Economic Effects of Tightening Accounting Standards to Restrict Earnings Management

2005 ◽  
Vol 80 (4) ◽  
pp. 1101-1124 ◽  
Author(s):  
Ralf Ewert ◽  
Alfred Wagenhofer
Keyword(s):  
Earnings Management ◽  
Rational Expectations ◽  
Earnings Quality ◽  
Accounting Standards ◽  
Relevant Information ◽  
Economic Effects ◽  
Real Earnings Management ◽  
Accounting Earnings ◽  
Marginal Benefit ◽  
Accounting Earnings Management

This paper examines the usual claim that tighter accounting standards reduce earnings management and provide more relevant information to the capital market. We distinguish between accounting and real earnings management and assume that a standard setter can only influence accounting earnings management by the tightness of standards. In a rational expectations equilibrium model, we find that earnings quality increases with tighter standards, but we identify several consequences that may outweigh this benefit. First, managers increase costly real earnings management because the higher earnings quality increases the marginal benefit of real earnings management. Second, tighter standards can increase rather than decrease expected accounting and total earnings management. Third, the expected total costs of earnings management can also increase. We provide conditions for the occurrence of each of these effects.

Analysts’ reactions to firms’ real activities management

2019 ◽  
Vol 18 (4) ◽  
pp. 589-612
Author(s):  
Joonho Lee ◽  
Sung Gon Chung
Keyword(s):  
Earnings Management ◽  
Accounting Standards ◽  
Negative Association ◽  
Production Costs ◽  
Accounting Earnings ◽  
Content Type ◽  
Stock Recommendations ◽  
Future Performance ◽  
Accounting Earnings Management ◽  
Operating Activities

Purpose Firms’ real activities management (RAM) can have a more detrimental effect on firms’ future performance than accrual earnings management. This paper aims to examine whether analysts, who play an important role as information intermediaries, understand the negative effect of RAM on firms’ future performance and respond to it accordingly. Design/methodology/approach The authors investigate whether analysts lower their earnings forecasts and stock recommendations of the firms with RAM. The authors measure RAM by examining firms’ abnormal decreases in discretionary expenses, abnormal increases in production and abnormal decreases in cash flow from operations following prior literature. Findings The authors find that after controlling for earnings surprises and other important firm characteristics, analysts lower their forecasts of future annual earnings and stock recommendations of the firms that show signs of RAM. Research limitations/implications First, as in other RAM studies, the results in this study are subject to measurement errors inherent in the estimation of RAM (i.e. abnormal production costs, abnormal CFO and abnormal discretionary expenditures). Second, we include only firm-year observations that barely make positive income in our samples following the previous study. This sample selection criterion helps increase the power of the test by examining the “suspect firms group,” which are more likely to engage in earnings management. However, one can challenge that our findings on the association between RAM and analysts’ reactions could be only case-specific and cannot be generalized. Practical implications This study contributes to the literature on earnings management and especially on RAM. Specifically, none of the previous studies clearly examines whether analysts understand the negative impact of RAM on firms’ future performance and respond accordingly, although there are studies showing the negative association between RAM and firms’ future operating performance and studies showing the negative association between analysts following and RAM. Thus, filling the gap, this study provides a specific reason for the negative association between the analyst following and real earnings management presented in previous studies. Social implications The findings will be of interest to regulators, who are concerned about the potential negative consequences in which tighter accounting standards can result. For example, Ewert and Wagenhofer (2005) theoretically demonstrate that tighter accounting standards can prompt more RAM instead of accounting earnings management. The study provides important evidence supporting that such suboptimal operating activities are closely watched by analysts and are potentially penalized by the market. If the market is able to detect RAM and allocate fewer resources to the firms that engage in it, then the concerns associated with the substitution effect between accrual-based earnings management and RAM can be diminished. Originality/value Prior research suggests that tighter accounting regulations (e.g. the Sarbanes-Oxley Act) prompt more RAM than accounting earnings management. The study provides evidence supporting that such suboptimal operating activities are closely watched by analysts and are potentially penalized by the market.

