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Article
Publication date: 19 July 2011

Salma Ibrahim, Li Xu and Genese Rogers

Prior research suggests that firms manipulate earnings through accruals to achieve certain reporting objectives. Recently, especially following the Sarbanes‐Oxley (SarbOx…

Abstract

Purpose

Prior research suggests that firms manipulate earnings through accruals to achieve certain reporting objectives. Recently, especially following the Sarbanes‐Oxley (SarbOx) Act, researchers have turned their attention to real account manipulation as an alternative. However, there is no evidence on whether the likelihood of being detected by outsiders is different for firms using these alternative manipulation methods. The purpose of this paper is to examine this research question in the context of seasoned equity offerings (SEOs).

Design/methodology/approach

First, the authors compare SEOs to a matched sample of non‐SEOs to document income‐increasing manipulation. Next, they identify SEOs that prompt lawsuits and compare sued and non‐sued firms to determine whether using a particular method of manipulation is more likely to be detected and associated with litigation.

Findings

The authors find evidence of income‐increasing accrual and real manipulation for SEOs in the year prior to the offering in the pre‐SarbOx period, and find some evidence of a shift to real account manipulation post‐SarbOx. The authors examine the subsequent litigation pattern of these SEOs, and find that firms that are subsequently sued have a higher prevalence of income‐increasing discretionary accruals when the lawsuit allegations involve accounting issues. Following SarbOx, investors are paying less attention to accrual manipulation through accounts receivable and there is more scrutiny of real account manipulation.

Originality/value

The implication in this paper is that firms that engage in income‐increasing earnings management are more likely to be sued when they engage in accrual manipulation while other forms of manipulation may be less understood. This finding is important to investors and regulators.

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Article
Publication date: 14 August 2017

Javeria Farooqi, Thanh Ngo and Surendranath Jory

This study aims to examine the ability of investors to process signs of real activities manipulations at bidder firms in the quarters leading to the announcement of a…

Abstract

Purpose

This study aims to examine the ability of investors to process signs of real activities manipulations at bidder firms in the quarters leading to the announcement of a merger. It further provides a supplementary explanation for the post-merger underperformance puzzle.

Design/methodology/approach

Examining a sample of cash-only, stock swap and mixed mergers completed between 1980 and 2011, it was found that bidder firms increase the use of real activities manipulation in the quarters leading up to the merger announcements. Using average abnormal stock return method, it is shown that the short-term positive effect of real activities manipulation on share prices is stronger than accrual-based earnings management.

Findings

While bidders are able to escape investors’ scrutiny in the short run, it is not the case in the long run. It was found that bidders’ long-run stock performance, measured by matched buy-and-hold stock returns, is inversely related to their pre-announcement level of earnings management. This paper contributes to the literature on earnings management by considering how real activities manipulations affect stock prices in mergers and acquisitions.

Originality/value

This study tests whether real activities manipulation, in addition to accrual-based earnings management, explains the underperformance puzzle of the acquiring firms in M&As. Zang (2012) argues that there is a greater likelihood for firms to engage in real activities manipulation, especially when firms are constrained in their use of accrual-based earnings management owing to heightened scrutiny or overuse in prior years.

Details

Review of Accounting and Finance, vol. 16 no. 3
Type: Research Article
ISSN: 1475-7702

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Article
Publication date: 6 November 2017

Talie Kassamany, Salma Ibrahim and Stuart Archbold

This study aims to investigate the occurrence of pre-merger earnings management for a sample of 197 stock- and cash-financed UK acquirers between 1990 and 2009. It also…

Abstract

Purpose

This study aims to investigate the occurrence of pre-merger earnings management for a sample of 197 stock- and cash-financed UK acquirers between 1990 and 2009. It also examines the earnings management behaviour around the change in the Corporate Governance Code in 2003 based on the Higgs recommendations.

Design/methodology/approach

Mean and median accrual- and real-based manipulation are examined in the period before the announcement of a merger and acquisition. These are compared across stock and cash acquirers as well as before and after the implementation of the Higgs recommendations. Logistic regressions are also run to examine accrual- and real-based manipulation across stock and cash acquirers after controlling for variables that may affect the acquisition type.

