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Managerial discretion in distressed firms

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  • Charitou, Andreas
  • Lambertides, Neophytos
  • Trigeorgis, Lenos

Abstract

This study examines the earnings management behaviour of 455 distressed US firms that filed for bankruptcy during the period 1986–2001. We examine (a) possible earnings management during the years prior to bankruptcy-filing, (b) whether qualified audit opinions cause conservative earnings management behaviour, (c) whether earnings management differs between firms that discontinued operations and firms that survived thereafter, and (d) the effect of earnings management on subsequent stock returns. Our results are consistent with downwards earnings management 1 year prior to the bankruptcy-filing. Results also show that (a) firms receiving unqualified audit opinions 4 or 5 years prior to the bankruptcy-filing event manage earnings upwards in subsequent years, consistent with Rosner [2003. Earnings manipulation in failing firms. Contemporary Accounting Research 20, 361–408], (b) more conservative earnings management seems to be related to the qualified audit opinions rendered in the preceding year, (c) firms with long-term negative accruals the year of bankruptcy-filing have a greater chance to survive thereafter, and (d) more pronounced (negative) earnings management is associated with more negative (next year's) subsequent returns.

Suggested Citation

  • Charitou, Andreas & Lambertides, Neophytos & Trigeorgis, Lenos, 2007. "Managerial discretion in distressed firms," The British Accounting Review, Elsevier, vol. 39(4), pages 323-346.
    • Handle: RePEc:eee:bracre:v:39:y:2007:i:4:p:323-346
    DOI: 10.1016/j.bar.2007.08.003
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    2. Felix Schumann & Toni W. Thun & Tobias Dauth & Henning Zülch, 2024. "Does top management team diversity affect accounting quality? Empirical evidence from Germany," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 28(1), pages 137-175, March.
    3. Sondes Draief, 2021. "Earnings Management Incentives and the Pricing of Discretionary Accruals," International Journal of Business and Management, Canadian Center of Science and Education, vol. 14(7), pages 1-77, July.
    4. Campa, Domenico & Camacho-Miñano, María-del-Mar, 2015. "The impact of SME’s pre-bankruptcy financial distress on earnings management tools," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 222-234.
    5. Nguyen, Hang Thu & Alphonse, Pascal & Nguyen, Hiep Manh, 2022. "Financial distress and the accrual anomaly," Journal of Contemporary Accounting and Economics, Elsevier, vol. 18(3).
    6. Ahsan Habib & Mabel D' Costa & Hedy Jiaying Huang & Md. Borhan Uddin Bhuiyan & Li Sun, 2020. "Determinants and consequences of financial distress: review of the empirical literature," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(S1), pages 1023-1075, April.
    7. Khushbu Agrawal & Chanchal Chatterjee, 2015. "Earnings Management and Financial Distress: Evidence from India," Global Business Review, International Management Institute, vol. 16(5_suppl), pages 140-154, October.
    8. Iatridis, George, 2012. "Hedging and earnings management in the light of IFRS implementation: Evidence from the UK stock market," The British Accounting Review, Elsevier, vol. 44(1), pages 21-35.
    9. Sara Hassanpour & Mehdi Nazemi Ardakani, 2017. "The Effect of Pre-bankruptcy Financial Distress on Earnings Management Tools," International Review of Management and Marketing, Econjournals, vol. 7(3), pages 213-219.
    10. Camacho-Miñano, María-del-Mar & Campa, Domenico, 2014. "Integrity of financial information as a determinant of the outcome of a bankruptcy procedure," International Review of Law and Economics, Elsevier, vol. 37(C), pages 76-85.
    11. Nagar, Neerav & Sen, Kaustav, 2016. "Earnings Management Strategies during Financial Distress," IIMA Working Papers WP2016-02-03, Indian Institute of Management Ahmedabad, Research and Publication Department.
    12. Philippe Jardin & David Veganzones & Eric Séverin, 2019. "Forecasting Corporate Bankruptcy Using Accrual-Based Models," Computational Economics, Springer;Society for Computational Economics, vol. 54(1), pages 7-43, June.
    13. Juan García Lara & Beatriz Osma & Evi Neophytou, 2009. "Earnings quality in ex‐post failed firms," Accounting and Business Research, Taylor & Francis Journals, vol. 39(2), pages 119-138.
    14. Ashraf, Sumaira & Félix, Elisabete G.S. & Serrasqueiro, Zélia, 2020. "Development and testing of an augmented distress prediction model: A comparative study on a developed and an emerging market," Journal of Multinational Financial Management, Elsevier, vol. 57.

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    More about this item

    Keywords

    Distress; Bankruptcy; Earnings management; Audit opinion; Stock returns;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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