Earnings management prior to private debt issuance

Abstract

Purpose The purpose of this paper is to evaluate the extent to which firms manage earnings prior to private debt issuance. Design/methodology/approach This is an empirical archival research paper using financial statement data and data related to private debt issuance. Findings The results indicate that, on average, firms engage in income-increasing earnings management in the period prior to a new private debt issuance. In addition, it was found that this income-increasing earnings management is limited to firms which have engaged in income-increasing earnings management to a greater extent in prior years. Research limitations/implications This paper provides insight into how managers’ balance competing incentives to use income-increasing earnings management to obtain more favorable lending terms, and to use income-decreasing earnings management to reduce the risk of a future debt covenant violation. The results indicate that firms’ incentive to use income-increasing earnings management dominates. However, reputational concerns significantly constrain firms’ earnings management decisions prior to private debt issuance. Originality/value The paper fills a notable void in the literature by investigating firms’ earnings management activity prior to private lending agreements, and thereby provides new insights into both the relation between private debt and accounting quality, and the literature investigating the use of earnings management to avoid debt covenant violations.

Earnings management through financing activities: Evidence from early debt extinguishments

“…Since Burgstahler and Dichev (1997) and Degeorge et al. (1999) identify three behavioral earnings benchmarks—avoid losses, avoid earnings declines and avoid missing analysts’ forecasts, a large volume of prior research provides substantial evidence that firms use accounting discretion to achieve earnings benchmarks (An et al., 2014; Ater & Hansen, 2020; Barua et al., 2010; Burgstahler & Eames, 2006; Cazier et al., 2015; Cohen et al., 2011; Fan et al., 2010; Lee, 2014; Matsumoto, 2002; McVay, 2006; Moehrle, 2002; Nagar & Sen, 2017).…”

“…Since Burgstahler and Dichev (1997) and Degeorge et al (1999) identify three behavioral earnings benchmarks-avoid losses, avoid earnings declines and avoid missing analysts' forecasts, a large volume of prior research provides substantial evidence that firms use accounting discretion to achieve earnings benchmarks Ater & Hansen, 2020;Barua et al, 2010;Burgstahler & Eames, 2006;Cazier et al, 2015;Cohen et al, 2011;Fan et al, 2010;Lee, 2014;Matsumoto, 2002;McVay, 2006;Moehrle, 2002;Nagar & Sen, 2017). Moreover, prior studies also provide substantial evidence of real activity management to achieve earnings benchmarks, mainly focusing on operating activities (Baber et al 1991;Bushee, 1998;Dechow & Sloan, 1991;Roychowdhury, 2006), and investing activities (Barth et al, 1990;Bartov, 1993;Beatty et al, 1995;Beatty & Harris, 1999;Collins et al, 1995;Dechow & Shakespeare, 2009;Jordan et al, 1998;Lifschutz, 2002;Scholes et al, 1990).…”

Creative Accounting as an Apparatus for Reporting Profits in Agribusiness

“…Al-Okaily et al (2020) find that earnings management is not significant in family businesses, while also investigating the higher predisposition for earnings management in enterprises with a financial connection. Ater and Hansen (2020) assess the range of business earnings manipulation strategies prior to private debt issuance. El Diri et al (2020) detect the discrepancies among markets of high and low concentration in applying accrual and real earnings management.…”

Analyzing earnings management preferences from business strategies

“…Previous studies have found various conditions that cause companies to undertake EM more intensively. Among them is the need for external funds (Zhang et al , 2020; Ater and Hansen, 2020; Alhadab, 2018; Liu et al , 2010). Ater and Hansen (2020) and Liu et al (2010) found that listed companies increase reported earnings ahead of debt issuance.…”

“…Among them is the need for external funds (Zhang et al , 2020; Ater and Hansen, 2020; Alhadab, 2018; Liu et al , 2010). Ater and Hansen (2020) and Liu et al (2010) found that listed companies increase reported earnings ahead of debt issuance. Alhadab (2018) proved that companies conduct EM around the initial public offering of equity.…”