SFAS 133 and income smoothing via discretionary accruals: The role of hedge effectiveness and market volatility

This study investigates whether the Statement of Financial Accounting Standard No. 133 (SFAS 133) influences firms’ income smoothing via discretionary accruals decisions. Moreover, we investigate whether the level of hedge effectiveness and market volatility affects the impact of SFAS 133 on firms’ income smoothing via discretionary accruals decisions. Consistent with our predictions, we find a significant increase in income smoothing via discretionary accruals activity after the adoption of SFAS 133. We also find that income smoothing via discretionary accruals after the adoption of SFAS 133 increases with the level of hedge ineffectiveness. By contrast, we find that perfect hedgers do not engage in more income smoothing via discretionary accruals after the adoption of SFAS 133. Finally, we find that the higher the market volatility is the larger the income smoothing is via discretionary accruals after the adoption of SFAS 133. This implies that higher market volatility makes it more difficult for firms to meet hedge accounting requirements, thereby increasing unmanaged earnings volatility and income smoothing. Prior studies suggest that regulators are expressing concern about the effect of earnings management on the quality of reported earnings and the functioning of capital markets (e.g., Barton, 2001 ). In this regard, our findings imply that accounting standard setters should take into account the trade‐off between transparency and income smoothing.     

Bank Relationships and Private Firms’ Financial Reporting Quality

Private firms with relatively high (proprietary) costs of disclosure may benefit from a close relationship with a bank. Relationship lending is based on intertemporal contracting that assumes that the bank is able to acquire private information about the firm and, moreover, to keep this information private. For both reasons, we expect and find that private firms with fewer bank relationships exhibit lower levels of financial reporting quality. Controlling for many other factors, firms with a single bank relationship disclose their financial reports about 14 days later. The size of such firms’ financial reports is also smaller, containing approximately 8% fewer words than the median report. Firms with a single bank relationship also exhibit more earnings management, exceeding the median value of the three-year sum of absolute discretionary accruals by about 20%. The results are robust to different econometric specifications, including endogeneity concerns. They indicate that private firms choose to be opaque in the presence of fewer lending relationships.     

Earnings Management Vehicles for Korean Firms

We investigated the vehicles that Korean firms use when the firms manage earnings. We partitioned our sample into low, mid and high accrual sub‐samples based on discretionary accruals. Low accrual firms are defined as income‐decreasing firms whereas the high accrual firms are considered income increasing firms in this study. We decomposed accounting earnings into cash from operations and various components of accruals in a systematic way. Next we examined the types of accruals individual firms use when the respective firms increase reported earnings. The empirical results of the study indicate that there are clear discrepancies in the earnings management vehicles firm use when the firms manage earnings depending on the directions of earnings management. More specifically, income‐increasing firms frequently employ non‐cash revenues including asset‐disposal gains. Income‐decreasing firms employ non‐cash expenses including bad‐debt expenses and asset‐disposal losses. Firms also tend to use current accruals but to a limited extent as current accruals entail cash flow implications in the following years.     

Earnings quality and corporate payout policy linkages: An Indian context

We investigate the role of accounting quality as an antecedent of dividend payout decision of firms, for both dividend levels and dividend event, in an emerging market context. Using the data for Indian firms through the years 2006–2016, we evaluate the impact of discretionary accruals on payout decision employing Tobit and Logit regression models amid set of idiosyncratic controls. We report that better earnings quality, on average, is associated with large dividend payments for Indian firms. Moreover, the likelihood of dividend payment reduces with poor earnings quality and more so when earnings manipulation is done to increase earnings. Nonetheless, we show that higher earnings quality reduces dividends during the crisis period and also for group-affiliated firms. However, the same doesn’t hold true for dividend likelihood. The relationship is robust to the idiosyncratic controls and the causality test confirms that results are not susceptible to endogeneity issue. Overall, we conclude that better earnings quality takes care of free cash flow problems and alleviates the agency and information asymmetry related costs, thereby stimulating payout policy.     

