nach oben

Review of Accounting Studies

Erschienen in:

01.09.2006 | Original Paper

Performance, Growth and Earnings Management

verfasst von: Chi-Wen Jevons Lee, Laura Yue Li, Heng Yue

Erschienen in: Review of Accounting Studies | Ausgabe 2-3/2006

Einloggen

Aktivieren Sie unsere intelligente Suche, um passende Fachinhalte oder Patente zu finden.

search-config

KI-gestützte Suche

Aus

Abstract

We study the relationship between the amount of managed earnings and firms’ earnings performance and expected growth in a reporting model, where managers manipulate earnings to influence the valuation of firms’ equity while bearing a cost that is increasing and convex in the amount of managed earnings. In the unique revealing equilibrium to the model, firms with higher performance and growth over-report earnings by a larger amount because price responsiveness increases with earnings performance and growth. And earnings quality, defined as the proportion of true economic earnings in total reported earnings, increases with earnings performance but decreases with earnings growth. We conduct empirical tests on a large sample and a restatement sample using different proxies for earnings management. Results from the large sample tests support our predictions while results from the restatement sample tests are mixed. Our study provides an alternative explanation to the positive relationship between discretionary accruals estimated from the Jones model and firms’ performance and growth.

Vorheriger Artikel Discussion of “The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly”

Nächster Artikel Discussion of “Performance, growth and earnings management”

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Nur mit Berechtigung zugänglich

For detailed discussions of earnings management literature, see Healy and Wahlen (1999), Kothari (2001), Schipper (1989), and other review papers.

An exception is Burgstahler and Dichev (1997b), who examined the distribution of reported earnings and used the discontinuity around specific thresholds as evidence of earnings management. However, this research method cannot identify the amount of managed earnings (see Healy & Wahlen, 1999)

Popular incentives include market based incentive, debt covenant, bonus and political costs. See, for example, Defond and Jiambalvo (1994), Rees, Gill, and Gore (1996), Teoh, Welch, and Wong (1998a, b) etc.

These include the time-series Jones model (Jones, 1991), cross-sectional Jones model (DeFond & Jiambalvo, 1994) and modified Jones model (Dechow, Sloan, & Sweeney, 1995).

Abarbanell and Lehavy (2003b) suggested that the amount of managed earnings could be positively relates to firm’s performance and growth and used it to explain the asymmetry in the distribution of analysts forecast errors. Dechow et al. (1995) and Kothari, Leone, and Wasley (2005) also recognized the possibility. However the above studies do not provide analytical explanations or direct empirical evidence for the existence of the relationship.

The definition of amount of managed earnings is the same as “reporting bias” in Fischer and Verrecchia (2000). Our definition of is also consistent with that in Schipper (1989), who defines earnings management as disclosure management that intervenes in the external financial reporting process with the intention of obtaining some private gain.

Another line of literature studies earnings management in an agent-principle problem setting. Representative work includes Arya, Glover, and Sunder (1998), Demski (1998), Demski, Frimor, and Sappington (2004), Dye (1988), Evans and Sridhar (1996), and Liang (2004).

Signal jamming model has also been employed in Fudenberg and Tirole (1986) and Holmstrom (1982).

Such models include Baiman, Evans, and Noel (1987), Demski and Dye (1999), Evans and Sridhar (1996), Fischer and Verrecchia (2000), Guttman, Kadan, and Kandel (2004), Newman and Sansing (1993), and Verrecchia (1986).

A group of studies focus on the managers’ inter-temporal earnings management. These study include Chaney and Lewis (1995), Fudenberg and Tirole (1995), Kirschenheiter and Melumad (2002), Ronen and Sadan (1985), Sankar and Subramanyam (2001), and Trueman and Titman (1988).

McVay (2005) shows that managers shift expenses from core expenses (cost of goods sold and selling, general, and administrative expenses) to special items. Bradshaw and Sloan (2002) find evidence that managers exclude some corporate expenses when releasing street earnings. Dye (2002) studies a model of “classifications manipulation” in which accounting reports consist of one of two binary classifications.

