Narrow Results

The study examines whether the board of directors with financial experience can effectively constrain earnings management pre- and post-International Financial Reporting Standards (IFRS). For a large balanced panel dataset of Taiwanese electronics companies over 2007–2017, we replace returns on assets in an augmented modified Jones model with efficiency scores derived using data envelopment analysis (DEA). Using DEA as an innovative adaptation in the accrual-based earnings management model, we aim to provide an accurate measure of earnings management. The results of our panel-estimated generalized least square (EGLS) regression models, which account for heteroskedasticity and auto-correlation problems, indicate that the proportion of board of directors with financial and/or accounting experiences reduces earnings management pre-IFRS. However, their ability turns weaker post-IFRS. Overall, this study thus not only has important theoretical significance in that a board of directors with financial experience might and might not curb earnings management but also has an important practical contribution to decision-makers in companies regarding the effectiveness of board financial experiences in the IFRS era.

This study uses a neuroscience experimental approach to evaluate managerial decision-making processes with respect to the proximity of violating debt covenants. The literature on debt covenant violation and earnings management posits that managers have incentives to manage earnings upward in periods prior to or concurrent with default to avoid the significant costs of technical default. This study argues that this behavior could be ascribed to differences in managers’ cognitive functions of evaluating and processing the information in proximity to violating debt covenants. Neuroscience research demonstrates that the ventral striatum (VS) brain regions in the limbic system are responsible for integrating information related to emotion and motivation, facilitating goal-directed motor behaviors, and influencing cognitive function and decision-making. We investigate whether managers’ VS brain activation reacts to this emotion-related information during earnings management decisions. We utilize functional magnetic resonance imaging (fMRI) to conduct an experiment with 52 managers who undergo fMRI scanning while making decisions regarding debt covenant scenarios. We find an inverse relationship between the proximity to debt covenant violations and VS brain activation. The findings provide initial evidence that emotion-related information of proximity to debt covenant violation affects brain activation when managers engage in earnings management.

This study examines the patterns of four discretionary financial variables surrounding president turnovers in Japanese firms. A new theory for earnings management, the coaching hypothesis, and three previously tested theories, the horizon, cover-up, and big bath hypotheses, are investigated. Our empirical results reinforce the importance of controlling for firm performance when testing earnings management. For routine turnovers, the evidence is consistent with the coaching hypothesis, which predicts mutual interests between incoming and outgoing presidents to portray a triumphant transition. We also find evidence for the horizon hypothesis, in that outgoing presidents in routine turnovers attempt to increase earnings during their last years, but the extent of the horizon problem may be curtailed by incentives to preserve a successful transition, the coaching hypothesis. For non-routine turnovers, we find little evidence of outgoing presidents attempting to cover up poor performance by employing income-increasing strategies. We also find weak support for the big bath hypothesis, which predicts incoming presidents of non-routine turnovers to decrease earnings in the transition year in order to report improved earnings in the following year.

We employ a sample of 3,177 events from Hong Kong industrial firms during the 1993–1999 period to examine insider trading activities around earnings and dividends announcements. By controlling for earnings management, special dividends, and other firm level financial indicators, we find that the presence of insider trading, its trading direction, and its trading intensity are related to the signals of these simultaneous earnings and dividends announcements. Various tests show that our findings are robust regardless of the proxies used for measuring insider trading activities, earnings, and dividend changes.

This study investigates whether the extent of earnings management has any impact on offer price in initial public offering (IPO). Using a sample of 581 JASDAQ IPO firms, we find that offer price reflects earnings management to some extent. Firms with conservative earnings management tend to have higher offer prices, and firms managing earnings aggressively tend to be discounted when they fail to exhibit smooth earnings growth. These results are consistent with the hypothesis that underwriters adjust for the effect of earnings management to appropriately pricing the issues. Overall, our evidence could lead to another explanation for IPO underpricing.

This paper investigates Japanese bank managers' use of the discretionary component of loan loss provisions to manage earnings during the recession of the late 1990s. Although studies of US banks document that bank managers use loan loss provisions to smooth earnings, manage regulatory capital, and signal undervaluation, factors that may affect discretionary loan loss provisions in Japanese banks have not been empirically examined. We find that discretionary loan loss provisions for our sample of Japanese banks are positively related to the demand for external financing, realized securities gains, and prior year taxes and are negatively related to capital and pre-managed earnings.

In face of broad adoption of International Financial Reporting Standards (IFRS), the Securities and Exchange Commission (SEC) is considering its quality and acceptability. This paper reports a study that examines changes in value relevance with a sample of Peru firms mandated to use international accounting standards between 1999 and 2007. The period under study is broken into a period of International Accounting Standards (IAS) between 1999 and 2001, a period of early IFRS between 2002 and 2004, and a more recent period of IFRS between 2005 and 2007 by major changes to accounting standards. The empirical results generally indicate that value relevance improved from the IAS period to the early IFRS period when the International Accounting Standards Board (IASB) took over the International Accounting Standards Committee (IASC), but worsened from the early IFRS period to the recent IFRS period when more accounting standards started to reflect IASB's preference for fair value measurement of assets and liabilities. Quality weakens to a greater extent for firms with more discretion for fair value estimates. Further analysis shows that such changes are less likely to result from changes in economic conditions, but from the changes of the standards. The findings are particularly alarming in face of rising IFRS adoptions and call for quality improvement to IFRS.

