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Earnings Management, Earnings Surprises, and Distressed Firms
Abstract
We examine the propensity of distressed firms to manage earnings and the impact of their earnings management on investor response to earnings. We find that distressed firms manage earnings upward and downward more than other firms. Distressed firms manage earnings upward significantly more than non-distressed firms after negative earnings surprises. Investor response to earnings surprises is smaller in magnitude for distressed firms. Investor response to positive earnings surprises of distressed firms is larger in magnitude than the response to negative earnings surprises. The change in bankruptcy probability after a negative earnings surprise is greater for distressed firms. Distressed firms have less post-announcement earnings drift. The results suggest that earnings management by distressed firms lowers earnings quality and weakens investor response. Our evidence has implications for investors, analysts, and compensation and audit committees.
... With the development of companies, increased economic activity, the intensification of competition and the cycle of inflation and recession in recent decades, the number of financially helpless companies and the importance of helplessness are on the rise. The issue of bank-ruptcy and financial distress is always a matter of concern, and investors, creditors, managers, accountants and employees are the most important groups that are heavily influenced by it (Howe & Houston, 2015). ...
... Because the unexpected negative profits, may lead to adverse reactions for market players, resulting in undesirable evaluation of management performance and companies often use strategies that are likely to fail to reduce the realized profit (Bartov et al., 2002;Barton & Simko, 2002;Brown & Caylor, 2005;Brown & Pinello, 2007). The literature of accounting research has shown that companies in various ways may avoid unexpected negative profits (Howe & Houston, 2015). One of these strategies is the use of optional accruals to manipulate the incremental profit that is known as earnings management based on accruals. ...
... These measures could include, for example, a reduction in avoidable expenditures in the area of research and development, advertising and maintenance, as well as a reduction in the cost of finished goods sold through increased production in the current period. One of the other ways of realizing predicted profit is to manage market expectations and investors by providing their predictions at a lower level (Howe & Houston, 2015). Brown and Pinello (2007) showed that in the process of realizing the expected profit, the method of incremental profit management through optional accruals and the method of decreasing profit prediction method are used, alternately. ...
Many financial crisis are related to public corporations, which are increasing. Many investors and creditors are having trouble predicting a financial crisis, especially when managing profits. Recent studies identify the factors associated with earnings management to determine the relationship between the factors and manipulated profits. In order to reduce the risk of financial crises and to help investors avoid large losses in the stock market, it is necessary to develop a model for predicting profit management. In addition, for traditional auditing technologies, it is also difficult to limit the time, human resources, costs, and the impact of abnormal behaviors on complex and large financial information. Therefore, developing a prediction model for managing profits for auditors is useful in identifying the degree of manipulation in financial statements. This paper examines the effect of corporate financial distress on unpredicted net earnings and corporate profits on accepted companies in Tehran Stock Exchange over the period 2010-2015. The models used to test the hypotheses of the research are linear regression using panel data. The results show that the coefficients of the financial distress, institutional ownership, annual sales growth, company loss, company size, the company's market share and firm fixed costs are statistically meaningful. In other words, these independent variables influence on unforeseeable profit and earnings management.
... The expectation is that increase in profitability is associated with higher earnings quality. The variable, financial distress, was included to controls for the effect of corporate distress on earning quality (Agrawal, 2015;Howe and Houston, 2016). It is predicted that financial distress is related to low earnings quality. ...
PURPOSE – The purpose of this paper is to re-examine the effect of CSR disclosures on earnings quality in Nigeria beyond the conventional wisdom of statistical significance.
DESIGN/METHODOLOGY/APPROACH – The sample consists of 300 company-year observations from 2013 to 2018 of listed companies on the Nigerian Stock Exchange. The research hypothesis was tested using multivariate linear regression on the total sample and subsamples. Pre-study statistical power analysis was carried out to ensure that the study is adequately powered to detect an effect if it exists.
FINDINGS – The main results suggest that corporate giving is not related to earnings quality. Though, additional analysis for the income-decreasing subsample was statistically significant, the effect size for both the primary and additional analyses is weak, negligible, and unlikely to be of any practical significance. The results retained their robustness after further analysis.
PRACTICAL IMPLICATIONS – The findings could inspire policymakers and regulators to shift attention to other areas of CSR that matters. It could also serve as an input to the current debate on CSR, especially the ongoing consideration of a Bill for an Act to regulate corporate giving in Nigeria.
ORIGINALITY/VALUE – This is probably the first papers to provide critical results index needed for substantive comparison of future studies. Hence, the paper serves as a baseline for future research on the topic.
... Financial distress is of extreme concern to those that are influenced the most by this problem (Howe & Houston, 2015). Financial distress is the result of bad management choices of financing policies and their inability of implementing the company's plan (Platt & Platt, 2006). ...
The aim of this study is to indicate the non-financial institutions financial health before and after the application of the Egyptian Financial Leasing and Factoring Act. Lessor firms applied the new Regulations for leasing on the year 2018. The study uses numerical data for 5 years during 2016-2020 from the financial reports of 10 lessors listed in the Egyptian Financial Regulatory Authority FRA. The sample of the study was equivalent to 43 firm year observations. The selected firms operate in cash, have annual reports that date from 1/1 to 31/12, have not been disqualified at any time during the study period, have complete data, and currency recorded in Egyptian pound. The test tool used to forecast financial health was the adjusted Altman Z-Score model (1995). In addition, the study applied the simple regression model and five step panel analyses. The dependent variable was the firm health represented by the sum of Z-Score. The independent variable was the Financial Leasing and Factoring Act represented by sales, financial liabilities, EBIT/operating profit or loss and financial leased fixed assets. The results indicate a strong significant impact of applying the Financial Leasing and Factoring Act on the lessor business health. The results of this study might increase the quality of predictability of lessor financial health. The length of the study period makes it possible to track progress of lessor firms to be able to predict their future business health. This is a modest contribution to the literature relating to lessors in Egypt.
... Financial distress occurs before the company bankruptcy. Howe & Houston (2016) suggested that earnings management behavior increases as the company's financial distress increases. In this case, the main role in the survival of the company is management that have to maintain business sustainably by avoiding the possibility of any financial difficulty. ...
