Testing Accrual-Based Model for Detecting Earnings Management: Comparison of Finland and France

The aim of this study is to test the accrual-based model suggested by Dechow et al. (1995) in order to detect and compare earnings management practices in Finnish and French companies. Also the impact of financial crisis of 2008 on earnings management behavior in these countries is tested by dividing the whole time period of 2003-2012 into two sub-periods: pre-crisis (2003-2008) and post-crisis (2009-2012). Results support the idea that companies in both countries have significant earnings management practices. During the post-crisis period companies in Finland show income inflating practices, while in France the opposite tendency is noticed (income deflating) during the same period. Results of the assumption that managers in highly concentrated companies are engaged in income enhancing practices vary in two countries. While in Finland managers are trying to show better performance for bonuses or other contractual compensation motivations, in France they avoid paying dividends or high taxes.

Earnings management in firms seeking to be acquired

Empirical evidence regarding accrual-based earnings management around mergers and acquisitions has been setting-specific as far as target firms are concerned. This might be due to the fact that target firms cannot always anticipate an acquisition proposal, and thus lack the motive and the time necessary to manage their earnings in order to facilitate or impede the deal. In this paper, we provide clear evidence of downward earnings management by a sample of target firms that have both time and motive to engage in such actions. These are firms that publicly announce their intention to be acquired. Publicly ‘seeking a buyer’ represents a rather unusual corporate event, and we find that these firms engage in downward earnings management in the years surrounding the ‘announcement year’. To some extent, this result is explained by overrepresentation of low performance and growth among these firms, and it can be interpreted under alternative explanations. Furthermore, we show that such downward earnings management negatively affects the probability for a ‘seeking buyer’ firm to secure an acquisition within a reasonable amount of time, a possible indication of efficient diligence by prospective buyers having a preference for firms ‘seeking buyer’ with no informationally obscure earnings.

Accrual-based and real earnings management before and after IFRS adoption: the case of Greece

Purpose – The purpose of this study is to examine the use of accrual-based vs real earnings management (EM) by Greek firms, before and after the mandatory adoption of International Financial Reporting Standards (IFRS). The research is motivated by the fact that past studies have indicated the existence of significant levels of EM for Greece in particular before IFRS. Design/methodology/approach – Accrual-based earnings management (AEM) is examined by assessing performance-adjusted discretionary accruals, while real earnings management (REM) is defined in terms of abnormal levels of production costs, discretionary expenses, and cash flows from operations, for a three-year period before and after the adoption of IFRS in 2005. Findings – The authors find evidence on a statistically significant shift from AEM to REM after the adoption of IFRS, indicating the replacement of one form of EM with the other. Research limitations/implications – The validity of the results depends on the ability of the empirical models used to efficiently capture the existence of AEM and REM. Practical implications – IFRS adoption aims to improve accounting quality, especially in countries with high need for such an improvement; however, the tendency to substitute one form of EM with another highlights unintended consequences of IFRS adoption, which do not improve the informational content of financial statements if EM continues under different forms. Originality/value – Under the expectation that IFRS adoption should lead to improvements in accounting quality, this study examines whether IFRS actually led to a reduction of EM practices for a country with exceptionally high levels of EM before IFRS, by accounting for all possible forms of EM.

The effect of financial leverage on real and accrual-based earnings management

Past research has documented a substitution effect between real earnings management (RM) and accrual-based earnings management (AM), depending on relative costs. This study contributes to this research by examining whether levels of (and changes in) financial leverage have an impact on this empirically documented trade-off. We hypothesise that in the presence of high leverage, firms that engage in earnings manipulation tactics will exhibit a preference for RM due to a lower possibility—and subsequent costs—of getting caught. We show that leverage levels and increases positively and significantly affect upward RM, with no significant effect on income-increasing AM, while our findings point towards a complementarity effect between unexpected levels of RM and AM for firms with very high leverage levels and changes. This is interpreted as an indication that high leverage could attract heavy outsider scrutiny, making it necessary for firms to use both forms of earnings management in order to achieve earnings targets. Furthermore, we document that equity investors exhibit a significantly stronger penalising reaction to AM vs. RM, indicating that leverage-induced RM is not as easily detectable by market participants as debt-induced AM, despite the fact that the former could imply deviation from optimal business practices.

