Download Empirical Research on the Earnings Manipulation Behavior of the

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Empirical Research on the Earnings Manipulation Behavior of the
Executives Owning Shareholdings
ZHAO Cui1.2, PEI Lina3
1. Hebei University of Economics and Business, P.R. China, 050061
2. PHD Candidate of Hebei University, P.R. China, 071002
3. Langfang Yanjing Polytechnic Institute, Hebei, P.R.China, 065200
[email protected]
Abstract: With China's state-owned enterprises accomplishing share-trading reform and capital markets
perfect constantly, more and more executives of a listed company became shareholders. The problem of
manipulating profits by executives owning the listed company’s shareholdings has been being paid more
and more attention. According to some of existing research, executives would manipulate profits in
order to maximize their own interests while they hold companies’ shareholdings. Based on this, two
samples are selected according to the A –share market where executives hold actual shares and stock
options respectively from 2007 to 2009. we make an inspection on the relationship between executives’
shareholdings and the earnings manipulation of the listed company by using the linear regression
method. As a result, the behavior of the earnings manipulation by executives owning shareholdings in
listed companies indeed exists.
Keywords: Executives owning shareholdings, Earnings manipulation
1 Introduction
In order to impel executives for the maximization of companies’ value and the reduction of
Principal-agent cost between business owners and Business Managers, the listed company introduces
into the mechanism of equity incentive. Compared with ideal situation, there are some differences when
executives’ incentive is carried out. To maximize personal benefit, executives manipulate surplus and
adjust the company’s share price by using the information superiority. Based on the above
considerations, this paper studies the earnings manipulation behavior of the executives owning
shareholdings, providing the basis for the improvement of the governance mechanism.
2 Literature Review
There is a linear relationship between the executives’ shares and earnings manipulation both at home
and abroad. Warfield 1995 points out that, more stocks held, less the cost of the agent and less the
possibility of earnings manipulation. Vernon and James 2002 shows that, the level of the company
earnings management in long-term incentive schemes is low. To study the relationship between equity
structure in listed companies and earnings management, Li changqing, Guan lianyun (2004) put 1262
observation value among 3 years in 421Shanghai listed companies as a sample and conclude that there is
negative correlation between executives’ shareholding and earnings management.
Other scholars believe that there is nonlinear relationship between the executives shares and earnings
manipulation. Teshima and shuto 2005 use Japanese companies as samples to verify their relation. The
result shows that interests’ convergence effect and defense effect exist at the same time and there is three
times in nonlinear relation between management equity and discretionary accruals. According to the
framework of abnormal accruals and modified Jones model, Mao hongan (2008) used listed companies’
data in the year 1995-2004 to analyze that listed companies’ management equity effect earnings quality
with the choice of accounting policy.
Throughout the literature, about the relationship between executive ownership and earnings
manipulation, scholars’ opinions are different because of the difference in samples and research
variables. Previous achievements provide good basis for later research and try to give more
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comprehensive empirical evidence for earnings manipulation.
3 Theoretical Analyses and Research Hypothesis
The hypothesis of “economic person” thinks human's behavioral motive root in the economical cause.
The economic man is in full pursuit of material benefits for the purposes of economic activity. People
want to pay as little as possible, maximizing the harvest and by hook or by crook. As the economics of
the "rational man", executives manipulate earnings to gain more bonuses or obtain a higher income by
raising the share price. Based on the previous studies, this paper divides stocks executives hold into two
types——actual shares and stock options, making empirical analysis correspondingly.
Firstly, executives holding actual shares can both gain bonuses according to their shares and as a stock
owner can sell shares in the stock market. So to maximize their own interest, they tend to manipulate
earnings. Based on this, propose the hypothesis H1 .
H1 : Executives shareholding where executives hold actual shares and earnings manipulation are
positively correlated.
Secondly, to make executives and shareholders have the same interest, listed companies implement
equity incentive system and let executives own companies’ stock. But because of this system is
imperfect in our country, executives intended to manipulate companies’ earnings in order to obtain
companies’ performance goals. Based on this, propose the hypothesis H .
2
H 2 : Executives shareholding where executives hold stock options and earnings manipulation are
positively correlated.
