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Efficient contracting, earnings smoothing and managerial accounting discretion

Khalil, Mohamed; Simon, Jon

Authors

Dr Mohamed Khalil M.Khalil@hull.ac.uk
Lecturer in Accounting and Finance and Programme Director for BSc Accounting and Financial Management

Jon Simon

Abstract

Purpose – The purpose of this paper is to examine whether the contracting incentives (i.e. bonus plans, debt covenants, political costs hypotheses), and income smoothing can explain accounting choices in an emerging country, Egypt. Design/methodology/approach – The paper uses the ordinary least square regression model to examine the relationship between earnings management and reporting objectives. A sample of 438 non-financial firms listed on the Egyptian Exchange over the period 2005-2007 is used. Findings – The paper finds that the contracting objectives explain little of the variations in accounting choices (i.e. discretionary accruals) in the Egyptian context. However, the paper finds that mangers are likely to smooth the reported earnings by managing the accrual component in an attempt to reduce the fluctuation in reported earnings by increasing (decreasing) earnings when earnings are low (high) in attempt to reduce the variability of the reported earnings. Research limitations/implications – The empirical results rely on the ability of earnings management proxies to adequately capture earnings manipulation activities. Practical implications – The findings of the study should be of substantial interest to regulators and policy makers. The results implicitly contribute to the ongoing argument in relation to the optimal flexibility permitted by standard setting and the argument that tightening the accounting standards and mandating International Financial Reporting Standards are likely to improve reporting quality and reduce opportunistic earnings management. The results reveal that many of the weaknesses related to corporate reporting in emerging countries may result from the inadequate enforcement of the law and the weak legal protection of minority shareholders. The results also highlight the crucial role of understanding the reporting incentives, which is mainly shaped by institutional and market forces and the legal environment, in explaining accounting choices. Originality/value – Unlike previous studies that tested an individual objective, this study examines the trade-offs among various reporting objectives in an emerging economy.

Publication Date May 6, 2014
Journal Journal of applied accounting research
Print ISSN 0967-5426
Publisher Emerald
Peer Reviewed Peer Reviewed
Volume 15
Issue 1
Pages 100-122
Institution Citation Khalil, M., & Simon, J. (2014). Efficient contracting, earnings smoothing and managerial accounting discretion. Journal of applied accounting research, 15(1), 100-122. https://doi.org/10.1108/JAAR-06-2012-0050
DOI https://doi.org/10.1108/JAAR-06-2012-0050
Keywords Discretionary accruals, Leverage, Earnings smoothing, Egyptian firms, Managerial compensation, Political costs
Publisher URL http://www.emeraldinsight.com/doi/full/10.1108/JAAR-06-2012-0050
Copyright Statement ©2014 University of Hull
Additional Information Authors' accepted manuscript of article published in: Journal of applied accounting research, 2014, v.15 issue 1.

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