Do Australian companies manage earnings to meet simple earnings benchmarks?

Measurement error in unexpected accruals is an important problem for empirical earnings management research. Several recent studies avoid this problem by examining the pooled, cross–sectional distribution of reported earnings. Discontinuities in the distribution of reported earnings around key earnings thresholds may indicate the exercise of management discretion (i.e. earnings management). We apply this approach to the detection of earnings management by Australian firms. Our results generally indicate significantly more small earnings increases and small profits than expected and conversely, considerably fewer small earnings decreases and small losses than expected. These results are much stronger for larger Australian firms. We undertake an exploratory analysis of alternative explanations for our results and find some evidence consistent with management signalling its inside knowledge about the firm's expected future profitability to smooth earnings, as opposed to 'management intent to deceive' as an explanation for our results.     

The impact of abnormal real earnings management to meet earnings benchmarks on future operating performance

Motivated by agency conflicts of real earnings management (e.g., opportunistic and signalling perspectives), this study investigates the association between firms that manipulate their business operations to meet earnings benchmarks (i.e., zero earnings, last year's earnings) and subsequent operating performance. We examine the effects of the magnitude of real earnings management on firms' future performance for the period 2009 to 2015 for UK firms. Our analysis shows that the manipulation of operating activities such as sales, discretionary expenditures, and production costs to meet earnings benchmarks has a significantly positive consequence for firms' subsequent operating performance and signals firms' good future performance. We also find that firms that manipulate their operating activities in the absence of meeting earnings benchmarks experience a decline in their subsequent operating performance. The findings of this research lend support to our understanding of the process that management follows to evaluate costs and benefits of real earnings management.     

Married couple work participation and earnings elasticities: evidence from tax data

This paper uses administrative tax panel data to estimate work participation and earnings elasticities of married couples by exploiting variation in tax policy. Not only may individuals alter labor supply by working more or less in response to changes in tax policy, they may also alter reported earnings or shift income between taxable and tax-deferred compensation. As a result, in addition to estimating the standard extensive and intensive labor supply elasticities, we also examine elasticities by type of income (wage earnings vs. self-employment earnings) and compensation (taxable vs. tax-deferred). We find that wives have more elastic work participation and earnings than husbands. Furthermore, self-employment income is more responsive to net-of-tax price changes than wage earnings for both husbands and wives, suggesting that it is easier for the self-employed to alter their work hours, work intensity, and/or reported income than wage earners. Finally, we find that wives respond to changes in the net-of-tax price of earnings by altering the amount of earnings subject to current-year taxes through adjustments of tax-deferred contributions to employer-provided retirement accounts.     

Stock price reactions to earnings announcements: evidence from Chinese markets

We examine the stock price reactions to changes in earnings per share (EPS) in the Chinese stock markets. We find that domestic A-share investors do not correctly anticipate the changes in earnings and fail to adjust new earnngs information quickly, but international B-share investors can predict earnings changes better than A-share investors. As a result, abnormal returns (ARs) can be obtained by trading on the earnings information, but for A shares only. An explanation is that most A-share holders are individuals with short-term investment horizon while most B-share holders are large institutions that trade on more detailed and accurate financial information not immediately available to A-share holders.     

CFO gender and earnings management: evidence from China

We study the effect of chief financial officer (CFO) gender on earnings management (EM) in China’s listed firms from 1999 to 2011. In the cross-sectional analysis, we find that female CFO firm-years exhibit significantly lower discretionary accruals, lower total accruals, lower abnormal production costs, and higher abnormal discretionary expenditures, than the male CFO firm-years. We further examine the relation between CFO gender and EM surrounding CFO transitions. We find that the departing male CFOs are more aggressive than the departing female CFOs in managing up earnings during their last year with the firm and the newly appointed male CFOs are more aggressive than the new female CFOs in managing down earnings during their first year on the job. The evidence surrounding CFO transitions suggests that male CFOs are more aggressive than female CFOs in manipulating earnings, either in the last attempt to save their jobs or to take bigger credit for any future performance gains. Overall, our empirical evidence suggests that female CFOs engage in less EM and are more conservative in financial reporting than their male counterparts.     

