Three Essays on the Dynamics of Earning Management

Abstract

This dissertation investigates financial and non-financial firms’ earnings management (EM) practices. It aims to shed light on firms’ EM practices by emphasising the consequences and incentives of EM. The dissertation is based on three complementary studies.
The first study focuses on the EM activities of non-financial firms. We propose a mechanism to estimate a relatively noise-free impact of earnings management on firms’ subsequent stock performance. Taking the United States as our empirical context and
covering two decades of data (1990-2016), we find a negative association between firms’ subsequent stock performance and aggressive earnings management. Our findings further suggest that investors react differently towards different approaches of earnings management, therefore, price correction occurs at different future periods for earnings manipulators. Additionally, when examining the effectiveness of the impacts, we find that investors and regulators who use accrual-based earning management (AEM) and real activities earnings management (REM) indicators individually to detect firms’ earnings management behaviour can be misled. Therefore, we propose an approach that combines AEM and REM, respectively, with the M-Scores to better capture aggressive earnings manipulators. This study has implications for investors and regulators with regards to detecting and eliminating firms’ artificial earnings management activities.

The second study focuses on the EM practices of commercial banks whereupon we generate a new indicator based on EM named accounting managerial behaviour (AMB). The study examines whether accounting managerial behaviour is associated with future
bank performance. In this paper, accounting managerial behaviour is defined as the interaction of earnings management and bank efficiency (or managerial ability) matrix. Based on a sample of 589 commercial banks from the United States (U.S.) over a period of
two decades (1998-2017), we show that banks with superior accounting managerial behaviour outperform their peers, whilst banks with poor accounting managerial behaviour underperform their peers in the near future. Our evidence suggests that banks short-term decisions, resource utilization and internal attributes could affect their long-term performance. We further find that the size effect on future bank performance can be dominated by banks’ accounting managerial behaviour, highlighting the importance of
accounting managerial behaviour in commercial banking studies.The third study is an event-based EM research. This study investigates the impact of TARP on commercial banks and bank holding companies’ earnings management practices, pure
bank efficiency and manager-driven bank efficiency. Based on a sample of 598 banks across the period 2005 to 2013, we show that TARP did not affect banks’ earnings management behaviour, neither their pure bank efficiency nor manager-driven bank
efficiency in the long term. Further, we find that commercial banks and bank holding companies that received a larger amount of TARP funds had better bank efficiency following capital infusions. Our evidence also suggests that the TARP amount mainly
affected recipients’ pure efficiency, not the one driven by the ability of managers. Our evidence from this study suggests that TARP rescued banks from distress but did not fundamentally change the performance of its recipients compared to their counterparts,
which implies that TARP is an effective temporary rescue project.

Overall, this dissertation contributes methodologically to EM detection literature, and contributes empirically to the literature of EM incentives and consequences.

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Identifiers

ORCID for Xiao Zhang: orcid.org/0000-0002-7753-5615

ORCID for Surendranath Jory: orcid.org/0000-0002-8265-0001

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