DOCSLIB.ORG

Free Cash Flow and Earnings Management Inbrazil

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Free Cash Flow and Earnings Management Inbrazil Global Journal of Management and Business Research: D Accounting and Auditing Volume 14 Issue 1 Version 1.0 Year 2014 Type: Double Blind Peer Reviewed International Research Journal Publisher: Global Journals Inc. (USA) Online ISSN: 2249-4588 & Print ISSN: 0975-5853 Free Cash Flow and Earnings Management in Brazil: The Negative Side of Financial Slack By Fabricio Terci Cardoso, Antonio Lopo Martinez & Aridelmo J. C. Teixeira F ucape Business School, Brazil Abstract- The article investigates whether Brazilian firms with excess free cash flow (FCF) and low growth perspectives (Jensen. 1986), when there is excess FCF, accompanied by limited growth perspectives, managers have incentives to camouflage the impact of investments in projects with negative net present value (NPV) by presenting inflated profits. The study includes firms listed on the BMF&Bovespa in the period from 2008 to 2012. Discretionary accruals (DA) were estimated by the modified Jones model and then the relationship between FCF and DA was ascertained by multiple regression. The results indicate that firms with low growth perspectives and excess FCF are more likely to manage earnings to increase profits. Shareholding concentration and adoption of IFRS moderate this relationship (FCF x DA), i.e., in practical terms they restrict the propensity to engage in this type of earnings management. This study is relevant by identifying a tendency to manage earnings. Regulators and investors should pay particular attention to the accounting results disclosed in the presence of excess free cash flow and low growth perspectives. Keywords: free cash flow, discretionary accruals, earnings management. GJMBR-D Classification : JEL Code: O16, M19 Free Cash Flow and Earnings Management in Brazil The Negative Side of Financial Slack Strictly as per the compliance and regulations of: © 2014 Fabricio Terci Cardoso, Antonio Lopo Martinez & Aridelmo J. C. Teixeira. This is a research/review paper, distributed under the terms of the Creative Commons Attribution-Noncommercial 3.0 Unported License http://creativecommons.org/licenses/by-nc/3.0/), permitting all non-commercial use, distribution, and reproduction in any medium, provided the original work is properly cited. Free Cash Flow and Earnings Management in Brazil: The Negative Side of Financial Slack α σ ρ Fabricio Terci Cardoso , Antonio Lopo Martinez & Aridelmo J. C. Teixeira Abstract- The article investigates whether Brazilian firms with invested. Identifying the agency cost associated with excess free cash flow (FCF) and low growth perspectives free cash flow (investments made in projects with engage in earnings management by means of income- negative NPV) is difficult. Managers normally do not increasing accruals. According to the agency cost hypothesis disclose the free cash flow projections of investments (Jensen. 1986), when there is excess FCF, accompanied by 2014 and the premises behind them. To avoid this disclosure, limited growth perspectives, managers have incentives to managers invoke the need for business secrecy. camouflage the impact of investments in projects with ear negative net present value (NPV) by presenting inflated profits. According to Jensen (1986), the payment of Y The study includes firms listed on the BMF&Bovespa in the dividends reduces the power of managers by 85 period from 2008 to 2012. Discretionary accruals (DA) were diminishing the amount of resources available to them. estimated by the modified Jones model and then the To prevent resources from leaving the firm, managers relationship between FCF and DA was ascertained by multiple look to invest these funds in projects to maintain regression. The results indicate that firms with low growth responsibility over them, and as a consequence, perspectives and excess FCF are more likely to manage maintain their power in the company. However, to retain earnings to increase profits. Shareholding concentration and these resources, it is necessary to promise higher future adoption of IFRS moderate this relationship (FCF x DA), i.e., in practical terms they restrict the propensity to engage in this returns to the shareholders, since they will only be willing type of earnings management. This study is relevant by to forgo dividends now when there is an outlook for identifying a tendency to manage earnings. Regulators and increased gains in the future. This promise of higher investors should pay particular attention to the accounting returns is not always easy to keep, so earnings results disclosed in the presence of excess free cash flow and management serves as an instrument to mollify the low growth perspectives. shareholders and preserve the positions of the Keywords: free cash flow, discretionary accruals, managers involved. These circumstances cause earnings management. ) companies to grow beyond their optimal size. D However, according to Chung, Firth & Kim ( I. Introduction (2005), bad investments are eventually revealed by the he objective of this study is to verify whether a firm’s future results. Investments that do not maximize relationship exists between free cash flow (FCF) shareholder wealth can reduce the stock price and T and the propensity to manage earnings by trigger efforts by shareholders to dislodge managers. manipulating discretionary accruals (DA) by firms with Therefore, to camouflage the impact of investments with low growth perspectives, a propensity that arises due to negative NPV, managers use accounting procedures to agency conflicts. According to Jensen (1986), the increase earnings. This “increase” soothes investors interests and incentives of managers and stockholders and boosts the firm’s stock price in the short run. are in conflict regarding the optimal size of the firm and Therefore, verifying whether the earnings payment of dividends, especially in firms with excess information disclosed corresponds to the firm’s real free cash flow and low growth perspectives, i.e., firms performance is fundamental. The importance of with more resources than investment opportunities. In earnings as a parameter for judging the performance of this case, managers can either increase dividends or firms and managers has been stated by various authors. invest in projects with low return, wasting these According to Martinez (2008, p. 2), “one of the most resources. important products of accounting for various users of For Chung, Firth & Kim (2005), in the absence financial information is earnings.” For Dechow, Ge & of efficient control by shareholders, managers can Schrand (2010), high-quality earnings supplies more choose to invest in projects that present negative net relevant information on the financial performance of present value (NPV) or that do not satisfy the profit firms, to serve as a base for investment decisions. Many Global Journal of Management and Business Research Volume XIV Issue I Version expectation of investors. The preference for using the authors have tried to identify factors that contribute to firm’s own resources is to avoid the attention of creditors the quality of earnings. interested in guaranteeing the return of the amounts The results of studies such as Dechow & Dichev (2002) and Dechow, Richardson & Tuna (2003) indicate A uthors α σ ρ: Fucape Business School - Vitória - Brazil. that earnings quality is influenced by accruals. In this e-mail: [email protected] ©2014 Global Journals Inc. (US) Free Cash Flow and Earnings Management in Brazil: The Negative Side of Financial Slack respect, Houge & Loughran (2000) state that accruals findings here can serve as the basis for new studies on and cash flows make an incremental contribution to the theme in Brazil. stock returns and the results obtained is the sum of these two contributions. Therefore, understanding the II. Theoretical Framework relationship between accruals and cash flow will enable better determining the performance of firms and their a) Agency Theory managers, especially from the standpoint of the return It is natural to expect human beings to try to on investment realized by the shareholders. maximize their wealth. According to Bhundia (2012), This return can fall short of what is desired and most people are not able to manage their assets in the one of the factors that can contribute to this is the most effective way, making it wise to contract others conflict of interest between firms’ managers and owners. with more expertise to perform this service. For this same author, according to agency theory the first group For Bhundia (2012) and Jensen (1986), this conflict encourages managers to manipulate the results to is composed of owners (proprietors of the means of 2014 maximize their own wealth, or to remain in their production) and the second is formed by agents or positions. For authors such as Schipper (1989) and managers. In reality, the agents are the representatives ear Y Dechow, Sloan & Sweeney (1995), this manipulation can of the owners of companies (the principals), engaged to be achieved by means of accruals. maximize the wealth of the owners. 86 Various models have been developed to study For Jensen & Meckling (1976), if both sides of this manipulation of earnings, such as those of Jones this relationship seek to maximize their own wealth, there is good reason to believe the agent will not always (1991) and Dechow, Sloan & Sweeney, (1995), among others mentioned in the work of Dechow Ge & Schrand act in the best interests of the principal. These authors (2010). According to Martinez (2008, p. 2), “these define the agency relationship as
Load more

Recommended publications
  • Earnings Management to Exceed Thresholds Author(S): François Degeorge, Jayendu Patel and Richard Zeckhauser Source: the Journal of Business , Vol
