More importantly, it was found that the degree of earnings management is significantly less after implementing corporate governance regulations both in developed and emerging markets.. Us
Trang 1Comparison of cosmetic earnings management for the developed
markets and emerging markets: Some empirical evidence from the
United States and Taiwan
Fengyi Lina, Sheng-Fu Wub,⁎
a Department of Business Management, College of Management, National Taipei University of Technology, Taipei, Taiwan
b
Institute of Industrial and Business Management, College of Management, National Taipei University of Technology, 1, Sec 3, Chung-Hsiao E Rd., Taipei, Taiwan
a b s t r a c t
a r t i c l e i n f o
Article history:
Accepted 1 October 2013
Available online xxxx
Keywords:
Cosmetic earnings management
Corporate governance
Benford's law
This study examines the effect of the implementation of corporate governance regulations on cosmetic earnings management in developed and emerging markets respectively Using Benford's Law, the analysis employs 84,870 positive earnings observations for all publicly listed US and Taiwan companies from 1990 to 2011
The empirical results show that, regardless of developed markets and emerging markets, the phenomenon of cosmetic earnings management exists In contrast to developed markets, corporate managers of emerging markets have stronger incentives to manipulate earnings More importantly, it was found that the degree of earnings management is significantly less after implementing corporate governance regulations both in developed and emerging markets This result suggests that the implementation of corporate governance regulations plays an important role in reducing the earnings manipulative behavior Thefindings of the study add more evidence to the ongoing debate about the effectiveness of corporate governance regulations in preventing earnings management
© 2013 Elsevier B.V All rights reserved
1 Introduction
Existing information asymmetry problem makes it difficult for
investors to understand the real underlying situation offirms The
information asymmetry problem is more acute in emerging markets
or developing economies, making financial statements of firms
in developing countries more suspicious than those in developed
countries (Vives, 2006) Several researches suggest that the value
relevance of accounting information is lower in less developed countries
than in more developed countries (Biddle and Hilary, 2006; Biddle et al.,
2009; Hope and Thomas, 2008; McNichols and Stubben, 2008)
High-quality accounting information seems to be desirable in mitigating
information asymmetry forfirms (Chen et al., 2011)
Earnings management is the manipulation of accounting numbers
within the scope of the Generally Accepted Accounting Principles
(GAAP) (Jackson and Pitman, 2001).Healy and Wahlen (1999)believed
that managers use subjective judgment in financial reporting or
transaction recognition to manipulate financial reports Earnings
management is often considered materially misleading and thus a
fraudulent activity to the stakeholders, even though the changes may
follow all of the accounting standards and laws Obviously the existence
of earnings management will reduce the quality offinancial statements
Excessive earnings management often causes serious corporate fraud To reduce the probability of occurrence of corporate fraud, numerous countries have enacted laws to strengthen the corporate governance mechanism, such as the United States and Taiwan.1 World Bank (1999)defines that the complete corporate governance framework consists of internal and external mechanisms Good internal corporate governance mechanisms, including ownership structure, the board of directors, and timely and accurate disclosure of relevant information, can reduce the earnings management motive of managers These internal mechanisms for corporate governance can be strength-ened by external laws, rules, and institutions In developed market economies, these policies and institutions minimize the divergence between social and private returns and reduce costly agency problems, primarily through greater transparency, monitoring by regulatory and self-regulatory bodies, and compliance mechanisms (World Bank, 1999) The extent of earnings management is strongly related to the countries' institutional arrangements (Man and Wong, 2013) Compared
⁎ Corresponding author.
E-mail addresses: sheng.fu.wu.tw@gmail.com , wsfbm@yahoo.com.tw (S.-F Wu).
1 The Sarbanes–Oxley Act of 2002 is one fundamental step toward enhancing the quality of financial statements in the United States In 2003, Taiwanese regulatory authorities began implementing programs to strengthen the corporate governance mechanism, including the Corporate Governance Best-Practice Principles (CGBPP) for TWSE/GTSM-Listed Companies, Market Observation Post System, Corporate Governance Best-Practice Principles for Securities Firms (2003), Corporate Governance Best-Practice Principles for Future Firms, and Information Disclosure Assessment of Publicly Listed Companies.
0264-9993/$ – see front matter © 2013 Elsevier B.V All rights reserved.
