Private Firms’ Incentives to Manage Earnings: Evidence from a Quasi-Natural Experiment

65 Pages Posted: 19 Sep 2017 Last revised: 13 Jun 2018

See all articles by Felipe Restrepo

Felipe Restrepo

University of Western Ontario - Richard Ivey School of Business

Jérôme Taillard

Babson College

Date Written: June 2, 2018

Abstract

We examine the behavior of a large sample of private firms before and after the elimination of an inflation adjustment system in Colombia in 2007. We show that firms avoid reporting small losses by exercising considerable discretion in their use of inflation adjustments, and find that this discretion is greater for firms that rely more on bank financing. Furthermore, we show that firms that manage earnings to report small positive profits are able to issue more bank debt the year following the reporting. After the law change, firms resort to other means to report positive earnings. In particular, the use of non-operating revenues increases, driven at least in part by higher use of real activities through asset sales. Finally, we evaluate the performance of model-based earning management measures commonly used in the literature. We highlight the potential difficulties in relying solely on these conventional measures where “normal” reporting has to be modeled in order to estimate “abnormal” behavior.

Keywords: bank monitoring, private firms, earnings management, accounting discretion, inflation adjustments

JEL Classification: M4, M41, G21

Suggested Citation

Restrepo, Felipe and Taillard, Jérôme, Private Firms’ Incentives to Manage Earnings: Evidence from a Quasi-Natural Experiment (June 2, 2018). Available at SSRN: https://ssrn.com/abstract=3037689 or http://dx.doi.org/10.2139/ssrn.3037689

Felipe Restrepo (Contact Author)

University of Western Ontario - Richard Ivey School of Business ( email )

1255 Western Road
London, Ontario N6G 0N1
Canada

HOME PAGE: http://www.ivey.uwo.ca/faculty/directory/felipe-restrepo/

Jérôme Taillard

Babson College ( email )

323 Tomasso Hall
Babson Park, MA 02457
United States
6145994184 (Phone)

HOME PAGE: http://https://www.babson.edu/academics/faculty/faculty-profiles/jerome-taillard.php

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