Evaluate the Practice of Earnings Management from the Prospective of Corporate Governance and Business Ethics

Evaluate the practice of Earnings Management from the prospective of Corporate Governance and Business Ethics

Definitions of Earnings Management

Traditionally earnings management is viewed as a distortion of economic events that is misleading to certain user of financial statements. Below are two widely quoted definition carrying this point of view:

Schipper (1989, 92): “a purposeful intervention in the external financial reporting process, with the intent of obtaining some private gain (as opposed to, say, merely facilitating the neutral operation of the process)...."

Healy and Wahlen (1999, 368): "Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers".

On the other hand, some academics viewed earnings management in a more positive manner.

McKee (2005, 1) defined earnings management as “Reasonable and legal management decision making and reporting intended to achieve and disclose stable and predictable financial results.”

Arya, Glover, Sunder (2002, 3-4): “The push for increased transparency in financial reporting and corporate governance serves shareholders only up to a limit. The problem of assessing the value of transparency to shareholders is subtle because both the level and pattern of earnings can convey information. Even when earnings management conceals information, it can be beneficial to shareholders.”

My personal view on Earnings Management

As a professional accountant, my personal view is that I support the use of legitimate earnings management within the boundary of accounting regulations, which is in indeed a common practice in the commercial world. Earnings management should be fine as long as it is not at an extreme level which distort the underlying performance of a...