Real Earnings Management Activities Research Articles

Firm borrowing capacity, government ownership and real earnings management

Purpose The purpose of this paper is to examine borrowing capacity (BC) of government-owned firms and whether real earnings management (REM) activities moderate the sensitivity of firm BC to government ownership. Design/methodology/approach A simultaneous equation analysis is applied to study 210 Tunisian non-financial firms over the 2001–2014 period. Findings The empirical results provide substantial evidence indicating that government-owned firms have higher BC and significant REM than other firms; the relationship between government ownership and firm BC is partially moderated by REM activities. Practical implications The findings imply that the implicit credit guarantee of government is not necessarily the unique determinant of firm BC and highlight the role of lenders in monitoring discretionary real transactions in government-owned and protected firms. These implications should be taken in to account by public sector policy makers. In particular, the findings predict that the current government accounting reform in Tunisia on the basis of IPSAS will, probably, improve information quality, but it is still insufficient to control real activities in public institutions. Originality/value This study extends a growing research stream on the relationship between BC and government ownership by focusing on the moderating effect of REM on this relationship and by considering the endogeneity issue. The findings provide evidence that government-owned firms use REM practices to improve their BC. Examining these practices in developing countries provides an opportunity to evaluate the efficiency of their public sector reforms and their effect on a firm’s performance and financing decisions.

Doing Good with Creative Accounting? Linking Corporate Social Responsibility to Earnings Management in Market Economy, Country and Business Sector Contexts

The mandate of doing good with earnings management has been a subject of inconclusive findings from the past literature and leave issues on the benefits of socially responsible activities and financial reporting of the company. This study investigates the effects of corporate social responsibility (CSR) on accrual-based (AEM) and real-activities earnings management (REM). This study hypothesized that the trade-off exists between these two earnings management strategies, in light of increasing attention of CSR among Asian firms. In addition, this study examines whether the performance of firms in socially responsible activities exhibit different patterns of effect across the two measures of earnings management under the market economy, country, and business sector contexts. This study contemplates on 3906 firm-year observations from 2011 to 2017 of eleven countries in Asia. Our findings show that CSR conceals AEM while it constrains REM. These effects vary according to the market economy classifications, country, and business sector types. Each market, country and business sector has different standpoints in implementing CSR activities and earnings management relevant to the culture, macroeconomic considerations and demands from the stakeholders. Lastly, the discernment on the relevance of building corporate citizenship on financial reporting transparency is elaborated.

Industry competition, earnings management and leader–follower effects

ABSTRACTThis article examines the impacts of industry competition on the leader-follower effects in different earnings management activities. The empirical results show that there are the leader-follower effects in the accrual-based earnings management in industries with different extents of competition, while there is the leader-follower effect in the real earnings management activities in industries with lower degrees of industry competition. The evidence implies that the industry competition affects the leader-follower effects in the different earnings management activities, and then the different extents of industry competition have different mediation effects on the leader-follower effect. We expect the empirical results not only fill the gap of literatures, but also provide a new insight for the investors and regulators in their investment decision and regulation revision.

Substitution between accruals‐based and real activities earnings management of listed Thai firms

AbstractThis article examines the association between accruals earnings management (AEM) and real activities earnings management (REM) based on 1,471 Thai firm observations during 2014–2017. The study follows a modified Jones model and Roychowdhury model to measure AEM and REM and extends the control variables by adding the factors of top management team characteristics. For the investigation, the study performs simultaneous equations and uses both ordinary least‐squares and two‐state least‐square methods to test the regression model. The results demonstrate the negative relationship between AEM and REM which implies that the Thai firms listed use AEM and REM as the substitution method, and the results based on industry groups support the main findings of this study by presenting the negative association between AEM and REM as a different level.

Earnings Management in Firms with Data Security Breaches

ABSTRACT Anecdotal research suggests that management is concerned about how Data Security Breaches (DSBs) impact a firm's financial performance. We investigate: whether managers in DSB firms manipulate earnings through real earnings management (REM) and/or accrual-based earnings management (AEM); how breach type, disclosure delay, and external monitoring impact earnings management activities; and how earnings management activities influence a DSB firm's performance. Using a propensity score matched sample, results suggest that DSB firms are more likely to manipulate earnings via REM, but not AEM. Additionally, we find that DSB firms engage in REM through cutting discretionary expenses, decreasing discretionary cash spending, and reducing the cost of goods sold through overproduction. We find some evidence that firms are more likely to increase REM when DSBs involve financial information or when firms delay the DSB disclosure or have low analyst coverage. We provide evidence that REM activities lead to lower subsequent performance in DSB firms. Data Availability: The data used are publicly available from the sources cited in the text.

