Earnings Management at Dutch Fundraising Institutions: the

Transcription

Vrije Universiteit Amsterdam
Faculty of Economics and Business Administration
Thesis: Master of Science Accounting & Control
Earnings Management at Dutch Fundraising Institutions: the Impact
of Supervisory Board & Audit Committee Characteristics
Author: Frederica Sophia van Os
Student number: 1755226
Email: [email protected]
Supervisor: Drs. D.R. Boterenbrood RA
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2
Earnings Management at Dutch Fundraising Institutions: the Impact of Supervisory Board & Audit Committee Characteristics
Frederica Sophia van Os
Abstract
Earnings management is an excessively investigated subject in the profit sector. In this thesis earnings
management is examined at Dutch fundraising institutions. An important incentive for fundraising
institutions to engage in earnings management and to manage earnings towards zero or a small
positive result is to show that all funds are required to fulfill the social tasks and to attract funds in the
future. The distribution approach was executed and results indicate that the distribution of the earnings
are discontinue around zero. Discretionary accruals and abnormal expenses (management &
administration, fundraising and spending on objectives) are used in this thesis as measures of earnings
management. Based on chi-squared tests it can be concluded that there is a relation between groups
and discretionary accruals & abnormal expenses: managers of fundraising institutions use
discretionary accruals and abnormal expenses in order to come close to zero or a small positive result.
Regressions results indicate a negative relationship between the CEO tenure and discretionary
accruals. Evidence suggests a positive relationship between the number of supervisory board meetings
and discretionary accruals. A positive relationship is found between the existence of an audit
committee and abnormal management and administration expenses. Financial expertise of an audit
committee is negatively related to abnormal management and administration expenses.
Key words: fundraising institutions, (real) earnings management, discretionary accruals, abnormal
expenses, supervisory board and audit committee.
3
Preface
This thesis is the final product in the fulfillment of the requirements of the degree Master of Science in
Accounting and Control at the Vrije Universiteit Amsterdam.
I have chosen to write my master thesis about earnings management at Dutch fundraising institutions
and its relation with characteristics of the supervisory board and the audit committee. This topic
seemed to me very interesting and challenging. Especially because this topic is an unexposed subject
in the literature. I worked on the thesis with a lot of pleasure and there are many people to thank for
their considerable support I received during the project.
First of all, I would like to thank my supervisor at the Vrije Universiteit Amsterdam, Rob
Boterenbrood, for his guidance, critical comments and good advice throughout the process. I have
written this thesis as an intern at PwC The Hague and I would like to thank them for the facilities they
offered while I was writing my thesis. I would like to express my gratitude to my coach at PwC,
Maartje Verhoeven for her guidance and advice. Especially a word of thanks to my parents; they
always have supported me in everything.
Voorburg, July 2012
4
Table of contents
Abstract
3
Preface
4
Chapter 1 – Introduction
8
1.1 Introduction and Purpose
8
1.2 Research Question and Sub Questions
8
1.3 Contribution to the Literature
9
1.4 Structure of the Thesis
11
Chapter 2 – Fundraising Institutions in the Netherlands
12
2.1 Introduction
12
2.2 Defining Fundraising Institutions and the Fundraising Sector in the Netherlands
12
2.3 The Central Bureau Fundraising
14
2.4 The Association of Fundraising Institutions
15
2.5 Dutch Accounting Standards for Fundraising Institutions (RJ 650)
16
2.6 Stakeholders of Fundraising Institutions
17
Chapter 3 – Earnings Management
18
3.1 Introduction
18
3.2 Information Asymmetry at Fundraising Institutions
18
3.3 Positive Accounting Theory
19
3.4 Defining Earnings Management
20
3.5 Incentives to Engage in Earnings Management
21
3.6 Earnings Management Trough Accruals
22
3.7 Earnings management Through Real Activities
26
Chapter 4 – Earnings Management at Non-profit Institutions
28
4.1 Introduction
28
4.2 Research related to Earnings Management at Non-profit Institutions
28
4.3 Incentives to Engage in Earnings Management at Fundraising Institutions
30
4.4 Expectations of Earnings Management at Non-profit Institutions
31
5
Chapter 5 – Corporate Governance at Fundraising Intuitions
34
5.1 Introduction
34
5.2 Corporate Governance at Non-profit Firms
35
5.3 Governance structures at Dutch Fundraising Institutions
35
Chapter 6 – Hypotheses Development
37
6.1 Introduction
37
6.2 Earnings Management at Dutch Fundraising Institutions
37
6.3 Characteristics of the Supervisory Board & Audit Committee on Earnings Management
38
6.3.1 Size of Supervisory Board and the Existence of an Audit Committee
38
6.3.2 Supervisory Board & Audit Committee Meetings Diligence
40
6.3.3 Tenure of the CEO and the Audit Committee Members
42
6.3.4 Financial Expertise of the Audit Committee
43
Chapter 7 – Research Methodology
45
7.1 Introduction
45
7.2 Sample Selection
45
7.3 Research Designs
46
7.3.1 Income Distribution
46
7.3.2 Models to Detect Earnings Management Through Discretionary Accruals and
Abnormal Expenses
47
7.3.3 Groups and the Direction of Discretionary Accruals and Abnormal Expenses
49
7.3.4 Supervisory Board &Audit Committee Characteristics on Earnings Management 51
Chapter 8 – Results
53
8.1 Introduction
53
8.2 Income Distribution
53
8.3 Models to Detect Earnings Management Through Discretionary Accruals and Abnormal
Expenses
56
8.4 Groups and Direction Discretionary Accruals and Abnormal Expenses
57
8.5 Supervisory Board an Audit Committee Characteristics on Earnings Management
60
6
Chapter 9 – Conclusion, Limitations and Implications for Future Research
65
References
70
Appendix A – Model for the Balance sheet and the Profit and Loss statement
76
Appendix B – Translation of Governance Bodies
78
Appendix C – Literature Overview
79
Appendix D – Explanation Normal Discretionary Expenses Model of Roychowdhury (2006)
85
Appendix E – Earnings Distribution
86
Appendix F – Assumptions of the (Modified) Jones Model and Normal Expenses Models
87
Appendix G – Significance of the (Modified) Jones Model and Normal Expenses Models
94
Appendix H – Chi-square test to Compare Groups
100
Appendix I – Regressions Discretionary Accruals and Abnormal Expenses, All dependent
Variables Included
102
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Chapter 1 – Introduction
1.1 Introduction and Purpose
Publicly available financial reports play an important role by mitigating the inherent principal-agent
conflict within institutions. One would expect that the bottom line for non-profit institutions is less
important compared to profit-making companies, since non-profit institutions have no investors who
expect a certain return on investments. In addition, in the profit literature one can find that earnings are
important since they are used as a summary measure of firm performance by a wide range of users
(Bissessur, 2008). However, reported earnings of non-profit institutions serve a number of important
purposes. Yetman and Yetman (2011); Leone and Van Horn (2005) investigated non-profit institutions
in the United States and they concluded that stakeholders use the reported earnings for credit
evaluation, managerial assessments and donation decisions. Furthermore, accounting information can
assist stakeholders in monitoring a non-profit institution and evaluating whether resources are being
used in the most efficient and effective manner (Krishnan and Yetman, 2011).
One can argue that managers of fundraising institutions manage earnings to report results that are
close to zero and nonnegative. Managers with small losses will manage earnings upwards so that
earnings are not negative to avoid violating zero profit constraint. Managers of fundraising institutions
can exploit the agency problem by managing earnings (through accruals or real variables).
Stakeholders make their decisions based on the result of the institutions, however due to the actions of
the management donors are not able to make good decisions.
1.2 Research Question and Sub Questions
This thesis is focussed on whether earnings management is applied at fundraising institutions: earnings
management through accruals and real variables will be investigated. Furthermore, characteristics of
the supervisory board and the audit committee and the relation with (real) earnings management will
be subject of this thesis. The following question will be the research question in the thesis:
“What is the effect of supervisory board & audit committee characteristics on earnings
management through discretionary accruals and abnormal expenses at Dutch fundraising
institutions?”
The following sub-questions will be answered in the thesis:
1. How are Dutch fundraising institutions organized and who are stakeholders?
2. What is earnings management, what are incentives to engage in earnings management for
managers and how can earnings be managed?
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3. What are motives for managers at non-profit institutions and specifically fundraising
institutions to engage in earnings management?
4. Why is corporate governance needed at non-profit institutions and how is corporate
governance organized at Dutch fundraising institutions?
5. What are the conclusions of prior research concerning the supervisory board and the audit
committee characteristics and their effect on earnings management?
6. What is the impact of the size of supervisory board and the existence of the audit committee on
earnings management at Dutch fundraising institutions?
7. What is the impact of the frequency of the supervisory board and audit committee meetings on
earnings management Dutch fundraising institutions?
8. What is the impact of the tenure of the Chief Executive Officer (CEO) (In Dutch: voorzitter
Raad van Bestuur) and the audit committee members on earnings management at Dutch
fundraising institutions?
9. What is the impact of financial expertise of the audit committee members on earnings
management at Dutch fundraising institutions?
1.3 Contribution to the Literature
Throughout the years extensive research has been conducted with respect to earnings management.
These studies focus on finding evidence about the existence of earnings management and the
incentives to engage in earnings management. These studies are mostly conducted in the profit sector,
the non-profit sector is less investigated by researchers. Although earnings management research in
non-profit institutions is rather scarce in comparison to for-profit institutions, researchers have found
its existence. Research related to earnings management in non-profit institutions is done in different
sectors, e.g. health care (Leone and Van Horn, 2005; Eldenburg, Gunny, Hee and Soderstorm, 2011)
and municipalities (Vinnari and Näsi, 2008). Differences between the incentives to engage in earnings
management at non-profit institutions and profit institutions are found in prior literature. For example,
managers of profit-institutions have incentives to report a pattern of continuous increases in earnings
and engage in income smoothing to show constant growth. However, managers of non-profit
institutions have incentives to manage earnings around a fixed point above zero. Furthermore, nonprofit institutions have no incentive to avoid reporting earnings decreases as long as current period
earnings are above zero. This is in contrast with profit firms, they are motivated by the equity markets
to avoid small losses (Leone and Van Horn, 2005) .
Despite research conducted at some non-profit sectors, there is a very small base of literature on
earnings management at fundraising institutions. Prior research at fundraising institutions is related to
discretionary accounting methods to maximize the program expense ratios and efficiency ratios (e.g.
9
Trussel, 2003; Baber, Roberts and Visvanathan, 2001, Jones and Roberts, 2006). Nevertheless,
earnings management through discretionary accruals and abnormal expenses (which are the main
methods used to measure earnings management), is not investigated at fundraising institutions.
Although earnings management at some non-profit sectors is investigated, the fundraising sector is a
different part of the non-profit sector: fundraising institutions have to comply with other financial
reporting standards, have other stakeholders, and receive income in another way compared to other
non-profit institutions (e.g. hospitals). Because fundraising institutions are another type of non-profit
institutions within the non-profit sector, investigating this institutions can help in getting a more
complete insight into non-profit institutions. For example, maybe managers of fundraising institutions
have other incentives to manage earnings compared to other non-profit institutions. So, investigating
earnings management at fundraising institutions can give another insight into non-profit institutions:
differences could exist between the (non-)profit sector and fundraising institutions.
In addition, research has been done with respect to earnings management and corporate governance
aspects. These studies focus on finding a relation between characteristics of the supervisory board &
audit committee and earnings management in the profit sector outside the Netherlands (e.g. Xie,
Davidson, DaDalt, 2003, Lin, Li and Yang, 2006; Vafeas, 2005; Klein, 2002, Machuga and Teitel,
2009). Although a substantial body of accounting literature examines the relationship between
governance and reporting quality in the for-profit setting, there is little evidence on the effects of
governance on non-profit reporting (Yetman and Yetman, 2011). Earnings management and the
impact of supervisory and audit committee characteristics on earnings management in the non-profit
sector, and more specifically at fundraising institutions in the Netherlands, remains an unanswered
question. This study will examine whether the characteristics related to the supervisory board and the
audit committee, are associated with earnings management in the fundraising sector.
Furthermore, why choose the Netherlands as a research field? The headlines of the articles on page 2
were published in several newspapers in recent years. Salaries, bonuses and inappropriate spending of
raised money by Dutch fundraising institutions became subject of public debate. It appears from the
headlines that the public is interested in Dutch fundraising institutions. Another interesting aspect of
the fundraising sector is the size of the sector. 831 fundraising institutions are registered with the
Central Bureau Fundraising (In Dutch: Centraal Bureau Fondsenwerving) (hereafter: CBF) and they
raised 3.7 billion EUR in 2010 (CBF, 2011).
10
1.4 Structure of the Thesis
The thesis will be divided into literature study and empirical research. Chapter 2 will provide some
background of fundraising institutions. The definition of financial institutions will be given and
important bodies in the sector and their main tasks will be described. Subsequently, the financial
reporting standards are described and the stakeholders of fundraising institutions will be described.
Chapter 3 will be focussed on earnings management. The definition of earnings management as used
throughout this thesis will be given and incentives to engage in earnings management are discussed.
Furthermore, the chapter will be focussed on the detection of earnings management. Chapter 4 will
discuss earnings management at non-profit institutions and specifically at fundraising institutions.
Corporate governance structures and the need for governance at non-profit institutions and Dutch
fundraising institutions will be subject of chapter 5. In chapter 6 hypotheses are composed.
Furthermore, this chapter will consist of the theory and the relevant prior research related to the
characteristics of the supervisory board and the audit committee which can be related to earnings
management. Chapter 7 described the research methodology. In chapter 8, the results of the analyses
will be described and discussed. Finally in the last chapter a conclusion will be drawn up, limitations
of the research will be described ,and recommendations for further research will be given.
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Chapter 2 – Fundraising institutions in the Netherlands
2.1 Introduction
This thesis will be focussed on Dutch fundraising institutions. For that reason it is important to
understand the fundraising sector in the Netherlands. The purpose of this chapter is to set out some
background on the Dutch fundraising sector. An answer on sub question 1 will be given: How are
Dutch fundraising institutions organized and who are stakeholders?
At first, definitions of fundraising institutions will be given. Subsequently, different bodies which have
an influence on Dutch fundraising institutions will be pointed out. Furthermore, the Dutch Accounting
Standards for Fundraising Institutions will be part of this chapter. Finally, the stakeholders of
fundraising institutions will be described.
2.2 Defining Fundraising Institutions and the Fundraising Sector in the Netherlands
There is not one clear definition of what a fundraising institution is. The Dutch Accounting Standard
Board, Donor Association and the CBF give the following definitions of fundraising institutions:
“A fundraising institution is a private organization that is not profit oriented and that makes
appeal to public generosity to realize its goals. The raised money is voluntary donated , there is no or
not a proportional consideration for the donated goods or services and no rights for care or aid can
be obtained” (RJ, Richtlijn 650.110).
“A fundraising institution is a charity that tries to realize its goals by approaching
individuals, companies or funds to donate money or goods. The institution makes an appeal to the
willingness of public donations” (Website: Donor Association).
“A fundraising institution is an association or foundation established under Dutch law, with
full legal capacity for realization of charitable, cultural, scientific or other general benefit objectives,
by making appeal to public generosity. Fundraising means that the received funds are donated
voluntary and there is no or no proportional consideration for the donated goods or services and no
rights for care or aid can be obtained”(Website: CBF).
All the definitions above have in common that fundraising institutions make an appeal to the public
generosity in order to achieve their objectives and that raised money is voluntary donated without a
reciprocal transfer. However, Karman and Swachten in Hoogendoorn, Klaassen and Krens (2004)
added a component; they emphasize that the goals of the institutions are focused on fostering social
utility.
12
Throughout this thesis the definition of the CBF, with the added component by Karman and Swachten
will be used. The reason for choosing that definition is that the definition is the most complete one.
The following main points are included in that definition: the forms of the institutions, the objectives,
public generosity and no reciprocal transfer.
The core activity of fundraising institutions is providing goods and/or services for social goals. Social
goals of fundraising institutions can be divided into four categories with subgroups (Website CBF):

Health: Public health, Disability care, Help for blind/visually handicapped/deaf people

International Aid: Development aid, Refugee aid and Aid to victims

Nature and Environment: Animal interests, Environmental, Conservation of the nature

