Where Do Firms Manage Earnings?

Despite decades of research on how, why, and when companies manage earnings, there is a paucity of evidence about the geographic location of earnings management within multinational firms. In this study, we examine where companies manage earnings using a sample of 2,067 U.S. multinational firms from 1994 to 2009. We predict and find that firms with extensive foreign operations in weak rule of law countries have more foreign earnings management than companies with subsidiaries in locations where the rule of law is strong. We also find some evidence that profitable firms with extensive tax haven subsidiaries manage earnings more than other firms and that the earnings management is concentrated in foreign income. Apart from these results, we find that most earnings management takes place in domestic income, not foreign income.

[1]  P. Hribar,et al.  The Use of Unsigned Earnings Quality Measures in Tests of Earnings Management , 2007 .

[2]  Thomas C. Omer,et al.  Exploring the Term of the Auditor‐Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation? , 2003 .

[3]  Thomas Z. Lys,et al.  Empirical Research on Accounting Choice , 2001 .

[4]  John D. Phillips,et al.  Earnings Management Strategies and the Trade‐Off between Tax Benefits and Detection Risk: To Conform or Not to Conform? , 2009 .

[5]  Charles E. Wasley,et al.  Performance Matched Discretionary Accrual Measures , 2002 .

[6]  Larry E. Toothaker,et al.  Multiple Regression: Testing and Interpreting Interactions , 1991 .

[7]  Luann J. Lynch,et al.  Tax Reporting Aggressiveness and its Relation to Aggressive Financial Reporting , 2009 .

[8]  Marilyn F. Johnson,et al.  The Relation between Auditors' Fees for Nonaudit Services and Earnings Management , 2002 .

[9]  Tony Kang,et al.  Pricing and Mispricing Effects of SFAS 131 , 2008 .

[10]  Ilia D. Dichev,et al.  Earnings Management to Avoid Earnings Decreases and Losses , 1997 .

[11]  Gordon M. Bodnar,et al.  The valuation of the foreign income of US multinational firms: a growth opportunities perspective , 1997 .

[12]  Nathan Y. Sharp,et al.  The Impact of Religion on Financial Reporting Irregularities , 2011 .

[13]  Daniel Bergstresser,et al.  CEO Incentives and Earnings Management , 2004 .

[14]  Robert M. Bowen,et al.  Determinants of the corporate decision to capitalize interest , 1981 .

[15]  Patricia M. Dechow,et al.  DETECTING EARNINGS MANAGEMENT , 1994 .

[16]  Weili Ge,et al.  Accruals Quality and Internal Control Over Financial Reporting , 2007 .

[17]  Alan D. Jagolinzer,et al.  Chief Executive Officer Equity Incentives and Accounting Irregularities , 2009 .

[18]  Mark L. DeFond,et al.  Debt covenant violation and manipulation of accruals , 1994 .

[19]  Sugata Roychowdhury,et al.  Earnings Management Through Real Activities Manipulation , 2006 .

[20]  Andrew J. Leone,et al.  The Importance of Distinguishing Errors from Irregularities in Restatement Research: The Case of Restatements and CEO/CFO Turnover , 2008 .

[21]  April Klein,et al.  Audit Committee, Board of Director Characteristics, and Earnings Management , 2002 .

[22]  Christopher D. Williams,et al.  Religious Social Norms and Corporate Financial Reporting , 2009 .

[23]  David M. Reeb,et al.  International Diversification and Analysts' Forecast Accuracy and Bias , 2002 .

[24]  Shivaram Rajgopal,et al.  This version: January 2011 Do the SEC’s Enforcement Preferences Affect Corporate Misconduct? , 2011 .

[25]  A. P. Sweeney,et al.  Debt-covenant violations and managers' accounting responses , 1994 .

[26]  Patricia M. Dechow,et al.  Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences , 2010 .

[27]  Mark L. DeFond,et al.  Investor Protection and the Information Content of Annual Earnings Announcements: International Evidence , 2007 .

[28]  Patricia M. Dechow,et al.  Predicting Material Accounting Misstatements , 2010 .

[29]  Patricia M. Dechow,et al.  The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors , 2002 .

[30]  J. Jones.  Earnings Management During Import Relief Investigations , 1991 .

[31]  Scott D. Dyreng,et al.  Using Financial Accounting Data to Examine the Effect of Foreign Operations Located in Tax Havens and Other Countries on U.S. Multinational Firms' Tax Rates , 2009 .

[32]  Ilia D. Dichev,et al.  Large-Sample Evidence on the Debt Covenant Hypothesis , 2002 .

[33]  Ross L. Watts,et al.  Towards A Positive Theory of the Determination of Accounting Standards , 2006 .

[34]  Patricia M. Dechow,et al.  Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators , 2000 .

[35]  James P. Weston,et al.  Religion and Corporate (Mis)Behavior , 2009 .

[36]  Shivaram Rajgopal,et al.  The Accrual Anomaly: International Evidence , 2005 .

[37]  Edward L. Maydew,et al.  How Much Will Firms Pay for Earnings that Do Not Exist? Evidence of Taxes Paid on Allegedly Fraudulent Earnings , 2002 .

[38]  P. Healy,et al.  A Review of the Earnings Management Literature and its Implications for Standard Setting , 1998 .

[39]  Mona M. Clayton,et al.  A Guide to Forensic Accounting Investigation: Golden/Guide , 2012 .

[40]  R. Ball,et al.  The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition , 2005 .

[41]  Sanjay Kallapur,et al.  Client Importance, Nonaudit Services, and Abnormal Accruals , 2003 .

[42]  Florin P. Vasvari,et al.  The Effects of SFAS 131 Geographic Segment Disclosures on the Valuation of Foreign Earnings , 2004 .

[43]  Katherine Schipper,et al.  The market pricing of accruals quality , 2005 .

[44]  Mark Lang,et al.  Earnings Management and Cross Listing: Are Reconciled Earnings Comparable to Us Earnings? , 2005 .

[45]  S. Rego.  Tax Avoidance Activities of U.S. Multinational Corporations , 2002 .

[46]  Wayne B. Thomas.  A Test of the Market’s Mispricing of Domestic and Foreign Earnings , 2011 .

[47]  Rebecca N. Hann,et al.  The Impact of SFAS No. 131 on Information and Monitoring , 2003 .

[48]  Robert W. Holthausen.  Evidence on the effect of bond covenants and management compensation contracts on the choice of accounting techniques: The case of the depreciation switch-back , 1981 .

[49]  Frederic S. Mishkin,et al.  A Rational Expectations Approach to Macroeconometrics: Testing Policy Ineffectiveness and Efficient-Markets Models. , 1984 .

[50]  R. Kalra,et al.  Earnings Management and Investor Protection: An International Comparison , 2004 .

[51]  N. M. Fan.  A Study Of Foreign Earnings Management Using An Empirical Distribution Approach , 2008 .

[52]  M. Zmijewski,et al.  Some economic determinants of accounting policy choice , 1979 .

[53]  R. Ball,et al.  The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition: loss recognition role of accruals , 2006 .

[54]  Ole-Kristian Hope,et al.  Geographic Earnings Disclosure and Trading Volume , 2008 .

[55]  Patricia M. Dechow,et al.  Predicting Material Accounting Misstatements*: Predicting Material Accounting Misstatements , 2011 .