Salma Ibrahim

Real and accrual-based earnings management and its legal consequences: Evidence from seasoned equity offerings

Purpose - Prior research suggests that firms manipulate earnings through accruals to achieve certain reporting objectives. Recently, especially following the Sarbanes-Oxley (SarbOx) Act, researchers have turned their attention to real account manipulation as an alternative. However, there is no evidence on whether the likelihood of being detected by outsiders is different for firms using these alternative manipulation methods. The purpose of this paper is to examine this research question in the context of seasoned equity offerings (SEOs). Design/methodology/approach - First, the authors compare SEOs to a matched sample of non-SEOs to document income-increasing manipulation. Next, they identify SEOs that prompt lawsuits and compare sued and non-sued firms to determine whether using a particular method of manipulation is more likely to be detected and associated with litigation. Findings - The authors find evidence of income-increasing accrual and real manipulation for SEOs in the year prior to the offering in the pre-SarbOx period, and find some evidence of a shift to real account manipulation post-SarbOx. The authors examine the subsequent litigation pattern of these SEOs, and find that firms that are subsequently sued have a higher prevalence of income-increasing discretionary accruals when the lawsuit allegations involve accounting issues. Following SarbOx, investors are paying less attention to accrual manipulation through accounts receivable and there is more scrutiny of real account manipulation. Originality/value - The implication in this paper is that firms that engage in income-increasing earnings management are more likely to be sued when they engage in accrual manipulation while other forms of manipulation may be less understood. This finding is important to investors and regulators.

Boards attributes that increase firm risk - evidence from the UK

Purpose The purpose of this paper is to identify the board attributes that significantly increase firm risk. The study aims to find whether board size, percentage of non-executive directors, women on the board, a powerful chief executive officer, equity ownership amongst executive board directors and institutional investor ownership are associated with firm risk. This is the first study that examines which board attributes increase firm risk using a UK-based sample. Design/methodology/approach This empirical study collected secondary data from Bloomberg and Morningstar databases. The data sample is an unbalanced panel of 260 companies’ secondary data on FTSE 350 index in the UK, from 2005 to 2010. The data were statistically analysed using STATA. Findings The study establishes the board attributes that were significantly related to firm risk. The results show that a board which can increase firm risk is one that is small in size, has high equity ownership amongst executive board directors and has high institutional investor ownership. Research limitations/implications The governance culture and regulatory system in the UK is different from other countries. As the data are a UK-based sample, the results can lack generalisability. Practical implications The results are useful for investors who invest in large firms, to have the knowledge about the board attributes that can increase firm risk. Regulators can also use the results to strengthen regulatory guidelines. Originality/value This study fills the gap in knowledge in UK governance literature on the board attributes that can increase firm risk.

Accrual and real-based earnings management by UK acquirers: Evidence from pre- and post-Higgs periods

Purpose This study investigates the occurrence of pre-merger earnings management for a sample of 197 stock- and cash-financed UK acquirers between 1990 and 2009. We also examine the earnings management behavior around the change in the Corporate Governance Code in 2003 based on the Higgs recommendations. Design/methodology/approach Mean and median accrual and real-based manipulation are examined in the period before the announcement of a merger and acquisition. These are compared across stock and cash acquirers as well as before and after the implementation of the Higgs recommendations. We also run logistic regressions to examine accrual and real-based manipulation across stock and cash acquirers after controlling for variables that may impact the acquisition type. Findings We find some evidence of upward pre-merger accrual-based earnings management by stock-financed acquirers, which is in line with the findings of Botsari and Meeks (2008). Furthermore, we do not find significant changes in the post-Higgs...

Corporate governance and firm risk

Purpose This study aims to explore the relationship between board governance structure and firm risk. In particular, this study develops a “governance index” based on four aspects of the board: board composition, board leadership structure, board member characteristics and board processes, and it examines how the overall index relates to firm risk. Design/methodology/approach The study is conducted using a sample of 268 UK firms from the FTSE 350 index over the period from 2005 to 2010. An index is constructed to capture the overall governance structure of the firm. Regressions of the index on three risk measures are examined. Findings This study finds that the governance index that aggregates the four sets of board attributes is significantly and negatively related to firm risk. Robustness tests confirm this result. Research limitations/implications A large number of studies have explored the relationship between the attributes of corporate boards and firm performance with mixed results. A much smaller number of studies have looked at board attributes and firm risk, but these have either focused on financial sector firms alone or have included only a single or a limited number of attributes. This study, using a broad agency framework, seeks to extend the work on firm risk and board attributes by both expanding industry sectors examined and using a comprehensive set of board attributes. Originality value The findings have policy and practical implications for investors, regulators and chairmen of boards of governors to the extent that they inform these constituencies about the set of board attributes that are associated with firm risk. This study is the first to use a comprehensive measure of governance and relate it to firm risk.

Legal Consequences of Earnings Components Management

This paper investigates how manipulating different earnings components will affect the likelihood of accounting-related shareholder litigation. Firms can manipulate earnings upward by accelerating revenue recognition, understating expenses, and overstating gains associated with special items. Firms can manipulate earnings downward by delaying revenue recognition, overstating expenses, and overstating losses associated with special items. This paper finds that firms accelerating revenue recognition or taking abnormal large losses through special items are more likely to be associated with accountingrelated shareholder litigation. Such association only exists in the post-PSLRA period.

The Relationship between Non-Financial Information and Financial Distress

There has been a prevalence of firms facing financial distress in the past few years, causing losses to many investors. Past research has shown that there are financial variables that are correlated with financial distress and these have been used in ratios and scores that are used to predict bankruptcy e.g Atmans Z-score (Altman, 1968) and Ohlsons O-Score (Ohlson, 1980). However, no research has studied the relationship between non-financial indicators and financial distress. Non-financial information, specifically customer satisfaction, was shown in prior research to be a leading indicator of financial performance (Ittner and Larcker, 1998) but it has never been established as an explanatory variable of financial distress. This paper seeks to explain the relationship between current financial distress of firms, proxied by the Z-score, and customer satisfaction indices in the current and past years. The results indicate that there is a significant relationship between these variables. Specifically, firms that have lower customer satisfaction indices in the current and prior two years are more likely to face financial distress in the short term. There are also significant differences in terms of customer satisfaction between firms that are expected to face bankruptcy in the short term (Z-scores below 1.81) and those that are financially healthy (Z-scores above 3.0). These findings pave the way for future research on models that estimate financial distress. In addition, results using returns indicate that market participants do not value this type of information. Long-term returns are not significantly related to current or past year customer satisfaction indices.