Well-being: Civil & social goals, Human rights, Arts & culture, Sports & recreation,
Education & research and Church & religion.
To get an indication of the size of fundraising sector and the different categories in the Netherlands,
the following figures are added in this thesis. Figure 2.1 shows the total income over 2006 till 2010 per
category. The category international aid is the largest one with approximately 1.200.000.000 euro
income per year. The smallest is the health category, they received an income of approximately
500.000.000 euro per year. In figure 2.1 is an histogram of the total amount spent on objectives per
subgroup over 2006 till 2010. The category international aid spent the most of the four categories,
namely approximately 1.200.000.000 euro per year.
Figure 2.1 – Total income for each sector over 2006 till 2010.
Source: website CBF
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Figure 2.2 – Total spending on goals for each sector over 2006 till 2010.
Source: website CBF.
2.3 The Central Bureau Fundraising
The CBF is an independent foundation which has been monitoring fundraising by fundraising
institutions since 1925. 831 institutions are registered at the CBF. The following tasks of the CBF can
be distinguished: conducting assessments for the CBF-seal (In Dutch: CBF-Keur) and the CBFCertificate for small fundraising institutions (In Dutch: CBF-Certificaat voor kleine goede doelen),
monitoring of responsible fundraising and spending and providing information and advice.
An accreditation system is designed to promote trustworthy fundraising and expenditure by reviewing
fundraising institutions and giving information and advice to government institutions and the public. A
tool used by CBF is a seal, which can be awarded if a fundraising institution exists for at least three
years, has a total income of 500.000 euro or higher and complies with the criteria set by the CBF
(CBF, 2011). The criteria for the seal are related to the following subjects: management, policy,
fundraising, education & communication, spending of funds and accountability. An important criterion
is that the costs for fundraising of the institution, expressed as a percentage of the revenues from its
own fundraising in any year, may not amount more than 25% of the revenues from its own
fundraising. Furthermore, the board must consist of independent members. In addition, for a clear
insight into the financial records every financial report must be drawn up according to the same
principles (www.cbf.nl). Compliance to the Dutch Accounting Standards for fundraising institutions
(RJ Richtlijn 650) is an important requirement for obtaining and keeping the CBF-seal.
CBF also awarded the CBF-Certificate for small charities and CBF-Certificate of no objection (In
Dutch: Verklaring van geen bezwaar). The CBF-Certificate for small charities is for fundraising
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institutions that act in the fundraising sector for more than three years, but have a total income of less
than 500.000 euro. The criteria consist of the following subjects: management, policy, fundraising and
reporting. Compliance with RJ 650 is also a requirement the award and keep the certificate (CBF,
2011). The CBF-Certificate of no objection is for new fundraising institutions in the Netherlands
which act in the sector for less than three years, irrespective to their income. The criteria for this
certificate are the same as for the CBF-seal; however they are not as extensive as the criteria for the
CBF-seal (CBF, 2011).
When a fundraising institution has a CBF-Seal or CBF-Certificate of no objection, the public can trust
that the institution has been reviewed on management, policy, spending, fundraising and reporting.
(CBF, 2011). Because participation in the system is voluntary, accredited philanthropic institutions
stand out as more trustworthy to the public than non-accredited institutions. Accreditation gives
fundraising institutions the right to use an accreditation seal to signal their trustworthiness to the
public. From the perspective of donors, relying on the accreditation seal can be viewed theoretically as
a strategy to cut down on the transaction costs of a donation: instead of deciding on the accountability
of the charity themselves, donors take the seal as a signal of trustworthiness (Bekkers, 2003).
2.4 The Association of Fundraising Institutions
The Association of Fundraising Institutions (In Dutch: Vereniging Fondsenwervende Instellingen),
(hereafter: VFI) is an association for the fundraising sector, founded in 1994, with more than 120
members. Fundraising institutions can become member if they raise funds and are located in the
Netherlands, and have a CBF-Seal or a CBF-Certificate of no objection. The main tasks of VFI are
promoting the interests of charities, self-regulation, and providing services to charities. The goal of
providing services is to increase professionalism and efficiency in the sector. Moreover, the VFI works
closely together with the government to improve transparency of the social contribution of charities
and to increase public trust.
VFI drafted a code during the summer of 2004 named, the code for good governance for charities (In
Dutch: Code goed bestuur goede doelen. The reason for designing the code was improving the
transparency of the institution and reducing the vulnerability of fundraising institutions. The code must
be applied by members of the VFI. The members may diverge from individual principles in the code,
but must motivate their decision to do so. This is possible according to the VFI because it says that
final responsibility lies with the supervisory board (Website VFI).
15
2.5 Dutch Accounting Standards for Fundraising Institutions (RJ 650)
Section 9, Book 2 of the Dutch Civil Code (In Dutch:Titel 9 Burgerlijk wetboek) consists of directives
for annual reporting. Fundraising institutions are mostly associations or foundations, therefore Section
9 of the Dutch Civil Code is not applicable for them, only large foundations and associations have to
apply with Section 9, Book 2 of the Netherlands Civil Code, as a consequence of Section 2:360 (3)
BW (RJ 650. 101).
The Dutch Accounting Standard Board (In Dutch: Raad voor de Jaarverslaggeving) was founded in
1981 and has the objective to foster quality in external reporting of non listed companies in the
Netherlands. The RJ is responsible for preparing and publishing of directives (In Dutch: Richtlijnen),
and giving advice to the government and other stakeholders. The Dutch Accounting Standards Board
has designed special standards for fundraising institutions, namely RJ 650 ’Verslaggeving
fondsenwervende instellingen, to address the public’s desire to be informed about the extent to which
fundraising institutions fulfil their missions. Consequently, the Dutch Accounting Standards Board
asks charities to publish a transparent overview of their fundraising income and activity services (RJ
650.102).
With respect to fundraising institutions information requirements of users of financial reporting are
related to the understanding of the following items (RJ 650.104):

objective, strategy and policy of the institution;

the design and functioning of the institution, administration and supervision;

communication with donors, volunteers and other stakeholders;

whether or not achieving the objectives and performance;

financial management and accountability, and;

the plans for the future.
The guidelines of Richtlijn 650 Fondsenwervende instellingen describes that the financial reporting
should at least consist of the annual report, the financial statements (consisting of the balance sheet,
the statement of income and expenditures and the notes) and other information. The income of
fundraising institutions is dependent on different sources. See Appendix A for a standard model of the
balance sheet and profit and loss statement, which is given in RJ 650. It is recommended to also report
a cash flow statement (RJ650.103). The annual report should contain information about five
components (RJ650.202):

General information about the fundraising institution;

Information about the activities and the financial position;

Information about the board of directors, the committee and the supervisory board;
16

The report of the supervisory board (if there is a supervisory board) and;

A paragraph about the future (specification and explanation of expected future income and
expenses).
Four other important facts that have to be mentioned in the annual report are: description of job
operating procedures, policy of executive compensation and the practices of the policy in the financial
year, the procedure for hiring new executives or members of the supervisory board and their contract
time, and other relevant work positions (RJ 650.208).
Although compliance with RJ 650 is not required by law it is increasingly applied, because fundraising
institutions are recognizing the need of reliable and transparent financial reports. In addition,
compliance with RJ 650 is one of requirements to receive a CBF-seal or the CBF Certificate of no
objection.
2.6 Stakeholders of Fundraising Institutions
Herremans, Mentink, Hartman and Hoogendoorn (1993); Aukes (1997) distinguish the following
stakeholders of fundraising institutions:

Donors

Subsidizers

Board of directors

Management

Public (donors, volunteers)

Members

Government

Consumer organizations

Creditors

Lenders
Fundraising institutions have different stakeholders compared to profit-institutions; they have no
shareholders and are largely dependent on donations of the government and public. The main objective
of non-profit institutions is not making profit but is mainly focused on fostering social utility.
In the case of the annual reports of fundraising institutions, users of the financial reports are primarily
interested in which part of the benefit is spent to the charity (RJ 650.105). Based on these information
needs, the Dutch Accounting Standard Boards, as described in the previous paragraph, sets guidelines
for the financial reporting of fundraising institutions.
17
Chapter 3 – Earnings management
3.1 Introduction
The purpose of this chapter is to set out some theoretical background on earnings management. The
following sub question will be answered: What is earnings management, what are incentives to
engage in earnings management for managers and how can earnings be managed?
At first, the concept of information asymmetry (at fundraising institutions) will be described and
Positive Accounting Theory will be explained. Furthermore, it will introduce the phenomenon
earnings management and incentives to engage in earnings management. Subsequently, earnings
management through accruals and real variables will be highlighted.
3.2 Information Asymmetry at Fundraising Institutions
Information asymmetry means that one party has an information advantage over another party. Due to
information asymmetry management of fundraising institutions has an information advantage over
important stakeholders (e.g. donors and government). An effect of information asymmetry is that
managers of fundraising institution can manage earnings, because stakeholders have little information
to assess whether the financial statements are reliable. Two types of information asymmetry could be
distinguished according to Scott (2009): adverse selection and moral hazard. The two types of
information asymmetry will be shortly pointed out based on the definitions given by Scott (2009).
Adverse selection is a type of information asymmetry whereby one or more parties to a business
transaction, or potential transaction, have an information advantage over other parties (Scott, 2009,
p.13). The management of a fundraising institution has more information about the future situation of
the institution and the financial statements than the stakeholders. The stakeholders are not certain
whether the financial statements represent the real situation of the institution. They could only
determine the reliability of the financial statements on available outside information.
Moral hazard is a type of information asymmetry whereby one or more parties to a business
transaction, or potential transaction, can observe their actions in fulfilment of the transactions but
other parties cannot (Scott, 2009, p.14). The moral hazard problem is approached by Scott (2009)
from a situation where ownership and control are separated. However, despite there is no separation of
ownership and control in the fundraising institutions, because there are no shareholders, a moral
hazard problem exists. A distinction could be made between the management and the stakeholders
(e.g. donors, government, society) of the institution. Moral hazard problems can arise because
18
stakeholders are not able to monitor the performance of managers continuously. Due to that, managers
could act in their own interest and not in the best interest of the stakeholders.
3.3 Positive Accounting Theory
Accounting research theory can be divided into two main parts: normative and positive. Normative
theories attempt to tell individuals or constituencies what they should do. Positive accounting theory
(hereafter: PAT) is concerned with predicting such actions as the choices of accounting policies by
firm managers and how managers will respond to proposed new accounting standards (Scott, 2009).
The predictions made by PAT are organised around three hypotheses, which are formulated by Watts
and Zimmerman (1986). The three hypotheses will be shortly mentioned.
The bonus plan Hypothesis
Given that all other things being equal, managers of firms with bonus plans are more likely to choose
accounting policies that shift reported earnings from future periods to the current period. Managers
like a high remuneration, so if their remuneration (partly) depends on a bonus related to reported net
income, then they may be able to increase their current bonus by reporting the highest possible
income. One way to do that is to choose accounting policies that increase current period earnings.
The debt covenant hypothesis
All other things equal, the closer a firm is to violation of accounting-based debt covenants, the more
likely that firm manager is to select accounting procedures that shift reported earnings from future
periods to the current period. The reason is that increasing reported net income will reduce the
probability of technical default. Most debt agreements contain covenants that the borrower has to meet
during the agreement term. If the covenants are violated the debt covenant may impose penalties. To
prevent or postpone such violation the management may adopt accounting policies to raise current
earnings. According to the debt covenant hypothesis the management is more likely to do this if the
firm approaches default or is actually in default.
The political cost hypothesis
All other things being equal, the greater the political costs faced by a firm, the more likely the manager
is to choose accounting procedures that defer reported earnings from current to future periods. The
political cost hypothesis introduces a political dimension into accounting policy choice. For example,
political costs can be imposed by high profitability which may attract media attention and consumer
attention. Such attention can result in political heat on the firm and politicians may respond with new
regulations.
19
3.4 Defining Earnings Management
In the literature several definitions of earnings managements are used. Healy and Wahlen (1999) give
the following definition:
‘Earnings management occurs when managers use judgment in financial reporting and in
structuring transactions to alter financial reports either to mislead some stakeholders about the
underlying economic performance of the company or to influence contractual outcomes that depend
on reported accounting numbers.’
However, Vander Blauwhede (2003) argued that earnings management can also be used by managers
to communicate inside information related to the future performance of the institution to the public.
Scott (2009) formulated earnings management more negatively:
‘Earnings management is the choice by a manager of accounting policies as at to achieve
some specific objective’
The objectives to engage in earnings management are not clear in the definition of Scott. Schipper
(1989) formulated these objectives in his definition:
‘Earnings management is disclosure management in the sense of a purposeful intervention in
the external financial reporting process, with the extent of obtaining some private gain, as opposed to
merely facilitating the neutral operation of the process.’
A more negative definition of earnings management stated that stakeholders are misled and a more
neutral definition does not directly assume misleading stakeholders. In both types of definitions
earnings management occurs due to an incomplete and imperfect market. Managers aim to reach
certain goals by structuring accruals and make certain decisions to manipulate surpluses and cost
allocations.
A minor extension to the definition would encompass real earnings management, accomplished by
timing investments or financing decisions to alter reported earnings or some subset of it (Bissessur,
2008). The definition of Roychowdhury (2006) is frequently used in empirical studies of earnings
management. He define real earnings management as:
‘Real activities manipulation is defined as departures from normal operational practices,
motivated by managers’ desire to mislead at least some stakeholders into believing certain financial
reporting goals have been met in the normal course of operations.’
20
Within the framework of this thesis the following definition of earnings management, which is based
on Scott’s definition, will be used:
‘Earnings management is the choice by a manager of accounting policies, or actions affecting
earnings, so as to achieve some specific objective’
Earnings management and earnings quality are closely related. Beaver (2002) suggests that earnings
management can improve or impair the quality of earnings through the exercise of discretion over
accounting numbers. Discretionary behaviour includes voluntary earnings forecasting, voluntary
disclosure, choice of accounting methods, and estimation of accruals.
Watts and Zimmerman (1986) distinguishes four different strategies for earnings management
intended by managers based on the positive accounting theory of Scott. The strategies are:

Big Bath Accounting. When institutions could not prevent reporting loss, they rather report a
large loss since they have nothing to lose at this point.

Income minimization. Earnings are managed downward to minimize profit.

Income maximization. Earnings are managed upward to maximize the profit level.

