Earnings Management: Continuum from Legitimacy to Fraud - Annotated Bibliography Example

Revised Annotated Bibliography on Earnings Management: Continuum from Legitimacy to Fraud My of the 24 March Revised Annotated Bibliography on Earnings Management: Continuum from Legitimacy to Fraud Jones, J. (1991). Earnings Management During Import Relief Investigations. Journal of Accounting Research, 29 (2), 193-223. This is one of the pioneer studies on earnings management. This study tested whether firms that would benefit from import relief attempt to decrease earnings through earnings management during import relief investigations by the United States International Trade Commission (ITC). The sample was drawn from the import relief investigations by the ITC. The data was therefore drawn from 49 firms in 5 industries namely automobiles, carbon steel, stainless steel, copper, and footwear. The results supported earnings management hypothesis that managers make income-decreasing accruals during import relief investigations. The model provided in this study has been cited by subsequent scholars in earnings management spheres and therefore provides the basis for model specification in the present study. Dechow, P., Sloan, R. and Sweeney, A. (1995) Detecting Earnings Management, The Accounting Review, 70, 193-225. This study evaluated alternative models for detecting earnings management. The study targeted firms targeted by the Securities and Exchange Commission for allegedly overstating annual earnings and the second sample is created by artificially introducing earnings management into a random sample of firms. A sample size of 32 firms was used in the study a sample of 1000 firm-years. The results showed that all the models were well specified when applied to a random sample of firm years. The study also found that the models generated tests of low power of earnings management of economically plausible magnitudes. The results also showed that the models rejected the null hypothesis of no earnings management at the rates that exceeded the test levels when they were applied to firms with extreme financial performance. These results led to the authors coming up with a modified version of the Jones (1991) model which they tested and found to exhibit the most power in detecting earnings management. The study is important as it gives alternative models for the estimation of earnings management. This is important for model specification in the present study and for the theoretical basis of the study on earnings management. McNichols, M. (2000). Research Design Issues in Earnings Management Studies. Journal of Accounting and Public Policy, 19, 313 – 345. This paper discussed trade-offs associated with three research designs commonly used in the earnings management literature: those based on aggregate accruals, those based on specific accruals and those based on the distribution of earnings after management. The author used a sample size of 20,517 firms from 1988 to 1998. The study found that aggregate accruals models that do not consider long-term earnings growth are potentially misspecified and can result in misleading inferences about earnings management behaviour. This study is also focused on the specification of models to estimate earnings management and therefore very important reference for building the model in the present study. Collins, D., and Hribar, P. (2002). Errors in Estimating Accruals: Implications for Empirical Research. Journal of Accounting Research, 40 (1), 105-135. This study examined the impact of measuring accruals using balance sheet accounts as opposed to directly from the statement of cash flows. The sample was comprised of all NYSE/AMEX firms on the Compustat Primary, a total of 14,558 firm years from 1988 to 1997. The results showed that the balance sheet method was inferior to the cash flow method in detecting earnings management in organisations. The authors give detailed reasons for the same. To the present study, the findings of this study are important as they inform on what method can be best applied to estimate earnings management in organisations. This study has been cited by many other scholars as a basis for favouring the cash flow method in estimating earnings management in firms. Xie, B., Davidson, W.N III and DaDalt, P.J., (2003). Earnings Management and Corporate Governance: the Role of Board and Audit Committee, Corporate Finance, 9 (3), 295 – 316. This study examined the role of the board of directors, the audit committee, and the executive committee in preventing earnings management. The study used a sample size of 282 firms selected from S&P 500 index as listed in the June Standard & Poor’s directory for each of the years 1992, 1994, and 1996. The data for the sampled firms was collected from Compustat. The results showed that the composition of a board in general and of an audit committee more specifically, is related to the likelihood that a firm will engage in earnings management. This study is useful as it informs on what measures would lead to higher likelihood of earnings management in organisations. This is important for practice. As for the empirical studies, it informs the present study of what reasons would lead to other firms practicing more of earnings management while others don’t and specially those practices that border on fraud. The model used can also