Earnings management is a form of accounting manipulation and not a new term, as it is one of the methods used by some corporate departments, with the aim of influencing financial reports, to reach the achievement of special interests by misleading stakeholders about the reality of the performance of some companies.
Although there are international accounting standards for financial reporting that contribute to increased transparency and improved quality, this type of negative management behaviour undermines the credibility and integrity of these financial reports and affects investor confidence to make appropriate decisions based on analysis of the operational and financial performance of companies.
Earnings management has inspired a plethora of scientific research to uncover the different motivations that motivate corporate governance to engage in such practices. One of the most important reasons is due to the contractual motives associated with many parties to stakeholders, as accounting financial statements are an important tool in the process of control and regulation of contractual relations between the various parties.
Remuneration contracts under which bonuses and incentives are determined for management are based on the results of net profits, so management in some companies focuses on managing profits in the income statement to obtain those benefits and rewards to achieve personal benefits that are often not related to the interest of the organization.
The other part of the contracts is that which is related to indebtedness contracts, and the inability to meet debt contracts, in the event of a lower than expected profit rate, especially when the financial crisis occurs for some companies, so companies resort to it for fear of defaulting on penal conditions, which may reach an amendment with harsh terms for loans with stakeholders.
In addition to the previous motives, capital-related motives are directly related to the use of profit management, as most investors and financial analysts employ the financial statements and reports of companies in order to evaluate the performance of companies, so those companies have become more concerned about the expectations of financial analysts for their shares and to avoid a negative market reaction to their share prices in the event of a large gap between the actual performance of the company and the expectations of financial analysts.
The role of some financial analysts in siding with corporate management in pursuit of personal interests has also been criticized, as most expectations for shares of some companies are optimistic and biased, thus causing some biased and opaque financial reports in the global stock market to collapse some major international companies.
In conclusion, we caution that under the circumstances of the Coronavirus (COVID-19) pandemic, which has cast a shadow over most of the world’s economies, an increase in the involvement of many companies in such opaque practices is expected, as a large proportion of companies are suffering from accumulated financial losses. Decision-makers should establish control management to minimize these practices, and independent auditors can be instrumental in detecting as well as reducing such fraudulent practices by developing an audit plan based on examining internal control systems, data, documents, and accounts to ensure that financial reports are free of different ways of managing profits.
