Use Of Real Earnings Management Research Articles

Do cultural differences moderate the relationship between CSR and earnings quality: common law evidence pre and during COVID-19 crisis

Purpose This paper aims to describe the role of corporate social performance as a potential mechanism for reducing earnings management. This paper contributes to the existing literature by addressing the moderator effects of national culture on the relationship between CSR and earnings management. Design/methodology/approach This study investigates the moderating impact of Hofstede’s cultural dimensions on the association between corporate social responsibility (CSR) and earnings management. The data set covers 71,893 firm-year observations spanning 2006–2022 and involving 4,229 firms listed in common law countries. Findings The result confirms that corporate social performance reduces the use of real earnings management and controls the change of method AEM to REM method. When testing the indirect effect, the results show that cultural dimensions moderate the relationship between CSR and earnings management. These findings have many theoretical and practical implications for researchers, investors and decision-makers. Originality/value This paper contributes substantially to extant literature by comprehensively exploring the moderating influence of national cultures on the intricate nexus between CSR and earnings management, encompassing the pre- and post-COVID-19 periods. The implications of these findings extend to researchers, investors and policymakers, offering valuable insights for informed decision-making.

Succession and real earnings management in family businesses: is socioemotional wealth a predictor for Cooking the Books?

PurposeEarnings management is a practice that is detrimental to future business viability. For family businesses, viability in the form of succession, continues to be difficult. The motivation to use earnings management is different in family businesses as they have unique pressures and characteristics. The purpose of this paper is to identify if the level of socioemotional wealth in a family business impacts real earnings management behavior during succession. The goal is to better understand what impacts the use of real earnings management for family businesses so that it can be curtailed, enhancing future business viability and successful generational transfer.Design/methodology/approachA sample of 200 small and medium size business owners participated in an experiment. Binary logistic regression was used to identify any relationship between SEW, succession and REM.FindingsThis study finds that socioemotional wealth and succession impact real earnings management behavior in family firms. When succession is not present, the study finds that companies with high socioemotional wealth are less likely to engage in real earnings management than low socioemotional wealth companies. However, when succession is present, the engagement in REM for companies with low socioemotional wealth drops significantly while the behavior of those with high socioemotional does not materially change.Practical implicationsUnderstanding how to position a family business for succession realization is important. We do not know exactly what factors impact the failure rate but identifying how facets of the businesses (SEW and succession) might impact REM and ultimately financial performance will be important to small and medium-sized family business owners in the US as they begin their succession journey.Originality/valueThe study’s experimental design using participants in a US family business, offers an opportunity to better understand this critical portion of the economy and the variables that potentially impact real earnings management decisions. It contributes to the literature by offering potential reasons behind the conflicting findings on REM in family businesses and the impact of SEW on earnings management. It offers a unique view of behavior within different family businesses as opposed to a comparison often found in the literature between family and non-family firms. It also contributes to a gap in literature for US small to medium family businesses.

Managerial incentives and earnings management: Insights from union certification elections

AbstractThis study examines how unionization affects firms' financial reporting. Using a regression discontinuity design, we compare practices of firms narrowly winning and losing union certification elections. We find that winning firms depress earnings significantly more by inflating discretionary expenses, particularly research and development expenses, to strengthen their bargaining positions with workers. We further show that this manipulation aligns with managers' financial incentives, career motives, and entrenchment levels. The paper highlights managers' strategic use of real earnings management in worker negotiations and provides causal evidence on how the dynamic relationships among managers, shareholders, and workers shapes firms' financial reporting.

THE NEXUS BETWEEN EARNINGS MANAGEMENT, DIVIDENT POLICY AND COPORATE PERFORMANCE: EVIDENCE FROM QUOTED BANKS IN NIGERIA

This research work examines the nexus between earnings management, dividend policy on corporate performance. The research study used ex-post-facto research design and stratify random sampling techniques to select all commercial banks quoted in Nigerian stock Exchange(NSE), selecting and Appling the secondary data obtained from the annual financial reports of quoted banks in Nigeria. And data collected were effectively analyzed using descriptive statistics, correlation analysis, normality test, variance inflation test, heteroscedasticity test and multiple regressions. The results finding shows that accrual earnings management (AEM) has a coefficient 49.5. This indicates that AEM has positive effect on the corporate performance of banks as measured by ROE. The result implies that a unit increase on the AEM will cause the mean of ROE to increase by 49 units, the results show that real earnings management (REM) has coefficient of 16.6, which indicates that the increase in the management use of real earnings management by the firm will amount to increase in corporate performance as measured by ROE, and the lesser the use of REM on the accounting numbers the lesser the reported ROE of the banks will be. Base on the finding, the study therefore makes policy recommendations thus; Regulators should checkmate the use of AEM by the banks, to be able to forestall an ailing entity on time and at best make public certain information that would be hidden by use of accrual earnings management. And firms Management should moderate the use of real earnings management in projecting earnings of the enterprise to guarantee sustainability of the firms.
 Keywords: Earnings Management, Dividends policy, corporate performance, Banking Sector, Nigeria.

