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Earnings Management in Chapter 11 Bankruptcy

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  • Timothy C.G. Fisher
  • Ilanit Gavious
  • Jocelyn Martel

Abstract

We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11. Using data on public US firms, we construct three measures of earnings management: a real activities manipulation measure (abnormal operating cash flows) and two accounting manipulation measures (discretionary accruals and abnormal working capital accruals). We find that, controlling for the impact of factors known to influence earnings management and firm survival in bankruptcy, earnings management prior to bankruptcy significantly reduces the likelihood of Chapter 11 plan confirmation and emergence from Chapter 11. The results are driven primarily by extreme values of earnings management, characterized by one or two standard deviations above or below the mean. The findings are consistent with creditors reacting positively to unduly conservative earnings reports and negatively to overly optimistic earnings reports. We also find that the presence of a Big 4 auditor is associated with a higher incidence of confirmation and switching to a Big 4 auditor before filing increases the incidence of emergence.

Suggested Citation

  • Timothy C.G. Fisher & Ilanit Gavious & Jocelyn Martel, 2019. "Earnings Management in Chapter 11 Bankruptcy," Abacus, Accounting Foundation, University of Sydney, vol. 55(2), pages 273-305, June.
  • Handle: RePEc:bla:abacus:v:55:y:2019:i:2:p:273-305
    DOI: 10.1111/abac.12158
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    Cited by:

    1. Ndiimafhi Norah Netshisaulu & Huibrecht Margaretha Van der Poll & John Andrew Van der Poll, 2022. "A Conceptual Framework to Analyse Illicit Financial Flows (IFFs)," Risks, MDPI, vol. 10(9), pages 1-20, September.
    2. Alam, Nurul & Gao, Junbin & Jones, Stewart, 2021. "Corporate failure prediction: An evaluation of deep learning vs discrete hazard models," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).

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