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Article

Weifeng He, Liping Chen and Wei Liu

Currently, most research studies focus on ownership reforms and governance reforms, while only a few research studies focus on management system innovations. Based on an…

Abstract

Purpose

Currently, most research studies focus on ownership reforms and governance reforms, while only a few research studies focus on management system innovations. Based on an evolution of state-owned enterprises’ (SOEs) performance appraisal systems, this paper investigates the influence of performance appraisal system on earnings management.

Design/methodology/approach

Using a natural experiment that central government-owned enterprises (CGOEs) carried out economic value-added performance appraisal (EVA-PA) in 2010, the authors adapt difference-in-difference method to analyze the relationship between EVA-PA and earnings management choice. Furthermore, the authors consider the situation which contained financial status, separation between decision-making rights and decision-control rights, separation between ownership and control and industrial characteristics.

Findings

The research finds that after carrying out EVA-PA, CGOEs prefer accrual-based earnings management to real earnings management, and there is substitution effect between the two types of earnings management. Moreover, further research studies reveal that enterprises suffering losses in the previous year and featuring higher separation between decision-making rights and decision-control rights and higher separation between ownership and control have stronger earnings management motive under EVA-PA. In contrast, enterprises achieving satisfactory financial performance in the previous year and engaging in businesses within protective industry have weaker earnings management motive under EVA-PA. After the implementation of EVA-PA, accrual-based earnings management and real earnings management both impair operating performances of CGOEs.

Originality/value

Theoretically, this paper enriches research studies on earnings management from the perspective of incentive mechanism and expands research studies on economic consequences of EVA-PA. In addition, it validates the relationship between the two types of earnings management. As an important mechanism of corporate management and control, performance appraisal system is an important part for establishing ownership management system and improving internal management system of SOEs.

Details

Nankai Business Review International, vol. 11 no. 2
Type: Research Article
ISSN: 2040-8749

Keywords

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Article

Feng Jui Hsu and Yu-Cheng Chen

The purpose of this paper is to investigate the relationships among corporate social responsibility (CSR), analyst forecast accuracy and firms’ earnings management

Abstract

Purpose

The purpose of this paper is to investigate the relationships among corporate social responsibility (CSR), analyst forecast accuracy and firms’ earnings management behavior using US-based firms.

Design/methodology/approach

The authors use the Kinder, Lydenberg, Domini (KLD) database to construct CSR performance scores and divide all firms into ten groups from high to low as a proxy for CSR performance. The authors obtained an initial sample of 33,364 firm-year observations from 1991 to 2012. Filtering for records which exist in the KLD, Compustat, and Center for Research in Security Prices databases lefts a total of 16,807 firm-year observations and CSR evaluation reports for 5,896 firms.

Findings

The authors find that high CSR-score firms have lower rates of analyst forecast error than their low CSR-score counterparts, suggesting that CSR performance is a useful means of forecasting earnings. Furthermore, firms with better CSR performance have significantly lower accrual-based earnings management behavior. However, the level of the manipulation behavior of real earnings management (REM) activities increased significantly in better CSR firms, suggesting that high CSR-score firms substituted REM methods for accrual-based methods. REM methods are consistent with the stipulations of the Sarbanes-Oxley Act and allow high CSR-score firms to better manipulate earnings behavior. These results hold after the authors control for various factors related to firm financial characteristics.

Originality/value

Overall, the findings have important implications for investors and regulators to more easily assess firms’ earnings manipulation behavior and earnings stability under CSR performance and financial information in financial markets.

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Article

Kais Baatour, Hakim Ben Othman and Khaled Hussainey

The study aims to examine the effect of multiple directorships on accrual-based earnings management and real earnings management. It analyses whether earnings management

Abstract

Purpose

The study aims to examine the effect of multiple directorships on accrual-based earnings management and real earnings management. It analyses whether earnings management practices in the Saudi context increase or decrease with the average number of multiple directorships.

Design/methodology/approach

The study uses the approach by Roychowdhury (2006) to capture the level of real earnings management and uses the cross-sectional model by Jones (1991) to measure accrual-based earnings management.

Findings

The paper provides partial evidence supporting the “busyness” hypothesis where earnings management practices increase with the number of multiple directorships. The evidence shows that multiple directorships have a positive and significant effect on real earnings management in the Kingdom of Saudi Arabia. However, we find no significant impact of multiple directorships on accrual-based earnings management.

Originality/value

This is the first study that empirically investigates the relationship between multiple directorships and earnings management in the Kingdom of Saudi Arabia. The paper contributes to the limited literature on multiple directorships in developing countries by examining their impact on opportunistic real earnings management.