The negative discretionary accrual may also come from the “reserve creating” behavior of the new managers.

Assuming the firm is an all-equity firm is just for simplicity. Our model and analysis can easily extend to firms with debt.

In our model, economic earnings x refers to firms’ core earnings, which would reoccur with a constant growth rate. x does not include extraordinary items.

For instance, Teoh et al. (1998a, b) found that managers manage earnings up prior to IPO and SEO, and Erichson and Wang (1999) documented earnings management before stock mergers. Managers sometimes will benefit from lower stock price, as in management buyout or stock repurchase. Our model does not apply to those situations.

For studies on the association between earnings management and management stock option or stockholdings, see Bergstresser and Philippon (2004), Berns and Kedia (2003), and Cheng and Warfield (2005). According to Bergstresser and Philippon, the median exposure of CEO wealth to firm stock price tripled between 1980 and 1994, and doubled again between 1994 and 2000. Core, Guay, and Verrecchia (2003) also document the same trend.

For now we assume the relation between r and x is one to one. Later we are going to show that this assumption is satisfied in the revealing equilibrium.

The manager observes x, chooses an amount of managed earnings m and reports earnings as r. We express m as a function of r because mathematically it is easier to get the expression of m in r and empirically r is observable.

We conduct comparative static analysis with respect to r, because first r is observable by the market and x is not; and second it is not easy to get an expression of the earnings management in terms of x. In equilibrium, when \(r< 0,\,x=r.\) When \(r> 0\), we have an exponential pricing function, which is strictly increasing in reported earnings. Because \(p=x/b,\,x\) is also strictly increasing in r. Therefore, the implicit function linking x and r is one-to-one.

NYSE and NASDAQ modified their requirements for audit committees in December, which now require that the listing firms have outsider directors at least on the audit committees. The new requirements respond to the SEC’s call for improving the effectiveness of corporate audit committee in overseeing the financial reporting process.

For example: Francis, Lafond, Olsson, and Schipper (2002). They use performance adjusted discretionary accruals as one of their measures of earnings quality.

See appendix for the description of variables. Thomas and Zhang (2000) use KS model in pooled sample. We use cross-sectional version of KS, similar to cross-sectional version of Jones model. Our total accruals are calculated from statement of cash flow. Using balance sheet method does not change the results.

If we exclude firms with negative discretionary accruals, our results are qualitatively the same but stronger.

We use the median of long-term growth forecasts in the last month of each fiscal year.

For tests of earnings quality, we also use the cross-sectional version of Jones model (as the way used in Becker et al., 1998; DeFond & Jiambalvo, 1994; Subramanyam, 1996). We reach the same conclusions.

For instance, see Agarwal and Chadha (2003), Beasley (1996), Desai, Hogan, and Wilkins (2004), Farber (2005), Richardson, Tuna, and Wu (2002), and Srinivasan (2005).

Using the Lexis–Nexis “Guided News Search” command and the “News Wire” database, we performed a keyword search using “restate,” “restated,” in the full text and the key word in the company’s name in the headline. We further require the date of the news to be within 3 days around the announcement date from GAO’s report.

Beaver, McNichols, and Nelson (2003) examine the relation between discretionary loss reserve accruals and the distribution of reported earnings for a sample of property-casualty insurers. They find that the least profitable firms understate reserves relative to the most profitable firms, which contradicts our prediction and findings.

Kothari et al. (2005) also notice the reduced power of performance matching. See their discussion at Page 170. However, our model suggests the performance matching may also produce biases results conditional on different performance or growth.