This research aims to find out whether the presence of independent commissioner can restrict the manipulation of earnings by management in financially distressed companies. Earning management used in this research is accrual as well as real earning management. This research employs quantitative method with data panel regression model. The sample used in this study is secondary data obtained from consumer goods industry listed on Indonesia Stock Exchange during the period of 2015 until 2019. The result of this study revealed that both accrual earnings management and real earnings management are significantly influenced by financial distress. However, independent commissioner fails to moderate the relationship of financial distress with both accrual earnings management and real earnings management. This research gives an insight and input to the management as the evaluation material, so that the earnings manipulation could be reduced or even not carried out. Abstrak: Penelitian ini bertujuan untuk mengetahui apakah keberadaan komisaris independen dapat membatasi manipulasi laba oleh manajemen pada perusahaan yang mengalami financial distress. Manajemen laba yang digunakan dalam penelitian ini adalah manajemen laba akrual dan manajemen laba riil. Penelitian ini menggunakan metode kuantitatif dengan model regresi data panel. Sampel yang digunakan dalam penelitian ini adalah data sekunder yang diperoleh dari industri barang konsumsi yang terdaftar di Bursa Efek Indonesia selama periode 2015 hingga 2019. Hasil penelitian ini mengungkapkan bahwa baik manajemen laba akrual maupun manajemen laba riil dipengaruhi secara signifikan oleh financial distress. Namun, komisaris independen gagal memoderasi hubungan financial distress dengan manajemen laba akrual dan manajemen laba riil. Penelitian ini memberikan wawasan dan masukan kepada pihak manajemen sebagai bahan evaluasi, sehingga manipulasi laba dapat dikurangi atau bahkan tidak dilakukan.
... Otherwise, Howe and Houston (2015) suggest that distressed firms manage earnings both upward and downward. In fact, managers have incentives to manage earnings upward to preserve their job and reputation. ...
The objective of this research is to investigate whether earnings management incentives influence the pricing of discretionary accruals. Specifically, we verify if growth opportunity, leverage, free cash flow, insider trading and financial distress are useful to investors to discriminate between opportunistic and informative earnings management. Using a sample of 486 American firms for the period 2002-2010, we find that discretionary accruals are positively related to stock returns. This relation is more intensive in high growth firms and high levered firms. Indeed, these firms use more informative earnings management to communicate future prospects and good financial situation to external investors. However, discretionary accruals are negatively priced by investors in distressed firms. These firms have a greater incentive to manage earnings opportunistically to hide any financial problem. Likewise, we detect a negative relationship between discretionary accruals and stock returns in firms with excessive free cash flow revealing the opportunistic perspective of earnings management. Finally, we demonstrate that investors award positive (negative) value to discretionary accruals in case of insider buying (selling).
... They document that earnings manipulation positively influences earnings string (consecutive positive earnings surprises) with related valuation. Howe and Houston (2016) examined earnings management, earnings surprises and distressed firms (in USA, from 1989(in USA, from -2011. Using a total of 131,751 quarterly observations; the regression results indicate that investors are significantly less responsive to earnings surprises of distressed firms and that distressed firm"s experience large-in-magnitude investor response to positive earnings surprises than negative earnings surprises. ...
The study was carried out to investigate the determinants of accounting earnings surprises in South Africa. A total of two hundred (200) firm-year data obtained from twenty (20) quoted companies for the period of Ten years (2008-2017) were used for the study. Descriptive statistics and correlation matrix was employed alongside the panel regression to investigate these determinants. The variables used for the study include Earning Surprises (ERNSP) as dependent variable while independent variables include Firm Reputation (FRMREP), Earnings Management (ERNMAG), Sales Growth (SALSGT), Cash Flow (CSHFL), and Firm Size (FSIZE). The results indicate that all the variables studied have no significant effect on earnings surprises of industrial firms in South Africa. Firm reputation and earnings management were found to have insignificant positive influences while sales growth, cash flow and firm size were found to have insignificant negative influences on earnings surprises. It was recommended that: investors in South Africa may not bother themselves about the variables tested in this study as none of them have significant effect on the earnings surprises of industrial companies in their country. Our study contributes to the earnings surprises literature by extending the study of earnings surprise determinants to South African industrial companies; modifying existing models and updating literature.
... They document that earnings manipulation positively influences earnings string (consecutive positive earnings surprises) with related valuation. Howe and Houston (2016) examined earnings management, earnings surprises and distressed firms (in USA, from 1989(in USA, from -2011. Using a total of 131,751 quarterly observations; the regression results indicate that investors are significantly less responsive to earnings surprises of distressed firms and that distressed firm"s experience large-in-magnitude investor response to positive earnings surprises than negative earnings surprises. ...
The study was carried out to investigate the determinants of accounting earnings surprises in South Africa. A total of two hundred (200) firm-year data obtained from twenty (20) quoted companies for the period of Ten years (2008-2017) were used for the study. Descriptive statistics and correlation matrix was employed alongside the panel regression to investigate these determinants. The variables used for the study include Earning Surprises (ERNSP) as dependent variable while independent variables include Firm Reputation (FRMREP), Earnings Management (ERNMAG), Sales Growth (SALSGT), Cash Flow (CSHFL), and Firm Size (FSIZE). The results indicate that all the variables studied have no significant effect on earnings surprises of industrial firms in South Africa. Firm reputation and earnings management were found to have insignificant positive influences while sales growth, cash flow and firm size were found to have insignificant negative influences on earnings surprises. It was recommended that: investors in South Africa may not bother themselves about the variables tested in this study as none of them have significant effect on the earnings surprises of industrial companies in their country. Our study contributes to the earnings surprises literature by extending the study of earnings surprise determinants to South African industrial companies; modifying existing models and updating literature.
... Return on assets is measured by the ratio net income divided by firm's total assets. This ratio is used in various studies, such as Dhaliwal et al. (2014) and Howe and Houston (2016). Muiño and Trombetta (2009) argue that because the ROA includes the risk level, it may be the best predictor for the cost of equity capital. ...
This paper aims to examine the effect of ownership structure on the cost of equity capital in the Tunisian context. Using panel data, the study provides evidence for a negative relationship between ownership concentration and cost of equity capital. However, most ownership composition variables validate the entrenchment effect. Results show an inverted U-shaped relationship between institutional ownership, foreign ownership and cost of equity capital. However, a U-shaped relationship is found between state ownership and the dependent variable. To alleviate endogeneity concerns and establish that the results are robust, the authors re-estimated the regressions using a dynamic approach. It supports the entrenchment effect of ownership concentration. A U-shaped relationship between this variable and the cost of equity capital is confirmed. However, a concave relationship is found when considering ownership composition variables. As for family ownership, the results from static and dynamic approaches are convergent and in favour of entrenchment effects.
... Otherwise, Howe and Houston (2015) suggest that distressed firms manage earnings both upward and downward more than other firms. On the one hand, managers have incentives to manage earnings upward as they can expect to have their bonuses cut, be replaced and suffer a loss of reputation. ...
