Unexpected Accruals Research Articles

Local peers and corporate reporting behavior

We find that firms exhibit greater earnings similarity when compared to industry peers in the same city, as the number of local peers increases. This is due to the potential adverse consequences of underperforming relative to local peers. As the number of local peers increases, there is increased local competition, which creates pressure to perform as well as competitors. Firms respond to this pressure by exhibiting earnings similarity to meet market expectations and to take advantage of external financing and growth opportunities. However, we show that this mimicking behavior creates a false similarity and is achieved by firms reporting higher levels of unexpected accruals. This is consistent with the idea that mimicking allows firms to maintain their relative performance with local rivals. These results continue to hold for a sample of firms that move to a location with a higher number of local peers than their initial location. We also find that firms in cities with more peers have a greater likelihood of earnings misstatements. In cross-sectional analyses, the adverse effect of more local peers on earnings quality is stronger for firms with greater market attention, where external financing dependence is higher, and among firms in locations with more growth opportunities. Overall, our evidence points to geographic proximity as a key mechanism in a firm’s reporting behavior in that firms mimic to produce a false similarity in earnings that is achieved through accruals management.

THE ASSOCIATION BETWEEN EARNINGS MANAGEMENT AND CAPITAL STRUCTURE: AN EMPIRICAL STUDY ON JORDANIAN FIRMS LISTED IN AMMAN STOCK EXCHANGE

The purpose of this study is to investigate the association between earnings management, measured by the absolute unexpected accruals and the firm's capital structure. The study sample consists of 44 manufacturing Jordanian firms listed in the Amman Stock Exchange during the 5 years (2008-2012), a total of 220 (firm-year) observations. The study provides evidence supporting the hypothesized association between capital structure and the absolute unexpected accruals. Consistent with most prior related studies' results, findings indicate a statistically positive association between earnings management and a firm's financial leverage which is used as a proxy of the firm capital structure. This result hold for one measure of financial leverage (long–term-debt to equity ratio). However, when we use alternative leverage measure (total debt to assets ratio) as a capital structure proxy, the association between earnings management and leverage remains positive but statistically insignificant at the conventional level. Consistent with most related prior studies' findings, the empirical evidence also shows that capital structure is negatively associated with profitability return on equity and positively related to firm size. The regression coefficients on both variables are statistically significant at the conventional level. Also, both external financing and investment opportunities, are positively and significantly associated with capital structure.Keywords: Earnings Management, Capital Structure, D/E Ratio, Unexpected Accruals, Profitability, Size, Amman Stock Exchange, Jordanian FirmsJEL Classifications: G32, G15, M41DOI: https://doi.org/10.32479/ijefi.8583

Do Analysts’ Cash Flow Forecasts Improve Their Target Price Accuracy?

ABSTRACTThe literature on the usefulness of analysts’ cash flow forecasts is unsettled, with Call et al. (), Mohanram (), and Radhakrishnan and Wu () providing evidence in favor of their usefulness, and Givoly et al. (), Bilinski (), and Ecker and Schipper () questioning this. Target prices provide a good setting to test the usefulness of cash flow forecasts because they are an ultimate output of an analyst's valuation process to which cash flow forecasts are an input. Moreover, studying the effect of cash flow forecasts on target prices is more relevant for assessing their usefulness than is studying their effect on earnings‐forecast accuracy, as the accuracy of target prices requires a comparison with market prices, which are less subject to management influence than reported earnings. By improving an analyst's understanding of unexpected accruals and permanent earnings, a cash flow forecast can increase an analyst's target price accuracy and signal an analyst's superior forecasting ability. We examine whether, conditional on their earnings forecasts, analysts’ cash flow forecasts improve their target price accuracy. We find that when analysts issue cash flow forecasts, their target price accuracy increases. We also find that this accuracy increases with the accuracy of their cash flow forecasts. Finally, we find that this increased target price accuracy is greater for more challenging‐to‐value firms. Our study provides confirmatory evidence of the usefulness of analysts’ cash flow forecasts.