This paper examines the quality of financial reporting of Chinese firms cross-listed in the United States, Hong Kong and noncross-listed Chinese firms. We examine quality of financial reporting based on measures of earnings management, timely loss recognition and price-earnings association. We find that both cross-listings and noncross-listings show significant earnings smoothing and use accruals to manage earnings, and are not timely in loss recognition. We surmise that cross-listing in the United States or Hong Kong has not changed the accounting choices of Chinese cross-listing firms. However, our findings show that the market considers earnings and book value data of cross-listing firms to be more informative than those of noncross-listing firms in the event of good news. Our contribution is to show that in contrast to previous literature, firms from China do not have better reporting quality when they cross-list in the United States. There are still significant accounting deficiencies in many Chinese firms cross-listed in the United States (Financial Times, 2011).

This paper examines the impact of outside block-holders on earnings management, using discretionary accounting accruals as the measure of earnings management. For the income-decreasing earnings management scenario, we do not find significant results. This may be attributable to the different natures and time horizons of outside block-holders. Since the majority of outside block-holders are institutional investors, we then investigate the relationship between ownership by institutional investors with different natures and earnings management. Specifically, we find a significant positive relationship between ownership by transient institutional investors (holding diversified portfolios with high turnover) and discretionary accounting accruals. However, we do not find a significant relationship between ownership by dedicated institutional investors (holding concentrated portfolios with low turnover) and discretionary accounting accruals. Therefore, due to the differing natures of institutional investors, we may not treat them as a homogeneous group.

This study investigates the relation between managerial overconfidence and earnings management and whether this relation is moderated by family control. Using a sample of Taiwan-listed firms, we estimate managerial overconfidence from manager dealings and determine the following: First, overconfident managers are more likely to engage in earnings management behaviors; second, family control negatively moderates the positive relation between managerial overconfidence and earnings management; and third, the negative moderating effects of family control primarily result from family chief executive officers.

This study examines the relationship between initial public offering (IPO) managers' earnings management behavior during lockup (measured with discretionary accruals, DAs) and operating performance following lockup expiration (measured with operating return on assets, OPROAs). Based on a U.S. IPO sample, the results indicate that DAs during lockup are significantly higher than after lockup expiration. In addition, the reversal effect of DAs results in a negative association of DAs in lockup with post-lockup OPROAs. This negative relation is primarily concentrated in small-sized, non-venture backed, high-tech, and hot-market issued IPOs and is consistent with prior findings that such IPO firms have poorer post-issue performance. The overall evidence supports the role of managerial earnings management behavior during lockup in explaining post-IPO operating underperformance.

The value of stock options increases in both stock prices and volatility. It suggests that options might engender incentives for managers to increase both stock prices and volatility. Recent studies have documented a negative association between earnings quality and idiosyncratic volatility: Hence, the lower the earnings quality, the greater the idiosyncratic volatility, and the higher the value of stock options. This study investigates whether there is a link between CEO equity compensation and earnings quality. Using a simultaneous system of equations, we find negative correlations between the two, suggesting that managers have incentives to reduce earnings quality.

This paper aims to investigate the role of corporate dividend policy and corporate governance in managerial timing decisions with regard to large exercise of executive stock options (ESOs). The findings indicate that the motivations behind managers’ decisions to exercise abnormally large ESOs vary depending on the strength of the related corporate governance mechanisms. Managers of weakly governed companies exploit abnormal earnings management when timing large exercises of ESOs. In contrast, managers of well-governed companies behave rationally in timing large exercises of ESOs, carrying them out in years in which their companies significantly raise dividend payouts.

We investigate how Korean officers manage revenue and earnings to achieve cognitive reference points (round up). In Korea, revenue has traditionally served as one of the key financial statement figures. Thus, we study revenue management around cognitive reference points both in isolation and to influence earnings around cognitive reference points through a chain effect. Our study compares the distributions of the second (from the left) and first digits in revenue and various proxies for earnings with their corresponding Benford distributions (Benford, 1938). Also, we perform a logistic regression analysis and compute probabilities based on this analysis. The results show that revenue observations have more first digit 1’s and second digit 0’s and fewer first and second digits 9’s than under a Benford distribution. Korean managers appear to round up revenues with high second digits to improve first digits. In addition, we document that revenue observations with second digits of 0 are associated with higher proportions of positive earnings (gross margin and earnings from operations) with second digits of 0. This suggests that Korean firms simultaneously convert the second digits of revenue and earnings to improve the first digits of those numbers. Results from additional tests convey more upward management of the second digit of revenue for firms that have characteristics that indicate higher ex ante benefits and stronger ex post effects from revenue management.

