Capital Structure, Earnings Management, and Sarbanes-Oxley: Evidence from Canadian and U.S. Firms

2013 ◽  
Vol 27 (2) ◽  
pp. 301-318 ◽  
Author(s):  
Kelly E. Carter
Keyword(s):  
Capital Structure ◽  
Earnings Management ◽  
Data Availability ◽  
Cost Of Debt ◽  
Equity Financing ◽  
Percentage Points ◽  
Sarbanes Oxley ◽  
The U.S ◽  
Jel Classifications

SYNOPSIS I examine Sarbanes-Oxley's (SOX) effect on capital structure. I find that SOX is associated with higher long-term debt ratios, as firms listed in the U.S. raise their long-term debt ratios by 2 to 3 percentage points. This finding is consistent with the idea that, although the reduction in information asymmetry associated with SOX could prompt managers to increase equity financing, debt is still safer and less costly than equity in the SOX era. Further analysis shows that the increase in debt occurs in the two quarters prior to SOX, suggesting that firms anticipate a higher cost of debt after SOX and acquire debt while it is relatively cheap. Also, firms that heavily (lightly) manage earnings prior to SOX use less (more) debt after SOX. This result is consistent with the view that firms that aggressively manage earnings before SOX reveal intrinsically weaker earnings after SOX, casting doubt on those firms' ability to repay debt and relegating those firms to issue equity for financing purposes. JEL Classifications: G32; G38. Data Availability: Data available upon request.

Clawbacks and Earnings Management

2018 ◽  
Vol 31 (3) ◽  
pp. 129-151 ◽  
Author(s):  
Carolyn B. Levine ◽  
Michael J. Smith
Keyword(s):  
Numerical Analysis ◽  
Earnings Management ◽  
Cash Flows ◽  
Data Availability ◽  
Real Earnings Management ◽  
Interim Report ◽  
Short Term ◽  
Period Model ◽  
Jel Classifications

ABSTRACT This study addresses the effect of clawbacks on earnings management (EM). In a two-period model, the manager can report truthfully or distort an interim report using either accrual or real EM. The principal can make short-term payments based on a manipulable accounting signal and long-term payments based on unmanipulable cash flows. The strength of the clawbacks determines the likelihood that the manager's compensation is reclaimed when the interim report was managed. Stronger clawback provisions may result in (1) a substitution between accrual and real earnings management, or (2) earnings management when no earnings management was optimal with weak clawbacks, and (3) lower expected profits for the principal. Numerical analysis suggests that strong clawbacks do not reduce aggregate earnings management. JEL Classifications: J33; M48; M52; G38. Data Availability: All data are simulated.

Long-Term Orientation and Earnings Management Strategies

2019 ◽  
Vol 18 (3) ◽  
pp. 97-119 ◽  
Author(s):  
Jesper Haga ◽  
Fredrik Huhtamäki ◽  
Dennis Sundvik
Keyword(s):  
Earnings Management ◽  
High Precision ◽  
Management Strategy ◽  
Management Strategies ◽  
Real Earnings Management ◽  
Short Term ◽  
Country Level ◽  
Earnings Benchmarks ◽  
Jel Classifications

ABSTRACT In this study, we investigate how country-level long-term orientation affects managers' willingness to engage in earnings management and choice of earnings management strategy. Using a comprehensive dataset of 47 countries for the period from 2003 to 2015, we find that firms in long-term-oriented cultures rely relatively more on earnings management through accruals, while firms in short-term-oriented cultures engage in relatively more real earnings management. Furthermore, we find a larger discontinuity around earnings benchmarks in long-term-oriented cultures suggesting that manipulation of accruals enables benchmark beating with high precision. JEL Classifications: M14; M16; M21; M41.

Bias in Quarterly Estimates of Annual Effective Tax Rates and Earnings Management

2012 ◽  
Vol 34 (1) ◽  
pp. 31-53 ◽  
Author(s):  
Joseph Comprix ◽  
Lillian F. Mills ◽  
Andrew P. Schmidt
Keyword(s):  
Earnings Management ◽  
Earnings Forecast ◽  
Tax Rates ◽  
Effective Tax Rate ◽  
Effective Tax Rates ◽  
Tax Rate ◽  
Sarbanes Oxley ◽  
Jel Classifications

ABSTRACT We investigate whether quarterly annual effective tax rate (ETR) estimates are systematically biased in comparison to year-end actual ETRs. We find that estimated annual ETRs in the first, second, and third quarters are systematically higher than year-end ETRs. We then investigate whether firms' overstatement of quarterly ETRs creates slack that is used for earnings management. We find that quarterly ETR increases are more likely to be reversed in subsequent quarters when firms would have missed their analysts' earnings forecast absent the reversal. Finally, we show that in the years subsequent to the passage of the Sarbanes-Oxley Act (SOX), changes in the ETR continue to be associated with earnings management. These results, documenting patterns of annual ETR estimates and revisions, contribute to research about how earnings management is accomplished. JEL Classifications: H25; M41.

