Earnings Management in Chapter 11 Bankruptcy

We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11. Using data on public US firms, we construct three measures of earnings management: a real activities manipulation measure (abnormal operating cash flows) and two accounting manipulation...

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Bibliographic Details
Published in:Abacus (Sydney) 2019-06, Vol.55 (2), p.273-305
Main Authors: Fisher, Timothy C.G., Gavious, Ilanit, Martel, Jocelyn
Format: Article
Language:English
Subjects:
Auditor choice
Auditors
Bankruptcy
Bankruptcy reorganization
Chapter 11
Correlation analysis
Creditors
Earnings
Earnings management
Financial reorganization
Manipulation
Optimism
Working capital
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Summary:We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11. Using data on public US firms, we construct three measures of earnings management: a real activities manipulation measure (abnormal operating cash flows) and two accounting manipulation measures (discretionary accruals and abnormal working capital accruals). We find that, controlling for the impact of factors known to influence earnings management and firm survival in bankruptcy, earnings management prior to bankruptcy significantly reduces the likelihood of Chapter 11 plan confirmation and emergence from Chapter 11. The results are driven primarily by extreme values of earnings management, characterized by one or two standard deviations above or below the mean. The findings are consistent with creditors reacting positively to unduly conservative earnings reports and negatively to overly optimistic earnings reports. We also find that the presence of a Big 4 auditor is associated with a higher incidence of confirmation and switching to a Big 4 auditor before filing increases the incidence of emergence.
ISSN:0001-3072
1467-6281
DOI:10.1111/abac.12158