The Effects of Corporate Social Responsibility on Real and Accrual‐based Earnings Management: Evidence from China

This study examines the relationship between Chinese firms’ corporate social responsibility (CSR) and their earnings management (EM) practices. As China rapidly emerges as one of the largest exporters as well as importers, an understanding of Chinese CSR practices is increasingly important not only to Chinese authorities and firms, but also to international stakeholders. However, Chinese CSR has been largely underestimated in previous studies, and this CSR–EM relationship has never been sufficiently examined with regard to Chinese firms. In addition, this study measures the level of EM using two different methods: accrual‐based EM (AEM) and real activity‐based EM (REM). In general, REM is regarded as more costly but less detectable, while AEM is regarded as less costly but more detectable, owing to the fact that AEM is subject to greater scrutiny from auditors and regulators. The results show that Chinese firms’ enhanced CSR generally decreases their EM practices. On the contrary, state‐controlled firms and firms operating in more institutionally developed regions are more likely to engage in REM, while increasing their CSR activities. These findings provide new evidence that managers in Chinese firms tend to opportunistically adopt CSR practices according to the firm's institutional environment.     

Mandatory IFRS adoption: the trade-off between accrual-based and real earnings management

This paper examines whether firms substituted real earnings management for accrual-based earnings management after the International Financial Reporting Standards (IFRS) became mandatory. Using a sample of 101,331 firm-year observations from 33 countries between 2000 and 2010, we show that IFRS adoption came with the unintended consequence of certain firms substituting real earnings management for accrual-based earnings management, especially among firms in countries with strict enforcement regimes. Furthermore, we document that the trade-off is confined to EU countries in which strong firm-level characteristics (i.e. the firm-level mechanism of control, the market’s level of scrutiny, and firm-specific incentives to provide transparency) are coupled with strong enforcement. We also show that IFRS had an effect in countries outside the EU, albeit at a different time. Overall, the results suggest that accounting regulators’ efforts to increase earnings quality might have had the unintended consequence of increasing real earnings management activities.     

Do foreign institutional investors monitor opportunistic managerial behaviour? Evidence from real earnings management

Employing a large sample of 13,860 firms in 41 economies from 2000 to 2017, we document that the ownership by foreign institutional investors (FIIs) is negatively associated with firms' real earnings management (REM) but unrelated to their accrual earnings management (AEM). We adopt a few identification strategies to tackle the endogeneity issues, including firm- and year-fixed effects regression, two-stage least squares (2SLS) regression, and difference-in-differences (DiD) estimation based on the passage of the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA). In addition, we show that the role of FIIs in curbing REM is achieved through the expertise channel and the monitoring channel. These results suggest that when facing disadvantages in curbing AEM, FIIs make the most of their monitoring strengths by curbing firms' REM, where they have both incentives and capabilities to monitor. Overall, this study highlights the important role of FIIs in monitoring opportunistic managerial behaviour.     

The Effect of IFRS Adoption Conditional Upon the Level of Pre-adoption Divergence

Prior studies on whether or not International Financial Reporting Standards (IFRS) adoption improves earnings quality have found mixed results. We note that some of the countries that have adopted IFRS had national accounting standards similar to IFRS prior to adopting IFRS, while others had national accounting standards divergent from IFRS. We examine the effects of IFRS adoption by taking into account the level of divergence prior to the adoption of IFRS. We find that countries experience a greater drop in earnings management when they have a higher level of divergence from IFRS prior to IFRS adoption. More specifically, high divergence countries with higher levels of enforcement benefit the most followed by high divergence countries with lower levels of enforcement. Lower divergence countries with higher levels of enforcement do not significantly benefit from IFRS adoption. Lower divergence countries with lower levels of enforcement do not benefit from IFRS adoption at all. Our results support the contention that countries with lower quality local accounting standards prior to IFRS adoption benefit more from IFRS adoption.     

Accrual anomaly and mandatory adoption of IFRS: Evidence from Germany

This study examines the effect of mandatory adoption of IFRS on the accrual anomaly in Germany. Using the setting in Germany between 2002 and 2008, we find that the accrual anomaly occurs between 2002 and 2004 (pre-IFRS period) but disappears between 2006 and 2008 (post-IFRS period). Results are consistent after extending the test period to 2010 and controlling for analysts' cash forecasts. We also find that German firms with more significant improvements in analysts following, forecast accuracy, forecast dispersion, and earnings management following mandatory adoption of IFRS in 2005 have greater decline of the accrual anomaly between 2006 and 2008. Overall, our findings suggest that IFRS adoption together with improved reporting enforcement significantly reduces the accrual anomaly in Germany.     

