Is Earnings Information Superior to Net Income as a Measure of Future Earnings? A Study on Accruals and Real Earnings Management

Abstract

This study examines the incremental information content of components of earnings by regressing future net income of earnings' components in a series of multivariate models. We find that the components of operating cash flow and accruals provide more information to effectively predict future profitability, particularly when we dismantles financial measurements into various combinations of operating cash flow and accrual-based components. However, the components of real earnings management provide less information of future profitability. We observe that the more informative the information content of earnings is, the more precise the prediction of future profitability can be.

Financial Statements Timeliness and Real Earnings Management in the Egyptian Context

“…There were no serious multicollinearity issues among the independent variables, as all VIF values are below 10, and the tolerance values are greater than 0.1 (Field, 2009). Both regression models are statistically significant at the 1 per cent level with an adjusted R2 of 18.9 per cent for Model 1.A and 17.6 per cent for Another explanation for the association between REM and total FST is the difficulty auditors may have in discovering REM activities (Zang, 2012;Enomoto et al, 2013;Lee and Lu, 2015). REM is activities performed by management during the year through the normal course of operations, and their impact on the direction of earnings is difficult to discover.…”

“…Earnings represent one of the most crucial indicators of firm performance for readers of financial statements, because they include information related to the managerial capabilities and determine the contribution of management to firm profits. Due to the informative characteristics of earnings, many executives are encouraged to engage in earnings management (Lee and Lu, 2015).…”

“…Prior studies have heavily emphasized accrual-based earnings management. However, these studies neglected how managers can also achieve certain earnings targets by manipulating real activities (Lee and Lu, 2015). In this regard, (Doukakis, 2015) reveals that while there are extensive studies examine the effects of IFRS adoption on accrual -based earning management, few studies investigate these effects on REM.…”

“…Auditors and regulators are more unlikely to detect and restrain real manipulation activities (Enomoto et al, 2013;Lee and Lu, 2015).…”

“…The lower production costs per unit improves the operating margins, and thus increases net income, as long as the reduction in fixed costs per unit due to overproduction is not offset by any increase in the marginal cost per unit (Gunny, 2010). Therefore, managers tend to lower the cost of goods sold through overproduction to boost earnings (Lee and Lu, 2015).…”