Browsing by Subject "earnings management"

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  • Huhtamäki, Fredrik (Hanken School of Economics, 2021-09-27)
    A fundamental question in financial research is how individuals make decisions under uncertainty, and how the structure of corporations and cultural aspects affect these choices. Correspondingly, in this thesis, I present three studies related to managerial utility maximization, investigated through the lens of agency theory to shed light on aspects related to managerial behavior. Whereas the theory of expected utility maximization typically focuses on the utility maximization of wealth, this dissertation gives evidence of managerial behavior consistent with the notion that utility is also derived from non-pecuniary factors. The first essay investigates whether powerful CEOs are detrimental to workplace safety and health or whether they are “ethical guardians of the workforce”. The empirical evidence provided in the study shows that corporations led by powerful CEOs have fewer workplace related injuries and illnesses. Powerful CEOs have more influence over corporate decisions related to workplace safety and health and from an agency theory point of view, the CEO will take actions that maximize her utility. Therefore, this study shows that CEOs can derive utility from good workplace safety and health. The second essay investigates the relationship between shared leadership and risk-taking through leverage. The amount of shared leadership within the corporation is difficult to measure directly. However, the second essay overcomes this empirical challenge by using corporations that are led by co-CEOs as a proxy for shared leadership. The study argues that CEOs maximize their utility at lower levels of risk than preferable from a shareholder point of view. The empirical evidence shows that shared leadership is negatively related to leverage, which could indicate that monitoring of more than one CEO is difficult, which enables co-CEOs to derive a private benefit in the form of low risk-taking. Moreover, the study finds a positive relationship between shared leadership and excess cash holdings and that shared leadership is related to higher agency costs. The third essay investigates whether the perception of time and more specifically longterm orientation is related to the choice of earnings management strategy. The study uses a comprehensive global sample and finds that corporations in long-term oriented cultures rely on relatively more accrual-based earnings management while corporations in short-term oriented cultures rely on relatively more real earnings management. Both earnings management strategies are associated with costs. This study shows that the manager chooses such a strategy that minimizes the perceived costs of earnings management, and that the perception of time thus plays a role in managerial utility maximization.
  • Höglund, Henrik (Svenska handelshögskolan, 2010-11-29)
    Detecting Earnings Management Using Neural Networks. Trying to balance between relevant and reliable accounting data, generally accepted accounting principles (GAAP) allow, to some extent, the company management to use their judgment and to make subjective assessments when preparing financial statements. The opportunistic use of the discretion in financial reporting is called earnings management. There have been a considerable number of suggestions of methods for detecting accrual based earnings management. A majority of these methods are based on linear regression. The problem with using linear regression is that a linear relationship between the dependent variable and the independent variables must be assumed. However, previous research has shown that the relationship between accruals and some of the explanatory variables, such as company performance, is non-linear. An alternative to linear regression, which can handle non-linear relationships, is neural networks. The type of neural network used in this study is the feed-forward back-propagation neural network. Three neural network-based models are compared with four commonly used linear regression-based earnings management detection models. All seven models are based on the earnings management detection model presented by Jones (1991). The performance of the models is assessed in three steps. First, a random data set of companies is used. Second, the discretionary accruals from the random data set are ranked according to six different variables. The discretionary accruals in the highest and lowest quartiles for these six variables are then compared. Third, a data set containing simulated earnings management is used. Both expense and revenue manipulation ranging between -5% and 5% of lagged total assets is simulated. Furthermore, two neural network-based models and two linear regression-based models are used with a data set containing financial statement data from 110 failed companies. Overall, the results show that the linear regression-based models, except for the model using a piecewise linear approach, produce biased estimates of discretionary accruals. The neural network-based model with the original Jones model variables and the neural network-based model augmented with ROA as an independent variable, however, perform well in all three steps. Especially in the second step, where the highest and lowest quartiles of ranked discretionary accruals are examined, the neural network-based model augmented with ROA as an independent variable outperforms the other models.
