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Stock pledging and earnings management: an empirical analysis

Stock pledging and earnings management: an empirical analysis The purpose of this paper is to investigate the impact of agency risk implied in case of personal debt obtained by promoters through pledging of their stock on accrual and real earnings management practices.Design/methodology/approachIn this paper abnormal accruals, as suggested in Dechow et al. (1995), and the real earnings management proxies as indicated in Dechow et al. (1998) and Roychowdhury (2006) are used. OLS regression is run over 29,054 firm-years of Indian companies starting from the year 2008 to 2016. Then the occurrence of earnings management is tested in firms in year t where promoters pledge/release their holdings from the pledge in year t+1.FindingsThe findings suggest that earnings management increases in the prior year with an increase in the proportion of promoters’ stock pledge in the subsequent year. The authors find evidence for increased earnings management through accruals and also for real earnings management using abnormal cash flows and abnormal discretionary expenses. However, the authors do not find real earnings management using abnormal production cost as a measure.Practical implicationsThe paper has considerable implications on managerial behavior toward earnings management because of the flexibility managers have in applying accounting policies and authority in operating decisions under domestic GAAP, and IFRS and earnings are prone to management tactics, fostering agency risk when they relate to the welfare of decision makers.Originality/valueThis paper addresses the consequences of individual borrowing of promoters collateralized by their stake in the firm, which is a global phenomenon, on reporting quality. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asian Review of Accounting Emerald Publishing

Stock pledging and earnings management: an empirical analysis

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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1321-7348
DOI
10.1108/ara-03-2018-0074
Publisher site
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Abstract

The purpose of this paper is to investigate the impact of agency risk implied in case of personal debt obtained by promoters through pledging of their stock on accrual and real earnings management practices.Design/methodology/approachIn this paper abnormal accruals, as suggested in Dechow et al. (1995), and the real earnings management proxies as indicated in Dechow et al. (1998) and Roychowdhury (2006) are used. OLS regression is run over 29,054 firm-years of Indian companies starting from the year 2008 to 2016. Then the occurrence of earnings management is tested in firms in year t where promoters pledge/release their holdings from the pledge in year t+1.FindingsThe findings suggest that earnings management increases in the prior year with an increase in the proportion of promoters’ stock pledge in the subsequent year. The authors find evidence for increased earnings management through accruals and also for real earnings management using abnormal cash flows and abnormal discretionary expenses. However, the authors do not find real earnings management using abnormal production cost as a measure.Practical implicationsThe paper has considerable implications on managerial behavior toward earnings management because of the flexibility managers have in applying accounting policies and authority in operating decisions under domestic GAAP, and IFRS and earnings are prone to management tactics, fostering agency risk when they relate to the welfare of decision makers.Originality/valueThis paper addresses the consequences of individual borrowing of promoters collateralized by their stake in the firm, which is a global phenomenon, on reporting quality.

Journal

Asian Review of Accounting – Emerald Publishing

Published: Oct 4, 2019

Keywords: Real earnings management; OLS regression; Reporting quality; Global phenomenon; Accrual-based earnings management; M41; M48

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