428_lecture22_Emgt_S09 - Valuation: Lecture 22 Earnings...

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Unformatted text preview: Valuation: Lecture 22 Earnings Management Materials from Beneish (1999), Mohanram (2003 ) and Lee (2005) Outline 1) Earning management, what, why and how? 2) Learning to play the Earnings Game 3) How might earnings be "managed" (manipulated)? 4) When do managers manipulate earnings? 5) Detecting earnings manipulation (quantitatively) : The M-score, Beneish (1999) 6) Detecting earnings management (qualitatively), Mohanram (2003 ) Earnings Management Operating & discretionary accounting methods to adjust earnings to a desired outcome; the incentives of management to modify earnings in their own best interests Earnings manipulation includes aggressive earnings management and fraud EM Choices ( Brad Badertscher 2002) Continuum of Regulatory Acceptable and Regulatory Unacceptable Earnings Management Choices. Why Earnings Manipulation? It pays to do it, its easy to do and its unlikely that youll get caught (Schilit) Meeting the benchmark Opportunism: self-interest with guile violating normal ethical boundaries for personal gain Executive incentives include bonuses and stock options Chance to be caught is small Environment for Earnings Management Strong CEO with substantial perks Board made up primarily of insiders Poor board committee structure Audit problems Executive compensation problems Overvalued stock price 2) Learning to Play the Earnings Game How do earning forecasts affect managers incentives? Why would companies want to match earning forecasts? Any choice with respect to sales? 3) How might earnings be manipulated? Two Directions for Manipulation 1. Borrowing income from the future Increase in current revenue Decrease in current expenses 1. Banking income for the future Decrease current revenue Increase current expenses Distinguish: Conservative Accounting vs. Liberal Accounting Aggressive Accounting vs. Big Bath Accounting Both increase current income Both reduce current income A matter of Accounting Policy A matter of short-term application of accounting that will reverse 4) When do managers manipulate earnings ? Research Results References To boost their bonus? Healy, 1985 To avoid reporting a loss or an EPS decrease? Burgstahler, D. and I. Dichev, 1997. During a proxy fight? DeAngelo, 1988 When requesting important relief? Jones, 1991 During a management buyout? DeAngelo, 1986 To meet bank and Insurance regulations? Moley, 1990 4) When do managers manipulate earnings? References: Burgstahler, D. and I. Dichev, "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics , 1997. DeAngelo, L., "Accounting numbers as market valuation substitutes: A study of management buyouts of public stockholders," The Accounting Review , July 1986, p.400-420....
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428_lecture22_Emgt_S09 - Valuation: Lecture 22 Earnings...

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