Earnings management in non-public companies: the case of for-profit hospice organizations

2017 ◽  
Vol 29 (1) ◽  
pp. 1-19
Author(s):  
Kelly Noe ◽  
Dana A. Forgione ◽  
Pamela C. Smith ◽  
Hanni Liu
Keyword(s):  
Earnings Management ◽  
Financial Statements ◽  
Accounting Earnings ◽  
Public Companies ◽  
For Profit ◽  
Management Literature ◽  
Political Cost ◽  
Accounting Earnings Management ◽  
Public Scrutiny ◽  
Cost Factors

We examine earnings management in non-publicly listed companies, with a focus on for-profit (FP) hospice organizations, and extend the accounting earnings management literature to the hospice industry. FP hospice organizations file Medicare cost reports that include complete financial statements not otherwise publicly available. Managers of FP hospice organizations have incentives to manage earnings to increase performancebased bonuses, meet or beat bond covenant requirements, or avoid public scrutiny. We find total accruals are significantly positively associated with profitability, debt, and size factors. However, discretionary accruals are significantly negatively associated with debt and size, but not profitability. Thus, monitoring and political cost factors appear to effectively mitigate earnings management in this industry sector.

scholarly journals Heterogeneity in earnings quality between different classes of companies after IFRS adoption: evidence from Brazil

2017 ◽  
Vol 28 (73) ◽  
pp. 113-131
Author(s):  
Roberto Black ◽  
Sílvio Hiroshi Nakao
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Value Relevance ◽  
Earnings Quality ◽  
Economic Incentives ◽  
Net Income ◽  
Accounting Earnings ◽  
Ifrs Adoption ◽  
Before And After

ABSTRACT This paper aims to investigate the existence of heterogeneity in earnings quality between different classes of companies after the adoption of the International Financial Reporting Standards (IFRS). IFRS adoption is generally associated with an increase in the quality of financial statements. However, companies within the same country are likely to have different economic incentives regarding the disclosure of information. Thus, treating companies equally, without considering the related economic incentives, could contaminate earnings quality investigations. The case of Brazil is analyzed, which is a country classified as code-law, in which tax laws determined accounting practice and in which IFRS adoption is mandatory. First, Brazilian companies listed on the São Paulo Stock, Commodities, and Futures Exchange (BM&FBOVESPA) were separated into two classes: companies issuing American Depositary Receipts (ADRs) before IFRS adoption and companies that did not issue ADRs until the adoption of IFRS. Then, this second class of companies was grouped, using cluster analysis, into two different subclasses according to economic incentives. Based on the groups identified, the quality of accounting earnings is tested for each class of the companies before and after IFRS adoption. This paper uses timely recognition of economic events, value relevance of net income, and earnings management as proxies for the quality of accounting earnings. The results indicate that a particular class of companies began showing conditional conservatism, value relevance of net income, and lower earnings management after IFRS adoption. On the other hand, these results were not found for the two other classes of companies.

The impact of the global economic crisis of 2008 on earnings quality in Mexico

2019 ◽  
Vol 9 (3) ◽  
pp. 407-421
Author(s):  
Jose Miranda-Lopez ◽  
Ivan Valdovinos-Hernandez
Keyword(s):  
Earnings Management ◽  
Economic Crisis ◽  
Earnings Quality ◽  
Accounting Standards ◽  
Previous Literature ◽  
Income Smoothing ◽  
Accounting Quality ◽  
Content Type ◽  
Global Economic Crisis

