Regulatory Profit Targets and Earnings Management in Initial Public Offerings: The Case of Malaysia

Journal of Financial Reporting & Accounting, Vol. 6, No. 1, 2008

25 Pages Posted: 16 Jul 2009

Date Written: November 1, 2008

Abstract

We examine the extent of earnings management associated with meeting forecasts made in IPO prospectuses in a developing economy where government regulation requires a profit forecast but allows promoters to choose either (1) to provide a profit guarantee or (2) to elect for a moratorium on share transfers for a defined period. Since the managers is mandated to make earnings forecast and there are costs associated with forecast error, we hypothesize that, in the first reporting period following the IPO, managers opting for a profit guarantee will signal their ability to produce a result within the target zone while managers opting for a share moratorium will match that performance to maintain their reputation, with the result that both groups are indistinguishable in the magnitude of earnings management.

Using a sample of 92 regulated IPO firms we find a strong negative association between forecast error before earnings management and a firm's discretionary accruals. Our results support the hypotheses, leading to the conclusion that earnings are managed towards the forecast amount, consistent with both the desire not to deviate excessively from the forecast and income smoothing.

JEL Classification: M41, M44

Suggested Citation

Ismail, Norashikin, Regulatory Profit Targets and Earnings Management in Initial Public Offerings: The Case of Malaysia (November 1, 2008). Journal of Financial Reporting & Accounting, Vol. 6, No. 1, 2008, Available at SSRN: https://ssrn.com/abstract=1434970

Norashikin Ismail (Contact Author)

Universiti Teknologi MARA ( email )

Menara SAAS
Level 11, UiTM
Shah Alam, Selangor 40500
Malaysia

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