Fundamental performance and earnings quality in private firms
International Journal of Accounting & Information Management
ISSN: 1834-7649
Article publication date: 28 November 2023
Issue publication date: 19 January 2024
Abstract
Purpose
The purpose of this paper is to examine the effect on earnings quality in private firms caused by a negative shock to fundamental performance, while simultaneously addressing methodological challenges measuring fundamental performance present in prior accrual-based earnings management literature.
Design/methodology/approach
Fundamental performance is unobservable and, therefore, difficult to measure. Existing research has used proxies that are subject to estimation errors and endogeneity concerns (e.g. DeFond and Park, 1997, Balsam et al., 1995). This study attempts to overcome these issues by taking advantage of the exogenous shock in oil price which occurred in 2014 and by using a difference-in-differences approach to investigate the effect on earnings management caused by a negative shift in fundamental performance.
Findings
The results suggest that a negative shock in fundamental performance, indicated by the oil price shock in 2014, reduces earnings quality. This result holds for various robustness tests such as the use of propensity score matching, and the inclusion of firm fixed effects. Additional analysis suggests that the reduction in earnings quality is driven by an increase in positive discretionary accruals, suggesting that managers of private firms experiencing poor performance manage earnings upwards to conceal true performance.
Originality/value
This study contributes to the literature by examining the effect of a negative shock to performance in a setting of private firms and by addressing methodological challenges in prior literature. Private firms are fundamentally different from public firms, with the consequence that results from public firms may not be generalizable to private firms (e.g. Hope et al., 2012, Burghstahler et al., 2006, Ball and Shivakumar, 2005).
Keywords
Acknowledgements
We are grateful to the Center for Corporate Governance Research (CCGR) at the BI Norwegian Business School for giving us permission to retrieve data from the CCGR database. We greatly appreciate helpful comments from Kjell Henry Knivsflå, Limei Che, Frøystein Gjesdal, Han Wu, Anna Rossi and participants at the EAA 44th Annual Congress. During the completion of earlier drafts of this paper Tonny Stenheim was a faculty member at the BI Norwegian Business School.
Citation
Sundkvist, C.H. and Stenheim, T. (2024), "Fundamental performance and earnings quality in private firms", International Journal of Accounting & Information Management, Vol. 32 No. 1, pp. 58-73. https://doi.org/10.1108/IJAIM-01-2023-0013
Publisher
:Emerald Publishing Limited
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