On the Relationship between Voluntary Disclosure,Earnings Smoothing and the Value-Relevance of Earnings: The Case of Switzerland

Abstract

This paper examines whether voluntary disclosure by Swiss firms constrains the use of discretionary accruals to smooth earnings, and explores the effect of voluntary disclosure on the value relevance of earnings. We focus on Swiss firms because Switzerland's financial reporting system provides managers with extensive discretion in corporate disclosure, and there are important variations in the level of information provided in their annual reports. We consider that managers can choose two different ways to voluntarily convey information, either through the quality and quantity of annual report disclosure or, through compliance with International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Principles (GAAP). Relying on a simultaneous equations approach, our results suggest that Swiss firms use discretionary accruals to smooth earnings. However, this relation is reduced for firms that voluntarily disclose more information in their annual report or comply with IAS/IFRS or US GAAP. Moreover, we show that discretionary accruals of high disclosers or of firms voluntarily complying with IAS/IFRS or US GAAP receive a lower valuation weight.     

The Stewardship Role of Analyst Forecasts,and Discretionary Versus Non-discretionary Accruals

We examine the interaction between discretionary and non-discretionary accruals in a stewardship setting. Contracting includes multiple rounds of renegotiation based on contractible accounting information and non-contractible but more timely non-accounting information. We show that accounting regulation aimed at increasing earnings quality from a valuation perspective (earnings persistence) may have a significant impact on how firms rationally respond in terms of allowing accrual discretion in order to alleviate the impact on the stewardship role of earnings. Increasing the precision of more timely non-accounting information (analyst earnings forecasts) increases the ex ante value of the firm and reduces costly earnings management. There is an optimal level of reversible non-discretionary accrual noise introduced through revenue recognition policies. Tight rules-based accounting regulation, as opposed to leaving firms more choice over non-discretionary accrual policies, may lead firms to rationally respond by inducing costly earnings management. More generally, regulating both earnings persistence and the tightness of admissible auditing policies may not result in less equilibrium earnings management.     

The Effect of CEO Stock-Based Compensation on the Pricing of Future Earnings

This paper examines whether CEO stock-based compensation has an effect on the market’s ability to predict future earnings. When stock-based compensation motivates managers to share their private information with shareholders, it will expedite the pricing of future earnings in current stock prices. In contrast, when equity-compensated managers attempt to temporarily manipulate the stock price to maximize their own benefit rather than that of shareholders, the market may not fully anticipate future performance. We find that a CEO’s stock-based compensation strengthens the association between current returns and future earnings, indicating that more information about future earnings is reflected in current stock prices. In addition, we find that the positive effect is weaker for firms that have a high level of signed discretionary accruals or a low management forecast frequency. Overall, our study suggests that on average, equity-based compensation improves the informativeness of stock prices about future earnings, while opportunistic discretionary accruals or lowered earnings guidance hamper this improvement.     

Earnings management as a predictor of future profitability of Finnish firms

This study investigates whether the level of current earnings management can be used to predict future profitability of Finnish firms. Earnings management is assumed to predict future profitability, because firms use discretional accruals to manage this year's earnings upwards/downwards, if they believe that the next year's earnings will be high/low. Finnish data are used because the extent of the earnings management can be directly measured from the published Finnish financial statements. The results indicate that the lagged earnings management is significantly related to the future profitability of a firm. The lagged earnings management also contains incremental information relative to past profitability or stock prices when predicting future profitability.     

Japanese Corporate Groupings (Keiretsu) and the Informativeness of Earnings

This paper examines the effect of Japanese corporate groupings, keiretsu , on the informativeness of earnings. Keiretsu firms maintain close financial and personal ties through cross-shareholding, credit holding, interlocking corporate directorates, and various business transactions. We propose that the strong interrelations of the keiretsu ownership structure enhance the informativeness of earnings through efficient monitoring of managerial performance. Our empirical results show that keiretsu firms have higher earnings response coefficients than those of non- keiretsu firms, the earnings response coefficient increases as the strength of the keiretsu relationship increases, and discretionary accruals by keiretsu firms are smaller than discretionary accruals of non- keiretsu firms. All of these results suggest that the monitoring ability of the keiretsu improves the informativeness of earnings.     