Abarbanell, J., & Lehavy, R. (2003a). Can stock recommendations predict earnings management and analysts’ earnings forecast errors? Journal of Accounting Research, 41, 1–31.CrossRef

Abarbanell, J., & Lehavy, R. (2003b). Biased forecasts or biased earnings? The role of reported earnings in explaining apparent bias and over/underreaction in analysts’ earnings forecasts. Journal of Accounting and Economics, 36, 105–146.CrossRef

Agarwal, A., & Chadha, S. (2003). Corporate governance and accounting scandals. Journal of Law and Economics, (Forthcoming)

Arya, A., Glover, J., & Sunder, S. (1998). Earnings management and the revelation principle. Review of Accounting Studies, 3, 7–34.CrossRef

Baiman, S., Evans, H., & Noel, J. (1987). Optimal contracts with a utility maximizing auditor. Journal of Accounting Research, 217–244.

Barton, J., & Simko, P. (2002). The balance sheet as an earnings management constraint. The Accounting Review, 77, 1–28.

Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting & Economics, 24, 3–37.CrossRef

Beasley, M. S. (1996). An empirical analysis of the relation between the board of director composition and financial statement fraud. The Accounting Review, 71, 433–465.

Beaver, W., McNichols, M., & Nelson, K. (2003). Management of the loss reserve accrual and the distribution of earnings in the property-casualty insurance industry. Journal of Accounting and Economics, 35, 347–376.CrossRef

Becker, C., DeFond, M., Jiambalvo, J., & Subrammanyam, K. R. (1998). The effect of audit quality on earnings management. Contemporary Accounting Research, 15, 1–24.

Beneish, M. D. (1997). Detecting GAAP violation: Implications for assessing earnings management among firms with extreme financial performance. Journal of Accounting and Public Policy, 16, 271–309.CrossRef

Berns, N., & Kedia, S. (2003). The impact of performance compensation on misreporting. Working Paper.

Bergstresser, D., & Philippon, T. (2004). CEO Incentives and earnings management: Evidence from the 1990s. Journal of Financial Economics, (Forthcoming)

Bradshaw, M. T., & Sloan, R. G. (2002). GAAP versus the street: An empirical assessment of two alternative definitions of earnings. Journal of Accounting Research, 40, 41–65.CrossRef

Burgstahler, D., & Dichev, I. (1997a). Earnings, adaptation and equity value. The Accounting Review, 72, 187–215.

Burgstahler, D., & Dichev, I. (1997b). Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, 24, 99–126.CrossRef

Chan, K., Chan, L. K. C., Jegedeesh, N., & Lakonishok, J. (2001). Earnings quality and stock returns. NBER working paper.

Cheng, Q., & Warfield, T. (2005). Equity incentives and earnings management. The Accounting Review, April.

Collins, D. W., Pincus, M., & Xie, H. (1999). Equity valuation and negative earnings: The role of book value of equity. The Accounting Review, 79, 29–61.

Core, J. E., Guay, W., & Verrecchia, R. E. (2003). Price vs. non-price performance measures in optimal CEO compensation contracts. The Accounting Review, (Forthcoming)

Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. The Accounting Review, 70, 193–225.

DeFond, M. L., & Jiambalvo, J. (1994). Debt covenant violation and manipulation of accruals. Journal of Accounting and Economics, 17, 145–176.CrossRef

Demski, J. S. (2004). Endogenous expectations. The Accounting Review, 79, 519–539.

Demski, J. S. (1998). Performance measurement manipulation. Contemporary Accounting Research, 15, 261–285.

Demski, J., & Dye, R. A. (1999). Risk, return and moral hazard. Journal of Accounting Research, 37, 27–56.CrossRef

Demski, J. S., Frimor, H., & Sappington, D. E. M. (2004). Efficient manipulation in a repeated setting. Journal of Accounting Research, 42, 31–49.CrossRef

Desai, H., Hogan, C., & Wilkins, M. (2004). The reputation penalty for aggressive accounting: Earnings restatements and management turnover. Working paper, Southern Methodist University.