How Test Power Impacts Research Relevance: The Case of Earnings Management Research

We argue that the broader applicability of accounting research is often limited by the way accounting researchers typically place far greater weight on the relative cost of type I versus type II errors. To illustrate the extent of this problem, we examine the performance of simple financial ratio-type analysis for detecting earnings overstatements when the total misclassification costs are minimized subject to the relative cost of type I versus type II errors. We then contrast the likelihood of type I versus type II errors from this approach with those arising from several widely used measures of unexpected accruals. The results demonstrate how commonly-used unexpected accruals measures reduce the type I error rate by sacrificing the type II error rate. Given that accounting information users and auditors typically face much higher costs of type II errors, we explicitly identify why unexpected accruals models are likely far less useful in detecting earnings overstatements than a relatively simple approach using financial statement analysis red flags. Our results highlight the fundamentally contrasting incentives facing accounting researchers relative to those who might otherwise use the research in practice, and serve as a warning when the broader relevance of accounting research is increasingly under question.

Overvalued equity, benchmark beating and unexpected accruals

AbstractWe investigate the extent to which the overvaluation hypothesis provides incentives for managers to beat earnings benchmarks, and whether this benchmark beating can be reliably interpreted as evidence of earnings management. We carefully identify firms immediately above earnings benchmarks that have a priori, overvaluation‐based incentives to achieve the benchmark. We therefore focus on benchmark‐beating observations where manipulation is most likely, providing a more powerful test of the existence of opportunistic financial reporting. Consistent with overvaluation‐related incentives encouraging earnings management, we find that overvalued firms that just exceed levels‐related earnings benchmarks have higher unexpected accruals than firms with less extreme valuations.

Overvalued Equity, Benchmark Beating and Unexpected Accruals: Australian Evidence

We investigate the extent to which the overvaluation hypothesis provides incentives for managers to beat earnings benchmarks, and whether this benchmark beating can be reliably interpreted as evidence of earnings management. We carefully identify firms immediately above earnings benchmarks that have, a priori, overvaluation-based incentives to achieve the benchmark. We therefore focus on benchmark-beating observations where manipulation is most likely, providing a more powerful test of the existence of opportunistic financial reporting. Consistent with overvaluation-related incentives encouraging earnings management, we find that overvalued firms that just exceed levels-related earnings benchmarks have higher unexpected accruals than firms with less extreme valuations.

Relationship between optional accruals and accounting conservatism

This inquiry is aimed at studying the relationship between Unexpected Accruals and Accounting Conservatism in the capital markets of Iran. The accruals in this inquiry are divided into the unexpected accruals and the expected accruals categories and are measured using Jones model. In order to examine the relationship between accruals (expected or unexpected) and conservatism Basu model is applied. The suppositions made in this research are as follows: Unexpected accruals hold a meaningful link with accounting conservatism. Expected accruals have a meaningful link with accounting conservatism. Expected and unexpected accruals represent accounting conservatism to a similar extent. Considering the above suppositions, expected and unexpected accruals are the independent variables and conservatism is the dependent variable. Based an a sample composed of 720 year-company among the corporations accepted in the stock exchange of Tehran between the years 1378 to 1386, the results suggest that the unexpected accruals have a meaningful relationship with accounting conservatism. on the other hand the analysis done in this study indicates absence of a meaningful relationship between the expected accruals and accounting conservatism. Therefore it can be claimed that expected and unexpected accruals do not represent conservatism to a similar extent.

