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Open Access
Article
Publication date: 14 March 2023

Wessel M. Badenhorst and Rieka von Well

This paper aims to investigate the pricing of discretionary earnings in South Africa. This is a unique setting, as South African listed firms also report mandatory non-GAAP…

Abstract

Purpose

This paper aims to investigate the pricing of discretionary earnings in South Africa. This is a unique setting, as South African listed firms also report mandatory non-GAAP earnings (“headline earnings”).

Design/methodology/approach

Results are based on multivariate regression analyses for South African firms that report from 2010 to 2019.

Findings

Findings show that the value-relevance of discretionary earnings exceeds that of both GAAP earnings and headline earnings. In addition, placement of discretionary earnings reconciliations communicates information about the decision-usefulness of earnings.

Originality/value

Discretionary earnings remain the most value-relevant earnings measure, despite the divergent decision-useful characteristics offered by headline earnings and GAAP earnings. Therefore, the most decision-useful earnings reflect unique industry or firm characteristics rather than the assurance arising from regulation.

Details

Pacific Accounting Review, vol. 35 no. 3
Type: Research Article
ISSN: 0114-0582

Keywords

Article
Publication date: 26 August 2022

Thi Thu Ha Nguyen, Salma Ibrahim and George Giannopoulos

The use of models for detecting earnings management in the academic literature, using accrual and real manipulation, is commonplace. The purpose of the current study is to compare…

Abstract

Purpose

The use of models for detecting earnings management in the academic literature, using accrual and real manipulation, is commonplace. The purpose of the current study is to compare the power of these models in a United Kingdom (UK) sample of 19,424 firm-year observations during the period 1991–2018. The authors include artificially-induced manipulation of revenues and expenses between zero and ten percent of total assets to random samples of 500 firm-year observations within the full sample. The authors use two alternative samples, one with no reversal of manipulation (sample 1) and one with reversal in the following year (sample 2).

Design/methodology/approach

The authors include artificially induced manipulation of revenues and expenses between zero and ten percent of total assets to random samples of 500 firm-year observations within the full sample.

Findings

The authors find that real earnings manipulation models have lower power than accrual earnings manipulation models, when manipulating discretionary expenses and revenues. Furthermore, the real earnings manipulation model to detect overproduction has high misspecification, resulting in artificially inflating the power of the model. The authors examine an alternative model to detect discretionary expense manipulation that generates higher power than the Roychowdhury (2006) model. Modified real manipulation models (Srivastava, 2019) are used as robustness and the authors find these to be more misspecified in some cases but less in others. The authors extend the analysis to a setting in which earnings management is known to occur, i.e. around benchmark-beating and find consistent evidence of accrual and some forms of real manipulation in this sample using all models examined.

Research limitations/implications

This study contributes to the literature by providing evidence of misspecification of currently used models to detect real accounts manipulation.

Practical implications

Based on the findings, the authors recommend caution in interpreting any findings when using these models in future research.

Originality/value

The findings address the earnings management literature, guided by the agency theory.

Details

Journal of Applied Accounting Research, vol. 24 no. 2
Type: Research Article
ISSN: 0967-5426

Keywords

Article
Publication date: 30 March 2022

Srikanth Potharla

The present study aims to examine the relationship between real earnings management and earnings persistence and also to test how the group affiliation of the firms influences…

Abstract

Purpose

The present study aims to examine the relationship between real earnings management and earnings persistence and also to test how the group affiliation of the firms influences this relationship.

Design/methodology/approach

The study draws the sample of listed non-financial firms in the Indian market from the year 2011 to 2018 and applies panel least squares regression with industry and year fixed effects. Future performance of a firm is measured by one year leading value of return on assets. The interaction term of real earnings management and return on assets is used to measure the impact of real earnings management on earnings persistence. The firm-specific controlling variables are also included in the empirical model. The robustness of the results is tested by sub-dividing the sample into group affiliated and non-group affiliated firms.