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Economic Modelling
j o u r n a l h o m e p a g e : w w w e l s e v i e r c o m / l o c a t e / e c m o d
Trang 2with emerging markets, developed markets have better investor
protection and more comprehensive legal systems.Burgstahler et al
(2006)show that countries with stronger legal systems have lower
earnings management In addition, countries with lower investor
protection usually have a higher extent of earnings management (Leuz
et al., 2003) Therefore, we expect that emerging markets with weaker
investor protection could give inside managers more incentive to
manipulatefirm performance
Prior research shows that the critical determinants of earnings
management have been separated into two major categories In the
first category, zero is adopted as the threshold of earnings management
Hayn (1995)suggested thatfirms avoid reported loss, conduct earnings
management, and cross over the zero-earnings thresholds In the
second category, a key reference point, represented by n × 10k, is
used as the threshold of earnings management (Guan et al., 2006;
Herrmann and Thomas, 2005; Lin et al., 2011) For example, if net
income is expected to be $70 million but the actual earnings are only
$69 million, managers may have an incentive to adjust the earnings
data to allow the net income to achieve the expected earnings
threshold Benford's law has been widely applied tofinancial data to
investigate instances of digital rounding
Although substantial studies have been performed on digital
analysis using Benford's law, there is still little research to compare
the difference between developed and emerging markets This study
aims at comparing the earnings management phenomenon between
developed and emerging markets by utilizing Benford's law We
observe the existence of earnings adjustments exceeding the key
re-ference point, and analyze whether an earnings management anomaly
exists Furthermore, has earnings management changed as
govern-ments gradually strengthen corporate governance mechanism? What
is the difference of cosmetic earnings management between a
developed market and an emerging market? Using Benford's law, this
study investigates the difference of cosmetic earnings management
between developed and emerging markets by observing the real
distribution of earnings numbers reported in the United States and
Taiwan The study could supply more evidence to the ongoing debate
about the effectiveness of corporate governance regulations in
preventing earnings management
2 Literature review
2.1 Corporate governance mechanism and earnings management
The occurrence of the agency problem results from the separation of
ownership and control The managers might pursue their self-interest
to maximize their own wealth, perhaps at the expense of other
stakeholders' wealth and interests (Jensen, 1986) Contracts may
request the managers to disclose relevant accounting information in
order to protect the stakeholders' interests However, due to accounting
information is provided by the managers, who may overstate the
numbers in thefinancial statements through their accounting estimates
and standards (Watts and Zimmerman, 1986) The existence of
earnings management will reduce the quality offinancial statements
Corporate governance would efficiently reduce the agency problem
between shareholders and managers (Gompers et al., 2003) John
and Senbet (1998) defined that corporate governance “deals with
mechanisms by which stakeholders of a corporation exercise control
over corporate insiders and management such that their interests are
protected.” Man and Wong (2013) consider that an institutional
environment which provides robust legal protection can control
managers' self-interest to a certain extent Prior researches have shown
that firms with effective governance mechanisms can successfully
minimize earnings management behavior (Dechow et al., 1995; Liu
and Lu, 2007; Marra et al., 2011; Peasnell et al., 2000; Shen and Chih,
2007; Zéghal et al., 2011)
Dechow et al (1995) demonstrated that thorough governance reduces the adverse effects of earnings management They found that firms that overstate earnings are more likely to have a board with inside directors and a CEO serving as the board chair.Peasnell et al (2000)
showed similarfindings in which firms with a high proportion of outside directors are unlikely to take earnings manipulation when earnings fall below the threshold.Liu and Lu (2007)investigate the relation between earnings management and corporate governance in the Chinese listed companies They demonstrate thatfirms with higher corporate governance levels have lower levels of earnings management
Chang and Sun (2009) find earnings management to be negatively related to the independence of the audit committee and the board of directors after SOX Theirfindings suggest that the SOX provisions improve the effectiveness of cross-listed foreignfirms' corporate-governance functions in monitoring the quality of accounting earnings.Zéghal et al (2011)show a positive influence of external audit quality on reducing earnings management Marra et al (2011)found an increase in the influence of audit committees in strengthening thefinancial reporting quality after the introduction
