Kaustav Sen

Board of Directors and Opportunistic Earnings Management: Evidence from India

Using a sample of 500 large companies over a two-year period, we examine the impact of board characteristics on opportunistic earnings management in India, a large emerging economy. In addition to board independence, we analyze how characteristics that proxy for the “quality” of inside and outside directors affect the role of boards in curbing earnings management. Our results indicate that it is not board independence per se, but rather board quality that is important for earnings management. We find that diligent boards are associated with lower earnings management, while boards that have directors with multiple appointments exhibit higher earnings management. With respect to inside directors, our results indicate that chief executive officer (CEO) duality and presence of controlling shareholders on the board increases earnings management. We also find that domestic institutional owners, one of our key control variables, act as a compensating control mechanism to mitigate the detrimental influence of controlling shareholders on earnings management. Our results complement the existing literature by analyzing the role of the board in reducing earnings management in emerging economies such as India, where the structures of business organizations are different from those in developed markets.

Does the measure of information quality influence survival bias

Examines certain issues related to application of total quality management to the information systems setting, in particular to the measurement of output quality. Data produced by a system are often transformed for decision making by end users. Although ensuring the quality of the data can be achieved, it is difficult to control for all the inferences made by end users. Using a financial reports database as an example, demonstrates how the choice of measure of information quality can sometimes bias the survival time of firms in the sample. The analysis uses the Cox proportional hazards model to demonstrate that when immaterial data errors are present after firms have incurred a loss, sometimes they increase their survival chances. Such consequences are valid in other settings as well and demonstrate that defining and measuring the quality of information systems needs more considerations than is generally assumed.

How Does Regulation Affect the Relation between Family Control and Reported Cash Flows? Comparative Evidence from India and the United States

Manuscript Type. Empirical. Research Question/Issue. We conduct a two‐country study to understand (i) how family and non‐family firms engage in classification shifting to manage reported operating cash flows in each country; (ii) how this behavior varies between the two countries; and (iii) how corporate governance regulation introduced independently in each country moderates the observed behavior. Research Findings/Insights. We find that family ownership has different effects on quality of cash flow reporting in the two countries. Furthermore, country‐level regulation moderates these effects differently. In particular, (i) firms in both countries engage in manipulating operating cash flows, but the evidence is stronger in the United States; (ii) family firms in India engage in more shifting than non‐family firms, but this is not observed in the United States; and (iii) family (non‐family) firms in India increase (reduce) shifting, whereas only non‐family firms in the United States increase shifting after regulation. Since non‐family firms in India raise more external capital than family firms after regulation, we infer that family firms in India reacted to this competition for capital and resorted to shifting. Theoretical/Academic Implications. Most studies assume that the incentives for family firm behavior are the same in different market settings. However, factors such as efficiency of public capital markets, enforcement of corporate laws and regulations, and other institutional practices can cause differences in family firm behavior across different market settings. We investigate the behavior of family and non‐family firms in each of these markets and study how a feature of the national governance system, regulatory design, moderates this behavior. Practitioner/Policy Implications. Our findings should be useful to global investors and regulators in both emerging and developed markets. The results indicate how similar regulation in the two different settings can trigger differences in the behavior of firms.

Insider Control, Group Affiliation and Earnings Management in Emerging Economies: Evidence from India

Using a sample of group affiliated and standalone firms for the years 2001-06 from India, a large emerging economy dominated by family business groups and firms with concentrated ownership, we examine the relationship between insider control and opportunistic earnings management with specific focus on the effect of business group affiliation on this relationship. We test the alignment and the entrenchment hypotheses by examining opportunistic earnings management. We further examine if such behavior is influenced by the complexity of ownership structures that are manifested in incomplete and fragmented information about ownership stakes. Our results indicate that a non-linear U-shaped relationship exists between insider control and opportunistic earnings management and that this relationship is stronger for group affiliated firms as compared to that for standalones. Finally, incomplete and fragmented ownership information is found to be strongly related to opportunistic earnings management in group affiliated firms. Our results highlight that both insider control and group affiliation may independently influence agency costs in emerging economies. This in turn calls for policy actions that focus not only on individual firms but on business groups as consolidated identities.

Do financially distressed firms misclassify core expenses

Purpose - This paper aims to examine whether financially distressed firms manipulate core or operating income through the misclassification of operating expenses as income-decreasing special items. Design/methodology/approach - This sample comprises firms in the USA with data from 1989 to 2010. The authors used the methodology given in Findings - Managers of financially distressed firms are more likely to inflate core or operating income as compared to the healthy firms to meet or beat earnings benchmarks. They do so by misclassifying core or operating expenses as income-decreasing special items. Specifically, core expenses are shifted to income-decreasing special items like goodwill impairments, settlement costs, restructuring costs and write downs. Practical implications - The paper sheds light on an important firm characteristic, financial distress that intensifies classification shifting – an earnings management tool which auditors, investors and regulators find tough to detect. The findings have implications for investors, as they fail to comprehend such shifting ( Originality/value - The authors extend the literature on accruals and real earnings management by the financially troubled firms and present first evidence that the managers of such firms also manipulate core or operating income through classification shifting.

Classification shifting: impact of firm life cycle

Purpose - This paper examines whether firms in the decline stage of life cycle manipulate core or operating income through misclassification of operating expenses as income-decreasing special items. Design/methodology/approach - Our sample comprises of firms from an emerging market, India with data from 1996-2011. We use the methodology given in McVay (2006) and multiple regressions. Findings - Managers of Indian firms also engage in classification shifting, primary incentive being desire to avoid reporting of operating losses. Further, the use of classification shifting is dependent upon the stage of life cycle in which firm is in. Specifically, firms in the decline stage of life cycle are more likely to use classification shifting to avoid reporting of operating losses. Practical implications - The paper sheds light on a critical phase of the firm life cycle – decline, which increases the possibility of use of classification shifting – an earnings management technique which auditors, investors and regulators find tough to detect. Originality/value - We extend the literature on classification shifting, and present first evidence that such shifting is more likely to take place during the decline phase of firm life cycle.

Classification Shifting in the Cash Flow Statement: Evidence from India

We present first evidence that the manipulation of operating cash flows through misclassification is likely to be more common in the countries with weak investor protection and governance. We also show that managers manipulate operating cash flows using different misclassification strategies. Specifically, they shift operating cash outflows to investing and financing cash outflows, and investing and financing cash inflows to operating cash inflows. We focus on an emerging market, India, which is characterized by weak corporate governance and investor protection, and the United States and present evidence that the magnitude of such misclassification is higher for the firms in India. Further, Indian firms in financial distress are more likely to manipulate operating cash flows as compared to the financially distressed firms in the United States by engaging in the misclassification of cash flows. Thus, we link weak governance and investor protection with the magnitude of cash flow misclassification.

Using an Augmented Revelation Mechanism to Resolve Tacit Collusion in Auditing

This paper reexamines the problem of multiple equilibria in an audit setting. When both the manager and the auditor are subject to moral hazard and truth-telling problems, one undesirable equilibrium that may arise results in both parties exerting low effort and reporting high output, interpreted here as tacit collusion. The Ma, Moore and Turnbull (1988) augmented revelation mechanism is used to remove the undesirable equilibrium. To keep the mechanism simple, only one agent (the manager) is given an expanded message space.