Do sin firms engage in real activities manipulation to meet earnings benchmarks?

Abstract

Purpose

Recent literature suggests that sin firms (firms in tobacco, gambling and alcohol industries) have lower institutional ownership, fewer analysts following, higher abnormal returns and higher financial reporting quality. This study aims to investigate empirically how sin firms engage in real activities manipulation (RAM) to meet earnings benchmarks in comparison to non-sin firms.

Design/methodology/approach

The authors examine two types of RAM, namely, Cutting discretionary expenditures including research and development (R&D), SG&A and advertising to boost earnings. Extending deep discount or lenient credit terms to boost sales and/or overproducing to decrease COGS to increase gross profit. Consistent with Roychowdhury (2006), the authors use abnormal discretionary expenditures as the proxy for expenditure reduction manipulation and abnormal production costs as the proxy for COGS manipulation.

Findings

The results for the abnormal discretionary expense model suggest that sin firms do not engage in RAM of advertising, R&D, SG&A expense to just meet earnings benchmarks. The results for the production costs model suggest that sin firms do not engage in COGS manipulation to just meet earnings benchmarks. The results are robust after controlling accrual-based earnings management (AEM). Overall, in this setting, these results suggest that managers of sin firms engage less in RAM to meet earnings benchmarks.

Originality/value

The findings are of interest to investors, auditors, regulators and academics with respect to financial statement analysis and earnings quality.

Citation

Ogilby, S.M., Xie, X., Xiong, Y. and Zhang, J. (2020), "Do sin firms engage in real activities manipulation to meet earnings benchmarks?", International Journal of Accounting & Information Management, Vol. 28 No. 3, pp. 535-551. https://doi.org/10.1108/IJAIM-09-2019-0110