Real Activities Manipulation Research Articles

Asset redeployability and the market reaction to cyberattacks

We examine how asset redeployability affects the market's response to cyberattacks. There is a robust positive relationship between the announcement returns and redeployable assets, and the correlation is stronger in firms that engage in fewer real activities manipulations and those with higher market share growth. Therefore, cyberattacks elicit a less negative response from investors when breached firms have more redeployable assets, as redeployability provides enhanced protection against adverse outcomes and higher liquidation values. Yet, breached firms that resort to asset sales to manipulate earnings face severe penalties. Our study underscores the value of cultivating redeployable assets for cyber risk mitigation.

Political connections of independent directors and earnings quality: The case of French firms

This paper examines the impact of political connections of independent board directors on earnings quality. We used two proxies of earnings quality, namely, discretionary accruals and real earnings management. Based on a sample of 1,936 firm-year observations from 2012 to 2022, our results reveal that firms with politically connected independent directors are more likely to display lower earnings quality in higher discretionary accruals and greater real activities manipulation. These results suggest that the monitoring role of independent directors in constraining earnings management practices, as emphasized by the agency theory, may be compromised by political connections.

Earnings management and judicial recovery: evidence for brazilian companies

Purpose: This study investigated the relationship between judicial recovery and insolvency with the Real Earnings Management (REM) level of publicly traded Brazilian companies in the period 2016-2020. Methodology: The estimated econometric model was panel data regression. The dependent variable was the level of REM measured based on Roychowdhury (2006), which estimates the manipulation of real activities through the analysis of abnormal movements in operating cash flow, discretionary expenses and production costs. The sample collected from 2016 to 2020 consists of 723 non-financial companies. Results: As main results, the study was able to demonstrate that there is an inverse relationship between judicial recovery and insolvency with earnings management. In other words, companies that are in judicial recovery or insolvent tend to have less earnings management. The findings of this research suggest that managers of companies undergoing judicial recovery have less incentive to engage in discretionary practices, as they are thus able to highlight their financial difficulties and obtain the judicial benefits of the process. Contributions of the Study: Although many studies evaluate the factors that influence earnings management, this work seeks to contribute to the study of accounting earnings management and uses an operational proxy, associating it with companies undergoing judicial recovery. Furthermore, with evidence of less earnings management by these companies, there is a possible improvement in the shareholders' perspective regarding the future of the company's finances, thus also contributing to investors' decision-making.

Bundle manipulation: the use of accounting and textual obfuscation

Purpose The purpose of this study is to explore whether managers and firms engage in bundle manipulation. It examines the effect of discretionary accruals and real activities manipulation on the level of complexity in annual reports. Design/methodology/approach The findings from the examination of the 1,435 annual reports of Canadian listed firms engaging in discretionary accruals and real activities manipulation indicate that these firms produce complex annual reports. Findings The authors, therefore, suggest that managers and firms use bundle manipulation, both accounting and textual, to mislead shareholders and stakeholders. The analyses also suggest that it is more difficult to detect the manipulation of real activities than discretionary accruals through textual analysis. Originality/value The authors propose an in-depth examination of how accruals and real activities manipulations affect the level of readability of firms’ reports. Furthermore, the authors suggest that firms engage in bundle manipulation, including accounting and textual manipulation. This paper aims to provide an in-depth analysis of the relationship between accounting and linguistic manipulations. The study suggests that investors could use the complexity of annual reports to detect earnings management. More specifically, it seems that firms engaging in discretionary accruals produce complex annual reports.

Making outside directors inside: Independent directors’ corporate site visits and real earnings management

We examine whether corporate site visits by independent directors enhance their monitoring effectiveness. Exploiting a novel dataset from the Chinese market, we find that such visits have a negative effect on the extent of real earnings management, and identify vetoing board proposals as a potential channel through which site visits constrain real activities manipulation. The effects are more pronounced for independent directors with greater monitoring ability or stronger monitoring incentives, and for firms with weaker internal or external governance. We further document that the intensity of site visits has an incremental negative effect on real earnings management, the restraining effect could persist for at least two years, and site visits also reduce accrual manipulation. This paper sheds new light on independent directors’ active participation in corporate governance and has practical implications for institutional improvements.

Do socially responsible firms demonstrate a preference for using classification shifting to manage earnings?

