An alternative approach to detect earnings management to meet or beat benchmarks

Abstract

PurposeThe authors propose an alternative robust technique to test for discontinuities in distributions and provide consistent evidence of discontinuities around zero for both scaled and unscaled earnings levels and changes. The advantage of the proposed test is that it does not rely on arbitrary choice of bin width choices.Design/methodology/approachTo evaluate the power of the test, the authors examine the density function of non-discretionary earnings and detect no evidence of discontinuities around zero in levels and changes of these non-discretionary earnings. As robustness, the authors use pre-managed earnings excluding accrual and real manipulation and find similar evidence.FindingsThe finding using our technique support the Burgstahler and Dichev (1997) interpretation on earnings management, even for smaller sample sizes and reject the theory that discontinuities arise from scaling and sampling methods.Originality/valueThe study provides an overview of those studies that support and those that oppose using “testing for discontinuities” as a way to examine earnings management. The authors advance the literature by providing an alternative methodology supporting the view that the kink in the distribution represents earnings management.

إستخدام هيكل الملكية الإدارية في تفسير العلاقة بين خصائص مجلس الإدارة وإدارة الأرباح الحقيقية: دليل من الشركات السعودية(باللغة الانجليزية)

“…Company managers can affect the earnings figure that is reported by influencing the method of accounting treatment of the economic activities carried out by the company, or how these are presented in the financial statements, or by influencing those activities themselves. Therefore, the attempt to influence earnings can be made through two approaches: (1) the accounting approach, which relies on accounting decisions to influence the earnings figure through various accounting means, the most important of which are discretionary accruals and judgemental estimates, discretionary accounting changes, and accounting disclosure management; and (2) the real approach, which is based on the real decisions taken by the management in the course of conducting the company's affairs with the aim of influencing the earnings figure (Degiannakis et al, 2023). Degiannakis et al (2023) explain the implications of the real approach to earnings management in terms of reliance on this method having a negative impact on the company itself, on the characteristics of the earnings that are reported, on the cost of funds obtained by the company to finance its operations, or on the value of its shares in the future.…”

“…Therefore, the attempt to influence earnings can be made through two approaches: (1) the accounting approach, which relies on accounting decisions to influence the earnings figure through various accounting means, the most important of which are discretionary accruals and judgemental estimates, discretionary accounting changes, and accounting disclosure management; and (2) the real approach, which is based on the real decisions taken by the management in the course of conducting the company's affairs with the aim of influencing the earnings figure (Degiannakis et al, 2023). Degiannakis et al (2023) explain the implications of the real approach to earnings management in terms of reliance on this method having a negative impact on the company itself, on the characteristics of the earnings that are reported, on the cost of funds obtained by the company to finance its operations, or on the value of its shares in the future. The main reason for these negative effects is that the activities that the management rely on to influence the earnings under this approach represent a departure by the management from the best decisions that should have been taken under the normal course of the activity; it is then expected that they will affect the profit for the current period or over subsequent or future periods.…”