Findings

The findings of the study reveal that opportunistic earnings management has a significant impact on earnings persistence when real earnings management is measured through abnormal increase in operating cash flows and abnormal reduction in discretionary expenditure. On the other hand, signalling earnings management has a significant impact on earnings persistence when real earnings management is measured through abnormal increase in the level of production. The results also reveal that REM has more negative implications on group affiliated firms compared to non-group affiliated firms supporting the theory of entrenchment effect.

Originality/value

This is the first study in the Indian context which tests the implications of real earnings management on earnings persistence by using three alternative measures of real earnings management. The study contributes to the existing literature on the implications of real earnings management in emerging markets like India.

Details

International Journal of Emerging Markets, vol. 18 no. 11
Type: Research Article
ISSN: 1746-8809

Keywords

Article
Publication date: 28 December 2021

Ben Le and Paula Hearn Moore

This study aims to examine the effects of audit quality on earnings management and cost of equity capital (COE) considering the impact of two owner types: government ownership and…

1157

Abstract

Purpose

This study aims to examine the effects of audit quality on earnings management and cost of equity capital (COE) considering the impact of two owner types: government ownership and foreign ownership.

Design/methodology/approach

The study uses a panel data set of 236 Vietnamese firms covering the period 2007 to 2017. Because the two main dependent variables of the COE capital and the absolute value of discretionary accruals receive fractional values between zero and one, the paper uses the generalised linear model (GLM) with a logit link and the binomial family in regression analyses. The paper uses numerous audit quality measures, including hiring Big 4 auditors or the industry-leading Big 4 auditor, changing from non-Big 4 auditors to Big 4 auditors or the industry-leading Big 4 auditor, and the length of Big 4 auditor tenure. Big 4 companies include KPMG, Deloitte, EY and PwC, whereas the non-big 4 are the other audit companies.

Findings

The study finds a negative relationship between audit quality and both the COE capital and income-increasing discretionary accruals. The effects of audit quality on discretionary accruals and the COE capital depend on the ownership levels of two important shareholders: the government and foreign investors. Foreign ownership is negatively associated with discretionary accruals; however, the effect is more pronounced in the sub-sample of state-owned enterprises (SOEs), the firms where the government owns 50% or more equity, than in the sub-sample of Non-SOEs.

Originality/value

To the best of the knowledge, no prior similar study exists that used the GLM with a logit link and the binomial family regression. Global investors may be interested in understanding how unique institutional settings and capital markets of each country impact the financial reporting quality and cost of capital. Further, policymakers of developing markets may have incentives to improve the quality of financial reporting and reduce the cost of capital which should result in attracting more foreign investments.

Details

Journal of Financial Reporting and Accounting, vol. 21 no. 3
Type: Research Article
ISSN: 1985-2517

Keywords

Article
Publication date: 30 November 2023

Mohamed Esmail Elmaghrabi and Ahmed Diab

This study aims to examine the association between anti-corruption corporate disclosure and earnings management practices by bringing evidence from a developed market.

Abstract

Purpose

This study aims to examine the association between anti-corruption corporate disclosure and earnings management practices by bringing evidence from a developed market.

Design/methodology/approach

The study uses data from non-financial FTSE 100 Shares in 2016 and 2017. This study develops a disclosure index to capture the anti-corruption disclosures and run pooled, fixed effects and generalized methods of moments regression models to explore the anti-corruption disclosure–earnings management association. This study also disentangles discretionary accruals into positive and negative, use adjusted discretionary accrual computation and take a more conservative view on discretionary accruals computation as an additional analysis.

Findings

The results show a negative and significant association between anti-corruption disclosure and earnings management practices. When disentangling discretionary accruals (overvalued/positive and undervalued/negative), the authors found that higher anti-corruption disclosures were negatively associated with positive discretionary accruals, but not associated with negative discretionary accruals. The additional analysis confirmed the previous results, showing that anti-corruption disclosures are perceived as a substantive practice, rather than a mere disclosure practice for legitimacy reasons.

Originality/value

This study contributes to debate on the symbolic versus the substantive uses of anti-corruption disclosures in the UK context.