Earnings Management Constraints and Classification Shifting

Prior literature has investigated three forms of earnings management: real earnings management (REM), accruals earnings management (AEM) and classification shifting. Managers make trade‐off decisions among these methods based on the costs, constraints and timing of each strategy. This study investigates whether managers use classification shifting when their ability to use other forms of earnings management is constrained. We find that when REM is constrained by poor financial condition, high levels of institutional ownership and low industry market share, managers are more likely to use classification shifting. Further, we find that when AEM is constrained by low accounting system flexibility and the provision of a cash flow forecast, managers are more likely to use classification shifting. In addition, when we limit our sample to firms that are most likely to have manipulated earnings, we continue to find support for constraints of both REM and AEM leading to higher levels of classification shifting. We also find support for the hypothesis that the timing of each earnings management strategy influences managers’ trade‐off decision. Our results indicate that managers use classification shifting as substitute form of earnings management for both AEM and REM.     

The real earnings management of cross-listing firms

We examine the existence of real and accrual-based earnings management before and after cross-listings on the U.S. market. The results indicate that firms actively manage their earnings around cross-listing events, using both accrual and real earnings management, but real earnings management is dominant. American Depositary Receipts (ADRs) cross-listed at Level 1 and sponsored ADRs show the largest increase in real earnings management from before to after the listing. Firms that have adopted International Financial Reporting Standards (IFRS) display lower increases than firms under domestic GAAP. Finally, our results confirm a significant negative relationship between long-run performance and real earnings management before and after major corporate events.     

The mediating effect of REM on the relationship between CEO overconfidence and subsequent firm performance moderated by IFRS adoption: A moderated-mediation analysis

The present paper is pursuing a new direction in the analysis of behavioral finance based on examining whether future performance of the firm is related to overconfidence displayed by the Chief Executive Officer (CEO). We suggest two channels for this relationship, real earnings management (REM) and the mandatory IFRS adoption. First, examining the impact of IFRS adoption on firms’ future performance, we find that overconfident CEOs who do not adopt IFRS exhibit poorer future performance. Other interactions related to overconfidence and IFRS are not significant. Second, examining the relationship between overconfidence and IFRS adoption on REM, we find that overconfident CEOs indulge in higher REM than non-overconfident CEOs. Further, overconfident CEOs who adopt IFRS display greater REM than do those who not adopt IFRS. Therefore, we prove that the indirect effect of CEO overconfidence on the subsequent firm performance through REM is contingent on the mandatory IFRS adoption.     

The effects of International Financial Reporting Standards,auditing and legal enforcement on tax evasion: Evidence from 37 African countries

This study examines the significance of International Financial Reporting Standards (IFRS), audting and legal enforcement on tax evasion for a group of 37 African countries for the period 2008–2017. These countries were subsequently regrouped into subsamples of four clusters. Three-stage least square regression was used for the analysis. The results indicate that there is a negative and significant relationship between IFRS and tax evasion in some clusters (i.e., early IFRS adopters and strong legal enforcers). The other clusters (late IFRS adopters and weak legal enforcers) have a similar sign of coefficient though statistically insignificant. Moreover, evidence suggests that adoption and application of IFRS lead to improved financial reporting quality and lessen tax evasion in some African jurisdictions. Additionally, legal enforcement is found to be statistically significant in relation to tax evasion in two clusters (i.e., early IFRS adopters and strong legal enforcers). Some African countries are slow or ineffective in adopting and implementing IFRS, which by itself cannot improve tax compliance. IFRS can only achieve its objective when there is strong legal enforcement (e.g., control of corruption, rule of law, effective regulatory framework, voice and accountability, strong monitoring, and auditing to promote transparency). More evidently, in contrast to weak legal enforcers, countries with strong legal enforcement have high IFRS compliance, which can strengthen auditing and reporting standards and hence, improve tax compliance.     

The influence of CEO and CFO power on accruals and real earnings management

In this study, we examine the effect of CEO and CFO power on both accruals and real earnings management (AEM and REM, respectively), and the extent to which CEO and CFO power mitigate the effect of one another on AEM and REM. We further examine whether the passage of the Sarbanes-Oxley Act (SOX) altered these effects. In the pre-SOX period, we find that AEM (REM) is greater when the CEO (CFO) is powerful relative to the CFO (CEO). In the post-SOX period, however, we find that the effect of relative CEO power on AEM subsides, whereas the effect of relative CFO power on REM persists. Additionally, we find evidence to suggest that powerful CFOs inhibit the AEM preferences of powerful CEOs in both the pre- and post-SOX periods. Finally, we find evidence to suggest that powerful CEOs inhibit the REM preferences of powerful CEOs in the pre-SOX period, but not in the post-SOX period. Collectively, our results suggest that the power of the CEO relative to the CFO is an important factor in the both the type and magnitude of earnings management.

