How does the possibility of being included on a corporate watch list (i.e., a public list that identifies companies engaged in more aggressive accounting practices) influence managers’ decisions to engage in earnings management? To answer this question, Erin L. Hamilton, Ph.D., CPA, Rina M. Hirsch, Ph.D., CPA, Uday S. Murthy, Ph.D., and Jason T. Rasso, Ph.D., CFE, distributed a survey to managers of publicly- traded companies who have considerable financial reporting experience.
In addition to the survey findings, the report offers perspective on the forms earning management can take, the ethical questions it can raise, and whether common benchmarks for right vs. wrong in use, such as “Would you want this action publicized in the news?” had any effect.
Among the key findings of the survey:
- Managers engage in more aggressive (income-increasing) earnings management when they believe such behavior will not be revealed publicly.
- The prospect of being included on a corporate watch list changes managers’ accounting choices. When managers fear inclusion on a watch list, they are less likely to engage in aggressive (income-increasing) earnings management and more likely to engage in conservative (income-decreasing) earnings management.
- Managers generally view earnings management as unethical (particularly income-increasing earnings management), but frequently engage in such behavior despite these beliefs.
- Managers give considerable thought to how their aggressive accounting choices might be perceived by others (such as investors, regulators, and auditors).