Findings

The study found some evidence of upward pre-merger accrual-based earnings management by stock-financed acquirers, which is in line with the findings of Botsari and Meeks (2008). Furthermore, no significant changes were found in the post-Higgs period, which indicates that the recommendations put forth by Higgs may not have been successful in mitigating earnings management. The evidence also shows that cash bidders engage in pre-merger real earnings manipulation through lower discretionary expenses, possibly to enhance cash availability for the bid.

Practical implications

The findings in this study confirm earnings management exists around mergers and acquisitions and provide some evidence that the recommendations set out in the Higgs Report do not appear to have mitigated earnings management activities. This is of interest to regulators as well as investors and academicians.

Originality/value

This provides the first analysis in the UK examining the use of real-based earnings management activities by UK acquirers. It also extends prior research around corporate governance changes that occurred in the UK.

Details

Journal of Accounting & Organizational Change, vol. 13 no. 4
Type: Research Article
ISSN: 1832-5912

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Article
Publication date: 7 November 2016

Raheel Safdar and Chen Yan

The purpose of this paper is to investigate whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in…

Abstract

Purpose

The purpose of this paper is to investigate whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in income smoothing.

Design/methodology/approach

The authors used negative correlation between pre-managed earnings of a firm and its discretionary accruals (DAs) as proxy for income smoothing and the firms having more negative correlation coefficient are expected to have lower volatility in their reported earnings. The authors used Kothari et al.’s (2005) version of modified-Jones model to estimate DAs and used least squares estimations to investigate the research questions using six-year (2007-2012) sample of non-financial firms listed over Karachi Stock Exchange, Pakistan.

Findings

The authors found that firms experiencing more volatility in economic activities and smaller firms are more aggressively involved in income smoothing. Moreover, a predominant majority (72.2 per cent) of firms in the sample are involved in income smoothing through accruals manipulation. Also, the authors found that firms which are more aggressively involved in income smoothing have lesser volatility in reported earnings. Lastly, the level of DAs per se does not have any impact on income smoothing.

Research limitations/implications

The proxy used for income smoothing, though the authors consider it to be better, is not the only one used in literature and the sample is limited to Pakistan.

Originality/value

This study adds to earnings management literature by providing evidence on extensive accrual manipulation for income smoothing in Pakistan.

Details

Journal of Accounting in Emerging Economies, vol. 6 no. 4
Type: Research Article
ISSN: 2042-1168

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Article
Publication date: 1 May 2006

Hamadi Matoussi and Mohamed Chakib Kolsi

In response to recent financial corporate scandals, this study aims to provide a helpful understanding for investors and accounting regulators on how firms manage their…

Abstract

Purpose

In response to recent financial corporate scandals, this study aims to provide a helpful understanding for investors and accounting regulators on how firms manage their reported earnings. This leads to a better firm valuation by financial intermediaries and more useful accounting standards.

Design/methodology/approach

Estimating discretionary accruals and opportunistic special purpose entities and using a simultaneous equation approach, the aim is to check how managers trade off between such tools of earnings management. Based on real earnings manipulation and accruals management of earnings, the goal is to understand if such tools are used simultaneously or as substitute by firms.

Findings

After controlling for each cost determinants of such earnings management tool, firms use discretionary accruals and financial engineering with special purpose entities as substitutes. Additional analyses show that managers use such tools in a sequential process. Indeed, they first use special purpose entities during the course of the year but they manipulate discretionary accruals especially at the end of the year.

Research limitations/implications

Despite sensitivity checks, measurement error in discretionary accruals proxy and opportunistic SPE estimation model remains an alternative explanation for the results. The sample size and the lack of accurate information about the size of special purpose entities may limit the extent of the findings.

Practical implications

It is a very useful tool for regulators when they plan to disclose new accounting standards. For investors, this study can help them in assessing the firm's value more accurately for investing and financing purposes.

