The Valuation Effects of Accrual-Based Earnings Management and Real Activities Manipulation Associated with the Elimination of the Form 20-F Reconciliation Requirement

• In Event: Earnings Management Issues

Abstract

This study investigates the earnings management potential of allowing U.S. cross-listed firms to choose IFRS reporting and compares the valuation implications of earnings management strategies for firms whose filing choices are most likely attributable to the SEC’s elimination of the reconciliation requirement (i.e., firms that switched to IFRS voluntarily from local standards after the elimination) and for firms that adopted U.S. GAAP voluntarily after the elimination. We find evidence of simultaneity and substitution between discretionary accruals and real activities manipulation for the two test samples. However, we also find that firms applying IFRS voluntarily since before the elimination engage in a sequential discretionary-expenses-then-accrual management process. In addition, we document that the value erosion derived from accrual-based earnings management is more pronounced for the U.S. GAAP sample, and that the value gain arising from real activities manipulation is greater for the IFRS sample. Differences in the valuation effects of earnings management strategies between the two groups before the SEC removed the reconciliation requirement generally do not explain their differences after the elimination. We generally find that U.S. GAAP firms do not exhibit significant differences before and after the elimination. We further document that IFRS firms engage in real activities manipulation to improve the informativeness of their reported earnings.

Authors

• Chia-Ling Chao, National Chung Cheng University

• Shwu-Min Horng, National Chengchi University