Earnings Management Types and Motivation: A Study in Taiwan

Article excerpt

Earnings management is an important issue in the study of modern accounting theories. Earnings management occurs when managers apply their judgment to financial reporting, and/or construction of transactions in order to change financial reports and mislead stakeholders on issues concerning the operational performance of companies or they may alter the contractual results based on accounting numbers. In other words, earnings management, also known as earning manipulation, is an accounting sleight of hand that managers use to meet earnings expectations. This is achieved by altering information and financial reports (Goel & Thakor, 2003). Although many countries worldwide have emphasized good corporate governance, it is nevertheless a global phenomenon (Collins & Kothari, 1989). Managers are still engaged in earnings manipulations in countries where lax corporate governance structure allows managers to operate with the goal of increasing their personal wealth by sacrificing the interests of shareholders (Scott, 2006). Davis-Friday and Frecka (2002) suggested that earnings management and its prevalence is relevant to legitimacy and moral standards issues, and reflects the interest of management, rather than the true performance of their companies.

The most commonly used method in earnings management is the manipulation of discretionary accruals analysis because it is easy to practice, has low manipulation costs, and is not easily identified by readers of financial reports. However, as measurement models of discretionary accruals are becoming increasingly robust, the manipulation of discretionary accruals is increasingly easy to detect (Graham, Harvey, & Rajgopal, 2005). Therefore, many companies have abandoned earnings management with discretionary accruals, and there is growing evidence that the manipulation of discretionary accruals is no longer the main method for earnings management (Roychowdhury, 2006; Eldenburg, Gunny, Hee, & Soderstrom, 2008).

Schipper (1989) argued that the manipulating of operational activities in order to purposefully intervene in financial reporting and achieve personal gain should be defined as a type of earnings management. Burgstahler and Dichev (1997) found that corporations often used cash flows from operating activities and working capital to manage earnings. Managers changed operational activities or decisions in order to produce earnings that met specific targets. This type of earnings management is called real activities manipulation. Dechow and Skinner (2000) indicated that managers could manipulate earnings by moving forward the recognition of revenues, changing delivery schedules, or delaying the recognition of research and development to maintain expenses. Thomas and Zhang (2002) found that companies reduced costs of overproduction of goods through sale to meet earnings targets. Penman and Zhang (2002) suggested that under a conservative accounting regime, companies enhance earnings by reducing capital investments. Pincus and Rajgopal (2002) found that managers were using derivatives and accruals to manage earnings in order to stabilize profits and losses.

However, in most studies of real activities manipulation the focus is on comparing discretionary accrual measurements with the levels of those measurements. Consequently, the nature of real activities manipulation, such as the correlation between earnings management and managers' and accountants' motivation is overlooked. Therefore, in this paper a real activities manipulation model was used to analyze earnings management behavior, and to conduct clustering analysis to classify these behaviors and explore earnings management motivation.



An analysis on earnings management requires statistics and financial reports. Therefore, in this study the companies listed on Taiwan's Over the Counter (OTC) market and Taiwan Stock Exchange were used to compile data. …