Prior research finds socially responsible firms are less likely to engage in earnings management, suggesting that socially responsible firms seek to provide more transparent financial reports (Hong and Anderson 2011; Kim, Park, and Wier 2012; Hwang, Choi, Choi, and Lee 2022). We investigate whether managers of CSR firms demonstrate a preference for classification shifting when making trade-off decisions among earnings management methods. First, our results support prior studies that find the overall extent of earnings management is lower for CSR firms. However, this study focuses on the use of classification shifting relative to other forms of earnings management. We find a robust positive relation between CSR performance and the relative use of classification shifting. Our results suggest that while CSR firms engage in lower levels of earnings management they demonstrate a preference to choose classification shifting when engaging in earnings management. These findings are consistent with managers perceiving classification shifting as a less unethical tool relative to accruals earnings management or real activities manipulation. Subsequent analyses reveal that our results are most pronounced for firms with lower external monitoring where managers have the most freedom to make trade-off decisions among earnings management methods based on ethical considerations. Overall, by demonstrating a preference for classification shifting relative to other earnings management tools our study furthers our understanding of the role of ethical considerations in earnings management decisions.

Economic uncertainty, risk-taking incentives and production management

PurposeThis study aims to validate the link between production manipulation and a firm’s performance variability (fundamentals and stock returns). It explores whether executives' risk-taking incentives encourage production deviations around the normal level during uncertainty.Design/methodology/approachUtilizing panel data of manufacturing firms from Compustat over three decades, the study investigates production management practices during economic uncertainty. The Economic Policy Uncertainty Index (EPU) is employed as a key metric. The empirical strategy involves documenting the effect of economic uncertainty on overproduction and underproduction, examining the role of executive compensation and assessing the impact on risk.FindingsThe research finds that risk-taking incentives increase over/underproduction, particularly amplifying the extent of underproduction during uncertainty. Production deviation rises, indicating that firms take greater risk by engaging in abnormal business operations. The study’s results are robust against various econometric methods, emphasizing the influence of risk-taking incentives on corporate production decisions.Research limitations/implicationsWhile providing valuable insights, the study acknowledges inherent limitations, including factors influencing production decisions beyond risk-taking incentives. Further research could explore additional determinants for a comprehensive understanding.Practical implicationsThe findings highlight the potential dark side of executive compensation that motivates suboptimal risk-taking decisions, impacting risk, cost of capital and firm performance. Policymakers and compensation committees can use these insights to design efficient systems that mitigate moral hazard problems associated with productivity changes.Social implicationsThe study emphasizes the broader social implications of production manipulation under uncertainty. It prompts discussions on the ethical considerations of managerial opportunism, its potential consequences for stakeholders and market dynamics.Originality/valueThis study contributes to the literature by examining the role of economic uncertainty on production manipulation and the influence of risk-taking incentives. It extends the earnings management literature by considering real activity manipulation and emphasizing the importance of decomposing production deviation into positive and negative values.

Institutional ownership and earnings quality: Evidence from China

We examine the impact of institutional ownership on earnings quality in China. We have employed two proxies of earnings quality: discretionary accruals and real earnings management. Using 19,743 firm-year observations from 2009 to 2017, we find that firms with higher institutional ownership are more likely to display higher earnings quality in lower discretionary accruals and lesser real activities manipulation. Our results are robust after controlling for endogeneity.

Corporate earnings management strategy under environmental regulation: Evidence from China

In response to external adverse factors affecting corporate performance, managers may be motivated to engage in earnings manipulation. Environmental regulation as an institutional factor threatens normal earnings for heavy-polluting firms. This paper discusses corporate earnings management strategy under an environmental regulation policy. A multistage difference-in-differences (DID) estimation is performed, based on the central environmental protection inspection (CEPI) that is widely acknowledged as China's most stringent environmental policy. The results show that heavy-polluting firms significantly adjust their earnings management strategy after CEPI. Managers tend to adopt real activities manipulation with the effects of CEPI, while reducing their reliance on accrual-based earnings management. CEPI stimulates heavy-polluting firms to increase environmental investment, which makes their managers more likely to manage earnings through real activity manipulation, simultaneously resulting in the reduction of discretionary accruals. This earnings management strategy only appears in firms inspected in 2016 or non-state-owned enterprises or firms located in the regions with low environmental pressure. Our findings show that managers could use the chances provided by exogenous shocks to manipulate earnings.

The Effect of Real-Profit Management Operations on the Market Returns of Jordanian Industrial Enterprises’ Shares

This research aims to examine the impact of actual earnings management activities on stock market returns. The study utilizes data from 56 industrial corporations listed on the Amman Stock Exchange (AXE) between 2011 and 2020. After removing entities with insufficient data, the sample size was reduced to 43 enterprises. The research findings indicate a significant positive relationship between actual earnings management activities and the market returns of industrial enterprise shares. This study contributes to the existing literature on earnings management by providing evidence on real activity manipulation, which has received less attention so far. Real activity manipulation refers to management actions that deviate from typical business operations to achieve specific profit targets. The significance of this research lies in its contribution to understanding the role of actual earnings management activities in influencing market returns. The results have implications for investors, regulators, and financial analysts, who can use this knowledge to make informed investment decisions, monitor financial reporting practices, and identify potential earnings management activities.

