Corporate Ownership and Control | 2019
Impact of excess cash on earnings management and firm value: Evidence from China
Abstract
Cash holdings and determination of optimum cash policy is one of the most challenging problems in finance (Myer, 1996). Holding optimal cash enables the firms to meet various activities associated with production and operations and thereby reduce the risk of financing. Excess cash can reduce the rate of return on investment and lead to the self-interest behavior of controlling shareholders. The association between excess cash and earnings management is an exciting and vital aspect in determining the success of firms. Managers engage in earnings management to manipulate the financial statements and show a rosy picture (Healy et al., 1995; Burgstahler & Dichev, 1997; Chen et al., 2011; Duong & Pescetto, 2019; Hill et al., 2019). Earnings management occurs when managers manipulate the company s earnings either to mislead stakeholders or to influence contractual outcomes. Often earnings management could be misleading the stakeholders, which is an important issue for both practitioners and academicians. Managers generally indulge in earnings management through three techniques. The first is the accrual-based method, where managers manipulate the earnings by using the difference between net income and cash flows. The second is real activities earnings management, where managers use cash flow statements to make operating decisions to arrive at the desired financial results. The third is classification shifting, by which expenses are shifted to the income statement as unique items to increase earnings. Earnings management is not a criminal activity, but often, it is considered as an opportunistic behaviour of managers. Prior studies focus on the impact of earnings management on compensation contracts (Healy, 1985; Watts & Zimmerman, 1986; Jones, 1991), government regulatory considerations (Dechow, Sloan, & Sweeney, 1995), corporate Abstract