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Article
Publication date: 6 December 2019

Bing Luo

The purpose of this paper is to investigate the association between managers’ short-term, quarterly earnings forecast characteristics and earnings management through real

Abstract

Purpose

The purpose of this paper is to investigate the association between managers’ short-term, quarterly earnings forecast characteristics and earnings management through real activities manipulation.

Design/methodology/approach

Using a propensity-score matched sample from 2000 to 2015, the author examines whether, compared to non-issuers, firms issuing short-term earnings forecasts exhibit abnormal levels of earnings management through the manipulation of real activities such as acceleration of sales, changes in shipment schedules and delaying R&D and maintenance expenditures.

Findings

The finding of this study suggests that firms actually engage in less real activities manipulation when they provide short-term management earnings forecasts. This result does not support the practitioners’ criticism that providing short-term management earnings forecasts increases earnings management. Instead, it suggests that providing management earnings forecasts can reduce information asymmetry between managers and external shareholders, thereby constraining managers’ opportunistic behaviors.

Originality/value

Practitioners have expressed concerns that issuing earnings forecasts may foster managerial myopia, therefore, increasing earnings management. However, recent empirical study found evidence that management earnings forecast mitigates accrual-based earnings management, which is inconsistent with practitioners’ view. This study hence aims to provide timely evidence to this debate by examining the relation between management earnings forecasts and real activities manipulation.

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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: 14 August 2017

Nana Y. Amoah, Anthony Anderson, Isaac Bonaparte and Susan Muzorewa

This study aims to examine the use of real activities manipulation by firms implicated in the stock option backdating scandal.

Abstract

Purpose

This study aims to examine the use of real activities manipulation by firms implicated in the stock option backdating scandal.

Design/methodology/approach

The real activity manipulation measures are as follows: abnormal R&D expense, abnormal SG&A expense, abnormal production cost and abnormal cash flow from operations. Using a sample of firms alleged to have backdated options during the period 1998-2006 and non-backdating one-on-one matched firms, a separate regression is run for each of the real activity manipulation measures (dependent variables) on backdating and other variables.

Findings

The authors report unusually low R&D and unusually low SG&A expenses among the backdating firms. They also find evidence of unusually high production costs among backdating firms compared to the matched firms.

Research limitations/implications

The findings imply that backdating firms are more aggressive in the use of real activities to manipulate earnings and the use of real activities appears to be opportunistic.

Originality/value

The study contributes to the literature by providing evidence of the use of real activities manipulation by firms under investigation for fraud. The authors also add to the debate on whether the use of stock options as part of compensation aligns the interest of management with the interest of shareholders.

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: 12 August 2021

Lara M. Alhaddad, Mark Whittington and Ali Meftah Gerged

This paper aims to examine the extent to which real earnings management (REM) is used in Jordan to meet zero or previous year's earnings, and how this impacts the…

Abstract

Purpose

This paper aims to examine the extent to which real earnings management (REM) is used in Jordan to meet zero or previous year's earnings, and how this impacts the subsequent operating performance of Jordanian firms.

Design/methodology/approach

The study used a sample of 98 Jordanian listed firms over the 2010–2018 period. To test the research hypotheses, which are formulated in accordance with both, agency theory and signalling theory, multivariate regression is performed using a pooled OLS estimation. Additionally, a two-step dynamic generalised method of moment (GMM) model has been estimated to address any concerns regarding the potential occurrence of endogeneity issues.

Findings

The results show that Jordanian firms that meet zero or last year's earnings tend to exhibit evidence of real activities manipulations. More specifically, suspect firms show unusually low abnormal discretionary expenses and unusually high abnormal production costs. Further, consistent with the signalling earnings management argument, the authors find that abnormal real-based activities intended to meet zero earnings or previous year's earnings potentially improve the subsequent operating performance of Jordanian firms. This implies that REM is not totally opportunistic, but it can be used to enhance the subsequent operating performance of Jordanian firms. Our findings are robust to alternative proxies and endogeneity concerns.

Practical implications

The findings have several implications for policymakers, regulators, audit professionals and investors in their attempts to constrain REM practices to enhance financial reporting quality in Jordan. Managing earnings by reducing discretionary expenses appeared to be the most convenient way to manipulate earnings in Jordan. It provides flexibility in terms of time and the amount of spending. The empirical evidence, therefore, reiterates the crucial necessity to refocus the efforts of internal and external auditors on limiting this type of manipulation to reduce the occurrence of REM activities and enhance the subsequent operating performance of listed firms in Jordan. Drawing on Al-Haddad and Whittington (2019), the evidence also urges regulators and standards setters to develop a more effective enforcement mechanism for corporate governance provisions in Jordan to minimise the likelihood of REM incidence.

Originality/value

This study contributes to the body of the accounting literature by providing the first empirical evidence in the Middle East region overall on the use of REM to meet zero or previous year earnings by Jordanian firms. Moreover, the study is the first to empirically examine the relationship between REM and Jordanian firms' future operating performance.

Details

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

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Article
Publication date: 19 March 2021

Syed Numan Chowdhury and Yasser Eliwa

The purpose of this paper is to examine whether audit quality influence real earnings management activities using a sample of UK listed firms that have strong incentives…

Abstract

Purpose

The purpose of this paper is to examine whether audit quality influence real earnings management activities using a sample of UK listed firms that have strong incentives to manage earnings upward through meeting past year’s earnings as a benchmark in the post-adoption period of International Financial Reporting Standards (IFRS).

