Academic journal article Journal of International Business Research

Japanese Managers' Earnings Management Using Several Different Types of Reserve Accounts

Academic journal article Journal of International Business Research

Japanese Managers' Earnings Management Using Several Different Types of Reserve Accounts

Article excerpt


The Japanese economy was booming in the late 1980s. Now it is slowly trying to regain its economic glory days which preceded the market crash in 1990. Many of its leading industries lost their worldwide leadership positions to South Korea and other countries. Samsung has the highest market share in the world TV market surpassing Sony and Panasonic, even though Toyota is still the best auto manufacturing company in the world (http//, February, 27, 2007). Since Japan does not own natural resources such as oil and lumber, most of their success depends on exports and the world economy. Currently China and other developing countries are demanding increasing quantities of oil. As a consequence, Japan still will continue to face hard times as long as oil prices remain high.

Japan is a unique country from the capital structure perspective. The Japanese capital structure has moved toward that of the U.S. and other western countries' systems after the market crash,. However, their government still has a large impact and their system is more tax oriented than those of western countries. In addition, Japanese corporations have more reserve accounts than those of any other country in the world. It is interesting to see how their corporate managers use these reserve accounts to manage corporate earnings to meet their goals.

Previous studies have used U.S. capital market data to understand managers' motivations regarding earnings management. Managers may have motivation to manage earnings to maximize their bonuses or to maintain target income levels. However, the U.S. and Japan have different capital and business environments. Under different capital and business environments, managers may or may not behave the same way to satisfy their self-interests. This is an interesting issue that we need to test using actual Japanese data.

The purpose of this study is to test the earnings management behavior of Japanese managers using different types of reserve accounts. Typical Japanese firms maintain ten or more reserve accounts and they are legally allowed to set up reserves for their guaranteed obligations starting from April 20, 1982 (Takahashi, 1984). (1) The total amounts of these reserve accounts are very large for some firms, creating the proper environment for possible earnings management using these accounts. This is the first empirical study to study Japanese managers' earnings management motivations using different types of reserve accounts.

The paper is organized as follows: Section 2 presents the background of earnings management and the different capital and business environments in Japan. The third section describes our research methodology and data collection procedures. The fourth section reports results and discusses sensitivity analyses. The last section concludes with a summary of our findings and future research avenues.


Evans and Sridhar (1996) defined "earnings management" as an activity which incorporates any accrual-based manipulation of economic earnings by the manager. Their study predicted that within less flexible financial reporting systems, managers' compensation would depend on reported earnings. However, if there are ten or more reserve accounts like may be present in the Japanese financial system, mangers are tempted to use some of these reserve accounts to manage earnings to meet their target income. Moses (1987) studied firm specific factors that may provide motivation for U.S. managers to manage earnings by choice of accounting methods. He showed that earning management was associated with factors such as firm size, the existence of bonus compensation plans, and the variation of actual earnings from expected earnings.

Several studies used discretionary accruals to study managers' earnings management behavior. While these studies are not in the same context as our study, they found that managers used their discretion to adjust their firm's reserve accounts and some of the same motivational factors may be relevant for our study. …

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