Purpose The purpose of this paper is to examine the earnings quality of companies listed on Mexico’s primary stock market, the Bolsa Mexicana de Valores (Bolsa) before and during the global economic crisis of 2008. Previous research has shown that these economic events can have potentially conflicting effects on the quality of earnings of listed companies in capital markets around the world. Design/methodology/approach This paper operationalizes earnings quality based on earnings management. Therefore, four constructs to proxy for earnings quality are developed from previous literature, and multiple regression analysis along with tests of differences across two time periods, 2005–2007 and 2008–2010, are used to determine if there is a significant change in the accounting quality of companies listed on the Bolsa before and after the start of the global economic crisis. Findings Results indicate a statistically significant decrease of earnings quality on three out of the four constructs used to proxy for earnings management. There is only one construct in this category that shows a significant increase of earnings quality. Research limitations/implications There are different number of constructs and methodologies used to test for earnings quality. This study draws on four different constructs on two dimensions of earnings quality from previous literature, but other methodologies and constructs can potentially be used as well, such as discretionary accruals. Furthermore, there is a chance that there can be confounding factors affecting the results of this study besides the effects of the global economic crisis. Finally, the sample used in this study comprises non-financial public companies listed on the Bolsa, which can affect the generalization of the results to countries other than Mexico. Practical implications The results of this study can be of interest to Mexican and foreign investors, standard setters and regulators of the Bolsa, as the results show a strong incentive to manage companies’ earnings using income smoothing in an emerging economy during an economic crisis even after converging to a higher-quality set of accounting standards. Results can also be of interests to investors and regulators in other Latin-American countries with economies similar to that of Mexico. Originality/value This is the first study to test the quality of earnings of Mexican companies before and during the global economic crisis of 2008. Thus, this study contributes to the accounting quality literature by offering evidence showing a significant increase of income smoothing during the global economic crisis for companies listed in a developing economy with a relevant history of economic crises, even when these companies were using recently converged, higher-quality accounting standards.

scholarly journals The Impact of Financial Statement Comparability on Earnings Management: Evidence from Frontier Markets

2020 ◽  
Vol 8 (4) ◽  
pp. 73
Author(s):  
Wil Martens ◽  
Prem W. S. Yapa ◽  
Maryam Safari
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Common Law ◽  
Accounting Standards ◽  
Real Earnings Management ◽  
Financial Statement ◽  
Financial Reporting Standards ◽  
Developed Markets ◽  
Accounting Comparability ◽  
The Impact

This paper examined whether financial statement comparability constrains opportunistic earnings management in frontier market countries. Using a large sample of 19 frontier market countries, and an accounting comparability method that maps comparability across several accounting standards, the results show that enhanced financial comparability constrains accruals earnings management (AEM). Contrary to developed markets and novel to this study, a significant relationship between financial comparability and real earnings management (REM) was not found. For greater robustness, AEM and REM were also tested on both International Financial Reporting Standards (IFRS) adopting and non-adopting countries. The results suggest IFRS adoption constrains AEM, yet exhibited no impact on constraining REM. Additionally, the use of BigN auditors failed to conclusively show an ability to moderate EM. When combined, the results suggest that frontier markets engage in less REM than expected. It is also noted that the legal roots (civil vs. common law) play a significant role in constraining earnings management. Common law countries exhibited lower AEM when comparability increased; this significance was not found in countries that were rooted in civil law. Contributions from this study show that findings from developed markets cannot be generalised to frontier markets.

A review of the influence of political connections on management’s decision in non-US settings

2020 ◽  
Vol 18 (4) ◽  
pp. 687-705
Author(s):  
Ines Amara ◽  
Hichem Khlif
Keyword(s):  
Earnings Management ◽  
Voluntary Disclosure ◽  
Management Practices ◽  
Empirical Studies ◽  
Tax Avoidance ◽  
Economic Effects ◽  
Real Earnings Management ◽  
Political Connections ◽  
Future Research ◽  
Content Type

Purpose Given the interest in better understanding the economic effects of political connections, this paper aims to review empirical studies in the accounting and finance domain investigating the effects of firms’ political connections on management’s decision in non-US settings. Design/methodology/approach Key words used to search for relevant studies include “political connections” linked with “tax avoidance,” “earnings quality” “voluntary disclosure.” The authors consult several editorial sources including Elsevier, Electronic Journals Service EBSCO, Emerald, Springer, Palgrave Macmillan, Sage, Taylor & Francis and Wiley-Blackwell. The authors’ search yields 46 published studies since 2006. Findings The review reveals a prevalence of studies conducted in Asia. A narrative synthesis of empirical findings shows mixed effects of political connections on earnings management, as measured by accrual-based or real earnings management practices. Mixed evidence also exists for the association between political connections and reporting policy (e.g. corporate social responsibility reporting). The review also reveals that firms with political ties adopt an aggressive tax policy aimed at reducing effective tax rates and are more likely to choose a Big 4 auditor. Originality/value The review discusses the political connections literature focusing on studies outside of the USA and the effect of such connections on decision-making by management. It identifies some limitations of this literature and offers guidance for future research avenues. The synthesis suggests that political connections can adversely or beneficially impact management’s decisions depending on the legal, institutional and cultural characteristics prevailing in a particular setting.