The Effect of Board Diversity on Real Earnings Management: Empirical Evidence From Jordan

This study considers the effect of foreign board members and age diversity on real earnings management (REM), by controlling the firm size, leverage and growth. This study employed quantitative methodology and longitudinal data for non-financial business firms, quoted on the Amman Stock Exchange from 2011 to 2015. Data were analysed using descriptive statistics and Panel Corrected Standard Errors (PCSE) regression. This study found that foreign boards member, age diversity, leverage and growth had negative and significant associations with REM. Based on the results, a firm should appoint young members to the board in addition to older members to pave the way to cross-ideology that can deter REM activities. At least one foreign director should exist within the board of directors because a foreign board member has different qualifications and experiences that may help to deter REM practices.

Government-Linked Investment Companies and Real Earnings Management: Malaysian Evidence

This study examines the association between government-linked investment companies’ (GLICs’) shareholdings and real earnings management activities in Malaysia. Consistent with prior research, this study uses three proxies to measure real earnings management; abnormal cash flow from operations (RCFO), abnormal production costs (RPC), and abnormal discretionary expenses (RDE). This study segregates GLICs’ shareholdings into two categories; Federal Government Pension Investment Funds (FGPIF) and other GLICs (OFGLIC). Using a sample of 213 firm-year observations of Malaysian government-linked companies from 2010 to 2015, this study finds that FGPIF is a more effective monitoring mechanism than OFGLIC in limiting real earnings management. The findings also show that there is a significant and negative relationship between Employee Provident Fund (EPF), Khazanah Nasional Berhad (Khazanah), Permodalan Nasional Berhad (PNB) and RCFO and RPC. The evidence suggests that these three are the most effective government institutional investors in promoting corporate governance, which in turn limit real earning management activities in Malaysia. In general, the findings support the incentive alignment hypothesis, which argues that companies with government intervention are normally better governed.

The effect of gender composition in joint audits on earnings management

PurposeThis paper aims to examine the association between gender composition of joint auditor pairs and the quality of reported financial information. More specifically, the authors attempt to assess whether and how these gender compositions affect the client firms’ earnings management behavior.Design/methodology/approachThe authors utilized the unique institutional setting of Taiwan, where joint auditors are required by law. They studied the effect of gender in joint auditor pairs on accrual earnings management and real earnings management to achieve financial reporting objectives.FindingsEmpirical results indicate that engaging a woman as the lead auditor can constrain accrual earnings management, regardless of whether the joint auditor is male or female. The authors also found that all-male signing auditor pairs with industry expertise can significantly reduce accrual earnings management. The authors also documented that all-female signing auditor pairs and auditor industry expertise could drive clients to engage in real earnings management activities as an alternative to accrual earnings management.Originality/valueThe empirical results demonstrate that gender indeed plays a role in the quality of client’s reported financial information. Female auditors in a lead position and male auditors with industry expertise tend to be more successful in delivering better-quality audits.

Real earnings management and loan contract terms

Abstract: We examine the design of loan contract terms in the presence of borrower pre-issuance real earnings management (REM). Unlike other measures of earnings quality, REM is particularly difficult for outsiders to detect. However, lenders possess some private information which may allow them to correctly identify REM. Our empirical findings show that greater REM is associated with higher interest spreads, shorter maturities, a higher likelihood of imposing collateral requirements, and more intensive financial covenants, suggesting that lenders are likely to detect and penalise the borrower firm's REM activities. These findings are robust to a series of sensitivity tests. In an additional test, we examine the impact of REM on bond terms and document that greater REM is related to higher bond yield spreads and more intensive covenants, but does not affect the maturity term or the collateral requirement. The findings in this paper can alert firms about the increase in borrowing costs when they use REM to boost current-period earnings.

Empirical research on the correlation between Real Earnings Management of state-owned enterprises and executive compensation — from the perspective of executive structural power

This paper focuses on the impact of the executive compensation of state-owned enterprises and executive power on Real Activity Earnings Management (REM). Furthermore, this paper discusses the differences of impacts mentioned above between the central government holding enterprises and the local government holding enterprises, in order to test the impact of the government compensation regulation and the executive compensation of different types of enterprises on the enterprise accounting behavior. The empirical research shows that executive compensation can induce accountings to implement REM, which is more notable in local state-owned enterprises than in central enterprises.