This research investigates the effect of the determinants of accounting discretion (beating last year’s earnings, overinvestment problems, growth options, debt, and financial risk) on the relationship between earnings management and stock returns. We use discretionary accruals as a proxy of earnings management.Based on a sample of 486 American firms for the period 2002-2010, our results show that discretionary accruals are positively priced by the market. This relation is even stronger when firms beat last year’s earnings, have higher growth options and increase their debt ratio. Indeed, firms’ accounting manipulations are used, in these circumstances, to convey private information about future prospects and signal good financial situation to external investors. However, discretionary accruals are negatively priced by investors in distressed firms and when overinvestment problems are intense. These firms have greater motivation to use opportunistic earnings management to camouflage the fall of firm value.
... Return on assets is reflected by the ratio net income divided by the firm's total assets. Many studies, such as Dhaliwal et al. (2014), Tsipouridou and Spathis (2014) and Howe and Houston (2016) use this ratio. Muiño and Trombetta (2009) argue that because the ROA includes the risk level, it may be the best predictor for the cost of equity capital. ...
This paper investigates the relationship between the financial information quality and the cost of equity capital. The financial information quality is described by the following three attributes: earnings quality, financial transparency and audit quality. This study used a sample of 26 companies listed on the Tunis Stock Exchange (TSE), over the period 2004 to 2010. After verifying endogeneity problem, regressions are estimated using the bootstrap technique associated with the Ordinary Least Squares method and consider nonlinear relationships. Different financial information quality attributes as well as a composite index are used as dependent variables. Our results indicated a negative relationship between most of the attributes mentioned above and the cost of equity capital. Furthermore, the existence of a nonlinear relationship, namely a U-shaped relationship, is confirmed between the financial information quality index and the cost of equity through a robustness check.
لا يطيل منع الإفلاس العمر الاقتصادي للشركة ويزيد من أدائها المالي فحسب ، بل يساعد أيضًا في تحسين الرفاه الاقتصادي العام للبلد. لذلك ، فإن التنبؤ بالعجز المالي يمكن أن يؤثر على عوامل مختلفة ويؤثر على جوانب مختلفة من الشركة ، بما في ذلك أرباح الأسهم. وفي هذا الصدد تبحث هذه الدراسة في التنبؤ بالعجز المالي للشركات التي تستخدم أسلوب الانحدار اللوجستي وتأثيره على ربحية السهم في الشركات المدرجة في البورصة العراقية. الفترة الزمنية للبحث هي من 2015 إلى 2020 ، حيث تم اختيار 33 شركة تم قبولها في البورصة العراقية كعينة ، وتم اختبار فرضيات البحث باستخدام انحدار المربعات الصغرى العادي والانحدار اللوجستي. أشارت نتائج اختبار الفرضية الأولى للبحث إلى أن نتائج الانحدار اللوجستي أحادي الاتجاه من Baytree أشارت إلى تأكيد هذه الفرضية ويمكن القول بثقة أنه من خلال الجمع بين المعلومات المحاسبية والسوقية ، يمكن استخدام نموذج مناسب للتنبؤ بالضائقة المالية للشركات المقبولة المعروضة في البورصة العراقية. كما أظهرت نتائج الفرضية الثانية للبحث أن ربحية السهم هي دالة للتنبؤ بالعجز المالي. تحاول الشركات التي تتنبأ بالعجز المالي إظهار ربح أقل لكل سهم وتحاول أن تكون صادقًا ومن خلال التنبؤ الدقيق لربح السهم وفقًا لنظرية الإشارة ، فإنها تكسب ثقة المساهمين والدائنين وتؤكد أن الشركة تحاول العثور عليها. طريقة جيدة للخروج من الأزمة القادمة.
فإن الأوجه الفقهية الكثيرة التي قال بها أئمة الشافعية من الأهمية بمكان، ذلك لأن هذه الأوجه ما هي إلاَّ آراء فقهاء أجلاء بلغوا درجة عالية من العلم حتى صاروا من أصحاب الوجوه، ثم إن هذه الآراء هي أقوال أخرى تضاف إلى الثروة الفقهية التي حوتها كتب الفقه، ومنهم فقهاء الشافعية، فقد يختلف الفقهاء فيما بينهم، إما بسبب عدم وجود النص عن إمامهم في مسألة ما، أو أن تكون المسالة أصلاً: لا نص فيها، فيجتهد أصحاب الوجوه بإيجاد رأي لها، تخريجاً من نصوص إمامهم في مسائل أخرى مقاربة، أو فيها جهة مشابهة، أو استناداً على أصوله، أو قياساً على مسائل أخرى، أو غير ذلك من الأسباب، وقد يختلف الفقهاء الذين جاءوا بعد طبقة أصحاب الوجوه في أغلب الأحيان في ترجيح بعض الوجوه على بعض، وقد يُفتى ببعض الوجوه، وإن لم تكن راجحة في عصر ما، لأجل مصلحة ما، تناسب ذلك العصر، لكن هذا منوط بمن بلغ درجة عالية من العلم، ومن هذه الأوجه الكثيرة: ما قال به الإمام أبو الفياض البصري. الأوجه الفقهية التي قال بها الإمام أبو الفياض البصري، والمنقولة عنه، قليلة بالمقارنة مع غيره من أصحاب الوجوه، والمعول في نقلها، هو في الأساس من: كتاب الحاوي الكبير للإمام الماوَرْدي، البصري. ما نقل من أوجه فقهية عن الإمام أبي الفياض، تتنوع بين رأي فقهي محض، وهو الأغلب، وبين توجيه لنص الشافعي رحمه الله تعالى، وبيان ما هو المراد منه، أو بيان المقصود من بعض المسائل، وبين نقل المذهب، أو حكاية المذهب، كما أن الأوجه الفقهية المنقولة عنه، تشتمل على أنواع المسائل الفقهية، على قلتها، إذ فيها من مسائل العبادات، ومن الأحوال الشخصية، ومن المعاملات، ومن الجنايات والحدود، ومن الدعاوى والبينات. هذا، وقد قدمت بحثاً سابقاً يخص الأوجه الفقهية للإمام أبي الفياض البصري في أحكام العبادات، وهذا هو القسم الثاني من الأوجه التي قال بها الإمام أبو الفياض البصري.
This study aims to provide empirical evidence regarding the effect of financial distress towards earnings management and the role internal audit as a moderating variable. This study uses all non-financial companies listed in Indonesia Stock Exchange during 2013-2019, totalled 1,442 observations. The results show that Distress1 proxied by z-score can reduce accrual and real earnings management practices, while D_Distress2 proxied by net working capital can increase accrual earnings management but reduce real earnings management practices. In addition, internal audit does not have a moderating role in weakening the effect of financial distress on earnings management but can reduce accrual and real earnings management practices.