scholarly journals The Optimal Level of Earnings Management Deterrence

2018 ◽  
Vol 8 (1) ◽  
pp. 66
Author(s):  
Michael Ehud Yampuler
Keyword(s):  
Social Welfare ◽  
Earnings Management ◽  
Financial Reporting ◽  
Rational Expectations ◽  
Substitution Effect ◽  
Optimal Level ◽  
Information Value ◽  
Real Earnings Management ◽  
Welfare Costs ◽  
Sarbanes Oxley

The social welfare costs of earnings management have been known to include the distortion of real investment decisions (resulting in inefficient allocation of resources), as well as deadweight loss incurred by the firms to manage earnings. One of the ways used to mitigate the effect of these costs is increasing the level of earnings management deterrence through legislation, regulation and enforcement, as in the Sarbanes-Oxley Act. However, by analyzing a rational expectations equilibrium that includes firms, investors, standard-setters, and legislators, I find that there are situations where such an increase in the level of earnings management deterrence may well be counter-productive. When considering the informational benefits of managing earnings and the substitution effect of accrual-based earnings management with real earnings management, increasing deterrence may result in decreasing the information value of financial reporting as well as increasing total social welfare costs of earnings management.

Did Japanese-SOX have an impact on earnings management and earnings quality?

2015 ◽  
Vol 30 (4/5) ◽  
pp. 482-510 ◽  
Author(s):  
Masumi Nakashima ◽  
David A. Ziebart
Keyword(s):  
Corporate Governance ◽  
Earnings Management ◽  
Reporting System ◽  
Earnings Quality ◽  
Business Environment ◽  
Real Earnings Management ◽  
Material Weakness ◽  
Content Type ◽  
Accruals Management

Purpose – The purpose of this paper is to investigate whether Japanese Sarbanes – Oxley Act (J-SOX) impacted earnings management and earnings quality of public firms in Japan. Design/methodology/approach – This archival study compares earnings management and earnings quality of firms that disclose at least one material weakness with a sample matched on size and industry without a material weakness. Findings – The authors investigate whether the differences in regulations, corporate governance and regulatory environment acceptance influence earnings management and earnings management of Japanese listed firms, relative to findings in the USA. They found the Japanese results to be slightly different from the results found in previous USA studies. First, the time-series observations suggest that while accruals management and real earnings management remained unchanged for control firms, accruals management and real earnings management increased for material weaknesses disclosing firms following J-SOX. The regression analyses suggest that accruals management for both the groups is significant in the pre-and post-J-SOX periods, but that real earnings management declined for both the groups post-J-SOX. Second, while, both accruals quality and accuracy of cash flow predictions improved in the post-J-SOX period. Research limitations/implications – The sample of Japanese firms disclosing a material weakness is small because the number of firms that disclose internal control deficiencies is decreasing in Japan. The authors have no evidence that their results are not generalizable to a larger sample and leave this for future research. Practical implications – The authors provide evidence that J-SOX, which does not have a direct reporting system, does not constrain earnings management. Their results drive the regulator to reconsider whether the reporting system works in the Japanese business environment. Additionally, their results show that J-SOX has no effect on earnings management; thus, regulators need to reconsider the governance function of directors and internal auditors. This paper communicates to the world how J-SOX works in Japan through changes in earnings quality and management post J-SOX and the root problems. Originality/value – This paper is the first (of which the authors are aware) to examine whether J-SOX impacted both earnings management and earnings quality in Japan. This paper discusses how the differences in regulations and corporate governance as well as the differences between USA-SOX and J-SOX may explain the results observed in Japan. This paper provides results regarding whether J-SOX improved earnings quality.

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