Impact of corporate diversification on earnings management

2017 ◽  
Vol 9 (2) ◽  
pp. 82-106
Author(s):  
Muhammad Hammad Masud ◽  
Faisal Anees ◽  
Haseeb Ahmed
Keyword(s):  
Asymmetric Information ◽  
Earnings Management ◽  
Cash Flows ◽  
Corporate Diversification ◽  
Main Function ◽  
Least Squares Regression ◽  
Content Type ◽  
Comparison Test ◽  
Information Hypothesis ◽  
Diversified Firms

PurposeThe purpose of this research is to examine the effects of corporate diversification on earnings management. Design/methodology/approachBased on listed firms regarding non-financial sector of Pakistan, the study runs mean comparison test along with panel least squares regression analysis. FindingsThe results of the study suggested that locally diversified firms and combination of industrial and geographical diversified firms mitigate earnings management. In support of the earnings equalizing hypothesis, managers of diversified firms have less need for accruals management because diversified firms had more free cash flows which naturally reduces earnings variability. This study also found that diversified firms had no informational asymmetry problems which reject the asymmetric information hypothesis. In addition, debt ratios are also associated with large organizations, but it shows that the more debt ratios are negatively associated with earnings management. Mean comparison test is also conducted, but the results are same as the regression results which does not confirm asymmetric information hypothesis. Research limitations/implicationsDifferent business segments are affected by the world financial crisis in 2008. Because of those financial shocks, the diversified firms are affected more. In future studies, results will become more favorable in context of diversified firms. Practical/implicationsThe main function of earnings management is to make up the company for investors point of view to look healthier than it really is. But it may cause to disappointment for investors regarding loss of investment. It shows future projections of the company and has vital importance for investor’s perspective. Social/implicationsThe misallocation of resources caused by earnings management refers to the value loss for society. Because the misallocation of funds will make that particular segment or division more vulnerable which ultimately make shareholders to go for entrenchment or liquidation. At the end, un-employment rises after entrenchment or liquidation and the society suffers. Originality/valueThis research makes an important contribution to the accounting and management literature by providing new and significantly different evidences on the relative roles of corporate diversification and earnings management.

Do corporate diversification and earnings management practices affect capital structure?

2015 ◽  
Vol 7 (4) ◽  
pp. 360-378 ◽  
Author(s):  
Ranjitha Ajay ◽  
R Madhumathi
Keyword(s):  
Capital Structure ◽  
Earnings Management ◽  
Management Practices ◽  
Negative Relationship ◽  
Corporate Diversification ◽  
Content Type ◽  
Diversification Strategies ◽  
Market Product ◽  
Diversified Firms ◽  
The Impact

Purpose – The purpose of this paper is to empirically examine the impact of earnings management on capital structure across firm diversification strategies. Design/methodology/approach – The study focuses on firms operating in the manufacturing sector (diversified and focused). Panel data methodology compares diversification strategies and identifies the impact of diversification strategy with earnings management practices on capital structure decision. Findings – International and product diversified firms have lower levels of leverage than focused firms in their capital structure. Asset-based earnings management is positive for diversified (market/product) firms. Earnings management using discretionary expenditure (project based) is found to be higher for market diversified but product-focused firms. Earning smoothing method is found to be significant for focused firms and shows a negative relationship with capital structure. Originality/value – This study offers an insight into the relationship between corporate diversification, earnings management and capital structure decisions of manufacturing firms. The results provide an important contribution to accounting and strategy literature. A distinction is made between market- and product-diversified firms and influence of earnings management practices (asset-based, project-based and earnings smoothing (ESM)) on capital structure decisions. Diversified firms (market/product) tend to have lower levels of leverage than focused firms and earnings management practices within firm groups significantly influence the capital structure decisions.

scholarly journals Corporate diversification and accrual and real earnings management

2018 ◽  
Vol 17 (2) ◽  
pp. 198-214 ◽  
Author(s):  
Mohammad Alhadab ◽  
Thang Nguyen
Keyword(s):  
Earnings Management ◽  
Linear Relationship ◽  
Real Earnings Management ◽  
Corporate Diversification ◽  
Publicly Traded ◽  
Content Type ◽  
Non Linear ◽  
The Usa ◽  
Diversified Firms ◽  
Reported Earnings

