Does Real Earnings Management Matter in Default Prediction?

52 Pages Posted: 27 Jan 2018

See all articles by Ruei-Shian Wu

Ruei-Shian Wu

Yuan Ze University

Hsiou-Wei Lin

National Taiwan University

Huai-Chun Lo

Yuan Ze University

Date Written: January 2018

Abstract

This study examines the extent to which incorporating current-period and/or cumulative real activities earnings management in default models enhances their predictability. Aiming at Altman’s (1968) Z-score as well as Ohlson’s (1980) O-score predictors, such adjustments help mitigate the overestimation (underestimation) of survival probability for firms with aggressive (with conservative or less) current-period real earnings management. More remarkably, for financial distress detection models, we document significant effectiveness of adjusting for the cumulative earnings management over the previous three years. Consistently, false loan acceptance (rejection) rates for firms with upward (downward or no) earnings management are reduced with our modification on the scoring models.

Keywords: Accrual-Based Earnings Management; Altman’s Z-Score; Cumulative Earnings Management; Default Prediction Model; Ohlson’s (1980) O-Score; Real Activities Earnings Management

JEL Classification: G14, G29, J44

Suggested Citation

Wu, Ruei-Shian and Lin, Hsiou-Wei and Lo, Huai-Chun, Does Real Earnings Management Matter in Default Prediction? (January 2018). Available at SSRN: https://ssrn.com/abstract=3110862 or http://dx.doi.org/10.2139/ssrn.3110862

Ruei-Shian Wu (Contact Author)

Yuan Ze University ( email )

135 Yuan-Tung Road
Chung-Li, 32003
Taiwan
886-3-4638800#2195 (Phone)
886-3-4633845 (Fax)

Hsiou-Wei Lin

National Taiwan University ( email )

1 Sec. 4, Roosevelt Road
Taipei, 106
Taiwan

Huai-Chun Lo

Yuan Ze University ( email )

135, Far-East Rd., Chung-Li
Taoyuan, ROC
Taiwan

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