Toward the Effect of Audit Quality on Earnings Management——Empirical Evidence from Manufacturing Enterprises Listed in Shanghai Stock Market

Nowadays, earnings management is a hot issue, but most of the researches focus on the incentives of earnings management and few of them refer to the effect of audit quality on earnings management. In this study, we directly examine the effect of external audit quality on earnings management by using discretionary accruals. We find that the discretionary accruals of non-dual audit companies are significantly greater than those of dual audit companies. We also find that clients of non-First Ten auditors intend to report greater discretionary accruals than those of First Ten auditors.     

How Do Financial Constraints Relate to Financial Reporting Quality? Evidence from Seasoned Equity Offerings

This paper examines how constraints on firms’ financing capacity relate to managers’ discretionary accounting choices. Three hypotheses of earnings management – the opportunism hypothesis, the rational expectations hypothesis, and the signaling hypothesis – predict that constrained firms engage in greater upward earnings management than unconstrained firms when selling equity. Using a sample of seasoned equity offerings (SEOs) announced between 1983 and 2014, I find support for this prediction. The relation between financial constraints and earnings management is robust to including controls such as offer size, growth opportunities, analyst following, and chief executive officer equity holdings, as well as to using the instrumental variable approach. Investors’ reaction around and following the SEO announcement supports the rational expectations hypothesis. I find that aggressive earnings management by constrained issuers is associated with lower SEO announcement returns but is not followed by negative abnormal returns in the long run. The evidence suggests that constrained issuers’ aggressive use of income-increasing accruals is an outcome of managerial myopia caused by capital market pressure, not managerial opportunism intended to mislead investors.     

Real and Accrual‐Based Earnings Management in the Pre‐ and Post‐IFRS Periods: Evidence from China

The purpose of this study is to investigate the prevalence of both accrual‐ and activities‐based earnings management for Chinese A‐share firms surrounding the adoption of substantially IFRS‐convergent accounting standards. Since 2007, all listed A‐share firms in China have been required to comply with a new set of accounting standards that have substantially conformed to IFRS. The new reform also produced a set of new auditing standards and internal control reporting requirements. Based on a sample of 4,050 firm‐year observations from 2002 to 2011, we find that Chinese firms in the post‐IFRS period (2007–2011) are less likely to engage in accrual‐based earnings management. The magnitude of discretionary accruals also declines after IFRS adoption. In response, we see firms turning to real activities manipulation as a substitute for upward earnings management. The reduction in accrual‐based earnings management could stem from higher quality accounting standards associated with IFRS adoption and/or concurrent changes in the governance regimes introduced with the IFRS mandate. A further analysis, however, indicates that the benefits of IFRS adoption in curbing upward accrual‐based earnings manipulation are not evenly distributed across firms. Specifically, the benefit diminishes for firms that are controlled by Chinese central or local governments, are located in less developed regions, and that have weak financial performance and therefore subject to delisting status. We also find that the benefit is less pronounced for manufacturing firms than for their non‐manufacturing counterparts.     

Shareholder Activism and Earnings Management Incentives: An Empirical Examination of Shareholder Proposals in the United States

In this article, we investigate the effect of shareholder activism on earnings management. Using a US sample of shareholder pay‐for‐performance proposals sponsored by institutional investors, we find that when compared to control firms, firms targeted by shareholder proposals have a greater magnitude of discretionary accruals (DA) in their reported earnings. In addition, we find that the likelihood of meeting or beating earnings benchmarks through the use of DA is higher for targeted firms whose managers have job security concerns due to the firms’ inferior stock performance in the past or have plans to sell company stock. Our results are consistent with the notion that pay‐for‐performance proposals have unintended consequences by introducing or exacerbating incentives to manage earnings for short‐term gains. The results also indicate that, for financial reporting, the short‐termism effect may dominate the alignment and/or disciplinary effect of shareholder monitoring.     

