Business strategy typologies and the preference of earnings management practices: Evidence from Indonesian listed firms

We examine the relationship between business strategy typologies and managers’ involvement in accrual earnings management (AEM) and real activities manipulation (RAM). Furthermore, we investigate whether prospectors (defenders) show a lower (higher) preference for earnings management than defenders (prospectors), both for the AEM and the RAM concurrently. The study sample was selected from publicly held companies in Indonesia from 2012 to 2018. Following Miles and Snow’s (1978, 2003) framework, we use a comprehensive construct of business strategy to determine each firm’s typology of business strategy based on the score, and we employ multiple regression models to test our hypotheses and robustness checks. Our test results find that prospector-type business strategies have lower AEM and RAM than defender-type business strategies. Next, we find strong evidence that prospectors are less likely to have earnings management preferences than defenders. Our additional tests using the individual RAM level find some evidence that prospectors are less likely to engage in discretionary operating expenses, supporting our main results. Our findings have practical implications for investors, policymakers, and other stakeholders that prospector-type business strategies that focus on innovation and long-term performance achievements do not necessarily provide incentives for management to engage in earnings management, leading to lower earnings quality.