The paper studies earnings management in public and private companies and whether earnings management is a function of leverage. A matched sample with 99 public and 99 private Finnish companies is used.
Earnings management is difficult to measure and several different approaches are used to identify earnings management. Firstly, following several prior studies, discretionary accruals, the ratio of small profits to small losses, the variation in earnings in relation to the variation in cash flows and the correlation between the change in earnings and the change in cash flows are used as measures of earnings management. Secondly, a number of specific accruals are studied, namely the depreciation, the amortization of goodwill and the recognition of impairment losses. Thirdly, whether companies use the timing of assets sales and other gains reported as a non-operating income as a way to manage earnings is studied.
The main findings are as follows: contrary to studies of U.K and U.S. data, this paper finds no significant differences in the accounting choice/earnings management measures between public and private companies. Furthermore, some of the measures used indicate that highly leveraged companies are more likely to use income increasing accounting methods than companies with a low leverage. However, the impact of leverage on accounting choices does not differ significantly between private and public companies.