  • Höglund, Henrik; Sundvik, Dennis (2019-04-16)
    This study investigates the association between private company auditing and intertemporal income shifting. Using a large reduction in the Finnish corporate tax rate as a strong incentive for income shifting and financial statement data coupled with proprietary information from the tax authorities, we analyse accruals and cost stickiness of small private companies. Our results reveal significant differences in accrual income shifting between audited and unaudited companies, but only among companies that on average could anticipate the tax reduction the most. Further, we find auditors to restrict sticky selling, general, and administrative cost behaviour that we hypothesise is associated with illegal actions. Additional tests expose a nontrivial number of incorrectly unaudited companies which are the ones mostly associated with income shifting. Taken together, our study highlights the effects of audit exemption and the importance of enforcement while also suggesting that the audit process is value adding for the tax authorities.
  • Sundvik, Dennis (Svenska handelshögskolan, 2016-09-21)
    The opportunistic aspects of financial reporting have largely been investigated under the umbrella term of earnings management. However, most research is devoted to capital market settings and listed firms in large economies, including the United States in particular. As a contrast, this dissertation examines earnings management based on tax incentives among private firms in European settings. In particular, the four interrelated essays analyze situations where the statutory corporate tax rate in a country is changed and firms are expected to report lower (higher) earnings while the tax rate is higher (lower) to reduce their total tax burden. While these tax changes are introduced to enhance international tax competitiveness, they also give rise to strong incentives for earnings management. For example, when the tax rate is to be decreased, firms may employ various accruals to defer earnings from high to low tax periods. The first essay of the dissertation contributes to the literature by investigating decomposed measures of earnings management instead of relying on a broad measure that does not provide much insight. Based on Swedish private firms, the analyses clearly show income-decreasing earnings management on the aggregate level before two tax rate cuts. The aggregate results are later observed to be largely driven by unexpected changes in accounts receivable. The second essay uses Finnish data and provides evidence that private firms, under certain circumstances, also change the end of the fiscal year to achieve benefits around tax reforms. Further, the analyses demonstrate that a reform that simultaneously lowers corporate tax and hikes dividend tax creates conflicting incentives to manage earnings. The motivation behind the third essay stems from the debate on the appropriate level of book-tax conformity. The essay documents that higher conformity between accounting and tax reporting in jurisdictions is associated with more earnings management in response to an upcoming change in the tax rate. A contribution of this study is the analysis of a clear incentive for earnings management instead of a sole focus on absolute measures. In the fourth and final essay, private firms that use external help in the financial reporting process are separated from firms that do not. The hypothesis is that firms, that handle their accounting function internally, have greater possibilities to influence their reporting opportunistically. The results also suggest that the minority of smaller private firms who perform the tasks in-house, and have the knowledge and resources needed, are able to manage taxes to a larger extent
  • Storå, Jakob (Svenska handelshögskolan, 2013-05-28)
    There is a great deal of research indicating that firms use the flexibility in accounting standards to engage in earnings management. This study examines whether firms that apply IFRS manage earnings through goodwill impairment accounting. IFRS require that firms shall test goodwill for impairment annually and whenever there is an indication that goodwill may be impaired. Impairment tests involve estimating the value of goodwill. More specifically, if the book value of goodwill exceeds its recoverable amount, as estimated in connection with an impairment test, the firm shall recognize the excess as an impairment loss. However, estimates of recoverable amounts for goodwill are subject to a high degree of unverifiable discretion. This suggests that goodwill impairment tests might be used for earnings management. This study examines earnings management in relation to earnings targets. It focuses on two earnings targets that might create incentives for earnings management: zero earnings and the previous year’s earnings. The findings of the study are consistent with the prediction that firms that apply IFRS manage earnings through goodwill impairment accounting. The findings suggest that firms manage earnings upwards by impairing less goodwill when pre-impairment earnings barely exceed an earnings target, presumably in order to avoid falling short of the target. Further, the findings suggest that firms manage earnings downwards by impairing more goodwill when pre-impairment earnings clearly exceed or clearly fall short of an earnings target, presumably in order to inflate future earnings.