Accrual and real earnings management in both state-owned and privately-owned Egyptian companies

This study aims to explore the difference between the level of both types of earnings management; Accrual Earnings Management (AEM) and Real Activity Earnings Management (REM)) between state and privately owned Egyptian companies. Using a sample of non-financial state and privately owned companies over the period from 2010 to 2017, with 1030 firm–year observations. The results reveal that there are no significant differences in the level of both AEM and REM using the two proxies; sales manipulation and discretionary expenses; between state and privately owned firms. This result could be attributed to the Egyptian government’s attempt to eliminate the differences between state-owned and private owned companies, especially in recent years.

Financial crisis and real earnings management in family firms: A comparison between China and the United States

This paper compares real earnings management (REM) between Chinese family firms and U.S. family firms after the financial crisis of 2008. For the U.S. sample, there is greater REM in family firms than non-family firms, and in the post-financial crisis period than the pre-financial crisis period. For the Chinese sample, there is greater REM in family firms than non-family firms, but REM is lower in Chinese family firms relative to non-family firms in the post-financial crisis period than the pre-financial crisis period. These findings indicate that REM activities differ between U.S. and Chinese family firms in crisis and non-crisis periods.

The Impact of SOX on Earnings Management Activities around CEO Turnovers

We assess the impact of the Sarbanes-Oxley Act (SOX) on discretionary accruals (DA) and real earnings management (REM) activities around CEO turnovers. Improved corporate governance post-SOX can either deter earnings management (the deterrence effect) or pressure CEOs to inflate earnings when facing imminent turnover risks (the pressure effect). We find a strong deterrence effect for new CEOs, while the pressure effect dominates the deterrence effect for outgoing CEOs. Pre-SOX firms with new CEOs manage earnings downward through both DA and REM and the effect is more pronounced in weakly governed firms. Post-SOX both types of earnings baths diminished. By contrast, post-SOX firms engage in more aggressive upward earnings management prior to CEO turnovers and the evidence is stronger prior to performance-induced CEO turnovers. The compulsory compliance with the 2003 NYSE and NASDAQ listing rule on audit committee independence is associated with a reduction in new-CEO REM baths.

Don’t Touch My Cheese: Short Selling Pressure, Executive Compensation Justification, and Real Activity Earnings Management

ABSTRACTThis article aims at investigating the effects of short selling on a firm’s executive compensation and earnings management. We use a panel data set of Chinese public firms from 2007 to 2014 to test our hypotheses. We find that the level of excess compensation in short-selling firms is greater than that in non-short-selling firms. Our further analysis shows that the executives of the short-selling firms will justify their excess compensation by improving the pay-performance sensitivity, which is accomplished through the real earnings management. Finally, we find that there is more prominent decrease/increase in accrual/real earnings management in short-selling firms.

Corporate social responsibility and managerial short-termism

ABSTRACT This study examines whether corporate social responsibility (CSR) mitigates or exacerbates managerial short-termism. Using earnings management (EM) as a proxy for managerial short-termism, we find that socially responsible firms engage in less accrual-based and real EM activities. This finding supports the argument that socially responsible firms not only focus on current profits but also maintain long-term sustainable development. Further analyses reveal that the moderate effect of CSR on managerial short-termism is evident only for mandatory CSR disclosure firms. This suggests that regulatory non-financial reporting potentially mitigates information asymmetry and effectively constrains managerial short-termism.

The effect of ownership-control disparity on the Chinese firm’s real activity earnings management

Purpose This paper aims to investigate the impact of the separation between control and cash flow rights (control-ownership disparity) on the earnings management practices of Chinese firms. The notable features of Chinese firms are those of concentrated ownership and the severe disparity that exists between the control and cash flow rights of controlling shareholders. Design/methodology/approach This study measures the level of Chinese firms’ earnings management by adopting two different methods of measurement: accrual-based earnings management (AEM) and real activity earnings management (REM). The authors also consider the possible trade-off effects between these two types of measurements. The data set in this study encompasses over 2,000 Chinese firms, using data from 2003 to 2015. Findings The results indicate that controlling shareholders are more likely to engage in AEM as their cash flow rights are more concentrated, while they are less likely to use REM as the disparity of control-cash flow rights increases. Further, this inverse relationship between REM and control-cash flow rights disparity becomes more pronounced in the case of a low cash flow rights group. As REM generally causes distortions in firms’ operations, it is possible that the controlling shareholders are more likely to constrain the use of REM as the disparity is perceived to grow. This result may indicate a reduced agency problem between controlling and minority shareholders due to the developing and/or existing ownership dispersions, which are mainly driven by recent reforms applied to Chinese capital markets. However, we do not entirely exclude the possibility of other types of expropriations by the controlling shareholders. It appears that the controlling shareholders are still able to exert a significant level of control, even following a substantial ownership dispersion, and they may seek alternative expropriation methods, including but not limited to intercorporate loan or related party transactions as the disparity of control-cash flow rights increases. Originality/value Although the Chinese economy is experiencing a series of reforms to infuse market forces into capital markets, little has been known about the effects of ownership-control disparity in Chinese firms. Our findings highlight the importance of the country specific context in this vein of research.

