Earnings Management, Earnings Benchmarks, and Directors’ Remuneration: UK evidence

Abstract

The primary objective of this study is to examine the quality of earnings reported by UK markets and explore whether firms manipulate reported earnings figures to hit specific targets. The analysis commenced by detecting earnings management using accrual-based earnings management and real activities manipulation. On the one hand, this study has aimed to investigate whether firms manage reported earnings by utilising accrual-based and real earnings management that just meet or beat important earnings benchmarks around zero earnings and last year’s earnings. On the other hand, this study purposed to examine the relationship between directors’ remuneration and their earnings management as to whether firm directors gain an excessive level of remuneration through managing reported earnings. Using accounting and financial data from firms in the FTSE All-share between 2009 and 2015, the first part of this thesis revealed that UK firms are more likely to engage in real activities manipulation through reducing discretionary expenses and overproducing to manage earnings upwards when just meeting the zero level of earnings benchmark. Moreover, it has been established that firms in the UK market are not engaging in managing earnings upwards by utilising real activities manipulation via sales-based manipulation and overproduction, but are involved more in real activities manipulation by reducing or cutting discretionary expenses when just meeting the previous year’s earnings benchmark. In addition, this study undertook an additional analysis ascertain that UK firms with negative earnings have incentives to use accrual-based earnings management and real activities manipulation through managing discretionary expenses and manipulating production costs to manage earnings downward. The second part of this thesis built a new model to measure abnormal directors’ remuneration and to indicate the degree of an excessive level of compensation gained by directors. Evidence was found that, UK directors report a decline in performance by using sales-based manipulation to manage earnings downward in order to receive additional rewards, whilst directors use production costs-based manipulation to boost earnings. The results also reveal that UK directors engage more in accrual-based earnings management to manipulate earnings downward to achieve abnormally high compensation themselves. Therefore, these results show that firms engage in accrual-based earnings management and real activities manipulation to manage earnings upwards or downwards to hit different specific targets. The thesis presented a more comprehensive understanding of earnings management for the UK market, and offered forward some practical implications for researchers, policy makers, standard setters, and other practitioners. For example, it implies that there is higher demand for increased scrutiny or constraints regarding accounting discretions to eliminate earnings management and to ensure firms disclose good quality earnings information to the public; it draws the attention of regulators or standard-setters to the limitations of accounting regulations and standards and encourages them to implement improvements; the necessity for a closer scrutiny by auditors and regulators is suggested whilst, this thesis may motivate the Board to improve remuneration package setting to ensure directors act in the best interests of shareholders.