Who is Miss World in Cosmetic Earnings Management? An Analysis of Small Upward Rounding of Net Income Numbers Among 18 Countries

41 Pages Posted: 4 Dec 2001

See all articles by Juha Kinnunen

Juha Kinnunen

Aalto University School of Business

Markku Koskela

University of Helsinki - Department of Political and Economic Studies

Date Written: October 2002

Abstract

Using a sample of approximately 87,000 earnings observations from almost 22,000 firms in 18 countries for the five-year period 1995-1999, we document firms' tendency to exercise cosmetic earnings management (CEM) worldwide. Following prior studies in the area (Thomas, 1989, among others), we define CEM by small upward rounding of reported net income that generates more than expected zeros and less than expected nines as second digit of earnings numbers. We partition our sample into positive and negative earnings to see whether the anomalous frequencies are reversed in negative earnings (losses) relative to positive earnings (profits), as predicted by CEM. In addition, we analyse net sales as a control variable. We find that, due to more ample opportunities to accounting manipulation, upward rounding is much more significant on the bottom line than on the top of an income statement. Consistent with prior studies, we find a reversed pattern of CEM for net losses. In addition, we find evidence for our expectation that CEM co-varies with some institutional factors. We report that CEM decreases in spending on auditing, whereas it increases in the latitude of country's GAAP, in its cultural values (power distance) and in the importance of management bonus schemes. Contrary to our expectation, we cannot find significant relationships between CEM and some factors commonly considered in related recent studies, such as the degree of shareholder protection, the alignment of financial and tax accounting, or the value relevance of earnings. Finally, we document a dramatic difference in CEM between US firms listed on the NYSE and the NASDAQ. Potential explanations for this finding relate to differences in firm size and audit quality.

Keywords: financial accounting, auditing, earnings management, institutional factors, Benford's law, aational culture

JEL Classification: G15, G30, G38, M41

Suggested Citation

Kinnunen, Juha and Koskela, Markku, Who is Miss World in Cosmetic Earnings Management? An Analysis of Small Upward Rounding of Net Income Numbers Among 18 Countries (October 2002). Available at SSRN: https://ssrn.com/abstract=292806 or http://dx.doi.org/10.2139/ssrn.292806

Juha Kinnunen (Contact Author)

Aalto University School of Business ( email )

PO Box 21220
FI-00076 AALTO
Helsinki
Finland

Markku Koskela

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland

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