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Introduction
The phenomenon of earnings management includes the factor of the companies’ ability to surpass the earnings threshold. The main issue is that a prevailing number of firms just meets or merely exceeds the benchmark of having positive profit compared to the very small number of extreme cases when the companies either do not meet the threshold or exceed substantially it (DeFond and Park 121). Such a phenomenon can be interpreted as a result of earnings management. Therefore, it is important to analyze the correlation between the income management and the benefits of the executives, as well as managerial stock sales. Moreover, the variations of financial reporting and the acts of earnings management can be explained by the factor of the availability of different potential benefits.
Hypothesis development, data, and variables definition
The important aspect of the incentives of the earnings management is that the substantial part of the managerial compensation depends on the stock sales factor. Therefore, in the situation, where the compensation and benefits are stock-based, and the forecasts of the analysts also focus on the short-run performance of the company, there is all the more motivation for the earnings management among the companies’ executives.
Another major motivation for applying earnings management is the necessity to represent the company’s performance in the right light. The study conducted by McVay, Nagar, and Tang (2006) analyzed the data collected from the 21,952 companies that, according to their financial reporting, just met the benchmark of the positive earnings, not exceeding it for more than 1%. The main variables that differ the firms that have just met or insignificantly exceed the threshold from the companies that deviate from the forecasts are their “performance, equity issuances, long-term growth prospects, and lagged insider sales” (McVay, Nagar and Tang 576).
Therefore, the main hypothesis is that the companies that are just meeting the benchmark of the short-run performance forecasts are more likely to have managerial insider sales and equity rates than those companies that largely deviated from the forecasts. Furthermore, the probability of boosting the stock sales after the reported meeting of benchmarks is also relatively high in the companies not deviating from the forecasts. It leads to the assumption that insider stock sales can be associated with the lack of control over the performance by the directors and the poor overall governance (Klein 398).
Results
The determination among the executives to meet earnings benchmarks is the result of the generally accepted assumption that the success and performance of the company can be linked to a certain set of expectations (Penman and Zhang 257). This factor is not only important in presenting information to the outside audiences but also relevant concerning the analysts’ forecasts. There are two ways of acting for meeting those standards.
The first one is for the company to undergo real economic actions that would influence the cash flow (Hand 599). The second one is the earnings management that only takes place in accruals, such as delaying the reporting of the payment in the financial documents or oppositely reporting the future profits. The objectives of such earnings management are information symmetry, corporate control contests, stock compensation (Healy and Palepu 410).
Conclusion
In conclusion, the major driver of earnings management is the motivations of the executives. The majority of their incentives relate to the attempts to meet the analysts’ forecasts. One of the most significant indicators of managerial efforts to benefit from earnings management is high rates of insider stock sales.
Works Cited
DeFond, Mark, and Chul Park. “Smoothing Income in Anticipation of Future Earnings.” Journal of Accounting and Economics 23.2 (1997): 115-139. Print.
Hand, John. “1988 Competitive Manuscript Award: Did Firms Undertake Debt-Equity Swaps for an Accounting Paper Profit or True Financial Gain?” Accounting Review 1.1 (1989): 587-623. Print.
Healy, Paul, and Krishna Palepu. “Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature.” Journal of Accounting and Economics 31.1 (2001): 405-440. Print.
Klein, April. “Audit Committee, Board of Director Characteristics, and Earnings Management.” Journal of Accounting and Economics 33.3 (2002): 375-400. Print.
McVay, Sarah, Venky Nagar, and Vicki Wei Tang. “Trading Incentives to Meet the Analyst Forecast.” Review of Accounting Studies 11.4 (2006): 575-598. Print.
Penman, Stephen, and Xiao-Jun Zhang. “Accounting Conservatism, the Quality of Earnings, and Stock Returns.” The Accounting Review 77.2 (2002): 237-264. Print.
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