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Article

Francesco Capalbo, Alex Frino, Vito Mollica and Riccardo Palumbo

Opposition to transnational calls for the adoption of accrual-based accounting in the public sector may stem from arguments that it is associated with poor earnings

Abstract

Purpose

Opposition to transnational calls for the adoption of accrual-based accounting in the public sector may stem from arguments that it is associated with poor earnings quality. The purpose of this paper is to determine whether state owned enterprises (SOEs) operating under accrual-based accounting manage their earnings, whether it is more prevalent vis-à-vis privately owned enterprises (POEs) and the conditions under which it is more likely to occur.

Design/methodology/approach

This paper measures earnings management for a large sample of unlisted Italian SOEs and POEs using a framework developed by Stubben (2010). The authors use regression analysis to estimate the variables which predict abnormal accruals including firm size, leverage and profitability.

Findings

The authors find no evidence that the level of state ownership (SO) is positively correlated with accrual-based earnings management. The authors also provide evidence that earnings management by SOEs decreases with firm size and increases with profitability.

Research limitations/implications

While the study is the first to examine earnings management in a public sector accrual accounting environment for a sample of European firms, namely Italian firms, the authors call for more research into this issue examining public entities in other European Union (EU) member states or public entities other than SOEs.

Practical implications

The EU recently introduced a new transnational accounting directive in which it prescribes the preparation of financial statements based on accrual accounting for all European public sector entities, arguing that it reduces the window dressing that is allowed by cash accounting. Since Italian SOEs already prepare their accounts on an accruals-basis, by analysing their accounting behaviour the authors are able to determine the variables which predict when earning management is more likely to occur in a public sector accrual accounting environment, and therefore the authors provide guidance which may be useful in shaping the transition process from cash accounting to accrual accounting by identifying the types of entities whose accounts should be subject to greater regulatory scrutiny. A better understanding of the relation between SO and earnings management will provide insight into public sector corporate governance and aid in the acceptance of transnational regulation that would otherwise significantly alter current accounting practices and possibly be opposed at a national level.

Originality/value

Earnings management in a public sector accrual accounting environment had been analysed only for Chinese listed companies. The authors extend previous analysis to a sample of European (Italian) SOEs which are unlisted. The authors also extend previous work by determining the characteristics of firms which manage their earnings.

Details

Accounting, Auditing & Accountability Journal, vol. 27 no. 6
Type: Research Article
ISSN: 0951-3574

Keywords

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Article

Justin Mindzak and Tao Zeng

Unlike firms listed in the USA, many large firms in Canada belong to business groups organized as pyramids. A pyramidal structure refers to a business group that consists…

Abstract

Purpose

Unlike firms listed in the USA, many large firms in Canada belong to business groups organized as pyramids. A pyramidal structure refers to a business group that consists of a set of enterprises or other entities and displays a top-down chain of control. The purpose of this paper is to investigate the relationship between pyramid ownership and earnings management.

Design/methodology/approach

The paper is an empirical study using a sample of 165 Canadian listed firms from 2010 to 2015. The impact of pyramid ownership on both accrual-based and real earnings management is examined.

Findings

The findings show that pyramid-affiliated firms engage in less accrual-based and real earnings management than non-pyramid-affiliated firms. The results further show that the divergence between control rights and cash flow rights of the controlling shareholders in the pyramid-affiliated firms is positively related to real earnings management. Moreover, the results highlight that intra-group transactions (other than internal financing) among pyramid-affiliated firms lead to higher level of both accrual-based and real earnings management, but internal financing is negatively associated with real earnings management. Overall, this study provides the evidence which indicates that pyramid ownership structure and earnings management are related to each other.

Originality/value

The paper contributes to the earnings management literature by studying the impact of pyramid ownership structure on earnings management, especially real earnings management.

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Article

Li‐Chin Jennifer Ho, Chao‐Shin Liu and Bo Ouyang

Barton and Simko argue that the balance sheet information would serve as a constraint on accrual‐based earnings management. This paper aims to extend their argument by…

Abstract

Purpose

Barton and Simko argue that the balance sheet information would serve as a constraint on accrual‐based earnings management. This paper aims to extend their argument by examining whether the balance sheet constraint increases managers' propensity to use either downward forecast guidance or real earnings management as a substitute mechanism to avoid earnings surprises.

Design/methodology/approach

Following Barton and Simko, the paper uses the beginning balance of net operating assets relative to sales as a proxy for the balance sheet constraint. The argument is that because of the articulation between the income statement and the balance sheet, previous accounting choices that increase earnings will also increase net assets and therefore the level of net assets reflects the extent of previous accrual management. Models from Matsumoto and Bartov et al. are used to measure forecast guidance. Following Rochowdhury and Cohen et al., a firm's abnormal level of production costs and discretionary expenditures are used as proxies of real earnings management. The empirical analysis is conducted based on the 1996‐2006 annual data for a sample of nonfinancial, nonregulated firms.

Findings

The paper finds that firms with higher level of beginning net operating assets relative to sales are more likely to guide analysts' earnings forecasts downward, and more likely to engage in real earnings management in terms of abnormal increases in production costs and abnormal reductions in discretionary expenditures.