    Earnings Management to Exceed Thresholds Author(s): François Degeorge, Jayendu Patel and Richard Zeckhauser Source: The Journal of Business , Vol. 72, No. 1 (January 1999), pp. 1-33 Published by: The University of Chicago Press Stable URL: https://www.jstor.org/stable/10.1086/209601 JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at https://about.jstor.org/terms The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to The Journal of Business This content downloaded from 206.253.207.235 on Thu, 21 May 2020 21:16:00 UTC All use subject to https://about.jstor.org/terms FrancËois Degeorge Hautes EÂ tudes Commerciales and the Centre for Economic Policy Research Jayendu Patel Boston University Richard Zeckhauser Harvard University and National Bureau of Economic Research Earnings Management to Exceed Thresholds* I. Introduction Earnings provide im- portant information for Analysts, investors, senior executives, and boards investment decisions. of directors consider earnings the single most im- Thus executivesÐwho portant item in the ®nancial reports issued by are monitored by in- publicly held ®rms. In the medium to long term vestors, directors, cus- tomers, and suppli- (1±10-year intervals), returns to equities appear ersÐacting in self- to be explained overwhelmingly by the ®rm's cu- interest and at times mulative earnings during the period; other plausi- for shareholders, have ble explanationsÐsuch as dividends, cash ¯ows, strong incentives to manage earnings.
    [Show full text]
  • Earnings Management: Friend Or Foe? Judith A
    Journal of Business & Economics Research Volume 1, Number 11 Earnings Management: Friend or Foe? Judith A. Laux (E-mail: [email protected]), Colorado College Abstract This study looks at some of the recent literature on quality of earnings and earnings management and debates the propositions that earnings management (1) is not new, (2) is an expected outcome of a GAAP approach to accounting, and (3) is not necessarily detrimental to efficient capital markets. It also offers suggestions for using earnings management in a positive fashion to influence the future of the profession. 1. Introduction ecent accounting scandals have engendered something akin to hysteria in the accounting community and led to a mass of new literature on the quality of earnings and the earnings management R phenomenon. At least one aspect of earnings management—income smoothing—has been known and debated since before Ronen and Sadan’s 1981 Smoothing Income Numbers: Objectives, Means, and Implications, as attested to by their excellent summary of a vast number of empirical studies on the subject up to that time. In addition, general purpose financial statements prepared under GAAP guidelines invite flexibility in reporting economic well being that, coupled with market reliance on short-term profitability, makes earnings management practically irresistible. While fraudulent reporting undoubtedly results in capital market inefficiency, earnings management within GAAP guidelines has provided a pretty firm foundation for capital allocation for decades. Still, the wealth of new literature suggests that the question “earnings management: friend or foe?” is subject to debate. 2. Recent Literature For a “pre-Enron” summary of the earnings management literature, see Healy and Whalen [1999] in which the authors look at studies of specific earnings management tools and the effect of earnings management on resource allocation.
    [Show full text]
  • Popular Earnings Management Techniques 15 Ings of the Acquiring Company If the Acquisition Is Properly Planned
    POPULAR EARNINGS 2MANAGEMENT TECHNIQUES This chapter briefly surveys a wide variety of popular legal earnings management techniques discussed in detail in later chapters. The most successful and widely used earnings management techniques can be classified into twelve categories. This chapter briefly overviews and lists some of the most common techniques within each category. More detail on these tech- niques, including the underlying concepts, GAAP requirements, illustrative numeric examples, and actual company cases containing accounting applications are to be found in later chapters. “COOKIE JAR RESERVE” TECHNIQUES A normal feature of GAAP-based accrual accounting is that management must estimate and record obligations that will paid in the future as a result of events or transactions in the current fiscal year. Since the future events cannot be known with certainty at the time of estimation, there is often substantial uncertainty sur- rounding the estimation process. In other words, there is no right answer. There is only a range of reasonably possible answers. From this range, GAAP insists that management select a single estimate. The selection process provides an opportuni- ty for earnings management. When management selects an estimation from the high end of the range of rea- sonably possible expenses, the effect is to record more expense in the current fis- cal period than would be recorded if a lower estimate had been selected. Recording more expense in the current fiscal period may make it possible to record less in a future fiscal period. Thus management creates a “cookie jar reserve” [also called “financial slack”] that they can tap into later to get an earnings boost.
