Managers' Ethical Evaluations of Earnings Management and Its Consequences

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Managers’ Ethical Evaluations of Earnings Management and
Its Consequences*
ERIC N. JOHNSON, University of Wyoming
GARY M. FLEISCHMAN, University of Wyoming
SEAN VALENTINE, University of North Dakota
KENTON B. WALKER, University of Wyoming
1. Introduction and motivation
The purpose of this study is to investigate, in an experimental setting, how favorable versus unfavorable organizational consequences influence managerial responses to an employee’s earnings management behavior. We focus on the following question: Do the ends of positive organizational consequences justify the means of earnings management?
Earnings management is defined as ‘‘the choice by a manager of accounting policies so as to achieve specific objectives’’ (Scott 2003: 369). Earnings management can be fundamentally classified as either accounting related, involving the manipulation of accounting records through aggressive or fraudulent applications of accounting principles, or operating related, involving choices made by management regarding the timing of investment or operating activities, with the result that reported earnings are influenced by these choices
(Lev 2003; Cohen, Dey, and Lys 2008; Roychowdhury 2006; Gunny 2010).1 The effect of earnings management on the value of the firm and the related issues of financial-based incentives for managing earnings has been widely examined in the accounting literature
(e.g., Healy 1985; Dechow, Sloan, and Sweeney 1995, 1996; Healy and Wahlen 1999;
Fields, Lys, and Vincent 2001; Marquardt and Wiedman 2004; Das, Shroff, and Zhang
2009; see Ronen and Yaari 2008 for a comprehensive review of earnings management studies). Ronen and Yaari (2008) classified earnings management activities as ‘‘black,’’ ‘‘white,’’ or ‘‘gray’’ in terms of their perceived transparency and intended purposes. ‘‘Gray’’ earnings management is defined by Ronen and Yaari…...

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