Discretionary Environment and Earnings Management
57 Pages Posted: 31 May 2016 Last revised: 19 May 2017
Date Written: March 16, 2017
This study adds the discretionary environment to the accrual-based earnings management model by Kothari, Leone and Wasely (2005) to control for the effect of an open system of governance and enhance the inferences made from earnings management proxies. In doing so, the Governance-Augmented Earnings Management model controls for unobserved heterogeneities in earnings management practices. The findings of this study show that the proxies of the discretionary environment, corporate governance and a set of contextual mechanisms, are associated with total accruals, hence they have the potential to explain the discretionary earnings management practices. Further, I relax the assumptions of firms’ stationarity and intra-industry homogeneity of accruals. By doing so, I find evidence in support of panel unit root and panel cointegration, which indicate the need for a rigorous modelling attempt. As a result, the non-stationary panel cointegrated regression method, which allows for heterogeneities, is used to model the total accruals. Hence, the coefficients are produced heterogeneously to decomposed the total accruals in order to obtain the earnings management proxies. The findings of this study implies that an open system of governance has a measureable effect on earnings management practices and this system can be used to unify the empirical approach toward enhancing the inferences made from earnings management proxies.
Keywords: Discretionary Environment, Unobserved Heterogeneity, Governance-Augmented Earnings Management, Panel Cointegrated Model.
JEL Classification: P34, G39, M41
Suggested Citation: Suggested Citation