Objetivo: O estudo analisa o efeito moderador da concentração de investidores institucionais na relação entre surpresa nos lucros e retornos anormais em companhias brasileiras de capital aberto. Método: Os dados foram coletados no banco de dados da Thomson Reuters®. O investidor institucional é tratado nessa pesquisa como um acionista que detém ações ordinárias e atua com ativos sob gestão (Assets Under Management - AUM). A surpresa nos lucros foi computada pela diferença entre o lucro divulgado pela companhia e o estimado pelo consenso dos analistas. Os retornos anormais foram calculados pelo método de Estudo de Eventos. As análises foram pautadas em regressões multivariadas com estrutura de painel. Foram investigadas 118 companhias listadas na B3 durante o período de 2010 a 2018, totalizando 2.264 observações. Resultados: Os resultados confirmaram que a surpresa positiva de lucro é capaz de gerar retornos anormais positivos após a divulgação dos resultados contábeis trimestrais. No entanto, o efeito moderador da concentração de investidores institucionais sobre a relação surpresa-retorno foi inconclusivo, pois não foram encontradas evidencias estatísticas de que a concentração dos investidores institucionais possa alterar a direção ou a força que a surpresa positiva dos lucros causa nos retornos anormais. Contribuições: O estudo contribui para o entendimento do papel dos investidores institucionais no mercado de capitais ao analisar se a sofisticação financeira atribuída a estes investidores é suficiente para diminuir as anomalias no preço das ações provocadas pelas surpresas nos lucros.
This paper investigates whether the management of the firms in financial distress apply creative accounting techniques in order to fine-tune the elements of their financial statements. For this purpose, the financial statements of 385 Greek bankrupt companies of the trade and industry sectors for the period 2003 to 2014 were analyzed.
The sample was divided into two sub periods; in the period before the financial crisis, that is from 2003 to 2008, and the period 2009-2014 during which the Greek economy was in crisis and recession. By applying factor analysis, five financial ratios were selected which formed the independent variables in a Discriminant Analysis (MDA) and Logit models in order to find those companies which, while they were bankrupt they classified in the last period of their operation as healthy (type I error).
By selecting these companies (common to both models), their accounting data for the last two years before went bankrupt has been investigated in order to determine whether they have been affected by the application of creative accounting methods.
The results showed that the management of some firms applied creative accounting techniques during the last year of operation before their bankruptcy, which led to the manipulation and falsification of the published financial statements during the period before the financial crisis. However, this is not the case for the period 2009 to 2014, when the Greek economy was in a financial crisis.
This paper investigates whether the management of firms in financial distress applies creative accounting techniques in order to fine-tune the elements of their financial statements. For this purpose, the financial statements of 385 Greek bankrupt firms of the trade and manufacturing sectors for the period 2003 to 2014 were analyzed. The sample was divided into two sub periods; in the period before the financial crisis, that is from 2003 to 2008, and the period 2009 to 2014 during which the Greek economy was in crisis and recession. By applying factor analysis, five financial ratios were selected, which formed the independent variables in a Discriminant Analysis (MDA) and Logit models in order to find those firms which, while they were bankrupt they were classified in the last period of their operation as healthy (type I error).By selecting these firms (common to both models), their accounting data for the last two years before they went bankrupt have been investigated in order to determine whether they have been affected by the application of creative accounting methods. The results showed that the management of some of the selected firms applied creative accounting techniques during the last year of operation before their bankruptcy, which led to the manipulation and falsification of the published financial statements during the period before the financial crisis. However, this is not the case for the period 2009 to 2014, because the economic crisis affects the behavior of managers in applying creative accounting, which is owing to the changes in market rules.
This study aims to investigate the effect of earnings information on market reaction with accrual and real earnings management as the moderating variables. The sample of this study is manufacturing companies listed in the Indonesia Stock Exchange in 2012-2015. Samples are collected by purposive sampling and resulted in 58 companies as the final sample. Data were analyzed using Moderated Regression Analysis (MRA) for testing hypothesis with significance level 5%. The statistical tool used is SPSS 22. The results of this study shown that market reacts positively significant toward earnings management and real earnings management in aggregate weaken the effect of earnings information toward market reaction. Real earnings management through discretionary expenses strengthen the effect of earnings information toward market reaction. Meanwhile, real earnings management through sales manipulation and overproduction, and accrual earnings management do not moderate the effect of earnings information toward market reaction.
This paper shows that the threat of litigation impacts managers’ accounting and stock-trading decisions in periods preceding technical default. We analyze managers’ pre-default accrual strategies separately and jointly with their pre-default insider trading activity in a sample of 462 firms that experience technical default in the period 1983-1997. We find that pre-default abnormal insider selling provides incentives for upward earnings management independent of debt contracts. Our evidence that insider trading incentives complement debt contract incentives suggests that researchers investigating earnings management among distressed firms can exploit managers’ trading patterns to increase the power of their tests. We also propose and find that abnormal selling occurs before rather than after earnings management. This suggests that earnings management in distressed firms is more likely to reflect a desire to avoid litigation (“dump and pump”) rather than to sell at higher prices (“pump and dump”). Indeed, evidence that earnings management can distance managers’ selling from the revelation of bad news suggests that investors and those with oversight authority (e.g., boards of directors, auditors, and regulators) consider monitoring insider trading activity prior to, rather than subsequent to, earnings management.
Empirical evidence on earnings management by financially distressed firms is very limited. This study examines discretionary accruals in distressed firms that have undertaken debt contract renegotiation subsequent to debt covenant violation with a view to determining whether managers adopt income-decreasing accruals during debt renegotiation. Using four established models for detecting discretionary accruals during the recent financial crisis in Malaysia, we find evidence that distressed firms manipulate earnings downward. The results show that the magnitude of discretionary accruals is statistically significantly negative during the year surrounding renegotiations with lenders, and that these accruals are significantly more negative than those of a control sample of firms which have not undertaken debt renegotiation during the same period but experienced similar financial performance. The results are robust after controlling for changes in top management, audit qualifications, audit firm size, as well as traditional measures such as firm size, performance, liquidity and leverage.
This is the first study to examine the post-earnings-announcement drift anomaly in a Real Estate Investment Trust (REIT) context.
