Earnings Management through Real activities Manipulation
Purpose:
Earnings management is a strategy where Company can easily control and manipulate their earnings to reach their pre-determined earning target. The purpose of this article is to develop empirical methods to detect earnings management through real activities manipulation. Companies reducing discretionary expenditures by increasing price discounts which increases sales temporarily, also overproduction report lower cost of goods sold. I think, real activities manipulation is influenced by the stock of inventories and receivables, incentives to meet zero earnings and the industry membership. Is earnings management good or bad and who is responsible to constrain earnings management? How does market react to firm's earnings management behavior?
Hypotheses:
Companies and accountants cannot predict every business structure, every new and innovative transaction. Therefore, they build up principles that allow for flexibility so that they can adapt to changing circumstances. Also companies use of that flexibility and they employ earnings management techniques to shade financial unpredictability. I think, the real results of the decisions of the management are veiled. In this article, there were two main hypotheses that are stated in alternative form, are the following:
H1A. After controlling for sales level, suspect company years shows evidence of at least one of the following: abnormally low cash flow from operations (CFO) OR abnormally low discretionary expenses.
H2A. After controlling for sales level, suspect company years shows exhibit abnormally high production costs.
Data:
The data for the sample was the all the firms in the COMPUSTAT and the data were collected from the period 1987-2001. These data was also available on the database of the Thomson Financial on 13f filings. It also reduced data from