Bruno Maria Franceschetti

Earnings Management: Origins

This chapter seeks to describe the field of inquiry by defining the concepts of earnings quality, earnings management, fraud, and earnings manipulation. It presents the earnings management phenomenon, specifically, from whence it comes. It reviews the mainstream studies, and focuses on two types of earnings management: accruals earnings management and real activities earnings management. In addition, studies related to fraudulent financial reporting (or non-generally accepted accounting principles, i.e. non-GAAP earnings management) will be presented and discussed as well. Furthermore, this chapter presents studies on managerial incentives for earnings management. The most important incentives (or causes) for managing earnings are discussed and the contradictory results provided by some of them highlighted. Finally, a few offsetting causes that may interfere with these main incentives for managing earnings are presented.

Financial Crisis as a Major Cause of Earnings Management: Theoretical Background and Literature Review

This chapter approaches the question of the relationship between financial crisis and earnings management. It presents a review of studies that identified financial crisis as a major cause of earnings management. Previous research on the impact of financial crisis on managers’ earnings management behavior has yielded ambiguous results, depicting different scenarios depending on the choice of firm context/type, and on the start date of the financial crisis. The results show that there is a lack of consensus on the direction and magnitude of earnings management in times of recession. Results of the performed literature review will be operationalized into a hypothesis presented in the following Chap. 5. Therefore, this chapter is essentially propaedeutic to Chap. 5.

A Critical Realist Perspective on Earnings Management

Prior studies have provided little evidence of earnings management activities although research designs have included the widespread use of strong incentives to manage earnings; i.e., a widespread approach in the earnings management literature is to first identify conditions in which managers’ incentives to manage earnings are likely to be strong, and then test whether patterns of earnings management are observable. Furthermore, the evidence provided by prior studies is often conflicted on what motivates managers to manage earnings. This chapter shifts away from the contradictory conclusions drawn on the causes of earnings management presented by prior positivist research (discussed in Chap. 2). It introduces critical realism as an alternative to the positivist philosophical perspective to investigate the earnings management phenomenon. Finally, it provides a critical realist evaluation of mainstream earnings management literature and related incentives (or identified causes) that have been proposed by prior studies for managing earnings.

Does Financial Crisis Cause Earnings Management

Previous research on how financial crisis affects managers’ earnings management behavior has resulted in different scenarios with inconclusive results. This Chapter presents both the positivist and the critical realist approach to the research question. To address the ambiguity in the findings in the literature, the present study used a mainstream approach, with the results showing no statistical support for the hypothesis that financial crisis influences earnings management. More specifically, results indicate that managers’ earnings behavior does not differ from the pre-crisis to the crisis periods. Further, it presents critical realism as an alternative to mainstream approach. The study argues against the existence of a causal law based on a constant conjunction model (i.e., whenever a financial crisis happens, earnings management happens) and concludes that financial crisis cannot be seen as the cause of earnings management. Finally, it suggests exploring other structures at work that might be responsible for earnings management.

Providing a Method for Supporting the Decision Making About a Meaningful XBRL Implementation According to the Specific Situation of an Organization

XBRL is in an increasing number of countries defined as the obligate format for the transmission of financial data to authorities by legal requirements. The legal requirement itself refers solely to the transmission of the information in XBRL format. How a formatting of a company’s report becomes realized is not regulated. This decision has to be done by the decision makers of the affected companies. There is no generally recommended realization or global valid implementation process. Each realization (bolt-on, built-in, and embedded) comprises a specific realization effort and offers different potential benefits for the implementing organization. Therefore, it is necessary to decide about the integration depth within an organization. The paper presents a methodology to support the decision process for the adoption of XBRL into the organization. By doing design science research, the constructed artifact enables a structured decision based on facts, individual properties, and needs of the organization.

Break-Up Analysis: A Method to Regain Trust in Business Transactions

The financial crisis resulted in a loss of trust; not only within the investment or banking sector, but in general between creditors and debtors, because many organizations faced insolvency. Such a financial situation can even result in a company’s bankruptcy. Therefore it is necessary to get a realistic understanding of the solvency or the possible insolvency of a company. The support of a decision on a debtor’s creditability is not yet sufficiently provided by the most prominent method (Altman’s Z’’-score). The paper presents a procedure called Break-Up Analysis (BUA). It helps to decide on the solvency of a company. The comparison of the BUA to Altman’s Z’’-score shows an improvement of the identification of solvent and insolvent companies by 22 %. The BUA enables herewith to regain trust in business transaction by not identifying only the insolvent companies but the solvent ones as well.