Effect of the Financial Security Law on Real and Accrual-Based Earnings Management: An Empirical Evidence Form Tunisia

Article excerpt


Earnings management is a much studied research topic in financial accounting. Empirical studies have documented various approaches in detecting earnings management behavior. For manipulation of earnings, managers have a variety of choices to increase or decrease earnings (Sun and Rath, 2010). Although there are quite a number of earnings management methods recognized in the literature, two of them receive the lion's share of attention. First, the most popular method is accruals management where managers exercise their discretion over the choices of accounting policies and estimations to affect earnings (Healy, 1999; Jones, 1991; Dechow et al., 1995). Second, managers can make sup-optimal real operation decisions to manipulate earnings (Schipper, 1989; Roychowdhury, 2006).

There is substantial evidence that managers engage in accounting earnings management (AEM) and/or real earnings management (REM) to achieve certain earnings targets (Zang, 2007; Cohen and Zarowin, 2008; Chen et al., 2008).

AEM refers to managers' opportunistic use of the flexibility allowed under General Accepted Accounting Principles (GAAP) to change reported earnings without changing the underlying cash flows. REM refers to managers' opportunistic timing and structuring of operating, investment and financing transactions to affect reported earnings in a particular direction; it results in sub-optimal business consequences and imposes a real cost on the firm.

The main goal of the Sarbanes-Oxley Act of 2002 (SOX) was to protect investors by improving the accuracy and reliability of information disclosure. Various U.S. studies compare earnings quality measures before and after SOX, and indeed report evidence suggesting that earnings quality has improved after SOX (see for example Cohen et al. (2008). Similarly, in Tunisia, the implementation of the financial security law of 2005 seeks to achieve greater transparency and improve the credibility of financial information. Consequently, the principal objective of the law no. 2005-96 was to constrain the earnings management in the Tunisian companies.

The purpose of this study, on the one hand, explains how managers manipulate earnings through accruals and/or real earnings management and, on the other, shows the effect of the adoption of the law no. 2005-96 on the reduction of the likelihood of earnings management in the Tunisian context.

The first objective of this study is to test whether managers manipulate earnings through discretionary accruals and/or real earnings management strategically according to the level of the pre-managed earnings relative to the earnings targets. The second objective is to investigate whether managers use accrual-based and real activity earnings management as complementary or substitutive approaches. The third objective is to examine the impact of the adoption of the law of financial security of 2005 on the reduction of the extent of earnings management in the Tunisian context.

This paper contributes to the literature on earnings management in several ways. We extend ongoing research investigating the characteristics and extent of earnings management. In addition, most studies, in the literature of earnings management, examine separately the two approaches AEM and REM except a few recent works (Graham et al., 2005; Cohen et al., 2008; Sam and Tina, 2011). Yet, to our knowledge, none study examines the real earnings management in the Tunisian company and evaluates of implication of the financial security law of 2005 on the reduction of the extent of REM and AEM.

The remainder of this paper is organized as follows. Section 2 reviews past related literature and develops our test hypotheses. Section 3 outlines the research design and describes the empirical data. Section 4 presents and discusses empirical findings.

Literature Review and Hypothesis

The academic literature has studied earnings management through the manipulation of discretionary accruals (e. …