The Four-Stage Financial Early-Warning Models Under Different Earnings Management Methods

The world economic and financial crisis makes great influence on world economic and political patterns. After the crisis there are more uncertainties in world economy. Corporations face greater financial risk, thus stakeholders’ need of financial early warning changes. On one aspect, corporation financial situation complexity calls for a more effective multistage dynamic financial early warning model, on the other, corporation face greater financial risks because the managers use earnings management methods to adjust financial ratios so that corporation can survive in the larger competitions. How to eliminate the voices in financial ratios has always been a problem in financial early warning models.It first defines financial distress in a new way, using special treatment and going concern opinion as two divisory criterions. Financial distress is divided into four different levels, health, been given going concern opinions only, been in special treatment only, receive both going concern opinion and special treatment, as the financial situation is worse. Then it includes earnings management into research because it will affect financial ratios’ fidelity. Earnings management was divided into accrual-based earnings management and real earnings management. The experience study result show a positive relation between accrual-based earnings management and financial distress and a negative relation between real earnings management. And there is no significant mutual affection between accrual-based earnings management and real earnings management. On the bases of those conclusions they establish a four-stage financial early warning model and examine its early warning accuracy. The prediction accuracy rate are both very high in accrual-based earnings management early warning model and real earnings management early warning model, and the prediction accuracy rate for healthy corporations is much higher than unhealthy corporations. Using data in year t-1 to predict healthy corporations and using data in year t-2 to predict unhealthy corporations are more accurate.It is a breakthrough for the research to use going concern opinion to define financial distress and divide financial situation into four stages, include earnings management into four stage financial early warning model. So that stakeholder will have a more accurate model to predict corporation financial situations, to protect personal benefits. The managers can improve corporation value and regulators can supervise and control corporations in a better way.