Effect of Capital Structure on Real and Accrual-Based Earnings Management in Sub-Sahara Africa

The study examines the effect of Capital Structure (CS) on real and accrual-based earnings management among listed firms in Sub-Sahara Africa (SSA). Real Earnings Management (REM) and Discretional Accruals (DA) were proxies by Rowchowdhury (2006) and Khothari et al. (2005) models respectively. Secondary data used were obtained from annual reports of 276 non-financial listed firms from six countries for eleven years (2010 to 2020). A Generalized Method of Moments (GMM) estimator was used to analyze the data collected. The findings show that CS among firms in Kenya, Tanzania and Nigeria have positive and significant effects on REM while the negative and significant influence of CS among firms in Zimbabwe, South Africa and Ghana was observed on REM. Also, CS among firms in Kenya, Zimbabwe and Nigeria have negative and significant effects on DA. However, CS among firms in South Africa and Ghana have a positive influence on DA. The study concludes that firms in SSA substitute REM and DA forms of earnings management. Hence, the study recommends that capital providers in the sampled countries should maintain sufficient attention to both REM and DA for sustainable leveraging, and management of opportunistic selections of accounting choices, but increase the use of REM.

Real earnings management, corporate governance and stock price crash risk: evidence from China

PurposeThe aim of this paper is to provide additional insights on the association between real earnings management (REM) and crash risk, particularly from the perspective of an emerging market economy. It also examines the moderation role that internal and external corporate governance may play in this area.Design/methodology/approachRelying on archival data from the RESSET and CSMAR databases over a timeframe from 2010 to 2018 of China listed company, the authors test the hypotheses by regressing common measures of crash risk on the treatment variable (REM) and crash risk control variables identified in the prior crash risk literature. The authors also introduce monitoring proxies (internal controls as an internal governance and institutional ownership as an external governance) and assess how effective internal and external governance moderate the relation between REM and stock price crash risk.FindingsThe results suggest firms with higher REM have a significantly greater stock price crash risk, and that this association is mitigated by external monitoring. That is, greater institutional ownership, particularly pressure insensitive owners, mitigates the impact of REM on stock price crash risk. However, internal control does not mitigate the association between REM and stock price crash risk.Originality/valueFollowing the passage of the Sarbanes–Oxley (SOX) Act, prior research has documented an increase in the use of REM and a positive association between REM and cash risk. The authors demonstrate that they persist in one of the largest emerging markets where institutional regulations, market conditions and corporate behaviors are different from those in developed markets. Also, the assessment of the moderation effect of internal and external governance mechanisms could have meaningful implications for investors and regulators in Chinese and other emerging markets.

Abnormal real activities, meeting earnings targets and firms' future operating performance: evidence from an emerging economy

PurposeThis paper aims to examine the extent to which real earnings management (REM) is used in Jordan to meet zero or previous year's earnings, and how this impacts the subsequent operating performance of Jordanian firms.Design/methodology/approachThe study used a sample of 98 Jordanian listed firms over the 2010–2018 period. To test the research hypotheses, which are formulated in accordance with both, agency theory and signalling theory, multivariate regression is performed using a pooled OLS estimation. Additionally, a two-step dynamic generalised method of moment (GMM) model has been estimated to address any concerns regarding the potential occurrence of endogeneity issues.FindingsThe results show that Jordanian firms that meet zero or last year's earnings tend to exhibit evidence of real activities manipulations. More specifically, suspect firms show unusually low abnormal discretionary expenses and unusually high abnormal production costs. Further, consistent with the signalling earnings management argument, the authors find that abnormal real-based activities intended to meet zero earnings or previous year's earnings potentially improve the subsequent operating performance of Jordanian firms. This implies that REM is not totally opportunistic, but it can be used to enhance the subsequent operating performance of Jordanian firms. Our findings are robust to alternative proxies and endogeneity concerns.Practical implicationsThe findings have several implications for policymakers, regulators, audit professionals and investors in their attempts to constrain REM practices to enhance financial reporting quality in Jordan. Managing earnings by reducing discretionary expenses appeared to be the most convenient way to manipulate earnings in Jordan. It provides flexibility in terms of time and the amount of spending. The empirical evidence, therefore, reiterates the crucial necessity to refocus the efforts of internal and external auditors on limiting this type of manipulation to reduce the occurrence of REM activities and enhance the subsequent operating performance of listed firms in Jordan. Drawing on Al-Haddad and Whittington (2019), the evidence also urges regulators and standards setters to develop a more effective enforcement mechanism for corporate governance provisions in Jordan to minimise the likelihood of REM incidence.Originality/valueThis study contributes to the body of the accounting literature by providing the first empirical evidence in the Middle East region overall on the use of REM to meet zero or previous year earnings by Jordanian firms. Moreover, the study is the first to empirically examine the relationship between REM and Jordanian firms' future operating performance.

