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Efficient contracting, earnings smoothing and managerial accounting discretion

Author

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  • Mohamed Khalil
  • Jon Simon

Abstract

Purpose - – The purpose of this paper is to examine whether the contracting incentives (i.e. bonus plans, debt covenants, political costs hypotheses), and income smoothing can explain accounting choices in an emerging country, Egypt. Design/methodology/approach - – The paper uses the ordinary least square regression model to examine the relationship between earnings management and reporting objectives. A sample of 438 non-financial firms listed on the Egyptian Exchange over the period 2005-2007 is used. Findings - – The paper finds that the contracting objectives explain little of the variations in accounting choices (i.e. discretionary accruals) in the Egyptian context. However, the paper finds that mangers are likely to smooth the reported earnings by managing the accrual component in an attempt to reduce the fluctuation in reported earnings by increasing (decreasing) earnings when earnings are low (high) in attempt to reduce the variability of the reported earnings. Research limitations/implications - – The empirical results rely on the ability of earnings management proxies to adequately capture earnings manipulation activities. Practical implications - – The findings of the study should be of substantial interest to regulators and policy makers. The results implicitly contribute to the ongoing argument in relation to the optimal flexibility permitted by standard setting and the argument that tightening the accounting standards and mandating International Financial Reporting Standards are likely to improve reporting quality and reduce opportunistic earnings management. The results reveal that many of the weaknesses related to corporate reporting in emerging countries may result from the inadequate enforcement of the law and the weak legal protection of minority shareholders. The results also highlight the crucial role of understanding the reporting incentives, which is mainly shaped by institutional and market forces and the legal environment, in explaining accounting choices. Originality/value - – Unlike previous studies that tested an individual objective, this study examines the trade-offs among various reporting objectives in an emerging economy.

Suggested Citation

  • Mohamed Khalil & Jon Simon, 2014. "Efficient contracting, earnings smoothing and managerial accounting discretion," Journal of Applied Accounting Research, Emerald Group Publishing Limited, vol. 15(1), pages 100-123, May.
  • Handle: RePEc:eme:jaarpp:v:15:y:2014:i:1:p:100-123
    DOI: 10.1108/JAAR-06-2012-0050
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    Citations

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    Cited by:

    1. Michele Fabrizi & Antonio Parbonetti, 2016. "CEO Risk Incentives and Real Earnings Management," International Journal of Business and Management, Canadian Center of Science and Education, vol. 11(3), pages 1-37, February.
    2. Jude Edeigba & Christopher Gan & Felix Amenkhienan, 2020. "The influence of cultural diversity on the convergence of IFRS: evidence from Nigeria IFRS implementation," Review of Quantitative Finance and Accounting, Springer, vol. 55(1), pages 105-121, July.
    3. Jonas Oliveira & Graça Azevedo & Bertina Oliveira, 2018. "Impairment Losses: The Impact of First‐time Adoption of the Accounting Standardisation System in Portugal," Australian Accounting Review, CPA Australia, vol. 28(4), pages 556-576, December.
    4. Mohamed Khalil & Aydin Ozkan, 2016. "Board Independence, Audit Quality and Earnings Management: Evidence from Egypt," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 15(1), pages 84-118, April.
    5. Asuman Atik & Iva Kovacevic, 2022. "Comparison of the Companies on the BIST Sustainability Index with Other Listed Companies in the Context of Earnings Manipulation," Istanbul Business Research, Istanbul University Business School, vol. 51(2), pages 399-416, November.

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