SOX 404, Auditor Effort, and the Prevention of Financial Report Misstatements

2017 ◽  
Vol 36 (4) ◽  
pp. 151-177 ◽  
Author(s):  
Yuping Zhao ◽  
Jean C. Bedard ◽  
Rani Hoitash
Keyword(s):  
Internal Control ◽  
Lower Incidence ◽  
Audit Fees ◽  
Data Availability ◽  
Section 404 ◽  
Financial Report ◽  
Auditor Tenure ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
Jel Classifications

SUMMARY Prior research shows that the Sarbanes-Oxley Act (SOX) Section 404(b) integrated audit is associated with a lower incidence of misstatements. We predict that under 404(b), the auditor's ability to detect misstatements increases relative to other internal control regimes when greater resources are exerted during the engagement. Supporting this prediction, we find that the benefits of 404(b) versus other regimes (including SOX 404(a)) in reducing misstatements increase with incremental audit effort (proxied by abnormal audit fees). We find no benefit of 404(b) in misstatement reduction when abnormal audit effort is low. This implies that the value of 404(b) testing is not uniform, but rather is greater when sufficient resources are available to thoroughly understand client controls. In contrast, we find no benefit of abnormal audit effort under other regulatory regimes. We further examine the conditions under which knowledge gained from auditor internal control testing is more valuable. We find that the benefits of increased audit effort under 404(b) do not vary across internal control regimes under AS2 versus AS5, and are more pronounced for engagements with shorter auditor tenure, non-Big 4 auditors, and industry-specialist auditors. JEL Classifications: M49. Data Availability: Data used in this study are available from public sources.

Non-CPAs and Office Audit Quality

2020 ◽  
Vol 34 (3) ◽  
pp. 169-191 ◽  
Author(s):  
Matthew G. Sherwood ◽  
Albert L. Nagy ◽  
Aleksandra B. Zimmerman
Keyword(s):  
Human Resources ◽  
Growth Regulators ◽  
Audit Quality ◽  
Data Availability ◽  
External Audit ◽  
Accounting Firms ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
Jel Classifications

SYNOPSIS During the time surrounding the Sarbanes-Oxley Act of 2002, the Big 4 firms either spun-off or downsized their consulting practices. However, in recent years, consulting service lines of the large accounting firms have seen a dramatic resurgence and growth. Regulators have taken notice of, and expressed concern over, this renewed focus on consulting. The accounting firms claim that such services enhance audit quality, mainly due to the prominent role of non-accounting specialists in today's external audit function. This study examines whether the availability of non-CPAs in U.S. Big 4 firm offices is associated with audit quality. We find that greater access to non-CPAs in the office is associated with higher audit quality and conclude that office audit quality is not just a function of audit-specific human resources but also the availability of non-CPAs to support audit engagement teams. JEL Classifications: M41; M42. Data Availability: All data are publicly available from sources identified in the study.

Irregularities in Accounting Numbers and Earnings Management—A Novel Approach Based on SEC XBRL Filings

2015 ◽  
Vol 12 (1) ◽  
pp. 117-151 ◽  
Author(s):  
Klaus Henselmann ◽  
Dominik Ditter ◽  
Elisabeth Scherr
Keyword(s):  
Earnings Management ◽  
Financial Analysis ◽  
Human Interaction ◽  
Data Availability ◽  
Analysis Approach ◽  
Financial Reports ◽  
Novel Approach ◽  
Accounting Numbers ◽  
Fully Automatic ◽  
Jel Classifications

ABSTRACT The SEC XBRL mandate enables the gathering of accounting numbers to be fully automatic in a database-like manner that provides vast opportunities for financial analysis. Using this functionality, this study proposes a simple analytical prescreening measure that uses abnormal digit distributions at the firm-year level to identify firms suspected of having managed earnings. On average, we find that the constructed measure indicates a greater amount of irregularities in the reported accounting numbers of firms with higher incentives to engage in earnings management. The suggested XBRL-enhanced digit analysis approach may provide the SEC and investors a simple measure to flag financial reports carrying a higher probability of human interaction. JEL Classifications: C10; M41; M43. Data Availability: Data used in this paper are publicly available. The analytical prescreening VBA-Tool is available upon request. A description of the tool is available; see Appendix B.