     

The Differential Impact of IFRS Adoption on Aspects of Seasoned Equity Offerings in the UK and France

We examine the potential for IFRS to influence the market for SEOs in the UK and France. The divergence between the UK domestic accounting standards and IFRS is minor (low-divergence firms) whereas domestic accounting standards in France differ materially from IFRS (high-divergence firms); however, both countries have similar legal enforcement and institutional settings that might confound the effect of IFRS adoption. We argue that IFRS adoption serves to mitigate information asymmetry and improve accounting quality. Accordingly, we find that, following IFRS adoption, earnings management activities decrease among high-divergence firms prior to issuing SEOs. As a result of the lower levels of earnings management and information asymmetry, we predict and find that the market reaction to issuing SEOs improves significantly for high-divergence firms following IFRS. Given that equity financing becomes less costly, we find that the propensity to issue new SEOs increases among high-divergence firms after IFRS adoption. We find no similar changes among low-divergence firms. The results persist after running a matched-sample analysis and controlling for potential self-selection bias.     

The effect of mandatory IFRS adoption on real and accrual-based earnings management activities

This study examines the effect of mandatory adoption of International Financial Reporting Standards (IFRS) on both accrual-based and real earnings management. While prior literature has mainly examined the effects of IFRS adoption on accrual-based earnings management, no study to date has focused on the impact of IFRS adoption on real earnings management. Using a sample of 15,206 observations from 22 European countries between 2000 and 2010, this study employs a control sample of voluntary adopters and applies a differences-in-differences design to control for confounding concurrent events. The results suggest that mandatory IFRS adoption had no significant impact on either real or accrual-based earnings management practices. Additional analysis on a sub-sample of firms with relatively strong earnings management incentives supports a dominant role for firm-level reporting incentives over accounting standards in shaping financial reporting quality.     

The information content of annual earnings announcements and mandatory adoption of IFRS

This study examines whether the information content of earnings announcements – abnormal return volatility and abnormal trading volume – increases in countries following mandatory IFRS adoption, and conditions and mechanisms through which increases occur. Findings suggest information content increased in 16 countries that mandated adoption of IFRS relative to 11 that maintained domestic accounting standards, although the effect of mandatory IFRS adoption depends on the strength of legal enforcement in the adopting country. Utilizing a path analysis methodology, we find evidence of three mechanisms through which IFRS adoption increases information content: reducing reporting lag, increasing analyst following, and increasing foreign investment.     

Measuring Country Differences in Enforcement of Accounting Standards: An Audit and Enforcement Proxy

In this paper we present an index designed to capture differences between countries in relation to the institutional setting for financial reporting, specifically the auditing of financial statements and the enforcement of compliance with each country's accounting standards. The use of a common set of standards such as International Financial Reporting Standards (IFRS) aims, in broad terms, to promote the comparability and transparency of financial statements and to improve the quality of financial reporting. However, the effectiveness of IFRS adoption may be hampered by differences, across countries, in the institutional setting in which financial reporting occurs. Studies of outcomes from adopting IFRS use a range of legal system proxies to capture these country differences, but the proxies are deficient in that they seldom focus explicitly on factors that affect how compliance with accounting standards is promoted through external audit and the activities of independent enforcement bodies. To address this deficiency, we calculate measures of the quality of the public company auditors’ working environment (AUDIT) and the degree of accounting enforcement activity (ENFORCE) by independent enforcement bodies. We do this for 51 countries for each of the years 2002, 2005 and 2008, using publicly available data provided by the International Federation of Accountants (IFAC), the World Bank and the national securities regulators. Preliminary tests suggest our indices have additional explanatory power (over more general legal proxies) for country‐level measures of economic and market activity, financial transparency and earnings management. We expect they will prove useful to researchers and other interested parties who require country‐level measures that focus on the degree of enforcement of financial reporting practices.     

Have IFRS Affected Earnings Management in the European Union?

There has recently been considerable discussion of those features of IFRS that are likely to help improve financial reporting in the European Union. However, certain issues may also have a negative impact on the quality of information. This paper focuses on the effect of IFRS on earnings management. Its main purpose is to examine whether the adoption of IFRS in the European Union has increased or decreased the scope for discretionary accounting practices by comparing discretionary accruals in the periods preceding and immediately after the regulatory change. Another objective is to determine which firms' features and country factors may explain the accounting discretion observed before and after IFRS. We consider a sample of non-financial firms listed on 11 EU stock markets. The results obtained show that earnings management has intensified since the adoption of IFRS in Europe, as discretionary accruals have increased in the period following implementation. The variables explaining accounting discretion are the same before and after IFRS (business size, leverage, investor protection and legal enforcement). These results suggest that variations in earnings management might be due to some room for manipulation under international standards when compared with local standards.     

