Earnings management and firm valuation under asymmetric information

This paper seeks to provide an explanation for why corporate officers manage the disclosure of accounting information. We show that earnings management affects firm value when value-maximizing managers and investors are asymmetrically informed. In equilibrium, the strategic management of reported earnings influences investors' assessments of the market values of companies' shares.     

Earnings management and earnings quality

Viewing the detection of earnings management from the perspective of a crime scene investigator sheds new light on prior research on earnings management and its close relative, earnings quality. The works of Ball and Shivakumar [2008. Earnings quality at initial public offerings. Journal of Accounting and Economics, in press.] and Teoh et al. [1998. Earnings management and the subsequent market performance of initial public offerings. Journal of Finance 53, 1935–1974.] are used to illustrate the application of seven components of a crime scene investigation to earnings management research.     

Earnings management of target firms and deal premiums: The role of industry relatedness

This paper contributes to the merger and acquisitions (M&A) literature by providing evidence for the role of industry relatedness in the association between target firms' earnings management (EM) before the deal and the premium offered by the acquirer. We argue that familiarity with the industry's policies and practices is a crucial factor that helps acquirers to see through targets' EM. Our evidence supports this prediction in relation to accounting manipulation as we observe that the income increasing accrual manipulation of the target results in significantly higher premiums offered by acquirers in interindustry deals, which is not the case when targets and acquirers belong to the same industry.     

Earnings management of seasoned equity offering firms in Korea

We investigated 249 Korean seasoned equity offering (SEO) firms during the period 1995-1997 to determine if the SEO firms manage earnings in the year before a planned issue of seasoned equity stocks. Using three test methods (accrual difference, correlation, and sign-change), we found that the Korean firms contemplating SEOs in the following year do manage earnings particularly when their relative performances have been poor. The results are robust irrespective of control samples. Analysis of operating performances around SEOs shows that SEO firms tend to increase reported earnings in the year immediately preceding and the year of SEOs, but no differences were found in operating cash flows between the SEO firms and the control firms. By using a regression analysis for discretionary accruals, we found that SEO firms are more likely to manage earnings if the operating performances are poor and if the offer sizes are relatively large. Association tests between stock returns and discretionary accruals indicate that the market reacts positively to net income but negatively to discretionary accruals. The results indicate that the market correctly analyzes the cash flow implications of the SEO firms' opportunistic use of discretionary accruals.     

Earnings management induced by tax planning: The case of Portuguese private firms

In Portugal, a concept of taxable income associated closely with reported accounting income is used to determine the tax liability of firms. Recently, the Portuguese government legislated to introduce a system of “special payment on account” (SPA). Firms were required to pay an amount of income tax in advance that varied between a promulgated minimum and maximum. Although such a tax is unique to Portugal, other countries have tax arrangements that are similar in intent. Thus, Portugal's experience with the introduction of a SPA regime is likely to be instructive in fiscal policy deliberations in other settings.We assess the extent to which the SPA tax policy measure encouraged private Portuguese companies to manipulate earnings. We find that earnings manipulation appears to have been motivated by desire to minimize SPA. Firms whose estimate of SPA liability fell within the range of minimum and maximum limits of the SPA had higher levels of discretionary accruals than firms whose estimate was (equal to or) above the ceiling imposed by the new legislation. Firms with higher rates of income tax were found to reduce earnings to near zero. Firms with higher average income tax rates were more likely to manipulate their earnings than other firms.Our results reinforce the importance for auditors, stakeholders, and tax policy advisors to be alert to the close association between tax planning considerations and reported earnings in their monitoring, analysis, and policy advising activities.     

Stock Price Reaction to Evidence of Earnings Management: Implications for Supplementary Financial Disclosure

We condition security price reactions to quarterly earnings announcements on whether firms disclose supplementary balance sheet and/or cashflow information that can be used to estimate the consequences of earnings management. Disclosure of supplementary information is voluntary, and thus, we consider the possibility that firms that disclose balance sheet and/or cashflow information differ systematically from firms that do not disclose. Results indicate that investors discount evidence of earnings management at the disclosure date when supplementary information is disclosed. Such results indicate more informed earnings interpretations of quarterly earnings when firms provide balance sheet and/or cashflow information concurrently.

Influence of Culture on Earnings Management: A Note

This article examines the influence of national culture on earnings management across a broad cross-section of countries. In addition to examining the relation between culture and earnings management in general, two different types of earnings management are examined, namely, earnings smoothing and earnings discretion. Regression results indicate that, as expected, the cultural dimensions of uncertainty avoidance and individualism are significantly related to earnings management, even after controlling for investor protection and other legal institutional factors. Culture has a stronger relation with earnings smoothing than with earnings discretion, and cultural dimensions explain a greater percentage of the variation in aggregate earnings management and earnings smoothing than do investor protection variables. These findings suggest that there is a significant link between culture and cross-national differences in earnings management, especially in the form of earnings smoothing.     

