Corporate Ownership Structure and the Informativeness of Earnings

This study extends prior studies by examining how managerial ownership and external unrelated blockholdings affect the informativeness of earnings. The results are in contrast to prior studies. A non–linear relation exists between managerial ownership and earnings informativeness. Earnings informativeness increases with managerial ownership at low levels but not at higher levels of managerial ownership where the entrenchment effect sets in. Consistent with the role of large shareholder monitoring, the evidence shows a strong positive relationship between external unrelated blockholdings and earnings informativeness. These results are supported when income–increasing and absolute discretionary accruals are used to measure the extent of earnings management     

On the association between institutional ownership and aggressive corporate earnings management in Australia

This study examines the association between institutional ownership and Australian firms' aggressive earnings management strategies. In contrast to similar studies, this study does not assume that the two views on how institutional ownership associates with firms' earnings management behaviour are mutually exclusive. The association between institutional ownership and firms' income increasing discretionary accruals is expected to vary as the level of institutional ownership increases. The results support the predicted non-linear association between institutional ownership and income increasing discretionary accruals. In particular, a positive association is found at the lower institutional ownership levels, consistent with the view that transient (short-term oriented) institutional investors create incentives for managers to manage earnings upwards. On the other hand, a negative association is found at the higher institutional ownership levels, consistent with the view that long-term oriented institutional investors' monitoring limits managerial accruals discretion. These findings suggest that institutional investors can act as a complementary corporate governance mechanism in mitigating myopic aggressive earnings management by corporations when they have a sufficiently high ownership level.     

Shareholder Rights,Insider Ownership and Earnings Management

This paper examines whether shareholder rights, which enable shareholders to replace managers, can constrain earnings management, and whether this effect is conditional on the level of insider ownership. Using the comprehensive shareholder rights measure constructed by Gompers et al. ( 2003 ), we find that firms with stronger shareholder rights are associated with fewer income‐increasing discretionary accruals, suggesting that stronger shareholder rights deter managers from reporting aggressive earnings. Moreover, if insider ownership introduces managerial entrenchment, managers with higher ownership would be insulated from shareholder discipline. Consistent with this entrenchment theory, we find that the association between shareholder rights and earnings management becomes insignificant in the presence of higher levels of insider ownership. Shareholder rights are negatively associated with earnings management only when insider ownership is low. Our results indicate that the disciplinary effect of shareholder rights can be attenuated by high levels of insider ownership.     

Institutional investor type,earnings management and benchmark beaters

This paper classifies institutional investors into transient or long-term by their investment horizons to examine the association between institutional investor type and firms’ discretionary earnings management strategies in two mutually exclusive settings – firms that (do not) use accruals to meet/beat earnings targets. The results support the view that long-term institutional investors constrain accruals management among firms that manage earnings to meet/beat earnings benchmarks. This suggests long-term institutional investors can mitigate aggressive earnings management among these firms. Transient institutional ownership is not systematically associated with aggressive earnings management and is evident only among firms that manage earnings to meet/beat their earnings benchmarks. This indicates transient institution-associated managerial myopia may not be as prevalent as posited by critics. This study highlights the importance of explicitly considering the type of institutional investor and the specific setting when investigating the association between institutional ownership and corporate earnings management.     

The nature of information in accruals and cash flows in an emerging capital market: The case of China

Our study investigates the relative and incremental information content of earnings, operating cash flows, and accruals in the emerging capital market of China. The issue is tested by regressing stock returns on the levels of earnings and their components. Based on a sample of 1516 firm-years for listed Chinese firms during 1995–1998, our results demonstrate that earnings have relative information content over operating cash flows. The autocorrelations and cross-sectional correlations also imply that earnings have greater persistence and predictability than operating cash flows. We also find that discretionary accruals provide incremental information beyond that contained in nondiscretionary accruals, consistent with the argument that discretionary accruals improve the relevance of earnings in reflecting the fundamental values of the listed Chinese firms. Unlike prior findings in the studies on developed markets, we find no strong evidence that the value attached to discretionary accruals is lower than the value attached to nondiscretionary accruals. This is consistent with the argument that managerial policy choices available for the listed Chinese firms were rather limited during our sample period under relatively uniform People's Republic of China Accounting Standards (PRC-GAAP), thus, producing fewer opportunities for earnings management. An alternative interpretation could be that Chinese investors are functionally fixated on earnings.     