We examine the effects of signed industry-average earnings management on the pricing of initial public offerings (IPOs). We posit that the variation in an IPOs earnings management is related to industry-average earnings management and, therefore, provides useful information regarding the IPO valuation. We find that higher industry-average earnings management negatively affects the pre-issuance price update and the initial return of IPOs. Our findings lend support to the partial adjustment phenomenon of IPO pricing which suggests information that influences valuation is partially incorporated in the initial offer price and more fully incorporated in the share price during the first-day of secondary market trading.

This study investigates whether and how the CEOs’ political spending choice is associated with their earnings management behavior. Using a sample of 8,502 firm-year observations from S&P 500 firms during 1993–2012 over 10 election cycles, we provide empirical evidence that CEOs making political spending mainly through the corporate channel to recipients advised by the firms’ own political action committees engage in less earnings management than those making political spending mainly through the private channel to their own selected recipients. This finding suggests that CEOs’ political spending choice of the private channel over the corporate channel represents their strong self-interests and is associated with higher agency costs. We further show that the distinction between the two channels is less important when the CEOs’ private political spending patterns are aligned with those of their own firms. Our results are robust to techniques alleviating the potential endogeneity issue related to political spending behavior.

China is one of the world’s major producers and consumers of energy. The investment value of China’s energy industry has attracted the attention of investors at home and abroad. Few studies, however, have specifically investigated investment ratings in China’s traditional energy industry. This study, therefore, uses scientific analysis methods to help investors measure the investment value and returns of China’s energy industry. From the perspectives of market performance and earnings management, we select factors that influence stock value evaluation indicators and undertake an empirical analysis using financial statement data for 2020 from the Wind database. Based on a factor analysis of the main financial indicators (e.g. amplitude, turnover rate, gross profit margin of sales, growth rate of operating revenue), we obtain five main factors: stock market performance, trading heat, profit quality, profit scale, and profit potential. The $k$-means algorithm in Python is then used to analyse 56 stocks in China’s energy industry, and we divide their investment ratings into six grades: risk stocks, prudent holding, undetermined class, hold rating, ordinary rating, and buy rating. By identifying the group characteristics of different types of stocks, this study can provide a decision-making basis for investors while also having reference value for research institutions, financial departments, and government departments.

Our study explores how firms respond to a tax rate reduction under an imputation tax system. By exploring Taiwanese data, we find that firms engage in significant downward earnings management preceding a tax rate reduction, and this earnings management behavior reverses in the following year. We further explore what factors drive this finding, given that corporate tax avoidance reduces shareholder imputation credits and thus generates limited tax benefits to most shareholders. We argue and find evidence that three factors explain the tax-induced earnings management: (1) financing benefits from tax savings, (2) managerial rent extraction, and (3) the influence of foreign and domestic institutional shareholders. Our results suggest that factors other than shareholder tax benefits have significant effects on corporate tax avoidance, suggesting that firms still have strong incentives to avoid taxes under an imputation tax system.

Using a sample of U.S. domestic deals from 1990 to 2016, we find that bidders adjust the amount of premium paid in mergers and acquisitions (M&As) based on the levels of earnings management at target firms. However, the way a firm manipulates earnings upward matters: earnings management via real activities manipulation is more detrimental than discretionary accruals. As a result, target firms that engage in real earnings management receive lower premiums in M&As, while accruals management has no effect on premiums. Correspondingly, we find that the targets’ M&A announcement-period cumulative abnormal returns are inversely related to their level of real earnings management, while the returns are not related to accruals management. Further analyses confirm that target shareholders’ wealth is not only driven by undervaluation, expected synergy, and managerial hubris, but also reflects bidders’ perception of the target firms’ earnings quality based on real earnings management.

This paper investigates whether a consideration of linguistic history is important when studying the relationship between economic and linguistic behaviors. Several recent economic studies have suggested that differences between languages can affect the way people think and behave (linguistic relativity or Sapir–Whorf hypothesis). For example, the way a language obliges one to talk about the future might influence intertemporal decisions, such as a company’s earnings management. However, languages have historical relations that lead to shared features—they do not constitute independent observations. This can inflate correlations between variables if not dealt with appropriately (Galton’s problem). We discuss this problem and provide an overview of the latest methods to control linguistic history. We then provide an empirical demonstration of how Galton’s problem can bias results in an investigation of whether a company’s earnings management behavior is predicted by structural features of its employees’ language. We find a strong relationship when not controlling linguistic history, but the relationship disappears when controls are applied. In contrast, economic predictors of earnings management remain robust. Overall, our results suggest that careful consideration of linguistic history is important for distinguishing true causes from spurious correlations in economic behaviors.