Earnings forecast disclosure regulation and earnings management: evidence from Taiwan IPO firms

This study examines whether the Taiwanese regulation requiring disclosure of earnings forecasts in the IPOs resulted in disclosure of more optimistic earnings forecasts and whether the forecast error was reduced more by manipulating the reported earnings rather than revising the earnings forecasts to meet the forecast error threshold. The study is based on 759 forecasts issued by the Taiwanese IPO firms from 1994 to 2001, i.e. 8-year period after the regulation was modified to increase the forecast error threshold to 20%. The findings show that the disclosure regulation resulted in more optimistic forecasts than conservative forecasts, especially for firms expecting better performance in the forecast year compared to the previous year. Firms disclosing optimistic earnings forecasts engaged more in manipulation of reported earnings than revision of forecasts to meet the forecast error threshold. These findings thus suggest that the disclosure regulation resulted in earnings manipulation, which reduced the quality of reported earnings. We received valuable comments at the 2003 American Accounting Association and 2004 Euorpean Accounting Association annual meetings. We also thank the participants at the research seminars at Rutgers University, City University of Hong Kong, and Pace University, for their insightful comments. Picheng Lee especially thanks Pace University for 2003 summer research grant.     

会计准则改革、实际控制人性质与盈余管理

以2003～2005、2008～2010年间沪、深A股制造业上市公司为样本,考察会计准则改革对实际控制人性质不同公司盈余管理程度的影响。结果表明,会计准则改革后,中央控股公司的盈余管理程度没有发生显著变化,地方控股公司和民营公司的盈余管理程度均显著提高,且二者盈余管理程度提高的幅度不存在显著差异。     

Earnings management of initial public offering firms: evidence from regulation changes in China

Discretionary current accruals of Chinese initial public offering (IPO) firms decreased after the abolition of fixed‐price offering systems that directly linked offering price to reported earnings. Results suggest IPO firms that decrease managerial ownership manage earnings upward during the fixed‐price offering period, but this relationship disappeared after the introduction of a book‐building system. We also find that bank debt is negatively related to discretionary current accruals during the fixed‐price offering period, but no relation exists for the book‐building period. Leverage has a significant positive relationship with earnings management. However, this finding is potentially attributable to nonoffering price objectives or endogeneity biases.     

Capitalization of R&D costs and earnings management: Evidence from Italian listed companies

The capitalization of research and development (R&D) costs is a controversial accounting issue because of the contention that such capitalization is motivated by incentives to manipulate earnings. Based on a sample of Italian listed companies, this study examines whether companies' decisions to capitalize R&D costs are affected by earnings-management motivations. Italy provides a natural context for testing our hypothesized relationships because Italian GAAP allows for the capitalization of R&D costs. Using a Tobit regression model to test our hypotheses, we show that companies tend to use cost capitalization for earnings-smoothing purposes. The hypothesis that firms capitalize R&D costs to reduce the risk of violating debt covenants is not supported.     

Earnings management following chief executive officer changes: the effect of contemporaneous chairperson and chief financial officer appointments

Using a sample of listed Australian firms from 1999 to 2007, we examine the relationship between discretionary accruals and concurrent senior management appointments. Employing panel data regression models and focusing on a measure of discretionary accruals that excludes the effect of transparent write‐downs such as restructuring charges, we find that chief executive officer (CEO) appointments, as a general phenomenon, are not significantly associated with opaque earnings management in the year of appointment or the following year. However, we find that CEO changes accompanied by a concurrent change in board chairperson are associated with significant income‐decreasing earnings management in the year of appointment. We detect no significant relationship between contemporaneous CEO and chief financial officer changes and discretionary accruals. We find no evidence of earnings management in the first compete financial period following CEO appointment, regardless of whether or not concurrent Chair or chief financial officer appointments occurred.     

A study of earnings-management motives in the Anglo-American and Euro-Continental accounting models: The Canadian and French cases

The purpose of this paper is to investigate factors that potentially influence earnings-management policy with reference to the Anglo-American and Euro-Continental accounting models. Canada and France, respectively, belong to those different socio-economic environments. Earnings-management practices detected in those countries are expected to be affected by specific socio-economic features of the Anglo-American and the Euro-Continental environments. We explain earnings-management practices by incentives suggested in the literature to reveal which motives are prominent within each environment.We tested our earnings-management motives (EMM) model using appropriate panel-estimation techniques over 1674 Canadian and 1470 French firm-year observations. Our results provide evidence that incentives for earnings management for French firms are specifically linked to contractual debt costs and effective tax rate. However, Canadian firms show specific incentives matched with a dynamic capital market. Issuing equity is a strong motive for earnings management in Canadian firms.     

