Purpose: The purpose of this paper is to examine the use of real earnings management by private and public firms in a unique institutional setting, which is the Gulf Cooperation Council (hereafter GCC) countries. The paper also compares the level of real earnings management between public and private firms in the GCC area. Design/methodology/approach: The GCC area is a unique setting to investigate the use of real earnings management because of the low enforcement of reporting standards and supervisory rules, lack of sophisticated financial analysis, specialized media tools and high concentration of capital ownership. We use different models of real earnings management proposed by (Roychowdhury, 2006); cash flow management, productions cost management and discretionary expenses management to examine the use of real earnings management. Findings: The paper documents evidence consistent with private and public firms using real earnings management to influence their earnings figures. The paper also, shows that the level of real earnings management is higher for private firms compared to public firms when cash flow management and discretionary expenses management models are used. The production cost model results show evidence consistent with public firms only engaging in real earnings management through production cost reduction. Practical implications: The findings of this study should promote a general understanding of firms’ behaviour in unique environment such as GCC countries. Regulators in the GCC region should be aware that real earnings management techniques have been used by firms and that extra caution is required when auditing or analysing the financial information of private and public firms in the GCC market. Originality/value: This paper contributes to the literature in many aspects. First, it provides additional evidence on the use of earnings management in unique market contexts outside the US and Europe. The GCC markets share many common characteristics that make them interesting settings to be investigated. Second, this paper adds more evidence on the use of earnings management between public and private firms. In this regard, the paper adds additional evidence in the discussions proposed by Ball and Shivakumar (2005) and Givoly et al (2010) who use two competing perspectives to investigate earnings quality in public and private firms; the demand hypothesis and the opportunistic behaviour hypothesis.

Introduction

Earnings management, both in the context of manipulation of accruals and real activities, has widely been studied in the literature and most studies use data on US publicly traded firms1 . Cross country studies on earnings management also limited their scope to publicly listed firms (e.g. Leuz, Nanda, and Wysocki, 2003). Private firms, however, constitute a significant share of any economy2 and with the recent availability of data, several studies examined various corporate policies for listed vs. unlisted firms3 . Earnings management for private firms versus public firms has also received scant attention, especially in developing country context. Beatty and Harris (1999) and Beatty, Ke and Petroni (2002) show that U.S. private banks exhibit less evidence for earnings management than U.S. public banks. On the contrary, Burgstahler, Hail and Leuz (2006) show that those results are not generalizable to a broader set of industries and countries. In their sample of private and public non-financial firms in 13 European countries, Burgstahler et al. (2006) find evidence that earnings management is more pervasive in private firms than in public firms. In this study, we investigate the real earnings management (i.e. manipulation of firm operations to achieve a specific goal) in the distinct institutional setting of Gulf Cooperation Council (GCC) countries, where legal enforcement is weak, by using a unique data-set of public and private firms. We find that both private and public firms engage in real earnings management, however, the direction of real earnings management from one model to another appears to be different. For example, using the (CFO) model, the results suggest that while both types of firms manage their earnings down the level is higher for private firms. Using the (DEXP) model, on the other hand, reveals that while both types of firms manage their earnings up, the level is higher for public firms. Furthermore, the results from the (PROD) model show that private firms manage their earnings up while public firms manage their earnings down. The magnitude of earnings management is higher for private firms. To our knowledge, our study is the first one that investigates real earnings management for public and private firms in a developing cross-country context. Our findings complement those of Burgstahler et al. (2006) who find that earnings management is more common in countries with weak legal enforcement and also that private firms exhibit more earnings management compared to public firms. Earnings management refers to the manipulation of earnings (profit) figures by companies to achieve some objective. Accounting earnings is comprised of two components; the cash component and the accrual component. Companies can alter their earnings by manipulating either the accruals component, referred to as accruals management, or by manipulating the cash component, referred to as real earnings management. In this paper, our focus is on the the use of real earnings management in public versus private firms in the GCC countries.