4 Empirical tests
4.1 Research design
4.1.1 Sample selection and data sources
Two samples are selected according to the A –share market where executives hold companies’
shareholdings from 2007 to 2009. Then the primary sample is selected as follow: firstly, eliminate listed
companies in finance and insurance industry. Secondly, eliminate listed companies where executives
hold no stock. Thirdly, eliminate listed companies with executives having no annual return. Fourthly,
eliminate listed companies lack of financial data for the truth and integrity in the final conclusion. As a
result, there are 35 companies where executives hold actual shares and 92 companies where executives
hold stock options. The sample data is from Rui Si database and the China Securities Regulatory
Commission website.SPSS13.0 software is used to process data.
4.1.2 The set of research variables
Research variables include dependent variable, Independent variable and control variables.
Table 4.1 Definition table of research variables
Variable type
Variable symbol
Variable definition
Independent variable
the ratio of total shares of the company
M
DA
Absolute value of discretionary accruals
Dependent variable
Executives
annual C
Executive compensation disclosed by listed
1
monetary reward
companies
control
C
variables
Natural logarithm of annual total assets
scale
C3
Ratio of liabilities to assets
Ratio of liabilities to assets
2
4.1.3 Design for the empirical model
Based on the proposed hypothesis, combined with previous analysis and on the basis of domestic and
foreign literatures, this paper should establish regression model.
DA = β
0
+ β1 × M + β
2
× C1 + β
3
× C
2
+ β
4
× C
3
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+ ε
（4-1）
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In the formula(4-1), DA is discretionary accruals’ absolute value; M is proportion of shareholding; C
is executives annual monetary reward; C is natural logarithm of annual total assets; C is Ratio of
liabilities to assets; β 0 , β1 , β 2 , β3 , β 4 is regression coefficient; ε is system error.
1
2
3
4.2 Non-parametric test to the earnings manipulation of executives holding actual shares and
stock options
Two selected samples are relatively independent and the data aren’t consistent with the normal
distribution. So Mann-Whitney U is used to analyze the difference between the two samples. The null
hypothesis is that the two population distributions from the two independent samples have no significant
difference.
Table 4.2 Difference test
DA
Mann-Whitney U
Wilcoxon W
Z
Asymp. Sig. (2-tailed)
4064.000
4694.000
-0.822
0.0411
a Grouping Variable: M
The sample we selected is small, so the exact probability of the U statistics. From table 4.2 we know
that if the significant level α is 0.05, the probability p value is less than the significant level α . So
the null hypothesis should be rejected. That is, the distributions of earnings manipulation conducted by
executives respectively holding actual shares and stock options are different significantly.
4.3Eempirical analysis
4.3.1 Empirical analysis in earnings manipulation of executives holding actual shares
(1) Descriptive statistics of research variables
Table 4.3 Descriptive statistics of research variables
DA
N
Mean
Median
Std. Deviation
Skewness
Std. Error of Skewness
Kurtosis
Std. Error of Kurtosis
Minimum
Maximum
Valid
Missing
35
0
0.062
0.038
0.052
0.705
0.398
-0.796
0.778
0.001
0.172
M
C1
C2
C3
35
0
0.042
0.000
0.134
3.978
0.398
16.64
0.778
0.000
0.683
35
0
1341942.8
407200.00
2871189.61
4.404
0.398
22.063
0.778
10000
16200000
35
0
21.15
21.09
1.198
0.647
0.398
0.280
0.778
19.046
24.391
35
0
0.460
0.462
0.209
-0.110
0.398
-0.364
0.778
0.018
0.907
From table 4.3, there’s no difference between the median and the mean of discretionary accruals in the
sample. And the slope is 0.705, greater than zero and to the left. The kurtosis is -0.796, less than zero
and lowers than that of the standard normal distribution N (0, 1). That is, the distribution of
discretionary accruals is more focused and discretionary accruals in every company have small
differences.
The standard deviation of executives’ shareholding proportion is 0.134, having some difference
compared with the median and the mean. That is, the distribution of executives owning shareholdings is
discrete. The slope is greater than zero and to the left. The kurtosis is 16.649, greater than zero and
higher than that of the standard normal distribution N (0, 1). We can see that the distribution of
executives owning shareholdings isn’t uniform and the ownership is generally low.
The median and the mean of Executives annual monetary reward are different. The slope is greater than
zero and to the left. The kurtosis is 22.063, higher than that of the standard normal distribution N(0,1).
The minimum and maximum vary greatly. That is, there’s great difference among Executives annual
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monetary reward of every company and the distribution isn’t concentrated.
