5. Does Financial Crisis Cause Earnings Management?

The sample selection process will be discussed in Sect. 5.2.3.

Institutional investors (e.g., insurance companies, superannuation and pension funds, investment trusts, financial institutions, etc.) play an active role in monitoring and disciplining managerial discretion (Hsu and Koh 2005), and generally encourage high quality of reported earnings (Velury and Jenkins 2006). Rajgopal and Venkatachalam (1998) find that institutional ownership is associated with less discretionary accruals manipulation. Specifically their findings are “consistent with institutional investors monitoring managers and thus constraining them from engaging in accrual manipulation” (Rajgopal and Venkatachalam 1998, p. 3).

The year 2010 was excluded since the study focuses on the Gfc and not on the current sovereign European debt crisis.

The Jones (1991) model and the subsequent versions of it developed by Dechow et al. (1995) and by Kothari et al. (2005), and other earnings management detection tools are presented in Chap. 2, Appendix.

Beneish’s model will be presented in Sect. 5.2.2.

These ratios are defined in Sect. 5.2.2.

Big bath accounting is a managerial stratagem (Walsh et al. 1991) based on the assumptions that “when circumstances are bad, making things just a little bit worse by cleaning out the rubbish does little harm to either reputation or prospects” and that “little damage will ensue when the market is so depressed that nothing can hurt it more” (Walsh et al. 1991, p. 174). Under the big bath hypothesis, managers may undertake income-decreasing strategies in lean years, perhaps believing “that one very poor performance report is not as harmful as several mediocre performance reports (Arya et al. 1998, p. 8). Even firms not severely affected by financial crisis may engage in income-reducing activity to benefit from improved borrowing conditions or extract more government support (Saleh and Ahmed 2005). Accordingly, “managers may have recognized that the market tolerates poor performance during an external shock (crisis) environment, so they may have depressed earnings further, via accruals, to enable greater post-shock performance improvements to the benefit of managers’ reputations” (Habib et al. 2013, p. 158). Therefore, “conventional wisdom suggests that an economic crisis should encourage managers to adopt big bath accounting” (Habib et al. 2013, p. 159).

Beneish (1999) used a total accruals variable named TATA (Total Accruals to Total Assets). In the earlier version of the M-score total accruals are calculated as the change in working capital accounts except of cash less depreciation:

\( TATA = \frac{{\begin{array}{*{20}c} {(\Delta Curren\, assets_{t} -\Delta Cash_{t} } \\ { -\Delta Current\,liabilities_{t} -\Delta Current\,maturities\,of\,Long\,term\,debt_{t} } \\ { -\Delta Income\,tax\,payable_{t} - Depreciation and amortization_{t} )} \\ \end{array} }}{{Total\,assets_{t} }} \).

The mean values for manipulators (non-manipulators) calculated by Beneish are as follows. DSRI: 1.412 (1.030); GMI: 1.159 (1.017); AQI: 1.228 (1.031); SGI: 1.581 (1.133); DEPI: 1.072 (1.007); SGAI: 1.107 (1.085); ACC: .049 (.015); LVGI: 1.124 (1.033).

I acknowledge that the sample may seem to be small compared with those in previous research. However, according to the central limit theorem, as the sample is greater than or equal to 30, it should not be considered to be small.

For 2005–2010, SGAI (39), LVGI (33), ACC (29), GMI (17), DSRI (12), and SGI (8); for 2006–2011, AQI (36), LVGI (28), ACC (28), GMI (11), DSRI (11), SGI (8).

Lucius Annaeus Seneca used the word “crisin” in Epistulae Morales ad Lucilium, Liber X, 83, in which he reflects upon his advancing years: “Hic quidem ait nos eandem crisin habere, quia utrique dentes cadunt” (Seneca 1920 [C. 62–65 AD], p. 258).

An example, may clarify my reservations. Consider extramarital affairs: the discovery of a secret extramarital affair may cause a matrimonial crisis, of which the fraudulent behavior is considered to be the cause. More in general, the betrayal of trust is thought to be the cause of the crisis. Yet, “trust (i.e., the unchallenged assumption that things will continue to be as they always have been) does not bring people together. Coming together requires intimacy (i.e., knowing one another). And knowing one another comes from handling crises, mourning and celebrating together, and talking about crises with one another until they can read one another’s minds” (Pittman and Wagers 2005, p. 1413). Thus, the loss of intimacy, as opposed to the extramarital affair or the betrayal of trust, might be seen as a “generative mechanism” (Bhaskar 2009, p. 18) that potentially causes marital crisis, i.e. the loss of intimacy is the disease that leads the couple to reach a point in which a decision is needed. Accordingly, I believe that the loss of intimacy, as well as other generative mechanisms, such as the betrayal of trust, might be seen as “structures at work” (Bhaskar 2011, p. 2) operating simultaneously in an open social system and that there might be “offsetting factors or countervailing causes” (Bhaskar 2008a, p. 88), which might or might not prevent the marital crisis.

Hartwig (2007) entry on “tendencies” in the Dictionary of Critical Realism defined enabling conditions as “the positive form of causality possessed by a causal power or powers (as distinct from the negative form of a constraint) or the generative mechanisms that give rise to a tendency. Moreover, it defined stimulating conditions as “all those factors that trigger, facilitate or reinforce the exercise of a tendency, some of which may involve an element of contingency” and releasing conditions as “the circumstances in which countervailing factors are either absent or weak—there are few or no impediments to the exercise of a tendency”.

Only the first five tendencies are presented in this subsection.

Bhaskar (2008a) observed: “Offsetting causes are often assumed to be always extrinsic. But the cause of a failure of a car to move when the gear is in neutral is not something distinct from and extraneous to the mechanism responsible for its normal motion. […]. Now intrinsic offsetting causes may or may not directly interfere with the operation of the mechanism responsible for the satisfaction of the intrinsic enabling conditions. If they do then we must say that the tendency₂ is no longer possessed” (p. 225).

“Extrinsic motivation” is a construct that pertains to whenever an activity is carried out in order to attain some separable outcome. It thus contrasts with intrinsic motivation, which refers to carrying out an activity simply for the enjoyment of the activity itself, rather than its instrumental value (Ryan and Deci 2000, p. 60).