The efficient markets hypothesis suggests that unexpected earnings should be fully incorporated into asset prices soon after
being publicly announced. We hypothesize that publicly announced earnings signals may be more certain for REITs due to the
presence of a parallel (private) asset market, suggesting less drift for REIT stocks. However, we find a large REIT drift
component that is both statistically and economically significant. Furthermore, while the initial earnings surprise response
is more muted for REITs, we find that the magnitude of the drift is significantly larger for REITs than for ordinary common
stocks (NonREITs). Thus, information does not appear to move between the private and public asset markets in such a way as
to render REIT earnings signals more certain than NonREIT earnings signals.
KeywordsREITs–Post-earnings-announcement drift–Market efficiency–Trading rule–Uncertainty
What is the role of information intermediaries in corporate governance? This paper examines equity analysts’ influence on managers’ earnings management decisions. Do analysts serve as external monitors to managers, or do they put excessive pressure on managers? Using multiple measures of earnings management, I find that firms followed by more analysts manage their earnings less. To address the potential endogeneity problem of analyst coverage, I use two instrumental variables based on change in broker size and on firm's inclusion in the Standard & Poor's 500 index, and I find that the results are robust. Finally, given the number of covering analysts, analysts from top brokers and more experienced analysts have stronger effects against earnings management.
We examine the impact of differential incentives arising from proximity to debt covenant violation on earnings management. We reason that firms with loans close to violation or in technical default of their debt covenants have greater incentives to engage in earnings management than firms that are far from violating their debt covenants. We find results consistent with this expectation. Firms close to violation or in technical default of their debt covenants engage in higher levels of accounting earnings management, real earnings management, and total earnings management than far-from-violation firms. In additional analysis, we find that firms with stronger incentives to avoid covenant violation switched from using more accounting earnings management before the Sarbanes-Oxley Act to using more real earnings management and more total earnings management after the Sarbanes-Oxley Act. We also document that the earnings management implications of debt covenant violation are observed primarily for firms with a poor credit rating and for firms that do not meet analyst forecasts.
I argue that hazard models are more appropriate than single-period models for forecasting bankruptcy. Single-period models are inconsistent, while hazard models produce consistent estimates. I describe a simple technique for estimating a discrete-time hazard model. I find that about half of the accounting ratios that have been used in previous models are not statistically significant. Moreover, market size, past stock returns, and idiosyncratic returns variability are all strongly related to bankruptcy. I propose a model that uses both accounting ratios and market-driven variables to produce out-of-sample forecasts that are more accurate than those of alternative models.
Does limited attention among investors affect stock returns? We compare the response to earnings announcements on Friday, when investor inattention is more likely, to the response on other weekdays. If inattention influences stock prices, we should observe less immediate response and more drift for Friday announcements. Indeed, Friday announcements have a 15% lower immediate response and a 70% higher delayed response. A portfolio investing in differential Friday drift earns substantial abnormal returns. In addition, trading volume is 8% lower around Friday announcements. These findings support explanations of post-earnings announcement drift based on underreaction to information caused by limited attention. Copyright (c) 2009 the American Finance Association.
This paper proposes that the inconsistent findings in previous studies of the relationship between corporate performance and CEO turnover may be due to insufficient attention to the type of performance indicator used by the individuals responsible for making CEO turnover decisions, namely, the board of directors. We argue that the board develops expectations of corporate performance, which it then uses to judge the CEO's performance. The study reported here analyzes financial analysts' forecasts of corporate performance, as a surrogate for the expectations board members could be expected to have, and then examines the relationship of forecasts to turnover. The principal finding is that turnover occurs when reported annual earnings per share fall short of expectations. For a sample of 408 CEOs under the age of retirement, this measure of corporate performance is a predictor of CEO turnover, whereas mechanical algorithms of abnormal security returns and historical accounting ratios are not.
We provide new evidence that the inferior returns to growth stocks relative to value stocks are the result of expectational errors about future earnings performance. Our evidence demonstrates that growth stocks exhibit an asymmetric response to earnings surprises. We show that while growth stocks are at least as likely to announce negative earnings surprises as positive earnings surprises, they exhibit an asymmetrically large negative price response to negative earnings surprises. After controlling for this asymmetric price response, we find no remaining evidence of a return differential between growth and value stocks. We conclude that the inferior return to growth stocks is attributable to overoptimistic expectational errors that are corrected through subsequent negative earnings surprises.
We test the predictions of Titman (1984) and Berk, Stanton, and Zechner (2010) by examining the effect of leverage on labor costs. Leverage has a significantly positive impact on CEOs’ cash, equity-based, and total compensation. Compensation of new CEOs hired from outside the firm is positively related to prior-year firm leverage. In addition, leverage has a positive and significant impact on average employee pay. The incremental total labor expenses associated with an increase in leverage are large enough to offset the incremental tax benefits of debt. The empirical evidence supports the theoretical prediction that labor costs limit use of debt.
Prior literature and anecdotal evidence suggest that failing firms are likely to overstate earnings. I predict and find that as (ex-post) bankrupt firms, that do not (ex-ante) appear to be distressed, approach bankruptcy, their financial statements reflect significantly greater material income-increasing accrual magnitudes, in non-going concern years, than control firms. These accrual magnitudes include receivables, inventories, payables, property, plant, and equipment, and sales. Nevertheless, these firms display significantly more negative changes in cash flows from operations and net cash than control firms. Finally, I predict and find that bankrupt firms' financial statements in going concern years, reflect evidence consistent with auditor prompted reversal of previous overstatements. These results are based on parametric and non-parametric tests for various combinations of sub-samples drawn from a sample of 293 bankrupt firms.
Several empirical papers document that there is a disproportionate number of firms that just meet or beat analyst earnings forecasts. Three explanations have emerged to explain this phenomenon: accruals manipulation, expectations management, and real activities manipulation. In this paper, we propose an alternative explanation: managers are opportunistically using the discretion afforded them in defining non-GAAP earnings to exclude enough expenses to allow them to exceed analyst forecasts. Using two empirical proxies for non-GAAP earnings, we find results that indicate the probability of meeting or beating analyst forecasts increases when managers choose to exclude expenses from GAAP and report a higher non-GAAP earnings number. We also find evidence that the market discounts the positive earnings surprises for firms that meet or beat estimates while using income-increasing non-GAAP exclusions. Finally, we find that this practice of meeting analyst estimates using income-increasing non-GAAP exclusions increased rapidly before Regulation G, leveled off during a period of heightened regulatory attention, but has begun again to increase in recent years.
