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Impact Of Earnings Management On Firms Profitability In Pakistan

1016 words - 4 pages

Abstract
This study is an attempt to examine the impact of Earnings management on the profitability of the firms. Earnings management has emerged as a vital issue in recent past for the firms, investors, analysts and the capital markets for profitability manipulation. The study was conducted on the companies listed at Karachi Stock Exchange. The sample included 98 companies comprising different sectors and taking five year financial data from annual reports of those selected companies from year 2002 to year 2006. Modified Jones model was applied to calculate the discretionary accruals which were violently used to manage earnings and used as a proxy of earnings management in the literature. Cross sectional time series regression was used for empirical verification of the findings of the study. Results showed that the Earnings Management has negative impact on the profitability of the companies.
This paper examines the impact of earnings management activities on the firms’ profitability. Earnings management has arisen as a very important issue for the firms, investors, analysts and the capital market at large. Investors estimate the businesses on the basis of earnings which indicate the extent of a company’s added value addition and provide crucial information in evaluations and comparisons of companies’ performance because they reflect concrete figures provided by the companies according to reasonable standards. Increased earnings indicate increased value, on the other hand, decreased earnings show value decline. Management remains vigilant about earnings disclosure, earnings growth, and minimization of uncertainty and manages the reports accordingly. Managers use accounting judgment and transactions to manipulate the expectations of capital market. Earnings management comes up because management has different incentives to do so. Reported income includes not only cash flows but also changes in value that are not apparent in current cash flows. These changes in firm value entail a great deal of discretion. Accruals are used to increase or decrease reported income and they are not reflected in current cash flows. Accruals in this context are defined as any accrued recognition of cash flows in those periods in which the respective activity took place. This includes, e.g., the capitalization of assets aimed at future depreciation, the creation of reserves or of deferred income or charges. Accounting accruals consist of discretionary accruals which are management determined and non-discretionary accruals. Thus, the focus of this article is to study the effect of earnings management on firm profitability. Further, this study determines whether corporate management is successful or not in misguiding the market players in capital market of Pakistan.

Works Cited

Anand, Manoj (2002). “Corporate Finance Practices in India: a survey,” Vikalpa: The Journal for Decision Makers, Vol. 27 (4), October-December, pp. 29-56.
Beneish, M and M. Vargus, 2002....

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