Earnings management and financial crisis in europe

Earnings management (EM) plays important role in modern financial management. It occurs when managers use judgment in financial reporting or/and in structuring transactions to alter financial data to change the picture of company in the eyes of other parties. Such practices may follow the letter of the rules of accounting standards practices but usually they are far from the spirit of those standards.  In our paper we discuss the issue of EM in Polish companies and compare its scope to other EU countries. On that ground we make conclucions concerning the relation between EM and economic crisis in Europe. Our main hypothesis  is: the stronger  EM in the country the higher probability of appearing the financial crisis symptoms in that country. 

We use  data from 27 EU contries for the period 2004-2011 (financial statements- Notoria database and Amadeus database). We apply two EM measures presented in the literature to determine the scope of EM in each country, i.e.: 

a/ EM-A= EM2-EM1 ; where   EM2 = Median (|Accruals|/|Cash Flow from Operations|) and EM1=Median (StdDev (Operating Income) / StdDev (Cash Flow from Operations)); 

b/  EM-B; the ratio of ‘‘small profits’’ to ‘‘small losses’’ computed, for each country, using after-tax earnings scaled by total assets.

On that ground we present the EM ranking of EU countries and  analyse the relation between EM  and symptoms of financial crisis in the country (as GDP growth, indebtedness an so on).

According to our preliminary results the scope of EM in Italy, Greece, Spain and Portugal is the highest among EU countries, which may confirm the hypothesis that there is a relation between EM and the crisis.