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.     

High accruals momentum

We examine the information content of high accruals momentum defined as a string of high discretionary accruals for four consecutive years. We find that firms that consistently report high levels of discretionary accruals experience low subsequent returns. The results are robust after we control for annual levels of discretionary accruals for the estimation period of high accruals momentum. Furthermore, the predictive power of the high accruals momentum for future returns is strongly persistent even after the existing accruals anomaly disappears. Our results also show that the high accruals momentum impact is more pronounced for low growth firms, suggesting that the overpricing of stocks with high accruals momentum is driven by managerial discretion to manage earnings.     

Insider-trading,discretionary accruals and information asymmetry

Using US data for the period from 2004 to 2012 and alternative discretionary accruals measures, we examine whether insiders manipulate earnings in an asymmetric information environment to profit from their informed trades, and whether the intervening information environment influences the relationship between earnings management and insider trading. We show that insider trading dominated by sell trades has a positive association with discretionary accruals. The incremental effect of information asymmetry as well as the interaction with insider trading is also prevalent in this relation, confirming the moderating effect of asymmetric information. Further, we show that the active involvement of some key insiders in high discretionary accruals is for personal benefit more in growth firms than in value firms. Our results also suggest that earnings management allows for insiders’ opportunistic, rather than routine, buy and sell trades. Our findings highlight that regulators should oversee and scrutinise both insider trading and earnings management to mitigate the risk of the opportunistic behaviour of insiders to avoid future corporate scandals.     

The Usefulness of Measures of Consistency of Discretionary Components of Accruals in the Detection of Earnings Management

Abstract:  Prior research has shown the prevalence of measurement error in models used to estimate aggregate discretionary accruals. In these models, the incremental information content of the various components of accruals is ignored. Limited prior research and data gathered from firms under Securities and Exchange Commission (SEC) litigation indicate that managers use either one or more than one component of accruals simultaneously, in a consistent way to manipulate bottom-line earnings in a given direction. I propose two measures that capture the consistency between the discretionary components of accruals and test their significance in earnings management (EM) detection in firms that have artificially added accrual manipulation and firms that were targeted by the SEC for accrual manipulation. There is evidence that this information is incrementally useful in detecting EM. This finding paves the way for improvements in the discretionary accruals measure by including consistency information from the components of aggregate accruals.     

The effect of alternative goals on earnings management studies: An earnings benchmark examination

Firms’ management manages earnings because they have incentives or goals to do so. Earnings management studies have to account for these different goals as tests of earnings management can be compromised by the effect of conflicting goals. I illustrate this in the setting of Dechow et al. (2003). Their study examines whether firms with small profits and firms with small losses (loss-avoidance benchmark) have differing levels of discretionary accruals. Dechow et al. (2003) find that firms just above the loss-avoidance benchmark do not have discretionary accruals that are significantly different than firms just below the benchmark. However, they do not consider firms just below the loss-avoidance benchmark that might be using discretionary accruals to avoid missing an alternative benchmark. I find that after I consider these alternate earnings benchmark goals, firms just above the benchmark have significantly higher discretionary accruals. This provides direct evidence that the ‘kink’ in the distribution of earnings arises from earnings management. I find similar results for the earnings changes benchmark. These findings highlight the need to consider alternative earnings benchmark goals when examining firms immediately around benchmarks.     

