Contributions to Management Science More information about this series at http://www.springer.com/series/1505 Bruno Maria Franceschetti Financial Crises and Earnings Management Behavior Arguments and Evidence Against Causality Bruno Maria Franceschetti Department of Economics and Law, University of Macerata, Macerata, Italy ISSN 1431-1941 e-ISSN 2197-716X Contributions to Management Science ISBN 978-3-319-54120-4 e-ISBN 978-3-319-54121-1 https://doi.org/10.1007/978-3-319-54121-1 Library of Congress Control Number: 2017946663 © Springer International Publishing AG 2018 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Printed on acid-free paper This Springer imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland To my son Valerio Acknowledgements I thank Carsten Felden and Claudia Koschtial, Technische Universität Bergakademie Freiberg (DE), and Francesca Bartolacci, Nicola Castellano, Andrea Fradani, Antonella Paolini and Michela Soverchia, University of Macerata (IT), for the continuous constructive discussions and comments Contents Introduction 1.1 Introduction 1.1.1 The Research Question 1.2 A Brief Overview of the Book and its Structure 1.3 Theoretical Contributions of the Present Work 1.4 Practical Contributions of the Present Work References Earnings Management: Origins 2.1 Introduction 2.2 Definitions of Earnings Management, Earnings Quality, Fraud, and Earnings Manipulation 2.3 Accruals Earnings Management, Real Activities Earnings Management, and Fraudulent Financial Reporting 2.3.1 Studies Related to Accruals Earnings Management 2.3.2 Studies Related to Real Activities Earnings Management 2.3.3 Studies Related to Non-GAAP Earnings Management: Fraudulent Financial Reporting 2.4 Main Incentives to Manage Earnings and Offset Causes 2.5 Conclusion Appendix: Earnings Management Detection Models References A Critical Realist Perspective on Earnings Management 3.1 Introduction 3.2 Critical Realism as an Alternative to Positivism 3.3 A Critical Realist Conceptualization of Powers and Tendencies 3.4 A Critical Realist Approach to Earnings Management References Financial Crisis as a Major Cause of Earnings Management: Theoretical Background and Literature Review 4.1 Theoretical Background 4.2 Literature Review 4.2.1 Methodology 4.2.2 Results 4.2.3 Discussion: Mainstream Approach to the Financial Crisis–Earnings Management Relation References Does Financial Crisis Cause Earnings Management? 5.1 Introduction 5.2 Positivist Mainstream Approach to the Research Question 5.2.1 Hypotheses Development 5.2.2 Measurement of Earnings Management: Beneish’s Model 5.2.3 Sample Selection 5.2.4 Empirical Results 5.3 Critical Realist (CR) Approach to the Research Question 5.3.1 Against the Causal Law of a Constant Conjunction Model: An Etymological Perspective 5.3.2 A New Critical Realist Conceptualization of Tendencies Applied to Earnings Management 5.4 Discussion and Conclusion Appendix: Extended Tables References © Springer International Publishing AG 2018 Bruno Maria Franceschetti, Financial Crises and Earnings Management Behavior, Contributions to Management Science, https://doi.org/10.1007/978-3-319-54121-1_1 Introduction Bruno Maria Franceschetti1 (1) Department of Economics and Law, University of Macerata, Macerata, Italy Bruno Maria Franceschetti Email: bruno.franceschetti@unimc.it Abstract This opening chapter presents the research question, gives a brief overview of the book, and pinpoints the main theoretical and practical contributions of the present work The study examines whether the generative mechanism for managing earnings identified by the previous research (i.e., financial crisis) is adequate Chapter presents the earnings management phenomenon while Chap provides a critical realist evaluation of mainstream earnings management literature Chapter approaches the question of the relationship between financial crisis and earnings management Finally, Chap presents both the positivist and the critical realist approach to the research question 1.1 Introduction 1.1.1 The Research Question According to Lo (2008), “earnings management has a lot in common with earnings quality” and “highly managed [manipulated] earnings have low quality” (p 351).1 Since earnings quality is essential to the decisions made by anyone with a vested interest in a company (Dechow et al 2010), discovering the causal factors or indicators associated with the use of earnings management is crucial to help detect and/or prevent the misreporting of a firm’s business activities Academics and regulators have strived to uncover the “causal laws of a ‘constant conjunction’ model (whenever A happens, B happens)” (Collier 2005, p 328) and have identified financial crisis as a major cause of earnings management Warnings such as “the financial crisis will exacerbate the increase in corporate fraud” (Levy 2009, p 11), and estimates of “a potential projected global fraud loss of more than $3.7 trillion” (ACFE 2014), are common Indeed, financial crises offer a unique opportunity to study the effects of crisis on financial reporting quality (Kousenidis et al 2013) since “antecedently available cognitive resources are used to construct plausible models of the mechanisms producing identified patterns of phenomena” (Bhaskar 2011, p 90) However, mistaking the effect for the cause, termed the “real corruption of reason” by Nietzsche (1888), poses a considerable risk While a constant conjunction model between financial crisis and earnings management may exist, the parts of the model that represent cause and flags found between the pre-crisis and crisis periods could occur by chance (i.e., the differences between the two periods are not statistically significant) However, this conclusion does not mean that the null hypothesis is necessarily true, only that insufficient evidence was found to reject it Furthermore, the DEPI values showed that in times of crisis companies prefer to revise upwards the estimates of the useful life of assets (or adopt an income-increasing method) rather than let them have a “big bath.” Although the mainstream approach did not provide relevant results, the causal law based on a constant conjunction model (i.e., whenever a financial crisis happens, earnings management happens) remains inconclusive While traditionally critical realism has been hostile to statistical methods, a greater acceptance of their value is now shown by critical realists (Mingers et al 2013) While limited by the openness of the system, I tried to isolate the mechanism (financial crisis) from the other driving forces (poor performances, insider trading, debt renegotiation, IPOs, financial distress, etc.) that might affect the outcome Furthermore, the companies were assessed in crisis and pre-crisis periods, partially transforming the mainstream research design from theory confirming into theory testing Further, I chose a positive test strategy for my investigation but my “inappropriate bolstering of hypotheses” (Nickerson 1998, p 175) was mainly driven by prior knowledge (Klauer et al 2000; Stanovich and West 2007) Finally I mitigated confirmatory bias by choosing financially healthy high earnings quality firms with available financial data for both the pre-crisis and the crisis periods The presented findings allow me to conclude that financial crisis tends to have no consistent effect on earnings quality since companies’ earnings management behavior tends not to differ from the pre-crisis to the crisis period Indeed, the results not change even when financial history is divided by using different financial crisis starting dates Overall, earnings manipulation tends to be “pervasive” (Dyck et al 2013) in pre-crisis and crisis periods, while listed financially nondistressed high earnings quality firms tend to not adopt a big bath strategy during the crisis period These tentative conclusions suggest abandoning the idea of “discovering [the] causal laws of a ‘constant conjunction’ model” (Collier 2005, p 328) since the research question cannot be investigated in the context of a closed system As an alternative, future researchers might aim to explore other structures or generative mechanisms responsible for the given phenomenon (Lawson 1997) and analyze them “as the tendencies and powers of enduring and transfactually acting things” (Bhaskar 2008a, p 221) Further, despite critically arguing against the causal law based on a constant conjunction model, I cannot exclude the opposite causal relation or the presence of other generative mechanisms that may cause financial crisis Indeed, I cannot exclude the absence of any causal law based on a constant conjunction model This study did not set out to demonstrate whether previous research may have mistook the cause for the effect, the dangerous error according to Nietzsche As Nietzsche (1888) pointed out, there might be either “false causality” (p 494) between financial crisis and earnings management or financial crisis may simply be an “imaginary cause” (p 496) of earnings management Fleetwood’s (2011) conceptualization of tendencies suggests that financial crisis is not the cause of earnings management, only an extrinsic enabling condition or, more likely, a stimulating or releasing condition for managing