Contemporaneous verification of language: evidence from management earnings forecasts

Research documents that linguistic tone is incrementally informative about stock returns. What remains a puzzle is the mechanism by which investors can assess its credibility. We examine whether contemporaneous information in management earnings forecasts serves as a timely alternative to ex post verification. We document that ex post verifiable quantitative news in unbundled forecasts, and characteristics of the linguistic tone itself, affect investors’ pricing of tone. Consistent with higher quality signals enhancing the credibility of contemporaneous lower quality signals, we find that quantitative news verifies the associated linguistic tone; when the two signals have the same sign, the price effect of tone is stronger. Furthermore, the pricing attenuation of tone is increasing in the imprecision of the quantitative forecast, suggesting that lower forecast quality compromises the quantitative signal’s credibility enhancement. Managerial incentives to inflate tone lead to the verification effect being greater for optimistic language, while management’s use of hyperbole results in attenuation of the tone’s pricing.     

Central supervision and earnings management: Quasi-experimental evidence from China

Earnings management is costly to society because it decreases the informativeness of earnings and hence distorts capital market efficiency. Drawing upon a natural experiment generated by the staggered random on-site inspection programme initiated by China's central government between 2013 and 2017, this paper finds that highly intensive central supervision significantly decreases local firms' earnings management behaviours. Moreover, the effect of central supervision is found to be more pronounced in provinces with severe GDP exaggeration, provinces with local governors facing impending promotion, and firms controlled by the government. These findings suggest that on-site inspections by the central government may alleviate local officials' political incentives and ability to pressure local firms to engage in earnings management. However, the estimation results of timing tests indicate that this monitoring effect is short-lived, calling for a more comprehensive strategy to enhance the supervision of local officials and consequently improve the reliability of firms' financial reporting quality. These findings highlight the importance of addressing the agency problem between central and local governments in curbing firms' earnings manipulation to improve the capital market efficiency of economies characterized by strong government intervention.     

GDP growth incentives and earnings management: evidence from China

Review of Accounting Studies - Using data from China, we examine whether and how the incentive to boost GDP growth at the government level affects earnings management at the firm level. We find...     

Executive compensation and earnings management: Empirical evidence from Japan

This study investigates the relation between discretionary accounting choices and executive compensation in Japanese firms. The results show that the use of discretionary accruals increases executive compensation. The analyses also show that firm managers receiving no bonus adopt income-decreasing accruals and extraordinary items. In particular, evidence shows that negative extraordinary items are strongly associated with no bonus payment. Finally, the research indicates that the association between discretionary accruals and executive bonus varies depending upon the circumstances of the firm. This study contributes to the literature on earnings management from an international comparative perspective since most previous studies on earnings management and executive compensation have focused on U.S. firms.     

The impact of religiosity on earnings quality: International evidence from the banking sector

We examine the impact of religiosity on earnings quality, utilising a global sample of 1283 listed banks headquartered in 39 countries and covering the period 2002–2018. Using instrumental variables two-stage least squares regressions, we demonstrate that religiosity has a significant positive impact on banks’ earnings quality. We further show that the impact of religiosity becomes more pronounced among banks headquartered in countries where religion is an important element of national identity and in countries with weak legal protection. We show that the effects of religiosity are more intense during the global financial crisis period. Overall, these findings support the notion that high religiosity tends to reduce unethical activities by managers and can function as an alternative control mechanism for minimising agency costs. Our empirical investigation is robust to alternative model and sample specifications.     

The information value of interim accounting disclosures: evidence from mandatory monthly revenue reports

Review of Quantitative Finance and Accounting - Using data from Taiwan, where listed firms are required to disclose monthly revenues, this paper examines the information value of mandatory interim...     

Firm diversification and earnings management: evidence from seasoned equity offerings

Popular press suggests that diversified firms are more aggressive in managing earnings than non-diversified firms. We examine this claim in the seasoned equity offering (SEO) setting, where firms have been shown to have the incentive to manage earnings upwards. Using the cross-sectional modified Jones [(1991) J Accounting Res 29:193–228] model to measure discretionary current accruals, we find that discretionary current accruals are higher among diversified firms than in non-diversified ones. Our evidence is consistent with the view that the extent of firm diversification is directly related to the degree of earnings management. We further show that diversified issuers with high discretionary accruals underperformed other SEO firms.