Corporate board, audit committee and earnings manipulation: does the corporate regulation matter? An emerging economy perspective

Purpose This paper aims to investigate the impact of the revised Code of Corporate Governance 2017 (CCG-2017) clauses pertaining to board independence, mandatory inclusion of female directors, audit committee (AC) chair independence and directors’ expertise on earnings manipulation. Design/methodology/approach Using an unbalanced panel of 323 listed companies from 2015 to 2019, this study uses panel data regression models with a robust methodology called difference-in-differences to tackle the potential endogeneity. Findings This study’s findings show that, as compared to the pre-CCG-2017 period, board- and AC-related variables increased significantly in the post-CCG-2017 period. Furthermore, financial experts on the board and board independence have a negative effect on discretionary accruals (DAs), whereas female directors and DAs are positively related, as is real activity manipulation. The AC-related variables, such as AC independence, expertise in AC, and AC chair independence, are significantly different from the preperiod to the postperiod, whereas their relationship is not according to the hypotheses of the study. Moreover, these results are robust to additional analysis of the alternative proxies for female directorship and the endogeneity problem. Practical implications The findings of this study have implications for regulators and practitioners who are concerned with the functions of the board of directors (BOD). The findings of this research study show that earnings management (EM) may be reduced by independent and expert directors. However, board gender diversity is not reducing the EM. Therefore, the decision to appoint female directors to the board should be based on their business and professional attributes rather than simply filling quotas or blindly adhering to regulations. Moreover, the findings of this research may assist the regulator in encouraging listed firms to enhance board governance via independence, diversity and competency, which are useful for effective monitoring. Originality/value This study fills a gap in the literature by providing the first evidence of country-specific regulation (CCG-2017), concerning the BOD and AC-related clauses on EM in Pakistan, which is missing in the relevant literature general and in Pakistan in particular.

Earnings management and sustainability assurance: The moderating role of CSR committee

AbstractThis study examines the effect of earnings management on the decision to acquire sustainability assurance (SA) reports. It also offers insight into the moderating impact of corporate social responsibility (CSR) committee over the earnings management‐SA nexus. To test the hypotheses, a logit regression for panel data is employed for a sample of 2972 firm‐year observations of non‐financial firms listed on the STOXX Europe 600 during the period 2012–2018. The findings reveal that firms that involve in earnings management, either accrual earnings management or real activities manipulation, tend to obtain SA reports to gain, repair, or maintain their legitimacy. Furthermore, the outcomes show that the existence of CSR committee alleviates the symbolic use of SA. Overall, this study highlights that the sustainability reporting assurance process can be used as a tool to deviate or shift stakeholders' attention from the earnings management techniques used in their reporting. The results, therefore, will benefit standard‐setters, policymakers, and stakeholders to be more cautious in differentiating between the substantial and symbolic SA reports.

Do Sin Firms Commit Accounting Sins?

Social norms deter socially responsible investors from investing in sin firms, i.e., firms that sell unethical products and profit from human vice. Existing literature documents that sin firms are less held by institutional investors and less followed by analysts, and this neglect effect leads to higher expected returns than in other firms. Our study explores the earnings management behavior of sin firms. Our empirical findings suggest that compared to others, sin firms are more likely to report small earrings surprises and small earnings increases, but less likely to report superior earnings. Sin firms’ earnings management behavior is exacerbated by lower non-transient institutional ownership, lower analyst coverage, and greater litigation risks. Additional analyses document that sin firms use both accrual-based management and real activity manipulation to report earnings that just meet earnings thresholds. The overall findings suggest that sin firms’ opportunistic behavior likely increases the information risks and contributes to the documented higher expected returns.

Policy uncertainty and real activities manipulation: evidence from Brexit

AbstractBrexit exposed the UK to substantial policy uncertainty that could affect the performance and behavior of British firms. We examine the impact of Brexit as an exogenous shock to policy uncertainty on real activities manipulation by British firms. Using several measures of real activities manipulation and a difference-in-differences design, we compare the earnings management of firms most adversely affected by Brexit uncertainty (affected firms) to other firms. Our results indicate that the affected firms exhibit higher real activities manipulation after the Brexit vote and we also find that they demonstrate similarly higher accruals management. Our findings suggesting that policy uncertainty induces the costly practice of real activities manipulation are relevant to various stakeholders including policymakers and financial statements users.

