ATJ Asian Tax Journal

Asian Tax Journal

Print ISSN 1738-3323 Online ISSN 2733-9270

The Relation between Industry－Specific Means of Real Earnings Management and Future Financial Performance

  • Yi, Hwa Deuk Hanyang University

Asian Tax Journal Vol. 11 No. 3 (2010), pp. 69-94

Abstract

In recent years, firms focus their core competencies on key business activities to remain competitive. High technology－based firms heavily depend on research and development for their survival and growth. On the other hand, low－tech firms rely on efficient use of their economic resources to be profitable. Firms are involved in real earnings management by adjusting the size of business activities to manage their reported earnings. The means of real earnings management include cutting research and development expenditures and overproduction. This study examines whether the cost of real earnings management is higher when the means of real earnings management is closely tied to their key activities. The cost of real earnings management is measured by future financial performance. High－tech firms' R&D cuts are expected to affect more adversely their future performance than low－tech firms' R&D cuts, while over－productions of low－tech firms are expected to be more detrimental to their profitability than those of high－tech firms. Firms are likely to cut their R&D costs and over－produce to avoid losses or earnings decreases(earnings management suspect firms). This study examines the relations between R&D cuts and over－productions of those firms and their future performance. The sample consists of 4222 manufacturing firm－years on Korean Stock Exchange from 1994to 2008. Empirical results are as follows：First, R&D cuts of high－tech firms are related negatively to their future performance, while R&D cuts of low－tech firms are not. These results indicate that one of main business activities,R&D cuts have negative impacts on future profitability of high－tech firms only. Overproductions of both high－tech and low－tech firms are negatively related to their future performance,indicating that high－tech firms as well as low－tech firms affects negatively the future profitability. Second, while R&D cuts of high－tech earnings management suspect firms are not related to their future performance, over－productions of both high－tech and low－tech earnings management suspect firms are negatively related to their future performance. Third, firms with limited accounting flexibility as a result of heavy past accrual earnings management have lower future performance than those with high accounting flexibility. The results of this study may be helpful for firms' decision makers to establish firms' reporting strategies and for financial analysts and accounting academics to analyze firms' profitability and to evaluate earnings quality.

Keywords

  • real earnings management
  • future performance
  • R&D expenditure
  • overproduction

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Asian Tax Journal

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