earnings Extrinsic enabling conditions or extrinsic stimulating or releasing conditions, if removed, will not change an earnings manager: he/she will still have an actualized tendency (tendency2) to manage earnings Future research could aim to investigate intrinsic enabling and offsetting causes rather than extrinsic enabling conditions or intrinsic/extrinsic stimulating or releasing conditions To sum up, managers working in certain kinds of companies have the power to manage earnings In this respect, earnings managers are predisposed or oriented towards managing earnings, but no intrinsic offsetting causes must interfere in this process (Bhaskar 2008a) Like a kleptomaniac or a car with its engine running and first gear selected, earnings managers are only one species in the genus manager by displaying, in addition to the exercised tendency, the actualized tendency to manage earnings Nevertheless, “the attribution of tendency2 requires more about things to be known” (Bhaskar 2008a, p 224), such as that a set of intrinsic enabling conditions (icw and icx) as well as a further set of intrinsic enabling conditions (icy and icz) are satisfied (Fleetwood 2011, p 11) and that intrinsic offsetting causes may cause interference The interesting scientific perspective is not whether an earnings manager really manages earnings, but why this behavior may occur (Bhaskar 2008a) Understanding the intrinsic enabling conditions and intrinsic offsetting causes that may excite or suppress their tendency to manage earnings thus remains an unanswered question Indeed, although the sets of intrinsic enabling conditions and offsetting factors may remain under-researched because “there is a level of [intrinsic] activity, perhaps unknown, […] that is predisposed to perform an action of a certain type” (Bhaskar 2008a, p 227), it is clear that they exist Appendix: Extended Tables Table 5.16 (extended), panel A (B) shows the number of companies classified as manipulators per year per period in 2005–2010 (2006–2011) and the sum of companies tagged as manipulators (∑M) Table 5.16 (extended) Companies classified as manipulator (M), per company and per year, over both time horizons Crisi Pre-crisis n 2010 2009 2008 Tot M a(yes = 1; no = 0) 2007 2006 Panel A 2005 Tot M (yes = 1; no = 0) 0 0 0 0 0 M 0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 M 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 10 0 0 0 0 0 11 0 0 0 0 0 12 0 0 0 0 0 13 0 0 0 M 1 14 0 0 0 M 1 15 0 M 1 0 M 1 16 0 0 M 0 1 17 0 0 0 0 0 18 0 0 0 0 0 19 0 0 0 M 1 20 21 0 0 0 0 0 0 0 0 0 22 M 0 1 0 0 23 0 0 0 0 0 24 0 0 0 0 0 25 0 0 0 0 0 26 M 1 0 0 27 0 0 0 0 0 28 M 1 0 0 29 0 0 0 0 0 30 0 0 0 0 0 31 0 0 0 0 0 32 0 0 0 0 0 33 0 0 0 0 0 34 0 0 0 0 0 35 0 0 M 0 1 36 0 0 0 M 1 37 0 M 1 M M M 38 0 0 0 0 0 39 0 0 0 0 0 40 0 0 0 0 0 41 0 0 0 0 0 42 0 0 0 0 0 43 0 0 0 0 0 44 0 0 0 0 0 45 0 0 0 0 0 46 0 0 0 0 0 47 0 0 0 0 0 48 0 0 0 M 1 49 0 0 0 0 0 50 0 0 0 0 0 51 0 M 1 0 0 52 0 0 0 0 0 53 0 0 0 0 0 54 0 0 0 M 1 55 0 0 0 0 0 56 0 0 0 0 0 57 0 0 0 0 0 58 0 0 0 0 0 59 0 0 0 M 1 60 M 0 1 M 1 61 M M M M 62 0 0 0 0 0 Tot 4 11 10 16 13 (16.1%) (6.4%) (12,9%) (6.4%) (6.4%) (6.4%) (4,9%) (21%) n Crisis Pre-crisis 2011 2010 2009 Tot M (yes = 1; no = 0) 2008 2007 2006 Tot M (yes = 1; no = 0) Panel B 0 0 0 0 0 M 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 M 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 10 0 0 0 0 0 11 0 0 0 0 0 12 0 0 0 0 0 13 0 0 0 0 0 14 0 0 0 M 1 15 0 0 M 0 1 16 0 0 0 M 1 17 0 0 0 0 0 18 0 0 0 0 0 19 0 0 0 0 0 20 0 0 0 0 0 21 0 0 0 0 0 22 M 1 0 0 23 0 0 0 0 0 24 0 0 0 0 0 25 0 0 0 0 0 26 0 M 1 0 0 27 0 0 0 0 0 28 0 M 1 0 0 29 0 0 0 0 0 30 0 0 0 0 0 31 0 0 0 0 0 32 0 0 0 0 0 33 0 0 0 0 0 34 0 0 0 0 0 35 0 0 0 M 1 36 0 0 0 M 1 37 0 0 M M M 38 0 0 0 0 0 39 0 0 0 0 0 40 0 0 0 0 0 41 0 0 0 0 0 42 0 0 0 0 0 43 44 0 0 0 0 0 0 0 0 0 45 0 0 0 0 0 46 0 0 0 0 0 47 0 0 0 0 0 48 0 0 0 M 1 49 0 0 0 0 0 50 0 0 0 0 0 51 0 0 M 0 1 52 0 0 0 0 0 53 0 0 0 0 0 54 0 0 0 M 1 55 0 0 0 0 0 56 0 0 0 0 0 57 0 0 0 0 0 58 0 0 0 0 0 59 0 0 0 M 1 60 M 1 0 M 1 61 M M M M M 62 0 0 0 0 0 Tot 4 15 12 (11.3%) (4.9%) (6.4%) (12.9%) (1.6%) (6.4%) (6.4%) aM stands (19.4%) for manipulator Table 5.17 (extended), panel A (B) reports the number of red flags per company in the crisis and pre-crisis periods, marked italics, and paired differences, marked bold, for 2005–2010 (2006–2011) Table 5.17 (extended) Number of red flags per index for the crisis and pre-crisis periods and paired differences Crisis (2008–2010) Tot Pre-crisis (2005–2007) Tot Differences n dsri gmi aqi sgi acc depi lvgi sgai (8)* (5)** dsri gmi aqi sgi acc depi