审计师工作量压力与盈余质量——基于门槛模型的研究

采用2012-2016年我国上市公司及其签字审计师为样本,引入门槛回归模型,实证分析不同事务所组织机制支持下审计师个人工作量压力如何影响审计行为决策及盈余质量。研究结果表明:会计师事务所行业专长存在门槛效应,行业专长水平越高,事务所组织支持力度越大,审计师工作量压力对公司盈余质量的负面影响越小;会计师事务所综合评价存在门槛效应,事务所综合评价水平越低,事务所组织支持力度越小,审计师工作量压力对公司盈余质量的负面影响越大;会计师事务所人力资本存在门槛效应,人力资本质量越高,审计师工作效率越高,审计师工作量压力对公司盈余质量的负面影响越小。     

The joint decision to manage earnings through discretionary accruals and asset sales around insider trading: Taiwan evidence

This study assesses the joint decision of multiple earnings–management tools around insider trading. The Taiwanese evidence indicates significantly higher magnitudes of both discretionary accruals and asset sales before insider selling. In addition, to investigate the endogenous relationship between discretionary accruals and asset sales, this study develops a set of simultaneous equations and includes the inverse Mill’s ratio as a regressor to account for firms that choose not to use asset sales. The results indicate a marginal complementary correlation between discretionary accruals and asset sales before insider selling. Further tests find this complementary correlation becomes stronger when accompanying abnormal insider selling. The findings support the view that insiders consider both tools jointly and adjust them as complements to meet their directional earnings management objective.     

The Impact and Importance of Mandatory Adoption of International Financial Reporting Standards in Europe

In this paper we report the results of conducting a two‐stage analysis on the impact and importance of mandatory adoption of international accounting reporting standards (IFRS) on European Union firms. In the first stage we determined the impact of mandatory adoption of IFRS across 13 countries and twenty industries. This was accomplished by identifying significant differences in return on assets (ROA) for firms computed under IFRS and local, generally accepted accounting principles (LG). Significant positive differences were detected for firms in Belgium, Finland, France, Italy, the Netherlands, Sweden, Switzerland and the United Kingdom: only German and Norwegian firms exhibited a negative average significant difference between ROA calculated using IFRS and LG. Repeating the analysis of differences in ROA on an industry‐by‐industry basis yielded additional Portuguese and Spanish firms for the second stage of the analysis in which the impact of mandatory IFRS adoption was assessed. Defining impact in terms of market and financial reporting quality, we found a statistically significant relationship between accounting information and market returns for firms in the all‐countries‐combined sample of 3,530 observations, and in the countries of Belgium, Finland, France, Greece, Italy, the Netherlands, Norway, Sweden and the United Kingdom. Support for the timeliness of accounting information was uncovered for firms in the all‐countries‐combined sample, and in the countries of Belgium, Finland, France, Germany, Italy, the Netherlands, Norway, Sweden and Switzerland. Finally, evidence to support the proposition that accounting regimes produce quality discretionary accruals was found for firms from the all‐countries‐combined sample of 3,480 observations and from Finland, Greece, the Netherlands, Sweden and the United Kingdom. When comparing differential accounting information constructed under IFRS and LG, however, few differences could be found. Specifically, there was no statistical support for any of the samples that accounting information produced under IFRS was any more value relevant than the accounting information derived using LG. When our examination shifted to the timeliness of earnings, a positive differential impact between earnings constructed on the basis of IFRS and local accounting standards was detected only for the all‐countries‐combined sample. Finally, the quality of discretionary accruals was shown to be significantly higher under IFRS than LG for firms in Finland, Greece and Sweden.     