Stock market liberalization and financial reporting quality

This study employs the Mainland-Hong Kong Stock Connect pilot program in China to investigate the influence of stock market liberalization on firm-level financial reporting quality (FRQ). First, through a staggered difference-in-difference specification strategy, we find that eligible firms experience a significant improvement in FRQ, as measured by a composite proxy of accrual earnings management, real activities manipulation, and financial report restatement. Second, cross-sectional analyses suggest that the effect is stronger when firms are headquartered in regions with weaker institutional environments, characterized by lower judicial efficiency and less developed financial markets. We also show that the impact is more pronounced when firms face less external pressure and possess more effective corporate governance before stock market liberalization. Third, further evidence highlights that augmented FRQ is associated with a reduction in regulatory compliance costs, an improvement in stock price efficiency, and a mitigation of financing constraints. Collectively, we shed new light on the role of stock market liberalization in shaping firms’ financial reporting behavior.

The same network auditor, family business groups and earnings manipulation: an evidence from emerging market

PurposeThis paper aims to examine whether family business groups’ (FBG) having the same network auditor among their affiliates mitigates earnings manipulation (EM).Design/methodology/approachThis paper used unbalanced panel data from the years 2010–2019. The sample of the study is composed of 327 nonfinancial listed Pakistan Stock Exchange firms, consisting of 187 FBG-affiliated firms and 140 nonaffiliated firms. The ordinary least square and generalized least square regressions have been used to check the hypothesized relationship. Furthermore, the propensity score matching technique is used to ascertain comparable companies’ features and to control the potential endogeneity problem. Finally, the results are robust to various measures of EM and FBG’ proxies.FindingsThe findings of the study show that the same network auditor is reducing EM in FBG affiliates. In addition, the BIG4 same network auditors are also instrumental in constraining EM as compared to non-BIG4 audit firms. Overall, the results of this study depict that the same network auditor in FBG’s affiliated firms significantly influences EM. These results are robust with respect to generalized least squares and the endogeneity problem.Research limitations/implicationsThis research study has two important implications for the interested parties. First, although the authors find in this research study that the same network auditor is negatively associated with EM in the FBG-affiliated firms, however, FBG-affiliated firms might use opportunistically the real activity manipulation. Second, regulators highlight the change in audit partner/firm rotation, though the study findings indicate that regulators and practitioners may consider the benefits associated with the same network auditors for FBG.Originality/valueThis research study adds a new investigation to previous literature by examining the role of the same network auditors in the EM of the FBG’ affiliates. To the best of the author’s knowledge, this is the first study to bring new knowledge by investigating the role played by the same network auditors along with the BIG4 same network audit firms in constraining EM in FBG.

Impact of Leverage on Real Activity Manipulation of Listed Oil and Gas Firms in Nigeria

Impact of Leverage on Real Activity Manipulation of Listed Oil and Gas Firms in Nigeria

Pengaruh real activities manipulation, opinion shopping, dan sales growth terhadap penerimaan opini audit going concern

This study aims to determine the effect of real activities manipulation, opinion shopping, and sales growth on the receipt of audit opinions in Industrial Companies listed on the Indonesia Stock Exchange for the 2016-2020 period. The sampling technique uses the purposive sampling method; the samples obtained are as many as 23 Industrial companies for five years registered on the IDX with a total observation of 115 financial statement data. The hypothesis testing method in this study was tested using descriptive statistical analysis and logistic regression analysis using Eviews version 10. The results of this study show that partially real activities manipulation does not affect the receipt of audit opinion going concern, opinion shopping involves the receipt of audit opinion going concern, and sales growth does not affect the receipt of audit opinion going concern.
 Public interest statement
 This study could give insight for company to handling audit opinion through the policy of choosing public accounting firm. The company should follow the rules that regulate in Indonesia.

Does options trading deter real activities manipulation?

Does options trading deter real activities manipulation?

Why are not men and women more alike? Gender and clawbacks in the trade-off between accrual and real activity earnings manipulation

PurposeThe purpose of this study is to examine the trade-off between accrual and real activity earnings manipulation by considering gender and punishment as one aspect of clawbacks.Design/methodology/approachTo achieve the research objectives, experimental design research was used, involving 183 professional accountants in Indonesia. This was followed by interviews with board members of public companies in Indonesia.FindingsAfter the adoption of clawbacks, the intention to manipulate accruals decreased more among women than among men. However, the possible unintended consequences of clawbacks, particularly an increase in real activity manipulation, did not differ between women and men.Originality/valueThere are still few studies that use experimental designs to examine the consequences of clawback. Our study is expected to provide a novel contribution to the literature on the consequences of clawbacks as we use an experimental method. Besides, previous research that tested the consequences of clawback, using both archival and experimental data, had not considered the gender aspect, thus prompting this study to fill the research gap related to the consequences of clawback adoption by including the gender variable.