lvgi sgai (8) (5) (8)*** (5)**** Panel A: (2005–2010) 1 0 0 1 1 0 0 0 0 0 0 1 0 0 1 3 0 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 0 0 1 0 0 1 0 0 0 1 0 0 0 0 0 1 0 0 0 0 0 0 0 10 0 0 0 0 11 1 0 0 0 0 0 0 12 0 0 1 0 0 0 13 0 0 0 1 0 1 0 14 0 0 1 0 0 0 −2 1 0 −2 −1 −2 −1 0 −1 −1 −1 −2 −3 −1 −4 −3 2 −1 0 −1 −1 15 16 0 0 0 0 1 0 1 0 1 0 0 1 0 17 0 0 1 0 0 1 18 0 0 0 0 0 19 0 0 0 0 1 0 0 20 0 0 0 0 0 21 0 1 0 0 0 0 22 0 0 3 0 0 0 0 23 0 0 0 0 0 0 1 24 0 0 0 0 0 0 0 0 25 0 0 0 0 0 0 1 26 0 0 0 0 0 0 0 27 0 0 0 0 0 0 28 1 0 0 0 29 0 0 0 1 0 0 30 0 0 0 0 0 0 0 31 0 0 1 0 0 0 32 0 0 0 1 0 0 0 33 0 0 0 0 0 0 0 34 0 0 1 0 1 0 35 0 0 0 0 0 1 0 36 0 0 0 2 1 0 1 37 0 0 0 1 38 0 0 0 1 0 0 0 39 0 0 0 1 0 0 40 0 0 0 0 0 0 41 0 0 0 0 0 0 0 42 0 0 1 0 0 0 1 43 0 0 0 1 0 0 0 44 0 0 0 1 0 0 0 0 0 45 0 0 0 0 0 0 46 0 0 0 0 0 0 0 0 47 0 0 0 0 0 48 0 0 2 0 0 0 49 0 0 0 1 0 0 0 0 50 0 0 1 0 0 0 51 0 0 0 1 0 0 0 52 0 0 0 0 0 0 0 0 2 53 0 0 0 0 0 0 54 0 0 0 0 0 1 55 0 0 0 0 0 0 1 56 0 0 0 2 0 0 0 57 0 0 0 0 0 0 0 1 58 0 0 0 0 0 0 59 0 0 0 0 1 0 2 −1 1 1 −1 1 −2 −4 −3 0 −3 0 −1 1 −3 −1 −3 1 0 3 3 6 1 1 0 0 0 −1 −1 0 −4 −3 −1 1 −1 0 −1 1 0 −1 −1 −1 0 −2 0 −1 0 2 −3 −1 −1 1 60 61 0 0 0 2 0 0 0 1 1 62 0 0 0 2 0 0 0 24 17 43 Tot 19 12 45 16 29 138 48 0 0 17 10 131 61 −7 −2 13 Crisis (2009–2011) Tot Pre-crisis (2006–2008) Tot Differences n dsri gmi aqi sgi acc depi lvgi sgai (8) (5) dsri gmi aqi sgi acc depi lvgi sgai (8) (5) (8) (5) Panel B: (2006−2011) 1 0 0 0 1 0 0 0 1 2 0 0 0 0 0 0 0 0 0 0 0 1 1 0 1 0 0 0 0 0 0 0 0 0 0 1 0 0 1 0 0 0 0 0 0 0 0 1 0 0 0 0 0 0 10 0 0 0 0 1 11 1 0 1 0 0 0 12 0 0 0 0 0 0 1 13 0 0 0 0 0 0 0 14 0 0 1 0 0 0 15 0 0 0 0 1 1 16 0 0 0 0 0 1 17 0 0 1 0 0 1 18 0 0 0 0 0 19 0 0 1 0 0 0 20 0 0 2 0 0 0 21 0 0 1 0 0 22 0 0 3 0 0 0 0 23 0 0 0 0 0 0 0 0 24 0 0 0 0 0 0 0 0 25 0 0 0 0 0 0 0 26 0 0 0 0 0 0 0 27 0 0 0 0 0 0 0 28 1 0 0 0 0 29 0 0 0 1 0 0 1 30 0 0 1 0 0 0 0 31 0 0 0 0 0 0 32 0 0 0 0 0 0 1 33 0 0 0 0 0 0 0 34 0 0 0 0 1 35 0 0 0 0 0 1 1 0 36 0 0 0 2 1 0 1 37 0 0 0 2 1 38 0 0 0 1 0 0 0 0 0 −4 −1 −2 −1 −2 1 −3 −1 −1 −1 −3 −1 −1 0 2 1 1 −1 −3 1 0 −3 0 −1 0 0 −1 0 −2 0 −1 −1 1 0 0 4 −1 −2 −1 −2 −1 0 1 −3 0 −2 0 −1 39 40 0 0 0 0 0 0 0 0 0 0 0 0 0 0 41 0 0 0 0 0 0 0 42 0 0 0 0 0 0 −1 −2 43 0 0 0 1 0 0 1 44 0 0 0 0 0 0 1 0 45 0 0 0 1 0 0 0 46 0 0 0 0 0 0 1 −1 47 0 0 0 3 0 0 −2 48 0 0 1 0 0 1 −1 1 49 0 0 0 0 0 0 0 0 1 50 0 0 0 1 0 0 0 1 51 0 0 0 0 0 0 1 52 0 0 0 0 0 0 0 0 1 53 0 0 0 1 0 0 0 54 0 0 0 0 0 1 1 55 0 0 0 0 0 0 1 56 0 0 0 3 0 0 0 −1 57 0 0 0 0 0 0 1 58 0 0 0 0 0 1 −1 59 0 0 0 0 0 60 0 0 2 0 1 0 1 −3 61 1 0 4 0 62 0 0 0 1 0 0 0 20 123 41 4 25 15 47 Tot 7 11 13 54 20 21 141 53 18 0 −1 −2 0 12 *(8) is the sum of red flags for all eight of Beneish’s ratios **(5) is the sum of red flags for the five statistically significant Beneish ratios (DSRI, GMI, AQI, SGI, ACC) ***Paired differences (marked bold) were computed as the sum of red flags in pre-crisis periods (marked italics) less the sum of red flags in crisis periods per company considering the eight and five ratios References Ahmad-Zaluki NA, Campbell K, Goodacre A (2011) Earnings management in Malaysian IPOs: the East Asian crisis, ownership control, and post-IPO performance Int J Account 46:111–137 doi:10.1016/j.intacc.2011.04.001 [Crossref] Ahmed K, Godfrey JM, Saleh NM (2008) Market perceptions of discretionary accruals by debt renegotiating firms during economic downturn Int J Account 43:114–138 doi:10.1016/j.intacc.2008.04.002 [Crossref] Arya A, Glover J, Sunder S (1998) Earnings management and the revelation principle Rev Acc Stud 3:7–34 doi:10.1023/a: 1009631714430 [Crossref] Ashbaugh H, LaFond R, Mayhew BW (2003) Do nonaudit services compromise auditor independence? Further evidence Account Rev 78:611–639 doi:10.2308/accr.2003.78.3.611 [Crossref] Bange MM, De Bondt WFM (1998) R&D budgets and corporate earnings targets J Corp Finance 4:153–184 doi:10.1016/s09291199(98)00006-6 [Crossref] Barth ME, Landsman WR (2010) How did financial reporting contribute to the financial crisis? Eur Account Rev 19:399–423 doi:10. 1080/09638180.2010.498619 [Crossref] Beneish MD (1999) The detection of earnings manipulation Financ Anal J 55:24–36 doi:10.2469/faj.v55.n5.2296 [Crossref] Beneish MD, Lee CM, Nichols DC (2013) Earnings manipulation and expected returns Financ Anal J 69:57–82 doi:10.2469/faj.v69.n2.1 [Crossref] Benford F (1938) The law of anomalous numbers Proc Am Philos Soc 78:551–572 Bhaskar R (2008a) A realist theory of science Routledge, New York Bhaskar R (2008b) Dialectic: the pulse of freedom Routledge, New York Bhaskar R (2009) Scientific realism and human emancipation Routledge, New York Bhaskar R (2010) Plato etc: problems of philosophy and their resolution Routledge, New York Bhaskar R (2011) Reclaiming reality: a critical introduction to contemporary philosophy Routledge, New York Bhattacharya U, Daouk H, Welker M (2003) The world price of earnings opacity Account Rev 78:641–678 doi:10.2308/accr.2003.78.3. 