Summary
We investigate the earnings management behavior of firms that file for bankruptcy and find that firms, which eventually file for bankruptcy, attempt to manage their earnings in order to make their financial statements appear more favorable over the years prior to filing for bankruptcy. Eventually, as the need to file for bankruptcy becomes imminent, they reverse their earnings management. More interestingly, the earnings management behavior of those bankrupt firms convicted of fraud versus those not convicted of fraud is different. Whereas non-fraudulent bankrupt firms reverse their earnings management prior to filing, fraudulent bankrupt firms do not. We also compare the earnings management behavior of bankrupt firms to an industry matched control sample. We find that the control firms do not engage in similar earnings management, even though they too are experiencing similar stock price performance and are of similar size.
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Extract
Do Firms Manage Their Earnings Prior to Filing for Bankruptcy?
INTRODUCTION
U.S. generally accepted accounting principles allow managers of firms considerable discretion with respect to how revenues and expenses are reported. In turn, this affords management the opportunity to engage in minor to severe earnings management practices with respect to how financial statements are prepared. Schilit (2002) claims that managers misreport the financial performance of their firm (i.e., manipulate earnings) for several reasons: (1) it is profitable to do it, (2) it is relatively easy to do it, and (3) it is highly unlikely that they will get caught. We investigate whether firms filing for bankruptcy manage their earnings in reporting periods leading up to the bankruptcy filing date. The sole objective of this paper is to address the question of whether firms manage their earnings prior to filing for bankruptcy.One plausible explanation for why managers of firms that eventually file for bankruptcy manage their earnings is to mask poor operating performance...See the full content of this document
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