Title: Accruals and real earnings management: testing the debt covenant hypothesis

Authors: Umar Butt; Trevor Chamberlain; Sudipto Sarkar

Addresses: College of Business, Zayed University, Dubai, UAE ' DeGroote School of Business, Hamilton, ON, L8S 4M4, Canada ' DeGroote School of Business, Hamilton, ON, L8S 4M4, Canada

Abstract: This paper examines earnings management activities around debt covenant violations. We focus on accruals management and real activities manipulation behaviour of managers in the quarters around the covenant violation. We expect covenant restrictions to influence these activities in the quarters surrounding and the quarter of the violation. The evidence is consistent with managers manipulating earnings using accrual-based and real earnings management activities and provides evidence for the debt covenant hypothesis. Cross-sectional analyses reveal that managers appear to manipulate accruals in successive quarters in order to increase reported earnings. The evidence on the use of real activities suggests that while managers increase reported earnings in the violation quarter, they have limited discretion over the use of real earnings management techniques in the quarters surrounding the violation.

Keywords: debt covenant violations; accruals manipulation; real earnings management; reported earnings.

DOI: 10.1504/IJAF.2016.081691

International Journal of Accounting and Finance, 2016 Vol.6 No.3, pp.167 - 196

Received: 04 Apr 2015
Accepted: 21 Apr 2016

Published online: 18 Jan 2017 *

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