Executive stock options missed earnings targets and earnings management
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This study aims to investigate that not-for-profit hospitals in South Korea also conduct opportunistic earnings management as for-profit organizations do. Medical corporations except clinics owned by individual doctors are classifies as not-for-profit organizations in South Korea Inheritance Tax and Gift Tax Act of Korea, On the considering launching of for-profit hospitals in South Korea, a lack of research exists to understand the types and motivations of earnings management in not-for-profit hospital settings.
With the evidence of earnings management in for-profit organizations, this research involves examining whether leaders of not-for-profit hospitals in South Korea manage earnings and how they manage earnings. The study included the logistic regression models of performance-matched discretionary accruals to test whether not-for-hospitals manage reported earnings with a sample of hospitals 1, hospital-year observations from to The findings show that not-for-profit hospitals manage earnings to make a cookie jar reserve by using reserve fund and manage earnings negatively to increase donation revenue.
Furthermore, this study found that public large hospitals engage in less earnings management than small sized hospitals to avoid reputation political costs. The reported earnings of hospitals play important roles in financing, performance evaluation, donation, negotiation talks and tax exemption benefits Leone and Van Horn, Earnings are negatively associated with the possibilities of manager terminations Brickley and Van Horn, Burgstahler and Dichev classified the kinds of earnings manipulation in for-profit organizations as smoothing earnings for the steady growth of earnings to prevent losses and to avert decreases in earnings.
Executive stock options missed earnings targets and earnings management and Tsai reported that managers manipulated their earnings to avoid a decrease in equity prices, to mitigate tax burdens and to meet the expectations of stakeholders in the capital market. According to the SKDI and SKHIDIlaunching of for-profit hospitals will improve the quality of medical services, help hospitals be innovative and boost global competitiveness by financing stabilized capital. The proponents added that Korean hospitals cannot compete with globally leading hospitals without the hospitals having a for-profit motive Dong-A Ilbo, Executive stock options missed earnings targets and earnings management to McCue and Nayarfor-profit rural referral center hospitals in the United States served less complicated medical cases and had lower costs per bed.
Some civic groups and medical experts oppose the introduction of for-profit hospitals in South Korea. The South Korean Federation of Medical Groups for Health Rights insisted that adopting for-profit hospitals would motivate the leaders of not-for-profit hospitals to increase medical costs that come from unnecessary medical tests and high salaries for their skilled medical professionals Bae, In a for-profit environment, hospital leaders are compelled to escalate the costs of medical treatments to make earnings for investors, which burden people with heavy medical expenses, by focusing on uncompensated medical services Woo, Fifteen of the 25 most profitable hospitals in the United States were for-profit hospitals Some researchers have indicated the large margin is the result of efficiency and high quality in the hospital, whereas others expect the profit might result from overcharging in the local monopoly.
The problem is that researchers have not properly studied the incentives and patterns of earnings management for not-for-profit hospitals in South Korea and regulation setters have limitations in decision making on establishing for-profit hospitals. The leaders of most not-for-profit hospitals want to operate as commercial businesses alleging that it is the way to increase the quality of medical services.
The opponents on launching for-profit hospitals asserted the for-profit system in hospitals would lead to increased medical fees that involve incremental charges for medical insurance subscribers. One of the most popular and discussable topics in accounting research is earnings management. To understand the ways and patterns of earnings manipulation, empirical studies have been conducted with various approaches. CEOs manage earnings by increasing or decreasing earnings with a variety of accounting principles.
From the s to the early s, the focus of most researches on earnings management was on the executive stock options missed earnings targets and earnings management exercise through the specific choice of Generally Accepted Accounting Principles GAAP.
Since the mids, researchers have focused on the discretionary and nondiscretionary accruals measurement Sun and Rath, Among the two types of accruals, discretionary accruals allow CEOs to move accounting revenue between accounting periods or to defer expense recognition. CEOs manipulate their earnings by discretionary accruals Dechow et al. Imhoff used income smoothing Sun and Rath and Burgstahler and Dichev applied benchmark beating to measure earnings management. With the pervasive evidence of earnings management in for-profit organizations, the study involves examining whether leaders of not-for-profit hospitals manipulate earnings and how hospital leaders manage earnings in South Korea.
An expectation for the study is that the methods and patterns of earnings manipulation in not-for-profit hospitals will differ from for-profit organizations and will give conclusive proof to standards setters and regulators for launching for-profit hospitals in South Korea. The results of the study also add to leadership knowledge and literature.
Safeek noted chief medical officers should exercise leadership in financing, planning and marketing by establishing customer relationships, margins and outcomes as parts of leadership in the health care industry.
The behavior of leadership in the health care industry wields influence over the hospital safety culture and performance Yang et al. Regulators, including government, organizational leaders, users of financial executive stock options missed earnings targets and earnings management data and academic professionals, will play a part in understanding earnings manipulation in the not-for-profit hospital industry.
Prior research has covered the issues of earnings management from various perspectives. The focus of the earlier studies was primarily on the motives, techniques, restrictions and research designs of earnings management. Prior review papers such as those by Fields et al.
Healy and Wahlen reviewed earnings management literature and presented implications for accounting criteria and regulation setters. McNichols discussed earnings manipulation research designs. The literature review includes a comprehensive overview about earnings management and about the issues of earnings management discussed in prior research.
Following a review of many studies on earnings management, Kothari noted that investors and the market react to reported earnings. Chief financial officers regard reported earnings numbers such as the earnings per share as a key metric instead of cash flows Graham et al. Due to the high cost of information processing, Graham et al.
