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Boundaries of the firm and real earnings management

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  • Marisetty, Vijaya Bhaskar
  • Moturi, Sairam

Abstract

Despite harmful effects, Real Earnings Management (REM) is increasingly becoming a more popular method of earnings management than Accruals based Earnings Management (AEM) (Cohen et al., 2008; Commerford et al., 2018). We argue that when a firm’s organizational structure has extended boundaries with other firms, the benefits due to REM can outweigh the costs. We use family business groups, that extend firm boundaries with other affiliated firms, for testing our conjecture. Using a large dataset of 11,417 firm-year observations of Indian firms, we show that REM is significantly higher in business group affiliated firms compared to standalone firms. Further, intra-group transactions, in the form of purchases, sales, and cash flows from operating activities, contribute to higher REM activities. More importantly, when group affiliated firms engage in intragroup transactions and report higher REM, mainly in the form of abnormal production, they experience an increase in their future profitability and a decrease in their cost of equity.

Suggested Citation

  • Marisetty, Vijaya Bhaskar & Moturi, Sairam, 2023. "Boundaries of the firm and real earnings management," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 52(C).
    • Handle: RePEc:eee:jiaata:v:52:y:2023:i:c:s1061951823000460
    DOI: 10.1016/j.intaccaudtax.2023.100567
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    More about this item

    Keywords

    Real earnings management; Firm boundaries; Related party transactions; India;
    All these keywords.

    JEL classification:

    • M1 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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