Earnings Quality in Ex-Post Failed Firms

Accounting and Business Research, Forthcoming

48 Pages Posted: 6 Dec 2008

See all articles by Juan M. García Lara

Juan M. García Lara

Universidad Carlos III de Madrid - Department of Business Administration

Beatriz Garcia Osma

Universidad Carlos III de Madrid - Department of Business Administration

Evi Neophytou

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: December 5, 2008

Abstract

This paper analyses earnings quality in ex-post failed firms. Using a large sample of UK bankrupt firms, we find that failed firms manage earnings upwards in the four years prior to failure. This manipulation is achieved in two ways: (1) through accounting (accruals) manipulation, and (2) by implementing real operating actions that deviate from normal practice. We show that these two types of manipulation lead to reduced earnings reliability. We use conditional conservatism as a proxy for reliability, as prior literature links conditional accounting conservatism to better governance and positive economic outcomes. Our results show that conditional conservatism decreases substantially in the years prior to failure. Finally, we show that accruals manipulation is more pronounced in ex-post bankrupt firms with low ex-ante probability of failure, and that ex-post bankrupt firms with high ex-ante failure probability, having likely exhausted the opportunities for accrual manipulation, manipulate real operations more aggressively.

Keywords: firm failure, accruals management, real earnings management, conditional conservatism, earnings quality, bankruptcy

JEL Classification: M41, M43, M44, G33

Suggested Citation

García Lara, Juan Manuel and Garcia Osma, Beatriz and Neophytou, Evi, Earnings Quality in Ex-Post Failed Firms (December 5, 2008). Accounting and Business Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1311806

Juan Manuel García Lara

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

Beatriz Garcia Osma (Contact Author)

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

Evi Neophytou

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece
+30 210 8203960 (Phone)

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