Accruals quality and the incentive contracting role of earnings

This paper investigates the association between accruals quality and the usefulness of accounting earnings in incentive contracting. Accruals quality, which measures the precision with which accruals predict future cash flows, has two potential opposing effects on the noise in earnings as a measure of managerial performance. Specifically, higher quality accruals should decrease the deviations of earnings from future cash flows and increase the sensitivity of earnings to cash flows that are not attributable to managerial actions. My evidence indicates that better accruals quality is associated with a higher weight on earnings in compensation contracts, which suggests that accruals quality overall reduces the noise in earnings. I also find that the positive association between accruals quality and the weight on earnings is mainly driven by innate accruals quality rather than discretionary accruals quality. Therefore, accrual errors resulting from the volatility of the operating environment are a primary source of noise in earnings considered by compensation committees.     

Ownership,two-tier board structure,and the informativeness of earnings – Evidence from China

This study extends previous research by empirically examining how ownership, two-tier board structure, and auditor affect the informativeness of earnings for companies listed in China. We measure the informativeness of earnings by the earnings–returns relation, discretionary accruals, and audit opinion. The results show that ownership concentration, the presence of foreign shareholders, the percentage of tradable shares, the type of dominant shareholder, the supervisory board, and independent directors affect the earnings response coefficients and discretionary accruals. We also find that the type of dominant shareholder, the size of the supervisory board, and the percentage of independent directors have an impact on the frequency of modified audit opinions. Our research has implications for China’s regulators who are striving to improve accounting information, transparency, and corporate governance.     

Ownership structure and the pricing of discretionary accruals in Japan

This paper examines the valuation effect of discretionary accruals for Japanese firms, taking into account the book value of equity. Consistent with US evidence, the Japanese market prices discretionary accruals, indicating that discretionary accruals enhance the value relevance of reported earnings. This value relevance is lower for cross-held firms, consistent with the view that cross-business shareholding aggravates tunneling or managerial opportunism through discretionary accounting choices. On the other hand, foreign shareholding and bond financing provide effective monitoring on managerial discretion of profit firms to enhance the valuation of discretionary accruals.     

Earnings Management in Public Family Firms under Economic Adversity

This paper explores the relationship between the ownership of public firms and their motivation to implement earnings management practices, providing evidence on whether family businesses differ from non‐family businesses in terms of earnings management practices. In addition, it focuses on the possibility of asymmetrical earnings management policies between periods of stability and economic adversity. Based on a sample of Portuguese listed family‐controlled firms for the 1999–2011 period and using a panel data approach, we find no significant differences in the incentive to manage earnings between public family and non‐family firms, suggesting a compensation between the alignment hypothesis, the long‐term orientation of family firms and the desire to pass firms onto succeeding generations, and the entrenchment effect. The evidence shows that earnings management decreases with firms’ profitability, and non‐family firms’ discretionary accruals are mainly influenced by the board of directors. In crisis periods, the discretionary accruals of family firms are especially influenced by firm size. After controlling for different earnings management measures, the determinants of earnings management practices seem somewhat sensitive to the earnings quality proxies. The results provide evidence that directors and policy makers should prevent earnings management procedures in particular situations.     

中国国有控股上市公司高管薪酬激励与盈余管理

以中国国有控股上市公司为样本,从盈余管理对高管薪酬及其薪酬业绩敏感性的影响两方面,研究高管薪酬激励与盈余管理的关系,实证检验表明在调高操控性应计利润情况下,盈余管理程度分别与管理者的年度报酬水平和股权激励呈正相关关系,另外,盈余管理对薪酬业债敏感性也有正向影响,据此提出了有效控制盈余管理行为的政策建议.     