inform the present study on how best to specify the model. Yaping, N. (2005) The Theoretical Framework of Earnings Management, Academic journal article from Canadian Social Science, 2 (2), 32 – 38. The paper opines that the definition of earnings management has been inconsistent in the literature especially ambiguity and immeasurability. The paper therefore intended to develop a constructive definition of earnings management and discuss the conceptual distinctions between earnings management and its counterparts. That being the reason, no sampling was made and no empirical analysis was performed. This paper offered a framework that researchers, regulators or practitioners can use to define whether the earnings management practices carried out are legitimate or not. This is the crux of the present study and therefore important in helping the study draw a line between legitimacy and fraud in the selected firms’ earnings management practices. Kothari, S.P., Leone, A.J. and Wasley, C.E. (2005) Performance Matched Discretionary Accrual Measures, Journal of Accounting and Economics, 39, 163-197. The study examined the specification and power of the test based on a performance-matched discretionary accrual measure and compared it with traditional discretionary accrual measures (e.g., Jones and Modified-Jones Models). The study began with a sample of 552,251 firm-year observations from the Compustat from 1959 to 1998. After a number of exclusions, 94,045 observations remained. The study reported a baseline simulation results for 250 samples from 100 firms each. The results suggested that the performance-matched discretionary accrual measure was a viable alternative to existing discretionary accrual models for use in earnings management research. This study builds on other studies that have designed models to estimate earnings management. It is therefore a very valuable study to our present study in helping build the model for the study. Abdul Rahman, R., and Ali, F. H., (2006). Board, Audit Committee, Culture and Earnings Management. Managerial Auditing Journal, 21 (7), 783-804. This study intended to investigate the extent of the effectiveness of monitoring functions of board of directors, audit committee and concentrated ownership in reducing earnings management. The study began with a sample size of 100 firms listed on the Bursa Malaysian Main Board from January 2002 to December 2003. After excluding some firms based on some criteria, a final sample of 97 companies was used. The study revealed that earnings management is positively related to the size of the board of directors. This study is important to the present study for two reasons. First, the study used a modified Jones model and this will be useful by informing the present study of the model choice. Secondly, the study provides an empirical evidence of some of the factors that could affect earnings management especially the cultural factors. Given the cultural differences across countries, the earnings management practices in the USA may be different from those of the other parts of the world. Prior, D., Surroca, J., and Tribo, J.A. (2007). Earnings Management and Corporate Social Responsibility. Working Paper 06-23, University of Carlos III de Madrid. This study draws on stakeholder-agency theory and the earnings management framework to explore the relationship between discretionary accounting accruals and corporate social responsibility. The study used a database comprising 593 firms from 26 nations for the period 2002-2004. The study confirmed the existence of a positive relationship between both variables. The results also showed that firms that manage earnings show superior levels of CSR. This study is important for the use of the stakeholder theory to study earnings management. The use of a database comprising of 32 different nations is also important as the study cuts across a number of countries. The model used in the study can also inform the model specification in the present study. Sun, L. and Rath, S. (2009) An Empirical Analysis of Earnings Management in Australia, International Journal of Human and Social Sciences 4 (14), 1069 – 1085. This study performed an empirical analysis of earnings management in Australia using a sample of 4,844 firm-year observations across nine industries from 2000 to 2006. The study found substantial corporate earnings management activity across several industries. The results showed strong evidence of size and return on assets being primary determinants of earnings management in Australia. The effects of size and return on assets were also found to be dominant in both income-increasing and income decreasing earnings manipulation. This study informs theory by providing what factors influence earnings management and where earnings management have a higher likelihood of occurrence. This can be instrumental in drawing conclusions on where the financial sector firms fall. The model used in the study is also important for the current model specification in the present study. Jaggi, B., Leung, S., and Gul, F. (2009). Family Control, Board Independence and Earnings Management: Evidence Based on Hong Kong Firms. Journal of Accounting and Public Policy, 28, 281–300. This study sought to achieve two main objectives. First, to evaluate whether the negative association between board independence and earnings management