Purpose This study aims to examine the non-linear relationship between corporate diversification and real and accrual earnings management, using a sample of 5,659 US firm-year observations for 1,221 firms covering the period from 2001 to 2012. Design/methodology/approach The authors use various techniques and regressions to test the hypotheses. Following prior research, several proxies have been used to measure diversification, accrual earnings management and real earnings management. Findings The study produces several important findings. First, the study provides evidence that diversified firms engage in real and accrual earnings management to manage their reported earnings upward. These results are consistent with recent research (Farooqi et al., 2014; Jirapon et al., 2008) that finds that diversified firms engage in earnings manipulation. Second, and most importantly, the study contributes to the literature by providing the first evidence on a non-linear relationship between corporate diversification and earnings management. Specifically, the study provides evidence that diversified firms engage in accrual (real) earnings management, but this engagement is associated with level of diversification in a non-linear U-shaped (inverted U-shaped) relationship. Research limitations/implications Like all other studies, the current study has some limitations. The study was conducted only on the largest firms in the USA that have market capitalization of more than US$10m; hence, the findings may not be generalizable to small publicly traded firms. Further, the findings may not be generalizable to other markets, given the unique characteristics of US markets such as the presence of very sophisticated investors. Practical implications This study provides some important implications for US regulators to revise their regulations to prevent diversified firms from using earnings management to manipulate reported earnings. Originality/value This study is the first in the USA to examine the non-linear relationship between corporate diversification and earnings management. The study focuses on one of the most active, most attractive and largest capital markets throughout the world, that of the USA. Also, this study is one of the few studies that examine whether diversified firms use real activities manipulation to manage their reported earnings.

Audit committee chairman characteristics and earnings management

2019 ◽  
Vol 11 (4) ◽  
pp. 339-370 ◽  
Author(s):  
Mujeeb Saif Mohsen Al-Absy ◽  
Ku Nor Izah Ku Ismail ◽  
Sitraselvi Chandren
Keyword(s):  
Earnings Management ◽  
Family Member ◽  
Audit Committee ◽  
Ordinary Least Squares ◽  
Committee Chairman ◽  
Least Squares Regression ◽  
Content Type ◽  
Listed Firms ◽  
Jones Model ◽  
Accounting Expertise

Purpose The purpose of this paper is to examine the influence of the characteristics of audit committee chairman (ACC) (tenure, age, gender, ethnicity, accounting expertise and directorship) on earnings management (EM) practices. Design/methodology/approach The Jones model and modified Jones model by Dechow et al. (1995) were used to determine the discretionary accruals (DA) of 288 Malaysian listed firms with lowest positive earnings for the years 2013‒2015. Findings The results of the ordinary least squares regression indicate that only tenure, gender and ethnicity of the ACC are associated with DA. A further test was conducted by dividing firms into two groups: firms whose boards are chaired by a family member and firms whose boards are chaired by a non-family member. The results reveal that it is possible for firms whose boards are chaired by family members to cause the corporate governance (CG) mechanisms, particularly the audit committee, to lose their effectiveness in overcoming the EM problem. In addition, robustness tests were conducted by using panel data regression, where the results were found to be similar to the original regression results. Originality/value This study alerts policymakers, firms and their stakeholders, as well as researchers, regarding the importance of having an independent board chairman, who has no relationship with any directors or major shareholders, as this may hinder the effectiveness of CG mechanisms in curbing EM, especially in emerging countries, such as Malaysia, where it is very difficult to stop members of the family from becoming board directors.

