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Acc & Ec

Two tales on nonprofit earnings management: - accounting and (micro)economics - empirical analysis Marc Jegers. Acc & Ec. Focus on agency gap between board and management (Steinberg 1986, Rand J. of Ec.). Acc & Ec. Manipulations: financial statement: - real: b R accounting: b A

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Acc & Ec

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  1. Two tales on nonprofit earnings management: - accounting and (micro)economics - empirical analysis Marc Jegers

  2. Acc & Ec • Focus on agency gap between board and management • (Steinberg 1986, Rand J. of Ec.) Navorsingsdag ES 2009

  3. Acc & Ec • Manipulations: • financial statement: - real: bR • accounting: bA - cost accounting: - profit vs. nonprofit: Δip - program vs. adm.+fundr.: Δis Agency: k (0: budget max.; 1: service max.) Navorsingsdag ES 2009

  4. Acc & Ec: real vs. accounting earnings disclosed: • ΠM = Π + bA + bR – ½ αRbA² - ½ βRbR² utility function: • S + F - ½ αPbA² - ½ βPbR² - k(½ αRbA² + ½ βRbR²) • Proposition 1: If subsidies and gifts are affected by the overall earnings disclosed by a nonprofit organization, a larger principal-agent gap will result in more important earnings manipulations. Navorsingsdag ES 2009

  5. Acc & Ec: taxable vs. non-taxable • earnings disclosed: • ΠM = Π + tΔipCI – γR| Δip| • utility function: • F + S + t ΔipCI – kγR|Δip| - ½ γP(Δip)² • Proposition 2: A deeper principal-agent gap results on average in more manipulations as to the allocation of indirect costs to taxable activities. Acc & Ec Navorsingsdag ES 2009

  6. Acc & Ec: service vs. non-service • earnings disclosed: • ΠM = Π – δR|Δis| • utility function: F + S - kδR|Δis| – ½ δP(Δis)² Proposition 3: A deeper principal-agent gap results on average in more manipulations as to the allocation of the mission related indirect costs to program activities. Acc & Ec Navorsingsdag ES 2009

  7. Acc & Ec: risk aversion • after having introduced risk aversion, maximising certainty equivalent utility function: • Proposition 4: Both risk-neutral and risk-averse managers of nonprofit organizations will, on average, manipulate more the profits reported, the costs allocated to profit activities, and the costs allocated to program activities, the wider the gap between their objectives and the board’s objectives. Navorsingsdag ES 2009

  8. Empirical analysis • NOT direct test of previous hypotheses • Hypothesis 1 (zero profit hypothesis): Nonprofit organisations prefer to manage earnings in order to disclose zero profits. • Hypothesis 2: Under the zero profit hypothesis, unmanipulated earnings and manipulated earnings are negatively correlated. • Hypothesis 3: Nonprofit organisations receiving relatively more subsidies, will be more inclined to manipulate earnings than nonprofit organisations receiving relatively less subsidies. Acc & Ec Navorsingsdag ES 2009

  9. Empirical analysis • Hypothesis 4: Nonprofit organisations characterised by a relatively deeper agency gap, will be more inclined to manipulate earnings than nonprofit organisations characterised by smaller agency gaps. • Hypothesis 5: There is a negative relationship between nonprofit organisations’ indebtedness and the level of earnings manipulations. • Hypothesis 5’: There is a positive relationship between nonprofit organisations’ indebtedness and the level of earnings manipulations. Navorsingsdag ES 2009

  10. Empirical analysis • Sample: 1,054 financial statements (2007) • Method: probit (yes/no), heteroscedastic-consistent OLS (amount) Navorsingsdag ES 2009

  11. Empirical analysis • Dependent: accruals (exc., fin.+exc., all) • Independent: earnings before ‘manipulation’, relative subsidies, agency gap, financial debt/TA, ln Assets, industry Navorsingsdag ES 2009

  12. Empirical analysis: before Navorsingsdag ES 2009

  13. Empirical analysis: after Navorsingsdag ES 2009

  14. Empirical analysis • Table 3: Correlations between absolute values of manipulated and unmanipulated earnings • Variables correlated Pearson correlation (%) Observations • absEBM-absME 63*** 844 • absEBM-absME (≠ 0) 64*** 665 • absEBEF-absMEFE 45*** 844 • absEBEF-absMEFE (≠ 0) 62*** 250 • absEBE-absMEE 43*** 844 • absEBE-absMEE (≠ 0) 70*** 166 • Note: • *,**,*** : 10%, 5%, 1% significance levels respectively (one-sided) Navorsingsdag ES 2009

  15. Empirical analysis: one of the tables • Table 6: Absolute levels of manipulated earnings (Panel A: overall manipulated earnings (absME): total sample (n=844), restricted sample (n=665)) • (14) (15) (16) (17) (18) (19) (20) (21) • Constant (1,000) 1,081** 1,469** -3,169*** 1 4,320*** -17 -1,302*** -1,791*** • RELSUB 5,286 2,917 13,049 5,110 15,699 2,427 • AG 21,406** 31,553** 52,196*** -10,419 69,391*** -12,052 • DEBT (1,000) 102 110 41 114 66 122 • absEBM 0.15** 0.16** 0.17** 0.18** • int:RELSUBabsEBM -0.09 -0.07 • int:AGEabsBM 0.22*** 0.20** • int:DEBTabsEBM 0.63** 0.62** • absrEBM (1,000) 311 846** • SIZE (1,000) 160** 212** 477*** 634*** 196*** 270*** • industry dummies yes yes yes yes yes yes yes yes • N 844 665 844 844 665 665 844 665 • R² 46 53 22 41 26 43 45 46 • Adj. R² 42 44 21 40 25 42 43 44 Navorsingsdag ES 2009

  16. Empirical analysis • Conclusions: • Effect of size, agency gap, debt. Navorsingsdag ES 2009

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