The slope of the scale in the sample companies is 0.280, greater than zero and to the left. Its maximum
(24.391) and minimum (19.046) have no difference. That is, every company’s scale is different and the
distribution is discrete.
Compared with the median and the mean, the standard deviation of the ratio of liabilities to assets has
little difference. That is, the distribution of the sample’s ratio of liabilities to assets is concentrated and
the dispersion is lower.
(2) The empirical results and analysis
（
1
）
Table 4.4 Regression coefficient and significant test table Coefficients
Unstandardized
Coefficients
Standardized Coefficients
B
Std. Error
Beta
Model
T
Sig.
(Constant)
0.189
0.182
1.013
0.031
M
C1
0.400
-2.901
0.489
0.003
-1.038
-0.161
0.219
-0.803
0.017
0.427
C2
0.005
0.009
0.151
0.723
0.025
-0.032
0.043
-0.131
-0.341
0.045
C3
DA
Dependent Variable:
From table 4.4, we can conclude the result of regression coefficient and significant test.
The probability of the constant t value is lower than 0.05, having obvious difference with zero. That is,
the constant term should appear in the equation.
The probability of the executives’ shareholding proportion t value is lower than 0.05, the constant
term having obvious difference with zero. That is, executives’ shareholding proportion should appear in
the equation as independent variable.
The probability of the Executives annual monetary reward t value is higher than 0.05, its coefficients
has no obvious difference with zero and it isn’t associated with executive ownership. That is, the
Executives annual monetary reward should not appear in the equation.
The probability of the natural logarithm of total assets t value is lower than 0.05, its constant term is
significantly different from zero. That is, total assets should be explanatory variable and appear in the
equation.
The probability of t t value is lower than 0.05, its constant term is significantly different from zero.
That is, The Ratio of liabilities to assets should be explanatory variable and appear in the equation.
4.3.2 Empirical analysis in earnings manipulation of executives holding stock options
(1) Descriptive statistics of research variables
Table 4.5 Descriptive statistics of research variables
DA
C1
C2
M
N
Mean
Median
Std. Deviation
Skewness
Std. Error of Skewness
Kurtosis
Std. Error of Kurtosis
Minimum
Maximum
Valid
Missing
247
0
0.086
0.052
0.104
2.778
0.155
10.134
0.308
0.001
0.731
247
0
0.126
0.006
0.193
1.475
0.155
1.103
0.308
0.000
0.724
228
247
0
2688944.753
1627700.000
3601729.100
4.192
0.155
24.149
0.308
53200
32520000
247
0
21.769
21.584
1.218
0.411
0.155
-0.381
0.308
18.916
24.948
C3
247
0
0.453
0.447
0.217
3.648
0.155
35.682
0.308
0.018
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From table 4.5, the median and the mean of the discretionary accruals have little difference. That is, the
distribution is concentrated and every discretionary accrual has little difference. Its slope and kurtosis is
2.778, 10.13, greater than zero, higher than that of the standard normal distribution N (0, 1).
The standard deviation of executives’ shareholding proportion is 0.193, having little difference from the
median value. That is, the distribution of executives owning shareholdings isn’t discrete. The slope is
greater than zero and to the left. The kurtosis is 1.103, higher than that of the standard normal
distribution N (0, 1). We can conclude the distribution of executives owning shareholdings isn’t uniform
and the ownership is generally low.
The kurtosis is 22.063, higher than that of the standard normal distribution N (0, 1). The minimum and
maximum vary greatly. That is, there’s great difference among Executives annual monetary reward by
every company.
There’s small difference from the mean and the median, their values are 21.769, 21.584. But its Standard
deviation (1.218) has little difference relatively. That is, every company’s scale is different largely. The
slope of the scale in the sample companies is 0.411, greater than zero and to the left. Its kurtosis is
-0.381, less than zero, lower than that of the standard normal distribution N (0, 1).
Compared with the median and the mean, the standard deviation of the ratio of liabilities to assets has
little difference. That is, the distribution of the sample’s ratio of liabilities to assets is relatively
concentrated and the dispersion is lower.
(2) The empirical results and analysis
Model
1
（
）
Table 4.6 Regression coefficient and significant test table Coefficients
Unstandardized Coefficients
Standardized Coefficients T
B
Std. Error
Beta
(Constant)
0.037
0.018
2.069
0.123
0.036
0.229
3.411
M
C1
0.000
0.000
-0.036
-0.479
C2
0.001
0.001
0.008
0.102
C3
0.079
0.033
0.165
2.374
DA
Sig.
