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Financial distress, earnings management and market pricing of accruals during the global financial crisis

Ahsan Habib (Accounting Department, Auckland University of Technology, Auckland, New Zealand)
Md. Borhan Uddin Bhuiyan (Accounting Department, Massey University, Auckland, New Zealand)
Ainul Islam (Accounting Department, Victoria University of Wellington, Wellington, New Zealand)

Managerial Finance

ISSN: 0307-4358

Article publication date: 11 January 2013

9136

Abstract

Purpose

The aim of this paper is to examine empirically the managerial earnings management practices of financially distressed firms, and to consider whether these practices changed during the recent global financial crisis. Although corporate distress has been a topic of research interest for many years, earnings manipulation by distressed firms has received relatively little attention.

Design/methodology/approach

The paper uses three measures of distress, and discretionary accruals, a popular proxy for earnings management, to investigate the impact of distress on earnings management.

Findings

The paper finds that managers of distressed firms engage more in income‐decreasing earnings management practices compared to their healthy firm counterparts. The paper also finds some evidence of the effect of the global financial crisis on the association between financial distress and earnings management. Finally, the paper shows some evidence of positive market pricing of discretionary accruals in the non‐crisis period, but a substantial reduction in pricing coefficients during the global financial crisis period.

Practical implications

Financial distress experienced by firms provides incentives to managers for earnings manipulation. However, the direction of the earnings management could be income‐increasing or income‐decreasing. The findings from this study will allow investors to make better investment decisions for firms that are experiencing financial difficulties.

Originality/value

This paper is the first in New Zealand to investigate the association between firm distress and managerial earnings management decisions. Recently, New Zealand experienced a spate of finance company collapses that somewhat contributes, indirectly, to financial distress experienced by firms. The New Zealand reporting environment is characterized by concentrated ownership, relaxed monitoring by regulatory authorities, and a very low litigation threat that provides an interesting setting to examine the research question. This paper is also the first to test the market pricing of earnings components in New Zealand.

Keywords

Citation

Habib, A., Uddin Bhuiyan, B. and Islam, A. (2013), "Financial distress, earnings management and market pricing of accruals during the global financial crisis", Managerial Finance, Vol. 39 No. 2, pp. 155-180. https://doi.org/10.1108/03074351311294007

Publisher

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Emerald Group Publishing Limited

Copyright © 2013, Emerald Group Publishing Limited

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