Pass-Through Business Entity Choice and Earnings Management: Evidence From Uk Real Estate Investment Trust Conversion

Abstract

This empirical study innovatively investigates how the choice of a pass-through business entity and corresponding regulatory regime influence firms’ earnings management (EM) behaviors by testing on the UK Real Estate Investment Trust (REIT) conversion. A substantial proportion of UK non-REIT publicly traded property companies (LPCs) have chosen to become REITs since the UK REITs were launched in 2007. We conduct a series of tests on a database containing UK LPCs and REITs from 2000 to 2019 and find that conversion into pass-through business entity regimes like REITs that enjoy more favorable tax treatment but face more restrictions leads to more accrual earnings management (AEM) activity, but less real earnings management (REM) activity.

Earnings management in European real estate firms during crisis periods

“…Further studies on earnings management in real estate firms could investigate whether firms engage more strongly in real activities manipulation than in accrual accounting. While Anglin et al (2013) discovered this to be the case among REITs, both Deng and Ong (2018) and Liang et al (2022)…”

“…While Anglin et al. (2013) discovered this to be the case among REITs, both Deng and Ong (2018) and Liang et al. (2022) found that REITs tend to engage in more real earnings management instead of accrual earnings management.…”

“…Thai and Lai (2019) found that earnings management through discretionary accruals was prevalent in Asian REITs, particularly in Malaysia, Singapore, and Hong Kong. Liang et al (2022) found that UK REITs engaged in more accrual-based earnings management but less real earnings management than non-REIT listed property companies. The conversion to REITs resulted in more accrualbased earnings management and less real earnings management, indicating that the restrictive REIT regulatory regime limits the room for REITs to engage in real earnings management and forces them to adopt more accrual-based earnings management.…”

“…Thai and Lai (2019) found that earnings management through discretionary accruals was prevalent in Asian REITs, particularly in Malaysia, Singapore, and Hong Kong. Liang et al. (2022) found that UK REITs engaged in more accrual-based earnings management but less real earnings management than non-REIT listed property companies.…”