The Informativeness Of Cash Flow Forecasts And The Regulation FD Environment

Prior literature shows that analysts forecast estimates serve as a proxy for the markets and investors beliefs which are unobservable. For decades, analysts have generated forecasts for use in valuation models including future estimates of earnings and growth. Yet, only recently, analysts have begun to voluntarily provide cash flow per share forecasts at the same time they are producing earnings per share forecasts for firms they follow. This study addresses whether the tendency of analysts to issue cash flow per share forecasts, as a result of changes in the regulatory environment, affects forecast properties. By examining the time frame surrounding Regulation FD, the analysis provides evidence that both the mere existence and the relative measure of analysts cash flow per share forecasts differ in explaining analysts earnings forecast accuracy. Specifically, the empirical results demonstrate that the relative value of analysts cash flow forecasts, the implied value of unexpected accruals, and cash flow forecast errors facilitate the reduction in analysts earnings forecast errors subsequent to the passage of Regulation FD. Further, the inverse relation between these analysts inputs and earnings forecast errors appear to be driven by firms with more accurate cash flow forecasts.

Errors in Estimating Unexpected Accruals in the Presence of Large Changes in Net External Financing

We demonstrate that managers’ “normal” operating decisions associated with large (positive or negative) net external financing activities are likely to lead to significant measurement errors in unexpected accruals. The problem occurs pervasively in samples drawn from different time periods, samples that reflect a wide variety of alleged earnings management stimuli, as well as random samples. Simulation tests show that even at modest levels of net external financing changes, rejection frequencies for the null hypothesis of no earnings management rise dramatically. These results are robust to controls for performance and firm growth. Further analysis suggests that net debt financing is more likely to induce measurement error than equity financing. We find that the use of a matched-firm approach using industry and external financing matches is generally appropriate. These findings highlight the importance of controlling for the effect of external financing on unexpected accruals measures, and also have implications for research testing earnings management and financial reporting quality.

Errors in Estimating Unexpected Accruals in the Presence of Large Changes in Net External Financing

We demonstrate that the articulation among accruals, cash flows and revenues which is typically assumed in tests of earnings management does not hold when large (positive or negative) external financing activities are present. Our study provides evidence that managers’ “normal” operating decisions associated with net external financing activities are likely to lead to economically and statistically significant measurement errors in unexpected accruals. This is a serious concern given the frequency with which the partitioning variable used to identify instances of alleged earnings management is correlated with significant movements in net external financing. Simulation tests show that even at modest levels of net external financing changes, rejection frequencies for the null hypothesis of no earnings management rise dramatically. This result underscores the importance of additional specification tests being conducted to control for estimation biases in unexpected accruals associated with external financing. We suggest the use of a matched-firm approach using industry and external financing matches. Using this method, we demonstrate that prior conclusions about the existence of earnings management around open market repurchases (Gong et al. 2008) do not appear robust when attempts are made to control for the effect on unexpected accruals of large changes in net external financing.

Modelling the Accruals Process and Assessing Unexpected Accruals

This paper formalises the accruals process to model both normal and abnormal accruals under clean surplus accounting. Based on theoretically derived abnormal accruals, I assess the ability of unexpected accruals extracted from the empirical Jones-type models in detecting earnings management. These models include the original Jones (1991) model, the modified Jones model developed in Dechow et al. (1995), and the model in Ball and Shivakumar (2006) that incorporates conditional conservatism. My analysis reveals that unexpected accruals from these models generally do not fully reflect abnormal accruals. I show that a plausible explanation for this could be that abnormal and normal accruals are inherently correlated and they cannot be completely disentangled from each other.

Cash Flow and Accrual Surprises: Persistence and Return Implications

This paper investigates the return implications of the cash flows and accruals components of unexpected earnings. We find that unexpected cash flows have greater persistence than unexpected accruals and that this difference is driven primarily by loss firms. We also find that markets appear to react more (less) strongly to the unexpected cash flow (accrual) component of total unexpected earnings, but that only firms that beat both earnings expectations and cash flow expectations are rewarded with higher returns. These results are consistent with at least some fixation on the total earnings number, to the exclusion of more economically important cash flow surprises.

