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Efficient contracting, earnings smoothing and managerial accounting discretion

Mohamed Khalil (Accounting and Finance, Hull University Business School, The University of Hull, Hull, UK and Accounting Department, Faculty of Commerce, Tanta University, Tanta, Egypt)
Jon Simon (Accounting and Finance, Hull University Business School, The University of Hull, Hull, UK)

Journal of Applied Accounting Research

ISSN: 0967-5426

Article publication date: 6 May 2014

1634

Abstract

Purpose

The purpose of this paper is to examine whether the contracting incentives (i.e. bonus plans, debt covenants, political costs hypotheses), and income smoothing can explain accounting choices in an emerging country, Egypt.

Design/methodology/approach

The paper uses the ordinary least square regression model to examine the relationship between earnings management and reporting objectives. A sample of 438 non-financial firms listed on the Egyptian Exchange over the period 2005-2007 is used.

Findings

The paper finds that the contracting objectives explain little of the variations in accounting choices (i.e. discretionary accruals) in the Egyptian context. However, the paper finds that mangers are likely to smooth the reported earnings by managing the accrual component in an attempt to reduce the fluctuation in reported earnings by increasing (decreasing) earnings when earnings are low (high) in attempt to reduce the variability of the reported earnings.

Research limitations/implications

The empirical results rely on the ability of earnings management proxies to adequately capture earnings manipulation activities.

Practical implications

The findings of the study should be of substantial interest to regulators and policy makers. The results implicitly contribute to the ongoing argument in relation to the optimal flexibility permitted by standard setting and the argument that tightening the accounting standards and mandating International Financial Reporting Standards are likely to improve reporting quality and reduce opportunistic earnings management. The results reveal that many of the weaknesses related to corporate reporting in emerging countries may result from the inadequate enforcement of the law and the weak legal protection of minority shareholders. The results also highlight the crucial role of understanding the reporting incentives, which is mainly shaped by institutional and market forces and the legal environment, in explaining accounting choices.

Originality/value

Unlike previous studies that tested an individual objective, this study examines the trade-offs among various reporting objectives in an emerging economy.

Keywords

Acknowledgements

The authors are grateful to Aydin Ozkan, Khaled Hussainey, Ros Haniffa, Julia Mundy (Editor), and two anonymous referees for their useful comments and suggestions.

Citation

Khalil, M. and Simon, J. (2014), "Efficient contracting, earnings smoothing and managerial accounting discretion", Journal of Applied Accounting Research, Vol. 15 No. 1, pp. 100-123. https://doi.org/10.1108/JAAR-06-2012-0050

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

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