Earnings Management in the Electric Utility Industry
Posted: 4 Dec 2001
This study examines whether accounting earnings are systematically managed as a response to regulation regime (rate vs. incentive regulation) and relative performance (over- vs. under-performance). Incentive regulation aims at mitigating efficiency problems arising from rate regulation under which managers have incentives to decrease accounting earnings to the extent that expenses are recoverable through a bargaining process at rate hearings. Specifically, I assess income-managing incentives of electric utilities by hypothesizing that income-decreasing accounting accruals are more pronounced (i) for rate regulated firms than for incentive regulated firms and (ii) for overearning firms than for underearning firms. Empirical results generally support the expectation. In particular, income-decreasing discretionary accruals are the most negative for rate regulated overearning firms (i.e., firms that earn above allowed return) among others.
Keywords: Discretionary accruals; Earnings management; Incentive regulation; Rate regulaiton
JEL Classification: M41, M43, L97
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