Earnings Management: Empirical Evidence Based On Share Allotment

Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports, to either mislead some stakeholders about the underlying economic performance of the economy, or to influence contractual outcomes that depend on reported accounting numbers. As an important issue in financial reporting, earnings management have been attracting the eyes of accounting researchers since 1980's. Many motivations have been put forward hi the literature. These motivations include remuneration, compliance with debt covenants clauses, political cost, taxes and initial public offering. Influenced by the market, share allotment has become the most important measure that public companies absorb new capital from market in China. To ensure quality, the regulatory bodies set a series of provisos for share allotment. Earnings play an important role in these provisos. This motivates the public companies to increase their report earnings. Our hypothesis in this essay is that public companies will increase total accruals in the period t|, to and t|, while decrease in the period \2-Net income consists of cash flows from operations and total accruals that can be divided into discretionary and non-discretionary accruals. How to derive discretionary accruals from earnings is the key in detecting earnings management. It is not possible to observe earnings management directly. Therefore, prior research has used a number of accounting accrual measures to detect earnings management. These measures include random walk model, industry model, mean-reverting model, Jones and modified-Jones models, K-S model, margin model and so on. Of all the above models, it is only the Jones and modified-Jones models who introduce the change of environment to the estimation of non-discretionary accruals, and who derive effectively discretionary part from total accruals. Using a sample of 87 non-financial companies from Shanghai Stock Exchange, we found empirical evidence showing the link between share allotment and earnings management. Our results indicate that entrepreneurs may seek to increase total accruals, temporarily deceiving regulatory bodies by opportunistically manipulating earnings through accruals management surrounding the allotment.