Research limitations/implications

Overall, the paper's evidence suggests that managers turn to real earnings management or downward forecast guidance as a substitute mechanism to avoid negative earnings surprises when their ability to manipulate accruals upward is constrained by the extent to which net assets are already overstated in the balance sheet.

Originality/value

This study adds to prior literature that examines how managers trade off different mechanisms used to meet or beat analysts' earnings expectations. It also contributes to the extant literature by providing further insights on the role of balance sheet information in the process of managing earnings and/or earnings surprises.

Details

Review of Accounting and Finance, vol. 11 no. 2
Type: Research Article
ISSN: 1475-7702

Keywords

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Article

Tao Zeng

– The purpose of this paper is to examine earnings management around tax rate reduction in the wake of the 2007 corporate tax reform in China.

Abstract

Purpose

The purpose of this paper is to examine earnings management around tax rate reduction in the wake of the 2007 corporate tax reform in China.

Design/methodology/approach

This paper is an empirical work using a sample of listed Chinese real estate firms.

Findings

This study finds that firms managed earnings, including accrual-based earnings management and real earnings management, to decrease income in the fourth quarter of 2007, and to increase income in the first quarter of 2008. It suggests that the real estate firms were shifting income from the fourth quarter of 2007, when the statutory tax rate was 33 per cent, to the first quarter of 2008, when the statutory tax rate was 25 per cent, and therefore saved on tax payments. It also finds that corporate ownership structures, including ownership concentration and state ownership, affect earnings management. In the fourth quarter, state ownership is negatively associated with accrual-based earnings management, while ownership concentration is positively related to both accrual and real earnings management. In the first quarter, state ownership is negatively related to real earnings management.

Social implications

Tax authority and policy makers might be interested in evidence on earnings management around tax rate reduction. Changes in tax rates increase the incentives to shift income, which may warrant a closer scrutiny by both outside auditors and tax auditors.

Originality/value

This paper is the first study that relates to both accrual-based earnings management and real earnings management to corporate tax rate changes by showing that firms manipulate income upward in the low-tax-rate periods and downward in the high-tax-rate periods.

Details

Asian Review of Accounting, vol. 22 no. 3
Type: Research Article
ISSN: 1321-7348

Keywords

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Article

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

Keywords

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Article

Guanglu (Luke) Xu and Xudong Ji

The main aim of this study was to examine the earnings management behaviours, including both accrual-based and cash flow-based earnings management, of Chinese firms during…

Abstract

Purpose

The main aim of this study was to examine the earnings management behaviours, including both accrual-based and cash flow-based earnings management, of Chinese firms during the Global Financial Crisis (GFC).

Design/methodology/approach

A data set of 1,392 firm-year observations derived from a large sample of China's top listed firms (based on total assets) was constructed and investigated via univariate and ordinary least squares regression analyses.

Findings

Two distinct conclusions can be drawn from the results of the study. First, the top Chinese listed firms did engage in earnings management, as indicated by comparisons of the means of the absolute values of both accrual-based and cash flow-based earnings management indicators in the periods before and after 2008 when the GFC started. Second, investigation of earnings management directions revealed that in response to the GFC, the firms from construction-related industries and the airline industry manipulated earnings upwards through either accrual-based and/or cash flow-based earnings management activities. On the other hand, firms in the household durables industry engaged in earnings-reducing activities. These findings reflect the effect of the stimulus package launched by the Chinese Government in an effort to combat the GFC. In addition, the results indicate that firm characteristics such as size, leverage, profitability and growth affected the earnings management behaviours of the firms analysed in the study.

Originality/value

The empirically derived findings of this study contribute to the literature pertaining to the effects of the GFC on earnings management practices in China, which has remained relatively scant to date.

Details

International Journal of Accounting and Information Management, vol. 24 no. 3
Type: Research Article
ISSN: 1834-7649

Keywords

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Article

Fernando Comiran, Tatiana Fedyk and Joohyung Ha

This paper aims to investigate how media coverage affects the quality of accounting information for seasoned equity offering (SEO) firms.

Abstract

Purpose

This paper aims to investigate how media coverage affects the quality of accounting information for seasoned equity offering (SEO) firms.

Design/methodology/approach

The sample includes SEOs completed between January 1993 and December 2014 in the USA that are available from Thomson Financial’s Securities Data Company. The FactSet database was used to measure the amount of media coverage. The paper considers two types of earnings management: accrual-based earnings management and real earnings management.

Findings

This study finds that the media serves as a watchdog for real earnings management but does not affect accrual manipulations. These findings hold when endogenous factors affecting firms’ earnings management choices are controlled for and also when alternative time windows for media coverage are examined.

Originality/value

This paper is the first to demonstrate that media attention affects the quality of accounting information during equity offerings, as it successfully reduces real earnings management.

Details

International Journal of Accounting & Information Management, vol. 26 no. 3
Type: Research Article
ISSN: 1834-7649

Keywords

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