Abstract

In a sample of 1,097 European merger and acquisitions (M&A) deals, we find that the targets exhibiting higher levels of accruals earnings management (AEM) relate to lower ownership stakes offered by acquirers. Real earnings management (REM) measures do not relate to ownership decisions. This research contributes to broadening our knowledge about accounting information’s role in the intricacies of M&A negotiations.

Introduction

The ownership decision refers to how much equity acquirers aim to get from targets in mergers and acquisitions (M&A). The objective of this study is to examine how the manipulation of the target’s financial statements affects this decision.

Manipulated accounting figures generate uncertainty, and highly uncertain settings are associated with minority deals, which leads to expect that higher target’s earnings management (EM) relates to lower ownership stakes. However, the bidder may be unable to detect the manipulation, or it may be easier or more convenient to adjust other terms of the deal to overcome the overpayment risk.

We examine 1097 European deal announcements between 1990 and 2021, showing that higher discretionary accruals (DA), our proxy of accruals-based earnings management (AEM), are associated with lower ownership stakes and higher odds of minority deals. This suggests that, on average, acquirers are conservative regarding the equity stake they bid for when the target’s financial statements are opaque, making difficult the assessment of the potential synergies from the transaction.

We also find that real earnings management (REM) proxies do not correlate with the ownership decision. This is consistent with acquirers having more difficulties in understanding REM than AEM. Indeed, REM models are proven to be less powerful than AEM models (Nguyen et al., 2023). Alternatively, this result supports the thesis that REM is less pervasive than AEM (Bagnoli and Watts, 2000).

Conclusion

We add the target’s EM to the pool of non-controlling deal drivers (Drees et al., 2013; Liao, 2014; Povel and Sertsios, 2014; Soloveva et al., 2021). We find that buyers prefer to proceed cautiously and bid for small equity stakes and/or carry out non-controlling deals when they detect upward AEM in the target’s financial statements. This provides new insights into the usefulness of financial statements in the due diligence of M&A to avoid potential negative consequences of the transaction. Considering AEM might help acquirers make better-informed ownership decisions when dealing with overvaluation. Our evidence is consistent with prior research suggesting that the firms involved in non-controlling deals create wealth by aligning incentives and improving the information flow (Drees et al., 2013).

Our evidence is consistent with prior research suggesting that the firms involved in non-controlling deals create wealth by aligning incentives and improving the information flow (Drees et al., 2013). Moreover, our results are in line with recent evidence that, despite its relatively scarcity in the past, toeholds are useful when performing difficult takeovers, such as is the case in hostile deals, tender offers, or multiple bidders contests (Dai et al., 2021). Our results are relevant considering that takeovers are sophisticated transactions which parties have many terms to negotiate. Moreover, our findings are more than timely for practitioners in the current context of M&A, plagued by uncertainty and the looming threat of a recession, since rather than avoiding value-driven deals due to the overvaluation risk, they may use minority acquisitions strategically to mitigate the risks. However, this also poses an interesting question. If acquirers have many tools to prevent the overpayment risk, why are there M&A that destroy value? Very and Schweiger (2001) claim that acquirers usually lose money in M&A because of problems concerning the reliability of the target’s financial information and the integration process. Given our findings and those of other studies, showing that acquirers adjust the terms of the deal to mitigate the uncertainty derived from the target’s financial statements, future research should delve deeper into the integration phase of M&A to cast light on this question.

Abstract

This study theoretically and empirically analyzes the impact and mechanism of corporate green transformation on accrual earnings management using a sample of China’s A-share listed companies from 2015 to 2021. The results indicate that the green transformation of enterprises helps restrain accrual-based earnings management, especially accrual-based earnings management, which increases profits, and that the inhibition effect of enterprise green transformation on earnings management is more significant in high-tech and growth-stage enterprises. The mechanism test shows that corporate green transformation can inhibit accrual-based earnings management by increasing analyst follow-up and easing financing constraints. Using China’s environmental tax law, promulgated in 2018, as an exogenous shock to construct the PSM-DID, the conclusion still holds after alleviating endogeneity. Further research has found that green transformations can also help inhibit real earnings management. This study provides new empirical evidence for a comprehensive understanding and evaluation of the governance role of corporate green transformation and provides a reference value for further comprehensively promoting the green transformation of Chinese enterprises and improving the quality of accounting information.

Introduction

With the continuous adoption of an extensive economic growth model in recent years, China has become the second largest economy in the world. However, this extensive economic growth has seriously damaged China’s environmental resources, making China’s total greenhouse gas emissions the highest in the world [1]. The green economy has always been an important tool for developing countries to achieve sustainable development [2]. Therefore, to avoid environmental degradation caused by greenhouse gas emissions and political pressure affecting sustainable economic development, the Chinese government has proposed a series of economic development strategies based on environmental protection.1 The Chinese government’s green development method of “promoting the construction of a resource-saving and environmentally friendly society” reflects the determination and attitude of the government in formulating and implementing new development policies during the transformation period of national economic development [3]. China’s listed companies have long been the main source of carbon emissions.2 Today, with increasingly serious environmental problems, the traditional “high carbon emission” development model of listed companies is unsustainable, and companies must choose a development path that takes into account both economic and environmental benefits [4], and green transformation can just become an important driving force for the sustainable development of the corporate economy [5]. Therefore, given the Chinese government’s vigorous promotion of the sustainable development of the green economy based on the “dual carbon” goal, the green transformation of listed companies has become a hot topic of concern in all walks of life.