Originality/value

Providing a new methodology and new models to detect pervasive earnings management strategies adopted by firms.

Details

Journal of Human Resource Costing & Accounting, vol. 10 no. 2
Type: Research Article
ISSN: 1401-338X

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Article
Publication date: 16 March 2015

Mahdi Moradi, Mahdi Salehi and Mohammad Zamanirad

– The purpose of this paper is to analyze the effect of managers’ incentive bonuses on both accrual and real earnings management.

Abstract

Purpose

The purpose of this paper is to analyze the effect of managers’ incentive bonuses on both accrual and real earnings management.

Design/methodology/approach

First, the authors investigate the relationship between managers’ bonuses and both accrual earnings management (measured by a modified Jones model) and real earnings management (measured by Roychowdhury proxies). Next, the authors examine whether management has any preferences for earnings management methods to enhance its bonuses. Finally, the authors investigate the possible effects of earnings management on future operating performance. The sample consists of compositional data in the period from 2006 to 2012.

Findings

The authors find a negative relationship between real earnings management and managers’ bonuses and detect that managers prefer to use accrual earnings management to earn more bonuses. The results also show that real earnings management will reduce a firm’s performance in future periods, and on the other hand that increasing managers’ bonuses links to improvement of the firm’s future performance. The results suggest that managers are typically aware of the negative effects of real earnings management on the firm’s future performance and thus prefer to improve the firm’s performance in securing their bonuses when their ability to manage accruals is constrained.

Originality/value

The implications of this paper provide further evidence on how managers’ bonuses affect their discretion in using accrual and real earnings management. This finding is important to investors and regulators.

Details

Management Decision, vol. 53 no. 2
Type: Research Article
ISSN: 0025-1747

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Article
Publication date: 17 December 2018

Leon Li and Nen-Chen Richard Hwang

The purpose of this paper is to postulate that market participants’ views on the nature of discretionary accruals as earnings management or earnings manipulation could…

Abstract

Purpose

The purpose of this paper is to postulate that market participants’ views on the nature of discretionary accruals as earnings management or earnings manipulation could relate to a rise or a fall in a firm’s stock prices.

Design/methodology/approach

Applying the quantile regression and measuring gains and losses according to the stock returns, this study shows that the relation between earnings manipulation and stock returns is non-uniform and it varies significantly across various quantiles of the latter.

Findings

The empirical results imply a positive (negative) |DA|-RETURN relation for stocks experiencing a rise (fall) in stock prices. This finding is consistent with the notion that market participants lean towards (become) trend followers (fundamentalists) when their stocks price rise (fall) and, thus, positively reward (negatively punish) discretionary accruals.

Originality/value

Using the behavioural heterogeneity of market participants as a research framework, this paper contributes to the literature by demonstrating that market participants’ decisions to positively reward (negatively punish) earning management behaviour depend on their perceptions on nature of discretionary accruals (earnings management vs earnings manipulation).

Details

Managerial Finance, vol. 45 no. 1
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 26 September 2019

Muhammad Safdar Sial, Xuan Vinh Vo, Lara Al-Haddad and Thao Nguyen Trang

The purpose of this paper is to check the impact of female directors on the board and foreign institutional investors on earnings manipulation.

Abstract

Purpose

The purpose of this paper is to check the impact of female directors on the board and foreign institutional investors on earnings manipulation.

Design/methodology/approach

The data sample includes Chinese listed companies on the Shenzhen and Shanghai stock exchanges. The data are collected from China Stock Market and Accounting Research database covering the period from 2010 to 2017. The authors use a dynamic generalized method of moments in the study.

Findings

The findings show that the presence of female director on the board has a significant negative impact on both discretionary accruals and real earning management. However, the authors obtain different results for foreign institutional investor investors. This may be the result of myopia as the foreign institutional stockholders in Chinese companies are looking for quick profit encouraging management to manipulate earnings. the findings survive several robustness tests.

Originality/value

The authors expect the research results provide ample evidence about how female directors affects earnings manipulation, and also hope the research helps to understand how, in China, institutional ownership affects earnings manipulation.

