11_Earnings Management(1)

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How can we think about earnings management?
Opportunistic behavior
An efficient contracting perspective
Information perspective
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I. Motivations for Earnings Management
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2. Efficient contracting perspective
Rigidity of contracts, but
Unanticipated state realizations
Contracting parties will allow for earnings
management
Figure 1. Distributions of ROEs of all listed firms, 1995-1998 (ROEs higher than 30% and lower than –10% are deleted)
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管制的刚性（陈信元、叶鹏飞和陈冬华，2003）
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3. Information perspective
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How to manage NI Accrual Voluntary changes in acct policies Conclusions Predictions of earnings management subject to bonus schemes were supported by the empirical results (accruals) Acct policy changes not found to be used to mange NI, two reasons: • Accruals are more effective way • Long-run earnings management device
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Can management “window dress” indefinitely?
Accruals reverse
How to decide the line between earnings management and earnings mismanagement?
Determined by standard setters, security commissions, and other courts
Earnings Management
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What is earnings management ?
Choose accounting policies so as to maximize managers’ own utility and/or the market value of the firm.
Income smoothing
12ቤተ መጻሕፍቲ ባይዱ
Healy (1985): test bonus plan hypothesis
Title: “the effect of bonus schemes on accounting decisions”, JAE, 1985 (april) Objectives: to explain and predict managers’ choices of acct policies, and change of average accruals Research samples: firms whose compensation plan are based on current reported net income only
1. Opportunistic behavior Executive compensation (bonus schemes) Healy (1985) Political costs
Jones (1991)
Taxation motivations Taxation accounting: Tax
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III. Patterns of earnings management
Taking a bath
CEO change
Income minimization
Politically visible firm Tax saving
Income maximization
Bonus plan Close to debt covenant violations
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Bogey and caps
Low NI (below bogey): take a bath>>>high NI, next year High NI (over cap): reduce NI>>>high NI, next year NI between bogey and cap: increasing NI, this means bonus plan hypothesis applies only when NI is between bogey and cap
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Changes of CEO Different motivations of CEO Murphy and Zimmerman (1993) Pourciau (1993) Defond and Park (1997) IPO Earnings in the prospectus and value of the firm Earnings forecast and value of the firm Friedlan (1994)
Give managers some flexibility to protect
themselves
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1997 (N=675)
30%
25%
1997 (N=675)
20%
Percent
15%
10%
5%
0% -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% ROE 12% 14% 16% 18% 20% 22% 24% 26% 28% 30%
Communication of management’s inside information to investors by earnings management
The market value of firm’s shares affected by earnings management Income smoothing
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How does management manage earnings?
The choice of accounting polices Straight-line vs. declining-balance amortization LIFO vs. FIFO The choice of value estimation Provisions for credit losses Value of inventory Below-the-line items (special in China)