Conclusion

Earnings management has always been a key issue in corporate governance and improving accounting information quality is an emerging market goal. As one of the most important forms of sustainable economic development in China, corporate green transformation has a governance effect on earnings management, and is worthy of study. This study selects A-share listed companies in China’s Shanghai and Shenzhen stock markets from 2015 to 2021 as the research sample and empirically tests the impact of corporate green transformation on accrual earnings management. The results were as follows:

First, there is a negative correlation between corporate green transformation and accrual-based earnings management, indicating that corporate green transformation effectively inhibits accrual-based earnings management. Simultaneously, corporate green transformation has a strong inhibitory effect on accrual-earnings management, which increases profits. After using the environmental protection “fee reform tax” policy issued by the Chinese government in 2018 to employ a PSM-DID analysis to alleviate endogeneity, the conclusion still holds after a series of robustness tests such as replacing explanatory variables and explained variables.

Abstract

Using the hand-collected data of 800 Vietnamese non-financial firms from 2008 to 2018, this study constructs a comprehensive corporate governance index in alignment with the corporate governance code of best practices in Vietnam. We provide strong evidence that corporate governance quality restrains earnings management, measured by both the absolute and signed discretionary accruals and the real earnings management. In particular, the negative association between corporate governance quality and earnings management is more profound in private firms (non-SOEs), firms with high foreign ownership and low concentrated ownership, and high growth firms compared to their peers. The observed results are robust to alternative measures of discretionary accruals, total accruals andreal earnings management. Furthermore, the results are corroborated using instrumental variables, firm fixed effects and propensity score matching methods to address potential reverse causality and sample selection bias.

Introduction

Earnings management has begun to attract public attention in the wake of recent corporate scandals in Vietnam. Vien Dong Pharmaceutical Joint Stock Company (DVD), one of the most lucrative-looking companies in the pharmaceutical industry, suddenly faced bankruptcy in 2011, even though the firm’s earnings growth rate was reported to be 325 percent in 2009, when DVD ranked the first in the industry. Inefficient corporate governance practices, such as the excessive concentration of power in the hands of top leaders, an inefficient board structure with conflicts of interest, and an ornamental supervisory board were blamed for assisting DVD management in defrauding its stakeholders. Similarly, other companies, such as Hoang Anh Gia Lai Group JSC (HAG) and Ho Chi Minh Infrastructure Investment JSC (CII), inflated their earnings to attract investors. On the other hand, other firms such as Quoc Cuong Gia Lai JSC (QCG) and Nafoods Group JSC (NAF), were revealed to have manipulated their earnings downward (Tap Chi Tai Chinh, 2020). These scandals motivate this study to explore the role of corporate governance quality as a significant driver of earnings management in Vietnam.

Globally, the infamous scandals involving Enron, Worldcom, Olympus, Parmalat, and Toshiba, to name but a few, have thrown up numerous questions about the efficiency of management accounting, auditing, and corporate governance practices. Di Miceli da Silveira (2013) reveals that Enron’s internal governance failures lead to managers’ taking advantage of accounting loopholes to manipulate its earnings and conceal its heavy losses. Chen et al. (2007) emphasise a pivotal role of corporate governance in stimulating transparency and efficiency, protecting minority shareholders’ wealth, ensuring the fair treatment of all shareholders, and facilitating the timely and accurate disclosure of all material matters. Deficient corporate governance mechanisms may result in severe agency costs and information asymmetry (Bhojraj & Sengupta, 2003) as well, which can be attributed to managerial misbehaviour. García-Meca and Sánchez-Ballesta (2009) propose that corporate governance helps to align the interest of managers with those of shareholders and to enhance the credibility of accounting information. It is notable that, Bao and Lewellyn (2017) and Lel (2019), in their recent multi-country studies, find that firms in emerging markets manipulate earnings to a much higher level, as their legal enforcement is less strict compared to developed markets.

Conclusion

The primary objective of this study is to examine, for non-financial listed firms in Vietnam from 2008 to 2018, the impact of corporate governance on earnings management, measured by the absolute value of discretionary accruals, signed discretionary accruals, and real earnings management. After controlling for firm-specific characteristics, we find that firms with higher corporate governance index are associated with lower earnings management. Results remain unchanged with the use of alternative measures of earnings management and alternative model specifications, which are used to allow for possible endogeneity biases. The findings from this study align with prior studies suggesting that corporate governance reduces agency and information costs. Considering the moral hazard, managers are more likely to act in their personal interests at the expense of stakeholders, in the absence of efficient corporate governance mechanisms. Reinforcement of corporate governance monitors managerial opportunism (Ali et al., 2018) and constrains earnings management activities (Liu & Lu, 2007; Shen & Chih, 2007). Our findings further suggest that the effectiveness of corporate governance’s monitoring role is subject to ownership structure and firms’ growth opportunities. The negative relationship is found to be significant only in non-SOEs, firms with high foreign ownership and low concentrated ownership, and high growth firms.