    [Show full text]
  • A STUDY of EARNINGS MANAGENT & FINANCIAL STATEMENT REPORTING ISSUES SURRODING PUBLIC TRADED CORPORATIONS by Juntao Wu a Thes
    A STUDY OF EARNINGS MANAGENT & FINANCIAL STATEMENT REPORTING ISSUES SURRODING PUBLIC TRADED CORPORATIONS by Juntao Wu A thesis submitted to the faculty of The University of Mississippi in partial fulfillment of the requirements of the Sally McDonnell Barksdale Honors College. Oxford May 2014 Approved by _______________________________ Advisor: Professor Victoria Dickinson _______________________________ Reader: Professor Brett Cantrell 1 Abstract: The purpose of this paper is to study some publicly traded companies’ financial reporting systems. I chose four companies in different industries to conduct a series of analyses and evaluations. In Section One, the quality of these companies’ financial reporting systems is carefully examined and evaluated. First, I discuss some potential earnings management strategies that managers from different departments tend to adopt. Next, some of the chosen companies’ important policies, such as revenue recognition, are compared with industrial standards or relevant policies from competitors. In addition, earnings management and financial reporting issues that relate to income taxes are discussed separately. Three major perspectives are considered: 1. recognition of deferred tax asset and valuation allowance accounts; 2. the possible effects of changing valuation allowance on earnings; 3. disclosure of tax planning strategies in the financial report. Section Two discusses corresponding internal control systems that can assist corporations in alleviating the adverse effects from inaccurate and inefficient financial reporting. First, COSO internal control framework is used as the guideline for developing the internal control process. Secondly, certain industrial factors are considered during the risk identification and assessment procedure. Next, a general audit plan is developed for each company. I discuss the budgeted work plan in terms of hours of effort for each task necessary to audit the internal control system.
    [Show full text]
  • Corporate Reputational Risk and ERM: an Analysis from the Perspective
    Corporate Reputational Risk and Enterprise Risk Management: An Analysis from the Perspectives of Various Stakeholders Sponsored by Joint Risk Management Section Society of Actuaries Casualty Actuarial Society Canadian Institute of Actuaries Prepared By Donald Pagach, Ph. D, Professor of Accounting and Richard Warr, Ph. D, Associate Professor of Finance, Jenkins Graduate School of Management, North Carolina State University, Raleigh, NC 27695 May 2009 © Society of Actuaries 1 Corporate Reputational Risk and Enterprise Risk Management: An Analysis from the Perspectives of Various Stakeholders Executive Summary In this paper we examine the effect of Enterprise Risk Management (ERM) adoption on a firm's corporate reputation. ERM may impact corporate reputation in a variety of ways. First, ERM is a management process that enables a firm to holistically manage all risks. This creates a process in which individual risks, including reputation risk, are identified, assessed, and managed in a unified manner so that the firm value is maximized. Second, ERM encourages disclosure of risks, so that stakeholders can better understand which risks a firm is accepting and which it is avoiding. This greater disclosure is generally viewed positively by outside stakeholders because it allows them to better manage their own risk profiles. Finally, ERM provides a strategic response to a reputation damaging event. From our examination of a range of reputation proxies, we find evidence that implementation of a ERM program may enhance corporate reputation, although not in the short-term. In addition, we find evidence that ERM adoption tends to occur during a period in which various reputation measures tend to be decreasing.