Use of hydroclimatic forecasts for improved water management in central Texas

Accurate seasonal to interannual streamflow forecasts based on climate information are critical for optimal management and operation of water resources systems. Considering most water supply systems are multipurpose, operating these systems to meet increasing demand under the growing stresses of climate variability and climate change, population and economic growth, and environmental concerns could be very challenging. This study was to investigate improvement in water resources systems management through the use of seasonal climate forecasts. Hydrological persistence (streamflow and precipitation) and large-scale recurrent oceanic-atmospheric patterns such as the El Niño/Southern Oscillation (ENSO), Pacific Decadal Oscillation (PDO), North Atlantic Oscillation (NAO), the Atlantic Multidecadal Oscillation (AMO), the Pacific North American (PNA), and customized sea surface temperature (SST) indices were investigated for their potential to improve streamflow forecast accuracy and increase forecast lead-time in a river basin in central Texas. First, an ordinal polytomous logistic regression approach is proposed as a means of incorporating multiple predictor variables into a probabilistic forecast model. Forecast performance is assessed through a cross-validation procedure, using distributions-oriented metrics, and implications for decision making are discussed. Results indicate that, of the predictors evaluated, only hydrologic persistence and Pacific Ocean sea surface temperature patterns associated with ENSO and PDO provide forecasts which are statistically better than climatology. Secondly, a class of data mining techniques, known as tree-structured models, is investigated to address the nonlinear dynamics of climate teleconnections and screen promising probabilistic streamflow forecast models for river-reservoir systems. Results show that the tree-structured models can effectively capture the nonlinear features hidden in the data. Skill scores of probabilistic forecasts generated by both classification trees and logistic regression trees indicate that seasonal inflows throughout the system can be predicted with sufficient accuracy to improve water management, especially in the winter and spring seasons in central Texas. Lastly, a simplified two-stage stochastic economic-optimization model was proposed to investigate improvement in water use efficiency and the potential value of using seasonal forecasts, under the assumption of optimal decision making under uncertainty. Model results demonstrate that incorporating the probabilistic inflow forecasts into the optimization model can provide a significant improvement in seasonal water contract benefits over climatology, with lower average deficits (increased reliability) for a given average contract amount, or improved mean contract benefits for a given level of reliability compared to climatology. The results also illustrate the trade-off between the expected contract amount and reliability, i.e., larger contracts can be signed at greater risk.

Earnings Management and Measurement Error

In this paper I consider the impact of a noisy indicator regarding a manager’s manipulative behavior on optimal effort incentives and the extent of earnings management. The analysis in this paper extends a twotask, single performance measure LEN model by including a binary random variable. I show that contracting on the noisy indicator variable is not always useful. More specifically, the principal uses the indicator variable to prevent earnings management only under conditions where manipulative behavior is not excessive. Thus, under conditions of excessive earnings management, accounting adjustments that yield a more congruent overall performance measure can be more effective than an appraisal of the existence of earnings management to mitigate the earnings management problem.

Earnings management in response to the introduction of the Australian gold tax

Earnings from gold mining in Australia remained tax-exempt for almost seven decades until January 1, 1991. In the early 1980s, rapid economic prosperity induced by escalated gold prices brought the Australian gold-mining industry under intense political scrutiny. Using a variant of the modified Jones model, this paper provides evidence of significant downward earnings management by Australian gold-mining firms, which is consistent with their attempts to mitigate political costs during the period from June 1985 to May 1988. In contrast, test of earnings management over a similar period in a control sample of Canadian gold-mining firms produced insignificant results. Further, empirical results are robust to several sensitivity tests performed. During the period from June 1988 to December 1990, the Australian firms were found to have engaged in economic earnings management. This is consistent with the sample firms' incentive of maximizing economic earnings immediately prior to the introduction of income tax on gold mining. The findings of this study help to understand the impact of earnings management on the efficient resource allocation in an economy. They also contribute toward understanding the linkage between regulation of accounting for special purposes and general-purpose financial. reporting.