Abstract

This study explores the association between the Covid-19 outbreak, corporate financial distress and earnings management practices in China. We investigate whether firms took advantage of the downturn in economic conditions during the pandemic to adjust their earnings using different earnings management techniques. Utilising a sample of 1832 listed firms and underlying theoretical frameworks (i.e., positive accounting and signalling theory), we find that firms were more inclined to manage earnings during the pandemic period. They favoured using the accrual-based rather than the real activity-based earnings management technique. We also find that firms engaged more in income-increasing practices in the shadow of the outbreak. In addition, our results further demonstrate that financially distressed firms were involved in earnings management, particularly accrual-based earnings management. However, compared to privately-owned firms, state-owned enterprises seem to be involved less in earnings management during the Covid-19 pandemic. Findings from this study raise some concerns for policymakers about the credibility of financial reporting information during Covid-19.

Introduction

The global coronavirus (i.e., Covid-19) pandemic and the associated economic recession brought many severe challenges to companies around the world, posing a profound threat to the viability of many businesses (Barai and Dhar, 2021). The crisis is regarded as the century’s largest health, economic and social crisis so far (The New Yorker, 2020). In addition to the human losses and the disease itself, Covid-19 slowed down global economic activities due to its extensive impacts and the different measures implemented by countries to control the disease’s spread. It caused a significant negative impact on employment (high unemployment rate), reduced economic activity and created uncertainties in many financial markets (Zhang, Hu, and Ji, 2020). Consequently, many firms faced financial distress and bankruptcy due to operational disruption (Lassoued & Khanchel, 2021).

The Covid-19 lockdowns had a profound effect on financial markets and corporate financial performance (Ruiz, Koutronas, and Lee, 2020; Zhang et al., 2020). Managerial behaviours were inevitably affected by the pandemic. In response to the poor market environment during the pandemic, many managers were under high pressure; hence, they may have manipulated earnings or polished their financial statements by using accounting discretion to achieve their targets (Ali, Amin, Mostafa, and Mohamed, 2022; Choi, Kim, and Lee, 2011; Liu & Sun, 2022). Their firms may make use of accounting techniques to improve their deteriorating income statements and balance sheets during a crisis (Arnold, 2009; Laux and Leuz, 2010) or possibly during a pandemic (Ali et al., 2022; Chen, Liu, Liu, and Wang, 2022; He and Jianqun, 2021; Liu & Sun, 2022; Ozili, 2021; Rahman, Ding, Hossain, & Khan, 2022). Earnings management can be done through accrual-based earnings management (hereafter, AEM), and real activity-based earnings management (hereafter, REM) (Graham, Harvey, and Rajgopal, 2005; Kim, Udawatte, and Yin, 2018). AEM occurs when executives manage the accrual component of earnings, while REM can be conducted by changing business operational activities, which has a direct influence on a company’s cash flow (Cimini, 2015). The financial report is an important basis for investors, analysts and stakeholders to make decisions, so it should be able to reflect the actual situation of firms. Arguably, there are numerous gaps in financial reporting that can provide space for executives to take part in earnings management (Azizah, 2021), especially because of the impact of Covid-19 social distancing on audit quality (Albitar, Gerged, Kikhia, & Hussainey, 2020). This leads to a lack of authenticity of accounting information and a lack of stability of enterprise development (Chen et al., 2022).

Conclusion

The Covid-19 pandemic had a catastrophic impact on global health and economic systems. Businesses saw a drop in profitability because of the pandemic, as most economic activities were suspended during lockdown measures. This paper examines the impact of the Covid-19 pandemic on the earnings management practices in a sample of listed companies in China. This is an important issue, given the relevance of the authenticity and reliability of accounting information to stakeholders during troubling periods.

Based on a sample of 1832 companies listed on the Shanghai and Shenzhen stock exchanges during the pre-pandemic period, from 2015 to 2019, and the pandemic period (2020−2021), with 8590 firm-year observations conducted, we examined the earnings management practice using both accrual earnings management and real earnings management techniques. Our findings reveal that the quality of financial reporting by Chinese companies tended to be lower during the pandemic. Listed companies affected by the pandemic were more likely to engage in AEM than REM. In particular, the results indicate that Chinese listed companies were more likely to engage in upward earnings management during the Covid-19 pandemic, which can be explained by the argument that businesses tried to show acceptable levels of losses and thus mitigate the impact of the pandemic in the eyes of investors and stakeholders. This is consistent with the finding of Lassoued & Khanchel (2021) that companies manage earnings upward by mitigating the reported losses level to rebuild the confidence of stakeholders and thus support economic recovery. Furthermore, the results also indicate that financially distressed firms engaged in earnings manipulation, especially accrual-based earnings management. However, this behaviour seems to be less prevalent during the Covid-19 pandemic, especially in the case of state-owned enterprises. The findings were robust after considering the factors that may influence the incentives and behaviours of earnings management. In detail, we used the corresponding company-level variables, such as debt performance, opportunity growth, board independence and audit quality. Furthermore, we also used other alternative proxies as dependent variables and panel data fixed effects to ensure the robustness of our results.