The incidence of earnings management on information asymmetry in an uncertain environment: Some Canadian evidence

In this study, we investigate the association between earnings management and information asymmetry considering environmental uncertainty. Results show that a complex and dynamic environment weakens the relationship between discretionary accruals and information asymmetry measured as share price volatility and bid-ask spread. More specifically, the positive relationship between earnings management and information asymmetry is weakened for diversified firms, those intensively investing in R&D, and those facing high sales volatility. This highlights the difficulty for investors to assess earnings management in an uncertain environment. Finally, in such a context, discretionary accruals are more likely to be detected by investors for firms cross-listed on a U.S. stock exchange, a more liquid and transparent stock market compared with the Canadian stock market.     

Opaque financial reports and R2: Revisited

In this study, we revisit the link between R² (synchronicity) and earnings management (opacity) because of the importance of the ongoing debate on the relation between idiosyncratic risk and earnings management in the finance and accounting literatures. Hutton et al. (J. Financial Economics, 2009) provide evidence of a positive link between opacity and R². They interpret their finding to imply that firms with high R² (high synchronicity) have less firm-specific information impounded in their stock price. Our results for this relationship fail to unequivocally support the results reported in Hutton et al. (2009). We show that their results are not only time variant but also not robust to the alternative empirical technique recommended for panel data by Petersen (2009) and alternative estimation of discretionary accruals adjusted for firm performance prescribed by Kothari et al. (2005). We also find no support for a convex relation between idiosyncratic risk and opacity. The findings documented in this study substantially revise some of Hutton et al.'s findings in this important and growing area of research.     

Hierarchy of earnings thresholds based on discretionary accruals

Prior studies identify hierarchies of earnings thresholds based on distributions of earnings (e.g., Degeorge et al., 1999) and survey opinions of CFOs (Graham, Harvey, & Rajgopal, 2005). We complement extant literature by investigating a threshold hierarchy in the context of accounting discretion exercised by managers. We examine the relative extent of discretionary accruals used to achieve three earnings thresholds—avoiding losses, avoiding earnings declines, and avoiding negative earnings surprises. Our empirical findings suggest that managers are likely to use the largest amount of discretionary accruals to avoid earnings declines, and the least amount of discretionary accruals to avoid negative earnings surprises. Thus, this study identifies the hierarchy of the earnings thresholds based on accounting discretion used in financial reporting. We also find that the hierarchy remains stable over the last two decades during our sample period. Then, we provide several explanations for why managers are likely to exercise more accounting discretion to avoid earnings declines. These explanations include earnings smoothing, reduction of stock returns volatility, and signaling of future growth potential. Overall, this study provides new insights into accruals management behavior.     

Accruals Quality, Information Risk and Cost of Capital: Evidence from Australia

Abstract:  Recent theoretical work argues that information risk is a non-diversifiable risk factor that is priced in the capital market. Using accruals quality to proxy for information risk, Francis et al. (2005) provide empirical support for this argument using a sample of US firms. This paper re-examines the interplay of accruals quality, information risk and cost of capital in Australia, where a number of important institutional and regulatory differences are hypothesized to affect the relation between accruals quality and cost of capital. The results suggest that, while accruals quality impacts on the cost of capital for Australian firms, some salient differences exist. In contrast to findings for US firms, the costs of debt and equity for Australian firms are largely influenced by accruals quality arising from economic fundamentals (i.e., innate accrual quality) but not discretionary reporting choices (i.e., discretionary accrual quality). This finding is consistent with our predictions based on the Australian institutional and regulatory environment. In addition, using both the asset pricing tests in Francis et al. (2005) and Core et al. (2008) , we provide evidence consistent with accruals quality being a priced risk factor.     

Information Asymmetry and Earnings Management: Some Evidence

This paper conducts an empirical investigation of the relationship between information asymmetry and earnings management predicted by Dye (1988) and Trueman and Titman (1988). When information asymmetry is high, stakeholders do not have sufficient resources, incentives, or access to relevant information to monitor manager's actions, which gives rise to the practice of earnings management (Schipper, 1989; Warfield et al., 1995). Empirical results suggest a systematic relationship between the magnitude of information asymmetry and the level of earnings management in two different settings.