    [Show full text]
  • Earnings Management to Meet Or Beat Analyst Earnings Forecasts Through Changes in Interim Expenses
    Earnings Management to Meet or Beat Analyst Earnings Forecasts Through Changes in Interim Expenses Joseph Comprix a, Lillian Mills b, and Andrew Schmidt c* a W.P. Carey School of Business, Arizona State University, Box 873606, Tempe, AZ 85287-3606 b The University of Texas at Austin, 1 University Station, B6400, Austin, TX 78712-0211 c Columbia Business School, 618 Uris Hall, 3022 Broadway, New York, NY 10027 Abstract We investigate whether firms manage quarterly earnings by adjusting expenses recorded during the year under the integral method. The integral method, which is used to determine interim cost of goods sold, selling, general, and administrative expenses, and income tax expenses, introduces management discretion into the amount and timing of costs allocated to quarterly expenses. We find that seasonal differences in each of the above expenses are significantly associated with meeting or beating analysts’ earnings forecasts in a given quarter. This study is the first to show that changes in interim cost of goods sold and selling, general, and administrative expenses are associated with earnings management. In addition, this study extends prior research showing that firms can decrease effective tax rates in the fourth quarter to lower tax expense enough to meet or beat year-end analysts’ forecasts. We document a positive association between seasonal differences in the provision for income taxes and meeting or beating analysts’ earnings forecasts in all four quarters. These findings complement research efforts to understand the limits of multi- year earnings management to show how flexible accounts like interim expenses permit firms to manage earnings within a year.
    [Show full text]
  • Earnings Management: an Analysis of Opportunistic Behaviour, Monitoring Mechanism and Financial Distress
    View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Elsevier - Publisher Connector Available online at www.sciencedirect.com ScienceDirect Procedia Economics and Finance 28 ( 2015 ) 190 – 201 7th INTERNATIONAL CONFERENCE ON FINANCIAL CRIMINOLOGY 2015 13-14 April 2015,Wadham College, Oxford, United Kingdom Earnings Management: An Analysis of Opportunistic Behaviour, Monitoring Mechanism and Financial Distress ab b b Aziatul Waznah Ghazali * , Nur Aima Shafie , Zuraidah Mohd Sanusi aKingston University London & Accounting Research Institute, Universiti Teknologi MARA Malaysia bAccounting Research Institute, Universiti Teknologi MARA Malaysia Abstract The aim of this study is to analyze the relationship between opportunistic behaviors (free cash flow and profitability), monitoring mechanism (leverage) and pressure behaviors (financial distress) toward earnings management. There are indeed several factors that could motivate the managers to manage earnings. In this study, it is assumed that the management incline to manage earnings in order to avoid reporting losses or to avoid showing any decreases in the reported earnings. This empirical research with a sample of Malaysian public listed companies from year 2010 to 2012 shows that managers of the companies would engage in earnings management when the company is financially healthy and when the profit of the company is high. The result of this study would provide a valuable explanation on the relationship between variables, thus, would give relevant views to regulators in tightening the rules and regulation in order to promote public confidence in the reliability of financial reporting. © 20152015 TheThe Authors.Authors. Published Published by by Elsevier Elsevier B.V. B.V.