Abstract

Empirical studies found that earnings management (EM) explains firms’ cost of capital both in companies in emerging and developed countries, but until now, it has not been analyzed whether the effect of EM on the financial cost is different among emerging countries inside or outside an economic area (Eurozone). Our results show that the cost of debt and the idiosyncratic component of the cost of equity are related to discretionary accruals and abnormal values of operating cash-flows, that the emerging country effect is more relevant on the cost of debt, that there is a Eurozone effect that makes discretionary accruals more relevant than abnormal values of operating cash-flow and that firms in emerging countries inside the Eurozone benefit from a lower EM penalty on the cost of debt than firms in other emerging European countries.

INTRODUCTION

The literature shows that cost of capital for companies in emerging countries is higher than that for companies in developed countries (González-Sánchez, 2022; Narayan et al., 2014). This means that investments in emerging countries have to achieve higher returns to compensate for this extra financial cost. In this context, our aim is to test whether the earnings management (EM) explains this extra financial cost of capital and, if the EM effect is different for companies in emerging countries if the country is inside or outside of Eurozone.

EM is the ability of the company’s management to manipulate the company’s results, with the intention of obtaining some private gain, but reducing the quality of financial reporting. The literature has analyzed whether EM has a negative impact on the quality of financial reporting, which may reduce the value of the company, causing stakeholders to lose confidence. More specifically, EM has also been analyzed in relation to issues such as the supervisory role of the majority owner in mitigating managers’ opportunistic behavior in EM (Mellado & Saona, 2005), insider trading (Sawicki & Shrestha, 2008), mergers and acquisitions (Zhu & Lu, 2013), debt issuance (Mellado et al., 2017), or bankruptcy risk (Agustia et al., 2020).

CONCLUSIONS

Empirical evidence shows that the financial cost of companies in emerging countries is higher than that of companies in developed countries. In this context, we test whether this difference is due to the way creditors and investors take into account EM in both types of companies or whether their interpretation of earnings manipulation is independent of the extra financial cost in emerging versus developed countries. Our main objective is to study whether there is a different effect for companies in the Eurozone and whether, as a consequence, companies from emerging countries inside the Eurozone have a different effect than other companies from emerging European countries outside the Eurozone.

To study this differential effect, we built a database composed of 4514 companies from 16 developed countries and 3399 companies from 21 emerging countries. The novelty of our sample is that all countries belong to the same geographical area (Europe), so that implicitly the economic, social, and cultural relations (among others) should not show substantial differences in the way EM explains financial cost. Moreover, by including in the sample developed and emerging countries that share a common regulatory framework and a common currency (euro), this difference should be nonexistent. The sample period is from 2012 to 2020.

Abstract

Recently, the defense industry in South Korea has been regarded with strong suspicion since a company responsible for producing parts for the aviation sector is being investigated for cost irregularities. Many people are concerned about these issues and the government is distrustful of defense industries. If the current situation continues, the defense industry market in South Korea (henceforth “South Korea”) will be hard to maintain. The South Korean government will have to rely on importing from abroad instead of buying products in the local market. This study looked at the sustainability of earnings management adopted in the defense industry of South Korea, exploring options for the government to maintain the scheme’s soundness. In particular, we used Kothari’s discretionary accrual as a proxy of earnings management and OLS method to analyze the relationship between them. The results are as follows. Firstly the firms with a high percentage of defense sales showed significant discretionary accruals; the higher the profit, the more likely it was that earnings adjustments were made; secondly, firms that had been certified by the government for defense cost-management were proven to be effective, because the earnings management activities were low compared to those of firms that did not have the defense cost-management certification; lastly, based on the accounting rules for the cost of defense products, it was found that significant results confirming defense firms were exercising their influence, through earnings management, on the improvement of the government system.

Introduction

In South Korea, defense scandals have recently become problematic [1]. The company that produces parts for the aviation sector is being investigated for cost irregularities. There is mounting suspicion that illegal costs in the defense industry are rising. Many people are concerned about these issues and the government is distrustful of defense industries. If the situation continues, the defense industry market in South Korea will be hard to sustain. Preventing earnings management in the defense industry is thought to be the first step to achieving transparency to help strengthen South Korean military power. The South Korean government will need to rely on importing instead of buying products in the local market. In this study, the relationship between the characteristics of domestic defense firms and earnings management in South Korea were examined.

We studied the unique cost structure of the defense industry, which compensates for profits based on the costs incurred, and examined the cost-management certification system in terms of the share of defense sales, the political cost hypothesis, and the characteristics of defense firms arising from the asymmetry of cost information between the government, which is the consumer, and the defense industry, which is the supplier.

Conclusions

This study aimed to examine the earnings management behavior of firms in the defense industry in South Korea and find a solution for the government to reduce the earnings management. The results of the study are as follows.

First, firms with higher defense product sales increased their degree of earnings management. This differs from the study by Kim et al. [13] that showed that the higher the reliance on the defense industry is, the lower the reported profit is recorded. That is, for defense firms, a profit-centered system does not produce only one result, but creates different earnings management systems that can increase and/or reduce reported profit.

