Earnings Management: The Effect of Accounting Flexibility on R&amp;D Investment Choices

Wang, Sean; D'Souza, Julia

doi:10.2139/ssrn.878345

Cited by 42 publications

(32 citation statements)

References 25 publications

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“…Like a number of studies ΔRD t-1 is the difference between ln(R&D t-1 ) and ln(R&D t-2 ), ΔSALES 1 is the difference between ln(Sales t ) and ln(Sales t-1 ) and ΔCapX is the difference between ln(CapX t ) and ln(CapX t-1 ) (Wang and D'Souza, 2006 ;Osma, 2008 ;Osma and Young, 2009;Zhang and He, 2013). It is expected that firms with high change in investment are more likely to cut R&D and firms with high growth and those with high maturity are less likely to cut R&D. it + ε it (1) Where: RD-CUT: a dummy variable equal to one if R&D spending is lower than previous period spending, zero otherwise; Zero-Press: a dummy variable equal to one if last period's earnings were less than or equal to zero, zero otherwise; Growth-Press: a dummy variable equal to one if period's earnings change is less than or equal to zero, zero otherwise; BDIND: the fraction of independent directors sitting on a board; RDI: the total investment in R&D undertaken by the firm divided by total sales; LEV: total debt divided by total assets; Log Asset: logarithm of the total assets of the firm; MKTB: the market value of equity divided by the book value (Tobin Q); RDI : ln(R&D t-1 ) -ln(R&D t-2 ); Sales : ln (Sales t ) -ln (Sales t-1 ); CapX : ln (CapX t ) -ln (CapX t-1 ).…”

Section: Firm Sizementioning

confidence: 99%

R D expenditures and earnings targets: evidence from France

Guidara¹

2015

Pressacademia

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Research and development (R&D) investments reduce current-period earnings while the benefits associated with the investments occur in the future. This problem implies an earnings management tool to boost short-term performance. While there is much evidence regarding managerial discretion through R&D capitalization, empirical studies that directly examine managerial discretion through R&D expenditure adjusting have not been widely provided in the European context. This paper seeks to determine if earnings targets influence R&D investment by encouraging R&D cuts after IFRS adoption. Focusing on a French setting, where companies invest heavily in R&D, results show that managers tend to cut the R&D expenditures in order to achieve earnings target. Studying two earnings management incentives: avoidance of losses (positive earnings target) and earnings decreases (positive earning growths target), findings support thresholds assumption and provide evidence on real earnings management through R&D expensing. This empirical research contributes to the literature by providing further evidence that post-FRS, R&D cut is a strategic decision influenced by earnings management to boost performance.

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Section: Firm Sizementioning

confidence: 99%

R D expenditures and earnings targets: evidence from France

Guidara¹

2015

Pressacademia

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“…Prior studies use NOA as a proxy for constraints on accruals manipulation in their empirical analysis. Specifically, Wang and D'Souza (2006) find that firms with high NOA are more likely to cut R&D expenditures to avoid earnings decrease. Hirshleifer, Hou, Teoh, and Zhang (2004) suggest that net operating assets represent the difference between cumulative net operating income (accounting value-added) and cumulative free cash flow (cash value-added) and measure the extent to which past earnings have been over-optimistic compared to the underlying operations.…”

Section: Notesmentioning

confidence: 94%

“…Barton and Simko (2002) show that there are limits to the extent firms could inflate accruals and firms with high level of constraints on accruals management are less likely to manage earnings by accruals. Wang and D'Souza (2006) document that firms with low accounting flexibility are more likely to cut R&D expenditures. Cohen, Dey, and Lys (2008) find that firms are more likely to manage earnings by manipulating real business activities rather than accruals in the post-Sarbanes Oxley era, possibly due to the heightened regulatory scrutiny on financial reporting.…”

Section: Introductionmentioning

confidence: 99%

Effect of Accounting Flexibility on Earnings Management through Stock Repurchases

Yang²

2013

IBR

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Prior research (Taylor & Xu, 2012) finds that firms that attempt to increase EPS to meet analyst forecasts through stock repurchases give up the opportunity to time their buybacks to benefit from temporary undervaluation of their stock as is the case for firms that repurchase stock for other purposes. The current study explores a possible explanation for the costly behavior by investigating whether firms with constraints in their ability to inflate accruals are more likely to use stock repurchases as a means to manage earnings. The research question is tested using a logit regression model with quarterly data from 1992 to 2009, controlling for various previously documented factors that affect stock repurchases and/or earnings management. The empirical test results are consistent with the hypothesis that firms with lower accounting flexibility are more likely to manage earnings through stock repurchases. The study contributes to the earnings management literature by documenting the substitution effect of alternative means of earnings management.

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“…These costs are important to consider because firms will only be tempted to manage earnings if the cost of managing earnings is less than the cost of violating debt covenants. Managing earnings may have a variety of costly consequences, including sacrificing real economic value for accounting earnings (Graham, Harvey, and Rajgopal, 2005;Roychowdhury, 2006;Wang and D'Souza, 2006), increasing regulatory scrutiny (Dechow et al, 1996;Liu and Ryan, 2006), increasing the likelihood of accounting restatements (Palmrose et al, 2004), and increasing the likelihood of shareholder litigation (Bonner et al, 1998;Skinner, 1997 …”

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confidence: 99%

The Cost of Private Debt Covenant Violation

Dyreng

2009

SSRN Journal

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This study quantifies costs that firms are willing to incur to avoid violation of private debt covenants. The results indicate that as firms approach covenant violation they engage in incomeincreasing earnings management, which increases their tax liability. By estimating the extent of income-increasing activities and the additional tax costs incurred, this study arrives at a lowerbound estimate of the cost of violating private debt covenants. The mean (median) firm with relatively tight debt covenants increases its current tax liability by an amount equivalent to increasing the cost of debt financing by between 12.92 (10.72) and 22.72 (12.81) basis points (where firms with relatively loose debt covenants serve as the baseline). The magnitude of this estimate indicates that the expected costs of covenant violation are meaningful. Combined with recent evidence that private debt covenant violations occur frequently (Dichev and Skinner, 2002;Roberts and Sufi, 2007a), this implies debt covenants and expected violations are economically important.I appreciate the helpful comments of my dissertation committee:

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Earnings Management: The Effect of Accounting Flexibility on R&D Investment Choices

Cited by 42 publications

References 25 publications

R D expenditures and earnings targets: evidence from France

R D expenditures and earnings targets: evidence from France

Effect of Accounting Flexibility on Earnings Management through Stock Repurchases

The Cost of Private Debt Covenant Violation

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