The effect of real earnings management on earnings persistence and informativeness before and during COVID‐19

• Published date: 01 January 2024
• Author: Le Thi Bao Nhu,Tran Thi Hong Diem,Yen Thi Tran,Trang Cam Hoang
• Date: 01 January 2024
• DOI: http://doi.org/10.1002/jcaf.22650

Received:  March  Revised:  June  Accepted:  June 

DOI: ./jcaf.

RESEARCH ARTICLE

The effect of real earnings management on earnings

persistence and informativeness before and during

COVID-19

Le Thi Bao Nhu1Tran Thi Hong Diem2Yen Thi T ra n2

Trang Cam Hoang2

Faculty of Finance and Accounting,

Saigon University, Ho Chi Minh city,

Vietnam

School of Accounting, University of

Economics Ho Chi Minh City, Ho Chi

Minh city, Vietnam

Correspondence

Trang Cam Hoang, School of Accounting,

University of Economics Ho Chi Minh

City, Ho Chi Minh city,Vietnam.

Email: tranghc@ueh.edu.vn

Funding information

University of Economics Ho Chi Minh

City, Grant/AwardNumber:

---

Abstract

This study examines the effect of real earnings management (REM) on earn-

ings persistence and informativeness and also considered in the context of the

COVID- pandemic. REM is quantified by two aggregate metrics. The sam-

ple consists of  firm-year observations of listed companies in Vietnam from

 to . We find evidence that REM is negatively associated with the per-

sistence of earnings and its components, with REM affecting cash flows more

strongly than accruals. We also find that REM limits the relationship between

current earnings and future cash flows. Furthermore, when confronted with the

COVID- pandemic, the effect of REM on earnings quality does not improve.

KEYWORDS

earnings persistence, earnings informativeness, real earnings management, COVID-

1 INTRODUCTION

Financial reporting plays a crucial role in providing rele-

vant information to assist investors, creditors, and other

users in making informed decisions regarding invest-

ments, credit, and similar matters (Alzoubi, ;Anag-

nostopoulou & Tsekrekos, ; Moardi et al., ).

Among the financial indicators, earnings reported in

financial statements hold significant importance for

assessing financial strength, valuing stocks, and attracting

investments (Tabassumet al., ). Stakeholders’ primary

concern lies in the quality of earnings, as managers have

the ability to manipulate them to shape stakeholders’ per-

ceptions of the company’s financial position (Healy &

Wahlen, ; Katherine, ; Salehi, Hoshmand, et al.,

; Tabassum et al., ). Earnings management can

have profound implications for investors’decision-making

and trust in the company (Azad et al., ). Managers

can manipulate earnings by changing accruals without

affecting cash flow, which is known as accrual earnings

management (AEM), or by changing actual operations,

which affects cash liabilities and, in some cases, accru-

als, which is known as real earnings management (REM)

(Ghaleb et al., ; Healy & Wahlen,; Roychowdhury,

; Salehi, DashtBayaz, et al., ). Compared with

AEM, REM is difficult to distinguish from normal business

activities, making it more difficult to detect (Anagnos-

topoulou & Tsekrekos, ; Cheung & Adelopo, ;

Roychowdhury, ; Salehi, Hoshmand, et al., ),

leading managers to be more inclined toward manipulat-

ing earnings through REM (Grahama et al., ). Scholars

argue that after the enactment of the Sarbanes-Oxley Act,

companies have increasingly shifted from AEM to REM

(Cohen et al., ; Francis et al., ). However, REM

poses higher risks as it directly impacts business decisions

and future cash flows (Khanh & Khuong, ; Seifzadeh

et al., ). Consequently, REM has gainedgreater recog-

nition and usage in the study of earnings management

compared to AEM (Enomoto et al., ;Jiangaetal.,;

Li, ).

76 ©  Wiley Periodicals LLC. J Corp Account Finance. ;:–.wileyonlinelibrary.com/journal/jcaf

NHU  . 77

Previous research shows that managers engage in earn-

ings management to meet thresholds and earnings stan-

dards (Guidry et al., ; Kasznik, ;Teohetal.,).

