Earnings Management or Earnings Manipulation?: A Narrative Review of Organizational Profitability

Introduction

Corporations often engage in earning management (Teixeira & Rodrigues, 2022; Vagner et al., 2021). Earnings management has been defined as the processes utilized by firms to achieve/manipulate and report desirable levels of earnings by taking advantage of the accounting principles in place in the country in which the firm operates (Al-Shattarat, Hussainey & Al-Shattarat, 2022; Christensen et al., 2022; Dyreng, Hillegeist & Penalva, 2022; Sofian et al., 2022; Teixeira & Rodrigues, 2022; Vagner et al., 2021). By manipulating their financial reports, companies can publicly disclose information that presents an overly positive outlook of their economic performance (Healy & Wahlen, 1999). In doing so, organizations can influence shareholders’, and potential investors’ opinions, as well as influence future contract conditions (Al-Shattarat, Hussainey & Al-Shattarat, 2022).

The current body of literature has categorized earning management under two main dimensions: accruals earnings management (AEM) (Sofian et al., 2022; Teixeira & Rodrigues, 2022) and real earning management (REM) (Roychowdhury, 2006). Corporations utilizing the AEM approach use accounting accruals to report their desired earning levels (Sofian et al., 2022; Teixeira & Rodrigues, 2022). Whereas organizations engaging in REM practices manipulate their earnings by programming and manipulating their business transactions. For example, organizations engaging in REM can: affect sales through price changes, manipulate their production expenses to boost their earnings or actively manage their inventory stock to reduce the costs of goods sold (Roychowdhury, 2006; Sadiq & Shafie, 2017).

Several empirical studies have gathered empirical evidence which highlights the utilization of various forms and dimensions of earnings management techniques by corporations and other organizations all over the world (Cussatt et al., 2018; Putra et al., 2018). Hence, this topic is of relevance because of its global implications for the trustworthiness of organizations’ reported financial and economic information (Abou-El-Sood & El-Sayed, 2022; Al-Shattarat, Hussainey & Al-Shattarat, 2022; Christensen et al., 2022; Dyreng, Hillegeist & Penalva, 2022; Sofian et al., 2022; Teixeira & Rodrigues, 2022).

Due to this topic’s relevancy, multiple studies have investigated various organizations’ dimensions and multiple forms and techniques of earning management. For example, some researchers have investigated the effects that financial information manipulation through earning management has on companies’ short-term reputation (Ariza, Ferrero & Sànchez, 2015), while others have gathered empirical findings to better understand how earnings management affects companies’ market capitalization (Azizi, 2018) and more. Nonetheless, as far as the authors are concerned, little efforts have been directed toward a more discursive and narrative approach to earnings management and its implications for companies’ future profitability. Therefore, the following research question has been formulated: “How does earnings management affect companies’ future profitability?”.