The impact of earnings management on innovation strategies in developed, developing, and transition economies

Marei, Y

Abstract

This study focuses on investigating the impact of earnings management on innovation strategies in developed, developing and transition economies. The study examines earnings management models and utilises accruals models: standard Jones model (Dechow and Sloan, 1991), Modified Jones model (Dechow et al., 1995), Kothari model (Kothari et al., 2005) working capital Peasnell model (Peasnell et al., 2000)
and real activities models (Roychowdhury, 2006): abnormal production, abnormal cash flow, and abnormal discretionary expenses. Under accruals models, this research examines how accruals utilise both the balance sheet and cash flow approach. A quantitative approach is adopted for this research as well as adopts linear regression and independent t-test, Manny Whitney U test. The data sample is drawn from 36,777 firms from 2008 through 2018.
Earnings management mainly affects earnings reports and, thus, the stockholders and potential investors who use the earnings report to decide whether to invest or continue to invest in a firm. There are various ways that allow executives to manipulate the earnings reports, such as real activities and the use of accruals. On the one hand, innovation is associated with the uncertainty of future economic benefit. As well, executives are under pressure to consistently provide the desired funds for innovation, precisely where a research and development strategy is embraced. On the other hand, Executives are also under pressure to meet earnings expectations. To do so, executives use earnings management. This study fills the gap in the literature regarding earnings management and innovation strategies. The results show that executives in innovated firms are not equally engaged in earnings manipulation in non-innovated firms in developed, developing and transition economies. In addition, the research found a strong relationship between earnings management and innovation strategies. Accruals manipulations in developed, developing economies have a positive relationship with innovation and transition economies have a significant positive relationship with innovation in the working capital model only. Real activities, abnormal production, abnormal cash flow, and abnormal discretionary expenses manipulations have a positive relationship with innovation in developed, developing economies and positive relationship in transition economies. These positive relationships when they exist between earnings management models and innovation suggest that executives do manipulate the financial statement in order to support innovation strategy.
Also, we find that abnormal production model is preferred by executives in innovated and non-innovated firms over accruals in abnormal production only, but accruals are preferred over abnormal discretionary expenses and abnormal cash flow. These results highlight that there is no preferred method, but executives utilised both approaches in order to achieve their incentives.
Also, these results documented the similarity of executives’ approach concerning managing earning and innovations in both developed and developing economies. Likewise, it provides evidence for stakeholders of the importance of earnings management and executives ‘strategies when pursuing innovation. It also provides pieces of evidence on which approach and models are more robust to detect earnings management in developed, developing and transition economies.
We also find that the power of models in accruals is different based on total accruals calculation methods. We find that the balance sheet approach is more potent than the cash flow approach. Correspondingly, abnormal production is a more robust model for explaining earnings management in developed, developing and transition economies. These finding could be beneficial to executives, investors, and policymakers in regard to decisions about innovation strategies and the earnings management tools. Finally, the results could be helpful

for future research on accruals, real activities and innovation in developed, developing and transition economies.

Citation

Marei, Y. The impact of earnings management on innovation strategies in developed, developing, and transition economies. (Thesis). University of Salford

• Thesis Type: Thesis
• Deposit Date: Aug 7, 2020
• Publicly Available Date: Aug 7, 2020
• Award Date: Jan 1, 2020