of the International Financial Reporting Standards (IFRS) The result shows that corporate governance mechanisms are key factors in earnings quality
There are differences in corporate governance between emerging markets and developed markets Prior studies find that the char-acteristics of weak investor protection institutions involve severe earnings management and a low level of earnings information (DeFond et al., 2007; Leuz et al., 2003) Several studies demonstrate that it is less likely for managers to manipulate earnings when there is greater legal protection (Nenova, 2003; Shleifer and Wolfenzon,
2002) Developed markets tend to have more extensive disclosure requirements, stronger private and public enforcement of security regulations, and stronger shareholder and creditor rights to reduce the level of managerial discretion
Leuz et al (2003) find that earnings management decreases in countries with stronger investor protection.Ball et al (2003)argue that the institutional arrangement of a country is the most important feature in controlling managers' self-interest, reducing opportunistic earnings manipulation, and improving the quality of financial statements.Shen and Chih (2007) show that earnings management lowers in countries with stronger investor protection and more transparent accounting disclosure Legal systems protect stakeholders' rights by conferring on their powers to discipline managers as well as
by enforcing contracts designed to limit managers' benefits (Claessens
et al., 2002; Dyck and Zingales, 2004; La Porta et al., 1998)
Mehmet and Emin (2012)find that whether international big audit firms provide high quality services or not, the audit environment, which
is affected directly by the legal environment and effectiveness of the legal system, is more important than audit quality Firms in a strong enforcement environment seem to induce a decrease in the level of discretionary accruals, compared tofirms in the weak environment The quality of a government depends on other institutional constraints such as constitution, laws, and the political system Firms under the
influence of a low quality government tend to have complex orga-nizational structures, poor transparency and weak corporate gover-nance (e.g.,Fan et al., 2012; Jiang et al., 2010; Leuz and Oberholzer-Gee, 2006)
Poor disclosure andfinancial opacity are common characteristics of emerging market firms It is well acknowledged that the financial opacity of emerging marketfirms cannot be improved by changing the accounting system alone, because the enforcement of accounting rules depends on strong institutions which are lacking in these markets (Ball et al., 2000) In countries with stronger investor protection laws, managers and controlling shareholders are less likely to expropriate thefirm's resources and more likely to invest in projects that benefit shareholders (Bekaert et al, 2010; Shleifer and Wolfenzon, 2002; Wurgler, 2000)
Trang 3In the past two decades, many cases of corporate fraud occurred in
the world Numerous countries have enacted laws to strengthen the
corporate governance mechanism, such as the United States and
Taiwan Previous studies have demonstrated that good corporate
gover-nance helps to reduce the degree of earnings management However,
there is less literature to investigate the difference of cosmetic earnings
management between a developed market and an emerging market
This study attempts to investigate several issues Do managers reduce
the extent of cosmetic earnings management with the increasingly
stringent legal regulations? What is the difference of cosmetic earnings
management between a developed market and an emerging market?
2.2 Benford's law and earnings management
The earnings management issue has become a concern throughout
the world (Islam et al., 2011) Earnings management is the managerial
use of procedures to adjust data onfinancial reports Earnings
manage-ment may mislead stakeholders of thefirm's corporate performance
This behavior can also explain the contractual behavior of senior
management using accounting data (Healy and Wahlen, 1999)
The major types of earnings management include the selection of
the timing of new accounting principles, the selection of accounting
standards, the control of transaction times, and the adjustment of
discretionary accruals (Dechow et al., 1995; Degeorge et al., 1999;
Jones, 1991)
Each earnings management method applied by managers affects the
presentation offinancial statements, which are the main resource for
outside stakeholders (including investors and creditors) to understand
the situation of corporate operating performance Hence, data
adjustment offinancial reports ultimately affects the assessment of a
firm by outside stakeholders Several studies have shown that managers
have an incentive to manipulate earnings to reach specific thresholds
(Barth et al., 1999; Matsumoto, 2002; Skinner and Sloan, 2001)
Since the mid-1980s, there has been explosive growth in using
accruals to detect earnings management (Sun and Rath, 2010) The
most popular accrual models are the standard Jones and modified
Jones models (Islam et al., 2011) Substantial studies have been
