There are several incentives to engage in earnings management, which managers need to consider. Likewise, there are different ways to drive earnings and cash flows in a certain direction. Given the complex context in which firms operate, earnings management may be seen has a continuous and iterative process characterized by a mixture of incentives and practices.
This research studies earnings management in Portuguese listed firms. The paper addresses two main strategies, namely real management and accrual management. They are measured by the component of cash-flow from operations and accruals that are not explained by firms’ activity, respectively. Portuguese firms seem to apply these two strategies as substitutes. The use of each strategy appears to depend on its relative cost. Healthier firms, as well as firms who face higher marginal tax rates, prefer accrual management, whereas Firms’ with lengthier operational cycles prefer real management. The findings also suggest Portuguese listed firms manage earnings upward mainly with the purpose of sustaining expected dividend payments. If the purpose is to smooth earnings, firms rely less on earnings management if they use derivatives. Besides, firms using derivatives pay fewer taxes, if their nominal marginal tax rate is higher than their effective tax rate.
Click here to go to the paper by Diogo Batista da Silva, António Melo Cerqueira and Elísio Brandão.