Towards an understanding of earnings management theory and practice in Egypt : motivations and mechanisms

• Main Author: Makhaiel, Nargis K. B.
• Published: University of Essex 2013
• Subjects: 658.32
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.601496

In response to the academic gaps in the existing literature, this research aims to investigate EM motives and techniques within the Egyptian context. This research is devoted to exploring the positive purpose of EM in terms of signalling a firm's value over the long-term to its outsiders, hence bringing advantages and future success to the firm, which will be reflected in the achievement of managerial long-term selfinterests and not short-term opportunistic self-interests. In order to serve the aims of the research, the New Institutional Sociology analytical framework and the interpretive approach are drawn on to explain the phenomena theoretically and empirically. Conducting semi~structured interviews and analysing official documents are two research methods used here for collecting primary and secondary data respectively. The research sample comprises thirty four individuals involved in EM, and is divided into four main categories, namely: firms' executives (service and industrial companies); auditors (big and small audit firms), users of financial reports (Le. financial analysts); and Stock Exchange regulators. The empirical results are consistent with the theoretical suggestions. Since this research has provided empirical evidence that firms' contexts and their unique circumstances have a significant influence on shaping executives' motives for managing a firm's financial image and on determining the mechanisms used for making such adjustments. The first part of the findings pertaining to the managerial motives reveals that, in the Egyptian context, there are two kinds of motivating factors: the first is the pressures or motives exerted by bodies that exist within a firm's external context, including: financial providers; EGX's listing rules and employees (coercive pressure); beating the prevailing level of profit (mimetic pressure); economic reform (economic pressure); and executives' characteristics, e.g. experiences and morals (normative pressures). The second is managerial self-interested motives, including: job security; managerial professional reputation; and cash bonus._ Importantly, the latter .motives can be served by complying with external motives or pressures. However, in Egypt, material suppliers and customers, and stock-based compensation plans have little or no motivating effect. The results also indicate the superiority of external motives over self-interested motives and of job market motives over monetary self~ interested motives. The findings further show the effect of the dominant type of ownership of a firm and of each firm's circumstances, such as their definition of the profit in its bonus managerial compensation scheme on managers' motives. Part two of the findings related to the EM mechanisms reports empirical evidence that each mechanism is effectively chosen in accordance with a firm's circumstances. In the Egyptian context, there are two rule~ based and unquestionable alternatives which can be used (in order to comply with the external requirements, i. e. pub lishing favourable FRs): accounting action mechanisms, including depreciation and inventory evaluation methods; and real economic activity mechanisms, including sale activities, advertising and R&D expenses, overproduction and sale of fixed assets. Importantly, empirical evidence shows that executives prefer to resort to a package of real business activities comprised of the most favoured mechanisms, including sale activities, followed by discretionary expenses. The reasons for the executives' preferences include: the real effect of using the mechanism on the firm 's profits and on its cash flows; the morality of using a particular mechanism; its ability not to attract scrutiny from outsiders; and its flexible use. The results additionally indicate a close association between better understanding EM motives and the accurate identification of the EM mechanisms that are preferred.