641 [Crossref] Bhojraj S, Lee CMC, Oler DK (2003) What’s my line? A comparison of industry classification schemes for capital market research J Account Res 41:745–774 doi:10.1046/j.1475-679X.2003.00122.x [Crossref] Bisman J (2010) Postpositivism and accounting research: a (personal) primer on critical realism Australas Account Bus Finance J 4:3– 25 Bland JM (2000) An introduction to medical statistics, 3rd edn Oxford University Press, Oxford Burgstahler D, Dichev I (1997) Earnings management to avoid earnings decreases and losses J Account Econ 24:99–126 doi:10.1016/ S0165-4101(97)00017-7 [Crossref] Caudill SB, Holcombe RG (1987) Coefficient bias due to specification search in econometric models Atl Econ J 15:30–34 doi:10.1007/ BF02316884 [Crossref] Charoenwong C, Jiraporn P (2009) Earnings management to exceed thresholds: evidence from Singapore and Thailand J Multinatl Financ Manag 19:221–236 doi:10.1016/j.mulfin.2008.12.001 [Crossref] Chia YM, Lapsley I, Lee HW (2007) Choice of auditors and earnings management during the Asian financial crisis Manag Audit J 22:177–196 doi:10.1108/02686900710718672 [Crossref] Choi J-H, Kim J-B, Lee JJ (2011) Value relevance of discretionary accruals in the Asian financial crisis of 1997–1998 J Account Public Policy 30:166–187 doi:10.1016/j.jaccpubpol.2010.09.002 [Crossref] Collier A (2005) Philosophy and critical realism In: Steinmetz G (ed) The politics of method in the human sciences: positivism and its epistemological others Duke University Press, Durham, pp 327–345 [Crossref] Dechow PM (1994) Accounting earnings and cash flows as measures of firm performance J Account Econ 18:3–42 doi:10.1016/01654101(94)90016-7 [Crossref] Dechow PM, Kothari SP, Watts RL (1998) The relation between earnings and cash flows J Account Econ 25:133–168 doi:10.1016/ s0165-4101(98)00020-2 [Crossref] Dechow PM, Sloan RG, Sweeney AP (1995) Detecting earnings management Account Rev 70:193–225 DeFond ML, Jiambalvo J (1994) Debt covenant violation and manipulation of accruals J Account Econ 17:145–176 doi:10.1016/01654101(94)90008-6 [Crossref] Degeorge F, Patel J, Zeckhauser R (1999) Earnings management to exceed thresholds J Bus 72:1–33 doi:10.1086/209601 [Crossref] Dyck A, Morse A, Zingales L (2013) How pervasive is corporate fraud Rotman School of Management Working Paper No 2222608 Eisenhardt KM (1989) Agency theory: an assessment and review Acad Manag J 14:57–74 doi:10.5465/amr.1989.4279003 Fleetwood S (2011) Powers and tendencies revisited J Crit Realism 10:80–99 doi:10.1558/jcr.v10i1.80 [Crossref] Fridson MS, Alvarez F (2011) Financial statement analysis: a practitioner’s guide, vol 597 Wiley, New York Goh J, Lee H-Y, Lee J-W (2013) Majority shareholder ownership and real earnings management: evidence from Korea J Int Financ Manag Account 24:26–61 doi:10.1111/jifm.12006 [Crossref] Golden TW, Skalak SL, Clayton MM (2006) A guide to forensic accounting investigation Wiley, New York Greenwald AG, Pratkanis AR, Leippe MR, Baumgardner MH (1986) Under what conditions does theory obstruct research progress? Psychol Rev 93:216–229 doi:10.1037/0033-295x.93.2.216 [Crossref] Grove H, Basilico E (2011) Major financial reporting frauds of the 21st century: corporate governance and risk lessons learned J Forensic Investig Account 3:191–226 Grove H, Cook T (2004) Lessons for auditors: quantitative and qualitative red flags J Forensic Account 5:131–146 Guay WR, Kothari SP, Watts RL (1996) A market-based evaluation of discretionary accrual models J Account Res 34:83–105 doi:10. 2307/2491427 [Crossref] Habib A, Bhuiyan BU, Islam A (2013) Financial distress, earnings management and market pricing of accruals during the global financial crisis Manag Finance 39:155–180 doi:10.1108/03074351311294007 Harre R, Madden EH (1975) Causal powers: a theory of natural necessity Blackwell, Oxford Harrington C (2005) Detecting financial statement fraud Fraud Magazine, Texas Hartwig M (2007) Dictionary of critical realism Routledge, London Healy PM (1985) The effect of bonus schemes on accounting decisions J Account Econ 7:85–107 doi:10.1016/0165-4101(85)90029-1 [Crossref] Healy PM, Wahlen JM (1999) A review of the earnings management literature and its implications for standard setting Account Horizons 13:365–383 doi:10.2308/acch.1999.13.4.365 [Crossref] Hrazdil K, Scott T (2013) The role of industry classification in estimating discretionary accruals Rev Quant Financ Acc 40:15–39 doi:10. 