Earnings Management Induced by Cognitive Reference Points

Abstract

Previous studies (Carslaw, 1988;Thomas, 1989;Niskanen & Keloharju, 2000) have shown that companies' managers tend to round-up the ®rst digits of reported earnings (i.e. for companies reporting pro®ts). According to Carslaw (1988), this type of behaviour is inspired by the existence of the so-called`$1Á99' phenomenon where a price of $1Á99 is perceived as being abnormally lower than one of $2Á00. In the current study, we try to determine whether managers of UK-listed companies also engage in this type of`earnings rounding-up behaviour'. Analogous to the earlier studies, our study compares observed and expected frequencies for the second-from-the-left digit in reported earnings. Our results suggest that managers of UK-listed companies tend to round-up reported pre-tax income, in a way that increases the ®rst digit by one, when they are faced with a nine in the second-from-the-left position for this particular earnings measure. The major contribution of the current study is that it introduces discretionary accruals in this line of research. Discretionary accruals were estimated using both the Jones model (1991) and the modi®ed Jones model as proposed by Dechow et al. (1995). Our results clearly suggest that discretionary accruals are used in order to round-up reported earnings ®gures. Moreover, discretionary accruals enabled us to increase the power of the tests used in previous studies.

Statistical detection of fraud in the reporting of Croatian public companies

“…Newcomb (1881) and later Benford (1938) noted that in a sufficiently large collection of numerical data expressed in a decimal form, the distribution of occurrences of first digits is not uniform (we explain Benford's distribution in more detail in section 2). Many authors, including Carslaw (1988), Guan et al (2006), Kinnunen and Koskela (2003), Nigrini (2005), Niskanen and Keloharju (2000), Skousen et al (2004), Thomas (1989) and Van Caneghem (2002, 2004 investigated the applicability of this fact in accounting and auditing, and specifically in the detection of "cosmetic earning management". It has been shown that the distribution of first digits in financial reports normally complies with Benford's law.…”

Creative accounting: To be or not to be?

“…Their study and others (e.g. van Caneghem, 2002) have indicated that some minor massaging of figures does take place in order to reach significant reference points.…”

Applying Benford’s Law to Examine the Quality of Reported Income Numbers of Unlisted Firms

“…Later on, Thomas (1989) confirms the existence of rounding up behaviour of listed companies in United States of America (USA). Subsequently, other studies like Shette and Kuntluru (2014) in India, Skousen et al (2004) in Japan, Niskanen aand Kelhoharju (2000) in Finland, Kinnunen and Koskela (2003) across eighteen different countries, Caneghem (2002) and Caneghem (2004) in United Kingdom find rounding up behavior in the reported income of listed companies. However, no study till date has focused on examining the quality of reported incomes of unlisted companies based on Benford"s Law.…”