Financial crisis and SME capital structure: Swedish empirical evidence

2019 ◽  
Vol 46 (4) ◽  
pp. 925-941 ◽  
Author(s):  
Darush Yazdanfar ◽  
Peter Öhman ◽  
Saeid Homayoun
Keyword(s):  
Financial Crisis ◽  
Capital Structure ◽  
Large Scale ◽  
Global Financial Crisis ◽  
Ordinary Least Squares ◽  
Data Availability ◽  
Cross Sectional ◽  
Content Type ◽  
The Global Financial Crisis

Purpose The purpose of this paper is to empirically examine capital structure determinants of small- and medium-sized enterprises (SMEs) during and after the global financial crisis. Design/methodology/approach Statistical methods, including ordinary least squares and the generalised method of moments, were used to analyse a sample of over 40,800 Swedish SMEs operating in four industries during the 2008–2015 period. Findings The results indicate that the independent variables – i.e. financial crisis, profitability, size, tangibility and industry affiliation – to various degrees explain changes in short-term debt (STD) and long-term debt (LTD) ratios. In particular, the empirical findings indicate that the sampled SMEs tended to rely more on STD and LTD during (2008–2009) than after (2010–2015) the financial crisis. Research limitations/implications Due to data availability, the current study is limited to a sample of Swedish SMEs in four industries covering eight years. Further research could examine the generalisability of these findings by investigating other firms operating in other industries and other countries. Originality/value This study is one of few examining determinants of short- and long-term SME debt during and after the global financial crisis, using data from a large-scale cross-sectional database.

scholarly journals Capital Structure Theory: An Overview

2017 ◽  
Vol 6 (1) ◽  
pp. 133 ◽  
Author(s):  
D.K.Y Abeywardhana
Keyword(s):  
Capital Structure ◽  
Market Timing ◽  
Order Theory ◽  
Structure Theory ◽  
Cost Of Debt ◽  
Equity Financing ◽  
Pecking Order ◽  
Pecking Order Theory ◽  
Trade Off ◽  
Capital Structure Theory

Capital structure is still a puzzle among finance scholars. Purpose of this study is to review various capital structure theories that have been proposed in the finance literature to provide clarification for the firms’ capital structure decision. Starting from the capital structure irrelevance theory of Modigliani and Miller (1958) this review examine the several theories that have been put forward to explain the capital structure.Three major theories emerged over the years following the assumption of the perfect capital market of capital structure irrelevance model. Trade off theory assumes that firms have one optimal debt ratio and firm trade off the benefit and cost of debt and equity financing. Pecking order theory (Myers, 1984, Myers and Majluf, 1984) assumes that firms follow a financing hierarchy whereby minimize the problem of information asymmetry. But neither of these two theories provide a complete description why some firms prefer debt and others prefer equity finance under different circumstances.Another theory of capital structure has introduced recently by, Baker and Wurgler (2002), market timing theory, which  explains the current capital structure as the cumulative outcome of past attempts to time the equity market. Market timing issuing behaviour has been well established empirically by others already, but Baker and Wurgler (2002) show that the influence of market timing on capital structure is regular and continuous. So the predictions of these theories sometimes acted in a contradictory manner and Myers (1984) 32 years old question “How do firms choose their capital structure?” still remains. 

Overvaluation and the Choice of Alternative Earnings Management Mechanisms

2011 ◽  
Vol 86 (5) ◽  
pp. 1491-1518 ◽  
Author(s):  
Brad A. Badertscher
Keyword(s):  
Earnings Management ◽  
Important Determinant ◽  
Data Availability ◽  
Present Evidence ◽  
Accruals Management ◽  
Early Stages ◽  
Jel Classifications

ABSTRACT In this study I examine how the degree and duration of overvaluation affect management's use of alternative within-GAAP earnings management, restrictions on further exploitation of within-GAAP accruals management, and subsequent non-GAAP earnings management. Further, I examine how one type of earnings management segues into another type as overvaluation persists. I present evidence that the longer the firm is overvalued, the greater is the amount of total earnings management. I also find that managers engage in accruals management in the early stages of overvaluation before moving to real transactions management, in order to sustain their overvalued equity. Finally, I find that the longer a firm is overvalued, the more likely it is to engage in one of the most egregious forms of earnings management, non-GAAP earnings management. Collectively, the results suggest that the duration of firm overvaluation is an important determinant of managements' choice of alternative earnings management mechanisms. JEL Classifications: M41, M43, M44. Data Availability: Data are available from sources identified in the text.

scholarly journals SOX Section 404 Twenty Years After: Reviewing Costs and Benefits

2020 ◽  
Vol 9 (1) ◽  
pp. 103-112
Author(s):  
Bianca Fischer ◽  
Bernadette Gral ◽  
Othmar Lehner
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Internal Control ◽  
Earnings Quality ◽  
Costs And Benefits ◽  
Section 404 ◽  
Positive Effects ◽  
Sarbanes Oxley

Some issues of the Sarbanes Oxley Act of 2002 are still discussed controversially in literature. Thereof, Section 404 concerning internal control over financial reporting is one of the most criticized parts. This article focuses on costs and benefits of the section and impacts on earnings management. Most authors agree that compliance costs of Section 404 far outweigh its benefits. However, long-term benefits are expected. Regarding earnings management, studies show that the section has positive effects such as increased earnings quality and improved internal control systems. Although the section is heavily debated in literature, there is consensus that SOX Section 404 greatly contributed to the improvement of quality of financial reporting and of corporate governance as a whole.

Sign in / Sign up

Export Citation Format

Share Document