    [Show full text]
  • A Study on the Relationship Between Analysts' Cash Flow Forecasts
    sustainability Article A Study on the Relationship between Analysts’ Cash Flow Forecasts Issuance and Accounting Information: Evidence from Korea Hyun Min Oh 1 and Ho young Shin 2,* 1 Department of Accounting, College of Social Sciences, Sunchon National University, Jeonnam 57922, Korea; [email protected] 2 School of Business, Hanyang University, Seoul 04763, Korea * Correspondence: [email protected] Received: 18 May 2019; Accepted: 17 June 2019; Published: 20 June 2019 Abstract: This study analyzes the relationship between the future cash flow forecast information provided by financial analysts and accounting information. We examine whether the joint issuance of financial analyst earnings forecasts and cash flow forecasts from 2011 to 2015 contributes to the information usefulness of Korean listed firms. The empirical results of this study are as follows. First, the issuance of analysts’ cash flow forecasts and earnings forecast accuracy were significant positive values. Cash flow forecast accuracy and earnings forecast accuracy were significant positive values. Second, the issuance of analysts’ cash flow forecasts and buy–sell bid spread are significant negative values. These results show that the information asymmetry between the manager and the investor can be reduced based on the rich information environment. This study suggests that cash flow forecasting information of financial analysts provides important evidence for capital market participants because it provides evidence that capital market participants’ information can be used as useful information for economic decision-making. These results show the sustainability of a firm from the viewpoint of a financial analyst who acts as an intermediary and external supervisor in the capital market.
    [Show full text]
  • Risk Management Committee Attributes: a Review of the Literature and Future Directions
    Universal Journal of Accounting and Finance 9(3): 388-395, 2021 http://www.hrpub.org DOI: 10.13189/ujaf.2021.090313 Risk Management Committee Attributes: A Review of the Literature and Future Directions Abdessetar Bensaid*, Suhaimi bin Ishak, Ifa Rizad binti Mustapa Tunku Intan Safinaz School of Accountancy, Universiti Utara Malaysia, Malaysia Received March 24, 2021; Revised May 13, 2021; Accepted June 6, 2021 Cite This Paper in the following Citation Styles (a): [1] Abdessetar Bensaid, Suhaimi bin Ishak, Ifa Rizad binti Mustapa, "Risk Management Committee Attributes: A Review of the Literature and Future Directions," Universal Journal of Accounting and Finance, Vol. 9, No. 3, pp. 388 - 395, 2021. DOI: 10.13189/ujaf.2021.090313. (b): Abdessetar Bensaid, Suhaimi bin Ishak, Ifa Rizad binti Mustapa (2021). Risk Management Committee Attributes: A Review of the Literature and Future Directions. Universal Journal of Accounting and Finance, 9(3), 388 - 395. DOI: 10.13189/ujaf.2021.090313. Copyright©2021 by authors, all rights reserved. Authors agree that this article remains permanently open access under the terms of the Creative Commons Attribution License 4.0 International License Abstract The aim of this paper is to review existing literature related to the risk management committee attributes (RMC) that can facilitate transactions between board committees and add value to corporations. The 1. Introduction emphasis of this study is on RMC as it has become a crucial element, especially after the collapse of large corporations. Risk Management Committee (RMC) has become one RMCs have attracted the attention of academics and of the crucial players in the current corporations’ era.
    [Show full text]
  • Management Deception, Big-Bath Accounting, and Information Asymmetry: Evidence from Linguistic Analysis
    Accounting, Organizations and Society xxx (xxxx) xxx–xxx Contents lists available at ScienceDirect Accounting, Organizations and Society journal homepage: www.elsevier.com/locate/aos Management deception, big-bath accounting, and information asymmetry: Evidence from linguistic analysis ∗ Ole-Kristian Hopea,b, Jingjing Wanga, a Rotman School of Management, University of Toronto, Canada b BI Norwegian Business School, Norway ARTICLE INFO ABSTRACT Keywords: Accounting big baths are pervasive in practice. While big baths can improve the information environment and Management deception reduce information asymmetry, they can also degrade the information environment and obscure operating Big-bath accounting performance. In this study, we examine the role of management ethics. Specifically, we investigate whether Linguistic analysis managers’ truthfulness (or conversely, deceptiveness) affects how investors perceive big baths. Using linguistic Information asymmetry analysis on earnings-conference calls to measure managerial deception and employing a difference-in-differ- ences research design with propensity-score matching, we find that information asymmetry is significantly higher following big baths taken by deceptive CEOs, compared with big baths taken by less deceptive CEOs. 1. Introduction 2006; Vitell, Lumpkin, and Rawwas 1991; Weber, 1990). Big baths are managerial decisions that can be the result of managers' ethical con- How does a firm's information environment change after accounting siderations of the firms' welfare, or can be the result of managers' in- big baths? Prior literature provides evidence on both positive (Elliott & centives to maximize their personal utility. Being truthful or deceptive Shaw, 1988; Francis, Hanna, & Vincent, 1996; Haggard, Howe, & to investors and other stakeholders also indicates management's ethical Lynch, 2015) and negative (Bens & Johnston, 2009; Kirschenheiter & choice of how they view their responsibility to the firm's stakeholders.
