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Corporate diversification and earnings management

Listed author(s):
  • Imen Khanchel El Mehdi

Purpose - The purpose of this paper is to find out whether corporate diversification provides a favourable environment for earnings management (agency conflicts hypothesis) or whether it mitigates this phenomenon (earnings volatility hypothesis). Design/methodology/approach - Based on a sample of US firms and making an explicit distinction between industrial and geographic diversification, univariate and multivariate analyses are used to test whether firm diversification has an impact on earnings management. Findings - Results show that the average diversified firm in the sample has somewhat more earnings management problems than a similarly constructed portfolio of stand-alone firms chosen to approximate the segments of the conglomerate. Consistent with the agency conflicts hypothesis, the authors find that geographic diversification increases earnings management whereas industrial diversification decreases it, consistent with earnings volatility hypothesis. Moreover, industrial and geographic diversification combined reinforce this phenomenon. These findings are consistent with the view that the costs of geographic diversification outweigh the benefits. Originality/value - The paper makes an important contribution to the accounting literature by providing new and significantly different evidence on the relative roles of corporate diversification in the earnings management. By linking two streams of research, earnings management and corporate diversification, one is taken into the unexplored area of the sources of the difference in earnings management between diversified and focussed firms. More specifically, this study provides evidence that earnings management is more intensively practiced in geographically diversified firms and even more so in firms that are both industrially and geographically diversified.

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Article provided by Emerald Group Publishing in its journal Review of Accounting and Finance.

Volume (Year): 10 (2011)
Issue (Month): 2 (May)
Pages: 176-196

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Handle: RePEc:eme:rafpps:v:10:y:2011:i:2:p:176-196
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  1. Rodríguez-Pérez, Gonzalo & van Hemmen, Stefan, 2010. "Debt, diversification and earnings management," Journal of Accounting and Public Policy, Elsevier, vol. 29(2), pages 138-159, March.
  2. Yoon, Soon Suk & Miller, Gary A., 2002. "Cash from operations and earnings management in Korea," The International Journal of Accounting, Elsevier, vol. 37(4), pages 395-412.
  3. Comment, Robert & Jarrell, Gregg A., 1995. "Corporate focus and stock returns," Journal of Financial Economics, Elsevier, vol. 37(1), pages 67-87, January.
  4. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
  5. Raghuram Rajan & Henri Servaes & Luigi Zingales, 2000. "The Cost of Diversity: The Diversification Discount and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(1), pages 35-80, 02.
  6. Lewellen, Wilbur G, 1971. "A Pure Financial Rationale for the Conglomerate Merger," Journal of Finance, American Finance Association, vol. 26(2), pages 521-537, May.
  7. Ahn, Seoungpil & Denis, David J., 2004. "Internal capital markets and investment policy: evidence from corporate spinoffs," Journal of Financial Economics, Elsevier, vol. 71(3), pages 489-516, March.
  8. Jiraporn, Pornsit & Kim, Young Sang & Mathur, Ike, 2008. "Does corporate diversification exacerbate or mitigate earnings management?: An empirical analysis," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 1087-1109, December.
  9. repec:bla:joares:v:36:y:1998:i::p:161-191 is not listed on IDEAS
  10. Robyn McLaughlin & Assem Safieddine & Gopala Vasudevan, 1998. "The Information Content of Corporate Offerings of Seasoned Securities: An Empirical Analysis," Financial Management, Financial Management Association, vol. 27(2), Summer.
  11. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-264, April.
  12. repec:ccp:journl:v:19:y:2001:i:8:p:1315-1346 is not listed on IDEAS
  13. Brenda van Tendeloo & Ann Vanstraelen, 2005. "Earnings management under German GAAP versus IFRS," European Accounting Review, Taylor & Francis Journals, vol. 14(1), pages 155-180.
  14. Dennis R. Oswald, 2008. "The Determinants and Value Relevance of the Choice of Accounting for Research and Development Expenditures in the United Kingdom," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(1-2), pages 1-24.
  15. Richardson, Vernon J, 2000. "Information Asymmetry and Earnings Management: Some Evidence," Review of Quantitative Finance and Accounting, Springer, vol. 15(4), pages 325-347, December.
  16. Nagy, Albert L. & Neal, Terry L., 2001. "An empirical examination of corporate myopic behavior: a comparison of Japanese and U.S. companies," The International Journal of Accounting, Elsevier, vol. 36(1), pages 91-113, February.
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