Earnings Management through Affiliated Transactions

Abstract

Prior research has investigated earnings management primarily through the use of discretionary accruals. We examine whether, in addition to discretionary accruals, firms further engage in earnings management using transactions with affiliated companies. When a parent company has a dominant relation over affiliated companies, the parent company can structure transactions between itself and affiliates in a way that allows it to achieve income-reporting objectives beyond the use of discretionary accruals. We address this research issue in Japan because Japanese firms issue both parent and consolidated financial statements. In addition to earnings management techniques that can be used to manage consolidated earnings, parent earnings can also be managed using transactions with affiliates. We find earnings management behavior for both parent and consolidated earnings around three earnings thresholds: avoiding losses, avoiding earnings declines, and avoiding negative forecast errors. Consistent with additional earnings management through affiliated transactions, parent earnings show stronger evidence of earnings management than consolidated earnings at each of these three earnings thresholds. Further tests indicate that the increased management of parent earnings around these three earnings thresholds is related to the firm's ability to use affiliated transactions, while the management of consolidated earnings is unrelated to the firm's ability to use affiliated transactions.

The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior

“…For example, Altamuro et al (2005) studied accelerated revenue recognition practices. Thomas et al (2004) found evidence of earnings management using transactions with affiliated companies. DeFond and Park's (1997) study results suggested that managers use earnings management to smooth earnings to increase job security.…”

The Effect of Corporate Social Responsibility on Financial Performance with Real Manipulation as a Moderating Variable

“…Real earnings management can be done with a variety of real activities, such as the use of affiliate transactions (Thomas et al, 2004), by cutting the cost of research and development, advertising and maintenance, as well as delaying the start of new projects (Graham et al, 2005), Instrumental stakeholder theory (Donaldson and Preston, 1995) (Aupperle, Carroll and Hatfield, 1985). Finally, managers can behave opportunistic against financial losses, following the practice of defense (Jones, 1995) with the aim to satisfy stakeholders as explained Research results by Abdolmohammadi et al (2010) showed that a family of private companies (Dechow et al, 1996).…”

R&D Investment, Governance and Management Entrenchment in French Companies Listed in SBF250

“…The managers can, particularly, make special transfer of resources serving their own needs (Jian andWong, 2003 andThomas et al, 2004). They manage to divert the firm resources to specific projects offering them more independence on the share-Volume 1 Number 2 July 2011 holders and other external controllers using internal transfers of capital between parent companies and their subsidiaries and/or between the subsidiaries themselves (Chang, 2003;Friedman et al, 2003;Liu and Lu, 2004).…”

“…Its presence reinforces the managers' opportunism and decreases the shareholders gain. Accordingly, the transfer of resources to the subsidiary with high R&D, through the ICM is considered as induced by the objective of maximization of the managers' wealth at the expense of the shareholders (Jian and Wong, 2003;Liu and Lu, 2004;Thomas, Herrmann and Inoue, 2004;Chang, 2003;Friedman, Johnson and Mitton, 2003).…”