performed in using accrual models to detect earnings management
However, several studies found that the accrual models are of low
power in detecting earnings management (Beneish, 1997;Islam et al.,
2011; Thomas and Zhang, 2000; Yoon et al., 2006)
Kinnunen and Koskela (2003) define cosmetic earnings management
(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 Thomas (1989) considered two reasons that
managers maybe engage in cosmetic earnings management One reason
relates to earnings numbers as key cognitive reference points The use of
lending, bonus and option contracts provides another reason why
managers round earnings numbers upward once in a while
This study detects cosmetic earnings management by observing the
real distribution of earnings numbers Benford's law has recently
become an accepted tool in the identification of contrived data, both
in academic literature and practice (Carslaw, 1988; Herrmann and
Thomas, 2005; Lin et al., 2011; Reddy and Sebastin, 2012; Thomas,
1989, 2012)
Examining the distribution of digits in earnings numbers to identify
earnings management has a number of appealing features First, the
researchers don't have to estimate the potentially noisy abnormal
accruals (Healy and Wahlen, 1999) Another appealing feature is that
the researchers can identify a large set of potential earnings
manipulators without invoking specific assumptions about earnings
management motivation or methods (Burgstahler and Dichev, 1997)
Benford (1938) demonstrated that the expected distributions of
naturally occurring numbers are skewed toward one for thefirst digits
(because zero cannot be afirst digit) and zero for the second digit
Benford's law provides the basis for the numerical analysis of a
sequence of numbers of a similar nature The deviation in actual data from these expected frequencies indicates the presence of manipulation (Thomas, 2012)
Rodriguez (2004)provided empirical evidence that, in the absence
of earnings management, corporate earnings follow Benford's law
Durtschi et al (2004)further examined the use of Benford's law in the detection of accounting fraud by specifically identifying data sets expected to follow Benford's law and the types of fraud that can be detected
In subsequent studies, researchers have extended the various analytic methods of Benford's law, such as increasing the number of digits used in analysis (Diekmann, 2007; Skousen et al., 2004) and investigating the heaping anomaly (Herrmann and Thomas, 2005; Lin
et al., 2011)
Thomas (2012)examined the extent to whichfirms manipulate theirfinancial statement numbers by engaging in cosmetic earnings management in a post Sarbanes–Oxley Act (SOX) environment Using
2009 data, Thomas found no evidence of cosmetic earnings manage-ment, indicating that the SOX has increased financial statement reliability and reduced earnings management
The summarized studies have shown clear evidence that Benford's law can be used to analyze cosmetic earnings management behavior Therefore, this study utilizes Benford's law to investigate the extent of changes on cosmetic earnings management, which uses Taiwan2 as the proxy of emerging market and the United States as the proxy of developed market
3 Hypotheses and mathematical model 3.1 Hypotheses
Man and Wong (2013)consider that an institutional environment which provides robust legal protection can control managers' self-interest Prior studies show that it is less likely for managers to manipulate earnings when there is greater legal protection (Nenova, 2003; Shleifer and Wolfenzon, 2002) Developed markets tend to have more extensive disclosure requirements, more complete regulatory mechanisms and laws, and stronger shareholder and creditor rights so
as to reduce the level of managerial discretion Therefore, this study hypothesized that the degree of earnings management of developed markets is weaker than that of emerging markets
Formally, ourfirst hypothesis is stated as follows: (in the null form) H1 The degree of earnings management of publicly listed companies in developed markets will not be significantly weaker than companies in emerging markets
As discussed, corporate governance mechanisms can successfully minimize earnings management behavior (Dechow et al., 1995; Jo and Kim, 2007; Marra et al., 2011; Park and Shin, 2004; Peasnell et al.,
2000) Effective corporate governance mechanisms can substantially reduce incentives for management to manipulate earnings Since
2002, the United States and Taiwan have enacted laws to strengthen the corporate governance mechanism.Cohen et al (2010)demonstrate
2 Taiwan is classified as the emerging market by many research institutions, including the Economist, Standard and Poor's (S&P), FTSE (Financial Times Stock Exchange) Group, Columbia University EMGP (Emerging Market Global Players) List, and BBVA (Banco Bilbao Vizcaya Argentaria) Research The FTSE Group (2010) distinguishes between advanced and secondary emerging markets on the basis of their national income and the development of their market infrastructure The advanced emerging markets are classified as such because they are upper or lower middle income GNI countries with advanced market infrastructures or high income GNI countries with lesser developed market infrastructures, such as Taiwan and Turkey The secondary emerging markets include some low income, lower middle income, upper middle income and high income GNI countries with reasonable market infrastructures and significant size and some upper middle income GNI countries with lesser developed market infrastructures, such as China