How Does Culture Impinge Upon Managers’ Demeanor of Earnings Management? Evidence from Cross-Country Analysis

We examine the impact of national culture on earnings. Specifically, we examine managers’ likelihood of using accrual or real earnings management (REM) and the role of culture on various attributes of earnings (accruals quality, persistence, smoothing, and predictability). We measure national culture using Hofstede’s six dimensions of culture (1984, 2001, 2010). Using data from 36 countries during 1997–2018, we find that managers are likely to use both accruals and REM in high power distance (PDI) countries. In long-term-oriented countries, managers are more likely to use REM. In uncertainty avoidance (UAI) countries, in high individualist countries, and in higher indulgent versus restraint countries, managers are less likely to use either type of earnings management. In masculine countries, managers tend to use lower accruals management and rely on production cost REM. We also find the use of accruals management and the use of REM are substitutes for each other. In addition, we are able to classify countries into four earnings quality groups based on the culture impact on the earnings attributes (primarily driven by accruals quality, predictability, and smoothing). Persistence is generally not significant in classifying countries by earnings attributes. Our findings indicate that a universal set of accounting standards is a challenging goal to achieve given the cultural diversity across countries. To improve the existing corporate governance framework and to ensure high quality and uniform financial statements, the enforcement of standards should be tailored to specific cultures, or at a minimum, corporate boards need to be more culturally diversified.

Political, economic, financial uncertainty, and real earnings management

AbstractWe examine the relationship between uncertainty (political, economic, and financial) on real earnings management (REM). Covering nine presidential elections in the U.S. from 1980 to 2012, we find that firms limit overproduction in pre‐election years followed by reductions in REM activities in election years. We also show that economic and financial uncertainty (FU) stimulate firms’ use of REM through cutting back discretionary expenses such as advertising, research and development, and selling, general, and administrative expenses. We also find that firms with higher agency costs reduce REM during election years whereas larger firms accelerate REM during political, economic policy, and FU.

Evidence on the Unconditional Preference for Accrual vs. Real Earnings Management

Prior research shows that a greater level of cumulative accrual earnings management (AEM) over prior periods limits managers’ ability to use AEM in the current period and has suggested that this constraint on AEM is associated with greater use of real earnings management (REM). First, we confirm this result using new, more intuitive measures of cumulative AEM and cumulative REM. Second, we document that while constraints on the ability to use AEM are associated with a shift toward REM, constraints on the ability to use REM are not associated with a shift toward AEM. These results suggest that managers shift toward REM when necessary, but all else being equal, would prefer to use AEM. We also find that the Sarbanes-Oxley Act of 2002 weakened managers’ preference for AEM over REM.

Chief Operating Officers and Real Earnings Management

Because Chief Operating Officers (COOs) are responsible for internal operations and because the use of real earnings management (REM) can have negative consequences on longterm operating performance, we posit that COO firms will be less likely to use REM to inflate near-term earnings. Consistent with this, we find that the level of REM is lower for firms with COOs in their list of named executive officers than for other firms. In subsequent tests, we investigate whether the use of REM varies based on whether COOs are dedicated operations officers or are likely to ascend to the Chief Executive Officer position. Using several approaches to classifying COOs as dedicated versus non-dedicated, we find that relative to firms with nondedicated COOs and firms without COOs, firms with dedicated COOs engage in less REM. Overall, our results suggest that the presence of a COO restricts the use of REM on average, and that this effect is driven by those COOs who are dedicated operations officers.