We find that lower ex-ante earnings volatility leads to higher Post-Earnings Announcement Drift (PEAD). PEAD is a function of both the magnitude of an earnings surprise and its persistence. While prior research has largely investigated market reactions to the magnitude of the earnings surprise, in this study we show that the persistence of the earnings surprise is equally important. A unique feature of the anomalous PEAD returns documented in this study concerns the association between abnormal returns and trading frictions. Besides documenting that firms with lower earnings volatility have higher abnormal returns, we also find that lower earnings volatility firms have lower trading frictions. Taken together, these findings imply that higher abnormal returns are associated with lower trading frictions. We exploit this implication to empirically demonstrate that PEAD returns due to earnings volatility are not concentrated in the firms with the largest trading frictions, which is in contrast to the findings in prior anomaly studies.
This study examines the profitability of trading on earnings surprises in the post-earnings announcement period for Canadian equities spanning the period 1994-2009. There is clear evidence that stock prices drift in the direction of earnings surprise for several months following an earnings announcement. Specifically, we find that standardized unexpected earnings based on analyst forecasts (SUEAF), our main definition of earnings surprise, indicates that a hedge strategy of going long on firms in the highest SUEAF decile and going short on firms in the lowest SUEAF decile generates a greater than 6% excess return in the 60 days following the earnings announcement. We also show that that while both the SUEAF and standardized unexpected earnings capture earnings surprise, each contains information that is not entirely subsumed by the other. In summary, we advance that the post-earnings announcement drift is caused by the market’s delay in responding to earnings information. Our findings have major investment implications, since investors in general and Canadian investors in particular can exploit this anomaly.
This paper analyses earnings quality in ex-post failed firms. Using a large sample of UK bankrupt firms, we find that failed firms manage earnings upwards in the four years prior to failure. This manipulation is achieved in two ways: (1) through accounting (accruals) manipulation, and (2) by implementing real operating actions that deviate from normal practice. We show that these two types of manipulation lead to reduced earnings reliability. We use conditional conservatism as a proxy for reliability, as prior literature links conditional accounting conservatism to better governance and positive economic outcomes. Our results show that conditional conservatism decreases substantially in the years prior to failure. Finally, we show that accruals manipulation is more pronounced in ex-post bankrupt firms with low ex-ante probability of failure, and that ex-post bankrupt firms with high ex-ante failure probability, having likely exhausted the opportunities for accrual manipulation, manipulate real operations more aggressively.
This paper examines the relation between economic incentives to manage earnings and discretionary accruals and the modifying effects of audit quality on this relation. We hypothesize that incentives to smooth earnings and incentives created by debt agreements motivate managers to strategically bias earnings. However, we expect that earnings manipulation is tempered by the quality of the firm's external auditor. The findings indicate that companies with non-Big Six auditors (a proxy for lower audit quality) report discretionary accruals that significantly increase income compared to companies with Big Six auditors. We also find that managers respond to debt contracting and income-smoothing incentives by strategically reporting discretionary accruals. In addition, companies with incentives to smooth earnings upwards (downwards) report significantly greater income-increasing (decreasing) discretionary accruals when they have non-Big Six auditors. However, we do not find that audit quality affects earnings management that occurs in response to high leverage.
This study examines the relation between audit quality and earnings management. Consistent with prior research, we treat audit quality as a dichotomous variable and assume that Big Six auditors are of higher quality than non-Big Six auditors. Earnings management is captured by discretionary accruals that are estimated using a cross-sectional version of the Jones (1991) model. Prior literature suggests that auditors are more likely to object to management's accounting choices that increase earnings (as opposed to decrease earnings) and that auditors are more likely to be sued when they are associated with financial statements that overstate earnings (as compared to understate earnings). Therefore, we hypothesize that clients of non-Big Six auditors report discretionary accruals that increase income relatively more than the discretionary accruals reported by clients of Big Six auditors. This hypothesis is supported by evidence from a sample of 10, 379 Big Six and 2, 179 non-Big Six firm-years. Specifically, clients of non-Big Six auditors report discretionary accruals that are, on average, 1.5 to 2.1 percent of total assets higher than the discretionary accruals reported by clients of Big Six auditors. Also, consistent with earnings management, we find that the mean and median of the absolute value of discretionary accruals are greater for firms with non-Big Six auditors. This also indicates that lower audit quality is associated with more "accounting flexibility."
We provide evidence that the auto-regressive structure of seasonally differenced quarterly earnings is consistent with the requirements of the integral approach to interim reporting. In particular, we show that the auto-regressive coefficients for standardized seasonally differenced quarterly earnings are larger when the quarters employed in the auto-regressions belong to the same fiscal year than when they belong to different fiscal years. We then show that the signs and magnitudes of abnormal stock returns following earnings announcements are systematically related to these differences in the auto-regressive structure of seasonally differenced quarterly earnings. Specifically, stock returns act as if investors underestimate the larger auto-regressive coefficients between quarters in the same fiscal year. Thus, we corroborate and extend the Bernard and Thomas (1990) hypothesis that stock prices fail to reflect the extent to which quarterly earnings series differ from a seasonal random walk.
In this paper I explore the effects of politics on corporate finance, including the determinants of capital structure and the regulatory and legal factors governing the market for corporate control. I examine the effects and consequences of the active corporate control market of the 1980s, then I outline the enormous political controversy and inaccurate media portrayals that ensued, and contrast them to the results obtained from intensive study of the phenomena by academic economists. First, I review new macroeconomic evidence on changes in productivity in American manufacturing that is dramatically inconsistent with popular claims that corporate control transactions were crippling the industrial economy in the 80s. Second, I show how the restructuring movement of the 1980s reflected the re-emergence of active investors in the U.S. and how restructuring addressed the conflict between management and shareholders over control of corporate free cash flow. Third, I summarize my conception of LBO associations as new organizational forms that overcome the deficiencies of large public conglomerates. I also discuss the similarity between LBO associations and Japanese business financing networks known as keiretsu. Fourth, I argue that the highly-leveraged financial structures of the 1980s should lead to a Japanese-style privatization of bankruptcy (i.e., out-of-court reorganization). Fifth, I present a theory of boom-bust cycles in venture markets that explains why many companies involved with late-1980s leveraged transactions encountered financial distress. Sixth, I argue that misguided changes in the tax and regulatory codes and in bankruptcy court decisions have distorted the normal economic incentives for out-of-court reorganizations, resulting in increased costs of financial distress and a sharp rise in the number of Chapter 11 filings. Seventh and last, I propose a set of changes in the Chapter 11 process designed to reduce the costs of financial distress and thus maximize the total value of the firm to all investors.