Dye, R. (2002). Classifications manipulation and nash accounting standards. Journal of Accounting Research, 40, 1125–1162.CrossRef

Dye, R. (1988). Earnings management in an overlapping generations model. Journal of Accounting Research, 26, 195–235.CrossRef

Evans, J., & Sridhar, S. (1996). Multiple control systems, accrual accounting, and earnings management. Journal of Accounting Research, 34, 45–65.CrossRef

Erichson, M., & Wang, S. (1999). Earnings management by acquiring firms in stock for stock mergers. Journal of Accounting and Economics, 27, 149–176.CrossRef

Farber, D., (2005). Restoring trust after fraud: Does corporate governance matter? The Accounting Review, (Forthcoming)

Fischer, P. E., & Verrecchia, R. E. (1997). The effect of limited liability on the market response to disclosure. Contemporary Accounting Research, 14, 515–541.

Fischer, P. E., & Verrecchia, R. E. (2000). Reporting bias. The Accounting Review, 75, 229–245.

Fischer, P. E., & Stocken, P. C. (2004). Effect of investor speculation on earnings management. Journal of Accounting Research, 42, 843–869.CrossRef

Francis, J., Lafond, R., Olsson, P. & Schipper, K. (2002). The market pricing of accruals quality. Journal of Accounting and Economics, 39, (Forthcoming)

Freeman, R., & Tse, S. (1992). A nonlinear model of security price responses to abnormal earnings. Journal of Accounting Research, 30, 185–209.CrossRef

Fudenberg, D., & Tirole, J. (1986). A ‘Signal-Jamming’ theory of predation. Rand Journal of Economics, XVII, 366–376.CrossRef

Fudenberg, D., & Tirole, J. (1995). A theory of income and dividend smoothing based on incumbency rents. Journal of Political Economy, 103, 75–93.CrossRef

Gao, P., & Shrieves, R. E. (2002). Earnings management and executive compensation: A case of overdose of option and underdose of salary? Working Paper, Northwestern University.

Guttman, I., Kadan, O., & Kandel, E. (2004). A rational expectations theory of the kink in accounting earnings. Working Paper.

Hansen, L. P. (1982). Large sample properties of generalized method of moment estimators. Econometrica, 50, 1021–1054.

Hayn, C. (1995). The information content of losses. Journal of Accounting Economics, 20, 125–153.CrossRef

Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13, 365–384.

Holmstrom, B. (1982). Managerial incentive problems: A dynamic perspective. In Essays in economics and management in honor of lars wahlbeck. Helsinki: Swedish School of Economics.

Hunt, A. S., Moyer, E., & Shevlin, T. (1996). Managing interacting accounting measures to meet multiply objectives: A study of LIFO firms. Journal of Accounting and Economics, 21, 339–374.CrossRef

Jiambalvo, J. (1996). Discussion of “Causes and consequences of earnings manipulation: an analysis of firms subject to enforcement actions by SEC”. Contemporary Accounting Research, 13, 37–47.CrossRef

Jones, J. (1991). Earnings management during import relief investigation. Journal of Accounting Research, 29, 193–228.CrossRef

Kang, S. H., & Sivaramakrishnan, K. (1995). Issues in testing earnings management and an instrumental variable approach. Journal of Accounting Research, 33, 355–367.CrossRef

Kasznik, R. (1999). On the association between voluntary disclosure and earnings management. Journal of Accounting Research, 37, 57–81.CrossRef

Kirschenheiter, M., & Melumad, N. (2002). Can big bath and earnings smoothing co-exist as equilibrium financial reporting strategies? Journal of Accounting Research, 40, 761–796.CrossRef

Klein, A. (2002). Audit committee, board of director characteristics and earnings management. Journal of Accounting Economics, 33, 375–400.CrossRef

Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 105–231.

Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measure. Journal of Accounting and Economics, 39, 163–197.CrossRef

Leone, A. J., & Horn, L. V. (1999). Earnings management in not-for-profit institutions: Evidence from hospitals. Working Paper.