Staggered Boards and Earnings Management

ABSTRACT: The literature suggests that staggered boards may have two opposite effects on earnings management: the expropriation view emphasizes the exacerbating effect, whereas the quiet life view advocates the mitigating effect. We use two approaches to examine this issue: a small-sample test based on whether firms are accused of committing financial reporting fraud, and a large-sample test based on the absolute value of unexpected accruals. We find that staggered boards are associated with lower likelihoods of committing fraud and smaller magnitudes of absolute unexpected accruals. Consistent with prior studies, we also find that staggered boards are negatively associated with firm value. The results suggest that staggered boards may enable managers to enjoy the quiet life and lessen their motivation to increase firm value; as a consequence, managers are not motivated to manage earnings.

Do managers manage earnings to ‘just meet or beat’ analyst forecasts?: Evidence from Australia

This paper examines whether managers manage earnings to ‘just meet or beat’ analyst forecasts in Australia. Previous Australian studies on benchmark-beating have focused on loss avoidance and small earnings increases as benchmarks [Coulton, J., Taylor, S., & Taylor, S. (2005). Is ‘benchmark beating’ by Australian firms evidence of earnings management? Accounting and Finance, 45, 553–576; Holland, D., & Ramsay, A. (2003). Do Australian companies manage earnings to meet simple earnings benchmarks? Accounting and Finance, 43, 41–62]. This paper extends this earlier research on benchmark-beating in Australia by incorporating analyst forecast as an important benchmark. Using three different models of unexpected accruals as proxies for earnings management, this study did not find any significant difference between the mean and median unexpected accruals of the “‘just meet or beat” group as against the “just miss” group. Furthermore, for a long period of time (1997–2002), the proportion of Australian firms ‘just meeting or beating’ analyst forecasts benchmark increased, although such increase was not statistically significant.

Identifying Earnings Overstatements: A Practical Test

We measure the power of some simple financial statement analysis techniques for identifying instances of significant earnings overstatements, and then contrast the results with those from several measures of unexpected accruals. Our results suggest that relative to a group of matched control firms, those firms identified by the SEC as having overstated earnings outside the boundaries of GAAP have significantly different financial statement characteristics. We also find that a simple measure of accruals, supplemented by a few financial statement indicators, has greater success in identifying these earnings overstatements than measures of unexpected accruals on which researchers typically rely. Because SEC enforcement actions likely represent the most extreme forms of upwards earnings management, they are a reflection of where most practical concerns are directed about the existence of accounting manipulation. Our results highlight a lack of power among widely used measures of unexpected accruals, consistent with the view that methods based on the approach of Jones (1991) are primarily a response to researchers' concerns with type I errors, rather than the type II errors which we characterize as being of primary practical concern. We conclude that future research directed at improved measures of earnings management for practical purposes might profitably focus on insights from financial statement analysis rather than further incremental refinement of models used to identify unexpected accruals.

Accounting Accruals and Tests of Earnings Management

The success of the Jones model has inspired a long line of research on learnings management that utilizes it. In this paper, I augment the Jones and performance-adjusted Jones models by incorporating three measures from financial statements: abnormal beginning non-cash working capital, working capital intensity, and historical depreciation rates. In a number of scenarios including loss avoidance and seasoned equity offerings, I show that unexpected accruals based on the proposed model evince less bias and higher power in testing earnings management compared to those based on the existing models. The proposed accruals model displays the advantages of both the cross-sectional and the time-series Jones models, but overcomes their shortcomings.

Unexpected Accruals and Conditional Accounting Conservatism

Abstract: This paper examines the impact of management discretion over accruals on conditional accounting conservatism, defined as the tendency of accountants to recognize bad news on a timelier basis than good news. Prior research suggests that conditional accounting conservatism reflected in earnings is mainly due to the accrual component of earnings, not the cash flow component of earnings. After decomposing total accruals into expected and unexpected accruals, I find that (1) conditional accounting conservatism reflected in accruals is mainly due to unexpected accruals; (2) the negative association between unconditional and conditional accounting conservatism is mainly attributable to unexpected accruals; and (3) firms with higher leverage exhibit conditionally more conservative accounting primarily through unexpected accruals. These results are robust to accrual models that take into account the systematic association between accruals and cash flows and their non‐linearity and to the asymmetric persistence of earnings changes specification of conditional accounting conservatism. Taken together, these results suggest that managers exercise their discretion over accruals to expedite the recognition of bad news rather than good news.