    [Show full text]
  • Do New Ceos Practice Big Bath Earnings Management Via Goodwill Impairments?
    Do New CEOs Practice Big Bath Earnings Management Via Goodwill Impairments? Charles E. Jordan Florida State University – Panama City Stanley J. Clark Middle Tennessee State University Research conducted during SFAS 142’s adoption year (2002) and shortly thereafter indicated new CEOs exhibited big bath behavior by impairing goodwill early in their tenure. A new CEO could blame the impairment on prior management while also paving the way for enhanced future profitability. However, several studies indicate that various types of earnings management declined precipitously in recent years. We re-examine the propensity of new CEOs to take big baths relative to goodwill impairments and find no evidence of this manipulative reporting. Instead, goodwill impairments by new CEOs seem to be justified based on their firms’ deteriorating performance over time. INTRODUCTION The big bath theory of earnings management suggests managers charge significant non-recurring items to income in periods when earnings are already depressed. These one-time hits are taken because the market punishes a company relatively the same regardless of whether the firm just misses its earnings mark or falls well below it. Thus, there exists little downside to taking a big bath, yet a clear upside occurs because recording the heavy charge now relieves future periods of the burden, thereby making it easier to reach earnings goals in later years (Henry & Schmitt, 2001). Numerous studies document the practice of big bath earnings management in general (e.g., Elliott & Shaw, 1988; Kirschenheiter & Melumad, 2002; Walsh et al., 1991). One particular area in which big bath earnings management has been studied relates to goodwill impairments under Statement of Financial Accounting Standard (SFAS) 142, Accounting for Goodwill and Other Intangible Assets, which is now located in Accounting Standards Codification (ASC) topic 350.
    [Show full text]
  • Enterprise Risk Management and Firm Performance
    J. Account. Public Policy 28 (2009) 301–327 Contents lists available at ScienceDirect J. Account. Public Policy journal homepage: www.elsevier.com/locate/jaccpubpol Enterprise risk management and firm performance: A contingency perspective Lawrence A. Gordon a,*, Martin P. Loeb a, Chih-Yang Tseng b a Robert H. Smith School of Business, Van Munching Hall, University of Maryland, College Park, MD 20742-1815, United States b Department of Accounting, National Taiwan University, Taipei, Taiwan article info abstract Keywords: In recent years, a paradigm shift has occurred regarding the way Enterprise risk management organizations view risk management. Instead of looking at risk Firm performance management from a silo-based perspective, the trend is to take a Contingency theory holistic view of risk management. This holistic approach toward Management control systems managing an organization’s risk is commonly referred to as enter- prise risk management (ERM). Indeed, there is growing support for the general argument that organizations will improve their perfor- mance by employing the ERM concept. The basic argument pre- sented in this paper is that the relation between ERM and firm performance is contingent upon the appropriate match between ERM and the following five factors affecting a firm: environmental uncertainty, industry competition, firm size, firm complexity, and board of directors’ monitoring. Based on a sample of 112 US firms that disclose the implementation of their ERM activities within their 10Ks and 10Qs filed with the US Securities and Exchange Commission, empirical evidence confirms the above basic argu- ment. The implication of these findings is that firms should con- sider the implementation of an ERM system in conjunction with contextual variables surrounding the firm.
    [Show full text]