Details

Journal of Financial Crime, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 25 April 2023

Ling Tuo, Shipeng Han, Zabihollah Rezaee and Ji Yu

This study aims to address the unanswered question of whether corporate sustainability has an impact on auditors’ overall judgment and to provide incremental evidence that…

Abstract

Purpose

This study aims to address the unanswered question of whether corporate sustainability has an impact on auditors’ overall judgment and to provide incremental evidence that corporate sustainability reporting has significant effect on financial auditors’ judgment.

Design/methodology/approach

Following prior research, the authors, respectively, apply auditors’ decisions on going-concern opinions and three discretionary accrual measures as proxies for auditor conservatism over financial risk and financial reporting risk. The authors collect corporate sustainability reporting and sustainability assurance data of U.S. firms from the global reporting initiative (GRI) database to construct and measure firms’ sustainability reporting activities.

Findings

The authors find that nonreporting firms are more likely to receive going-concern opinions than the reporting firms. In addition, reporting firms have a larger scale of discretionary accruals than their nonreporting counterparts. The authors also obtain consistent findings that sustainability assurance or accounting assurance providers strengthen the effect of sustainability reporting on auditors’ judgment.

Research limitations/implications

First, using discretionary accruals as measures of auditor conservatism is controversial, as accruals are the joint product by auditors and clients. Second, binary variables as a measure of sustainability reporting activities limit the inference. Lastly, the findings based on limited samples may weaken the external validity.

Practical implications

The findings imply that firms engaging in sustainability activities are lower in financial or financial reporting risk. Firms can influence audit practitioners’ overall judgment through sustainability reports. Sustainability commitments and reporting have become a part of firms’ risk management.

Social implications

The findings imply that sustainability reporting could become an integrated part of regulated corporate disclosure. Sustainability assurance reduces social costs by lending credibility to sustainability reports.

Originality/value

This paper provides incremental evidence that sustainability reports provide useful information and signals that influence auditors’ professional judgment. The findings also suggest that sustainability assurance strengthens auditors’ confidence in using sustainability information, thus amplifying the effect of sustainability reporting on auditors’ judgment.

Details

International Journal of Accounting & Information Management, vol. 31 no. 3
Type: Research Article
ISSN: 1834-7649

Keywords

Open Access
Article
Publication date: 6 November 2023

Justin G. Davis and Miguel García-Cestona

As the influence of institutional investors over managerial decision-making grows, so does the importance of understanding the effect of institutional investor ownership (IO) on…

Abstract

Purpose

As the influence of institutional investors over managerial decision-making grows, so does the importance of understanding the effect of institutional investor ownership (IO) on firm outcomes. The authors take a comprehensive approach to studying the effect of IO on earnings management (EM).

Design/methodology/approach

The authors study the relation between IO and EM using a sample of 59,503 listed U.S. firm-year observations from 1981–2019. The authors proxy EM with earnings surprises and with accrual-based and real activity measures. The authors test for nonlinear relations and analyze changes resulting from the passage of the Sarbanes–Oxley Act.

Findings

The findings support a positive IO-EM relation overall, but show that the relation is dynamic and heavily context-dependent with evidence of nonlinearity. The authors also find evidence that IO positively affects accrual-based EM and real activities EM negatively.

Originality/value

To the authors’ knowledge, this is the first study of the IO-EM relation to consider evidence of nonlinearity in the U.S. context, measuring changes to the relation over time, and with the use of several measures of EM.

Details

Journal of Economics, Finance and Administrative Science, vol. 28 no. 56
Type: Research Article
ISSN: 2077-1886

Keywords

Article
Publication date: 7 February 2024

Yuri Gomes Paiva Azevedo, Mariana Câmara Gomes e Silva and Silvio Hiroshi Nakao

The purpose of this study is to examine the moderating effect of an exogenous corporate governance shock that curbs Chief Executive Officers’ (CEOs) power on the relationship…

Abstract

Purpose

The purpose of this study is to examine the moderating effect of an exogenous corporate governance shock that curbs Chief Executive Officers’ (CEOs) power on the relationship between CEO narcissism and earnings management practices.

