Earnings Quality in Ex-Post Failed Firms
Accounting and Business Research, Forthcoming
48 Pages Posted: 6 Dec 2008
Date Written: December 5, 2008
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: Suggested Citation