Design/methodology/approach

The authors use a sample of 4,774 firm-year observations of UK listed firms during the period 2005–2018. Univariate and multivariate analyses have been conducted to test the association after controlling for firm characteristics and institutional variables.

Findings

The study reports that the presence of Big 4 auditors is significantly and positively related with greater levels of sales and discretionary expenses manipulation. Though the authors do not find any conclusive evidence on production costs manipulation, the aggregated measure of real earnings management shows a significant positive association with the presence of Big 4 auditors.

Practical implications

The study implies that managers who have incentives to manage earnings upward around the UK firms take advantage of the accounting flexibility in defining policies while reducing information asymmetry among the investors to signal better future performance. The approach to detect earnings manipulation as described in the auditing standards fails to limit the managerial use of real activities due to limited scope and unclear guidance. Thus, due to the significant impact on public policies, the results should, therefore, be of interest to the regulators and standard setters.

Originality/value

To the best of the authors’ knowledge, this is the first study that examines the association between audit quality and real earnings management for the UK all-purpose operational firms in sampled data that just meet past year’s earnings as a benchmark in the post-IFRS period.

Details

International Journal of Accounting & Information Management, vol. 29 no. 3
Type: Research Article
ISSN: 1834-7649

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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.

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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: 6 February 2019

Sirada Nuanpradit

The purpose of this paper is to investigate the individual and interaction effects of chief executive officers (CEO)-chairman leadership structure (CEO duality) and…

Abstract

Purpose

The purpose of this paper is to investigate the individual and interaction effects of chief executive officers (CEO)-chairman leadership structure (CEO duality) and CEO-serviced early years (the first three years in office) on real earnings management (REM) through sales activities of listed firms in the Stock Exchange of Thailand (SET).

Design/methodology/approach

The longitudinal data on CEO and chairman names of 3,825 firm-year observations were manually gleaned from the SET market analysis and reporting tool and the annual reports from 2001 to 2015. Multiple regressions were utilized to analyze the effects.

Findings

The findings show a positive relationship between CEO duality and sales-driven REM. However, the CEO-serviced early years have no association with sales-driven REM. The CEO duality/serviced early year interaction effect is positively correlated to sales manipulation. In addition, firms with the CEO duality engage in upward or downward sales-driven REM, while firms with newly appointed CEO adopt only the upward sales-driven REM. In firms which their newly appointed CEO concurrently serves as chairman, either upward or downward sales-driven REM strategy is introduced.

Practical implications

The findings provide some grounds for capital market and regulators to exercise caution when it comes to firms with the newly appointed CEO and/or the CEO duality, given a high tendency to manipulate sales revenues.

Originality/value

This study is the first to investigate the relationship between the CEO duality/serviced early years on sales-driven REM. The findings are expected to complement existing publications on REM.

Details

Asia-Pacific Journal of Business Administration, vol. 11 no. 1
Type: Research Article
ISSN: 1757-4323

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Article
Publication date: 3 February 2014

Jerry Sun, George Lan and Guoping Liu

The purpose of this study is to investigate the effectiveness of independent audit committees in constraining real earnings management. This study examines the…

Downloads
6339

Abstract

Purpose

The purpose of this study is to investigate the effectiveness of independent audit committees in constraining real earnings management. This study examines the relationships between audit committee characteristics and real activities manipulation.

Design/methodology/approach

US firms with stronger incentives to undertake real earnings management are selected as a sample. Regressions are run for the empirical analyses.

Findings

It is found that audit committee members' additional directorships are positively associated with real earnings management measured by abnormal cash flows from operations, abnormal discretionary expenses and abnormal production costs, suggesting that audit committees with high additional directorships are less effective in constraining real earnings management. The findings are consistent with the notion that audit committee members' busyness impairs their monitoring effectiveness.

Originality/value

This study extends the extant research on audit committees' oversight of real earnings management by using refined research design and updated data. This study also provides further evidence on how audit committee members' additional directorships affect their ability to oversee both accrual and real earnings management.

Details

Managerial Auditing Journal, vol. 29 no. 2
Type: Research Article
ISSN: 0268-6902

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Article
Publication date: 14 October 2020

Naser Makarem and Clare Roberts

The purpose of this study is to investigate whether earnings boosts before the year end trigger earnings management. It examines whether firms that substantially…

Abstract

Purpose

The purpose of this study is to investigate whether earnings boosts before the year end trigger earnings management. It examines whether firms that substantially outperformed their last year earnings during the first three quarters push their earnings down to avoid reporting earnings boosts.

Design/methodology/approach

Regression analysis is used to compare earnings management of firms with earnings boosts and other firms.

Findings

The results indicate that firms outperforming their last year results by the end of the third quarter manipulate their earnings downwards by means of real activities manipulation, while they do not indicate income-decreasing accruals management. It is also found that consistent with the prominent shift from accruals management to real activities manipulation, accruals management is less costly which justifies why it is used for downward manipulation.

Research limitations/implications

The results are limited to one single earnings benchmark i.e. last year earnings. Further research may individually or collectively examine other benchmarks including analysts' forecasts.

Practical implications

The findings suggest that users should be more vigilant of firms exceeding their last year interim results, as they could be involved in downward earnings management.

Originality/value

This study documents earnings management in a new setting where earnings boosts before the year end trigger downward manipulation of real activities.

Details

Journal of Applied Accounting Research, vol. 21 no. 4
Type: Research Article
ISSN: 0967-5426

Keywords

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