Trang 4that the corporate governance environment has significantly improved
in the Post-Sarbanes–Oxley Era We expect that the earnings
management level will continue to decline because of the gradual
implementation of corporate governance mechanisms since 2003 To
investigate the differences before and after the strengthening of the
corporate governance mechanism, the sample was divided into two
periods in this study, using 2003 as the division point Formally, the
second hypothesis is stated as follows:
H2a The degree of cosmetic earnings management of publicly listed
companies in developed markets after 2003 will not be significantly weaker
than before 2003
H2b The degree of cosmetic earnings management of publicly listed
companies in emerging markets after 2003 will not be significantly weaker
than before 2003
3.2 Mathematical model
3.2.1 Benford's law
To test our hypotheses, we identify the expected proportions of each
of the 10 digits (zero to nine) in each place of the earnings numbers
under the null hypothesis The true distribution of the digits without
managerial manipulation of the reported earnings is not publicly
observable (Thomas, 1989) Therefore, we approximate this
distribu-tion with Benford's law (Carslaw, 1988)
Benford (1938)demonstrated that, contrary to basic intuition, the
expected distributions of naturally occurring numbers are skewed
toward one for thefirst digits (because zero cannot be a first digit)
and zero for the second digit If earnings management is conducted by
achieving the key reference point represented by n × 10k, an abnormal
distribution of the digits in the place to the right of the reference point
is expected For example, if the key reference point is the second digit
of positive earnings and management tends to distort earnings to
achieve this key point, more zeros and fewer nines are expected in the
third place of the earnings numbers
Benford postulated that the expected proportions or occurrences of
a number as thefirst digit in a number series can be approximated by
the following relation:
proportion a is the first digitð Þ ¼ log10ðaþ 1Þ− log10ð Þ:a ð1Þ
Furthermore, the expected proportion of the given number a as the
first digit and the number b as the second digit can be found in the
following relation:
log10aþb10þ 1− log10aþ10b: ð2Þ
Using the established equations and summing all possible a values
for any b value produce an overall expected proportion for b as the
second digit This equation is presented as follows:
proportion b is the second digitð Þ ¼X log10 aþb10þ 1
− log10 aþ10b
:
ð3Þ The expected proportion of numbers in the third, fourth,fifth digits,
and so on, can be similarly derived
3.2.2 Chi-square test
The chi-square test has often been used to test for conformity to
Benford's law (Nigrini, 2012) The chi-square test is an extension of
the z test, which tests only one digit at a time The chi-square test
combines the results of testing each digit's expected frequency with
each digit's actual frequency into one test statistic If the chi-square
test rejects the hypothesis that the probability of all digits conforms to the Benford law, then the entire account warrants further examination The chi-square test is generally less discriminatory than the individual z-test results, but results in fewer false positives (Durtschi et al., 2004) The chi-square test is presented as follows:
χ2
¼X 9
i ¼1
nP0−nPe
nP0 for the first digit ð4Þ
χ2
¼X9
i ¼0
nP0−nPe
nP0
for the other digits ð5Þ
where Pe and P0 are the observed and expected proportions, respectively The sample size is represented by n
3.2.3 Z statistic
If the chi-square value is significant, the number that has deviated from Benford's law and the degree of the deviation can be identified
by examining the Z statistic on numbers zero to nine To test our null hypothesis of no managerial effort to round earnings, we compared the observed frequency of each number x in various places of the earnings numbers to the expected occurrences of the number as predicted by Benford's law [Eqs.(1) through (3)] To perform a
sig-nificance test of the observed deviations from the expected proportions,
we used a normally distributed Z statistic:
Z¼jP0−Pej−
1 2n ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
P0ð1−P0Þ n
The second term in the numerator is a correction term; it should be applied only when it is smaller than |P0− Pe| (Thomas, 1989) These Z statistics reject the null hypothesis at the 10%, 5%, and 1% levels if their values exceed 1.64, 1.96, and 2.57, respectively
3.2.4 Cramer's V Cramer's V was used as a post test to determine the strengths of association after the chi-square test determined significance The chi-square test demonstrated that a significant relationship existed between variables, but cannot identify the extent to which the significance occurs Cramer's V is based on adjusting the chi-square significance to factor out sample size Cramer's V varies between zero and one A value close to zero shows little association between the variables Values close to one indicate a strong association between the variables
