Content area
Full text
ABSTRACT
The ethics of earnings management was examined in prior studies (Merchant and Rockness 1994; Kaplan 2001a, 2001b; Bruns and Merchant 1990) with mixed results. The current study extends this work by further examining individuals' judgments of ethical acceptability related to specific earnings management activities as they relate to the intent and type of the earnings management manipulation.
In an experimental study, business students respond to six hypothetical vignettes involving the management of earnings. Earnings management intent represents an independent variable with two treatment levels: (1) opportunism (individual intent) and (2) efficient firm contracting (company intent). The manner of earnings manipulation represents the second independent variable with three treatment levels: (1) accounting method change, (2) accounting estimate change, and (3) operating change. The dependent variable is the response to the question: How ethical was the action in the vignette?
We find support for both propositions. The study finds that the intent of the earnings management matters. That is, subjects find that managers engaging in earnings management that was deemed opportunistic or selfish were considered more unethical (or less ethical) than earnings management behavior aimed at increasing firm contracting efficiency. Additionally, the study found that the method of the manipulation was also important. Accounting estimate manipulations was considered the least ethical followed by economic operating decisions. Changes in accounting method were considered the least unethical.
Introduction
Generally accepted accounting principles (GAAP) permit a certain degree of managerial discretion in the application of accounting methods. Using this discretion and flexibility to enhance the perception of the firm is commonly referred to as "earnings management" in the academic and professional literature. Although no universally acceptable definition of earnings management currently exists, Healy and Wahlen (1999) define earnings management as ...managers' use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers. Note that the process involves taking deliberate steps within the constraints of GAAP to bring about a desired level of reported earnings.
The use of earnings management or income smoothing is not new in the current financial environment. Its use, however, continues to draw increased media and investor scrutiny...