Authors: Elizabeth Georgoula, Anastasios Tsamis
Title: Empirical examination of earnings manipulation and earnings conservatism of FTSE 250 of the London Stock Exchange
Abstract
This study focuses on FTSE 250 listed companies of the London Stock Exchange. The study examines the following research questions: if the companies followed by financial analysts tend to exhibit less manipulation and higher profit conservatism; if profit manipulation is positively linked to achieving analysts' earnings forecasts; whether the number of analysts following a company and the buy recommendation issued by them are positively linked to the meeting and/ or beating analyst forecasts;if companies for which a buy recommendation is issued by analysts tend to exhibit lower earnings manipulation and higher profit conservatism; whether company fundamentals are significantly associated with analyst forecasts; and whether companies with high earnings forecasts for the far future (≥ 2 years) exhibit lower earnings manipulation and higher conservatism.
The main findings of the study show that companies that are followed by many financial analysts and are highly-geared tend to display lower profit manipulation. Companies that are followed by many analysts and show low liquidity display low manipulation. Companies for which analysts recommend a buy position also show low manipulation. The higher the manipulation is, the higher the prediction error will be, reflecting the uncertainty that exists. Companies tend to resort to manipulation practices to ensure that short-term as well as long-term analyst forecasts will be satisfied. Companies that are followed by many analysts show high earnings conservatism. Companies that enjoy a strong buy recommendation from analysts showhigh profitability. Companies followed by many analysts meet earnings forecasts more than marginally showing lower likelihood of manipulation.
Furthermore, companies that exhibit bad news and negative market valuation while they are followed by many financial analysts, tend to display higher earnings per share.Companies for which a buy recommendation is issued by analysts tend to exhibit lower leverage. Moreover, companies that have significantly beaten analyst forecasts are less likely to use earnings manipulation practices. Companies that are small in size, and for which there is a strong buy recommendation because of good future prospects, tend to display lower levels of manipulation.Companies with high leverage tend to exhibit less manipulation due to stronger monitoring by banks.High growth companies tend to invest more in order to have higher returns.Marginally beating analyst forecasts may be related to earnings manipulation. Companies that have already beaten analyst forecasts enjoy positive forecasts for the future.Companies that use less earnings manipulation practicestend to display higher earnings forecasts.
The study contributes to the literature by providing evidence that companies using high quality accounting standards in their financial reporting practices follow a conservative approach to reporting losses and profits, which further enhances the reliability of their financial statements. The study suggests that accounting information with high quality makes annual reports more reliable by reducing the skepticism of market participants. This would be more pronounced in countries with strong investor protection mechanisms, where the demand for high quality information is stronger. In contrast, in countries with weak investor protection mechanisms, the disclosure of difficult-to-verify accounting information will be highly valued by the stock market and will attract investors after reducing uncertainty and asymmetry of information.