Earnings management strategies to maintain a string of meeting or beating analyst expectations

Prior studies provide consistent evidence that firms use a combination of management forecast guidance, accrual earning management (AEM), and real activity earnings management (REM) to meet or beat analyst expectations (MBE). While recent evidence (e.g. Kross, Ro, & Suk, 2011) suggests that management forecast guidance is a less effective MBE strategy for firms with longer strings of MBE, less is known about the use of AEM and REM to manage MBE strings as the string lengthens. Since managements' incentives and actions taken to maintain earnings strings may differ as the string lengthens and becomes more difficult to sustain, we examine the extent to which managers use AEM and REM to MBE as the string grows longer. We find evidence that while firms with shorter MBE strings appear more likely to use income increasing AEM to sustain their MBE strings, the use of income increasing AEM decreases for longer MBE strings. Further, we document that firms with longer MBE strings use more income increasing REM to avoid breaking the MBE string. Collectively, our results suggest that researchers investigating firms' earnings management choices to sustain MBE strings should control for the length of the MBE string in their research design.

Largest Shareholder Ownership and Downward Real‐activity Earnings Management in Korean Seasoned Equity Offerings Firms

AbstractWe investigate whether firms’ real‐activity earnings management (REM) around seasoned equity offerings (SEOs) and stock return performance after SEOs are different for the largest shareholders’ participation in SEOs. Using Korean firms, we find that an increase in the largest shareholders’ ownership is negatively related to REM in the quarters preceding an SEO. Additionally, positive market responses to SEO with the largest shareholders’ ownership increases are mitigated by the level of REM. We conclude that firms manage earnings in favor of the largest shareholders rather than other existing shareholders.

The Effect of Internal Control Certification Regulatory Changes on Real and Accrual-based Earnings Management

ABSTRACTThis study examines the effect of changes in internal control certification requirements (ICCR) on the earnings management choices of Australian firms in the period 2007–2015. The Australian setting is unique as the certification requirements change from voluntary in 2004–2007 to mandatory in 2008–2014, before being abolished in 2015. Consistent with the notion that real earnings management (REM) is less susceptible to detection, the results suggest that firms place greater reliance on REM than on accrual-based earnings management (ABEM) when having to comply with certification requirements. In particular, I find voluntary certifiers have lower REM and ABEM relative to first-time certifiers in the mandatory period between 2008 and 2014, and there is an increase in REM activities among first-time mandatory period certifiers. Moreover, firms that discontinue certification, after the abolition of the requirement in 2015, switch from REM to ABEM. This suggests that regulatory ICCR changes affect firms’ earnings management choices.

The impact of executive compensation and audit quality on accrual-based and real-based earnings management: Evidence from Jordan

This study investigates the relationship between executive compensation, audit quality, and accrual and real earnings management in Jordan. While prior literature focuses on examining the impact of audit quality on accrual earnings management in Jordan, this study contributes to the literature by investigating the impact of executive compensation on real earnings management activities in Jordan. Further, this study contributes to the literature by investigating the impact of audit quality on real earnings management. By examining a Jordanian sample of 445 firm-year observations over the period from 2000 to 2011, this study presents new evidence that executive compensation is positively associated with accrual earnings management, suggesting that managers engage in accrual earnings management to increase reported earnings and, therefore, increase their pay-performance compensation. Further, the results show that managers who engaged in a higher level of real earnings management (via sales-based manipulation) received a lower level of compensation, suggesting that managers in Jordan are punished for the use of real activities. In terms of audit quality, the results show no evidence that audit quality is associated with accrual and real earnings management in Jordan. This study uses the corrected model of Jones (1991) as suggested by Dechow et al. (1995) is to estimate normal accruals, while the models of Roychowdhury (2006) are used to estimate real earnings management activities