However, REM has a negative effect on performance and

future value (Cohen & Zarowin, ; Cohen et al., ;

Grahama et al., ; Moradi et al., ), and managed

earnings cannot represent high-quality financial informa-

tion (Ferentinou & Anagnostopoulou, ). Moreover,

earnings quality is reflected in aspects such as earnings

persistence and the ability to predict future cash flows

(Atwood et al., ;Li,). The objective of this study

is to investigate the effect of REM on earnings quality

through the following research questions:

The first research question is whether REM affects

earnings persistence. Earnings management has differ-

ent effects on earnings persistence depending on earnings

management motivation (Li, ). Ali and Zhang ()

present evidence that CEOs are liable to manipulate earn-

ings early in their tenure to dominate the market and

build their reputation, which affects future results, with

the outcome that the relationship between REM and future

results is not clear. According to other studies, compa-

nies use earnings management to meet analyst forecasts,

which are positively associated with future performance

(Bartov et al., ). Gunny () discovered a positive

relationship between earnings management and future

performance on the basis that REM allows companies to

achieve their goals in the present and is a sign of bet-

ter performance in the future. This finding is supported

by Zhao et al. (), who find that abnormal real activi-

ties are associated with greater future outcomes solely for

the achievement of earnings goals. Bhojraj et al. ()

show that cutting discretionary expenditures and man-

aging accruals results in lower earnings quality. Cutting

discretionary expenditures also has a negative effect on

future financial performance and stock value (Bhojraj

et al., ; Mizik, ). Similarly, Francis et al. ()

demonstrate that using REM causes negative informa-

tion hoarding and the market may be unable to keep up

with such business anomalies, resulting in future stock

price declines. Li () also demonstrates that earnings

persistence decreases under the effect of REM by cut-

ting discretionary expenditures and investments. Since

REM negatively affects future performance, REM is more

restricted in countries with stronger investor protection

(Enomoto et al., ). If REM results from cutting discre-

tionary costs and increasing unusual manufacturing costs,

or cutting discretionary costs and abnormal cash flows,

we conjecture that REM has a negative effect on earnings

persistence.

Earnings consist of two components: cash flows and

accruals. Information from current cash flows and accruals

can be used to forecast future earnings and influence earn-

ings persistence (Sloan, ). Thus, the second research

question seeks to determine how REM affects the per-

sistence of earnings components. Roychowdhury ()

argues that REM through abnormal cash flow from oper-

ations, abnormal discretionary expenses, and abnormal

production costs can reduce firm value because this

earnings manipulation increases earnings in the current

period, but has a negative effect on future cash flows. In

contrast to AEM, which primarily affects accruals, REM

through abnormal cash flow from operations, abnormal

discretionary expenses, and abnormal production costs as

in Cohen et al. () or through the sum of the standard-

ized three REM proxies can have a direct negative effect

on both current and future cash flows and accruals (Cohen

et al., ;Sohn,). Similarly, other studies show that

REM decreases earnings and cash flow persistence (Jeong

& Choi, ;Li,).Through various methods, previous

studies have demonstrated the effect of REM on the per-

sistence of earnings components. However,c omparing the

persistence of these components under the effect of REM

through two aggregate REM measures has not yet been

conducted. When the relationship between current earn-

ings and future cash flows is stronger, firms have higher

earnings quality (Atwood et al., ). Nevertheless, earn-

ings persistence does not imply the predictability of future

cash liabilities (Li, ). We prioritize not only persis-

tence but also the informativeness of earnings. Following

this argument, the third research question seeks to address

how REM affects the prediction of future cash flows from

current earnings. Dechow () contends that current

earnings predict future cash flows better than current cash

flows. According to Atwood et al. (), book-tax compli-

ance hurts the relationship between current earnings and

future cash flows. Recognizing that REM comprises abnor-

mal cash flow from operating activities and abnormal

discretionary expenses, we conjecture that REM negatively

affects the informativeness of current earnings.

Research on REM is becoming increasingly impor-

tant in emerging markets, as many countries implement

strict accounting standards, leaving less room for discre-

tionary accounting policies (Cohen et al., ;Zang,

). Vietnam, recognized as one of the most dynamic

emerging economies, is experiencing rapid growth in its

economy and stock market (Nasir et al., ;Nguyen

et al., ). Vietnam’s governance system is built on

a centralized power structure within a one-party state,

with a significant presence of state-owned corporations

(Phung & Mishra, ). The influence of major sharehold-

ers in Vietnam’s corporate system is pronounced, shaping

firm decisions (H. A. Nguyen et al., ). The role of

the public sector is pivotal in most cases, underscoring

its importance (Chung & Phan, ). The construction

of a stock exchange in Vietnam is an important step