company. But as becomes clear from Deegan & Unerman the market bonus schemes have both upsides and downsides. One of the downsides is that the financial markets do not value the expenses made for research and development as value increasing expenses and are therefore not represented in the share price. This may result in a cut in research and development expenses in order to influence the share price. A second downsides is that managers may not always be able to influence the share price due to changes in the overall market. A further downside is that it could be that company earnings may be viewed as less positive (more negative) in light of overall market wide movements in equity values. The advantage of the market bonus scheme is that managers with an equity interest will be more willing to disclose more information about the company and its performance and perspectives. This results in a situation of more information symmetry between the managers and the owners. Debt contracting Besides the contract between the manager and the shareholder, the company may engage in a contract with an external party willing to lend the company funds for their operations. As with the relation between the manager and the shareholder, the lender carries risk that of non-repayment due to manager actions. This may occur when the company uses the money for additional dividend payouts to the shareholders or investments in high risk projects. The costs related to divergent behaviour of the borrower are referred to as the agency costs of debt in the PAT. According to the PAT it is assumed that, in the absence of safeguards to protect the lender, the manager will not take those actions that are in the best interest of the lender. Due to this it is assumed that the company will have to pay higher costs of interest to compensate the lender for the high risk exposure. The company has the possibility to reduce the higher costs of interest if it is willing to engage in a debt agreement declaring that they will not use the received funds for activities such as mentioned before i.e. agreement upon certain constraints. By doing so it will reduce its interest costs and the lender risk. Examples of the debt constraints are leverage covenants, a minimum interest coverage and a minimum current ratio.
The difference between 2 and 3 lies in the fact that in situation 2 the revenue are managed without taking the relevant expenses into account in situation 3 the relevant expenses are taken into account. The conclusions of their research are: All models produce reasonably well specified test for a random sample of event years; Should the models be used to sample extreme financial performance, all models do not perform good; The most relevant model to use is the Modified Jones Model; and, The selection of the variables used, can be selected incorrectly, resulting in incorrect assumptions and conclusions. Items that additionally have to be taken into account are cash performance - and earnings performance measurements. Based on these conclusions the model that best be used is the Modified Jones Model. As it can be used over a sample of years. But at the same time should the conclusions regarding the wrong assumptions be taken into account, the result of the model will not presented the actual situation. But if this model is combined with the suggested cash - and earnings performance measurements (ratios), this issue would be solved. Literature review on models used to detect financial distress In this paragraph a literature review will be performed on models that have been studied relating to detecting and predicting financial distress or bankruptcy of companies. In general the bankruptcy prediction models are mainly based on financial ratios. As these give the best presentation of current situation of the company. The ratios can be divided into different categories such as return of assets, liquidity ratio’s and financial statement ratio’s. Hereafter several research studies will be discussed. Hopwood, McKeown and Matchler.(1994) A reexamination of auditor versus model accuracy within the context of the going-concern opinion decision.
Hypothesis 3: The used model will outperform the opinion of the auditor. Based on the results of the research the conclusion can be drawn that the most important proxies, the revenue - and cash flow proxies, show a significant difference in comparison to the control group. That would indicate that these companies are in financial distress and the conclusion could even be drawn that there would be a chance that these companies were going to file for bankruptcy. If the auditor would have realized this, their audit opinion would most probably have been different. There by the model outperformed the assessment of the auditor. Based on the total findings of my research one can state that the companies who filed for bankruptcy have applied earnings management. And based on the findings of my research it is possible to predict that the companies are in financial distress and even may fill for bankruptcy.