Earnings quality and short selling: Evidence from real earnings management in the United States

Prior research provides evidence consistent with managers using real earnings management (REM) to increase earnings. This study examines whether short sellers exploit the overvaluation of firms employing REM. I find that firms with more REM have higher subsequent short interest. The positive relation between REM and short interest is more pronounced in settings where the costs associated with accrual‐based earnings management are high, such as when a firm has low accounting flexibility or faces greater scrutiny from a high quality auditor. I also find some evidence that short sellers respond to REM more than to other fundamental signals of firm overvaluation. My inferences are robust to the use of propensity score matching. Collectively, my evidence suggests that short sellers not only trade on REM information, but they also trade as if they understand the substitutive nature of alternative earnings management methods. This study provides additional insight into the important role that short sellers play in monitoring managerial operating decisions and overall earnings quality.     

Investment allocation decisions,home bias and the mandatory IFRS adoption

We examine the familiarity hypothesis of home bias by studying how foreign ownership of Swedish firms is affected by the mandatory adoption of IFRS. We decompose foreign investors into institutional and non-institutional investors. Foreign investors are further decomposed into EU (IFRS adopting countries) and non-EU residents (non-IFRS adopting countries). We analyse the equity investments of these foreign investor groups in Sweden during the period of 2001–2007. We find that after the mandatory adoption of IFRS, foreign ownership/owners from countries that adopted IFRS and particularly those from the EU increased. These effects are particularly strong in small firms. Foreign institutional investors increased their ownership stake after the mandatory IFRS adoption, whereas foreign non-institutional investments were not affected significantly by the IFRS adoption. In contrast to ownership from non-adopting countries, ownership from the EU increased in firms with both more and less tangible assets. Similarly, foreign ownership from the EU increased in firms with both concentrated ownership and dispersed ownership after the adoption. Because Sweden has already had strict legal enforcement and a low level of earnings management prior to the adoption, our results suggest that increased foreign ownership is due to better abilities to compare firms rather than an improved quality.     

Investor protection,prospect theory,and earnings management: An international comparison of the banking industry

This paper raises three issues related to the earnings management (EM) of banks across 48 countries. First, does earnings management of banks exist in all 48 countries? Second, what is the incentive of banks to manage earnings? Third, why does EM vary across countries? To answer these three questions, two thresholds (viz., a threshold of zero earnings and a threshold of zero earnings change) are employed.The answer to the first question above is that banks in more than two-thirds of the 48 countries sampled are found to have managed their earnings. With respect to the second question, prospect theory is used to provide an answer. The relationship between return and risk is positive for high earnings groups, but is negative for low earnings banks. Finally, as to the last question, stronger protection of investors and greater transparency in accounting disclosure can reduce banks’ incentives to manage earnings. Also, higher real GDP per capita decreases the degree of earnings management. It is seen that stronger enforcement of laws can counter intuitively result in stronger earnings management. However, this effect appears in low-income countries only, and not in high-income countries.     

IFRS and U.S. GAAP: Assessing the impact of reporting incentives on firm restatements in foreign and U.S. markets

This study examines the impact of reporting incentives on firm restatements in foreign and U.S. markets. We investigate whether financial reporting, using International Financial Reporting Standards (IFRS) results in quality disclosures, given differences in institutional and market forces. This study examines the quality of financial statements prepared in accordance with IFRS and U.S. GAAP by concentrating on firm restatements as a measure of earnings management. Our results indicate that there is no significant difference in the value of restatements due to differences in accounting standards when the rule of law is high in the international market. Furthermore, firms with better law enforcement and higher traditions of law and order, tend to have smaller restatement amounts or less earnings manipulation. This study contributes to the literature by providing evidence of the quality of financial information prepared under IFRS and its dependency on the institutional factors and market forces of a country.     

Does pedigree matter? Earnings quality of U.S. listed domestic firms via reverse mergers

This paper examines earnings quality of U.S. domestic firms that access capital markets via a reverse merger transaction (RM firms) compared to those via the more traditional initial public offering (IPO firms) during the period from 1997 to 2011. In order to mitigate confounding effects of legal regime, law enforcement, and culture, we require both the acquiring and target firms to be incorporated and headquartered in the U.S. to be included in our sample. We also use the Heckman (1976) procedure to control for self-selection bias. To capture earnings quality, we use a battery of measures established in prior literature, including discretionary accruals, discretionary revenues, real activities earnings management, and accrual estimation errors. Our measures have both convergent and discriminant validity and therefore appear to capture earnings quality fairly well. We find consistent evidence that U.S. domestic RM firms have lower earnings quality compared with U.S. IPO firms. Our evidence suggests that investors and other stakeholders should take into account the fact and consequences of the method that firms use to access capital markets in their investment decision making process.