Earnings management has been a well-researched topic in the
US as well as in other countries. This article puts together
some of the research findings that have emerged out of various
studies on the subject in different countries. It helps
us to understand the key drivers of earnings management
in countries where businesses have developed in vastly different
environments.
Earnings management pervades reporting horizons across
the globe. It taints reported earnings in various countries,
undermining investor's rights to quality information and
shaking the basis of creditor decisions. The extent to which
earnings management prevails depends upon factors like predominance
of corporate governance, relationship between reported earnings
and remuneration to corporate honchos and the level of investor
sophistication.
Earnings management behavior is studied by analyzing variables
like income accruals. Income accruals refer to the difference
between the reported income and the income on the basis
of cash flows. Researchers suggest that a change in the
pattern of accruals in the period under study as compared
to the pattern of accruals in the past reveals the presence
of earnings management.
Iqbal, Espenlaub and Strong have studied the motivations
of firms in the UK to go in for earnings management before
their rights issues. In their paper entitled "An Analysis
of the Motivation for Earnings Management around UK Rights
Issues", they study earnings management initiatives
taken up by management for income increasing or cost decreasing
accruals when they want to prop up share prices, and therefore,
make their rights issues successful.
Equity issues in the US markets are generally public issues,
whereas in the UK, rights issues are a popular form of raising
seasoned equity. Some interesting observations arise from
the study, the most important among which are summarized
here. Firms with a high debt-equity ratio are more likely
to manipulate earnings in order to reduce the cost of debt
covenant violation.
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