Corporate diversification

2018 ◽  
Vol 17 (3) ◽  
pp. 405-424 ◽  
Author(s):  
Garrett C.C. Smith ◽  
Jeffrey M. Coy
Keyword(s):  
Design Methodology ◽  
Negative Relationship ◽  
Corporate Diversification ◽  
Diversification Discount ◽  
Firm Level ◽  
Content Type ◽  
Long Run ◽  
Fundamental Value ◽  
Diversified Firms ◽  
Investor Preference

Purpose The purpose of this study is to compare two theories that relate the proportion of diversified firms in the economy and the implied discount for diversified firms: the first is a real-options model predicting a positive relationship between the discount and management’s choice to operate a diversified firm; the second is based on catering theory, in which a negative relationship is predicted, as management is attentive to investor preference concerning diversified firms. Design/methodology/approach This study proposes a new aggregate measure of the diversification discount. The authors’ measure allows for decomposition of the discount into firm-level mispricing, industry-level mispricing and long-run fundamental value components. Findings Results support a catering theory of diversification. The discount appears to be the result of firm-level mispricing. Thus, providing an explanation for why, in light of the observed discount, a large number of diversified firms persist. Originality/value To the authors’ knowledge, this is the first study to provide evidence that firm-level mispricing may drive the observed diversification discount.

Earnings smoothing around open-market share repurchases

2015 ◽  
Vol 14 (1) ◽  
pp. 64-80
Author(s):  
Hui Di ◽  
Dalia Marciukaityte
Keyword(s):  
Earnings Management ◽  
Market Share ◽  
Discretionary Accruals ◽  
Cash Flows ◽  
Share Repurchases ◽  
Open Market ◽  
Content Type ◽  
Operating Cash Flows ◽  
Earnings Smoothing ◽  
Open Market Share Repurchases

Purpose – The purpose of this paper is to examine whether firms engage in earnings decreasing management before share repurchases to mislead investors or to smooth earnings and improve earnings informativeness. Design/methodology/approach – The authors examine discretionary accruals and cash flows around open-market share repurchases. The primary discretionary accruals measure is industry- and performance-adjusted discretionary current accruals estimated from cash-flow data. Findings – Results show that, firms experience temporary increases in operating cash flows and use negative discretionary accruals to smooth earnings before share repurchases. Firms with the highest pre-repurchase cash flows use the lowest pre-repurchase discretionary accruals. Moreover, pre-repurchase discretionary accruals reflect expectations about future operating cash flows. Firms with the strongest deterioration in operating cash flows after repurchases use the lowest pre-repurchase discretionary accruals. These findings suggest that repurchasing firms use earnings management to increase smoothness and predictability of reported earnings rather than to mislead investors. Originality/value – This paper provides an alternative explanation to the finding of negative discretionary accruals before share repurchases. It adds to the literature on repurchases and earnings smoothing by showing that firms use earnings management around share repurchases to smooth earnings.

Internal audit quality and earnings management: evidence from the UK

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Hazem Ramadan Ismael ◽  
Hany Kamel
Keyword(s):  
Earnings Management ◽  
Management Practices ◽  
Audit Quality ◽  
Negative Relationship ◽  
Internal Audit ◽  
Ordinary Least Squares ◽  
Least Squares Regression ◽  
Content Type ◽  
Abnormal Accruals ◽  
The Uk

Purpose This study aims to examine the association between internal audit quality and the involvement of UK companies in earnings management practices. Design/methodology/approach To measure the internal audit quality, this study uses 115 responses for a postal questionnaire that was addressed to the heads of internal audit departments in a sample of non-financial listed companies in the UK context. The other financial and governance data for the respondent companies were collected from the Datastream and the companies’ annual reports. The present study uses the signed abnormal accruals as a proxy for earnings management and uses both logistic and ordinary least squares regression models to test the research hypothesis. Findings This study finds a negative relationship between the internal audit quality and the abnormal accruals, implying the prominent role of internal audit in reducing the upwards earnings management. The study also finds a significant impact of the internal audit competence on reducing the engagement of UK companies in income-increasing earnings management compared to the internal audit independence. This remarkable result suggests the companies need to focus more on enhancing the internal audit competence to reduce the opportunistic management’s behaviour. Practical implications This study has important implications for the internal audit’s practice, regulation and research. Originality/value This is the first study that investigates the relationship between internal audit quality and earnings management in the UK context. Furthermore, it uses a comprehensive measure for the internal audit function (IAF) quality covering different aspects of IAF quality based on the global Institute of Internal Auditor standards and prior internal audit literature.