0.040
0.001
0.632
0.049
0.018
Dependent Variable:
From table 4.6, we can conclude the result of regression coefficient and significant test.
The probability of the constant t value is less than 0.05, having obvious difference with zero. That is,
the constant term should appeared in the equation.
The probability of the executives’ shareholding proportion t value is 0.001, less than 0.05, the constant
term having obvious difference with zero. That is, executives’ shareholding proportion should be
explanatory variable and appeared in the equation.
The probability of the Executives annual monetary reward t value is greater than 0.05, its coefficients
has no obvious difference with zero and it isn’t associated with executive ownership. That is, the
Executives annual monetary reward should not appeared in the equation.
The probability of the natural logarithm of total assets t value is less than 0.05, its constant term is
significantly different from zero. That is, total assets should be explanatory variable and appeared in the
equation.
The probability of the Ratio of liabilities to assets t value is less than 0.05, its constant term is
significantly different from zero. That is, total assets should be explanatory variable and appeared in the
equation.
5 Regression Analyses
5.1 The relation between Executives shareholding proportion and earnings manipulation degree
Whether executives hold actual shares or stock options, it’s verified through empirical analysis that there
is significantly positive correlation between executive ownership and earnings manipulation in Chinese
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listed companies. That is, the degree of the equity incentive in Chinese listed companies cannot put
executives into shareholders’ position. Conversely it stimulates executives to manipulate earnings for
their own income.
5.2 The relationship between the monetary reward of executives and earnings manipulation
There is non-significant correlation between executives’ annual monetary reward and earnings
manipulation. Because there isn’t high correlation among net profit and executives’ annual monetary
reward in Chinese listed companies. And the ratio of executives’ shareholding is lower and the degree of
equity incentive in listed companies is lower. So the incentive is invalid for executives. They often
intend to grab some hidden income like excessive consumption, not manipulate earnings to maximize
their own interest.
5.3 The relationship between firm size and the earnings manipulation
Through empirical analysis, there’s a positive correlation between company scale and the degree of
earnings manipulation. It’s consistent with the foregoing analysis results The larger companies are, the
more focus on companies by Government and public interest. Then higher the political cost is, more tax
would be bear. To avoid this situation, executives would defer earnings to the next one or several periods
so as to reduce current profit and reduce the political cost. Larger the listed company is, more complex
the internal organizational structure is. Because of information asymmetry, executives’ behavior cannot
be observed by external stakeholders and the possibility of earnings population is larger.
。
5.4 The relationship between the rate of assets and liabilities and earnings manipulation
According the empirical analysis, there’s negative correlation between the rate of assets and liabilities
and earnings manipulation where executives hold actual stocks. It isn’t consistent with the foregoing
theoretical analysis. The higher ratio of liabilities to assets shows that this company has stronger debt
financing ability and have stronger solvency. Creditors tend to trust this kind of companies and believe
executives wouldn’t manipulate earnings. Whereas, there’s positive correlation between the rate of
assets and liabilities and earnings manipulation in which executives hold stock options. It is consistent
with the foregoing theoretical analysis. Because of companies’ debt pressure, executives would
manipulate earnings to ease companies’ debt problem. That is, there’s correlation between the rate of
assets and liabilities and earnings manipulation. The rate of assets and liabilities is different and the
effect to earnings manipulation is different.
6 Conclusion
The empirical result shows that the behaviors of earnings manipulation by executives holding stocks do
exist. And the higher ratio of executives’ shareholdings is, the more degree of the earnings manipulation
is. That is, the incentive to executive in Chinese listed companies cannot develop long-term constraint
effect, but stimulate executives to manipulate earnings to increase their own income.
References
[1]. Warfield T.D., John. J. Wild and Kenneth. L. Wild. Managerial Ownership, Accounting Choices
and Informativeness of Earnings. Journal of Accounting and Economics, 1995.
[2]. Ma Huiqi. Gan Shengdao. Hu Jianping. Correlation study on the earnings management and stock
price manipulation based on the equity incentive——from Chinese listed companies’ empirical
evidence. Accounting Communications, 2010:18(in Chinese)
[3]. Mao Hongan. The management equity the choice of accounting and earnings quality. Accounting
Communications(Academic Edition), 2008:1(in Chinese)
[4]. Zou Wuping. The eight channels of companies’ earnings management in the new accounting
standards. Accounting Research. 2010(in Chinese)
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