Is there a trade-off between accrual-based and real earnings management? Evidence from equity compensation and market pricing

Abstract

Recent studies indicate a trade-off relation between accrual-based and real earnings management strategies. This paper studies the relation by examining the impact of the equity compensation of chief executive officers (CEOs) on earnings management and the market pricing of the two types of earnings management. Moreover, this study proposes a "withingroup difference" approach for both the explained and explanatory variables to mitigate the over-parameter problem in the conventional fixed effects regression model for panel data.Our empirical results show that CEO equity compensation is positively associated with both accrual-based and real earnings management. Moreover, the reward of the joint effect of accrual-based and real earnings management is positive in terms of stock returns and stronger than a stand-alone strategy. Overall, our results indicate that the relation between accrualbased and real earnings management for firms is complementary rather than a trade-off.

Corporate social responsibility, board gender diversity and real earnings management: The case of Jordan

“…EM is considered as a form of information asymmetry and agency problem between managers and shareholders (Ghaleb et al, 2020). Usually, managers manage earnings to mislead investors using accrual-based EM (AEM) or/and real-based EM (REM) (Cohen et al, 2008;Li, 2019). Researchers argue that managers have recently favoured REM rather than AEM (Chi et al, 2011;Cohen et al, 2008), because it is not subject to the scrutiny of auditors and is thus less costly and less detectable than AEM.…”

How do Indian firms cope with a crisis? - Earnings management characteristics of CNX Nifty 100 companies

“…Dechow et al (2011) and others use the list of SEC enforcement actions to identify a sample of firms engaging in accruals misstatements and try to predict characteristics of misstating firms using F-statistics to get rid of chances of Type I errors in the model. Li (2019), Hsieh et al (2018) and Lewellen and Resutek (2019) again emphasize for our paper the importance of accrual-based earnings management in unravelling corporate governance because of the low persistence of accruals and their direct linkages with managerial incentives and managerial background while Ozili (2018) and Dayanandan and Sra (2018) confirm effective procyclical governance using accrual based earnings management and their obvious value relevance.…”

“…Real Earnings Management becomes more possible with lower discretionary expenses. However, Li (2019) confirms that real and accrual-based earnings management are complementary. Attia, Lassoued and Attia (2016); Ahmed (2015); Safdar and Yan (2016); and Dayanandan and Sra (2018) comment on the accrual-based earnings management in emerging markets and their earnings quality, informativeness and value relevance in a growth environment.…”

“…However, reporting enforcement of real measures that include one-off expenses may be unreliable and we rely on accrual-based earnings measures of earnings management. Recent analyses link earnings management propensity of firms with market returns (Li andHwang, 2019, Dayanandan andSra, 2018).…”

Mediating Effects of Remuneration on Earnings Management and Firm Equity Value

“…This is in line with agency theory where managers are presumed to pursue their personal interest at the expense of shareholders' interest (Jensen & Meckling 1976), among others, through earnings management, which causes discrepancies between a firm's actual financial performance and reported financial performance. Extant literature in the area has established two effective earnings management methods, i.e., AEM and REM, through which managers attempt to bias the firm's financial statements through the use of accruals or real activities, respectively (Li 2019;Alhadab & Clacher 2018;Healy, Serafeim, Srinivasan & Yu 2014;Schipper 1989).…”