Liang, P. J. (2004). Equilibrium earnings management, incentive contracts, and accounting standards. Contemporary Accounting Research, 21, 685–718.CrossRef

Fischer, S. E. (2005). Earnings management using classification shifting: an examination of core earnings and special items. Working Paper.

McNichols, M. F. (2000). Research design issues in earnings management studies. Journal of Accounting and Public Policy, 19, 313–345.CrossRef

Murphy, K. J., & Zimmerman, J. (1993). Financial performance surrounding CEO turnover. Journal of Accounting and Economics, 16(1-2-3), 273–315.CrossRef

Newman, P., & Sansing, R. (1993). Disclosure policies with multiple users. Journal of Accounting Research, 31, 92–112.

Palmrose, Z., Richardson, V. J., & Scholz, S. (2004). Determinants of market reactions to restatement announcements. Journal of Accounting and Economics, 37, 59–89.CrossRef

Pourciau, S. (1993). Earnings management and nonroutine executive changes. Journal of Accounting and Economics, 16, 337–347.CrossRef

Richardson, S. A., Tuna, A. I., & Wu, M. (2002). Predicting earnings management: The case of earnings restatements. Working Paper.

Sankar, M. R., & Subramanyam, K. R. (2001). Reporting discretion and private information communication through earnings. Journal of Accounting Research, 39, 365–386.CrossRef

Schipper, K. (1989). Commentary on earnings management. Accounting Horizons, 91–102.

Shivakumar, L. (2000). Do firms mislead investors by overstating earnings before seasoned equity offerings? Journal of Accounting and Economics, 29, 339–371.CrossRef

Srinivasan, S. (2005). Consequences of financial reporting failure for outside directors: Evidence from accounting restatements and audit committee members. Journal of Accounting Research, (Forthcoming)

Stein, J. (1989). Efficient capital markets, inefficient firms: A model of myopic corporate behavior. Quarterly Journal of Economics, 104, 655–670.CrossRef

Teoh, S. H., Welch, L., & Wong, T. J. (1998a). Earnings management and the pos-issue underperformance of seasoned equity offerings. Journal of Financial Economics, 50, 63–100.CrossRef

Teoh, S. H., Welch, L., & Wong, T. J. (1998b). Earnings management and the long-run underperformance of initial public equity offerings. Journal of Finance, 53, 1935–1974.CrossRef

Thomas, J., & Zhang, X. J. (2000). Identifying unexpected accruals: A comparison of current approaches. Journal of Accounting and Pubic Policy, 19, 347–376.CrossRef

Trueman, B., & Titman, S. (1988). An explanation of accounting income smoothing. Journal of Accounting Research, 26, 127–139.CrossRef

Veronesi, P. (1999). Stock market overreaction to bad news in good times: A rational expectations equilibrium model. The Review of Financial Studies Winter, 12, 975–1007.CrossRef

Verrecchia, R. E. (1983). Discretionary disclosure. Journal of Accounting Economics, 179–194.

Verrecchia, R. (1986). Managerial discretion in the choice among financial reporting alternatives. Journal of Accounting and Economics, 175–196.

Titel: Performance, Growth and Earnings Management
verfasst von: Chi-Wen Jevons Lee
Laura Yue Li
Heng Yue
Publikationsdatum: 01.09.2006
Verlag: Kluwer Academic Publishers-Plenum Publishers
Erschienen in: Review of Accounting Studies / Ausgabe 2-3/2006
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-006-9009-9

Springer Professional

Abstract

Bitte loggen Sie sich ein, um Zugang zu Ihrer Lizenz zu erhalten.

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Weitere Artikel der Ausgabe 2-3/2006

Editorial

Divisional performance measurement and transfer pricing for intangible assets

Which approach to accounting for employee stock options best reflects market pricing?

Feedback loops, fair value accounting and correlated investments

Over-investment of free cash flow

Discussion of “Feedback loops, fair value accounting and correlated investments”