One of the most common incentives that researchers discussed on earnings management was strongly associated with the capital market. They found that Chen and Tsai noted that one of the motivations for managers to manipulate earnings in the reported financial status is to maintain confidence executive stock options missed earnings targets and earnings management banks. Chen and Tsai noted this type of earnings management comes from altruistic motivation.
Failing to meet the targets of the stock market provides investors with a negative influence in stock returns Barth et al. If the targets of analysts are lower than the premanaged earnings, CEOs might decrease the earnings, also called cookie jar accounting, executive stock options missed earnings targets and earnings management bad years or might not engage in earnings management for the stock returns.
As not-for-profit organizations do not have stock market and residual claimants, if the earnings of the current accounting period are positive, there are no incentives for CEOs of not-for-profit hospitals to avoid earnings decreases Leone and Van Horn, Hoerger and Leone and Van Horn noted that managers of not-for-profit hospitals manipulate earnings with the increases or decreases in discretionary expenditures at the end of the fiscal period to meet or beat the levels of earnings they desire.
Although, a number of researchers studied earnings management, the majority focused on for-profit publicly traded companies in the United States. Even in a for-profit environment, Cormier et al. It is, therefore, significant to study if critical but differential factors are not revealed in earnings management in the South Korean not-for-profit hospital industry.
CEO compensation or contracting motivations: Bartov and MohanramBushman and SmithCore et al. CEOs manage the accruals of working capital to meet the targets of earnings McVay et al. Managers managed earnings with income-increasing discretionary accruals when the compensation for CEOs was more bounded by stock options Bergstresser and Philippon, Laux and Laux noted that more stock incentives for CEOs were not necessary if the board supervised the managers appropriately.
Fama and Jensen insisted that a directorate should approve, monitor and choose the significant decisions of the agents and reward them because agents do not share the wealth created by their decisions. Other researchers documented that a nonlinear s-shaped relation exists between meeting earnings benchmarks and abnormal returns Freeman and Tse, ; Kinney et al.
Earnings benchmarks include just-above-zero earnings, the earnings of the previous accounting period and the expectations of analysts. Jiang examined the relationship between beating those earnings benchmarks and the debt costs with the proxies of credit ratings and initially yielded bond spread.
Jiang noted that the firms that won the earnings targets enjoyed higher credit ratings in the previous accounting period and a smaller initial bond yield. It is not clear why institutional investors who dominate the bond market and can process compound information simply rely on the experience. As South Korea has adopted the IFRS for listed companies since January 1,leaders of corporations are expected to improve accounting transparency, accountability, comparability and reliability of financial information in the global market.
IFRS accommodates a fair value accounting in firm valuation. According to Healy and Wahlenfair value accounting is aimed at reducing earnings management, providing stakeholders with proper financial information and improving the quality of decision making by regulators. The IFRS globally unified accounting standard might reduce the cost of financial reporting.
Any investments from investors in for-profit hospitals in South Korea require a full understating of earnings management and accurate financial information on hospitals. According to Healy and Wahlenresearchers have examined two types of regulation motivations when looking at earnings management in the perspective of regulatory incentives: Earnings management methods for beating the benchmarks: Healy and Wahlen examined the distribution of reported earnings and provided evidence that CEOs participated in earnings management when they expected to miss the earnings benchmark.
Habib and Hansen noted that Healy and Wahlen did not provide an immediate influence on regulators. This section shows how firm managers manage their reported earnings around the benchmarks of earnings, categorized by earnings management through specific accruals, earnings management through specific activities and earnings management through meeting or beating the targets of executive stock options missed earnings targets and earnings management.
Earnings management through specific accruals: The difference in discretionary accounting accruals did not exist between companies with petty profits and companies with diminutive losses Dechow et al. Firm managers have some incentives when they manage earnings. The companies with earnings just over the target did not show significantly different discretionary accruals compared to the companies with earnings just below the benchmark Dechow et al. Hansen noted that the alternative benchmarks around the earnings level benchmark as well as earnings changes can influence the discretionary accruals levels.
The discretionary accruals of the companies that had earnings just over the benchmark are considerably higher than the discretionary accruals for companies with earnings just below the benchmark Executive stock options missed earnings targets and earnings management, Deferred corporate taxes can detect earnings management using a modified Jones model Phillips et al.
According to Phillips et al. Cash flow can be a discretionary accrual proxy, as used by Ayers executive stock options missed earnings targets and earnings management al. Earnings management using real activities: According to Roychowdhurysome companies manipulate their earnings through real activities instead of financial activities.
Real activities include lower prices, inventories and discretionary expenses to achieve the earnings benchmarks. Roychowdhury found that firms that are just above the benchmarks of earnings provided their clients with price discounts to increase short-term sales, reduced cost of goods sold using an overproduction method executive stock options missed earnings targets and earnings management lowered discretionary expenses.
Earnings management through classification shifting: McVay found that CEOs shifted key expenses such as cost of goods sold to specific accounts within the income statement. The term used for the intentional misclassification of the expense accounts within the income statement is shifting of expenses McVay, Through shifting expenses within the income statement, managers cannot change the last calculated earnings but they can exaggerate certain earnings McVay, CEOs use classification shifting as a tool of earnings manipulation to achieve or beat the analyst targets benchmark McVay, Earnings management through target guidance: Brown and Higgins demonstrated that CEOs use forecast guidance by guiding the targets of analysts downward, as examined by Matsumotoin the nations that protect investors strongly more than in executive stock options missed earnings targets and earnings management nations that protect investors weakly to achieve positive earnings surprises.
Feng and McVay demonstrated that analysts valued the guidance of managers more heavily than expected in the perspectives of usefulness and credibility of management guidance. Brown and Higgins noted that U. Research designs employed in prior studies: