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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…

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. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0967-5426

Keywords

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…

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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.

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.

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

Keywords

Article
Publication date: 14 October 2022

Neerav Nagar and Mehul Raithatha

The authors examine whether internal corporate governance mechanisms are effective in curbing cash flow manipulation through real activities, misclassification, and timing.

Abstract

Purpose

The authors examine whether internal corporate governance mechanisms are effective in curbing cash flow manipulation through real activities, misclassification, and timing.

Design/methodology/approach

The sample comprises of firms from an emerging market, India with data for years 2004 through 2015. The authors use the methodology given in Roychowdhury (2006).

Findings

The authors find that corporate boards in India play an active role in curbing cash flow manipulation through real activities but fail to control cash flow manipulation through misclassification and timing.

Practical implications

The study suggests that corporate boards should pay more attention to the reported cash flow numbers. Regulators can reduce the opportunities available for cash flow misclassification by fixing relevant accounting and governance norms. Auditors can also help by critically focusing on the cash flow classifications presented by management.

Originality/value

This study, to the authors’ knowledge, is the first study that talks about the role of internal governance in a trade-off between different cash flow manipulation techniques.

Details

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

Keywords

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. 12 no. 2
Type: Research Article
ISSN: 2042-1168

Keywords

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

Keywords

Article
Publication date: 13 May 2022

Apostolos Christopoulos, Ioannis Dokas, Christos Leontidis and Eleftherios Spyromitros

This paper attempts to investigate the effect of corruption on the real and accrual earnings management of target firms in the process of mergers and acquisitions.

Abstract

Purpose

This paper attempts to investigate the effect of corruption on the real and accrual earnings management of target firms in the process of mergers and acquisitions.

Design/methodology/approach

The sample includes target firms from the European area that participate in mergers or acquisitions announced during 2010–2020. The preliminary empirical part estimates the level of earnings management during the period two years before the deal's announcement to identify whether the sample follows the manipulation behavior that the literature suggests for target firms. The primary empirical analysis focuses on the impact of corruption on real and accrual-based earnings management proxies, employing regression models and two alternative proxies for corruption. The existing literature points out that the combination of low levels of corruption and an integrated legal system reduces earnings manipulation.

Findings

The findings provide strong evidence for systematic downwards accounting manipulation practices, whereas the findings for real earnings management are not significant. The findings of the main empirical part show that corruption is positively associated with accrual-based manipulation and negatively related to real earnings management. In essence, in economies with a high level of transparency, managers adopt the manipulation of operating activities as a less detectable practice of earnings management instead of engaging in accounting procedures.

Originality/value

This study contributes to the literature highlighting the diversification of these firms' manipulation strategies according to the national level's corruption status.

Details

EuroMed Journal of Business, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1450-2194

Keywords

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

Keywords

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

Keywords

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