We used Cramer's V to compare the level of deviation from Benford's law by different groups, and the related equation is as follows:
Cramer0s V¼
ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
χ2
n k−1 ð Þ
s
ð7Þ where n and k are the sample size and number of variables, respectively
4 Empirical results 4.1 Data
The data used in this study were obtained from the Compustat Research Insight (Compustat) database and the Taiwan Economic Journal (TEJ) database The analysis includes the annual net incomes
offirms listed on the stock exchanges of the United States and Taiwan from 1990 to 2011 After deleting incomplete data and 1% extreme values, the final sample consisted of 84,870 positive earnings observations, including 65,977 observations in the United States and 18,893 observations in Taiwan
Trang 54.2 Test of hypothesis 1
Tables 1 and 2list the distributions of each number (zero to nine)
appearing in thefirst through third places of positive earnings of U.S
companies and Taiwanese companies, respectively.3Thefirst number
in each cell of the table represents the observed proportion of the
sample data (in terms of a percentage of the sample) The second
number is the proportion predicted by Benford's law The third number
represents the difference between the actual and expected proportions
of the sample (in terms of a percentage of the sample) The last number
represents the Z statistic result
InTable 1, the results of a chi-square test of thefirst through third
places were 16.58, 36.57, and 53.86, respectively The results indicate
that managers in the U.S have strong incentives to manipulate earnings
by exaggerating the earnings numbers
The distribution of thefirst digits reveals that number seven was
observed more frequently than expected, suggesting that firms are
more likely to round to numbers when seven is set as thefirst digit In
addition, number nine was observed less frequently than expected
The lack of number nine as thefirst digit suggests that firms are more
likely to round when thefirst digit is any of these numbers than they
are to round to afigure that has any of these numbers as the first digit
Moreover, consistent with our expectations, significantly more zeros
(or ones) and fewer nines occurred in the second and third places,
suggesting thatfirms may use the first and second digits as reference
points.4The proportion of zeros as the second digit, expected to be 11.97% of the sample, was actually 3.84% higher, and the Z statistic was 3.67 The number nine exhibited a rate of deviation of−5.53% and a Z statistic of 4.33 This indicates thatfirms are likely to use the number zero as the key reference point for the second digit, causing the anomaly of more zeros than nines Similarly, the proportion
of ones, twos, threes and fives as the third digit was higher than expected The proportion of eights and nines was lower than expected simultaneously
In addition, we found the similar earnings management situation in Taiwan InTable 2, the results of a chi-square test of thefirst through third places were 26.96, 54.43, and 19.89, respectively, suggesting that managers in the Taiwan also have strong incentives to manipulate earnings by exaggerating the earnings numbers There are significantly more zeros and fewer nines occurring in the second and third places The proportion of zeros as the second and third digits was 9.11% and 8.25% higher than expected, respectively (The Z statistics were 4.6 and 3.82) The proportion of nines as the second and third digits was 12.47% and 4.27% lower than expected, respectively (The Z statistics were 5.23 and 1.93) This result concurs with prior studies (Carslaw, 1988; Herrmann and Thomas, 2005; Lin et al., 2011; Thomas, 1989) and suggests that window dressing is a pervasive phenomenon
A chi-square test is affected by the size of a sample To eliminate the problem of sample size, we used Cramer's V to compare the level of deviation from Benford's law of different groups After controlling for the size effect, the results show that the Cramer's V of thefirst through
Table 1
Distribution of first through third digits in positive annual net income of companies in the United States from 1990 to 2011.
First digit
(n = 65,977)
Second digit
(n = 65,875)
Third digit
(n = 64,868)
Notes: The observed, expected proportion and deviation rate are measured as the percentage of the sample The deviation rate = (observed proportion−expected proportion)∕(expected proportion) *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively (two-tailed test).
Table 2
Distribution of first through third digits in positive annual net income of companies in Taiwan from 1990 to 2011.
First digit
(n = 18,893)
Second digit
(n = 18,893)
Third digit
(n = 18,893)
Notes: The observed, expected proportion and deviation rate are measured as the percentage of the sample The deviation rate = (observed proportion−expected proportion)∕(expected proportion) *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively (two-tailed test).