Income smoothing. Earnings are managed in order or provide a stable flow of earnings without
large increases or decreases.
3.5 Incentives to Engage in Earnings Management
Positive Accounting Theory, which is described in paragraph 3, has generated a large amount of
empirical research. Much of this research has been done related to the implications of the three
hypotheses. Healy and Wahlen (1999) structured the reasons why managers engage in earnings
management into three incentives for earnings management: capital market expectations and
valuation, contract written in terms of accounting numbers and anti-trust or other government
regulation.
Contract written in terms of accounting numbers
The contracting motives are largely based on PAT. An institution can be seen as a group of different
contracts: the firm has contracts with employees, lenders, management and suppliers. Contracts are
used as a solution of the agency problem to align interests between managers and stakeholders
(compensation contracts) and managers and lenders (lending contracts). One of the objectives of the
institution is to minimize the various contracting costs. In this theory accounting data is used to
monitor and regulate the contractual regulations between management and different stakeholders.
21
Capital market expectations and valuation
Investors and analysts value stocks by discounting future cash flows of firms. Accounting information,
including financial statements and quarterly figures, is used to determine the stock price. This creates
an incentive for management to manipulate earnings, when trying to influence the short-time stock
price performance. The incentives in this group are related to management buyouts, initial public
offers, meeting or exceeding financial analysts’ forecasts and type of investors and research and
development expenditures.
Anti-trust or other government regulation
Another incentive, which is based on the political cost hypothesis, involves the phenomenon of the
social relevance of firms and that these firms can be subject of the political agenda. Institutions may
have an interest to influence the results in order to be more or less visible in politics and media.
3.6 Earnings Management through Accruals
There are many ways to apply earnings management. Earnings can be management by manipulation of
accruals with no direct cash flow consequences. This paragraph will have a look at this method.
Accruals arise when an institution records revenue or expense on its books prior to (or after) the
related cash flow occurs (Scott, 2009). According to Ball and Shivakumar (2005) there is sufficient
flexibility in the application of accounting standards to allow the supply of financial reporting quality
to respond to demand. It is well known that accruals present flexibility in financial reporting, because
accruals by definition are not observable cash outcomes at the time of reporting and require estimates
of future cash outcomes. However, estimation errors and their subsequent corrections are noise that
reduces the beneficial role of accruals. Accruals consist of two components: non-discretionary accruals
and discretionary accruals. The discretionary accruals identify management choices and the nondiscretionary part reflects business conditions. Accruals can be of poor quality for two reasons; (1)
management intentionally bias accruals through earnings management and (2) unintentional errors in
accrual estimation could occur because it is difficult to predict an uncertain future, or because there are
insufficient controls in place to catch errors (Doyle and Ge, 2007).
Discretionary accruals allow managers to exercise their discretion over accounting choices and
estimates, and the literature documents that firms use discretionary accruals to practice earnings
management (e.g. Jones, 1991; Healy, 1985; Dechow, Sloan and Sweeney, 1995). The accrual-based
method requires a separation of accruals into discretionary and non-discretionary components in order
to use the discretionary accruals as a proxy for earnings management. One major limitation of this
method is the difficulty of identifying and separating total accruals into its unmanaged and managed
components.
22
One can distinguish several accrual models to measure earnings management; Healy model (1985),
DeAngelo model (1986); Jones model (1991); Modified Jones model (Dechow et al., 1995). Healy
(1985) and DeAngelo (1986) were the first to use total accruals and the change in total accruals,
respectively, as measures of managers’ discretion over earnings (McNichols 2000). Jones (1991)
introduced a regression approach to control for non-discretionary factors influencing accruals,
specifying a linear relation between total accruals and change in sales and property, plant and
equipment. These approaches are typically called aggregate accruals studies. The change-in-accruals
measures (Healy model and DeAngelo model) assume that the unified determinants of un-manipulated
accruals are constant over time. In contrast, the direct estimation (Jones model) identifies accounting
fundamentals as the determinates of unmanipulated earnings (Schipper and Vincent, 2003).
This thesis will be focussed on the (Modified) Jones model; the models will be used in the empirical
research; the reason for that choice will be explained in the empirical part of this thesis.
Jones model (1991)
Jones (1991) investigated whether institutions that benefit from import relief tend to minimize their
surplus during import relief investigations among these institutions by the United States International
Trade Commission (ITC). A smaller surplus increases the chance that measures will be taken that are
positive for the institution, as the ITC will protect the institution with respect to foreign competitors.
Regulatory and political motives are reasons for institutions to manage their earnings.
The Jones model describes the effect of changes in firm’s economic circumstances on nondiscretionary accruals. The simplest and most frequently used way to calculate these accruals is taking
the difference between operational cash flows and net income. However, Jones defines accruals as: (Δ
current assets – Δ cash) + (Δ current liabilities – Δ current maturities of long term debt) – Δ income
taxes payable – depreciation and amortization expenses. The total accruals must be split in a
discretionary and non-discretionary part. The following equitation is the Jones model (1991):
With:
= Total accruals in year t for institution i;
= Total assets for institution i in year t-1;
= Revenues for institution i in year t less revenues of institution i in year t-1;
= Property plant and equipment for institution i in year t and;
= residual term that captures all impacts on
other than those from
and
.
23
Ordinary least square regression is used to estimate the values of
Total accruals are a
function of the change in revenue and the level of property, plant and equipment. To control for
changes in working capital accounts which are caused by changes in the level of business activity, the
change in revenue is included in the model. Property, plant and equipment is included in the model to
control for non-discretionary depreciation expenses. The variables are scaled by total assets for the
year t-1 to reduce heteroscedasticity. The error term in the regression shows to what extent earnings
are being managed: a positive error term shows motives for income maximizing and a negative error
term indicates income minimizing. The discretionary accruals are the part of the total accruals which
do not correlate with the change in the level of business activity. The regression residuals are
considered to be managed accruals, and can be defined as:
With:
=Level of discretionary accruals at time t for institution i.
One implicit assumption of the Jones (1991) model is that revenues are non-discretionary. The
explanatory power of the Jones model is low. An interpretation of the low explanatory power is that
managers have considerable discretion over the accrual process, which they use to mask financial
performance (Dechow, Ge and Schrand, 2010). Dechow et al. (1995) modify the Jones model to adjust
for growth in credit sales in an attempt to reduce Type II errors.
Modified Jones model (Dechow et al., 1995)
The modification of the Jones model is designed to eliminate the conjectured tendency of the Jones
model to measure discretionary accruals with error when discretion is exercised over revenues. The
only adjustment relative to the Jones model is that the change in revenues is adjusted for the change in
receivables in the event period. The modified Jones model implicitly assumes that all changes in credit
sales in the event period result from earnings management. This is based on the reasoning that it is
easier to manage earnings via exercising discretion over the recognition of revenue on credit sales than
it is to manage earnings via exercising discretion over the recognition of revenue on cash sales
(Dechow et al.,1995).
The modified Jones model assumes that the non-discretionary component of total accruals (NDA) is a
function of the change in revenues adjusted for the change in receivables and the level of property,
plant and equipment. The modified Jones model is:
24
With:
= Net receivables for institution i in year t less net receivables for institution i
in year t-1.
In the modified Jones model, discretionary accruals are estimated during the event period as:
Credit sales are frequently manipulated, so this modification increase the power of the Jones model to
yield a residual that is uncorrelated with expected revenue accruals and better reflects revenue
manipulation. However, the modified Jones model still suffers Type I errors, perhaps even more than
the original Jones model. Furthermore, the modified Jones model cannot be used to identify distortions
induced by long term accruals, which is an important limitation of the model. Impairments of PPE and
goodwill are likely to reflect earnings management or accounting distortions (Dechow et al., 2010).
It has to be noticed that some errors can exist in the accruals models: misclassification errors can
include Type I errors, which classify accruals as abnormal when they are a representation of
fundamental performance, and Type II errors, which classify accruals as normal when they are not
(Dechow et al., 2010). In the Jones model, sales is the key non-discretionary variable driving current
accruals, and capital expenditures is the key variable driving non-current accruals. Total accruals are
then regressed on only the non-discretionary accruals and it is assumed that the residual is
discretionary. Failure to identify fully the non-discretionary component implies the regression residual
contains both discretionary and non-discretionary components, leading the research to measure the
estimated discretionary and non-discretionary components with error. To interpret accruals-based tests
as evidence for earnings management, one must be confident that measurement error in the
discretionary accrual proxy is not correlated with an omitted variable in the estimation of the
discretionary accrual (Bissesseur, 2008 and Dechow et al., 2010).
25
3.7 Earnings Management through Real Variables
The previous paragraph was focused on earnings management through accruals. However, real
activities, which affect cash-flows and earnings can also be manipulated (Roychowdhury, 2006;
Vander Blauwhede, 2003). Real earnings management is achieved by changing the timing or
structuring of operations and transactions to alter reported earnings in a particular direction. Real
earnings management is achieved by changing the timing or structuring of operations and transactions
to alter reported earnings in a particular direction. Real transactions such as advertising, R&D are
strategically planned. The real activity must have two characteristics to affect accounting performance.
At first, it must be in an area where accounting performance-enhancing changes can be implemented
over the short term. Secondly, the impact on accounting performance must be essentially immediate
(Eldenburg et al., 2011).
The possibility of manipulating real activities by managers is discussed in prior literature, however
these studies are mainly related to the profit-sector. Most of the research is related to real earnings
management with R&D expenses (Baber, Fairfield and Haggard, 1991; Cheng, 2004). There are few
studies related to how mangers use specific transactions other than R&D expenses to influence
earnings. Some studies are focused on the sale of fixed assets (Herrmann, Tatsuo and Wayne, 2003;
Bartov, 1993), sales price reductions (Jackson and Wilcox, 2000), non-revenue generated expenditures
at non-profit institutions (Eldenburg et al., 2011), overproduction, managing sales, advertising and
SG&A expenses (Roychowdhury 2006). Results of these studies will be shortly mentioned.
Baber et al. (1991) investigated whether concern about reporting favorable trends in accounting net
income influences decisions to invest in R&D. They used data for 438 United States industrial
institutions during the years 1977-1987. Analysis indicated that relative R&D spending is significantly
less when spending jeopardizes the ability to report positive or increasing income in the current period.
Cheng (2004) provided evidence that compensation committees establish a greater positive association
between changes in R&D spending and changes in CEOs options in order to prevent opportunistic
reductions in R&D spending.
Herrmann et al, (2003) examined the usage of income from the sale of fixed assets and marketable
securities to manage earnings. They found a negative relation between income from asset sales and
management forecast error. When current reported operating income is below (above) management's
forecast of operating income, firms increase (decrease) earnings through the sale of fixed assets and
marketable securities. Bartov (1993) investigated whether managers manipulate earnings through the
timing of income recognition from disposal of assets and he showed that the profit from sales of assets
is negatively correlated with earnings changes. It is argued that institutions facing earnings declines
boost profits through increased asset sales.
26
Jackson and Wilcox (2000) examined whether managers grant sales price reductions in the fourth
quarter to accelerate customer purchases and, as a result, avoid losses and declines in earnings and
sales. Consistent with expectations, the results indicated that managers grant sales price reductions in
the fourth quarter to meet annual financial reporting targets.
Management of sales, reduction of discretionary expenses, overproduction are examined by
Roychowdhury (2006). He developed the empirical methods to detect real activities manipulation
other that reduction of R&D expenses. The results suggested that drawing inferences on earnings
management by analyzing only accruals may be inappropriate, because suspect firm-years manipulate
real activities to avoid reporting losses. Additionally, institutions appear to be managing real activities
to a greater extent if they have a higher proportion of current liabilities.
Eldenburg et al. (2011) investigated whether non-profit hospital managers change real activities to
manage net income toward a benchmark of zero. They used 191 Californian hospitals over the years
1997 – 2003. They found evidence that expenditures associated with non-operating and non-revenuegenerating activities are managed to achieve positive income and asset dispositions are managed to
avoid large positive net incomes.
27
Chapter 4 – Earnings Management at Non-Profit Institutions
4.1 Introduction
Research related to earnings management in the non-profit sector will be discussed in this chapter to
get an insight into the differences between non-profit and profit institutions and the reasons for
engaging in earnings management. Incentives for managers at fundraising institutions to engage in
earnings management will be described and the expectations related to earnings management by
managers of fundraising institutions will be discussed. Research related to the expectations of earnings
management at fundraising institutions will be based on research done at non-profit institutions
because literature focused on earnings management at fundraising institutions is scare. Research done
at fundraising institutions is mainly focused on managing ratios and not earnings itself (e.g. Krishnan
et al., 2006; Baber et al. 2001).
Sub-question 3 will be answered in this chapter; what are the motives for managers at non-profit
institutions and specifically fundraising institutions to engage in earnings management?
4.2 Research related to Earnings Management at Non-profit Institutions
Although earnings management research in non-profit institutions is relatively scarce in comparison to
for-profit institutions, a number of authors have documented its existence. Non-profit institutions
adjust accounting numbers for several reasons: improving their efficiency ratios (Jones & Roberts,
2006; Krishnan, Yetman & Yetman, 2006;), avoiding taxes (Hofmann, 2007; Omer & Yetman, 2003)
and avoiding small losses and high profits (Ballantine, Forker and Greenwood, 2007; Leone & Van
Horn, 2005).
Non-profit institutions have other incentives to engage in earnings management than for-profit
institutions. While for-profit institutions focus on meeting or beating external benchmarks to increase
stock price, these objectives are irrelevant for non-profit institutions (Eldenburg et al., 2011). The
priority of non-profit institutions consists in providing programs and services that are of public benefit.
The definition of non-profit does not imply that the institutions do not make any profit, but rather that
the residual profits of the institution need to be spent on the goal of the institution as stated in the
statutes of the foundation. The realization of profit is not the main purpose of non-profit institutions
(Deneffe and Masson, 2002).
Non-profit institutions have incentives to engage in earnings management related to the reduction of
cost of debt, ally creditor’s concerns and to maintain or increase the institution’s donation base (Leone
and Van Horn, 2005; Eldenburg et al., 2011). Leone and Van Horn (2005) examined the incentives of
28
CEOs in non-profit institutions to engage in earnings management. The research is done at non-profit
hospitals in the United States. Leone and Van Horn (2005) investigated the incentives to manage
earnings to a range just above zero. Managers of hospitals can adjust discretionary spending and
accounting accruals. They found that non-profit hospital managers adjust discretionary spending to
manage earnings. In addition, discretionary accruals are also used to meet earnings objectives.
Eldenburg et al. (2011) investigated whether non-profit hospital managers change real activities to
manage their net income toward a benchmark of zero. They found evidence that expenditures
associated with non-operating and non-generating activities are managed to achieve positive income
and management of asset dispositions to avoid large positive incomes. Ballantine et al. (2007)
investigated non-profit hospitals in England, which have the legal obligation to report financial
breakeven. They showed that earnings are managed via discretionary accruals such that this happens.
Leone and van Horn (2005) suggested that hospitals are expected to spent available resources to
pursue the objectives while remaining financially solvent. In contrast to the investor-owned setting
where earnings are used to evaluate managers’ ability to increase the value of the institution, managers
of non-profit institutions are evaluated on their ability to meet a non-value maximizing objective (e.g.
for fundraising institutions allocating raised money to goals and efficiency) subject to a zero-profit
constraint. Leone and Van Horn (2005) describe the intuition behind the zero-profit constraint. They
argue that non-profit institutions have a social objective and some amount of charity care to the
indigent. The institution is expected to spend the available resources to pursue its objectives while
remaining financially solvent.
There are costs associated with reporting losses and costs associated with reporting profits (Eldenburg
et al., 2011; Leone and Van Horn, 2005). Leone and Van Horn (2005) and Ballantine et al. (2007)
suggested that profitability serves as a measure of the CEO’s ability to sustain the hospital as a going
concern. Reporting any loss suggests that the hospital CEO violated the zero profit constrain, which
will increase the likelihood that a CEO is terminated. If the compensation or job security of managers
depends on achievement of (internal) objectives, managers will manage earnings in order to report
small profits. Furthermore, Leone and van Horn (2005) suggested that managers in non-profit
hospitals manage earnings to reduce the cost of debt. Cost of debt can be reduced by decreasing the
variance of earnings. Since hospitals have a constraint of earnings zero long run profit, hospital CEOs
have an incentive to manage earnings toward zero to minimize the earnings variance. By reducing the
cost of debt through earnings management, managers can use the saved cost to increase the quality of
services the hospitals provides or to increase their own perquisites.
When hospital’s report excessive profits, it is argued that the philanthropic activities are exhausted,
there is a delay in these activities until a future period or there is not sufficient effort extended to
identify additional philanthropic projects. Frank, Salkever and Mitchell (1990) reported a negative
29
correlation between reported income and the level of donations. This indicates that donors take
reported earnings into account when they decide to give donations and that they are less willing to
donate money to profitable institutions. Donors are less likely to donate to institutions that report high
profits, because donors do not view that the institution need charity. Furthermore, donors may view
the presence of profits in the institution as evidence that the philanthropic goal has either been met or
is not being pursued appropriately by the institution (Frank et al., 1990). Eldenburg et al. (2011)
suggested that hospital mangers want to reduce scrutiny by lowering income. In addition, they argued
that high profits may alienate donors and conflict with the mission of a non-profit institution.
Earnings are managed towards zero or a small profit by managers of non-profit institutions, because
managers will decrease the likelihood of termination, reduction of cost of debt, increase or maintain
the donation base and the scrutiny will be reduced.
4.3 Incentives to Engage in Earnings Management at Fundraising Institutions
In the next paragraphs the focus will be on fundraising institutions. The incentives for managers to
engage in earnings management will be described and the expectations related to earnings
management at Dutch fundraising institutions will be set out.
As mentioned before, Healy and Wahlen (1999) have structured the reasons for engaging in earnings
management into three incentives. One has to be notified that the research related to incentives to
engage in earnings management is mainly done in the United States. Dutch government regulation is
different compared to the United States regulation. The three incentives will be described for
fundraising institutions.
Dutch fundraising institutions do not have a lot of debt on their balance sheet. The short term debt on
their balance sheet is mainly related to project obligations of fundraising institutions. Long term debt
does not exist at the most Dutch fundraising institutions. For that reason the empirical study will not
be focused on earnings management in order to reduce the probability of covenant violation in debt
contracts. Moreover, it is uncommon that bonuses are used for earnings management purposes at
fundraising institutions. The compensation of managers at Dutch fundraising institutions is in the most
cases not dependent on a performance-based measure. Furthermore, fundraising institutions are
usually foundations or associations. For that reason they do not offer shares to the public are not
owned by investors. The incentives tied to shares are of no consequence to managers at fundraising
institutions and are not applicable to fundraising institutions.
The anti-trust or other government regulation is an important incentive for managers of fundraising
institutions to engage in earnings management. Fundraising institutions are visible for the society; they
30
are subject of the public debate and are discussed in the by politicians. High profitability can lead to
discussions at the Parliament which can lead to new regulations. Based on the assumption that
fundraising institutions want to minimize the political costs they face, it is expected that fundraising
institutions strive towards zero or a small positive result. The different incentives to manage earnings
at non-profit institutions are presented in table 4.1.
Table 4.1 – Reporting Incentives by Non-Profit Institutions.
Costs to report losses
Costs to report profits
Debt costs are higher
Cost related to regulation
Reputation costs for the CEO
Less donations from the public
Less donations from the government
Based on Leone and Van Horn; Eldenburg et al., 2011; Ballantine et al. (2007)
4.4 Expectations of Earnings Management at Non-Profit Institutions
In the previous paragraph research related to earnings management at non-profit institutions in the
United States is described. Based on literature described in the previous paragraph the expectations
related to earnings management at fundraising institutions will be described.
Fundraising institutions do not strive towards profit maximization but they have social duties. They do
not have to maximize incoming cash flows in order to make outgoing cash flows possible; they receive
funds. Leone and Van Horn (2005), Ballantine et al. (2007) and Eldenburg et al. (2011) argued that
managers of non-profit firms try to work to an outcome close to zero or a small positive result. These
studies are done for other non-profit institutions (e.g. hospitals). Some incentives described in the
previous paragraphs are less strong (the reduction of the cost of debt) in the Netherlands, while others
are important drivers to engage in earnings management (e.g. incentives related to the donation base).
The expectation is that fundraising institutions manage their result towards zero or a small positive
result. Since fundraising institutions are income-spending entities, they do not try to be very profitable.
Donors consider the profitability of a hospital when making donation decisions (Frank et al., 1990).
Donations are important for fundraising institutions, without donations objectives cannot be
accomplished. Managers of fundraising institutions will try to spend their budget in order to show that
the policy of the institution is effective and efficient and in order to maintain or increase their donation
base. Reporting a zero or small result indicates that all resources are used to make the fundraising
institution’s goals possible. All resources acquired, due to gifts from the public and government, were
required to enable the execution on the policy of the institution. Managers want to show that in the
future the fundraising intuition needs these funds at least to execute the policy that was developed.
Managers will manage the earnings towards zero in order to maintain or increase their donation base.
31
As mentioned before, fundraising institutions are visible for the society. The media is interested in the
institutions and they can bring institutions in public debates. High profitability can lead to political
heat and new regulations. Based on the assumption that institutions want to minimize the political
costs, it is expected that fundraising institutions strive towards zero or a small positive result. In
addition, managers of fundraising institutions will not show large losses because that can indicate that
they are not capable to manage the institution. Profitability is used as a measure of a CEO’s ability to
sustain the institution as a going concern. To reduce the likelihood that a manager is terminated, the
managers will manage the earnings towards a small positive result.
Reporting losses can lead to reputation damage of the CEO of the institution. However, reporting large
profits by fundraising institutions may lead to:

Receiving less funds from the government in the future;

Receiving less funds from the public and other donors in the future;

Discussions in at the Parliament (political heat), which can lead to new regulations;

Discussions in the media.
In conclusion, it is expected that mangers of fundraising institutions manage earnings to report profits
that are close to zero and nonnegative. Managers with small losses will manage earnings upwards so
that earnings are not negative to avoid violating zero profit constraint.
Managers of fundraising institutions can exploit the agency problem by managing. When profits are
far above (or below) a small positive result or zero, managers can make income-decreasing (incomeincreasing) accruals so that the income is close to zero or a small positive result. Due to such actions
of the management, donors and other stakeholders cannot make good decisions based on the result of
the fundraising institution.
Managing earnings could also be accomplished by increasing or decreasing some types of
expenditures, but only if income is potentially high. Managers of fundraising institutions can have an
influence on the expenses for the institution. They can increase (decrease) fundraising expenses and/or
management & administration expenses in order to reduce (increase) the result. If earnings are high
(low), managers can increase (decrease) management & administration expenses and/or fundraising
expenses during the year in order to come close to a small positive result or zero.
Another possibility to influence earnings in order to come close to the result is managing the subsidy
obligations. A lot of subsidy obligations are concerned for several years. There is a subsidy obligation
if the board made a decision and if this decision is indicated in writing to the subsidy recipient; hereby
a legal or constructive obligation arises. This obligation should be included as debt on the balance
sheet (RJ 650.326). If a subsidy obligation is done, the fundraising institution added this obligation to
32
the costs (expenses) in the profit and loss statement under the account spending to objectives.
Managers of a fundraising institution can influence these accounts in order to reduce (increase) their
reported result. If the result deviates much from a small positive result or zero, they can decide to
subsidize a project, as an effect the expense on the profit and loss statement increases and the surplus
of the institution will be lower. So, besides managing management & administration and fundraising
expenses, managers of fundraising institutions can also manage the spending on objectives which is a
part of the expenses of an institution.
The hypotheses related to the use of earnings management via accruals and real variables (expenses) at
fundraising institutions will be composed in chapter 6.
33
Chapter 5 – Corporate governance at Fundraising Institutions
5.1 Introduction
In this chapter the focus will be on why corporate governance is needed at non-profit institutions. In
addition, corporate governance structures at Dutch fundraising institutions are described. This is
needed in order to understand the different governance structures at fundraising institutions and to set
the hypotheses in the next chapter. After reading this chapter sub-question 4 is answered; why is
corporate governance needed at non-profit institutions and how is corporate governance organized at
Dutch fundraising institutions?
5.2 Corporate Governance at Non-profit Institutions
The concept of corporate governance stems from principal-agent theory, which focuses on issues of
responsibilities (Fama and Jensen, 1983). To align the interests of shareholders and managers when
ownership is separated from control in an institution is the main rationale for creating strong
governance structures. Fama and Jensen (1983) argue that the non-profit form serves to mitigate
potential principal-agent problems between donors and residual claimants. In non-profit institutions
there are no explicit residual claimants, which reduce the incentives to expropriate cash-flows from
received donors. However, the lack of residual claimants does not eliminate agency problems in nonprofit institutions between donors and internal agents. Non-profit institutions suffer agency problems
that are similar to for-profit institutions (Krishnan, Yetman and Yetman, 2006). Krishnan et al. (2006)
argued that accounting information can assist donors and other stakeholders in monitoring their
implicit contracts by providing a means for donors to evaluate whether the non-profit institution is
using its donations in the most efficient and effective manner. Donors use accounting measures to
monitor the efficiency of non-profit institutions to ensure stewardship of their donated resources and to
assist them in making their donation allocation decisions (Baber et al. 2001; Krishnan et al., 2006;
Krishnan and Yetman, 2011).
O’Regan and Oster (2005) suggested that governance mechanisms should ensure the mission of the
non-profit institution is preserved and that the constituents are protected. So, also non-profit
institutions (like fundraising institutions) need various governance mechanisms to serve control or
monitoring purpose in order to give stakeholder an accounting measure for making decisions.
Improper financial accounting practices are assumed to obscure real performance and diminish
investors’ ability to make informed decisions (Xie et al., 2003). On behalf of donors and other
stakeholders, the supervisory board has a fiduciary duty to ensure that financial statements are free
from misreporting (O’Regan and Oster, 2005). Agency theory emphasizes that the board is in place to
34
monitor management. The agency view of an audit committee requires the committee to reduce
agency costs by monitoring financial reporting quality (Dhaliwal, Naiker and Navissi, 2010). The
supervisory board and audit committee are needed to monitor financial reporting quality and thereby
earnings management of an institution.
Yetman and Yetman (2011) investigated the effects of corporate governance on financial reporting
quality at non-profit institutions. Various stakeholders use non-profit financial information for
donating, contracting and regulating decisions, and these decisions can be affected by the quality of
the underlying financial information. Inaccurate reports can lead to suboptimal decisions and potential
misallocation of resources. Their findings suggest that attempts to enhance the monitoring and
oversight of non-profits can lead to higher quality financial reports, particularly if those efforts involve
market participants such as lenders or donors.
So, stakeholders at fundraising institutions need to know the earnings in order to make decisions (e.g.
whether or not give a donation at the fundraising institutions. Improper financial accounting practices
diminish stakeholders of non-profit-institutions to make informed decisions. The supervisory board
and audit committee can reduce information asymmetry between the insiders and the outsiders by
monitoring the financial reports of the institutions.
5.3 Governance Structures at Dutch Fundraising Institutions
There are different governance models in the Netherlands, United States and United Kingdom, so for
that reason a clear definition for each function is necessary to understand the research and conclusions
of prior literature discussed in this chapter.
Several models related to the structure of a fundraising institution can be distinguished; therefore it is
important who is seen as the supervisory board, as the governing board and the board of directors for
setting the hypotheses. In practice there is a so-called board-model (In Dutch: Bestuursmodel) and the
oversight-model (In Dutch: Raad van Toezichtmodel). A graphical representation is added in this
thesis to get an understanding of the different models (table 5,1 on the next page). The translation of
the functions is presented in appendix B.
As said in chapter 2, fundraising institutions are mostly associations or foundations. At associations
there is a general assembly meeting (hereafter: GAM). The GAM has several legal responsibilities
pertaining to the appointing and discharging management, establishing the annual report, and
approving amendments to the articles of association. The boards or oversight boards always have to
give responsibility to the GAM.
35
Figure 5.1 – Governance Structures of Dutch Fundraising Institutions.
Source: Code goed bestuur voor goede doelen
At the oversight- model (model IV in previous figure), the management function is usually filled by
statutory directors, but it can also be done by the governing board. The task of the oversight board is to
supervise (the policy of) the board of directors and operations in general and advice the board of
directors. This body is not allowed to receive compensation, but only a reimbursement of expenses.
In the board model legal management is carried out by the board. In model III, the board has an
oversight function and has delegated most of his tasks to management. Although the board performs
an oversight function, the main difference with model IV is that the board is still legally responsible.
In models I and II the board is more closely involved with operational tasks.
Within the financial institution, a clear distinction should exist between the supervisory role and the
managerial role or the executive role. The governing board determines policy, establishes the financial
guidelines and holds the final responsibility for the daily management. The supervisory board adopts
or approves plans and critically monitors the institution and its results. They monitor the governing
board (Seal Regulations CBF Seal of Approval, 2010).
Prior research has found that the existence of an audit committee and the composition of the audit
committees and the supervisory board have an impact on earnings management (e.g. Klein, 2002; Xie
et al., 2003; O’regan and Oster, 2005; Vafeas, 2005; Felo, Krishnamurthy and Solieri, 2003; Beaver,
2002). In the following chapter some characteristics of the supervisory board and the audit committee
will be discussed which will have a relationship with earnings management of fundraising institutions.
36
Chapter 6 – Hypotheses Development
6.1 Introduction
In this chapter hypotheses will be formulated with respect to earnings management at Dutch
fundraising institutions. Subsequently, hypotheses related to characteristics of the supervisory board &
audit committee and the relationship with earnings management will be composed. In order to get an
clear overview of the discussed literature on which the hypotheses in this paragraph are based, an
overview of the discussed literature is added in Appendix C.
The research discussed in this paragraph is mostly related to the impact of corporate governance
aspects and earnings management at profit-institutions. However, research is mostly conducted at forprofit institutions and there is a very small base of literature on earnings management at non-profit
institutions and the impact of supervisory board &audit committee characteristics. The there are no
reasons beforehand why characteristics of the supervisory board & the audit committee have another
impact on earnings management at non-profit institutions. For that reason the hypotheses in this
paragraph are based on for-profit literature.
Sub question 5 will be answered in this chapter; what are the conclusions of prior research concerning
the supervisory board and the audit committee characteristics and their relation with earnings
management.
6.2 Earnings Management at Dutch Fundraising Institutions
As described in chapter 4, managers of fundraising institutions will manage their result towards zero
or a small positive result. Ballantine et al. (2007) and Leone and Van Horn (2005) found that reported
income by hospitals in the Netherlands and United States is discontinuous around zero. The approach
used by Ballantine et. al (2007) and Leone and Van Horn (2005) was derived from the study
performed by Burgstahler and Dichev (1997). The expectation is that if managers manage earnings to
avoid small losses, a discontinuity of income with unusually low frequencies in the interval just to the
left of zero will be observed. The following hypothesis is composed:
Hypothesis 1: Small losses are managed upward to small profits.
As mentioned before, earnings can be managed by discretionary accruals or abnormal expenses. A
relationship between group and the direction of the discretionary accruals is expected. In addition, a
relation is predicted between groups and the direction of abnormal expenses (management &
administration, fundraising and spending on objectives). For example: managers who have negative
earnings will use positive discretionary accruals and/or negative abnormal expenses to come close to
37
zero or a small positive result. The reverse situation is the case for managers who have a high positive
result: they will use negative discretionary accruals and/or positive abnormal expenses. The following
hypotheses will be tested:
Hypothesis 2: Negative (Positive) discretionary accruals occur more (less) often at some earnings
groups.
Hypothesis 3: Negative (Positive) abnormal management & administration expenses are more
(less) often used at some earnings groups.
Hypothesis 4: Negative (Positive) abnormal fundraising expenses are more (less) often used at
some earnings groups.
Hypothesis 5: Negative (Positive) abnormal spending on objectives are more (less) often used at
some earnings groups.
6.3 Characteristics of the Supervisory Board & the Audit Committee on Earnings Management
In this paragraph the hypothesis related to earnings management and characteristics of the supervisory
board and audit committee will be composed.
6.3.1 Size of the Supervisory Board and the Existence of an Audit Committee
The size of the supervisory board and the impact on earnings management is a much discussed
characteristic in the literature (e.g. Xie et al. 2003; Yang and Krishnan, 2005; Rahman and Ali, 2006;
Jouber and Fakhfakh, 2010). There is no consensus in the literature about the direction of the
relationship between the size and earnings management. Ex ante, adding more directors to a
committee is likely to have a non-linear effect on committee performance. Initially adding more
members to the committee enhances performance because there are more people on whom to drawn
(Vafeas, 2005) and facilitate quality discussions among audit committee members (DeZoort and
Salterio, 2001). Rahman and Ali (2006) argued that large boards with varied expertise could increase
the synergetic monitoring of the board in reducing the incidence of earnings management. However,
when the committee is too large, performance declines because of process losses and diffusion of
responsibilities (Vafeas, 2005).
Lin, Li and Yang (2006) examined the association between the characteristics of audit committees
(size, independence, financial expertise, and activity and stock ownership) and earnings restatements,
which is a direct measure of earnings management. They investigated 267 publicly-held corporations
38
in the United States that restated their reported earnings for the fiscal year 2000 and found a negative
association between the size of the audit committee and occurrence of earnings restatements. Their
results show that larger audit committees may provide more oversight over the financial reporting
process. Earnings quality seems to improve due to such oversight by reducing the probability of
restating financial statements.
Xie et al. (2003) investigated the role of the board of directors and the audit committee in preventing
earnings management. They choose the years 1992, 1994 and 1996 and included 282 firm-year
observations from the S&P 500 index and found a negative relationship between earnings
management and board size. They conclude that larger boards are associated with lower levels of
discretionary accruals. An argument for that is that larger boards may bring greater number of
experienced directors to the board. Peasnell, Pope and Young (2005), Rahman and Ali (2006) and
Bradbury, Mak and Tan (2006) found also an association between larger boards and less earnings
management.
The corporate governance literature also suggests that small corporate boards are more effective
monitors than large boards because they have a high degree of membership coordination, less
communication difficulties and a lower incidence of severe free-rider problems (Ahmed, Hossain and
Adams, 2006). Jensen (1993) suggests that agency problems increases with size; as boards increases it
is generally argued that free-rider-problems increases as they do in a team setting. The responsibility
of monitoring management is likely to become more diffused, when less of the burden falls on each
director. So, in smaller boards each individual board member will be more likely to take responsibility
for monitoring of the financial. Another argument for a smaller board is that smaller boards may be
less encumbered with bureaucratic problems (Xie et al., 2003). Yermack (1996) analysed 452 boards
of profit firms in the United States over the period 1984-1991 and he found that smaller boards could
monitor the CEO more effectively.
The CBF sets some guidelines for the supervisory board. In the case of a governing board with a
supervisory board established in accordance with the articles of association the governing board
consists of at least one natural person. Some researchers found a negative association between the size
and earnings management, while others showed a positive association between the variables.
Initially adding more members to a supervisory board enhances the performance however when too
many members are added the performance will decrease due to the free riding problem and less time is
spend on problems like earnings management. The following hypotheses are set:
Hypothesis 6A: The size of the Supervisory Board is quadratic related to Discretionary
Accruals (U-shaped relationship).
39
Hypothesis 6B: The size of the Supervisory Board is quadratic related to Abnormal, Spending
on Management & Administration, Fundraising Expenses and Objectives (U-shaped relationship).
The existence of an audit committee is not mandated by law or included in the criteria for the CBFseal, and not all the fundraising institutions have an audit committee. It is interesting to investigate
whether the existence of an audit committee has a relationship with earnings management at
fundraising institutions.
Prior research has found that the existence and composition of the audit committee has an impact on
financial reporting. There are studies which found an effect between the existence of an audit
committee and earnings management. Turley and Zaman (2004) emphasize the effect of audit
committees on financial reporting quality. Evidence of a positive link between audit committee
existence and the quality of financial reporting had been provided by analysis indicating that earnings
overstatements are less likely among companies that have audit committees and that companies
manipulating earnings are less likely to have audit committees. This is in line with the research of
Baxter and Cotter (2009), who investigated whether audit committees are associated with improved
earnings quality at listed companies on the Australian Stock Exchange (ASX) and found that
