Healy, Paul M, and Wahlen, James M. (1999). A Review of the Earnings Management Literature and Its Implications for Standard Setting.

INTRODUCTION

The main purpose of this review is to examine the scholarly evidence on earnings management to help standard setters and regulatory agencies assess the degree of earnings management and the integrity of financial reporting and to identify future opportunities for future research on earnings management. Through the examination of earnings management, standard setters can determine the degree of earnings management use and if investors, creditors, or regulatory bodies are being deceived. There can be major consequences if the previously mentioned people and bodies are misled.
Investors rely heavily on financial information from a company’s management. If this information is misleading, a lot of money can be lost. Another group that relies on the integrity of a company is creditors. Creditors can be liable for the loss of capital if a company goes into bankruptcy and the creditor bases everything (interest rates, money borrowed) off of the financial position of a company. Financial misrepresentation can have a major effect on these financial institutions. Regulatory agencies are also affected by earnings management and can be deceived by companies that are trying to dodge industry regulations, have regulations changed, or seek industry relief.

REVIEW/BACKGROUND

The major issues examined in this review include: tests of earnings management incentives, contracting motivations, regulatory motivations, and tests of distribution of reported earnings and accruals. Tests of earnings management incentives have been difficult for researchers to document because researchers have to estimate earnings before the effects of earnings management. Contracting motivations are of interest to standard setters because it can lead