1007/s11156-011-0268-6 [Crossref] Hribar P, Collins DW (2002) Errors in estimating accruals: implications for empirical research J Account Res 40:105–134 doi:10.1111/ 1475-679x.00041 [Crossref] Hsu GCM, Koh P-S (2005) Does the presence of institutional investors influence accruals management? Evidence from Australia Corp Gov Int Rev 13:809–823 doi:10.1111/j.1467-8683.2005.00472.x [Crossref] Iatridis G, Dimitras AI (2013) Financial crisis and accounting quality: evidence from five European countries Adv Account 29:154–160 doi:10.1016/j.adiac.2013.03.001 [Crossref] Jaggi B, Tsui J (2007) Insider trading, earnings management and corporate governance: empirical evidence based on Hong Kong firms J Int Financ Manag Account 18:192–222 doi:10.1111/j.1467-646x.2007.01012.x [Crossref] Jones JJ (1991) Earnings management during import relief investigations J Account Res 29:193–228 doi:10.2307/2491047 [Crossref] Jones KL, Krishnan GV, Melendrez KD (2008) Do models of discretionary accruals detect actual cases of fraudulent and restated earnings? An empirical analysis Contemp Account Res 25:499–531 doi:10.1506/car.25.2.8 [Crossref] Kim J-B, Yi CH (2006) Ownership structure, business group affiliation, listing status, and earnings management: evidence from Korea Contemp Account Res 23:427–464 doi:10.1506/7t5b-72fv-mhjv-e697 [Crossref] Klauer KC, Musch J, Naumer B (2000) On belief bias in syllogistic reasoning Psychol Rev 107:852–884 doi:10.1037//0033-295x.107.4. 852 [Crossref] Klayman J, Ha Y-W (1987) Confirmation, disconfirmation, and information in hypothesis testing Psychol Rev 94:211–228 doi:10.1037// 0033-295x.94.2.211 [Crossref] Koh P-S (2003) On the association between institutional ownership and aggressive corporate earnings management in Australia Br Account Rev 35:105–128 doi:10.1016/s0890-8389(03)00014-3 [Crossref] Kothari SP, Leone AJ, Wasley CE (2005) Performance matched discretionary accrual measures J Account Econ 39:163–197 doi:10. 1016/j.jacceco.2004.11.002 [Crossref] Kousenidis DV, Ladas AC, Negakis CI (2013) The effects of the European debt crisis on earnings quality Int Rev Financ Anal 30:351– 362 doi:10.1016/j.irfa.2013.03.004 [Crossref] Lawson T (1997) Economics and reality Routledge, New York [Crossref] Lee BB, Seo SD (2010) Reforms in the Korean financial reporting systems and earnings quality Asia-Pacific Financ Mark 17:51–61 doi:10.1007/s10690-009-9101-9 [Crossref] Leuz C, Nanda D, Wysocki PD (2003) Earnings management and investor protection: an international comparison J Financ Econ 69:505–527 doi:10.1016/S0304-405X(03)00121-1 [Crossref] Lev B, Thiagarajan SR (1993) Fundamental information analysis J Account Res 31:190–215 doi:10.2307/2491270 [Crossref] Luchs C, Stuebs M, Sun L (2009) Corporate reputation and earnings quality J Appl Bus Res (JABR) 25(4):47–54 doi:10.19030/jabr. v25i4.1016 Mande V, File RG, Kwak W (2000) Income smoothing and discretionary R&D expenditures of Japanese firms Contemp Account Res 17:263–302 doi:10.1506/QXBV-UY71-A6W1-FWT4 [Crossref] Masruki R, Azizan NA (2010) The impact of Asian financial crisis to earnings management and operating performance in Malaysia J Int Finance Econ 10:38–46 Miller KD, Tsang EWK (2011) Testing management theories: critical realist philosophy and research methods Strateg Manag J 32:139– 158 doi:10.1002/smj.868 [Crossref] Mingers J, Mutch A, Willcocks L (2013) Critical realism in information systems research MIS Q 37:795–802 Nickerson RS (1998) Confirmation bias: a ubiquitous phenomenon in many guises Rev General Psychol 2:175–220 doi:10.1037/10892680.2.2.175 [Crossref] Nietzsche FW (1888) Twilight of the idols (The portable nietzsche trans Walter Kaufmann) Penguin, New York Oxford Dictionaries (2014) Definition of ‘crisis http://oxforddictionaries.com/definition/english/crisis Accessed 15 Sep 2014 Perry S, Grinaker R (1994) Earnings expectations and discretionary research and develop Account Horizons 8:43 Pittman FS, Wagers TP (2005) Teaching fidelity J Clin Psychol 61:1407–1419 doi:10.1002/jclp.20190 [Crossref] Rajgopal S, Venkatachalam M (1998) The role of institutional investors in corporate governance: an empirical investigation In: Working paper Graduate School of Business, Stanford University Roychowdhury S (2006) Earnings management through real activities manipulation J Account Econ 42:335–370 doi:10.1016/j.jacceco. 