Second, the defense industry cost-management system, which shares cost management information about defense firms, was examined in relation to earnings management. We found that the level of earnings management was lower for the companies with the certified system than those without the system. This can be interpreted in two ways. Firstly, for a company that has the certified defense cost-management system, due to the information asymmetry between the government and the company about the decrease in costs after the implementation of the system, the level of earnings management decreased; secondly, the firms with the certified system have already received the cost-related certification from the government because they did not engage in earnings management activities. Of these two interpretations, the latter is valid because the system for cost control in defense firms has been in effect since 2012. However, because there is not enough data (4 firms in 2012, 9 in 2013, and 12 in 2014), the effectiveness of the test could not be measured.

Abstract

     Human cognitive time has become a key asset of the digital economy, yet we lack the means to manage it. In response to that need, we propose a technology to manage cognitive time in economic organizations. This technology is called cognitive time-driven activity-based costing (CTABC), and it extends the established time-driven activity-based costing technology. CTABC accounts for human agents’ cognitive time and the fact that cognitive time typically does not equal physical clock time for a given economic activity. CTABC also unearths a hidden lever effect that leads to considerable economic inefficiencies. An illustration of the proposed CTABC shows the limitations of contemporary approaches to cost assessments, which ignore errors caused by workers’ cognitive time estimation. This paper contributes to the literature on cost accounting technology and the future of the digital economy. Specifically, it enriches the literature on the problem of the accuracy of employees’ time estimates.

Introduction

     “In an information-rich world, the wealth of information means a dearth of something else: a scarcity of whatever it is that information consumes. What information consumes is rather obvious: it consumes the attention of its recipients. Hence a wealth of information creates a poverty of attention and a need to allocate that attention efficiently among the overabundance of information sources that might consume it.”

     In today’s competitive business environment, cost accounting systems must provide accurate information to managers so that they can make well-grounded decisions without negative impacts on the quality of products and services (Ganorkar et al., 2020; Hardan and Shatnawi, 2013; Zamrud and Abu, 2020). Without accurate cost accounting, managers cannot balance incomes and costs to sustain the endeavors of projects and govern organizations, firms, and even whole economies (Berisha, 2017; Ganorkar et al., 2020; Hardan and Shatnawi, 2013). Cost management is crucial for both for-profit and not-for-profit organizations that aim to be competitive and cost efficient (Hofmann and McSwain, 2013; Stouthuysen et al., 2014; Varila et al., 2007). Although the importance of cost accounting is beyond reasonable doubt, studies have shown that understanding cost structures and dynamics and cost assessments is not a trivial task for accountants and managers (Berisha, 2017; Hardan and Shatnawi, 2013; Uyar and Kuzey, 2016).

Discussion and conclusions

     In today’s highly competitive environment, there is an urgent need to calculate costs and revenues accurately so that companies can survive and ensure long-term profitability (Berisha, 2017; Ganorkar et al., 2020). Calculating the cost of products and services, however, remains a difficult exercise to ensure that costs do not exceed market prices. The TDABC model was proposed to remove the limitations of traditional costing systems and the ABC model. The distinctive feature of TDABC is that the time of an activity is at the forefront of the assessment of the cost of that activity. However, employees’ time estimates are prone to measurement errors in cost assessment (Barros and da Costa Ferreira, 2017; Cardinaels and Labro, 2008; Gervais et al., 2010). They lead to misinformed managerial decision making because TDABC accounts for only one kind of time, namely physical or clock-time, assuming that it is objective. The cognitive science literature shows a significant difference between a worker’s cognitive time and physical clock time, understood as the relationship between perceived time and physical time (Block and Eisler, 1999; Levin and Zakay, 1989). In this paper, we propose an updated version of TDABC that accounts for human agents’ cognitive time and the fact that cognitive time typically does not equal physical time, hence producing CTD. The CTABC technology proposed in this paper remedies the shortcomings of time assessment using traditional TDABC by accounting for CTD and incorporating it into the TDABC calculations.

Abstract

     We provide a systematic literature review of the determinants and consequences of real earnings management (REM) in an international context. We provide a theoretical framework for REM, the development of REM measures, and review the determinants of REM, categorising these into financial reporting, auditing, governance and controls, capital market incentives, and regulatory determinants. We then review the empirical literature on the consequences of REM. We provide some suggestions for future research on measurement issues related to REM, and on filling gaps in the empirical research investigating its determinants and consequences.

Introduction

     We provide a systematic review of the determinants and consequences of real earnings management (hereafter REM) in an international context. Earnings management research has dominated the accounting research landscape for about three decades. Researchers initially investigated the determinants of accruals earnings management (hereafter AEM) following the seminal paper of Jones (1991). However, after the passage of the Sarbanes Oxley Act (hereafter SOX) of 2002, research on the determinants and consequences of REM proliferated.

     REM is defined as ‘departures from normal operational practices, motivated by managers’ desire to mislead at least some stakeholders into believing certain financial reporting goals have been met in the normal course of operations’ (Roychowdhury, 2006, p. 337). Examples of REM include, but are not limited to, overproduction designed to decrease the cost of goods sold and the cutting of R&D investment to boost current-period earnings. Managers are increasingly using REM, particularly in the post-SOX period, owing to the greater possibility of AEM being detected by auditors and regulatory authorities (Cohen et al., 2008).1 In a survey of 401 chief financial officers (CFOs) in the US, Graham et al. (2005), reveal that ‘80% of survey participants report that they would decrease discretionary spending on R&D, advertising, and maintenance to meet an earnings target. More than half (55.3%) state that they would delay starting a new project to meet an earnings target, even if such a delay entailed a small sacrifice in value’ (p. 32).2 This increased use of REM has, consequently, expanded academic research on the determinants and consequences of REM. In this paper, we use REM and real activities manipulation interchangeably.