Details

Asia-Pacific Journal of Business Administration, vol. 11 no. 3
Type: Research Article
ISSN: 1757-4323

Keywords

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Article
Publication date: 18 December 2019

Priyesh Valiya Purayil and Jijo Lukose P.J.

Prior research on earnings management largely assumes that newly public firms manage earnings opportunistically around IPOs. However, only a few studies have empirically…

Abstract

Purpose

Prior research on earnings management largely assumes that newly public firms manage earnings opportunistically around IPOs. However, only a few studies have empirically examined the real motives behind newly public firms’ earnings management. The purpose of this paper is to examine the impact of ownership dilution on earnings management among IPO firms. The authors chose the setting of security offerings in an emerging market, which is characterised by unique ownership structure, to examine the possible incentive of owners or pre-IPO shareholders to engage in earnings management.

Design/methodology/approach

The study employs accrual and real transactions measures to check the presence of earnings management among 409 IPO firms from India during the period 2000‒2018. Subsequently, using ordinary least squares regression models with heteroscedasticity-robust standard errors, this paper examines the relationship between earnings management and selling or dilution incentives of pre-IPO shareholders.

Findings

The study finds that the degree of earnings manipulation by issuer firms is positively associated with the ownership dilution at the time of IPO as well as around lockup expiration.

Practical implications

The findings of this study will help the investors and regulators to understand the practice of earnings management among IPO firms and how it is linked to the ownership dilution of pre-IPO shareholders.

Originality/value

The paper contributes to the limited stream of research that investigates the motives of earnings management among IPO firms. It empirically establishes an association between the selling incentive of pre-IPO shareholders and earnings management.

Details

Managerial Finance, vol. 46 no. 3
Type: Research Article
ISSN: 0307-4358

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Book part
Publication date: 4 March 2015

Matthias Nnadi, Kamil Omoteso and Yi Yu

This paper provides evidence on the impact of regulatory environment on financial reporting quality of transitional economies. This study compares the financial reporting…

Abstract

This paper provides evidence on the impact of regulatory environment on financial reporting quality of transitional economies. This study compares the financial reporting quality of Hong Kong firms which are cross-listed in mainland China with those of Hong Kong firms cross-listed in China using specific earnings management metrics (earnings smoothing, timely loss recognition, value relevance and managing towards earnings targets) under pre- and post-IFRS regimes.

The financial reporting quality of Chinese A-share companies and Hong Kong listed companies are examined using earnings management measures. Using 2007 as base year, the study used a cumulative of −5 and +5 years of convergence experience which provide a total of 3,000 firm-year observations. In addition to regression analyses, we used the difference-in-difference analysis to check for the impact of regulatory environments on earnings management.

Through the lens of contingency theory, our results indicate that the adoption of the new substantially IFRS-convergent accounting standards in China results in better financial reporting quality evidenced by less earning management. The empirical results further shows that accounting data are more value relevant for Hong Kong listed firms, and that firms listed in China are more likely to engage in accrual-based earnings management than in real earnings management activities. We established that different earnings management practices that are seemingly tolerable in one country may not be tolerable in another due to level of differences in the regulatory environments.

The findings show that Hong Kong listed companies’ exhibit higher level of financial reporting quality than Chinese listed companies, which implies that the financial reporting quality under IFRS can be significantly different in regions with different institutional, economic and regulatory environments. The results imply that contingent factors such as country’s institutional structures, its extent of regulation and the strength of its investor protection environments impact on financial reporting quality particularly in transitional and emerging economies. As such, these factors need to be given appropriate considerations by financial reporting regulators and policy-makers interested in controlling earnings management practices among their corporations.

This study is a high impact study considering that China plays a significant role in today’s globalised economy. This study is unique as it the first, that we are aware of, to compare real earnings activities against accrual-based earnings management in pre- and post-IFRS adoption periods within the Chinese and Hong Kong financial reporting environments, distinguishing between cross-listed and non-cross-listed firms.

Details

Neo-Transitional Economics
Type: Book
ISBN: 978-1-78441-681-2

Keywords

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