2006.01.002 [Crossref] Rusmin R, Scully G, Tower G (2013) Income smoothing behaviour by Asian transportation firms Manag Audit J 28:23–44 doi:10.1108/ 02686901311282489 [Crossref] Ryan RM, Deci EL (2000) Intrinsic and extrinsic motivations: classic definitions and new directions Contemp Educ Psychol 25:54–67 doi:10.1006/ceps.1999.1020 [Crossref] Saleh NM, Ahmed K (2005) Earnings management of distressed firms during debt renegotiation Account Bus Res 35:69–86 doi:10. 1080/00014788.2005.9729663 [Crossref] Schopenhauer A (1896) The art of controversy: and other posthumous papers, vol S Sonnenschein & Company, London Scott DW (1979) On optimal and data-based histograms Biometrika 66:605–610 doi:10.2307/2335182 [Crossref] Seneca LA (1920 [C 62–65 AD]) Ad lucilium epistulae morales (English translation by Gummere RM), vol Heinemann, London Smith M, Kestel J-A, Robinson P (2001) Economic recession, corporate distress and income increasing accounting policy choice Account Forum 25:334–352 doi:10.1111/1467-6303.00070 [Crossref] Stanovich KE, West RF (2007) Natural myside bias is independent of cognitive ability Think Reason 13:225–247 doi:10.1080/ 13546780600780796 [Crossref] Teoh SH, Wong TJ, Rao GR (1998) Are accruals during initial public offerings opportunistic? Rev Acc Stud 3:175–208 doi:10.1023/a: 1009688619882 [Crossref] Tilden C, Janes T (2012) Empirical evidence of financial statement manipulation during economic recessions J Finance Account 12:1–15 Velury U, Jenkins DS (2006) Institutional ownership and the quality of earnings J Bus Res 59:1043–1051 doi:10.1016/j.jbusres.2006.05. 001 [Crossref] Vladu AB (2013) Smoothing behavior of firms in times of crisis: empirical evidence from the Spanish economic environment Annales Universitatis Apulensis: Series Oeconomica 15:473–480 Wahlen JM, Baginski SP, Bradshaw M (2010) Financial reporting, financial statement analysis and valuation: a strategic perspective Cengage Learning, Boston Walsh P, Craig R, Clarke F (1991) ‘Big bath accounting’ using extraordinary items adjustments: Australian empirical evidence J Bus Finance Account 18:173–189 doi:10.1111/j.1468-5957.1991.tb00587.x [Crossref] Wells JT (2001) Irrational ratios J Account 192:80–83 Yu FF (2008) Analyst coverage and earnings management J Financ Econ 88:245–271 doi:10.1016/j.jfineco.2007.05.008 [Crossref] Footnotes The sample selection process will be discussed in Sect 5.2.3 Institutional investors (e.g., insurance companies, superannuation and pension funds, investment trusts, financial institutions, etc.) play an active role in monitoring and disciplining managerial discretion (Hsu and Koh 2005), and generally encourage high quality of reported earnings (Velury and Jenkins 2006) Rajgopal and Venkatachalam (1998) find that institutional ownership is associated with less discretionary accruals manipulation Specifically their findings are “consistent with institutional investors monitoring managers and thus constraining them from engaging in accrual manipulation” (Rajgopal and Venkatachalam 1998, p 3) The year 2010 was excluded since the study focuses on the Gfc and not on the current sovereign European debt crisis The Jones (1991) model and the subsequent versions of it developed by Dechow et al (1995) and by Kothari et al (2005), and other earnings management detection tools are presented in Chap 2, Appendix Beneish’s model will be presented in Sect 5.2.2 These ratios are defined in Sect 5.2.2 Big bath accounting is a managerial stratagem (Walsh et al 1991) based on the assumptions that “when circumstances are bad, making things just a little bit worse by cleaning out the rubbish does little harm to either reputation or prospects” and that “little damage will ensue when the market is so depressed that nothing can hurt it more” (Walsh et al 1991, p 174) Under the big bath hypothesis, managers may undertake income-decreasing strategies in lean years, perhaps believing “that one very poor performance report is not as harmful as several mediocre performance reports (Arya et al 1998, p 8) Even firms not severely affected by financial crisis may engage in income-reducing activity to benefit from improved borrowing conditions or extract more government support (Saleh and Ahmed 2005) Accordingly, “managers may have recognized that the market tolerates poor performance during an external shock (crisis) environment, so they may have depressed earnings further, via accruals, to enable greater post-shock performance improvements to the benefit of managers’ reputations” (Habib et al 2013, p 158) Therefore, “conventional wisdom suggests that an economic crisis should encourage managers to adopt big bath accounting” (Habib et al 2013, p 159) Beneish (1999) used a