The Effect of Real Earnings Management on Bond Grading
Asian Tax Journal Vol. 12 No. 2 (2011), pp. 585-610
Abstract
This article considers the relation between firms’ earnings management and credit rating. Unlike preceding papers focusing earnings management by accual (thereafter, AEM), this paper examines the relation between real activity earnings management measure(thereafter, REM) and credit rating. REMs have more negative effects on firms’ forward cash flow generation abilities and long term operating performances than AEMs. So, REMs are more negative signals for credit analysts than AEMs. But credit analysts have much difficulty in seeing through REM, because if credit analysts want to find out REMs, they have to understand firms’ internal operating activities, cost structures, receivables collection practices, and review whether profit distortions are due to abnormal change of them. Empirical evidence shows that REMs are negatively related to credit rating. this result implies that credit analysts see through REMs in interpreting financial informations, that is to say, they discount credit rating in considering level of REM. This paper also finds that AEMs are more negatively related to credit ratings than REMs. this result suggests that credit analysts don’t take REMs into account in credit rating process as much as AEMs.
Keywords
- Credit Rating
- Real Activity Earnings Management
- Financial Statements Analysis
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