This study examines whether audit committee and board characteristics are related to earnings management by the firm. A negative relation is found between audit committee independence and abnormal accruals. A negative relation is also found between board independence and abnormal accruals. Reductions in board or audit committee independence are accompanied by large increases in abnormal accruals. The most pronounced effects occur when either the board or the audit committee is comprised of a minority of outside directors. These results suggest that boards structured to be more independent of the CEO are more effective in monitoring the corporate financial accounting process.
The purpose of this study is to investigate whether companies listed on the Jakarta Stock Exchange (JSE) conduct efficient or opportunistic earnings management and to examine the effect of ownership structure, firm size, and corporate-governance practices on it.Using multiple regressions, we find evidence that the type of earnings management selected by JSE listed firms tends toward efficient earnings management. This evidence is inconsistent with the common view that earnings management in Indonesia is opportunistic. Family ownership has a significant influence on the type of earnings management selected. Firms with a high proportion of family ownership and non-business groups are more inclined to choose efficient earnings management than other types of firms. We find inconsistent evidence with regard to the impact of institutional ownership, firm size, and corporate-governance practices on type of earnings management.
I find evidence consistent with managers manipulating real activities to avoid reporting annual losses. Specifically, I find evidence suggesting price discounts to temporarily increase sales, overproduction to report lower cost of goods sold, and reduction of discretionary expenditures to improve reported margins. Cross-sectional analysis reveals that these activities are less prevalent in the presence of sophisticated investors. Other factors that influence real activities manipulation include industry membership, the stock of inventories and receivables, and incentives to meet zero earnings. There is also some, though less robust, evidence of real activities manipulation to meet annual analyst forecasts.
We examine CEO turnover and firm financial performance. Accounting measures of performance relative to other firms deteriorate prior to CEO turnover and improve thereafter. The degree of improvement is positively related to the level of institutional shareholdings, the presence of an outsider-dominated board, and the appointment of an outsider (rather than an insider) CEO. Turnover announcements are associated with significantly positive average abnormal stock returns, which are in turn significantly positively related to subsequent changes in accounting measures of performance. This suggests that investors view turnover announcements as good news presaging performance improvements.
Assistant Professor of Finance, New York University. The author acknowledges the helpful suggestions and comments of Keith V. Smith, Edward F. Renshaw, Lawrence S. Ritter and the Journal' reviewer. The research was conducted while under a Regents Fellowship at the University of California, Los Angeles.
Purpose
The purpose of this paper is to examine the relation between earnings management behavior and the activity of both the board and audit committee. Design/methodology/approach – Different models to isolate abnormal accruals as a proxy for earnings management are applied to a sample of manufacturing companies.
Findings
Earnings management is negatively related to both board and audit committee independence. Such negative relation is stronger when the audit committee is more active. However, this result is not valid for the board activity.
Research limitations/implications
Results are limited by the accuracy of the models applied to isolate abnormal accruals.
Practical implications
Results may have implications for corporate governance regulations such as board composition, audit committee composition, and their activity.
Originality/value
Results of earnings management research are sensitive to the different models suggested in literature to isolate the abnormal accruals.
The paper investigates the determinants of bankruptcy on three representative unbalanced samples of Italian firms for the periods 1989-1991, 1992-94 and 1995-97 with two different estimating techniques. The first (logit) approach shows that: i) the impact on the probability of bankruptcy of both level and trend balance sheet variables is sample - and business cycle specific since financial factors are predominant over real factors before periods of financial distress but not otherwise - with the exception of the interest charge to value added ratio which is always significant; ii) qualitative regressors such as customers' concentration and strength and proximity of competitors have significant predictive power and suggest that banks should not restrict their monitoring activity to balance sheet variables. The paper also shows, through a stochastic frontier approach, that productive efficiency and the probability of bankruptcy are significantly correlated and that the significance of the relationship between the distance from the efficient frontier and the probability of failure is robust across the last two sample periods. The distance from the frontier is in fact shown to have marginal explanatory power, net of balance sheet and qualitative variables considered in the previously mentioned logit model.
I argue that hazard models are more appropriate than single-period models for forecasting bankruptcy. Single-period models are inconsistent, while hazard models produce consistent estimates. I describe a simple technique for estimating a discrete-time hazard model. I find that about half of the accounting ratios that have been used in previous models are not statistically significant. Moreover, market size, past stock returns, and idiosyncratic returns variability are all strongly related to bankruptcy. I propose a model that uses both accounting ratios and market-driven variables to produce out-of-sample forecasts that are more accurate than those of alternative models. Copyright 2001 by University of Chicago Press.
Earnings provide important information for investment decisions. Thus, executives--who are monitored by investors, directors, customers, and suppliers--acting in self-interest and at times for shareholders, have strong incentives to manage earnings. The authors introduce behavioral thresholds for earnings management. A model shows how thresholds induce specific types of earnings management. Empirical explorations identify earnings management to exceed each of three thresholds: report positive profits, sustain recent performance, and meet analysts' expectations. The positive profits threshold proves predominant. The future performance of firms suspect for boosting earnings just across a threshold is poorer than that of control group firms. Copyright 1999 by University of Chicago Press.
ABSTRACT In this study, we examine whether managers delay disclosure of bad news relative to good news. If managers accumulate and withhold bad news up to a certain threshold, but leak and immediately reveal good news to investors, then we expect the magnitude of the negative stock price reaction to bad news disclosures to be greater than the magnitude of the positive stock price reaction to good news disclosures. We present evidence consistent with this prediction. Our analysis suggests that management, "on average", delays the release of bad news to investors. Copyright (c), University of Chicago on behalf of the Institute of Professional Accounting, 2008.
This study examines the responsiveness of analyst forecasts to current earnings announcements. The results show considerable cross-sectional variation in analyst responsiveness and suggest that this variation is related to the costs and benefits associated with prompt forecast revisions. More importantly, this study finds that with responsive forecast revisions, more of the market reaction takes place in the event window and less in the drift window, suggesting that analyst responsiveness mitigates the post-earnings-announcement drift and facilitates market efficiency.
This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson's (1980) O-score, the difference in returns between high and low book-to-market securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage. Copyright The American Finance Association 2002.
This article investigates market reactions to initiations and omissions of cash dividend payments. Consistent with prior literature, the authors find that the magnitude of short-run price reactions to omissions are greater than for initiations. In the year following the announcements, prices continue to drift in the same direction, though the drift following omissions is stronger and more robust. This postdividend initiation/omission price drift is distinct from and more pronounced than that following earnings surprises. A trading rule employing both samples earns positive returns in twenty-two out of twenty-five years. The authors find little evidence for clientele shifts in either sample. Copyright 1995 by American Finance Association.