total accruals variable named TATA (Total Accruals to Total Assets) In the earlier version of the M-score total accruals are calculated as the change in working capital accounts except of cash less depreciation: The mean values for manipulators (non-manipulators) calculated by Beneish are as follows DSRI: 1.412 (1.030); GMI: 1.159 (1.017); AQI: 1.228 (1.031); SGI: 1.581 (1.133); DEPI: 1.072 (1.007); SGAI: 1.107 (1.085); ACC: 049 (.015); LVGI: 1.124 (1.033) 10 I acknowledge that the sample may seem to be small compared with those in previous research However, according to the central limit theorem, as the sample is greater than or equal to 30, it should not be considered to be small 11 For 2005–2010, SGAI (39), LVGI (33), ACC (29), GMI (17), DSRI (12), and SGI (8); for 2006–2011, AQI (36), LVGI (28), ACC (28), GMI (11), DSRI (11), SGI (8) 12 Lucius Annaeus Seneca used the word “crisin” in Epistulae Morales ad Lucilium, Liber X, 83, in which he reflects upon his advancing years: “Hic quidem ait nos eandem crisin habere, quia utrique dentes cadunt” (Seneca 1920 [C 62–65 AD], p 258) 13 An example, may clarify my reservations Consider extramarital affairs: the discovery of a secret extramarital affair may cause a matrimonial crisis, of which the fraudulent behavior is considered to be the cause More in general, the betrayal of trust is thought to be the cause of the crisis Yet, “trust (i.e., the unchallenged assumption that things will continue to be as they always have been) does not bring people together Coming together requires intimacy (i.e., knowing one another) And knowing one another comes from handling crises, mourning and celebrating together, and talking about crises with one another until they can read one another’s minds” (Pittman and Wagers 2005, p 1413) Thus, the loss of intimacy, as opposed to the extramarital affair or the betrayal of trust, might be seen as a “generative mechanism” (Bhaskar 2009, p 18) that potentially causes marital crisis, i.e the loss of intimacy is the disease that leads the couple to reach a point in which a decision is needed Accordingly, I believe that the loss of intimacy, as well as other generative mechanisms, such as the betrayal of trust, might be seen as “structures at work” (Bhaskar 2011, p 2) operating simultaneously in an open social system and that there might be “offsetting factors or countervailing causes” (Bhaskar 2008a, p 88), which might or might not prevent the marital crisis 14 Hartwig (2007) entry on “tendencies” in the Dictionary of Critical Realism defined enabling conditions as “the positive form of causality possessed by a causal power or powers (as distinct from the negative form of a constraint) or the generative mechanisms that give rise to a tendency Moreover, it defined stimulating conditions as “all those factors that trigger, facilitate or reinforce the exercise of a tendency, some of which may involve an element of contingency” and releasing conditions as “the circumstances in which countervailing factors are either absent or weak—there are few or no impediments to the exercise of a tendency” 15 Only the first five tendencies are presented in this subsection 16 Bhaskar (2008a) observed: “Offsetting causes are often assumed to be always extrinsic But the cause of a failure of a car to move when the gear is in neutral is not something distinct from and extraneous to the mechanism responsible for its normal motion […] Now intrinsic offsetting causes may or may not directly interfere with the operation of the mechanism responsible for the satisfaction of the intrinsic enabling conditions If they then we must say that the tendency2 is no longer possessed” (p 225) 17 “Extrinsic motivation” is a construct that pertains to whenever an activity is carried out in order to attain some separable outcome It thus contrasts with intrinsic motivation, which refers to carrying out an activity simply for the enjoyment of the activity itself, rather than its instrumental value (Ryan and Deci 2000, p 60) ... manipulation, and focuses on two types of earnings management: accruals earnings management and real activities earnings management Both accruals earnings management and real activities earnings management. .. 2.2 Definitions of Earnings Management, Earnings Quality, Fraud, and Earnings Manipulation 2.3 Accruals Earnings Management, Real Activities Earnings Management, and Fraudulent Financial Reporting... concepts of earnings quality, earnings management, fraud, and earnings manipulation In line with prior studies, it focuses on two types of earnings management: accruals earnings management and real