formation of audit committees reduces intentional earnings management. Also Davidson, GoodwinStewart and Kent (2005) investigated listed companies on the ASX and found a negative relation
between the existence of the audit committee and earnings management. Peasnell et al. (2005)
investigated United States listed institutions and found no evidence that the presence of an audit
committee directly affects the extent of income manipulations.
Most studies found a negative relationship between the existence of an audit committee and earnings
management which lead to the following hypotheses:
Hypothesis 7A: The Existence of an Audit Committee is negatively related to Discretionary
Accruals.
Hypothesis 7B: The Existence of an Audit Committee is negatively related to Abnormal
Spending on Management & Administration, Fundraising and Objectives Expenses.
6.3.2 Supervisory Board and the Audit Committee Diligence
A proxy used to measure supervisory board and audit committee diligence is the number of meetings.
The motive for that proxy is that inactive supervisory board or audit committees are unlikely to
monitor effectively (Menon and Williams, 1994). The level of activity of a board or committee has
40
been recommended as important to enhance its effectiveness in improving earnings quality (Baxter
and Cotter (2009), which is related to earnings management. Boards that meet more frequently are
expected to have lower earnings management and therefore report higher quality earnings compared to
boards which seldom meet because boards which meet more frequently are able to allocate more time
on issues such as earnings management (Xie et al., 2003; Rahman and Ali, 2006).
Xie et al. (2003) found a negative association between level of earnings management and the meeting
frequency of the board. This finding is consistent with the idea that an active board may be a better
monitor than an inactive board. In contrast, Vafeas (1999) showed that boards meet more often during
periods of turmoil. Jensen (1993) suggested that boards should be relatively inactive and that boards
are usually forced to maintain higher activity levels in the presence of problems. So, if the board or
audit committee meets not very frequently can be interpreted as stable, with less earnings
management. Boards that meet often can have problems (e.g. earnings management).
Bedard, Chtourou and Courteau (2004) found no association between the number of meetings and
annual discretionary accruals. The research is done in the United States in 1996. In addition, Lin et al.
(2006) and Davidson et al. (2005) found no association between the activity of audit committee
members and earnings management.
There are no specific guidelines for the frequency of supervisory board and audit committee meetings
in the Regelement CBF-keur. The number of supervisory board meetings and the number of times the
members are presented at these supervisory board meetings have to be included in the annual report
(RJ Richtlijn 650). More meetings of the supervisory board and the audit committees can lead to less
earnings management because there is more time to spend on issues in the fundraising institutions (so
better monitoring is possible when the frequency of meetings is higher). However, it can also be
suggested that more meetings are a sign that there are problems in the institutions. More supervisory
board meetings and audit committee meetings may indicate that there are problems in the institutions.
Given the mixed results of prior research the following hypotheses are formed:
Hypothesis 8A: The number of Supervisory Board meetings is related to Discretionary
Accruals.
Hypothesis 8B: The number of Supervisory Board meetings is related to Abnormal Spending
on Management & Administration, Fundraising and Objectives.
Hypothesis 9A: The number of Audit Committee meetings is related to Discretionary Accruals.
Hypothesis 9B: The number of Audit Committee meetings is related Abnormal Spending on
Management & Administration, Fundraising and Objectives.
41
6.3.3 Tenure of the CEO and the Audit Committee Members
Two conflicting views on the impact of director tenure on board effectiveness can be indicated. One
can argue that more experienced directors have greater knowledge about the firm’s operations that
enable them to exercise better decision control compared to less experienced directors. Beasley (1996)
argue that the likelihood of fraud decreases as the tenure of directors increases. However, if the
directors severed the firm for a long time, their independence is compromised as they become more
likely to befriend management and hence be less critical about the quality of financial reports (Vafeas,
2005; Yang and Krishan, 2005). A CEO who serves the board for a longer period can use his
discretion to manipulate earnings. Based on prior research, which found only support for a positive
relationship between earnings management and CEO tenure so, it is hypnotized that:
Hypothesis 10: The tenure of the CEO is positively related to Discretionary Accruals.
Rahman and Ali (2006) argued that experience of audit committee members allows members to gain a
better understanding of the firm and its people, thus enabling them to develop better governance
competencies. They investigated 97 institutions listed on the Main Board of Bursa Malaysian over
2002 till 2003. However, they found no association between tenure and the level of earnings
management.
Yang and Krishnan (2005), who investigated institutions in the United States, showed that the average
tenure of the audit committee members is negatively associated with quarterly earnings management,
which suggest a possible positive effect of experience with the firm and its accounting. Xie et al.
(2003) found a positive relation between the tenure of outside directors and the level of discretionary
current accruals. Board members with longer tenure as directors, in this case, may be less effective
monitors and perhaps have been co-opted by management.
The Regelement CBF-Keur gives some guidelines for the tenure of the supervisory board members.
The members of the supervisory board resign periodically. Appointments and any re-appointments are
tenable for a maximum period of five years. A negative relationship between the tenure of the audit
committee and earnings management is expected in this thesis:
Hypothesis 11A: The tenure of Audit Committee is negatively related to Discretionary
Accruals
Hypothesis 11B: The tenure of Audit Committee is negatively related to Abnormal Spending
on Management & Administration, Fundraising and Objectives.
42
6.3.4 Financial Expertise of the Audit Committee
The audit committee expertise is generally considered as an important characteristic for effective
operation. It has been argued that effective oversight by an audit committee requires that the members
possess sufficient expertise in accounting and auditing to assess the matters that are presented to them
(Beasley and Salterio, 2001; DeFond, Hann and Xu, 2005).
Three financial expertises can be distinguished in the literature, namely accounting, finance and
supervisory expertise. The method to measure the expertise of the audit committee is based on
Dhaliwal et al. (2010). The three different expertises will be shortly explained. Assignment of
accounting expertise will be done when a member of an audit committee currently has (or previously
had) work experience as certified public accountants, chief financial officers, vice presidents of
finance, financial controllers, or any other major accounting positions. Finance expertise is assigned to
audit committee members who currently have (or have previously had) work experience as investment
bankers, financial analysts, or any other financial management roles. This is because regulators also
consider those individuals with experience in analyzing or evaluating financial statements as financial
experts. Finally, assignment of supervisory expertise will be done to audit committee members who
currently have (or previously have had) work experience as chief executive officers or company
presidents.
Felo et al. (2003) investigated whether audit committee financial expertise is related to financial
reporting quality for two different time periods. The sample consisted of 119 firms between 1992 and
1993 and analysts’ ranking of a firm’s financial reporting quality from the Association for Investment
Management and Research database as a proxy for financial reporting quality. They concluded that
financial and accounting expertise of the audit committee is positively related to financial reporting
quality. Dhaliwal et al. (2010) examined which type of audit committee expertise (accounting, finance
or supervisory expertise) has a stronger effect on accruals quality in the presence of strong
governance. The sample consisted of 770 firms in the United States. A positive relation between
accounting expertise in audit committees and accruals quality is found but no significant association
between accruals quality and the presence of finance or supervisory expertise in audit committees
showed in their research.
Rahman and Ali (2006) suggested that an audit committee that has knowledge and skills in financial
reporting is more likely to uncover opportunistic earnings management. In line with Rahman and Ali
(2006), Xie et al. (2003) argued that audit committee members with corporate and financial
backgrounds should have experience and training to understand earnings management and therefore
earnings management is less likely to occur. They found evidence that firms with audit committee
members with corporate or financial backgrounds are associated with firms that have smaller
discretionary current accruals.
43
Bedard et al. (2004) investigated whether the expertise, independence and activities of an audit
committee have an effect on aggressive earnings management. They found that earnings management
is negatively associated with the financial and governance expertise of audit committee members. In
line with that, Yang and Krishnan (2005) reported that earnings management is lower for firms whose
audit committee directors have greater governance expertise.
Contrasting is the research of Baxter and Cotter (2009), who investigated whether audit committees
are associated with improved earnings quality (measured by Jones model and Dechow and Dichev
model) and found no association between earnings management and audit committee accounting
expertise.
Requirements related to the financial expertise are not included in the CBF criteria for receiving the
CBF-seal. Based on the fact that more researchers have found a negative relationship than no
relationship between earnings management and experience of the audit committee, a negative
relationship between the financial, accounting and supervisory expertise of the audit committee and
earnings management in the Dutch fundraising sector is expected. The following hypothesis is set:
Hypothesis 12A: Financial expertise of the Audit Committee is negatively related to
Discretionary Accruals.
Hypothesis 12B: Financial expertise of the Audit Committee is negatively related to Abnormal
Spending on, Administration & Management, Fundraising and Objectives.
Table 6.1 included an overview of the hypotheses set related to the characteristics of the supervisory
board & audit committee and earnings management.
Table 6.1 – Overview Hypotheses: Characteristics Supervisory Board & Audit Committee
Characteristic
Predicted Relation on Earnings Management
H 6 A/B
Size of the Supervisory Board
U-shaped relationship (Quadratic relationship)
H 7 A/B
Existence of an Audit Committee
-
H 8 A/B
Number of Supervisory Board meetings
?
H 9 A/B
Number of Audit Committee meetings
?
H 10 A/B
Tenure of the CEO
+
H 11 A/B
Tenure of the Audit Committee members
-
H 12 A/B
Financial expertise of the Audit Committee
members
-
44
Chapter 7 – Research Methodology
7.1 Introduction
This chapter includes the research method that will be used to carry out this research. A description
will be given on the sample that will be used to obtain the data, and from which sources the data will
be extracted. Furthermore, the research designs to test the hypotheses depicted in chapter 6 will be
described.
7.2 Sample Selection
A dataset from the CBF is received and consist of 268 Dutch fundraising institutions which have a
CBF-seal. 6 institutions are not usable because they have not a book year ending at December or the
financial statements of the institutions could not be found. The dataset included financial data of the
institutions over 2009 and 2010. However, the received dataset was incomplete and faults were found.
The years (2009 and 2010) of the balance sheet accounts and profit and loss statement items were
confused. Also the account fixed assets and total assets were confused. Based on a sample of 30
randomly selected institutions there is concluded that these items were incorrect and the columns are
changed.
For 262 institutions the current assets and current liabilities over 2009 and 2010 are manually
collected. In order to test the characteristics of the supervisory board and the audit committee on
discretionary accruals and abnormal spending on management & administration, fundraising and
objectives, the 139 largest institutions, based on total assets over 2010 are selected. The largest
fundraising institutions are chosen, because one can expect that these institutions have the most
attention of the public, government and media. For these 139 institutions the supervisory board and
audit committee characteristics, which are mentioned in chapter 6, are manually collected.
The needed data related to the supervisory board and audit committee characteristics is found in
financial statements and annual reports of the selected institutions on the website of the CBF. Some
data related to these characteristics could not be found in the financial statements or annual reports.
For 46 institutions all the necessary data related to the characteristic of the supervisory board and audit
committee is collected. For the other 93 institutions one or more characteristics related to the
supervisory board or audit committee is/are missing. An overview of the sample selection can be
found in table 7.1.
45
Table 7.1 – Sample Selection
Initial data obtained
268
Unusable due to other book years or financial statements not available
(11)
Sample to test hypotheses 1 till 5
257
Largest institutions in the initial data obtained (based on total assets 2010)
139
Missing data points related to characteristics supervisory board and audit committee
(93)
Sample to test hypotheses 6 till 12
46
7.3 Research Designs
In the coming paragraphs there will be a description of the approaches in order to test the hypotheses
set in chapter 6. At first, the method to investigate the earnings distribution of fundraising institutions
will be pointed out. Subsequently, the used models to determine discretionary accruals and abnormal
expenses will be explained. Thereafter, the research design to investigate the relationship between
groups and the direction of the discretionary accruals and abnormal expenses will be described.
Finally, the models to examine the relationship between characteristics of the supervisory board &
audit committee and discretionary expenses/abnormal expenses are explained.
7.3.1 Income Distribution
In order to test hypothesis 1 and find out whether the distribution of earnings is discontinuous around
zero, earnings data will be plotted in a histogram and the normality of the distribution of earnings
around zero will be examined. Visual examination of the distribution of income scaled by total income
in preceding year (2009) is performed. Scaling with total income is necessary in order to control for
the size of the institutions.
Besides a graphical examination of the earnings distribution around zero a statistical test, which is
derived from the method developed by Burgstahler and Dichev (1997) will be performed. The
expected number of observations in the interval containing zero is:
be:
, its variance will
. The test statistic Z is defined as the difference between
and
divided by the standard deviation, approximately follows the standard normal
distribution. N is the overall number of observations,
the observed probability of falling
into the interval containing zero, the nearest interval with lower earnings, and the nearest interval with
higher earnings.
46
7.3.2 Detection Earnings Management Through Discretionary Accruals and Abnormal Expenses
Earnings management through accruals will be measured by the (modified) Jones models, which are
explained and discussed in chapter 3. Based on the method used by Jones (1991) total accruals will be
calculated. However, the change in current maturities of long term debt is not included in the
calculation. This account could not be received from the CBF neither it was manually collectable.
Naturally the accounts long term debt can be found in the financial statements, however the part which
mature in one year cannot be found. The modified Jones model and the Jones model are used because
these models are complementary. The Jones model suffers type II errors and model I suffers type I
errors, so using the two models can give an insight into the different outcomes of the models.
Besides investigating earnings management through accruals there will also be an examination of
earnings management via real variables. As mentioned in chapter 4 the focus will be on earnings
management through expenses of management & administration, fundraising and spending on
objectives. Measuring normal management & administration expenses, fundraising expenses and
spending on objectives is based on the discretionary abnormal expenses model of Roychowdhury
(2006) who built his model based on Dechow, Kothari and Watts (1999). For an explanation of the
model of Roychowdhury (2006) see appendix D.
The three models which will be used to measure the normal expenses are:
With:
= Management & Administration costs for institution i at year t;
= Total assets at period t-1 for institution i;
= Total income during period t for institution i, and;
= Error term.
With:
= Fundraising costs for institution i at year t.
47
With:
= Spending on objectives for institution i at year t.
The abnormal management & administration expenses, abnormal fundraising expenses and abnormal
spending on objectives are the residuals of the models.
Model 4 expresses the total abnormal expenses. The model included the residuals of models 1, 2, and
3, which are the abnormal spending on management & administration, fundraising and objectives.
With:
= Total abnormal expenses for institution i at year t;
= Total abnormal management & administration expenses for institution i at
year t;
= Total abnormal fundraising expenses for institution i at year t;
= Total abnormal spending on objectives for institution i at year t.
It has to be noticed that Roychowdhury (2006) investigated R&D expenses, SG&A expenses and
marketing expenses. Furthermore, the model of Roychowdhury (2006) is used to measure normal and
abnormal expenses in the profit sector. The model of Roychowdhury (2006) will be used to measure
normal and abnormal expenses in the non-profit sector, nevertheless there is no indication that
differences in the profit and non-profit sector for determining the normal and abnormal expenses
exists. For that reason a model extracted from the profit sector will be used in this thesis to
investigated the abnormal expenses in the fundraising sector.
48