  • Ahmed, Sheraz (Svenska handelshögskolan, 2009-09-02)
    A growing body of empirical research examines the structure and effectiveness of corporate governance systems around the world. An important insight from this literature is that corporate governance mechanisms address the excessive use of managerial discretionary powers to get private benefits by expropriating the value of shareholders. One possible way of expropriation is to reduce the quality of disclosed earnings by manipulating the financial statements. This lower quality of earnings should then be reflected by the stock price of firm according to value relevance theorem. Hence, instead of testing the direct effect of corporate governance on the firm’s market value, it is important to understand the causes of the lower quality of accounting earnings. This thesis contributes to the literature by increasing knowledge about the extent of the earnings management – measured as the extent of discretionary accruals in total disclosed earnings - and its determinants across the Transitional European countries. The thesis comprises of three essays of empirical analysis of which first two utilize the data of Russian listed firms whereas the third essay uses data from 10 European economies. More specifically, the first essay adds to existing research connecting earnings management to corporate governance. It testifies the impact of the Russian corporate governance reforms of 2002 on the quality of disclosed earnings in all publicly listed firms. This essay provides empirical evidence of the fact that the desired impact of reforms is not fully substantiated in Russia without proper enforcement. Instead, firm-level factors such as long-term capital investments and compliance with International financial reporting standards (IFRS) determine the quality of the earnings. The result presented in the essay support the notion proposed by Leuz et al. (2003) that the reforms aimed to bring transparency do not correspond to desired results in economies where investor protection is lower and legal enforcement is weak. The second essay focuses on the relationship between the internal-control mechanism such as the types and levels of ownership and the quality of disclosed earnings in Russia. The empirical analysis shows that the controlling shareholders in Russia use their powers to manipulate the reported performance in order to get private benefits of control. Comparatively, firms owned by the State have significantly better quality of disclosed earnings than other controllers such as oligarchs and foreign corporations. Interestingly, market performance of firms controlled by either State or oligarchs is better than widely held firms. The third essay provides useful evidence on the fact that both ownership structures and economic characteristics are important factors in determining the quality of disclosed earnings in three groups of countries in Europe. Evidence suggests that ownership structure is a more important determinant in developed and transparent countries, while economic determinants are important determinants in developing and transitional countries.
  • Spohr, Jonas (Svenska handelshögskolan, 2005-12-07)
    There is much literature developing theories when and where earnings management occurs. Among the several possible motives driving earnings management behaviour in firms, this thesis focuses on motives that aim to influence the valuation of the firm. Earnings management that makes the firm look better than it really is may result in disappointment for the single investor and potentially leads to a welfare loss in society when the resource allocation is distorted. A more specific knowledge of the occurrence of earnings management supposedly increases the awareness of the investor and thus leads to better investments and increased welfare. This thesis contributes to the literature by increasing the knowledge as to where and when earnings management is likely to occur. More specifically, essay 1 adds to existing research connecting earnings management to IPOs and increases the knowledge in arguing that the tendency to manage earnings differs between the IPOs. Evidence is found that entrepreneur owned IPOs are more likely to be earnings managers than the institutionally owned ones. Essay 2 considers the reliability of quarterly earnings reports that precedes insider selling binges. The essay contributes by suggesting that earnings management is likely to occur before high insider selling. Essay 3 examines the widely studied phenomenon of income smoothing and investigates if income smoothing can be explained with proxies for information asymmetry. The essay argues that smoothing is more pervasive in private and smaller firms.
  • Haga, Jesper Per Alexander; Huhtamäki, Fredrik Johannes; Sundvik, Dennis (2019-07)
    In this study, we investigate how country-level long-term orientation affects managers' willingness to engage in earnings management and choice of earnings management strategy. Using a comprehensive dataset of 47 countries for the period from 2003 to 2015, we find that firms in long-term-oriented cultures rely relatively more on earnings management through accruals, while firms in short-term-oriented cultures engage in relatively more real earnings management. Furthermore, we find a larger discontinuity around earnings benchmarks in long-term-oriented cultures suggesting that manipulation of accruals enables benchmark beating with high precision.