Conclusion

     The current study is a timely review of the body of knowledge of REM, based on the papers published from 2006 to 2021. Since the passage of SOX in 2002, research on the determinants of REM has proliferated, owing primarily to a shift from more easily detectable AEM to difficult-to-scrutinise REM actions. We surveyed and synthesised the REM literature with respect to the measurement, determinants and consequences of REM. Our review suggests that the existing REM literature has made little effort to adopt suggestions aimed at improving the measurement models of REM originally proposed by Roychowdhury (2006). Second, the passage of the SOX, as well as IFRS internationally, motivated managers to engage more in REM than in AEM. Capital market incentives arising from IPOs, SEOs and acquisition activities also appear to drive firms’ REM behaviour. A vast body of literature has examined the relation between REM and various factors related to corporate governance and controls. Some such factors include corporate boards, TMT characteristics, incentive compensation structures, external ownership structure, market competition, and country-level political, economic, legal and cultural characteristics. However, the evidence on the relation between corporate governance and REM remains mixed. Third, studies that examined the consequences of REM are fewer in number than the ones that examined the determinants of REM and, importantly, also provide inconclusive evidence.

Abstract

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Abstract

We present empirical evidence regarding the association between audit quality and real earnings management in case of the capital market of Bangladesh. Our analysis visualizes a panel of 2195 firm data with year-level observations which are listed on the Dhaka Stock Exchange throughout the period of 2000–2017. We report inverse association between ‘big 4’ audit firms’ service and levels of real earnings management practices. This result suggests that the client pool of big audit firms are less likely to engage in earnings management. This particular result is also consistent with the ‘big 4’ audit firms’ commitment to their reputation and long track-records of noted exhibition of due diligence. Also, we find no association between industry-specialized auditor (in terms of audited assets) and real earnings management. This result provides important insights to the nature of competition in the audit market of Bangladesh. Finally, we also observe no correlation between audit specialization (in terms of audited revenue) and real earnings management. This pattern invokes significant findings regarding the industrial depth of specialization of Bangladeshi firms. It also uncovers whether ‘specialized’ provision of audit service can meaningfully serve the more ‘generalized’ nature of industrial composition of the firms active in the capital market of the country.

Introduction

Bangladesh has graduated from the category of ‘least-developed countries’ to the status of a ‘developing country’ back in 2018 (Khatun 2018). Bangladesh achieved this recognition from United Nation with respect to compliance to all of the three requirements for graduation (GNI Per Capita, Human Assets Index and Economic Vulnerability Index). The country has maintained more than six percent average GDP growth rate in last 10 years (MOF 2018). The International Monetary Fund (IMF) predicts that Bangladesh will be able to maintain the growth rate (Ahasan 2019). For the coming years. PricewaterhouseCoopers expect that by maintaining this growth rate, Bangladesh’s economy will be the 23rd largest in the world by 2050. Despite the episodes of developmental success story of Bangladesh, the capital market of Bangladesh is widely regarded as inefcient to supply the required funds for burgeoning corporate sector.

During the last seven years, Performance of Bangladesh Capital market has not been consistence with developments in the macro-economic realm. In 1st July, 2010, General Index of Dhaka Stock Exchange was 6153 and in 1st July 2017, it was 5654. During this period, there was a decrease of five hundred points, yet GDP growth rate was more than 6.5 percent on average. There may be diferent reasons underlying this anomaly. In 2010, Bangladesh Capital Market witnessed a massive downside of its indexes. Government formed an investigation committee to fnd out the reasons for this unusual drive of the market. This committee mentioned diferent reasons for such anomalous behavior of the market.

Abstract

1. Introduction

2. R&D Accounting in China

3. Theoretical Analysis and Hypothesis Development

4. Research Methodology

5. Empirical Tests and Analysis of Results

6. Conclusions

Acknowledgments

References

Abstract

     This study investigates the relationship between earnings management (EM) and capitalization of research and development (R&D) expenditure from the perspective of major shareholders expropriation, using Modified Jones Model and Bidirectional Fixed Effect Model for the period 2009–2018. And the study further discusses the moderating effect of ownership concentration on the relationship between earnings management (EM) and capitalization of research and development (R&D) expenditure. Our results confirm that the level of accrued earnings management (EM) presents a positive impact on capitalization of research and development (R&D) expenditure. The effect of the shareholding ratio of the biggest shareholder on the relationship between accrued EM and capitalization of R&D expenditure is inverted U-shape.

