Can unconditional conservatism be opportunistic? Evidence from subsequent real earnings management at Business groups
Description
By focusing on the more pervasive phenomenon of unconditional conservatism, this study provides fresh insights into how conservatism can potentially undermine financial reporting quality. We examine whether unconditionally conservative (UC) firms engage in higher levels of real earnings management (REM) in order to meet or beat earnings benchmarks (MBE). UC firms, by their nature, tend to exhibit prudence, reflected in persistently lower reported earnings. In contrast, REM represents a costly strategy—with long-term consequences—used to inflate earnings. Consistent with expectations, we find that UC firms exhibit higher discretionary expenses. However, UC firms suspected of engaging in MBE reduce these expenses (a form of REM) by 0.5 to 2 percent of earnings. Our findings also reveal differences in manipulation strategies across organizational forms: group-affiliated UC firms employ this approach more opportunistically. We further find that stronger monitoring mechanisms are associated with lower levels of REM in UC firms. Additionally, accrual-based manipulation and insider ownership significantly influence a UC firm’s choice of REM strategies. Overall, our results suggest that decisions related to real earnings management and conservative reporting policies are closely intertwined, contributing to the broader debate on whether conservatism enhances or diminishes reporting quality. The study highlights opportunistic behavior and the real economic costs associated with conservative reporting, which is somewhat counterintuitive and raises important regulatory concerns that merit attention from standard setters and policymakers.
Copyright Date
January 2017
Publication Date
1-1-2017
Keywords
Prudence, Financial reporting quality, Opportunism, Monitoring, International financial reporting standards (IFRS), Emerging markets, Business groups, Insider ownership, India
Conference
American Accounting Association annual meeting, 5-9 August, 2017, San Diego, USA