The Joint Effect of Audit Quality and Legal Regimes on the Use of Real Earnings Management: International Evidence

ABSTRACTThis study investigates whether and how a firm's real earnings management (REM) is influenced by the strength of a country's legal regime and the presence of a Big 4 auditor. In a cross‐country examination using data from 22 countries, we find that REM increases in countries with stronger legal regimes as firms switch from accrual‐based earnings management (AEM) to REM. The presence of a Big 4 auditor reduces REM (as well as AEM) and attenuates the positive relation between legal regime strength and REM. Our results suggest that higher‐quality auditors limit client firms’ use of REM, especially in countries with a strong legal regime.

How does competition affect real earnings management to meet or beat targets? Evidence from import tariff reductions

Targets provide incentives for earnings management, and a longstanding question is whether earnings management is undertaken opportunistically or to communicate private information about future firm value. To discriminate between these motivations, I follow analytical research showing that an increase in competition through a large decrease in tariffs disciplines managers and better aligns their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it signals future performance expectations, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management to avoid reporting negative earnings or a negative change in earnings. In addition, by showing that the lessening of trade barriers through import tariff reductions reduces the use of real earnings management to meet or beat earnings targets, I provide evidence on the role of macroeconomic conditions as a determinant of earnings quality.

Product Market Competition and Real Earnings Management to Meet or Beat Earnings Benchmarks

Targets provide incentives for earnings management, and a longstanding question is whether earnings management is undertaken opportunistically or to communicate private information about future firm value. To discriminate between these motivations, I follow analytical research showing that an increase in competition through a large decrease in tariffs disciplines managers and better aligns their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it signals future performance expectations, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management to avoid reporting negative earnings or a negative change in earnings. In addition, by showing that the lessening of trade barriers through import tariff reductions reduces the use of real earnings management to meet or beat earnings targets, I provide evidence on the role of macroeconomic conditions as a determinant of earnings quality.

Managerial ability and real earnings management

Prior studies investigate the determinants and consequences of real earnings management (REM) as a function of firm-specific characteristics. In this study, we examine how managerial ability relates to the use of REM and future firm performance. We find that higher-ability managers engage in less REM. Furthermore, we find that managers with superior ability reduce the negative impact of REM on future firm performance. This is consistent with prior studies, which link higher-ability managers to better management of firm resources and more positive outcomes.

Real earnings management in public vs private firms in the GCC countries: a risk perspective

PurposeThe purpose of this paper is to examine the use of real earnings management by private and public firms in a unique institutional setting, which is the Gulf Cooperation Council (GCC) countries. The paper also compares the level of real earnings management between public and private firms in the GCC area.Design/methodology/approachThe GCC area is a unique setting to investigate the use of real earnings management because of the low enforcement of reporting standards and supervisory rules, lack of sophisticated financial analysis, specialized media tools and high concentration of capital ownership. The authors use different models of real earnings management proposed by Roychowdhury, 2006, cash flow management, productions cost management and discretionary expenses management to examine the use of real earnings management.FindingsThe paper documents evidence consistent with private and public firms using real earnings management to influence their earnings figures. The paper also shows that the level of real earnings management is higher for private firms compared to public firms when cash flow management and discretionary expenses management models are used. The production cost model results show evidence consistent with public firms only engaging in real earnings management through production cost reduction.Research limitations/implicationsThe results of this study might not be applicable to other emerging markets.Practical implicationsThe findings of this study should promote a general understanding of firms’ behavior in unique environment such as GCC countries. Regulators in the GCC region should be aware that real earnings management techniques have been used by firms and that extra caution is required when auditing or analyzing the financial information of private and public firms in the GCC market.Originality/valueThis paper contributes to the literature in many aspects. First, it provides additional evidence on the use of earnings management in unique market contexts outside the USA and Europe. The GCC markets share many common characteristics that make them interesting settings to be investigated. Second, this paper adds more evidence on the use of earnings management between public and private firms. In this regard, the paper adds additional evidence in the discussions proposed by Ball and Shivakumar (2005) and Givoly et al. (2010) who use two competing perspectives to investigate earnings quality in public and private firms: the demand hypothesis and the opportunistic behavior hypothesis.

