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Empirical Research on Financial Notes to the Accounts and Earnings Management

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Birk, Michael (2018) Empirical Research on Financial Notes to the Accounts and Earnings Management. PhD thesis, University of Gloucestershire.

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Abstract

Managers can influence the amount of net income their firm reports by variation in the application of accounting policies or by making real cash flow decisions. 'Earnings management' is the term given when such choices or decisions distort the fair presentation of earnings. Such earnings management activities can lead to negative consequences in the long-term. Accounting scandals in the past have shown that earnings management can even threaten the existence of a firm. Therefore, it is of crucial importance to detect and restrict earnings management. The notes to the accounts can provide information, which is otherwise not presented on the face of the financial statements. Especially the accounting policy disclosures improve the understanding about a firm’s current and future earnings. According to the comparability theory, there should be comparable accountings of firms in the same industry that are subject to similar economic events. Extending this theory, managers of comparable firms should translate the same economic events into similar notes to the accounts and contain similar earnings and discretionary accruals. Therefore, this PhD thesis examines whether similar notes to the accounts are negatively associated with a firm’s propensity to manage earnings. This means that the effect of similar textual accounting policy disclosures or rather notes relative to other firms in the same industry is tested on both, accrual-based and real earnings management proxies. This research uses detail-tagged XBRL notes from SEC EDGAR system as data source. To operationalize the within-industry similarity of the XBRL-formatted notes, the co-sine similarity measure was utilized in this study. Two different similarity scores of the notes are adopted. First, the full set of accounting policy disclosures and second, the revenue recognition disclosures. The key findings demonstrate that firms with more similar notes of the previous year conduct less accrual-based earnings management activities in the following fiscal year. Also, the empirical analyses show that more similar accounting policy and revenue recognition disclosures are negatively associated with real earnings management activities. Collectively, these results indicate that firms with an overall better accounting information environment as measured by more similar notes, relative to industry peers, engage in less accrual-based and real earnings management activities in the following year.

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Thesis (PhD)

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