Introduction

     In corporate governance, with the increasing prevalence of high ownership concentration, the analysis of the role of major shareholders is gaining attractive. The main contradiction of corporate governance has also changed from the principal-agent issue between shareholders and managers to the conflict between major and minority shareholders. The major shareholders have the capability and inclination to make use of the advantage to empty the listed company and encroach on the interests of the company, thus harming the interests of the minority shareholders. The development of China’s capital market is relatively backward, and the special background results in a “one dominant share” phenomenon of enterprises in China. Shleifer and Vishny (1997) found that in countries where investor protection is insufficient, major shareholders tend to seize the interests of minority shareholders. In generally, the encroachment of major shareholders is mainly due to three reasons: high level of ownership concentration, insufficient supervision and restriction on the behavior of major shareholders, and inadequate legal protection for investors. The main ways of major shareholders’ expropriation include the direct and indirect occupation of resources, such as earnings management (EM), related party transactions and dividend distribution, etc. Xu, Huang, and Wang (2014) believes that the absolute right of controlling shareholders improves the probability of financial fraud and earnings management (EM). LaPorta et al. (2000) found that major shareholders in the absolute controlling position would obtain private benefits through related party transactions, accrued EM, and other ways to realize the interest expropriation of minority shareholders. Morck, Shleifer, and Vishny (1988) argued that the inconsistent interests of major shareholders and minority shareholders led to conflicts between them. In the absence of an effective supervision mechanism, major shareholders would use their control right over the company for their personal gains, which would harm the interests of minority shareholders.

Conclusions

     The expropriation of major shareholder has a negative effect on the quality of accounting information which will affect the decision making of users, but also restricts the healthy development of the capital market. Recently, the capitalization of R&D expenditure has been used as a means of major shareholder expropriation. Therefore, it is worthy to examine the relationship between accrued EM and capitalization of R&D expenditure from the perspective of major shareholder expropriation. And we also proposed that ownership concentration plays a moderating effect role in the study. The empirical analyses show that: (1) accrued EM has a positive effect on the amount of capitalized development expenditures. (2) the effect of ownership concentration is inverted U-shape in the relationship between accrued EM and capitalization of R&D expenditure. What’s more, endogeneity test and robustness test were carried out in this paper to verify the reliability of the finding.

     The policy implications run as follows. After the accounting standard of Intangible assets changed in 2006, China’s R&D investments have enjoyed rapid and vigorous development. Thus, the favorable policy for R&D investments creates a positive environment for the development of enterprise innovation. However, we should mention that the capitalization of R&D has not received enough attention in the accounting literature. Irrational capitalization of R&D expenditure is becoming a way for the management to manipulate the earnings and the main reason for that is the current accounting standards are not clear on the division of the research stage and the development stage, as well as the capitalization amount. Over-capitalization of R&D expenditures can lead to overinvestment in continuing projects and destroy the firm value. Therefore, the standard-setting body should improve and refine the existing provisions of R&D expenditure and reduce the space for earnings management through capitalization of R&D expenditure.

Abstract

     Financial data, such as financial statements, contain valuable and critical information that may assist stakeholders and investors in optimizing their capital to maximize overall economic growth. Since there are many variables in financial statements, it is crucial to determine the causal relationships, that is, the directional influence between them in a structural way, as well as to understand the associated accounting mechanisms. However, the analysis of variable-to-variable relationships in financial information using standard correlation functions is not sufficient to unveil directionality. Here, we use the volatility constrained correlation (VC correlation) method to predict the directional relationship between two arbitrary variables. We apply the VC correlation method to five significant financial information variables (revenue, net income, operating income, own capital, and market capitalization) of 2321 firms listed on the Tokyo Stock Exchange over 28 years from 1990 to 2018. This study identifies which accounting variables are influential and which are susceptible. Our findings show that operating income is the most influential variable while market capitalization and revenue are the most susceptible variables. Surprisingly, the results differ from the existing intuitive understanding suggested by widely used investment strategy indicators, the price–earnings ratio and the price-to-book ratio, which report that net income and own capital are the most influential variables affecting market capitalization. This analysis may assist managers, stakeholders, and investors to improve financial management performance and optimize firms’ financial strategies in future operations.

Introduction

     The advent of information technology has made it possible to store and classify a large amount of financial data in real time on an unprecedented scale [1]. Financial information can be represented by a vast variety of data types. However, one of the most abundant types of data is multivariate time-series data, in which correlations among different assets are often used to perform risk management analysis, determine investment strategies, and improve financial management. The correlation structure in financial markets has been investigated in many studies at different scales. Preis et al

     analyzed 72 years of daily closing prices of the 30 stocks of the Dow Jones Industrial Average and found that the average correlation among the stocks is linearly scaled with market stress at various time scales [2]. Laloux et al. applied random matrix theory to understand the statistical structure of the correlation matrix of price changes and showed that there is a significant agreement between theoretical predictions and real data related to the density of eigenvalues [3]. This study raises serious questions about Markowitz’s naive use of empirical correlation matrices for portfolio risk management. Plerou et al. also applied random matrix theory to analyze the cross-correlation matrix of price changes of the largest 1000 US stocks [4]. Their findings showed that randomness cannot explain the universal and non-universal properties that enable the identification of cross-correlations between stocks. Jiang and Zheng uncovered the positive and negative subsector structures of Chinese, US, and global stock markets by applying a random matrix theory analysis and taking into account the sign of the components in the eigenvectors of the cross-correlation matrix [5]. Cross-correlations between volume change and price change of financial indexes were studied by [6]. Long-range magnitude cross-correlations in real-world data from various fields, such as finance, have also been studied intensively, using time-lag random matrix theory [7]. The integration of random matrix theory and network methods was also used to unveil correlation and network properties of 20 financial indexes [8]. The importance and novelty of physical methods applied to the study of financial cross-correlation analysis have been highlighted by Kwapien and Drozdz in their extensive review [9]. In particular, the application of random matrix theory to financial multivariate time series data deserved special attention. In this regard, several works have extended and further applied this statistical mechanics approach to the field of finance, namely [10–15].