3 Based on the following two reasons, this study focuses on the first through third
places The first reason is that previous studies show that the fourth place is less
significant The second reason is that investors have relatively less attention to the fourth
4
The phenomenon of earnings manipulation still exists in companies with negative earnings There are significantly more nines and fewer zeros occurring in the second or
Trang 6third digits of the samples in Taiwan was larger than that of the samples
in the United States For example, the Cramer's V of the second digit in
Taiwan was 0.0179, which is larger than the Cramer's V of the second
digit in the United States (0.0079) Overall, the degree of deviation in
Taiwan is larger than the degree of deviation in the United States The
results reject thehypothesis H1, indicating that corporate managers of
emerging markets have stronger incentives to manipulate earnings by
exaggerating the earnings numbers
4.3 Test of hypothesis 2
Since 2002, the United States and Taiwan have enacted laws to
strengthen the corporate governance mechanism We expect that the
cosmetic earnings management level will continue to decline because
of the gradual implementation of corporate governance mechanisms
since 2003 Therefore, the sample period was divided into two groups,
1990 to 2002 and 2003 to 2011, to investigate whether differences in
cosmetic earnings management behavior occurred between these two
periods The results are presented inTables 3 and 4
For developed markets, such as the United States, thefirst through
third digits in positive earnings before 2003 and the third digit after
2003 revealed that the chi-square value is significant We found that
the distribution of thefirst and second digits in the earnings numbers
shows significant differences between these two periods The first digit
was more likely to be manipulated before 2003 (with a chi-square
value of 16.78) than after 2003 (with a chi-square value of 12.57)
Similarly, the second digit was more likely to be manipulated before
2003 (with a square value of 38.22) than after 2003 (with a
chi-square value of 12.47) In contrast, thefirst through third digits were
less frequently manipulated after 2003 than before 2003 The results
reveal that manipulation behavior is decreasing in developed markets
Moreover, to control for the effect of inconsistency of the number of
samples of different groups, we also calculated the Cramer's V We found that thefirst through third digits of the samples before 2003 obtain higher Cramer's V (0.0082; 0.0116; and 0.0122, respectively) than the samples after 2003 (0.0068; 0.0063; 0.009) Therefore, our results reject thehypothesis H2a, indicating that improvements to the corporate governance mechanisms in the United States led to less cosmetic earnings management in publicly listedfirms
For emerging markets, such as Taiwan, thefirst through second digits in positive earnings before 2003 and the second through third digits after 2003 revealed that the chi-square value is significant We first look at the distribution of digits in the second place of the earnings numbers Our results show that the proportion of nines as the second digit, expected to be 8.5% of the sample, was actually significantly lower in both periods The Z statistics of nine as the second digit in the first and second periods were 3.23 and 4.14, respectively Moreover,
Table 4also reveals a greater number of zeros in the second place of earnings (the Z statistics were 1.92 and 4.54, respectively) This implies that the second-place digit was manipulated in both periods
In addition, we found that the distribution of thefirst and third digits
in the earnings numbers shows significant differences between the two periods Thefirst digit was more likely to be manipulated before 2003 (with a chi-square value of 26.33) than after 2003 (with a chi-square value of 7.03) And the third digit was more likely to be manipulated after 2003 (with a chi-square value of 19.45) than before 2003 (with a chi-square value of 14.08) These results show that managers used the first and second digits as reference points to round earnings before
2003 In contrast, the second through third digits were more frequently manipulated after 2003 than before 2003
The Cramer's V of the second and third digits of the samples after
2003 was larger than the samples before 2003 in Taiwan The result shows that the effect of reducing cosmetic earnings management is not fully revealed although Taiwan is also committed to the improvement
Table 3
Distribution of first through third digits in positive annual net income of companies in the United States at different periods.
