seems to reverse over time, having no significant impact in the long run on the probability of fraudulent financial reporting.

Do CEOs influence CFOs’ equity incentives to manage earnings?

This study examines whether CEOs’ incremental equity incentives relative to CFOs (i.e., the gap between CEO equity incentives and CFO equity incentives) and CEO power constrain or exacerbate CFOs' equity incentives to manage earnings. In most companies, CEOs own more equity than CFOs and may pressure CFOs to engage in earnings management. I find no evidence that CEO incremental equity incentives or CEO power affect the association between CFOs’ equity incentives and earnings management. In addition, I find that CFOs’ equity incentives mitigate real earnings management activities, which can help align the interests of CFOs with shareholders.

An Empirical Study on the Impact of Economic Policy Uncertainty on Earnings Management of Listed Companies

Taking 273 listed companies from 2011 to 2019 as the research sample, we have a total of 2730 balanced panel data. And we uses the Uncertainty Index of China Economic Policy constructed by Baker et al. (2016) as the measure of economic policy uncertainty (EPU). Besides, using the Jones model and Roychowdhury's calculation method respectively, with accrual earnings management (EM) and real earnings management (REM) as the explained variables, the paper constructs a multiple regression model. Using STATA15.1 empirical analysis, it is found that the level of economic policy uncertainty increases, and listed companies reduce accrued earnings management activities and real earnings management activities.

The effect of internal control quality on real and accrual-based earnings management: evidence from France

This paper examines the effect of internal control (IC) quality, measured by IC weakness disclosures, on the quality of financial statements’ information, measured by real and accrual-based earnings management. The sample consists of 686 firm-year observations of French non-financial companies listed in the SBF 120 index during the period between 2012 and 2018. Using ordinary least squares (OLS) and generalized method of moments (GMM) regression, our empirical results indicate that IC weakness disclosures are positively and significantly related to real activities manipulation and negatively associated with discretionary accruals. This provides empirical evidence that a good system of IC reduces accrual-based earnings management activities and improves the reliability of financial statements; however, it cannot control real earnings management (REM). The research findings are of practical interest not only to financial analysts, auditors, and investors—guiding them to pay attention to REM activities in case of disclosures of IC weaknesses—but also to regulators, who may consider additional disclosure requirements when reporting material IC weaknesses and designing policies that could help in reducing REM practices.

Impact of Earning Volatility, Real Earnings Management and Accruals on Investment Policy: Evidence From Indonesia

This study aims to analyze earnings volatility, real earnings management activities, and accruals on the company's investment policy. The sample used is manufacturing companies on the Indonesian stock exchange as many as 117 companies with a total of 351 observations during the 2018-2020 period. This study used 2 models, each of which was tested using linear regression. The results showed that earnings volatility increased management motivation in carrying out accrual earnings management practices and real earnings management through the manipulation of production costs by managers, but the effect of greater volatility was found in the real earnings management model. Accrual earnings management has an effect on the company's over-under investment policy, while real earnings management through operating cash flow and production costs has no significant effect on investment policy. Accrual earnings management is able to increase the company's over-under investment policy

Tata Kelola, Kepemilikan Keluarga, Auditor Berkualitas, dan Manajemen Laba

This paper examines the relationship between corporate governance quality, family ownership, auditor quality, towards accrual and real earnings management activities among publicly listed firms in Indonesia. Using non-financial industry sector listed firms for the period of 2010-2019, we empirically demonstrate that firms with higher corporate governance quality have lower levels of both real and accruals earnings management activities. Furthermore, there is evidence that a higher level of family ownership is related to a lower level of real earnings management activities but has no significant effect on accrual earnings management activities. Meanwhile, the appointment of the big four public accounting firms has a lower level of accruals earnings management activities but no significant effect on real earnings management activities. Only a firm with high corporate governance quality and a qualified auditor significantly decreases real and accrual earnings management. Furthermore, there is evidence that the mitigating effect of higher corporate governance quality in reducing earnings management activities is more pronounced for family firms. The empirical findings seemed to suggest that family firms in Indonesia want to protect their interests by reducing the potentially harmful real earnings management activities.