Herding in analyst earnings forecasts: evidence from the United Kingdom

We present an empirical analysis of herding behavior in analyst forecasts of earnings-per-share. Herding is defined as 'excessive agreement' among analyst predictions, i.e., a surprising degree of consensus relative to the predictability of corporate earnings. The data are for U.K. companies between 1986 and 1997. We examine the effects of forecast horizon and analyst coverage on forecast accuracy and dispersion. The evidence supports overoptimism, overreaction, and herding in analyst forecasts.
G1, G14     

Underwriter choice and earnings management: evidence from seasoned equity offerings

Using a sample of seasoned equity offerings (SEOs), this paper examines the association between the choice of financial intermediary and earnings management. We contend that with more stringent standards for certification and intense monitoring, highly prestigious underwriters restrict firms’ incentives for earnings management to protect their reputation and to avoid potential litigation risks, while firms with greater incentives for earnings management avoid strict monitoring by choosing low-quality underwriters. Consistent with our predictions, we find an inverse association between underwriter quality and issuers’ earnings management. In addition, we find that underwriter quality is positively related to SEOs’ post-issue performance, even after controlling for the effect of earnings management. We also find that firms with low-underwriter prestige and high levels of earnings management under-perform the most. However, the effect of underwriter choice on post-issue performance does not last long.

External financing and earnings management: Evidence from international data

Corporate financing conditions in the external capital market are significantly affected by information asymmetry, while internal financing is not. Given that earnings information influences market perceptions regarding firms’ quality, firms relying on external financing should have incentives to manage earnings to improve their financing conditions. This study investigates the effect of corporate external financing behavior on earnings management. Using a sample comprising 75,790 observations of 12,874 firms in 43 countries, we find that accrual-based and real earnings management are positively associated with firms’ reliance on external financing. This positive relationship holds especially true for firms that rely on equity rather than debt financing. We argue that reliance on external financing (especially equity financing), which is subject to problems arising from information asymmetry, generates a motive for earnings management.     

The influence of earnings per share on capital issues: some evidence from UK companies

This paper investigates the simple hypothesis that when companies issue more capital, they have a tendency to select the type of capital, all other things being equal, which results in the higher short-term earnings per share (eps). The methodology employs probit analysis to test the hypothesis that the form of issue selected was that which gave the higher eps after controlling for other factors such as leverage and industry classification. The results lead us to conclude that there is evidence in capital issues of functional fixation on eps.     

Effects of takeover protection on earnings overstatements: evidence from restating firms

A staggered board can substantially protect a firm’s incumbents from takeover in either a hostile acquisition or a proxy contest. We use the existence of a staggered board as enhanced takeover protection and examine the association between staggered boards and earnings manipulation. Following a rigorous procedure to identify a sample of restating firms that overstated earnings, manually collecting data on several governance characteristics and using a matched-pairs methodology, we find that firms with staggered boards are less likely to overstate earnings. One potential interpretation of our results is that staggered boards lessen takeover threats and thus mitigate managers’ pressure to overstate earnings.     

Strategic timing of annual earnings announcements: evidence from an order-driven market

Using Spanish data, this paper examines, for the first time, the differences in the intraday response of an order-driven market to earnings announcements made during trading and non-trading hours. We show that the speed of reaction depends on timing of the announcement: for overnight (daytime) announcements, the improvement in liquidity is (not) immediate. This finding could explain why Spanish firms prefer to release the bad (good) earnings announcement in trading (non-trading) hours. This strategic timing differs from the traditional disclosure policy in American markets, suggesting that different microstructures may react differently to news releases and, consequently, drive the strategic timing of corporate disclosures.

The impact of climate risk on earnings management: International evidence

This study explores the influence of climate risk on properties of firms’ financial reporting practices with observations collected from 64 countries between 2005 and 2016. We use a country-level climate risk indicator developed by Germanwatch to measure the degree of damage from extreme weather events, and find that climate risk positively influences firms’ engagements in both accruals-based and real earnings management. Furthermore, we document that the above-mentioned effects of climate risk are moderated by the quality of country-level public governance. Subsample analysis suggests that the main effect of climate risk on earnings management is more pronounced for firms from developed countries, for firms in environment-sensitive industries, and for firms reporting losses. Our findings, which are supported by a battery of robustness tests, have important implication for regulators and policymakers.     

Disagreement over the persistence of earnings components: evidence on the properties of management-specific adjustments to GAAP earnings

We examine disagreement between management and Thomson Datastream over the persistence of earnings components. Using income statement and footnote disclosures, we identify the source and properties of disputed items. Disagreements typically reflect opaque reporting practices (for example, in the case of transitory operating items) and restrictive classification rules (for example, in the case of discontinued operations). Incremental and relative value relevance tests suggest that the majority of management-specific adjustments reflect appropriate classification of earnings components by insiders. Nevertheless, evidence consistent with strategic disclosure does emerge for a subset of management adjustments.