Camouflaged Indicators of Earnings Management

European Accounting Review, Forthcoming

42 Pages Posted: 31 Dec 2010 Last revised: 15 Apr 2019

See all articles by Itay Kama

Itay Kama

University of Michigan, Stephen M. Ross School of Business

Nahum D. Melumad

Columbia Business School - Accounting, Business Law & Taxation

Multiple version iconThere are 2 versions of this paper

Date Written: February 28, 2019

Abstract

We argue that, in response to increased scrutiny and greater attention to accruals versus sales, firms become more likely to engage in accrual conversion (AC) cash management aimed at aligning cash and accruals with earnings and sales (e.g., by factoring of receivables). In doing so, they reduce the statistical power of standard indicators of accrual-based earnings management—in effect, camouflaging their earnings management activity. This proposition is of interest because many influential papers on earnings management have utilized accrual-based indicators to reach their conclusions. Our results indicate that firms indeed became more likely to engage in AC cash management after the passage of the Sarbanes-Oxley Act (SOX), and that this tendency was particularly pronounced among firms with strong incentives (or enhanced ability) to perform and hide earnings management. In particular, our findings suggest that the post-SOX decrease in standard measurements of accrual-based earnings management, identified in prior research, is partially attributable to firms’ increased engagement in AC cash management activity.

Keywords: Earnings Management, Camouflaged Earnings Management, Cash Management, Sarbanes-Oxley Act

JEL Classification: M41, M48

Suggested Citation

Kama, Itay and Melumad, Nahum D., Camouflaged Indicators of Earnings Management (February 28, 2019). European Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1733107 or http://dx.doi.org/10.2139/ssrn.1733107

Itay Kama (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4538 (Phone)

Nahum D. Melumad

Columbia Business School - Accounting, Business Law & Taxation ( email )

3022 Broadway
611 Uris
New York, NY 10027
United States
212-854-2475 (Phone)

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