Perceptions of earnings management:the effect of national culture

Manipulating, or "managing," reported earnings is a temptation faced by every accountant and corporation around the world. This study investigates whether national culture influences perceptions of the acceptability of earnings management. Participants from eight countries evaluated 13 vignettes describing various earnings management practices (Merchant & Rockness, 1994). Our results demonstrate considerable variation in perceptions across nations to the earnings management scenarios, providing strong evidence that the practice of earnings management was not perceived similarly in all countries. Using Hofstede’s (1991) cultural indices, we find that the differences in aggregate perceptions across countries were not closely associated with any of the cultural dimensions examined. We do, however, find that perceptions of earnings manipulations involving the timing of operating decisions were associated with both the Power Distance Index and the Masculinity Index.

'Family' ownership, tunnelling and earnings management:a review of the literature

In this review paper, we bring together a number of aspects of family firms that are ubiquitous in a number of institutional contexts, often as part of larger business groups. We pay particular attention to the mechanisms by which families retain control over firms, and the incentives of the families in control to expropriate other stakeholders by way of tunnelling. We examine the role of earnings management in facilitating tunnelling, and evidence about the incidence of earnings management in family firms. Our review suggests that while the literature on these aspects of family control is rich, the contexts in which the empirical exercises are undertaken are relatively few, and hence there is considerable opportunity to expand it to other contexts, in particular in the form of cross-country comparisons of the relative impact of agency conflicts and institutions on these issues.

Loan loss provisions, earnings management and capital management under IFRS:the case of EU commercial banks

Prior research has shown that loan loss provisions are primarily used as a tool for earnings management and capital management by listed banks. Effective 2005 all listed companies in the European Union (EU) are required to comply with International Financial Reporting Standards (IFRS). Adherence to IFRS, it is claimed, should enhance transparency of reporting practices relative to local General Accepted Accounting Principles (GAAP). The overall objective of this paper is to examine the impact of the implementation of IFRS on the use of loan loss provisions (LLPs) to manage earnings and capital. We use a sample of 91 EU listed commercial banks covering a period of 10 years (before and after implementation of IFRS). Since early adopters may have different incentives and motivations relative to those who adopt mandatorily, we dichotomize our sample into early and late adopters. Overall, we find that earnings management (using loan loss provisions) for both early and late adopters while significant over the estimation window is significantly reduced after implementation of IFRS. We also find that, for risky banks, earnings management behavior is more pronounced when compared to the less risky banks, but is significantly reduced in the post IFRS period. Capital management behavior by bank managers is not significant in both pre and post IFRS regimes. Overall, we conclude that the implementation of IFRS in the EU appears to have improved earnings quality by mitigating the tendency of bank managers of listed commercial banks to engage in earnings management using loan loss provisions.

Corporate social responsibility and earnings management in U.S. banks

Business decision making depends on financial reporting quality. In identifying the drivers of financial reporting quality, proxied by earnings management (EM), prior literature has drawn attention to the association between corporate EM practices and commitment to corporate social responsibility (CSR). Empirical evidence, however, provides inconclusive results regarding the direction of this association. Using simultaneous equations, we examine the bi-directional CSR-EM relationship in U.S. commercial banks. We demonstrate that, although banks that engage in EM practices are also actively involved in CSR, the reverse relationship is not significant. We provide implications for investors, analysts, business participants and regulators. © 2014 Elsevier Ltd.