7.3.3 Groups and the Direction of Discretionary Accruals and Abnormal Expenses
In order to test hypotheses 2 till 5 different groups will be distinguished: the fundraising institutions in
the sample will be divided into six different groups based on their earnings before discretionary
accrual (EBDA). There will be an examination whether a relation between the groups and the direction
of the discretionary accruals exists.
In addition, there will be tested whether a relation between the groups and the direction of the total
abnormal expenses (management & administration, fundraising and spending on objectives expenses)
exists. Groups are formed based on earnings before total abnormal expenses (EBTAE) to test whether
this relation exists. Furthermore, groups are composed based on earnings before abnormal
management & administration expenses (EBAMAE), earnings before abnormal fundraising expenses
(EBAFE) and earnings before abnormal spending on objectives (EBASO).
In order to determine EBDA, discretionary accruals will be calculated through the Jones model and are
cleared with the earnings over 2010. The EBAMAE will be determined by clearing the earnings with
the abnormal management & administration expenses. The same is done for the EBAFE and EBASO.
In addition, the EBTAE will be calculated by clearing the earnings with the abnormal management &
administration expenses, abnormal fundraising expenses and abnormal spending on objectives. EBDA,
EBTAE, EBAMAE, EBAFE, and EBASO are scaled by total income in order to control for the size of
the fundraising institutions.
The following groups can be distinguished:
Group 1 – This group consists of institutions with EBDA or EBTAE larger than -,5. The limit of -,5 is
chosen arbitrary, because no further rules were found in prior literature. Institutions in this group have
large losses and it is expected that managers of the intuitions ’take a bath’. It is expected that managers
of this group use negative discretionary accruals and positive abnormal expenses in order to decrease
earnings further.
Group 2– The managers of this group use negative discretionary accruals and positive abnormal
expenses, while they have positive EBDA and/or EBTAE. The earnings of these institutions are
unexpectedly managed towards a (large) negative result, which is against the idea that managers of
fundraising institutions manage their earnings towards zero or a small positive result. So, this group
consists of institutions which manage earnings towards a negative result which means that they do not
follow the expected pattern of managing earnings towards zero or a small positive result.
Group 3 – Institutions which have negative EBDA or EBTAE will fall in this group. It is expected that
managers strive towards zero or small positive result. In order to accomplish that, managers will use
positive discretionary accruals and negative abnormal expenses.
49
Group 4 –Institutions which have positive EBDA or EBTAE will be included in this group. It is
expected that managers of this group would like to reduce their income in order to come close to zero
earnings. This will be accomplished by using negative discretionary accruals and positive abnormal
expenses.
Group 5 – Fundraising institutions which have negative EBDA or EBTAE will fall in this group.
Managers of this group use positive discretionary accruals and negative abnormal expenses to prevent
reporting negative results. However, the reported earnings are highly positive. Managers of this group
unexpectedly do not strive towards zero or a small positive result, which is not in line with the idea
that managers of the institutions strive towards a small positive or zero result.
Group 6 – This group consist of institutions which use positive discretionary accruals and negative
abnormal expenses in order to increase their income. Managers of this group do not decrease their
earnings to come to a small positive result, which would be in line with the theory.
Figure 7.1 – Graphical Presentation of the Expectations for each Groups
4
1
2
3
6
5
0
EBDA/EBTAE
In conclusion, managers of fundraising institutions which fall in group 3 and 4 strive towards zero or a
small positive result, which can be accomplished by using discretionary accruals or abnormal
expenses. It is expected, based on the theory that non-profit institutions strive towards zero or a small
positive result, that the most institutions will fall into these groups. Managers of group 1 manage their
earnings downwards, because it is not likely that they can use discretionary accruals and/or abnormal
expenses to come close to a zero or small positive result. Groups 2, 5 and 6 consist of the institutions
which unexpectedly do not strive towards zero or a small positive result.
After forming groups, a chi-square test will be performed in order to test whether a relation exists
between the direction of the discretionary accruals & abnormal expenses and the groups. It is expected
that institutions which fall in group 4 an 1 use more often negative (positive) discretionary accruals
50
(abnormal expenses) than expected. Institutions which fall in group 3 use more often positive
(negative) discretionary accruals (abnormal expenses) than expected and institutions of group 1 use
more often negative (positive) discretionary accruals (abnormal expenses) than expected. Managers of
group 2, 5 and 6 manage their earnings unexpectedly not towards zero and it is predicted that these
groups will not include many fundraising institutions.
7.3.4 Supervisory Board and Audit Committee Characteristics on Earnings Management
Hypotheses 6 till 12 are formulated in chapter 6. The empirical models to examine the relationship
between characteristics of the supervisory board & audit committee and discretionary accruals &
abnormal expenses will be described in this paragraph.
The following model will be used to investigate the relationship between the characteristics of the
supervisory board & audit committee and earnings management by using accruals.
As mentioned before, the discretionary accruals will be calculated through the Jones model and the
modified Jones model. The absolute value of the discretionary accruals will be the dependent variable
in the regressions. The absolute value is chosen because the focus of this study is on the degree of
earnings management and not whether the discretionary accruals increases or decreases the earnings.
When using the absolute values, a relationship between the supervisory board and audit committee
characteristics and earnings management is more easy to found than using the real values.
The following models (model 2, 3, 4 and 5) will be used to investigate the relationship between
abnormal expenses and characteristics of the supervisory board and audit committee:
51
The regressions as presented in the models above will be produced in the next chapter. In addition the
regressions will be created with a quadratic term SBSIZE², because in chapter 6 a quadratic effect
between the size and dependent variables is predicted.
Table 7.2 included the descriptions of the variables of the above equations.
Table 7.2 – Variable Descriptions
Variables
Description
Dependent Variables:
ABS DA
Absolute value discretionary accruals
ABS AMAE
Absolute value abnormal management & administration
ABS AFUNE
Absolute value of the abnormal fundraising expenses
ABS ASO
Absolute value of the abnormal spending on objectives
ABS TAE
Absolute value of the abnormal spending on management & administration, fundraising
and objectives
Independent Variables:
SBSIZE
Number of supervisory board members
SBSIZE²
The squared number of supervisory board members,
ACEXI
Dummy variable for having an audit committee
SBMEET
Number of supervisory board meetings
ACMEET
Number of audit committee meetings
CEOTEN
Number of years of board service of the CEO
ACTEN
The average number of years of the audit committee service
FINEX
Dummy variable for having experience in accounting, finance and/or supervisory
52
Chapter 8 – Results
8.1 Introduction
In this chapter the results of the empirical research will be discussed. sub questions 6 till 8 will be
answered:
-
What is the impact of the size of supervisory board and the existence of the audit committee on
earnings management at Dutch fundraising institutions?
-
What is the impact of the frequency of the supervisory board and audit committee meetings on
earnings management Dutch fundraising institutions?
-
What is the impact of the tenure of the Chief Executive Officer (CEO) (In Dutch: voorzitter
Raad van Bestuur) and the audit committee members on earnings management at Dutch
fundraising institutions?
-
What is the impact of financial expertise of the audit committee members on earnings
management at Dutch fundraising institutions?
At first, the results of the investigation of the earnings distribution of fundraising institutions will be
depicted. Subsequently, the analysis of the used models to determine discretionary accruals and
abnormal expenses will be discussed. Thereafter, the outcomes of the relation tests between groups
and the direction of the discretionary accruals and abnormal expenses will be described. Finally, the
regression results, which examine the relationship between characteristics of the supervisory board &
audit committee and discretionary accruals & abnormal expenses, will be shown and discussed. Only
the main tables an figures are included in this theses, additional analysis (tables and figures) can be
found in the appendixes.
8.2 Income Distribution
The results of the earnings distribution will be examined to conclude whether the distribution of
earnings is discontinuous around zero. Table 8.1 present the descriptive statistics of the Earnings (t)
scaled by Total Income (t-1). If an observation differs three times the standard deviation or more form
the mean, the observation is declared as an outlier and is deleted. A range between -0,8423 and 0,9517
is formed to examine the normality of the distribution. Table 8.2 presents descriptive statistics without
outliers.
53
Table 8.1 - Descriptive Statistics
N
Earnings (t) scaled by Total Income (t-1)
263
Valid N (listwise)
263
Minimum
Maximum
-2,61
1,76
Mean
Std. Deviation
,0547
,29900
Table 8.2 - Descriptive Statistics, Outliers Excluded
N
Earnings (t) scaled by Total Income (t-1)
257
Valid N (listwise)
257
Minimum
-,64
Maximum
,95
Mean
Std. Deviation
,0495
,18885
Figure 8.1 shows that the frequency of the interval of small losses between -,05 and 0,0 is less than the
frequency of the interval 0,0 and 0,05. Just before the zero line there are approximately 40
observations and after the zero line almost 80. So, small losses occur less than small profits; a
discontinuity can be observed around zero. However, a statistical test has to be done to conclude if the
distribution is discontinuous. As mentioned in the research design the research approach of Burgsthler
and Dichev is used to investigate the continuity around zero statistically. The Z-statistic for interval
0.0; 0.05 is 8.14 and for the interval -.05; .00 a Z-statistic of -7.68 is calculated. These values are
significant, implying a discontinuity around zero. In appendix E a table is presented including the
observed count for each interval.
In addition, a histogram with the same range and interval used by Burgstahler and Dichev (1997) is
produced. Figure 8.2 shows the earnings scaled by total income with an interval width of 0,005 and a
range from -.25 to + .35, which is used by Burgstahler and Dichev (1997). The figure shows that the
frequency of the interval of small losses between -,05 and 0,0 is less than the frequency of the interval
0,0 and 0,05. Just before the zero line there are approximately 6 observations and after the zero line
11. Small losses occur less than small profits; a discontinuity can be observed around zero. A
statistical test has to be done to conclude whether the distribution is discontinue. The Z-statistic for
interval 0.000; 0.005 is 1.56 and for the interval -.005; 0.00 , a Z-statistic of -3,05 is calculated.
However, it cannot be concluded whether earnings are managed; it can also be the case that there was
good control within the fundraising institutions
54
Figure 8.1 - Histogram Earnings (t) scaled by Total Income (t-1); interval width 0,05
Figure 8.2 – Histogram Earnings(t) scaled by Total Income (t-1), interval width 0,005
55
8.3 Models to Detect Earnings Management Through Discretionary Accruals and Abnormal
Expenses
In this paragraph the results related to the (modified) Jones models and the normal expenses models
will be described.
The process of deriving the discretionary accruals and abnormal expenses (management
&administration, fundraising and spending on objectives) can be found in appendix G. The
assumptions of the (modified) Jones model and normal expenses models are tested and can be found in
appendix F.
(Modified) Jones Model
The descriptive statistics of the accrual and expenses models are presented in table 8.3.
Table 8.3 – Descriptive Statistics Variables (Modified) Jones Model
N
Minimum
Maximum
Mean
Std. Deviation
1/Total Assets (t-1)
253
3,35072E-9
,0000147639
7,74576388E-7
,000001515016
∆Rev /Total Assets (t-1)
253
-5,961
1,941
,077
,528
∆Rev-∆Rec / Total Assets (t-t)
262
-5,254
2,458
,061
,502
PPE(t)/Total Assets (t-1)
252
0E-10
100,203
,491
6,308
Total Accruals(t) /Total Assets (t-1)
253
-1,840
1,995
-,011
,297
Valid N (listwise)
252
The (unstandardized) residuals are used to estimate the discretionary accruals for both the Jones model
and the modified Jones model. The process for getting the discretionary accruals can be found in
Appendix G. The regression of the Jones model lead to the following equitation:
The regression of the modified Jones model results in the following equitation:
56
Normal Expenses Models
Table 8.4 present the descriptive statistics of the variables Normal Expenses Models.
Table 8.4 – Descriptive Statistics Variables Normal Expenses Models
N
Minimum
Maximum
Mean
Std. Deviation
MA/Total Assets(t-1)
246
,00
1,46
,1
,1
SO/Total Assets (t-1)
263
,02
51,77
1,4
3,3
FUN/Total Assets(t-1)
238
,00
1,17
,1
,2
253
3,35072E-9
,00001476
7,74576388E-7
,000001515912
Total Income (t-1)/Total Assets (t-1)
263
,05
57,56
1,6
3,7
Valid N (listwise)
226
The (unstandardized) residuals of the normal expenses models, as presented in paragraph 7.3.2, are the
abnormal spending on management & administration, fundraising and objectives. The residuals of the
three types of expenses (management and administration, fundraising and spending on objectives)
models form the total abnormal expenses. The process to determine the abnormal expenses can be
found in Appendix G. The following equations are composed:
8.4 Groups and Direction of Discretionary Accruals and Abnormal Expenses
As mentioned in the research design, groups are formed in order to investigate whether a relation
exists between the groups and the direction of the discretionary accruals. In addition, there will be an
examination whether a relation exists between the groups and the direction of abnormal expenses
(management & administration, fundraising and spending on objectives). In table 8.5 and 8.6 the cross
tables are presented. For each cross table a chi-square test is done in order to conclude whether the
observed and expected count differ significantly. Based on the chi-square tests, which can be found in
appendix H, it can be concluded that there is a relation between the groups and the direction of the
discretionary accruals. A relation between groups and abnormal expenses (management &
administration, fundraising and spending on objectives) is also proved. The chi-square tests and cross
tables for these relations can also be found in appendix H.
57
After concluding that the relations are significant (based on the chi-square tests), the cross tables have
to be interpreted to determine the direction of the relation between groups and discretionary accruals
and abnormal expenses. Based on table 8.5, one can conclude that group 4 uses more (less) often
negative (positive) discretionary accruals than expected. In addition, group 3 uses more (less) often
positive (negative) discretionary accruals than expected. Furthermore, the cross table shows that
managers of group 1 use more (less) often positive (negative) discretionary accruals implying that
managers increase income by using positive discretionary accruals. So managers of group 1 do not
take a bath and use negative accruals in order to decrease income. Finally, institutions in groups 2, 5
and 6 do unexpectedly not strive towards zero or a small positive result as a consequence it was
predicted that these groups will not include a lot of institutions. Few fundraising institutions fall within
these groups, which is in line with the expectations.
Table 8.5 – Cross table Direction Discretionary Accruals and Groups
The cross table of the direction of the total abnormal expenses is only included in the thesis. The cross
tables for each type of abnormal expenses (management & administration, fundraising and objectives)
can be found in appendix H. The individual cross tables of the 3 types abnormal expenses show the
same tendency as the total abnormal expenses. The focus will be on the total abnormal expenses
because the focus of this thesis is on the effect of the total abnormal expenses.
Based on table 8.6, which shows the cross table for the total abnormal expenses, one could conclude
that group 4 use more (less) often positive (negative) abnormal expenses than expected. Furthermore,
group 3 uses more (less) often negative (positive) abnormal expenses than expected. The cross table
shows that managers of group 1 are willing to increase income by using negative abnormal expenses,
so they do not take a bath and use positive abnormal expenses in order to decrease their income
further.
58
In addition, institutions in groups 2, 5 and 6 do not strive towards zero or a small positive result and it
was expected that these groups do not include a lot of institutions. Some institutions fall within these
groups, so this is in line with the expectations.
Table 8.6 – Cross table Direction Total Abnormal Expenses
The relations between the groups and the direction of the discretionary accruals and abnormal
expenses are tested separately: the total effect of both the discretionary accruals and abnormal
expenses is not investigated. Overall, it can be concluded that a relation exists between the groups and
the direction of the discretionary accruals Furthermore a relation is found between groups and the
direction of abnormal expenses. Managers of fundraising institutions use discretionary accruals and
abnormal expenses in order to report earnings close to zero or a small positive result. Managers do not
take a bath if their earnings are highly negative. If earnings are very high, managers use discretionary
accruals to reduce earnings. However they do not use abnormal expenses in order to decrease earning.
In this chapter the distribution of the earnings of Dutch fundraising institutions around zero are
examined. In addition there is tested whether discretionary accruals and abnormal expenses are used to
manage earnings towards zero or a small positive result. These tests are performed in order to
investigate the relationship between characteristics of the supervisory board & audit committee and
earnings management. The discretionary accruals and abnormal expenses are measures for earnings