Design/methodology/approach

The authors performed a quasi-experiment using a differences-in-differences approach to examine Brazil’s duality split regulatory change on 101 Brazilian public firms during the period 2010–2022.

Findings

The main findings indicate that the introduction of duality split curtails the positive influence of CEO narcissism on earnings management, suggesting that this corporate governance regulation may act as a complementary corporate governance mechanism in mitigating the negative consequences of powerful narcissistic CEOs. Further robustness checks indicate that the results remain consistent after using entropy balancing and alternative measures of CEO narcissism.

Practical implications

In emerging markets, where governance systems are frequently perceived as less than optimal, policymakers and regulatory authorities can draw insights from this enforcement to shape governance systems, reducing CEO power and, consequently, improving the quality of financial reporting.

Originality/value

To the best of the authors’ knowledge, this is the first study to examine whether a duality split mitigates the influence of CEO narcissism on earnings management. Thus, this study contributes to the corporate governance literature that calls for research on the effectiveness of external corporate governance mechanisms in emerging markets as well as the CEO narcissism literature that calls for research on moderating factors that could curtail negative consequences of narcissistic CEO behavior.

Details

Corporate Governance: The International Journal of Business in Society, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1472-0701

Keywords

Article
Publication date: 15 December 2023

Eric Valenzuela and Michael Zheng

The authors seek to analyze the impact of weak corporate governance by top executives of a firm on the firm's earnings reports. This research is meant to further emphasize the…

Abstract

Purpose

The authors seek to analyze the impact of weak corporate governance by top executives of a firm on the firm's earnings reports. This research is meant to further emphasize the impact of co-opted executives on a firm, primarily through their impact on earnings management.

Design/methodology/approach

Using financial data from 11,473 firm-year observations, the authors utilize ordinary least squares (OLS), 2-stage IV regressions, propensity score matching (PSM) and entropy balancing to analyze the impact of a co-opted top management team on discretionary accruals and restatements.

Findings

The authors find empirical evidence that firms with weak corporate governance from top executives are more likely to manipulate reported earnings and have lower financial reporting quality. The authors also find that the effect of co-opted executives on earnings management is weaker when a chief executive officer's (CEO’s) incentives are not aligned with those of top executives, suggesting that executives prevent earnings management due to reputational concerns. Co-opted chief financial officers (CFOs) increase the magnitude of earnings management in a firm but are not solely responsible for the authors' results.

Originality/value

The authors' results suggest that the top executive team provides an important first defense in the prevention of earnings management and corporate wrongdoing. Co-option of the top executive team may be an important consideration when doing research into corporate governance.

Details

Managerial Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 27 November 2023

Justin G. Davis and Miguel Garcia-Cestona

Motivated by rapidly increasing CEO age in the USA, the purpose of this study is to analyze the effect of CEO age on financial reporting quality and consider the moderating role…

Abstract

Purpose

Motivated by rapidly increasing CEO age in the USA, the purpose of this study is to analyze the effect of CEO age on financial reporting quality and consider the moderating role of clawback provisions.

Design/methodology/approach

This study uses a data set of 18,492 US firm-year observations from 2003 to 2019. Financial reporting quality is proxied with accruals-based and real activities earnings management measures, and with financial statement irregularities, measured by applying Benford’s law to financial statement line items. A number of sensitivity tests are conducted including the use of an instrumental variable.

Findings

The results provide evidence that financial statement irregularities are more prevalent when CEOs are older, and they suggest a complex relation between CEO age and real activities earnings management. The results also suggest that the effect of CEO age on financial reporting quality is moderated by the presence of clawback provisions which became mandatory for US-listed firms in October 2022.

Originality/value

This study is the first, to the best of the authors’ knowledge, to consider the effect of CEO age on financial statement irregularities and earnings management. This study has important implications for stakeholders evaluating the determinants of financial reporting quality, for boards of directors considering CEO age limitations and for policymakers considering mandating clawback provisions, which recently occurred in the USA.

Details

Journal of Financial Reporting and Accounting, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1985-2517

Keywords

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