Earnings management: The relative role of ethics and economics in managers' decision making

59 Pages Posted: 15 Nov 2016 Last revised: 23 Dec 2020

See all articles by Paul Coram

Paul Coram

University of Adelaide - Business School; Financial Research Network (FIRN)

James R. Frederickson

Melbourne Business School

Matt Pinnuck

University of Melbourne - Department of Accounting and Business Information Systems

Date Written: December 23, 2020

Abstract

This study uses responses from CFOs and CEOs to a case-based survey, as well as interviews with CFOs and CEOs, to address two broad issues. The first is the relative importance of ethics versus economic factors on managers’ decisions whether to engage in earnings management (EM), and if so, the extent of reliance on accounting adjustments versus real, operational adjustments. In our multivariate analysis, ethics has the greatest explanatory power for our participants’ assessments about whether to manage earnings. While — consistent with conventional wisdom — ethical concerns about EM reduce EM, we also find, surprisingly, that ethical concerns about not managing earnings and missing the market’s earnings benchmark is an important motivator of EM. The primary economic motivation for EM in our setting is to shield current shareholders from the short-term costs of the firm missing market expectations. Our survey participants trade off these costs against the costs of EM to current shareholders, future shareholders, and debtholders. We find no evidence that manager self-interest motivates EM. With respect to the use of accounting versus operational adjustments for EM, ethical concerns and the likelihood of each approach being successful are the only factors that influence our participants’ assessments. The second broad issue we address is CFO and CEOs’ beliefs about the extent to which EM is lying. We find considerable heterogeneity in their beliefs. We also find that these beliefs affect their EM assessments through two paths: a direct path and an indirect path through their perceptions about the ethics of EM.

Keywords: earnings management; ethics; real earnings management

JEL Classification: M41

Suggested Citation

Coram, Paul J. and Frederickson, James R. and Pinnuck, Matthew, Earnings management: The relative role of ethics and economics in managers' decision making (December 23, 2020). Available at SSRN: https://ssrn.com/abstract=2868350 or http://dx.doi.org/10.2139/ssrn.2868350

Paul J. Coram (Contact Author)

University of Adelaide - Business School ( email )

10 Pulteney Street
Adelaide, South Australia 5005
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

James R. Frederickson

Melbourne Business School ( email )

200 Leicester Street
Carlton, Victoria 3053
Australia

Matthew Pinnuck

University of Melbourne - Department of Accounting and Business Information Systems ( email )

Victoria
Melbourne, Victoria 3010 3010
Australia

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