Small-sized companies' earnings management: evidence from Italy

Abstract

This study explores the earnings management practices of small-sized Italian companies. Adopting the earnings distribution approach, it finds that these companies are likely to manage their earnings to achieve two earnings level targets. On the one hand, they manage their earnings to report slightly positive earnings. Those with negative earnings manage them upward to be above the zero threshold. Those with positive earnings manage them downward to bring them close to zero. On the other hand, they manage their earnings to minimize earnings changes. The main implication of the findings of this study is that the small-sized Italian companies' earnings are not unconditionally informative regarding their performance. In other words, they are of poor quality. As a result, they should be interpreted with caution by those who use financial statement information. This study mainly enriches the literature on earnings management in two ways. Firstly, it provides evidence on small-sized companies' earnings management practices which are very little explored in literature. Secondly, it provides additional evidence on the earnings management practices undertaken in the Italian setting, and so in countries which are characterized by a code law system and a close alignment between accounting and tax systems.

Do Ownership Structure Characteristics Affect Italian Private Companies’ Propensity to Engage in the Practices of “Earnings Minimization” and “Earnings Change Minimization”?

“…The verification of the statistical significance of the two discontinuities, using the test statistics suggested by Burgstahler and Dichev (1997) and Garrod, Pirkovic, and Valentincic (2006), for which the data is not shown, has revealed that they are statistically significant at a level of 1%. Figure 1 shows that the EM practices are widely popular among Italian private companies, confirming the findings of previous studies (Poli, 2013a(Poli, , 2013b.…”

“…6;2015 204 private companies (e.g. Poli, 2013aPoli, , 2013b, whether and how such practices are influenced by ownership structure characteristics have not yet been investigated. Our study, therefore, fills this knowledge gap.…”

“…Beaver, McNichols, & Nelson, 2007;Dechow, Richardson, & Tuna, 2003;Durtschi & Easton, 2005, 2009Holland, 2004;Lahr, 2014;McNichols, 2003), it has been widely used to detect the presence of earnings management practices (e.g. Baber & Kang, 2002;Beatty, Ke, & Petroni, 2002;Brown & Caylor, 2004;Burgstahler & Dichev, 1997;Collins, Pincus, & Xie, 1999;Coppens & Peek, 2005;Daske, Gebhardt, & McLeay, 2006;Degeorge, Patel, & Zeckhauser, 1999;Easton, 1999;Gore, Pope, & Singh, 2007;Hamdi & Zarai, 2012;Hayn, 1995;Holland & Ramsay, 2003;Jacob & Jorgensen, 2007;Kerstein & Rai, 2007;Marques et al, 2011;Moreira, 2006;Phillips, Pincus, Rego, & Wan, 2004;Poli, 2013aPoli, , 2013bRevsine, Collins, Johnson, & Mittelstaedt, 2009). According to this approach, we assume that a company practices EM if the reported earnings of a fiscal year, scaled to total assets of the previous fiscal year, assumes a value between 0 and 0.005 (0 is included, 0.005 is excluded) and that a company practices ECM if the reported earnings change of a fiscal year (determined as the difference between the reported earnings of a fiscal year and the reported earnings of the previous fiscal year), scaled to total assets of the second previous fiscal year, assumes a value between -0.0025 and 0.0025 (-0.0025 is included, 0.0025 is excluded).…”

“…The frequency distribution of earnings, therefore, displays the typical characteristics of earnings management practices aiming to minimize earnings (e.g. Coppens & Peek, 2005;Marques et al, 2011;Poli, 2013aPoli, , 2013b. The verification of the statistical significance of the two discontinuities, using the test statistics suggested by Burgstahler and Dichev (1997) and Garrod, Pirkovic, and Valentincic (2006), for which the data is not shown, has revealed that they are statistically significant at a level of 1%.…”

The Links between Accounting and Tax Reporting: The Case of Bad Debt Expense in the Italian Context

“…In other words, they may be of poor quality, confirming the findings of previous studies (e.g., Poli, 2012Poli, , 2013aPoli, , 2013bPoli, , 2013c. As a result, they should be interpreted with caution by those who use financial statement information.…”