Impact of Earnings Management on Firms Profitability in Pakistan

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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 expectatio... ... middle of paper ... ...f Private Firms: Insights into Smoothing, Agency Costs, and Information Asymmetry. Spohr, J. (2002). The quality of accounting and earnings: The role of accrual estimation errors. Swedish school of economics and business administration dept of accounting. Vol. 7, p. 3-19. Sudipto Bhattacharya (1979). Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy. The Bell Journal of Economics, 10: 259-270. Sumit Agarwal, Souphala Chomsisengphet, Chunlin Liu and S. Ghon Rhee (December 2003). Earnings Management during Distinct Periods of Capital Demand: Evidence from Japanese Banks. Ofheo Working Papers Yan Zhang (May, 2004). Do speculative short sellers detect earnings management? Yuan Ding, Hua Zhang, Junxi Zhang (6 July 2004). Ownership concentration and earnings management: a comparison between Chinese private and state-owned listed companies.
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