公司治理结构对财务报告品质可靠性的影响*——从盈余门坎的角度分析

研究重点在于探讨台湾上市公司治理结构是否会影响公司财务报告品质可靠性.由于台湾上市公司的核心代理问题主要来自控制股东与小股东之间的利益冲突.本文预期,控制股东会通过盈余管理达到门坎.实证结果发现,代理问题较严重的公司,裁决性应计项目较大,并会通过盈余管理跨越前期盈余门坎,造成财务报告信息可靠性降低.相较于其他类型的控制股东,具有家族色彩的控制股东较会通过盈余管理达到门坎,并降低财务信息品质可靠性.     

Discretionary Accruals and Auditor Behaviour in Code-Law Contexts: An Application to Failing Spanish Firms

This study examines the relationship between earnings management and auditor behaviour in the pre-bankrupt client segment of the Spanish audit market. As proxies for auditor behaviour, we use type of audit firm (Big N/non-Big N) and type of audit report. In contrast to the USA, audit reports in Spain often include modifications other than a going-concern opinion. This allows us to study the relationship in more detail than is possible with US data. The results of our study show that discretionary accruals are negatively related to going-concern opinions but are positively related to reports modified for reasons other than going-concern problems. However, unlike Butler et al. (Journal of Accounting and Economics, 37, pp. 139–165, 2004) the negative relationship is explained not by liquidity survival tactics but by auditor conservatism. We find this conservatism not only in the value of discretionary accruals but also in the qualifications that accompany a going concern. In these cases GAAP violations have a much greater income effect and a stronger relationship with the reversal of manipulation accumulated over the years than with the manipulation introduced during the last year. Finally, our results suggest that Big N differentiation in a code-law country is context-specific and depends on the business risk parameter of the ‘audit risk model’. In particular, for high-risk firms, Big N auditors show a significantly lower level of discretionary accruals and a greater propensity to issue a going-concern opinion.     

Audit firm tenure and audit quality: A cross‐European study

Directive 2014/56/EU and Regulation (EU) No. 537/2014, which came into effect in June 2016, introduced the mandatory rotation of audit firms after a maximum period of 10 years with the same client. We conduct a cross‐European study with the aim of assessing whether long audit firm tenures are associated with lower levels of audit quality. The sample for the study is based on the constituents of the Standard & Poor's Europe 350 index for the years between 2009 and 2016, and we utilize three different sets of proxies for audit quality: discretionary accruals, differences between reported earnings and earnings benchmarks, and accounting restatements. The main result of the study finds that companies with more than 10 years of tenure with their auditors do not have a lower audit quality than other firms. In fact, this study provides some evidence of a higher audit quality for these firms. The results are robust to various checks. Therefore, if there does not seem to be a problem of a lack of audit quality associated with long audit firm tenures, the necessity of establishing a maximum tenure, as the new European regulation does, may be questioned.     

Managing Underpricing? The Case of Pre‐IPO Discretionary Accruals in China

Previous studies have found that companies use income‐increasing positive discretionary accruals (DAC) prior to initial public offerings (IPOs) to inflate earnings as a signal to anticipate future income and future dividends. This study, directly explores the role of DAC in prospectus information of 691 A‐shares IPOs in China during the period 1995–2002 and its relationship with market‐adjusted returns. The results suggest that in China, pre‐IPO non‐discretionary accruals (NDAC) as well as DAC have informative value in explaining first‐day returns as well as first‐year adjusted returns. However, in yearly cross‐sectional models, I find that firms use income‐decreasing accruals (conservative accounting) in prospectus financial statements. This downward manipulation or income “understatement” creates a regulatory setting that could explain initial underpricing and abnormally high IPO returns for A‐shares. In addition, the results show that as state ownership (SO) increases, cash flow also increases, exacerbating agency costs and adverse selection problems. These findings may suggest that managers might be using more conservative accounting in Prospectus financial data to offset the agency costs related to high cash flow, and high SO, by “banking income” and possibly therefore “smoothing” the effects of possible future suboptimal earnings.