that has been documented in the US and UK also holds for Hong Kong firms. The second objective was to examine whether family ownership control or family members on corporate boards moderate the monitoring effectiveness of independent boards. Using the Global Vantage database CD, the study initially selected 391 firms in 1998, 394 firms in 1999 and 399 firms in 2000. After excluding some firms that did not have the entire information required, the final sample applied was 770 firm-years. The study found that a higher proportion of independence is associated with more effective monitoring to constrain earnings management. This means that a higher proportion of independents on corporate boards is likely to deter managers from manipulating the reported earnings. Therefore, the quality of reported earnings of firms with a higher proportion of independents is expected to be high. However, the monitoring effectiveness of independents is reduced in family-controlled firms, proxied by family ownership concentration or the presence of family members as board directors. These results suggest that an increase in the number of outside directors with a sole purpose of strengthening board monitoring is unlikely to be effective in family-controlled firms. This study notes that independent corporate boards provide effective monitoring of earnings management despite differences in institutional environments. The monitoring effectiveness of corporate boards is moderated in family-controlled firms. This adds onto the increasingly many studies on the factors that influence earnings management and the understanding that family-control on a business leads to effective monitoring and therefore better financial reporting could be important for reducing the severity of earnings management in organisations. Dechow, P.M., Hutton, A.P., Kim, J.H. & Sloan, R.G., (2011) Detecting Earnings Management: A New Approach. Available at SSRN: http://ssrn.com/abstract=1735168 or http://dx.doi.org/10.2139/ssrn.1735168 This study follows up on the previous study by Dechow et al. (1995) by providing a new approach to testing for accrual-based earnings management. This new approach exploited the inherent property of accrual accounting that any accrual-based earnings management in one period must reverse in another period. The study used a final sample of 209,530 firm-year observations between 1950 and 2009. The study reports that incorporating reversals can increase test power by over 40% and also provides a robust solution for mitigating model misspecification arising from correlated omitted variables. This new evidence is important in specification of the model in the present study in order to come up with a model that will better detect earnings management in organisations. Alghamdi, S.A.L (2012) Investigation into Earnings Management Practices and the Role of Corporate Governance and External Audit in Emerging Markets: Empirical Evidence from Saudi Arabia, Durham e-Theses, Durham University. Retrieved on 24 Mar. 2013 from http://etheses.dur.ac.uk/3438/1/SALIM_ALGHAMDI_(2012)PDF.pdf?DDD2 This study applies agency theory and institutional theory to explain earnings management practices. The primary purpose of this study was to: (1) investigate the motivations and techniques of earnings management and; (2) to what extent corporate governance and external audit can affect earnings management practices in Saudi Arabia. The initial sample size was all 280 companies listed on the Saudi Stock Exchange with the exception of financial and insurance companies. However, the study only collected 124 questionnaires which were used in the final data analysis. The study used questionnaire survey to explore the motivations and techniques of earnings management in Saudi Arabia. To examine the role of corporate governance and external audit in reducing earnings management practices, two models were constructed and a set of hypotheses formulated and tested using a logistic regression model. Further, semi-structured interviews were conducted with 15 individuals including board members, audit committee members, external auditors and academic staff after the questionnaire survey. The study found that the four main incentives for Saudi managers to manage earnings were ‘to increase the amount of remuneration’, ‘to report a reasonable profit and avoid loss’, ‘to obtain a bank loan’ and ‘to increase share prices’. The findings also indicated that only seven statements relating to earnings management that received support from respondents were techniques of earnings management in Saudi companies. The study found that the results were not consistent with agency theory that ownership concentration, audit committee, and external audit might mitigate agency problems leading to reduced agency cost by aligning the interests of controlling owners with those of the company. This study is important for it shows how primary data can be used to examine earnings management practices. Secondly, the use of logistic regression is important as it provides an understanding of probability of earnings management occurrence. Third, the study model informs the present study on the modelling of earnings management hence a major boost to the present study. The study did not focus on financial firms hence the deviation from the present study which focuses mainly on financial firms. Read More