Conclusion

     Previous studies of correlation coefficients in finance data have found out about the correlation between two variables but not their direction [2,4–8]. However, we were able to capture the directionality between variables in financial statement data that cannot be captured by ordinary correlation coefficients.

     In this study, the VC correlation approach unveiled the directionality between five major accounting variables, which is difficult to obtain using standard correlation methods. Our data-driven computations yielded new insights on major accounting variables, which can be translated into novel recommendations for investment strategies. We summarize our findings as follows.

     First, from the directionality network, we observed that operating income is the origin of influence on the other four accounting variables (net income, own capital, market capitalization, and revenue). Market capitalization and revenue are the most susceptible accounting variables. Second and more importantly, although market participants often focus on net income and own capitalization to evaluate the share price for investment strategy, operating income may be a better accounting variable on which to focus. Third, the influence order of revenue, operating income, and net income differs from the order of accounting calculation of income statements.

Abstract

1. Introduction

2. Hypothesis development

3. Data and methodology

4. Empirical result

5. Conclusions

CRediT authorship contribution statement

Acknowledgements

References

Abstract

     By utilizing listed firms inand China from 2014 to 2018, this paper investigates how air pollution affects firms’ accrual earnings management. Empirical results show that higher air pollution promotes a firm’s earnings management. Next, we conduct a series of robustness checks, including a random discontinuity design regression and an instrumental variable regression; and confirm the causal effect of air pollution on companies’ earnings manipulation behaviors. Our results indicate that air pollution affects earnings management by lowering labor productivity and strengthening executives’ negative sentiments. In the additional analysis, air pollution transfers firms’ real earnings management to accrual earnings management. Finally, we found that the positive effect of air pollution on earnings management is more pronounced in firms in low polluting industries and non-state-owned firms. In summary, our study not only enriches the literature on how the external natural environment reshapes firms’ behaviors but also contributes to the literature on the determinants of firms’ earnings management. Our research could also provide policy implications for developing countries to balance the relationship between environmental protection and economic development

Introduction

     In most developing countries, rapid economic development and industrialization are associated with environmental pollution, especially air pollution. According to the 2018 Environmental Performance Index Report, which was constructed by Yale University and Columbia University, China’s environmental performance ranks 120th out of 180 countries, and 20% of the deaths in China are associated with air pollution. In addition to physical health, air pollution could also reshape human sentiment and decisions (Qin and Zhu, 2018; Roback, 1982) and affect firms’ behaviors (Shen et al., 2020; Tan et al., 2021; Wang et al., 2021a; Wang et al., 2021b; Zhang et al., 2021). Our paper intends to examine the impact of air pollution on firms’ accruals earnings management.

     Air pollution might reshape a firm’s earnings management in two ways. First, air pollution is detrimental to labor productivity and increases operating costs (Chang et al., 2016; Graff Zivin and Neidell, 2012; Zhu et al., 2022). The existing literature shows that air pollution lowers employees’ cognitive capacity and psychological concentration, finally resulting in lower productivity (Graff Zivin and Neidell, 2012; Heyes et al., 2016) and reducing firms’ total factor productivity (Li et al., 2020). On the other hand, air pollution might affect managerial sentiment and finally change firms’ earnings management. Previous studies show that air pollution could reshape investors’ and funds managers’ sentiment, thereby altering their risk preferences and lowering investment returns and volatility (Ding et al., 2021; Lepori, 2016; Wu et al., 2018). Besides, air pollution could also impact managerial sentiment and ultimately promote a firm’s investment in social responsibility. Combining these analyses together, air pollution could reshape labor productivity and managerial sentiment and finally affect a firm’s earnings management. Yao and Liu (2020) analyze the uncertainty of air quality and confirm that stronger uncertainty regarding air quality could promote a firm’s downside earnings management. However, it is still unclear how air quality affects firms’ earnings manipulation. Our studies enrich the research on the economic consequences of air quality and extend the external determinants of earnings management.

Conclusions

     By utilizing the data on public companies in China from 2014 to 2018, we investigate the causal relationship between air pollution and accrual earnings management. Our results show that firms engage in more earnings management when air pollution is stronger. This result is robust to alternative measurements for earnings management and air pollution and the random discontinuity design. Moreover, air pollution affects earnings manipulation by affecting managerial sentiment and labor productivity. This is reflected by the impact of air pollution being stronger in firms with higher labor productivity and lower negative managerial sentiments. In addition, we find that firms are more likely to positively manipulate earnings when air pollution is high. Then, we show that real earnings management is reduced by air pollution, indicating that earnings management is transferred. Finally, the relationship between air pollution and earnings manipulation is weaker in firms in polluting industries and state-owned firms.