The relationship between earnings management and information asymmetry during firm life cycle stages

Academic Thesis for Master Degree (M.Sc.)

Field: Accounting

Abstract:

The purpose of this research is to investigate the relationship between profit management and information asymmetry with regard to the life cycle of the company in companies listed on the Tehran Stock Exchange. For profit management using the adjusted Jones model (Dicho et al., 1995), the information asymmetry that exists from the model of Chiang and Wekintosh 1986 to determine the range of the bid price for buying and selling shares and four control variables including company size, financial leverage, book value to market ratio and systematic risk; Four variables have been used to separate companies into life cycle stages: sales growth, capital expenditures, dividend ratio and company age. The statistical population studied in this research is the companies admitted to the Tehran Stock Exchange and a sample of 100 companies was selected as the research sample, of which 15 companies were in the growth stage, 70 companies were in the maturity stage, and 15 companies were in the decline stage. During the research period of 5 years (1387-1391). Correlation and multiple regression tests have been used to test the research hypotheses. In general, the results of the research show that there is no significant relationship between information asymmetry and profit management in each of the stages (growth, maturity and decline) of the life cycle of companies listed on the Tehran Stock Exchange.

Key words: profit management, information asymmetry, company life cycle

Introduction

Financial reports are important sources of information for economic decisions that managers, investors, Creditors and other users use them to meet their information needs, since information is not provided to users in the same way, information asymmetry is created between managers and investors. Information asymmetry is a situation where managers have more undisclosed information about future operations and aspects of the company compared to investors. This causes managers to have the motivation and opportunity to manage profits; Managers can use earnings management to get benefits from shareholders, for example, to increase bonuses or reduce the possibility of the manager being fired due to poor performance, etc.

In addition, what should be considered in the capital markets is that many people who invest are ordinary people whose only way to access important information is through announcements published by companies. Now, if among the investors there are people who are in a better position in terms of information load than profit, they will be able to influence the supply and demand of the market and, so to speak, lead to a price gap. The life cycle theory is based on the assumption that economic enterprises have a life cycle like all living organisms, companies in different stages of their life cycle in terms of financial and economic have certain indicators and behaviors, which means that the manager's behavior in disclosing information and also in applying profit management of a company is influenced by the stage of the life cycle in which the company is located.

1-2) statement of the problem

Studies show that managers through the selection of specific accounting policies, changes in estimates Accrual accounting and management adjust reported profits. One of the basic goals of establishing accounting standards is that users can make relatively relevant and correct decisions by relying on financial statements, so the accounting profession needs such a way of reporting that the resources of all users are properly respected (Mashaikhi and Safari, 2015, 36).

Information asymmetry exists if the managers and the market have the same information about the company.  Therefore, managers and the market tolerate uncertainty about the company equally. But in case of information asymmetry, managers have more and better information than the market due to having private and confidential information about the company. That is, they have access to the company's information before the market. Company-specific information is transferred to the market over time through information disclosure events. The market has some uncertainty about the company before the disclosure.The firm's information asymmetry is equal to the total uncertainty about the firm, because managers and the market are likely to be equally aware of the impact of market variables on the firm's value. The market reaction to the profit announcement can be the first measure of the company's information asymmetry through information disclosure. Information asymmetry can be determined by the information environment, the number of public announcements and the number of company transactions, and it can also be influenced by the behavior of managers or the market. For example, when a public announcement of news about the company is made, assuming other factors are constant, the market may become more aware of the company's real situation and information asymmetry is reduced (Ahmedpour and Ajam, 2009). Perhaps, from the point of view of the efficient market hypothesis, the reason for the existence of accounting can be stated as information asymmetry, in which one party to the exchange has more information than the other party. This is due to the existence of transactions and inside information. What should be considered in the capital markets is that many people who invest are ordinary people whose only way to access important information is the announcements published by companies. An example of this type of announcement can be considered as the announcement of the estimated profit per share, in which the proposed profit of each share is predicted by the company and made public. Now, if among the investors who are active in the capital markets, there are people who are in a better position than others in terms of information and, for example, they are aware of the announcements that are going to be made about profit, they will be able to influence the supply and demand of the market and, so to speak, lead to a price gap. The main reason is the existence of information asymmetry in the capital market, according to which people who are aware of the profit announcement (or any other important news) are in a more appropriate decision-making position than others (Qaemi and Watanparast, 2014).

Given that profit is one of the most important factors affecting economic decisions, users' awareness of the reliability of profit can help them make better decisions about profitability and analysis of financial statements.

One of the basic goals of establishing accounting standards is that users can make relatively relevant and correct decisions by relying on financial statements. So the need of the accounting profession is such a way of reporting that the interests of all users are well respected. On the other hand, in order to achieve certain goals that logically provide the interests of certain people, managers may report the profit in a way that contradicts the goal of providing the general interests of users. Auditors have the duty to verify the suitability of financial statements by checking the compliance of financial statements with the framework specified in accounting standards. While the flexibility in accounting standards has emphasized the professional judgment of accountants in some cases to choose the accounting method. In fact, the problem arises from the fact that profit management sometimes causes financial statements to be misleading, while financial statements do not have a problem in terms of being within the framework of accounting standards, and auditors cannot find fault with financial statements from this point of view (Yaqub Nejad et al., 2013). Such creatures are born, grow, grow old and finally die. The life cycle theory assumes that companies and economic enterprises, like all living things that are born, grow and die, have a life curve or life cycle. In economic and management theories, the life cycle of companies and institutions is divided into stages. Institutions and companies follow a specific policy and policy according to each stage of their economic life. These policies are somehow reflected in the companies' accounting information. In the field of accounting, some researchers have investigated the effect of the company's life cycle on accounting information. These researchers have explained four stages to describe the company's life cycle as follows: birth or emergence stage, growth stage, maturity stage, decline or stagnation stage (Karami and Omrani, 2019).