Empirical Evidences On Budget Ratchet And Earnings Management

The modern business theory and compact theory states that business is a combination of a series of (explicit and hidden) compacts. There would be a possibility of interest conflict between clients and agencies due to the separation of ownership and management within enterprises, and the fact is mostly indeed. Corporation agents are considered having their own benefit function. As the wealth effect led by the consequence of decision-making normally influences their own income-level, agents will usually set their own expected performance lower than the actual performance in order to avoid their clients proposed penalty; meanwhile, clients observe and assess agents'competence and effort level through agents'past achievements and therefore the current performance standards as an essential reference for the later, resulting in a ratchet effect.By associating the ratchet effect with business budget management, the thesis will firstly verify whether the ratchet effect exists in business budget, and then if the enterprise management group impose importance on budget ratchet effect. Under the hypothesis that the ratchet effect does exist in budget, management would control the budget ratchet effect by managing surplus. In view of the 2005-2008 data analysis of ShenZhen and ShangHai listed companies'annual report, it indicates that business ratchet effect exists in budgetary procedure, and the positive budget ratchet effect is greater than the negative; there is a significantly positive correlation between positive budget ratchet effect and positive earnings management, a significantly negative correlation between positive budget ratchet effect and negative earnings management and a significantly negative correlation between negative budget ratchet effect and positive earnings management, but there is no systematically correlation between negative budget ratchet effect and negative earnings management. The findings illustrate from the other side that management group do not control achievement by combining the budget ratchet effect with earnings management. In most cases, listed companies do not put much weight on budget management. As the reward of management group are loosely associated with the fulfillment of budget, management group do not value the change of budget brought by the budget ratchet effect., which shows that management group do not lay much stress on the budget ratchet effect, or in other words, the budget ratchet effect does not exert actual effects on surplus management. On the whole, the findings above inform us that the budget ratchet effect ought to exist and the positive budget ratchet effect is greater than the negative. However, the budget ratchet effect does not have an actual impact on management actions and does not push the management forward to control business achievement, which is mostly because the fulfillment of budget will not influence reward of management group. Therefore, under the circumstance that the fulfillment of budget will not influence the reward of management group, the budget ratchet effect does not have an actual impact on management actions even though it exists indeed. Only when the reward design is associated with the budget ratchet effect, we then need to concern about the influence of budget ratchet effect towards management actions.