The impact of earnings management on the value relevance of earnings

Abstract

Purpose This paper aims to examine the association between earnings management and the value relevance of earnings (the latter is operationalized by earnings response coefficient). Specifically, this study examines whether opportunistic earnings management has a negative impact on the value relevance of earnings for a sample of firms listed on the Egyptian Stock Exchange. Design/methodology/approach Different from prior work and due to data limitations in the Egyptian market, this paper first examines for the existence of earnings management based on the whole operating performances of the firms by testing whether firms with low/poor operating performance are more likely to choose income-increasing actions (strategies) than firms with high operating performance. After confirming that low operating performance firms manage earnings upward, the authors then assess whether this opportunistic earnings management by these low operating performance firms reduces the value relevance of earnings. This is performed by estimating a model of the relationship between stock returns and accounting earnings with a dummy variable that allows parameter shifts for earnings of low operating performance firms. Findings The results show that discretionary accruals are positive and significantly higher for firms with low operating performance than those for firms with high operating performance. These results indicate that low operating performance firms increase the earnings management practices by probably increasing their reported earnings opportunistically to mask their low performance. Furthermore, the results show that the earnings response coefficient is significantly smaller for earnings of low operating performance firms than that for earnings of high operating performance firms. These results suggest that earnings of firms with low operating performance (that are engaged in opportunistic earnings management strategies) have less value relevance than earnings of firms with high operating performance, i.e. the informativeness of managed earnings is lower than that of non-managed earnings. Practical implications Based on these results, it is plausible that the presence of opportunistic earnings management adversely affects the value relevance of accounting earnings. Originality/value Consistent with previous results from developed countries, this study shows that earnings management is a significant factor that affects value relevance of earnings in Egypt.

The Impact of Earnings Management on the Value Relevance of Earnings: Empirical Evidence From Turkey

“…According to these results, there is no difference in value relevance in market adjusted returns and earnings management practices of Turkish listed manufacturing companies with respect to their operating performance. In other words, there is no difference between high and low performance companies' market adjusted returns, which is different from the findings of Mostafa (2017).…”

“…Panel data regression analysis results show that the change in earnings and earnings have significant effect on market adjusted returns. Additionally, because the total of the two coefficient is greater than zero ( ), there is significantly positive relation between earnings and market adjusted returns, which is consistent with the findings of Mostafa (2017). In other words, there is significant and positive value relevance between the earnings and market adjusted returns of the Turkish listed manufacturing companies.…”

“…For this purpose, first the total accruals are calculated for every year. The total accruals are defined as below (Mostafa, 2017); Total accruals (TA) are consisted of non-discretionary (NDA) and discretionary accruals (DA). For calculating discretionary accruals, Modified Jones Model (1991) is used.…”

“…For completeness, we first examined value relevance of earnings for the whole sample, and then investigated the impact of earnings management on value relevance of earnings. Model 1 is used to determine the relation between annual stock returns and the level and change of earnings as previous research such as Easton and Harris, 1991;Strong, 1993;Lev and Zarowin, 1999;Francis and Schipper, 1999;Hellström, 2006;Ragab and Omran, 2006;Filip and Raffournier, 2010;Mostafa, 2017.…”

Debt covenant slack, earnings management, and value relevance of accounting information

“…Thus, the information which is contained manipulation becomes less relevant, thereby reducing the explanatory power of such information in explaining the stock price (Whelan & McNamara, 2004). Empirical studies conducted by Habib (2004); Rahman (2009); Shan (2014); and Mostafa (2017), confirm the evidence presented in Whelan & McNamara (2004), by providing empirical evidence that earnings management has a negative effect on the value relevance of earnings and book value. Based on the description, this research, therefore, predicts that the more likely the firms' manager manage their earnings opportunistically, the less the value of adjusted R 2 obtained from the regression of earnings and book value on the firms' share price.…”