Recent studies document that firms conducting seasoned equity offerings experience poor stock price and earnings performance in the post-offering period. I investigate whether earnings management around the time of the offering can explain a portion of the poor performance. Consistent with this explanation, I show that earnings management during the year around the offering predicts both earnings changes and market-adjusted stock returns in the following year. These findings suggest that the stock market temporarily overvalues issuing firms and is subsequently disappointed by predictable declines in earnings caused by earnings management.
We provide evidence that transient institutional investors (i.e., those actively trading to maximize short term profits) trade to exploit the post-earnings announcement drift (PEAD). We estimate that transient institutions' arbitrage generates an abnormal return of 5.1 percent (or 22 percent annualized) after transaction costs. In addition, their arbitrage trades accelerate the speed that stock prices reflect the implications of current earnings for future earnings. However, transient institutions trade less aggressively to exploit PEAD in firms with high transaction costs. Our results contribute to understanding the role of transient institutional investors in explaining the persistence of PEAD.
We examine a sample of 459 firms filing for Chapter 11 during the period 1991-1998 and find that our sample firms experience significant improvements in their operating performance during Chapter 11. Our evidence is consistent with the hypothesis that Chapter 11, if anything, provides net benefits to bankrupt firms. In the cross section, firms with higher debt ratios experience greater improvements in operating performance, and the complexity of the renegotiation process negatively affects the improvement. We find no relationship between Chapter 11 outcome and changes in risk-adjusted firm value in Chapter 11.
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
Matching university places to students is not as clear cut or as straightforward as it ought to be. By investigating the matching algorithm used by the German central clearinghouse for university admissions in medicine and related subjects, we show that a procedure designed to give an advantage to students with excellent school grades actually harms them. The reason is that the three-step process employed by the clearinghouse is a complicated mechanism in which many students fail to grasp the strategic aspects involved. The mechanism is based on quotas and consists of three procedures that are administered sequentially, one for each quota. Using the complete data set of the central clearinghouse, we show that the matching can be improved for around 20% of the excellent students while making a relatively small percentage of all other students worse off.
Post-earnings announcement drift is the tendency for a stock's cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks following an earnings announcement. We show that the drift is significantly larger when defining the earnings surprise using analysts' forecasts and actual earnings from I/B/E/S than when using a time series model based on Compustat earnings data. Neither Compustat's policy of restating earnings nor the inclusion of "special items" in reported earnings contribute significantly to the disparity in drift magnitudes. Rather, our results suggest that this disparity is attributable to differences between analyst forecasts and those of time-series models-or at least to factors correlated with these differences. Further, we document that analyst forecasts lead to return patterns around future earnings announcements that differ from those observed when using time-series models, suggesting that the two types of surprises may capture somewhat different forms of mispricing. Copyright 2006 The Institute of Professional Accounting, University of Chicago.
In 1992, the Cadbury Committee issued the "Code of Best Practice" which recommends that boards of U.K. corporations include at least three outside directors and that the positions of chairman and CEO be held by different individuals. The underlying presumption was that these recommendations would lead to improved board oversight. We empirically analyze the relationship between CEO turnover and corporate performance. CEO turnover increased following issuance of the "Code"; the negative relationship between CEO turnover and performance became stronger following the "Code"'s issuance; and the increase in sensitivity of turnover to performance was concentrated among firms that adopted the "Code". Copyright The American Finance Association 2002.
This paper examines whether the incidence of earnings management by UK firms depends on board monitoring. We focus on two aspects of board monitoring: the role of outside board members and the audit committee. Results indicate that the likelihood of managers making income-increasing abnormal accruals to avoid reporting losses and earnings reductions is negatively related to the proportion of outsiders on the board. We also find that the chance of abnormal accruals being large enough to turn a loss into a profit or to ensure that profit does not decline is significantly lower for firms with a high proportion of outside board members. In contrast, we find little evidence that outside directors influence income-decreasing abnormal accruals when pre-managed earnings are high. We find no evidence that the presence of an audit committee directly affects the extent of income-increasing manipulations to meet or exceed these thresholds. Neither do audit committees appear to have a direct effect on the degree of downward manipulation, when pre-managed earnings exceed thresholds by a large margin. Our findings suggest that boards contribute towards the integrity of financial statements, as predicted by agency theory. Copyright Blackwell Publishers Ltd, 2005.
Using a sample of 859 U.S. bankruptcy-filing firms over the period 1986-2004, we examine the earnings behaviour of managers during the distressed period by looking at sources of abnormal accruals prior to the bankruptcy-filing year. Results show that managers of highly distressed firms shift earnings downwards prior to the bankruptcy filing. We test and provide evidence in support of two potential contributing factors. First, top-level management turnover among distressed firms leads new managers to earnings bath choices during the distressed period. Second, qualified audit opinions exert pressure on managers to follow more conservative earnings behaviour during the distressed period. Evidence is also provided that the management of distressed firms with lower (higher) institutional ownership has greater (lesser) tendency to manage earnings downwards. Results also show that higher institutional ownership mitigates the negative abnormal returns of firms with top management turnover. To the authors' knowledge, this is the first study that attempts to examine whether institutional ownership relates to market reaction in conjunction with a top management turnover or a qualified audit opinion during the distressed period. Prior studies focused on the investigation of earnings management or institutional ownership (separately) during the distressed period, but did not examine if the effect of institutional ownership on earnings behaviour also influences subsequent returns. Thus, the results of this study should be of interest to analysts, standard setters and regulatory bodies since our results show that management turnover, qualified audit opinions and firm governance mechanisms affect the quality of earnings and the level of abnormal returns.
Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most "aggressive" quartile of earnings managers have a three-year aftermarket stock return of approximately 20 percent less than IPO issuers in the most "conservative" quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications. Copyright The American Finance Association 1998.
Discretionary Accruals Behavior of Iranian Distressed Firms. Middle Eastern Finance and Economics
- H Etemadi
- M Dastgir
- M Momeni
- Hassan Dehkordi
Etemadi, H., Dastgir, M., Momeni, M., & Hassan Dehkordi. (2012). Discretionary Accruals Behavior of Iranian
Distressed Firms. Middle Eastern Finance and Economics, 16, 44-53. http://dx.doi.org/10.5897/AJBM11.2543
The Rewards to Meeting or Beating Earnings Expectations
- E Bartov
- D Givoly
- C Hayn
Bartov, E., D. Givoly, & C. Hayn. (2002). The Rewards to Meeting or Beating Earnings Expectations. Journal of
Accounting and Economics, 33(2), 173-204. http://dx.doi.org/10.1016/S0165-4101(02)00045-9