Abstract

This study investigated how firm characteristics can differentiate possibilities of implementing the real activity earnings management(REM) using actual business activities. Among the various REM methods, the REM through overproduction(OPREM) that adjusts profit report by increasing a production level more than it is needed in normal is of particular interest；the research questions are if a larger OPREM is observed from the firms with the cost structure characterized by high fixed expenses and if OPREM have a substitute relationship with the REM through sales manipulation (AbCFO) and the REM through discretionary expenditure manipulation(AbDISE). The analysis results are as follows. First, the relationship between fixed asset ratio(FAR) and fixed asset to long－term capital ratio(FALCR) with OPREM has been investigated to verify if a larger OPREM is observed from the firms having the cost structure with high fixed expenses. As a result, the higher the rates of fixed expenses are, the more actively the firms tend to implement OPREM. Second, a portfolio analysis that controlled overall REM levels has been conducted to see if the firms with high fixed expenses show relatively smaller profit adjustment levels when the AbCFO or the AbDISE is used. The result showed the firms high rate of fixed expenses tend to have the larger OPREM and the smaller AbCFO or AbDISE when the overall REM levels are controlled. The results means that even among the firms that have the similar levels of REM in overall, firms with high fixed expenses rate implement the OPREM more actively due to the cost structure and the other REM such as AbCFO and AbDISE are relatively less used. In conclusion, the current study result implies that the previous research might have reported a biased result unless firm characteristics are properly considered. Therefore, basic firm characteristics that can influence the implementation and effects of REM should be incorporated to analyze the REM effects with more accuracy.

Keywords

• Firm characteristics
• Cost structure
• Real activity earnings management(REM)
• REM through overproduction

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