Earnings Management to Avoid Earnings Decreases and Losses

Do institutional investors reinforce or reduce agency problems? Earnings management and the post-IPO performance

The primary purpose of this study is to investigate the impacts of earnings management (EM) and related party transactions (RPTs) on corporate financial performance in an emerging market, Iran. This paper also aims to examine the moderating role of internal control weakness (ICW) in the relationship between them. The study sample includes 108 Iranian manufacturing companies listed on the Tehran Stock Exchange (TSE) between 2013 and 2018, and panel data with random effects are used to test the hypotheses. When an accounting-based measure called ROA is defined as a proxy for corporate performance, the results show that there is a negative association between real earnings management (REM) and corporate financial situation, while accrual-based earnings management (AEM) and firm value are correlated positively. However, when Tobin’s Q index is defined as a proxy for corporate performance, we do not find any significant association between them. Consistent with the tunneling hypothesis or agency theory, our findings confirm RPTs damage corporate value (ROA and Tobin’s Q) because managers probably consider it a mechanism to exploit enterprise resources owing to existing conflictual interests. Moreover, purchase-related party transactions lead to lower ROA, whereas sale-related party transactions and Tobin’s Q are correlated negatively. Moreover, weak internal control has a positive moderating influence on the linkage between AEM and Tobin’s Q index. Finally, we provide robust evidence that there is a positive association between sale growth and institutional owners with ROA and Tobin’s Q, although financial leverage and mergers and acquisitions (M&A) have a destructive effect on corporate value.

Earnings Management, Related Party Transactions and Corporate Performance: The Moderating Role of Internal Control

Previous studies (see, for example, Carslaw, 1988; Thomas, 1989; Niskanen and Keloharju, 2000; Kinnunen and Koskela, 2002; Van Caneghem, 2002) clearly suggest that public companies' managers tend to round up the first digit of reported earnings (i.e. for companies reporting profits). Based on a sample of listed UK companies and employing earnings rounding-up behaviour (henceforth ERUB) as an indication of earnings management, I attempt to determine the impact of differences in audit quality on earnings management. When I rely on the very popular brand-name proxy (i.e. BigFive versus non-BigFive auditors) to capture differences in audit quality, findings are inconsistent with BigFive auditors constraining earnings management practices (i.e. findings suggest ERUB for both BigFive and non-BigFive clients). Employing an alternative proxy (i.e. based on auditors' industry expertise), findings are only weakly consistent with specialist BigFive auditors constraining earnings management (i.e. ERUB) practices.

The impact of audit quality on earnings rounding-up behaviour

Pre-IPO earnings management: Evidence from India

Purpose




This paper aims to examine the impact of initial public offerings (IPO)-year opportunistic earnings management on long-term market and earnings performance.




Design/methodology/approach




A sample of 150 book-built IPOs over 2001-2006 are analysed based on industry adjusted return on sales and industry adjusted return on assets for six post-IPO years. The quality of earnings is measured in two ways using discretionary accruals and Beneish manipulation score. Modified Jones model is used to estimate the expected accruals and to compute the discretionary accruals for each IPO firm year. Regression model is used to examine the impact of IPO-year quality of earnings on future earnings performance.




Findings




The paper finds that earnings and market performance of IPO companies are abnormally higher in the IPO-year, as compared to the post-IPO years. Similarly, the quality of earnings during the IPO-year is lower than those in the post-IPO years. The results also show that the opportunistic earnings management in IPO-year has significant negative impact on the long-term adjusted earnings and market performance.




Research limitations/implications




The present study is confined to the period from 2001 to 2006 for the purpose of post-IPO analysis for a period of six post-IPO years. Thus, the conclusions of this study are to be viewed with this limitation.




Originality/value




This paper is the first study based on the Indian context to examine the relationship between the quality of earnings of the IPO firm and long-term earnings and market performance.

Opportunistic earnings management during initial public offerings: evidence from India

Existing literature focuses on the evaluation of the readability of annual reports of non-banking companies. However, banking companies’ opaque nature and a double motivation to abuse accounting di...

Readability of Annual Reports and Operating Performance of Indian Banking Companies

Purpose – This paper aims to investigate the rounding-up in reported income numbers of Indian companies by examining the evidence of unusual occurrence of zero and nine in reported income numbers such as profit after tax and earnings per share (EPS). It also examines such rounding-up patterns under different scenarios such as companies varying across different time periods, income size, market capitalization, industries, initial public offering and earnings news. Design/methodology/approach – All 1,707 companies listed on National Stock Exchange of India were considered for analysis. This study covered a period of 21 years from 1991-1992 to 2011-2012. Data were collected from PROWESS database. Findings – In Indian companies, the rounding-up pattern in reported income numbers is in conformity with existing studies (Carslaw, 1988; Thomas, 1989). In case of income numbers, the observed proportionate occurrence of zero and nine is significantly different from the expected proportionate occurrence. The study f...

Rounding-up in reported income numbers

The present study makes an attempt to examine the quality of reported income numbers of unlisted firms in India. The Benford’s Law is applied to examine the digital occurrence of reported income numbers of unlisted firms. The analysis is based on 43,996 reported annual income numbers of 22,147 sample firms during the financial years from 2000-01 to 2011-12. Further, the results are analyzed under four different scenarios viz., ownership, size, age and nature of industry. The empirical results show that the observed proportionate occurrence of zero is significantly less than the expected proportionate occurrence. These results are contrary to the findings of the related studies of listed companies. The results indicate lower quality of reported income numbers of unlisted firms. Based on the scenario analysis, the empirical results indicate that the proportionate occurrence of second single digits of state-owned unlisted firms confirm the Benford’s Law. The present study contributes to the literature by examining the quality of reported income numbers of unlisted firms using the Benford’s Law.

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Applying Benford"s Law to Examine the Quality of Reported Income Numbers of Unlisted Firms

The present study aims to examine, and to test the monitoring effect of institutional investment on, the relationship between insider ownership and real earnings management in Indian companies. The study examines the non-linear association between insider ownership and real earnings management using a sample of listed non-financial companies in the Indian market from 2011 to 2018. The study used pooled data OLS regression and Quantile regression. The findings reveal significant non-linear U-shaped relationship between insider ownership and real earnings management and that the large-size institutional investment makes such non-linear relationship insignificant. Contribution of the present study to the literature is two-fold. First, it proves the differential impact of the size of insider ownership on real earnings management. It indicates that firms having large-size insider ownership have greater scope for real earnings management, underscoring the need for the more scrutiny of reported earnings by the outsider shareholders. Second, it proves significant positive effect of the size of institutional investment in constraining the entrenchment by the insider owners. It signals that firms with large-size institutional investment have better quality of financial reporting and also contribute to efficient price discovery in the capital markets.

Rachappa Shette

Papers

Opportunistic earnings management during initial public offerings: evidence from India

Readability of Annual Reports and Operating Performance of Indian Banking Companies

Rounding-up in reported income numbers

Applying Benford"s Law to Examine the Quality of Reported Income Numbers of Unlisted Firms

Insider Ownership and Real Earnings Management in Indian Companies