A Review of Dominant and Emerging Issues in Corporate Earnings Management

The form and means of corporate earnings management (CEM) have evolved and become ever more sophisticated; however, in substance, CEM remains the misinforming of the users of an organization's financial statements, via the strategic abuse of timing, reorganizing, reclassifying, and/ or omitting of material information. Thus, even though CEM rarely involves outright deception, it is a fundamental breach of trust. As such, CEM is immensely damaging to the primary role of financial statements (i.e., the creation and/ or maintenance of informed trust between organizations and their key stakeholders) . This study is structured as follows. After discussing the importance of CEM, this article elaborates on the definitions, key concepts in the CEM literature with a focus on CEM evolution, incentives, and motivations. The discussion also includes the important proximal causes of CEM and the flow-on effects of CEM; for example, the short-term survival needs of firms during economic downturns likely increases their incentive to engage in CEM (Healy & Wahlen, 1999). In counter-point, domestic and international business partners are aware that the bad acts of their managers (such as CEM) may have contagion or spill-over implications for their suppliers, customers, creditors, auditors, financial analysts, etc. Compounding the current mix of difficulties and complexities of the global economy is the rise of protectionism; as evidenced by the ongoing difficulties in recent World Trade Organization discussions.1 Finally, the balance of the study follows a description of the specifications of various CEM models, listing each model's strengths and weaknesses, along with conclusions and suggestions for future research.Uncertainty in the global economic and finance markets in 2008 and 2009 (e.g., a global credit crisis compounded by rollercoaster volatility in interest rates, consumer prices, and prices of commodities, food-stuffs, and oil) heightened the importance of the corporate sector's need to show its survivability via solid profitability, competitiveness, market share, and access to inputs. Bourgeois (1985) commented on strategic goals and economic performance in volatile environments. Research on the reality of how performance is communicated to stakeholders has addressed such important concepts as* Are the agency problem and its cost important? * Does manager wrongdoing cause lasting harm to investor relations and financial public relations? * Have the CEM issues been satisfactorily recognized and addressed? * What are the future directions left for researchers to focus on? This descriptive study examines the development of extant CEM literature over last few decades, with the intent of identifying trends by tracking dominant issues, thinking, views, motivation, and activities in CEM. This imposition of order on the large and rapidly expanding volume of CEM research is a prerequisite to gathering the trends in CEM under-standing into an underlying theory of CEM. This CEM-research taxonomy should provide insight on the current and potential direction of the expanding volume and variety of CEM incidents and help regularity bodies in their efforts to tighten and improve reporting standards and regulations.The Importance of CEMThe importance of research on CEM arises because earnings on financial statements are a vital input into resourceallocation decisions. Consistent with this importance, business ethics and agency issues2 are among the most frequently investigated issues in financial management and accounting. The potential of managers to use CEM to gain wealth, recognition, and/ or other benefits at a potentially unfair cost to stakeholders has long been a worry of governments, private sector regulators, investors, practitioners, analysts and researchers; however, the nature, extent, motivation for and consequences of CEM have been formally investigated and modeled in CEM empirical literature, only in the last few decades (Coughlan & Schmidt, 1985; MacNichols & Wilson, 1988; Natarajan, 1999). …