Audit Fees, Non-Audit Services and Auditor-Client Economic Bonding

We investigate whether auditor independence is compromised by either the mix of audit and non audit services (NAS), or simply unusually large or audit fees. The results help reconcile apparently conflicting evidence in prior studies linking and indicators of earnings management, as well as providing new insights on the relation between the incentive structures faced by auditors and variation in audit quality. Using the unexpected accrual component of earnings as a proxy for the effect of impaired auditor independence, we initially find that client firms purchasing an unexpectedly large fee mix (i.e., relative to audit fees) display some evidence of aggressive accounting. However, when we explicitly allow for the possibly endogenous nature of unexpected accruals and unexpected NAS, this no longer holds. In contrast, similar evidence of a positive relation between the magnitude of unexpectedly large audit fees and positive unexpected accruals still occurs (albeit more weakly) after explicitly allowing for possible endogeneity. A significant positive association between unexpected total fees (audit plus NAS) and the magnitude of positive unexpected accruals is even more robust. However, further tests shows that these result are confined to clients of Non-Big 6 auditors. We therefore conclude that for large audit firms, the incentive to protect larger than expected fees is outweighed by the importance of their reputation for providing high quality audits relative to smaller audit firms. The results also highlight how sensitive conclusions about possible NAS effects are to the choice of proxy for economic bond as well as the precise experimental design.

The Effects of Board Characteristics on Earnings Management around Australian CEO Changes

Prior research has shown evidence of earnings management in financial reports of US and Australian firms changing chief executive officer (CEO). This paper examines whether corporate boards, with certain characteristics associated with strong corporate governance, are effective in controlling any earnings management in the financial reports of Australian firms that change CEOs. Since hiring, monitoring and replacing the CEO are key roles of the board of directors, research in this specific context is considered particularly appropriate. After controlling for contemporaneous and lagged profitability in the year of CEO change, we find evidence of negative unexpected accruals in our sub‐sample of firms where the CEO resigned. For this group, larger boards and a higher proportion of independent directors appear to limit observed negative earnings management. In the case of CEO retirements there is evidence of positive unexpected accruals in the period of CEO change. However, none of the board characteristics show any significant relationship with unexpected accruals. In the period after CEO change, we find no evidence of positive unexpected accruals for CEO resignations and none of the board characteristics show any significant relationship with unexpected accruals. For CEO retirements, our analysis indicates that a higher proportion of executive and affiliated director shareholding goes some way towards counteracting the observed positive unexpected accruals. When lagged unexpected accruals are included in the regression equation to control for accrual reversals, CEO duality significantly increases the already positive earnings management found in CEO retirements in the period following CEO change.

Stratégie comptable des dirigeants et parité d'échange : le cas des fusions françaises

<titre>Résumé</titre>Cet article s’intéresse à la détermination de la parité d’échange dans les opérations de fusion françaises et notamment à l’impact de la politique comptable des dirigeants des sociétés absorbantes sur cette parité. Les résultats de l’article suggèrent que les opérations de fusion-absorption françaises sont un contexte favorable à la gestion des résultats l’année qui précède la réalisation de l’opération. Ainsi, notre étude montre d’une part, que les dirigeants des sociétés absorbantes gèrent les résultats comptables l’année qui précède la fusion. Les ajustements discrétionnaires représentent environ 6,7 % du total de l’actif. D’autre part, cette gestion est influencée par plusieurs facteurs : l’actionnariat majoritaire de l’absorbante (famille(s), dirigeants, famille dirigeante, investisseurs institutionnels), l’influence des critères de nature comptable dans la détermination de la parité, la dilution du capital après la fusion, la réputation des auditeurs et la performance de la société absorbante.