management and will be the Y-variables in the regressions. The regressions will be presented and
discussed in the next paragraph. It is necessary to determine whether the discretionary accruals and
abnormal expenses are a good measures of earnings management in order to perform the regressions.
Based on the distribution approach one cannot conclude that earnings are managed at Dutch
fundraising institutions, because it is not possible to observe whether good control or earnings
management result in more observations just after the zero line. Based on the chi-square tests and
cross tables, one could conclude that managers use discretionary accruals and abnormal expenses in
order to manage earnings towards zero or a small positive result.
59
8.5 Supervisory Board an Audit Committee Characteristics on Earnings Management
In table 8.7 the descriptive statistics of the variables related to the characteristics of the supervisory
board, audit committee, discretionary accruals and abnormal expenses can be found.
Table 8.7 - Descriptive Statistics
Variable
N
Minimum
Maximum
Mean
Std. Deviation
ABS DA (Jones)
252
,000103
1,85
,1585
,24284
ABS DA (Modified Jones)
252
,000130
1,99
,1580
,24474
ABS AMAE
236
,000132
,65
,0514
,08505
ABS AFUNE
231
,0016
1,02
,0817
,12285
ABS ASO
253
,0008
3,05
,2624
,31354
ABS TAE
226
,0025
3,72
,3484
,41683
Supervisory board and audit committee variables
SBSIZE
129
1
40
8,73
6,714
SBSIZE²
138
1
1600
101,25
221,340
ACEXI
130
0
1
,46
,500
SBMEET
116
1
12
4,80
1,861
ACMEET
46
1
7
3,09
1,363
CEOTEN
117
0
25
4,77
4,656
ACTEN
46
0
11
3,54
2,610
FINEX
138
0
1
,28
,448
Valid N
Variable definitions:
ABS DA(Jones)
ABS AMAE
ABS AFUNE
ABS ASO
ABS TAE
40
= the absolute value of discretionary accruals based on Jones (1991)
= the absolute value of discretionary accruals based on Dechow et al. (1995)
= the absolute value of the abnormal management & administration expenses
= the absolute value of the abnormal fundraising expenses
= the absolute value of the abnormal spending on objectives
= the absolute value of the total abnormal expenses (management & administration, fundraising
and spending on objectives)
Supervisory board and audit committee variables:
SBSIZE
= the number supervisory board members
SBSIZE²
= the squared number supervisory board members
ACEXI
= a dummy variable coded 1 if an audit committee exists at a fundraising institution, and 0
otherwise.
SBMEET
= the number of meetings held by the supervisory board
ACMEET
= the number of meetings held by the audit committee.
CEOTEN
= tenure of the CEO
ACTEN
=average tenure of the audit committee members
FINEX
=a dummy variable coded 1 if the audit committee has at least one member with financial
experience (finance, supervisory or accounting experience), and 0 otherwise.
The number of observations of the variables ACMEET and ACTEN are very low (46) for that reason
ACMEET and ACTEN will be excluded in the models in order to get regressions which are based on a
higher number of observations. In appendix I an overview of the regression analysis which includes all
the variables can be found.
60
Earnings Management at Dutch Fundraising Institutions; the Impact of Characteristics of the Supervisory Board & Audit Committee
Table 8.8 contains results of the regression models with the dependent variable ABS DA. In model 1
and 3 the linear variables SBSIZE, ACEXI, SBMEET, CEOTEN, and FINEX are tested on
discretionary accruals, which are calculated via the (modified) Jones Model. In model 2 and 4 the
quadratic variable SBSIZE² is added because hypothesis 6A predicted a quadratic relationship between
SBSIZE and discretionary accruals.
All the regression models are significant: models 1, 3, and 4 at 5% level and model 2 at 10% level,
implicating that the individual coefficients can be interpreted. The models have R-squares between
10.9 % and 14,9% , which indicated that the model explains minimal 10.9%% of the variation in the
discretionary accruals of the fundraising institutions in the sample. Yang and Krishnan (2005), who
investigated the relationship between audit committee characteristics and quarterly earnings
management in the United States based on 896 firm-year observations, reported R-squares around
3.1% and 16,2%.
A negative relationship in regression 1 and 3 is found between the size of the supervisory board
(SBSIZE) and discretionary accruals. A possible reason why a negative relationship is found is based
on the argument that adding more members enhances the performance of the members. Larger boards
allow for more specialized division of labour and increases monitoring ability of boards, resulting in
less earnings management. Adding the quadratic effect in model 2 and 4 does not improve model 1 nor
model 3. Meaning that there is no curvilinear (u-shaped) relationship between the size of the
supervisory board and discretionary accruals: hypotheses 6A is not supported.
In advance, no expectation for the direction of the variable SBMEET on discretionary accruals is
formed in hypothesis 8A. Regressions 3 and 4 indicate a positive relationship between the number of
supervisory meetings (SBMEET) and discretionary accruals. This result could be explained by the
idea that more supervisory board meetings indicate the presence of problems in the fundraising
institutions. Boards which meet not very often can be interpreted as stable, with less earnings
management.
Hypothesis 10A predicted that the CEO tenure is positively related to discretionary accruals.
Unexpectedly, the coefficient CEOTEN is negative in all the models. Furthermore, a negative
relationship between the existence of an audit committee (ACEXI) cannot be proved. In addition a
negative relationship between financial experience of the audit committee members (FINEX) and
discretionary accruals is not found. These two variables are not significant in any model; hypotheses
7A and 12A cannot be proved.
61
8.8– Regression Discretionary Accruals
Dependent variables
Independent variables
SBSIZE
1
ABS DA
(Jones Model)
2
ABS DA
(Jones Model)
3
ABS DA
(Mod. Jones Model)
4
ABS DA
(Mod. Jones Model)
-0.002
(0.147)
-0.002
(0.255)
-0.001
(0.090)*
-0.002
(0.190)
SBSIZE ²
-2.372E-005
(0.336)
-1.672E-005
(0.670)
ACEXI
-0.023
(0.276)
-0.023
(0.286)
0.001
(0.926)
0.002
(0.912)
SBMEET
-0.001
(0.786)
-0.001
(0.732)
0.005
(0.065)*
0.005
(0.086)*
CEOTEN
-0.005
(0.004)***
-0.005
(0.004)***
-0.003
(0.014)**
-0.003
(0.013)**
FINEX
0.016
(0.491)
0.015
(0.503)
0.002
(0.891)
0.002
(0.908)
Constant
0.130
(0.000)***
0.135
(0.000)***
0.067
(0.000)***
0.001
(0.000)***
Significance model
N
R-Square
(0,054)*
99
10.9%
(0.088)*
99
11.0%
(0,020)**
89
14.7%
(0.036)**
89
14.9%
Variables definitions:
ABS DA(Jones)
ABS AMAE
ABS AFUNE
ABS ASO
ABS TAE
SBSIZE
SBSIZE²
= the squared number supervisory board members
ACEXI
otherwise.
SBMEET
ACMEET
CEOTEN
= tenure of the CEO
ACTEN
FINEX
***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively.
Table 8.9 contains results for the regression models with the dependent variable ABS AMAE, ABS
AFUNE, ABS ASO and ABS TAE. In regressions 5, 7, 9 and 11 the linear variables SBSIZE, ACEXI,
SBMEET, CEOTEN, and FINEX are tested on abnormal expenses (management & administration
expenses, fundraising expenses, spending on objectives and total abnormal expenses). In regressions 6,
62
8 and 10 the quadratic effect of SBSIZE² is added in order to examine whether the quadratic effect will
improve the model 5, 7 and 9. When interpreting the p-values of the regressions it can be concluded
that only the models 5 and 6 are significant. As a consequence only the coefficients of model 5 and 6
can be interpreted.
Hypothesis 7B states that the existence of an audit committee (ACEXI) is negatively related to
abnormal management & administration expenses. The result presented in table 8.9 does not support
this hypotheses: a positive relationship is found between ACEXI and abnormal management &
administration expenses. The existence of an audit committee lead to more abnormal management and
administration expenses.
Hypothesis 12B predicted that the financial experience of that audit committee is negatively related to
abnormal expenses. As shown in table 8.9, this hypothesis is supported: a negative relationship
between the financial experience of audit committee members (FINEX) and abnormal management &
administration expenses is found.
Hypotheses 6B, 8B, and 10B cannot be proved because the size of the supervisory board (SBSIZE),
the number of supervisory board meetings (SBMEET) and the tenure of the CEO (CEOTEN) are not
significant.
63
Table 8.9 – Regression Abnormal Expenses
Dependent variables
SBSIZE
5
ABS AMAE
-0.000279
(0.341)
SBSIZE²
6
7
ABS AMAE ABS AFUNE
-0.000306
(0.357)
-0.001
(0.934)
-4.971-009
(0.862)
8
9
ABS AFUNE ABS ASO
-0.001
(0.341)
2.376E-005
(0.239)
ACEXI
0.021
(0.001)***
0.021
(0.001)***
0.014
(0.077)*
0.014
(0.085)*
SBMEET
-0.001
(0.429)
-0.001
(0.808)
-0.001
(0.422)
0.001
(0.319)
CEOTEN
-0.000304
(0.489)
-0.000292
(0.4513)
-0.001
(0.319)
FINEX
-0.020
(0.003)***
-0.020
(0.001)***
Constant
0.014
(0.055)*
Significance model
N
R-Square
(0,011)**
97
14.0%
Variable definitions:
ABS DA(Jones)
ABS AMAE
ABS AFUNE
ABS ASO
ABS TAE
0.001
(0.552)
10
11
ABS ASO ABS TAE
0.001
(0.464)
0.002
(0.392)
-4.706E-008
(0.700)
0.028
(0.227)
0.028
(0.236)
-0.011
(0.761)
0.008
(0.057)*
0.008
(0.081)*
0.003
(0.620)
-0.000443
(0.424)
0.003
(0.106)
0.003
(0.125)
0.004
(0.160)
-0.013
(0.144)
-0.012
(0.156)
-0.031
(0.210)
-0.032
(0.210)
-0.016
(0.697)
0.014)
(0.061)*
0.042
(0.000)***
0.037
(0.000)***
(0.023)**
97
14.8%
(0,427)
96
5.2%
( 0.390)
96
6.7%
0.082
0.083
0.141
(0.004)*** (0.004)*** (0.003)**
(0.199)
90
8.2%
(0.279)
90
8.4%
(0.608)
90
3.1%
SBSIZE
SBSIZE²
ACEXI
otherwise.
SBMEET
ACMEET
CEOTEN
= tenure of the CEO
ACTEN
FINEX
64
Chapter 9 – Conclusion, Limitations and Implications for Further Research
This thesis focused on earnings management at Dutch fundraising institutions. Throughout the years
research has been conducted with respect to earnings management in the profit sector, while the nonprofit sector is getting less attention. Prior literature to earnings management in the non-profit sector
mainly includes research conducted in the health care sector and municipalities. There is a very small
base of literature on earnings management at fundraising institutions. Fundraising institutions and the
discretionary methods to mange spending and efficiency ratios are investigated, however this thesis
investigated earnings management at Dutch fundraising institutions. In addition, research has been
done with respect to earnings management and corporate governance (supervisory board and audit
committee characteristics) aspects in the profit sector. This thesis investigated the relationships
between characteristics of the supervisory board & audit committee and earnings management in the
Dutch fundraising institutions.
The following research question is composed:
“What is the effect of supervisory board & audit committee characteristics on earnings
management through discretionary accruals and abnormal expenses at Dutch fundraising
institutions?”
In order to answer the research question the concept of (real) earnings management is discussed. The
definition of earnings management as noticed by Scott (2006) has been used throughout this
thesis:“The choice by a manger of accounting policies, or actions affecting earnings, so as to achieve
some specific objectives.” Managers of fundraising intuitions have an information advantage over
stakeholders. Due to information asymmetry it is possible for managers to manage earnings, since
stakeholders have little information to assess whether the disclosed financial statements are reliable.
There are a number of reasons why managers engage in earnings management. Healy and Wahlen
(1999) have structured these reasons into three incentives for engaging in earnings management:
capital market expectations and valuation, contract written in terms of accounting numbers and antitrust or other government regulations. These incentives are related to the profit-sector.
Incentives to apply earnings management in the non-profit sector differ from those in the profit sector.
Prior research is mainly done at non-profit hospitals in the United Kingdom and United States. An
important incentive for fundraising institutions to engage in earnings management is related to antitrust or other government regulation. Fundraising institutions are visible for the society and are subject
to the political agenda. High profitability can lead to increased political heat and public debate and as a
consequence a decrease of the donation base. Based on that, it is expected that fundraising institutions
manage their earnings towards zero or a small positive result.
65
This thesis also focused on the relationship between characteristics of the supervisory board & audit
committee and (real) earnings management. Based on prior research, it is expected that the size of the
supervisory board, the number of supervisory board & audit committee meetings, the tenure of the
CEO & audit committee members, and the financial experience of the audit committee members have
a relationship with discretionary accruals and abnormal expenses of Dutch fundraising institutions.
After setting out prior research related to earnings management, hypothesis are formulated and
empirical research is done. Different approaches are used to detect earnings management at Dutch
fundraising intuitions. At first, the income distribution of Dutch fundraising institutions is discontinue
around. However, it cannot be concluded that this is an effect of earnings management or good control
within the institutions. Subsequently, groups are formed (based on EBDA) to investigate whether a
relation exists between groups and the direction (positive or negative) of discretionary accruals.
Furthermore, an examination of the relation between groups (based on EBAE) and the direction of the
abnormal expenses (abnormal spending on management & administration, fundraising and objectives)
is done. A relation between groups and discretionary accruals & abnormal expenses is found. Earnings
are managed towards zero or a small positive result. Moreover, results suggested managers do not take
‘a big bath’ if their earnings are highly negative by using negative discretionary accruals and/or
positive abnormal expenses.
Supervisory board & audit committee characteristics and its relationship with discretionary accruals
and abnormal expenses is investigated. A negative relationship between the size of the supervisory
board and discretionary accruals is found. Furthermore, results show that the number of supervisory
board meetings is positively related to discretionary accruals. A negative relationship between
financial expertise of the audit committee members and discretionary accruals was expected.
However, this relationship cannot be proved.
Prior literature discussed in this thesis found evidence for a positive relationship between the tenure of
the CEO and earnings management. Unexpectedly, the results show that the tenure of the CEO is
negatively related to discretionary accruals. The ethical behaviour and the moral of CEOs at non-profit
institutions compared to CEOs at profit institutions can be an explanation for finding a negative
relationship between the tenure of the CEO and earnings management.
Bower and Shrader (2000) investigated differences in moral reasoning and ethical climate between
board members in profit institutions and non-profit institutions at the United States. Six profit
institutions and seven non-profit corporations participated in the survey study. They argue that
although CEOs who serve on for-profit and non-profit institutions are generally in the same age and
have similar educational levels, the motives and expectations for serving on a non-profit board are
different from those serving on a for profit board. A CEO for a non-profit institution is seeking some
type of esoteric reward and is often committed to making decisions in the best interest of the
66
stakeholders which are served by the institution. Non-profit CEOs are not charged with the role of
oversight as in for profit institutions which has CEOs chosen to protect the shareholders’ interests
(Bower and Shrader, 2000). In addition, less ethical behavior of the CEOs is expected in the for profit
sector because non-profit CEOs are closer and often more accountable to their constituents which may
influence the ethical appearance of their decisions (Metzger and Dalton, 1996). The decisions made
would generally not contribute to the personal wealth. However, for-profit CEOs often stand to benefit
or suffer personal consequences for decisions (Bower and Shrader, 2000). Based on these arguments
one could carefully conclude that CEOs of fundraising institutions make decisions based on the best
interest of the stakeholders, and as a consequence do not manage earnings. The longer the CEO serves
the board, the better the understanding of the institutions and its stakeholders. Furthermore, CEOs at
fundraising institutions do not suffer personal consequences as a result of the reported earnings and are
for that reason less willing to manage earnings. It has to be noticed that the results and explanations
for the outcomes have to be interpreted very carefully. Further research has to be conducted on this
aspect in order to generalize the results of this thesis to other non-profit institutions and to fundraising
institutions in other countries.
Unexpectedly, no relationship between discretionary accruals & abnormal expenses and the existence
of an audit committee was found in this research. Prior studies indicated a negative relationship
between the existence of an audit committee and earnings management. However, it has to be noticed
that these studies were done at profit-institutions. Based on results in this thesis, one could carefully
conclude that the existence of an audit committee at non-profit institutions has no relation with
earnings management. In addition, it can be cautiously concluded that a difference is found in the
impact of the existence of an audit committee on earnings management at non-profit institutions and
profit institutions. The existence of an audit committee will lead to less earnings management at profit
institutions but the existence of an audit committee will not have an impact on earnings management
at non-profit institutions. If this result found in this study is confirmed in the future, it can be
concluded with more certainly that the impact of the audit committee is not related to earnings
management at non-profit institutions and that a difference in the existence of an audit committee at
profit institutions and non-profit institutions is found.
Due to the insignificance of the other regressions, only the model related to characteristics of the
supervisory board & audit committee and abnormal management and administration can be
interpreted. Consistent with previous research, a negative relationship between financial expertise and
abnormal spending on management & administration is found. The size of the supervisory board, and
number of board meetings are not related to abnormal management & administration expenses.
As with every research there are several limitations that should be taken into account with regard to
the results. At first, the selection of a small number of institutions limits the power of the statistical
67
tests. The power of a test decreases when fewer observations are included. Due to reasons of time and