Corporate governance and earnings management in the Chinese listed companies: A tunneling perspective

This paper examines the relation between earnings management and corporate governance in China by introducing a tunneling perspective. We document systematic differences in earnings management across the universe of China's listed companies during 1999–2005, and empirically demonstrate that firms with higher corporate governance levels have lower levels of earnings management. We study two China-specific situations, in which the listed firms have strong incentives to manage earnings in order to meet certain return on equity (ROE) thresholds, and earnings management has been shown to be the most conspicuous. We identify tunneling evidence for each. Our empirical findings, although not being able to completely exclude other explanations, strongly suggest that agency conflicts between controlling shareholders and minority investors account for a significant portion of earnings management in China's listed firms.     

Pension accrual management and research and development investment

This study investigates whether discretion in reporting pension expenses mitigates research and development (R&D) manipulation. Using a sample of Japanese manufacturing firms during the fiscal years 2001–2011 where both pension costs and R&D expenditures have large impacts on the bottom‐line earnings, I find that higher discount rates are associated with higher R&D investment among firms in which pension expenses could have large impacts on reported earnings. I also find that this relationship is found only among firms in high‐tech industries. These results suggest that pension accrual management substitutes costly R&D manipulation that may hurt future competitive edge.     

Labor cost voluntary disclosures and firm equity values: Is human capital information value-relevant?

This study examines the market value relevance of labor cost voluntary disclosures using a valuation model relating firm market values to book values of equity and to disclosed human capital information, such as labor costs, net pension liabilities (NPLs), and estimated average and marginal labor productivity and efficiency indicators. Results indicate that labor cost disclosing companies command higher equity market values in general, and that labor productivity and efficiency measures appear to be undervalued. Both findings suggest that there might be market opportunities for firms with valuable human capital to differentiate themselves from their industry peers, which might encourage further human capital disclosure in the future. More refined measures of human capital assets and investments are needed to assess firms’ human resource management decisions and performance impacts in the capital markets more adequately.     

Earnings management and initial public offerings: Evidence from the Netherlands

This paper presents one of the first studies of earnings management by initial public offering (IPO) firms in a European country. Using a sample of 64 Dutch IPOs, we investigate the pattern of discretionary current accruals (DCA) over time. We find that managers manage their company's earnings in the first year as a public company but not in the years before the IPO. We also examine the impact of earnings management on the long-run stock price performance of IPOs. We find a negative relation between the size of the DCA in the first year as a public company and long-run stock price performance over the next 3 years. A number of additional tests support these findings.     

A Comparative Analysis of Real and Accrual Earnings Management around Initial Public Offerings under Different Regulatory Environments

While earnings management around IPOs has been researched in a number of settings, there has been a relative absence of work that analyses the impact of the regulatory environment on such activities. We find that the regulatory environment does impact the real and accrual earnings management activities of IPO firms. Our results show that IPO firms listing on the lightly regulated UK Alternative Investment Market (AIM) have higher (lower) levels of accrual‐based and sales‐based (discretionary expenses‐based) earnings management around the IPO than firms listing on the more heavily regulated Main market in the UK.     

Earnings management in the pre-IPO process: Biases and predictors

We analyze a sample of 3,293 IPOs from 29 countries to investigate the firm, industry, and country characteristics related to earnings management during the IPO process. We find that IPO firms tend to have significantly positive discretionary accruals (DCA) both prior to and after the IPO, suggesting that IPO firms tend to engage in pre-IPO earnings management. However, we also find that using a proxy for earnings management in the IPO year may lead to biased conclusions concerning pre-IPO earnings management. Firms that are more likely to need access to capital markets in the future (firms with high leverage, and firms backed by a venture capitalist) are less likely to engage in pre-IPO earnings management. Firms operating in countries with a superior rule of law are also less likely to engage in earnings management. Lastly, we find that firms may engage in pre-IPO earnings management in part to avoid returning to the capital markets to raise more funds (capital market staging). This result is robust to possible endogeneity bias stemming from management self-selection.     

Earnings management and the allocation of net periodic pension costs to interim periods

We examine the pattern of reported quarterly net periodic pension costs. Quarterly pension costs are one of the largest single expense items for firms with pension plans (around 15% of income before extraordinary items in our sample). Under ASC 270, net pension costs should be recognized as incurred, or as the benefit provided by the expense is realized. We find that over the period of 2004–2010, there is significant variation in the amount of quarterly pension cost firms report. In addition, we find that income-increasing changes in pension costs are significantly associated with meeting or beating analysts' forecasts in a given quarter. We also show that income-decreasing changes to net periodic pension costs that would cause a firm to miss its earnings forecast are extremely rare. Finally, we find evidence that income-increasing and income-decreasing changes in quarterly pension costs are “settled up” in the fourth quarter (e.g., they are reversed).