Influence Of Accounting Conservatism On A Firm’s Earnings Management (Research Proposal Sample)

INFLUENCE OF ACCOUNTING CONSERVATISM ON A FIRM’S EARNINGS MANAGEMENT: AN AUSTRALIAN PERSPECTIVE By: Course: Professor’s Name: University: City: Date: Influence of Accounting Conservatism on a Firm’s Earnings Management: An Australian Perspective Introduction The highly used performance index by most economies to make decisions, which include performance evaluation and determination of executives’ rewards is the accounting earnings. Therefore, because of the conflicting interests in the firms between the stockholders and the managers, there is the likelihood that the executives will try to change the earnings figures. According to Fang, Maffett, and Zhang (2015), altering the figures helps the managers to cheat the investors as they give positive views on the financial reports to the shareholders. Such views are important to managers but affect the investors as they depend on the data that corporations publish, hence, invest in them. The conflicting interests arise because of the separation of ownership from the executives, thus, motivating them towards selfishness and become opportunistic. The present study is vital, since, it will assist the investors and the public to understand how to pick businesses that have highly sustainable earnings with better quality in order to maximize their money receipts in the future. Practical Motivation Firms’ executives get pressure when managing the earnings and through the accountants, they manipulate the corporations’ accounting practices in order to realize what they expect financially while keeping the share prices of the business up (Mao and Renneboog 2015). Most of the managers obtain bonuses depending on how the earnings perform while some might become qualify for stock options, which create an income when their prices improve. Auditors do not disclose several forms of earnings’ manipulation, therefore, shareholders remain in the dark. Therefore, the executives who mind about the firms’ stockholders will find the current research helpful because they will get its findings, which will suggest the methods to reduce the pressure that they get when managing the earnings. By following the proposed ways, the firms will produce true financial statements that the shareholders will rely on when making investment decisions. Theoretical Motivation Scholars have carried out a lot of studies about the firms’ earnings management in various parts of the globe but not many have studied the relationship between the firms’ earnings management and accounting conservatism especially in Australia. Hence, the present research will concentrate on that association in Australia. According to Akdogan and Ozturk (2015), managers must explain any variation in the accounting principles to the users of the financial accounts by disclosing in the footnotes of the statements. These disclosures would ensure that there is consistency and the financial accounts become comparable, thereby, exposing any manipulation of the earnings. The current study will improve on the prevailing theory because it will demonstrate how the executives should manage the earnings of their firms in order to avoid giving misstatements and help the financial accounts’ users to make prudent investment decisions. Literature Review This section discusses the earnings management, agency theory, and the relationship between a firm’s earnings management and its relationship with accounting conservatism. Firm’s Earnings Management and its Relationship with Accounting Conservatism Earnings management is a situation where the managers of a firm use the accounting methods to come up with financial accounts, which exaggerate a corporation's commercial activities and financial position in a positive way. According to Ali and Zhang (2015), several accounting rules and principles allow business managers to make their decisions by following them. Ali and Zhang assert that the earnings management such benefits of the accounting and principles to create financial reports, which inflate the income and assets of the firms, hence, smooth out variations in earnings and show consistent returns either monthly or annually.  There is a negative relationship between the firm’s earnings management and accounting conservatism. Conservatism is a principle, which tries to create the asset and income values, hence, decelerates the recognition of revenue while accelerating the recognition of expenses. According to Lara, Osma, and Penalva (2016), conservatism slows the future cash inflows recognition and allows the accountants to report the highest liabilities’ values, and the lowest assets and revenues’ values, therefore, producing the lowest equity book values. Conservatism produces high profits, since, the principle does not allow companies to exaggerate their earnings, thus, assists the accounting information users as they present earnings and assets that they do not overstate (Guan 2014). Therefore, the organizations’ managers and accountants might require to start using accounting conservatism when calculating the values of the assets and incomes in order to enhance the revenues’ quality for the stakeholders to use when evaluating the business. Agency Theory The agency theory expounds on the association that exists between a business’s principals and the agents. According to Pepper and Gore (2015), the purpose of agency theory is to resolve the challenges that arise in agency relations because of the objectives that are not aligned or when the levels of averting risk are different. Pepper and Gore assert that in finance the commonest agency association happens between the shareholders who are the principals and the corporation’s executives who are the agents. Agency problems might happen due to the principal not being aware of the agent’s activities or the lack of funds prohibit him or her from getting the information (Chari, David, Duru, and Zhao 2018). For instance, the firm’s managers might wish to grow the corporation to other marketplaces, which will take much of the current profits of the business as the executives prospect more incomes. On the other hand, the shareholders who want more growth in the current capital might not be aware of the managers’ strategies. According to Eisdorfer, Giaccotto, and White (2015), Jensen and Meckling are the ones who proposed the agency theory in 1976 by defining the corporations' managers as the "agents" and the shareholders as the "principals". Jensen and Meckling acknowledged that shareholders are at odds with the directors because the shareholders delegate decision-making to the managers. However, the challenge is that the directors do not make decisions in the favor of the shareholders. Jensen and Meckling posited that agency theory assumes that the "agents" and the "principals" have a conflict of interest. The views of the two were that what motivates the managers is in their private interests, which conflicts with the interests of the shareholders to maximize wealth. This opinion posits that the motivations, which include rewards, contracts, political motivations, tax incentives, and changing the Chief Executive Officer (CEO), are some of the major earnings management inducements. The Review of Literature Nahandi, Baghbani, and Bolouri (2012) undertook a study about the earnings management and accounting conservatism with a case study of Iran. The scholars investigated, “the relationship between earnings management and accounting conservatism in Iranian firms.” Nahandi, Baghbani, and Bolouri measured the earnings management using the modified Jones model while they measured conservatism using the Basu (1997) model. The scholars studied the firms listed in Tehran Stock Exchange between 2001 and 2008, and used the systematic omission method to get the sample and the ordinary least squares (OLS) regressions to test the relationship between earnings management and accounting conservatism. Nahandi, Baghbani, and Bolouri found out that the association between the earnings management and accounting conservatism is negative. The organizations whose earnings management was at low levels appeared to possess big asymmetric timeliness coefficients while the institutions whose earnings management was at high levels had small asymmetric timeliness coefficients. Zhang (2012), in his research about, “the empirical study of earnings management based on Chinese listed companies” used the margin return on equity (ROE) and the Jones model in the empirical examination on the selected manufacturing firms in China. From the results, Zhang found out that changing of accounting principles does not escalate the earnings management although sometimes it can go up slightly, hence, not statistically significant. Martin and Roychowdhury (2015), in their study about, “Do financial market developments influence accounting practices? Credit default swaps and borrowersЧі reporting conservatism” studied how conservatism relates to both the accrual and real earnings management. The authors used a large sample of the banks from1991 to 2010. From the results, Martin and Roychowdhury found out that there is a positive relationship between conservatism and the real earnings’ management and a negative relationship between conservatism and the accruals interference’s measures. Abbasiazadeh and Zamanpour (2016) studied about, “Investigation of the Effect of Audit Size on Earnings Management in Tehran Stock Exchange.” The authors investigated the effect of audit size on the earnings management in the 116 corporations registered with the Tehran stock market from 1387 to 1392. Abbasiazadeh and Zamanpour tested earning management using multiple regressions. The authors used a sample of 5 corporations that are listed on the stock market and utilized the Excel statistical tool for analysis. From the findings, Abbasiazadeh and Zamanpour established that the au...