Whose cash compensation has more influence on real earnings management, CEOs or CFOs?

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Radwan Alkebsee ◽  
Adeeb A. Alhebry ◽  
Gaoliang Tian
Keyword(s):  
Earnings Management ◽  
Least Squares ◽  
Real Earnings Management ◽  
Least Squares Regression ◽  
Content Type ◽  
Equity Compensation ◽  
Cash Compensation ◽  
Management Literature ◽  
The Relationship

PurposeScholars have investigated the association between executives' incentives and earnings management. Most of the extant literature focuses on equity executives' incentives, while most of the earnings management literature focuses on accrual earnings management (AEM), not real earnings management (REM). This paper investigates the association between chief executive officers’ (CEOs) and chief financial officer (CFOs) cash compensation and REM and explores who has more influence on REM, the CEO or the CFO.Design/methodology/approachThe authors use the data of all listed companies on the Shanghai and Shenzhen Stock Exchanges for the period from 2009 to 2017 and ordinary least squares regression as a baseline model and the Chow test to capture whether the CEO's or the CFO's cash compensation has more influence on REM. To address potential endogeneity issues, the authors use a firm-fixed effect technique and two-stage least squares regression.FindingsThe authors find that CEOs' and CFOs' cash compensation is significantly associated with REM, suggesting that paying non-equity compensation to the CEO and CFO is negatively associated with REM. The authors also find that the CFO's cash compensation has a more significant influence on REM than the CEO's cash compensation, suggesting that the CFO's accounting and financial knowledge strengthens his or her power on the quality of financial reporting.Practical implicationsThe study contributes to the literature of agency and contract theories by using cash-based compensation to provide strong evidence that CEO's and CFO's compensation is associated with REM. It also contributes to the earnings management literature by examining the effect of CEOs' and CFOs' cash compensation on earnings management using proxies for REM-related activities. The study also contributes to the institutional theory by providing empirical evidence on the governance role of executives' cash compensation in deterring REM. Finally, it is the first to examine the relationship between CEO's and CFO's cash compensation and REM, and the first to explore who is more influential regarding REM in emerging markets, the CEO or the CFO.Originality/valueAs a response to the call for investigations of the role of non-equity-based compensation in earnings management and the call to consider non-developed institutional contexts in governance research, this study extends prior studies by providing novel evidence on the relationship between CEOs' and CFOs' non-equity compensation and REM in China's emerging market. The study documents that the CFO has a greater influence on REM than the CEO does.

The relationship between managerial entrenchment, earnings management and firm innovation

2018 ◽  
Vol 67 (9) ◽  
pp. 2089-2107 ◽  
Author(s):  
Mahdi Salehi ◽  
Mahbubeh Mahmoudabadi ◽  
Mohammad Sadegh Adibian
Keyword(s):  
Emerging Markets ◽  
Earnings Management ◽  
Significant Relationship ◽  
Cash Flows ◽  
Production Costs ◽  
Firm Innovation ◽  
Content Type ◽  
The Real ◽  
Managerial Entrenchment ◽  
Study Results

PurposeThe purpose of this paper is to evaluate the qualitative effect of corporate governance components, in the form of managerial entrenchment index, on earnings management and innovation.Design/methodology/approachIn this study, the variable of managerial entrenchment, which includes the variables of management independence, dual role of management, management tenure, the board compensation and the board ownership percentage, was initially estimated through the exploratory factor analysis and its effect was evaluated on the dependent variables of the study using the test of multivariable regressions. Hence, a total of 103 listed companies on the Tehran Stock Exchange were selected and analyzed during 2011–2016. In this paper, the Jones model is used as the variable of accrued earnings management and for calculating the real earnings management, the models of abnormal operational cash flows, abnormal production costs and abnormal optional costs are employed. Moreover, the research and development cost to total costs ratio is used for calculating the innovation.FindingsThe results indicate a negative and significant relationship between managerial entrenchment and accrual-based earnings management; moreover, the entrenched managers are less likely to engage in manipulating the real activities accruals in Iran context. Furthermore, the findings show that there is a positive and significant relationship between managerial entrenchment and firm innovation.Originality/valueWhat really sets this paper apart from other studies is that this research will make aware investors and stakeholders of this fact that managerial entrenchment will be a good way to diminish the manipulation of financial reporting and improve the corporate situation in emerging markets, particularly those bazaars facing with economic sanctions such as Iran. Undeniably, the study results will complete the knowledge gap between the developed economies and the emerging markets.

