The Ethics of Earnings Management: The Case of Income Smoothing
James Gaa University of Alberta May 2007
In Most Situations, People Do Not Have the Same Information Management Inevitably Has Information that Would be Useful to Investors – and other Stakeholders In Financial Reporting: Information Asymmetry Follows Immediately from the Separation of Ownership and Management
The Ethics of Earnings Management
Corporate Transparency (OECD)
“The Corporate Governance Framework Should Ensure that Timely and Accurate Disclosure is made on All Material Matters regarding the Corporation, ...view middle of the document...
The word ‘Secrecy’ Refers to the Resulting Concealment.”
(Bok, Secrecy 1983, pg. 5)
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Secrecy and Information Asymmetry
There are Two Cases: Decreasing Information Asymmetry Truthful Disclosures Reduce Asymmetry Maintaining or Increasing Information Asymmetry Secrecy Maintains Asymmetry In the Setting of Publicly Accountable Entities, Transparency – Disclosure of All Material Information – is the Standard Case In this Setting, Secrecy Needs to be Justified
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The Basic Ethical Problem
Every Company Needs to Make Disclosures Keep Secrets So, Every Company Needs a Strategy for Disclosing Information about Itself Often: to Maximize Secrecy / Minimize Disclosure May Include Earnings Management Is Earnings Management a Legitimate Part of a Company’s Disclosure Strategy?
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The Problem of Earnings Management
Earnings Management The Alteration of Financial Reports In Order to Affect the Behaviour of Others For Me: the Biggest Issue in Financial Accounting and Reporting Why: It Strikes at the Core of the Traditional Ideal of Accounting: The Preparation of Neutral – Unbiased – Information
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Earnings Management is Common Strategies are Often Complex and Multiperiod It is Done for a Variety of Motivations: Often for the Benefit of Management, Not (Solely) to Benefit Stakeholders Managers are Willing to Incur Real Economic Costs in Order to Alter Financial Reports
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The Alteration of Financial Information to Produce a Predetermined Result by Intervening or Interfering in the Neutral Operation of the External Financial Reporting Process Involving the Use of Judgment in Financial Reporting, or in Creating or Structuring Transactions in Ways that have No Business Purpose Other than to Alter Financial Reports to Alter the Distribution of Information, for the Purpose of either Affecting Some Stakeholders’ Evaluation of the Underlying Economic Performance of the Company or Influencing Contractual Outcomes that Depend on Reported Accounting Numbers.
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Earnings Management: What
The Alteration of Financial Information to Produce a Predetermined Result by Intervening or Interfering in the Neutral Operation of the External Financial Reporting Process
The Ethics of Earnings Management
Neutrality – FASB
100. … It is, above all, the Predetermination of a Desired Result, and the Consequential Selection of Information to Induce that Result, that is the Negation of Neutrality in Accounting. To be Neutral, Accounting Information Must Report Economic Activity as Faithfully as Possible, Without ...