Additional Notes on Earnings Management (PDF)

College 1: Information content: - Do earnings capture info that is contained in stock price Timeliness - Do earnings convey new info to the stock market College 2: Accruals: - Revenue recognition principle - Matching principle College 3: Use of earnings management to: - Mislead...

College 1: Information content: - Do earnings capture info that is contained in stock price Timeliness - Do earnings convey new info to the stock market College 2: Accruals: - Revenue recognition principle - Matching principle College 3: Use of earnings management to: - Mislead stakeholders or shareholders about true economic performance - Influence contractual outcomes - Accrual EM - Real EM - Big bath accounting - Income minimisation - Income maximisation - Income smoothing - Capital markets - Two main research areas - Capital market transactions - Capital market expectations - Contracting - Compensation contracts - Debt contracts - Regulatory - Anti-trust regulation and other political considerations - Detection of EM - Accounting analysis - Asset distortion - Under-/overstatement assets through depreciation, amortization, impairment and timing of revenue - Liability distortion - Unearned revenue, provisions, pension obligations - Equity distortion - Reclassification financial instruments College 4 - Conditional conservatism - Book values are written down under adverse circumstances but not written up under favourable circumstances. - Unconditional conservatism - Predetermined application of conservative accounting policies - Accelerated depreciation of tangible assets - Immediate amortization of intangible assets - LIFO vs FIFO - Reasons conservatism - Contracting - Limiting moral hazard caused by asymmetric info - Litigation - More likely when assets are overstated - Taxation - Delaying recognition revenue and accelerate recognition of expenses to defer tax payments - Regulation - Preventing macroeconomic shocks - Losses of overstated assets usable in political proces - Measurement - Formula variables - B0: timeliness of earnings for good news - B1: measure difference in sensitivity to earnings to negative and positive news College 5: - Types of disclosure - Mandatory - Voluntary - Healy and Palepu: - Motives - Capital market transactions hypothesis - Corporate control contest hypothesis - Litigation cost hypothesis - Management talent signalling hypothesis - Proprietary cost hypothesis - Credibility of voluntary disclosure - Two mechanisms - Assurance by third party intermediaries - Validation through mandatory disclosure (e.g. expected vs actual) - Limitations - Endogeneity - Firms size - Financial health - High corporate governance quality - Earnings quality - Disclosure quality = disclosure quality? - Economic consequences of voluntary disclosure - Improved stock liquidity - Reduced cost of capital College 6 - Difference capital/financial lease vs operating lease - Risk/reward transferred: capital lease - Risk/reward remain with lessor: operating lease