To read this content please select one of the options below:

Do managers manipulate earnings to influence credit rating agencies’ decisions? Evidence from Watchlist

Qiuhong Zhao (Texas A&M University Corpus Christi, Corpus Christi, Texas, USA)

Review of Accounting and Finance

ISSN: 1475-7702

Article publication date: 14 August 2017

2607

Abstract

Purpose

This study aims to investigate whether firms engage in earnings management behavior that attempts to manipulate Credit Rating Agency (CRA) perceptions during the Watchlist process and, if so, whether earnings management behavior appears to influence CRAs’ decisions.

Design/methodology/approach

To measure earnings management activities, this paper computes accrual-based and real earnings management measures in the year or in the quarter immediately before the Watchlist resolutions for all negative and positive Watchlist firms. To examine the association between the levels of earnings management and Watchlist resolutions, a logit model is applied to the data obtained from a sample of Watchlist firms.

Findings

Some evidence suggests that managers in Watchlist firms manage earnings in attempts to gain favorable Watchlist treatment. The findings are consistent with the Graham et al.’s (2005) survey evidence, which shows that one of the primary reasons for earnings management is to gain (or preserve) a desirable rating. In addition, CRAs appear to be misled by these attempts during the negative Watchlist process period.

Research limitations/implications

The findings support SEC’s (2011, 2013a, 2013b) rules to reduce its reliance on credit ratings and the recent regulation reforms concerning the competition in the rating industry [the Credit Rating Agency Reform Act (2006)], and concerning conflicts of interest of CRAs among others [Dodd–Frank Wall Street Reform and Consumer Protection Act (2010)].

Originality/value

While many studies examine whether managers use discretionary accruals as a tool to manage earnings to obtain favorable ratings, those studies do not consider manipulation of real operating activities to manage earnings and CRA perceptions.

Keywords

Acknowledgements

This paper is based on part of the author’s dissertation. The author is thankful for comments received from the dissertation committee and the seminar participants at the 2009 Annual Meetings of the American Accounting Association and workshops at Florida Atlantic University, the University of Arkansas at Fayetteville, the University of Colorado at Boulder, the University of Illinois at Springfield, the University of Massachusetts at Boston, the University of Missouri at Columbia, the University of North Carolina at Greensboro and the University of Wisconsin at La Crosse. The author is also thankful for insights gained through conversations with Moody’s Investors Service’s Greg Jonas and Mark LaMonte.

Citation

Zhao, Q. (2017), "Do managers manipulate earnings to influence credit rating agencies’ decisions? Evidence from Watchlist", Review of Accounting and Finance, Vol. 16 No. 3, pp. 366-384. https://doi.org/10.1108/RAF-05-2016-0078

Publisher

:

Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited

Related articles