First digit
(n = 65,977)
1990–2002
(n = 31,536)
2003–2011
(n = 34,441)
Second digit
(n = 65,875)
1990–2002
(n = 31,473)
Deviation rate 7.12 −0.24 −1.75 −0.29 −3.17 2.67 1.48 −0.93 −0.40 −6.62 38.22*** 0.0116
2003–2011
(n = 34,402)
Third digit
(n = 64,868)
1990–2002
(n = 30,912)
Deviation rate −0.39 3.67 6.50 2.13 −2.09 3.90 −3.28 −2.15 −5.42 −3.15 41.59*** 0.0122 Z-statistics 0.22 2.16** 3.82*** 1.24 1.22 2.27** 1.90* 1.25 3.14*** 1.82*
2003–2011
(n = 33,956)
Z-statistics 0.69 1.65* 0.45 2.66*** 0.42 2.21** 0.20 0.91 3.00*** 1.28 Notes: The deviation rate is measured as the percentage of the sample The deviation rate = (observed proportion − expected proportion)/(expected proportion) *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively (two-tailed test).
Table 4
Distribution of first through third digits in positive annual net income of companies in Taiwan at different periods.
First digit
(n = 18,893)
1990–2002
(n = 9222)
2003–2011
(n = 9671)
Second digit
(n = 18,893)
1990–2002
(n = 9222)
2003–2011
(n = 9671)
Third digit
(n = 18,893)
1990–2002
(n = 9222)
2003–2011
(n = 9671)
Notes: The deviation rates are measured as the percentage of the sample The deviation rate = (observed proportion− expected proportion) ∕ (expected proportion) *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively (two-tailed test).
Trang 7of corporate governance mechanisms Therefore, the results do not reject
thehypothesis H2b Nevertheless, even if this is the case, the effect of the
improvement of corporate governance cannot be ignored The Cramer's
V of thefirst digit from years 1990 to 2002 was 0.0189, which is larger
than the Cramer's V of the first digit from 2003 to 2011 (0.0095)
Therefore, the degree of deviation of thefirst digits from years 1990 to
2002 is larger than the degree of deviation from 2003 to 2011 This is
because improvement of the corporate governance mechanisms has
caused earnings management to become more difficult than in the
years preceding 2003 Consequently, the adjusted digits have moved
backwards In contrast, the developed markets have greater
improve-ment than the emerging markets
Comparing different periods for Taiwan and the United States by
using Cramer's V, regardless of any period, this study found that the
degree of deviation in Taiwanese companies is larger than the degree
of deviation in the U.S companies (Table 5) For example, thefirst
through third digits of earning in Taiwanese companies after 2003
obtain the higher Cramer's V (0.0095; 0.0209; 0.0149, respectively)
than U.S companies after 2003 (0.0068; 0.0063; 0.0090) Our results
showed that cosmetic earnings management of emerging markets
may be more serious than developed markets This result also supports
withhypothesis H1again
5 Conclusion
This study examines the earnings of companies publicly listed in
Taiwan and America from 1990 to 2011 This study investigated whether
corporate managers adopt accounting adjustments to engage in
cosmetic earnings management behavior by using Benford's law The
results show that in both developed markets and emerging markets,
publicly listed companies engage in the practice of cosmetic earnings
management It is generally recognized that the developed markets
have more complete regulatory mechanisms and laws, and earnings
are less likely to be manipulated by corporate managers This study
provides empirical evidence that corporate managers of emerging
markets have stronger incentives to manipulate earnings by
exag-gerating the earnings numbers
Over the last two decades, corporate governance has attracted a
considerable amount of public interest because of increased instances of
corporate fraud both domestically and abroad Numerous countries
have enacted laws to strengthen their corporate governance mechanisms
This study documents pervasive evidence that improvements to the
cor-porate governance mechanisms led to less cosmetic earnings
manage-ment in publicly listed firms, regardless of developed markets and
emerging markets This result suggests that the implementation of
corporate governance regulations plays an important role in reducing
the earnings manipulative behavior In contrast, the developed markets
have greater improvement than the emerging markets Overall, our
results show that cosmetic earnings management offinancial statements
has become more difficult for managers because of improvements to the
corporate governance mechanisms Thefindings of the study add more
evidence to the ongoing debate about the effectiveness of corporate
governance regulations in preventing earnings management These
findings have implications for supervisory authority and investors In
recent years, the International Accounting Standards (AIS) in the world
is being widely recognized and promoted, the accounting items of
financial statements are becoming more flexible, and the importance of vigorous corporate governance mechanisms is increasing We recom-mend supervisory authority to further enhance corporate governance regulations and mechanisms to minimize earnings manipulation For international investors, this study suggests that investors should pay more attention to the accuracy offinancial statements when investing
in emerging markets
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