Audit quality and the trade-off between real and accrual earnings management in the oil and gas industry: the GCC evidence

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Yosra Mnif ◽  
Afef Ben Hamouda
Keyword(s):  
Earnings Management ◽  
Audit Quality ◽  
Oil And Gas ◽  
Cash Flows ◽  
Institutional Setting ◽  
Related Factors ◽  
Trade Off ◽  
Content Type ◽  
Oil And Gas Firms ◽  
The Impact

PurposeThis paper examines the impact of audit quality on the managerial preferences between real and accrual earnings management (REM and AEM, respectively) in oil and gas firms operating in the Gulf Cooperation Council (GCC) member countries.Design/methodology/approachThe study relies on the modified Jones model’s (Dechow et al., 1995) to capture AEM and employs Roychowdhury (2006) approach to examine the use of REM through abnormal cash flows, abnormal production and abnormal discretionary expenditures. Audit quality is measured by auditor-industry specialization. The analyses are based on a sample of 30 oil and gas firms from 2008 to 2019.FindingsThe findings highlight that sample companies may substitute between earnings management strategies and tend to shift from AEM to REM when audited by an industry expert. Further analysis points out that the trade-off decision of the pooled sample stems from both upstream and downstream sectors.Research limitations/implicationsThis study is subject to two main limitations. First, the narrowed scope of audit quality related factors due to the scarcity of corporate governance reports of companies. Second, the sample size is reduced.Practical implicationsThe regulators and users of financial statements should be aware that REM strategy is used by oil and gas firms even when scrutinized by a high quality auditor, calling for extra caution when auditing or analyzing the financial information.Originality/valueThe current research is the first, unveiling the association between audit quality and the trade-off between AEM and REM in a less inspected sector and a unique institutional setting.

Accrual-based and real earnings management before and after IFRS adoption

2016 ◽  
Vol 17 (1) ◽  
pp. 2-23 ◽  
Author(s):  
Aikaterini C. Ferentinou ◽  
Seraina C. Anagnostopoulou
Keyword(s):  
Earnings Management ◽  
Cash Flows ◽  
Unintended Consequences ◽  
Production Costs ◽  
Real Earnings Management ◽  
Significant Shift ◽  
Accounting Quality ◽  
Content Type ◽  
Ifrs Adoption ◽  
Before And After

Purpose – The purpose of this study is to examine the use of accrual-based vs real earnings management (EM) by Greek firms, before and after the mandatory adoption of International Financial Reporting Standards (IFRS). The research is motivated by the fact that past studies have indicated the existence of significant levels of EM for Greece in particular before IFRS. Design/methodology/approach – Accrual-based earnings management (AEM) is examined by assessing performance-adjusted discretionary accruals, while real earnings management (REM) is defined in terms of abnormal levels of production costs, discretionary expenses, and cash flows from operations, for a three-year period before and after the adoption of IFRS in 2005. Findings – The authors find evidence on a statistically significant shift from AEM to REM after the adoption of IFRS, indicating the replacement of one form of EM with the other. Research limitations/implications – The validity of the results depends on the ability of the empirical models used to efficiently capture the existence of AEM and REM. Practical implications – IFRS adoption aims to improve accounting quality, especially in countries with high need for such an improvement; however, the tendency to substitute one form of EM with another highlights unintended consequences of IFRS adoption, which do not improve the informational content of financial statements if EM continues under different forms. Originality/value – Under the expectation that IFRS adoption should lead to improvements in accounting quality, this study examines whether IFRS actually led to a reduction of EM practices for a country with exceptionally high levels of EM before IFRS, by accounting for all possible forms of EM.

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