Earnings management detection over earnings cycles: the financial intelligence in Indian corporate

Author:Sandeep Goel
Position:Department of Finance, Management Development Institute, Gurgaon, India
Pages:116-129
SUMMARY

Purpose It is largely believed that stock pricing is influenced by disclosure of earnings. This motivates the corporate to exercise earnings management practices. This paper aims to analyse and detect the earnings management practices of Indian firms over earnings cycles. The earnings behaviour of the firms has been analysed at three levels of earnings cycles for the pricing effect: complete, incomplete and prospective. In India, the corporate ownership model is promoter-dominated shareholders’model (PDSHM) which highlights the relevance of the study for earnings-management motivation. This paper contributes by examining earnings management of the units at three levels of earnings cycle with regard to stock pricing. Earnings cycles have been decomposed into three components: complete, incomplete and prospective. While earnings management has been studied extensively, virtually all studies have focused on firm-specific effects. This study relates... (see full summary)

 
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Earnings management detection
over earnings cycles: the nancial
intelligence in Indian corporate
Sandeep Goel
Department of Finance, Management Development Institute, Gurgaon, India
Abstract
Purpose It is largely believed that stock pricing is inuenced by disclosure of earnings. This motivates the
corporate to exercise earnings management practices. This paper aims to analyse and detect the earnings
management practices of Indian rms over earnings cycles. The earnings behaviour of the rms has been
analysed at three levels of earnings cycles for the pricing effect: complete, incomplete and prospective. In India,
the corporate ownership model is promoter-dominated shareholders’model (PDSHM) which highlights the
relevance of the study for earnings-management motivation. This paper contributes by examining earnings
management of the units at three levels of earnings cycle with regard to stock pricing. Earnings cycles have
been decomposed into three components: complete, incomplete and prospective. While earnings management
has been studied extensively, virtually all studies have focused on rm-specic effects. This study relates
earnings management to the cycle of the earnings for stock-price effect.
Design/methodology/approach The cash-ow model has been used for the computation of accruals
(Collins and Hribar, 1999), and D’Angelo model (for calculating discretionary accruals) has been used for
detecting earnings management in the present study, being comprehensive in nature and detailed in approach.
The results of the “complete earnings cycle”are measured by net income. The results of the “incomplete
earnings cycle” are measured by the ratio of gross margin over sales multiplied by inventory. It yields an
approximate measure of the unrealized holding gains and losses. The “prospective earnings cycle” stems from
the management decision to choose a rate of income growth. Statistical tools have been used for testing the
results. These include regression analysis and descriptive statistics like arithmetic mean, median and
standard deviation.
Findings An examination of the units shows that rms report more discretionary accruals (DACC) at
complete cycle, i.e. when nancial markets are more certain about their future prospects which inuence their
securities’ pricing. It veried that unrealized income and growth prospects have very little role to play in
determining returns. The results indicated that each of the components of the earnings cycle has a relevance
factor for returns. In complete earnings cycle, DACC had the highest signicance on returns than operating
cash ows (OCF) and non-discretionary accruals (NDACC). Its determination content is the highest. So, the
rms report more negative DACC when nancial markets are less certain about their future prospects.
Stock-price responses to earnings surprises are moderated when rm-level uncertainty is high, consistent with
performance being attributed more to chance rather than performance.
Research limitations/implications The present study could be conned to only top 12 prot-making
corporate enterprises in the private sector in India, leaving all other enterprises due to data non-availability. Of
25 enterprises, there were public sector undertakings too which had to be excluded. The period in the study is
of ve years (from 2003-2004 to 2007-2008) to highlight earnings management motivation. This period is best
suited to identify the effects of global recession on the practice of earnings management in India. Researchers
may like to select a different time-period based on their perspective.
Practical implications It is hoped that the study would improve the understanding of the manner in
which the capital markets process the publicly available earnings and its components for global rms. The
ndings of this study are signicant not only for organisations that function in India but also for other
companies that are based in economies with relatively mature corporate governance mechanisms. So, the
authors’ ndings have important policy implications for the Western world, as the sample companies are
multinationals and operate globally. Similar efforts in other countries would be rewarding in controlling the
management of reported earnings and enhance the reliability and transparency of reported earnings to
promote economic efciency.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1368-5201.htm
JMLC
20,2
116
Journalof Money Laundering
Control
Vol.20 No. 2, 2017
pp.116-129
©Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-06-2016-0023

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