Real earnings management and loan contract terms

Abstract

We examine the design of loan contract terms in the presence of borrower preissuance real earnings management (REM). Unlike other measures of earnings quality, REM is particularly difficult for outsiders to detect. However, lenders possess some private information which may allow them to correctly identify REM. Our empirical findings show that greater REM is associated with higher interest spreads, shorter maturities, a higher likelihood of imposing collateral requirements, and more intensive financial covenants, suggesting that lenders are likely to detect and penalise the borrower firm's REM activities.These findings are robust to a series of sensitivity tests. In an additional test, we examine the impact of REM on bond terms and document that greater REM is related to higher bond yield spreads and more intensive covenants, but does not affect the maturity term or the collateral requirement. The findings in this paper can alert firms about the increase in borrowing costs when they use REM to boost current-period earnings.

Is there any association between real earnings management and crash risk of stock price during uncertainty? An evidence from family-owned firms in an emerging economy

“…LEV has a negative and significant impact showing that higher the leverage higher the chances of the spillover effect of the stock price crash. Moreover, ROA has a positive and significant impact revealing that a more profitable firm is, lesser is the chance of the crash risk [21,48,49]. Overall, the statistical results in Table 3 reinforce H2.…”

Board Structure of Corporate Organizations and Earnings Management: Does Size and Independence of Corporate Boards Matter for Nigerian Firms?

“…As observed, in a bid to accomplish specific targets through the management of reported earnings, some managers avoid or under report losses and in some other cases, the operating policies of the companies are changed to obtain short-term targets at the expense of the companies' interests (Al Saedi, 2018;Chan, Li & Lin, 2019;Pappas, Walsh & Xu, 2019). This is why Obigbemi et al (2016), described earnings management as managements' deliberate effort, targeted at obtaining a desired amount of earnings through several possible means.…”

Earnings Management. An overview of the relative literature

“…Prior studies (Anagnostopoulou, 2017;Bharath, Sunder & Sunder, 2008;Grahan, Li, and Qiu, 2008) indicate that banks can detect the accrual earnings management and financial statements quality and incorporate the associated risk in the terms and pricing of loan contracts. Pappas et al (2019) investigated that, rather than the difficulty in detecting real earrings management, banks have the mechanisms to recognize the existence of manipulation of real activities. Consequently, this has an impact on interest spreads, maturity, and the requirement of collaterals.…”

“…In essence, this fact can be interpreted that firms with higher levels of debt combine the two earnings management methods. Pappas et al (2019) investigated the impact of real earnings management on the loan contract terms such as interest rate, the loan's maturity, the collateral requirements, and the number of financial covenants required by a loan contract. The results point out that real earnings management proxies are significantly positively related to interest rate, financial covenant intensity, and the likelihood of collaterals and significantly negatively with maturity.…”