Earnings Management in Developing Countries. the Case of Brazilian Real Estate Industry

By Matteo, Pozzoli; Francesco, Paolone | Academy of Accounting and Financial Studies Journal, January 2018 | Go to article overview

Earnings Management in Developing Countries. the Case of Brazilian Real Estate Industry


Matteo, Pozzoli, Francesco, Paolone, Academy of Accounting and Financial Studies Journal


INTRODUCTION

Managing accounting information and financial data may be referred to in several ways. In the academic literature, the most commonly used term is "earnings management" that, in Schipper's definition (Schipper, 1989), consists of an intervention in the external financial reporting process, with the intent of achieving some private advantages. Leuz et al. (2003, p.506) provide a definition of earnings management as "alteration of firms' reported economic performance by insiders either to mislead some stakeholders or to influence contractual outcomes".

Therefore, it derives from a managers' opportunistic behaviour. In fact, earnings management found its origin in the positive accounting and agency theories and, thus, has emerged in the context of information asymmetry between managers and other business partners. According to Watts & Zimmerman (1986), managers are motivated to manipulate earnings in order to publish more informative disclosures following the contexts of efficient market theory.

The aim of this study is to analyse whether the earnings management (EM) practices are originated by the accumulation of revenue on credit sales instead of cash sales in the context of Brazilian listed companies belonging to the real estate industry. This papers attempts to answer a prior call for research on earnings management practices in specific industries (Siregar & Utama, 2008; Greco, 2012).

This research intends to examine an emerging market with a huge economic improvement, despite the global crisis which has led to different outcomes worldwide. For the above purpose, the modified Jones model (Jones, 1991; Dechow et al., 1995) has been applied to the entire population of publicly traded companies belonging to the real estate industry in Brazil.

In our work, we chose Brazil as it represents one of the main emerging markets of the so-called BRIC countries, together with Russia, India and China.

The results show that the probability of earnings management does not depend on the main variable that measures the accumulation of credit sales, as it has found to be statistically not significant. On the other hand, previous academic studies have highlighted the importance of such a variable in predicting earnings management practices (Jones, 1991, Dechow et al., 1995; Xie, 2001; Dechow & Dichev, 2002; Hribar & Collins, 2002; Peasnell et al., 2005; Chamberlein et al., 2014; Fang et al., 2015; Collins et al., 2016) since management uses its discretion to accrue revenues at year-end when the cash has not yet been received. In these cases, it is highly questionable whether sales revenues have been earned. They assume that discretion is not exercised over revenue but earnings management results from changes in credit sales. This is based on the reasoning that it is easier to manage earnings by exercising discretion over the recognition of revenue on credit sales than to manage earnings through discretion over the recognition of revenue on cash sales (Dechow et al., 1995; Dechow et al., 2012).

Although the above studies concentrated on the relevance of the revenues, our study provides no statistical significance in interpreting the variable of revenues to predict EM practices. It should be noted that, although earnings management literature has been broadly analysed in different sectors, the real estate industry has been neglected in terms of earnings management practices. This is one of the reasons why we have decided to concentrate the study on this industry.

The reason why we decided to focus on Brazilian real estate industry was due to the fact that, despite the global financial crisis, this specific sector has seen a significant growth and has attracted opportunities for foreign investors. In this context, we want to investigate whether this growth has been effectively real or, on the other hand, has been affected by earnings management policies. …

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