The influence of culture on real earnings management

PurposeThe purpose of this paper is to extend prior literature regarding the interrelationships between national culture and accounting practices.Design/methodology/approachUsing Hofstede’s (1980) cultural indices, the authors employ hierarchical linear modeling to examine the impact of economic growth (emerging markets), country, and culture on real earnings management (REM) for a sample of firms from 31 countries.FindingsThe results reveal a negative association between REM and Hofstede’s (1980) measures of individualism, masculinity, and uncertainty avoidance, but a positive association with power distance. These results hold even after controlling for discretionary accruals. The results further reveal that measures of investor protection are subsumed by culture.Research limitations/implicationsThe findings are limited by the use of Hofstede’s (1980) data. There is, however, a significant body of research that continues to rely on and support the use of Hofstede’s model.Practical implicationsThe results should be of significant importance to investors who should consider cultural characteristics when assessing firm reported performance, and should prompt auditors and regulators to apply greater scrutiny to the financial reports in cultures characterized by high levels of power distance, especially given the apparent tradeoffs between accruals and REM.Social implicationsThe results reveal that status as an emerging market does not influence managers’ use of REM, and that the strength of a country’s investor protection mechanisms are subsumed by culture. Similarly, accounting systems (e.g. International Financial Reporting Standards), by themselves, do not bring about a convergence of managerial behavior. Rather, investors should consider culture when making decisions regarding capital allocation.Originality/valueThe increasing trend toward economic globalization and accounting harmonization makes the understanding of differences in accounting practices, and the possible impact of national culture on manager’s decisions, more important than ever. This research links REM to cultural values and tests for evidence that national culture, values, and structures of investor protection affect REM in the ways they affect managers’ attitudes toward the management of earnings through accruals.

Empirical Evidence on Earnings Management Strategies and Their Consequences in Innovative Small and Medium Entities

We investigate innovative Small and Medium Entities’ (SMEs) earnings management strategies and their related economic consequences. Uncertainty and complexity surrounding innovative SMEs’ activities lead to high information asymmetries between managers and investors which facilitate earnings management strategies. Yet managers do not want to be penalized by market participants which could impair their innovative capacity and future performance. It is generally argued that real activities-based earnings management are more difficult to detect by outsiders than accrual-based earnings management. We examine SMEs listed on the AIM London stock exchange, an exchange for firms of smaller size, over the 1995-2014 period. We document that innovative SMEs engage less intensively in accrual-based earnings management and more intensively in real activities-based earnings management relative to non-innovative SMEs. Our evidence shows that innovative SMEs undertake earnings management strategies that are more difficult to detect externally. We find that the combination of low accruals earnings management and high real earnings management is done efficiently by focusing resources towards investments in R&D in the future years which lead to higher market value. We further examine the role of external monitoring on accounting quality, comparing innovative SMEs listed on stock exchanges with different regulatory requirements, i.e., the AIM London and the Nasdaq stock exchanges. We document that stricter rules reduce the level of accrual earnings management, while it leads to more use of real earnings management. This paper contributes to the literature on SMEs’ financial reporting quality and on the effect of regulation on financial reporting quality.

Alternative Earnings Management Techniques: What Audit Committees and Internal Auditors Should Know

The desire to meet analysts' earnings expectations has driven companies to abandon credible financial reporting by stretching the boundaries of generally accepted accounting principles (GAAP), and even making operational and investment decisions that compromise future financial performance. Although external auditors have made strides in curtailing GAAP‐based earnings management, real earnings management (REM) has been adopted by management who hope to improve reported earnings. Such behavior should be of concern to audit committees (ACs) whose responsibilities extend beyond simple compliance with GAAP, to include ensuring that financial information is credible enough to facilitate risk assessments and to maintain effective internal control systems to monitor the effective use of resources by management to maximize long‐term shareholder wealth.The purpose of this article is to increase awareness about the nature, extent, and consequences of management's use of REM to meet Wall Street expectations. We also discuss company and governance attributes that are associated with REM so that ACs and internal auditors (IAs) are able to identify circumstances in which REM is employed to generate earnings that satisfy Wall Street. Specific techniques to detect REM are provided, as well as disclosure alternatives that the AC may use to assist financial statement users in assessing current‐ and future‐period financial performance. © 2017 Wiley Periodicals, Inc.

Institutional ownership stability and real earnings management

We examine the relationship between institutional ownership stability and real earnings management. Our findings indicate that firms held by more stable institutional owners experience lower real activities manipulation by limiting overproduction. We further examine how the stability in the shareholdings of pressure-sensitive and insensitive institutional investors affect target firms’ use of real earnings management, respectively. Unlike pressure-sensitive institutional investors, the stability in the share ownership of pressure-insensitive institutional investors (i.e., investment advisors, pension funds and endowments) mitigates target firms’ use of real earnings management. Overall, our results are consistent with the view that institutional investors presence acts as a monitor on target firms’ use of real earnings manipulation activities.