resource availability, it was not possible to investigate more institutions. Moreover, the small number
of observations has an effect on the ability to generalize the results to all fundraising institutions.
Another limitation is that this research is conducted on Dutch fundraising institutions. Generalizing the
results of this research to other countries should be done carefully. Future research can be focused on
the relationship between characteristics of the supervisory board & audit committee and earnings
management at fundraising institutions in other countries in order to generalization of outcomes
possible.
The research has been done by analyzing financial statements of fundraising institutions. Data is
received from the CBF and some data is manually gathered. Corrections in the dataset are made,
because mistakes were found. Despite these corrections, errors can exist in the dataset which could
have an impact on the outcomes of the analysis. Assumptions are made about the incentives to apply
earnings management. The theoretical background of this thesis is mainly built on research done at
profit institutions and at non-profit institutions outside the Netherlands. Differences can exist between
profit institution, non-profit institutions and countries. This can lead to other outcomes in the
fundraising sector (non-profit) than in the profit sector. This has also an effect on comparability of the
results. Furthermore, the estimations of the discretionary accruals and abnormal expenses are
debatable; the independent variables are not normally distributed and could indicate that the regression
analysis are impropriate to apply.
Earnings management is focused on the intention of the management, the use of earnings management
itself is not measured. Qualitative research methods should be performed in order to measure the use
of earnings management. Internal information about specific accounts which are used to manage
earnings are needed. Getting that kind of information will be hard, because it is expected that
managers will not communicate whether or not earnings are managed. Due to that this research is
focused on detecting the use of earnings management through the distribution approach, discretionary
accruals and abnormal expenses. However, this type of research can be done in the future.
An interesting point for further research is the order of application accruals or real variables to manage
earnings. Managers can influence accounting income by using different methods. Some methods
require real transactions while some are pure accounting decisions. Zang (2011) found that managers
determine real manipulation before accrual manipulation. Moreover, Graham, Harvey and Rajgopal
(2005) suggested that firms switched to managing earnings using real methods, possibly because these
techniques are likely to be harder to detect. Further research can be done related to the application of
(real) earnings management if an audit committee exists at fundraising institutions. It is interesting to
investigate whether institutions which have an audit committee tends towards using real variables (e.g.
abnormal expenses) and institutions without an audit committee are more likely to use accruals.
68
Finally, this research focused on the relationship between characteristics of the supervisory board &
audit committee and earnings management at the largest (based on total assets) fundraising
institutions. However, further research can be conducted to earnings management and the subgroups
(health, international aid, nature & environment and well-being & social goals) in the population.
69
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75
Appendix A - Model for the Balance sheet and the Profit and Loss statement
Figure A.1 - Model for the Profit and Loss statement
Figure A.2- Model for the Balance Sheet
In order to allocate costs at the profit and loss statement, figure A.3 have to be
filled in.
Figure A.3 – Model for Cost Allocation.
77
Appendix B - Translation of governance bodies
English
Dutch
Board of Directors
Directie
Governing board
Bestuur
Titular execution
Titulaire directie
Statutory board
Statutaire directie
Supervisory body
Toezichthoudend orgaan (RvT)
General assembly meeting
Algemene ledenvergadering (ALV)
Audit Committee
Auditcommissie
Based on: Seal Regulations CBF Seal of Approval (English version), 2010
78
Appendix C – Literature overview; Characteristics Board of Directors & Audit Committee on Earnings
Management
Authors
Subject of study
Sample
Methodology
Results
Abbott, Parker
and Peters
(2000)
The impact of certain audit
committee characteristics identified
by the Blue Ribbon Committee on
improving the effectiveness of
corporate audit committees on the
likelihood of financial misstatement.
This study tests the relation between
earnings informativeness and the
structure of corporate boards in New
Zealand.
Examination of 83
firms which misstated financial
reports in the period 1991-1999,
together with a matched pairs
control group of similar size.
Regressions
They find that independence of the
committee is negatively related to
misstatement, but the size of the committee
and the financial expertise of the audit
committee members are not related
Sample consists of 615 firm-year
observations. Firms are listed on
the NZ exchange for the years
1991 through to 1997.
Regressions
Smaller boards are more effective than a
larger boards in monitoring the quality of
earnings.
Baxter and
Cotter (2009)
Investigation whether audit
committees are associated with
improved earnings quality, measured
by Jones model (1991) and Dechow
and Dichev model (2002).
The sample consists Australian
listed companies.
Matched pairs
t-test and
regressions
Beasley and
Saltero (2001)
This study examines the relation
between board of director
characteristics and the extent that
audit committee composition
voluntarily exceeds minimum
mandated levels and includes outside
directors with accounting and audit
committee knowledge and
experience.
Sample is based on firms
included in the Report on
Business 1000 Canadian firms
(which represent a listening of
1,000 most profitable firms) for
fiscal year 1994. 627 Canadian
firms are included in the sample.
Regressions
Intentional earnings management is
reduced when an audit committee is
formed. They also found differences in the
associations between audit committee
accounting expertise and the two earnings
quality measures.
The results confirm the prediction that
firms with greater representation of outside
directors on the board, firms that segregate
the board chairperson and CEO positions,
and firms with larger boards are more
likely to create audit committees that
voluntarily include more outsiders than
Canadian corporate law requires, and those
firms are more likely to voluntarily include
outsiders on the audit committee with a
Ahmed, Hossain
and Adams
(2006)
79
Bedard,
Chtourou and
Couteau (2004)
Investigation whether expertise,
independence, and activities of the
audit committee have an effect on
the quality of financial information
(measured by abnormal accruals)
Sample is drawn from
population of US firms that are
included in Compustat in 1996.
From that population 100 firms
with the highest income
decreasing abnormal accruals,
100 highest income increasing
abnormal accruals, and 100 with
the lowest abnormal accruals are
identified.
(Logit)Regressi
on model
Bradbury, Mak
and Tan (2006)
The purpose of this paper is to
examine the relation between board
and audit committee characteristics
and accounting quality (measured by
abnormal accruals).
Sample comprises of 139 firms
listed on the Singapore Stock
Exchange and 113 firms listed
on the Kuala Lumpur Stock
Exchange for the year 2000.
Regressions
Davidson,
GoodwilStewart and
Kent (2005)
Research the role of the internal
governance structure of a firm in
constraining earnings management
434 listed Australian firms, for
the financial year ending in
2000.
Regressions
DeFond, Hann
and Xu (2005)
Testing the whether the market react
positively to the appointment of
directors with financial expertise to
the audit committee.
850 newly appointed outside
board members assigns to audit
committees during 1993-2002.
Corporate library database is
used to make a sample selection.
Regressions
greater breadth of financial reporting and
audit committee knowledge and
experience.
Aggressive earnings management is
negatively associated with the financial and
governance expertise of the audit
committee members, with indicators of
independence, and the presence of a clear
mandate defining responsibilities of the
committee.
Board size and audit committee
independence are related to lower
abnormal working capital accruals.
Furthermore, the relation between audit
committee independence and higher
quality accounting exists only when the
abnormal accruals are income increasing.
Lower likelihood of earnings management
when majority of the board and audit
committee consists of non-executives.
Negative association between earnings
management and the existence of an audit
committee.
Positive CARs around the appointment of
accounting financial experts to the audit
committee is found, but not around the
appointment of non-accounting financial
experts or directors without financial
expertise.
80
DeZoort and
Salterio (2001)
This study reports the investigation
whether audit committee members’
corporate governance expertise and
financial reporting and audit
knowledge affect their judgements in
auditor-corporate management
conflict situations
68 Canadian audit committees
members
Regressions
Consistent with the calls for audit
committees to be made up of independent
directors and who are financially literate
Dhaliwal,
Naiker and
Navissi (2010)
Investigation of the association
between three types of audit
committee financial expertise
(accounting, financial and
supervisory) and accrual quality.
Final sample consists of 770
firms out of COMPUSTAT and
Board Analyst databases during
2004 to 2006
Cross-sectional
regressions
The most positive impact on accruals
quality is achieved when firms posses a
combination of both accounting and
finance and supervisory experts in the audit
committee
Felo,
Krishnamurthy
and Solieri
(2003)
The researchers examine the
relationship between the
composition (expertise and
independence) and the size of the
committee – and the quality of
financial reporting.
The sample consists of firms
from the 1992-93 and 1995-96
AIMR Review of Corporate
Reporting Practices. 119 firms
are included for the period 199293, and for 1995-96 130 firms.
Regressions
After controlling for firm size, board
composition and institutional ownership,
the percentage of audit committee
members having expertise in accounting or
financial management is positively related
to financial reporting quality. In addition
some evidence is found of a positive
relation between the size of the audit
committee and financial reporting quality.
Jouber and
Fakhfakh (2010)
Investigation of the relationship
between board of directors’
characteristics and earnings
management.
180 French and Canadian listed
firms ‘data over 2006-2008
Regressions
Evidence shows that CEO stock
ownership, independent monitoring and
institutional investor's property are strong
earnings management determinants.
Leadership structure and board size seem
to be neutral.
81
Lin, Li and
Yang (2006)
Researchers focus on the association
between several characteristics of
the audit committee (size, expertise,
independence, activity and stock
ownership) and earnings
management, proxied by earnings
restatements.
106 publicly held corporations
in the USA, which restated their
reported earnings for the fiscal
year 2000 and 106 control firms.
They are matched based on fourdigit SIC code and total assets.
Univariate
correlations
and (Logistic)
Regression
Negative association between the size of
the audit committee and the occurrence of
earnings restatement is found. For the other
characteristics, no relation is found
Peasnell, Pope
and Yang (2005)
Examination whether the incentives
of earnings management depends on
board monitoring
Tests are conducted using data
from UK listed firms. Sample
consists of 1,271 firm-years
OLS
regressions and
Logistic
regression
Rashidah and
Ali (2006)
Investigation the extent of the
effectiveness of monitoring
functions of the board of directors
and the audit committee.
97 firms listed in the Main Board
of Bursa Malaysia over 20022003
Regressions
Turley and
Zaman (2004)
Providing a synthesis and evaluation
of empirical research on the
governance effects associated with
audit committees.
Discussion of prior literature,
suggests a number of general
observations concerning the
development of future research
Literature
review
The likelihood of managers making
income-increasing abnormal accruals to
avoid reporting losses and earnings
reductions is negatively related to the
proportion of outsiders on the board. Little
evidence found that outside directors
influence income-decreasing abnormal
accruals when pre-managed earnings are
high. Also no evidence that they presence
of an audit committee directly affects the
extent of income-increasing manipulations
to meet or exceed these thresholds. Neither
do audit committees appear to have a direct
effect on the degree of downward
manipulation, when pre-managed earnings
exceed thresholds by a large margin.
Earnings management is positively related
to the size of the board of directors. No
significant relation between independence
of the board and the audit committee on
earnings management found. Ethnicity has
no effect on mitigating earnings
management.
No automatic relationship between the
adoption of audit committee structures or
characteristics and the achievement of
particular governance effects, and caution
82
A framework for analyzing the
impact of audit committees is
described, identifying potential
perceived effects which may have
led to their adoption and documented
effects on aspects of the audit
function, on financial reporting
quality and on corporate
performance.
Vafeas (1999)
Vafeas (2005)
Xie, Davidson
III and DaDalt
(2002)
may be needed over expectations that
greater codification around factors such as
audit committee members’ independence
and expertise as the means of ‘‘correcting’’
past weaknesses in the arrangements for
audit committees.
The most fundamental question concerning
what difference audit committees make in
practice continues to be an important area
for research development.
Overall the results suggest that board
activity is an important dimension of board
operations.
This study examines whether the
frequency of board meetings helps in
reducing the problem of limited
director interaction.
This research examines how the
structure and activity of audit
committees and the structure of
corporate boards relate to the quality
of earnings information produced by
firms. To study the link between
boards and audit committees with
earnings quality, two proxies for
poor earnings quality are used: small
earnings increases and negative
earnings avoidance.
1,382 observations for 307 firms
over the period 1990 to 1994 are
included in the sample.
Regressions
The sample compromised an
panel of data over a seven-year
period, ranging from 252 U.S
firms in 1995 to 182 U.S firms in
2000, with a total of 1,621firmyear observations.
(Logistic)
Regressions
and regressions
of changes in
audit
committees and
boards on the
indicators of
poor earnings
quality.
Results related to small earnings increases
are consistent with prior literature. Audit
committee insiders are associated with
lower quality, active business executives
protect management over shareholders, and
audit committee meeting frequency is
associated with higher earnings quality.
The results on negative surprise avoidance
compare modestly with prior research;
equity incentives increases earnings quality
and length of board tenure decreases
earnings quality.
Examination of the role of the board
of directors, the audit committee and
the executive committee in
preventing earnings management.
Sample is based on the first 110
(alphabetically) from the S&P
500 index as listed in the June
S&P directory for each of the
year’s 1992, 1994 and 1996. The
final sample consists of 282
firm-year observations
Regressions
Earnings management is less likely to
occur or occurs less often in companies
whose boards include both more
independent outside directors and directors
with corporate experience. The
composition of the audit committee is
associated with the level of earnings
management. The proportion of audit
83
committee members with financial
expertise is negatively related to the level
of earnings management. There is also an
association between lower levels of
earnings management and the meeting
frequency of boards and audit committees.
Yang and
Krishan (2005)
Testing the association between
audit committee characteristics
(independence, number of meetings,
financial expertise, stock ownership,
outside directorships, experience,
tenure, number audit committee
members) and measures of quarterly
earnings management.
896 firm-year observations for
the years 1996-2000.
Regressions
Yermack (1996)
Finding evidence consistent with
theories that small boards of
directors are more effective
Firms drawn from the annual
Forbes magazine ranking of the
500 largest U.S public
corporations. Sample of 3,438
observations of 452 U.S public
companies across 1984 and
1991.
Regressions
Quarterly earnings management is lower
for firms which audit committee directors
have greater governance expertise. In
addition, the extent of stock ownership of
audit committee directors is positively
associated with quarterly earnings
management. Furthermore, the average
tenure of
audit committee directors is negatively
associated with quarterly earnings
management.
An inverse association between board size
and firm value is found. The association
appears to have a convex shape, suggesting
that the largest fraction of lost value occurs
as boards grow from small to medium size.
84
Appendix D – Explanation Normal Discretionary Expenses Model of
Roychowdhury (2006)
Discretionary expenses included: R&D, advertising, and SG&A expenses. Institutions can reduce or
increase reported expenses. The following model is used by Roychowdhury (2006) in order to
determine normal discretionary expenses:
When estimating non-discretionary accruals it is general convention in the literature in the literature to
include a scaled intercept,
. This avoids spurious correlation between scaled DISEX and scaled
sales due to variation in the scaling variable, total assets. The unscaled intercept is included to ensure
that the mean abnormal DISEX for every industry-year is zero. The variable
including
is used because
created a problem; if managers manage sales upward to increase earnings in any year
they can exhibit unusually low residuals even when they do not reduce discretionary expenses.
Table D.1 shows how sales and R&D expenses are related; if sales increase the R&D expenses will be
higher. The error represent the abnormal R&D expenses.
Table D.1 – Graphical Presentation Abnormal Discretionary Expenses Model
Discretionary expenses
(like R&D)
o
error Abnormal Discretionary Expenses
Sales
Fundraising institutions do not have sales, so for that reason total income is included as a substitute for
sales.
85
Appendix E – Earnings Distribution
Table E.1 – Income smoothen, interval width 0,05
Interval
Observed count
Interval
0 ; 0,05
0,05 ; 0,0
N
257
257
po
34,5
48
p-
0,151
0,066
p+
0,12
0,31
29,86
39,035
St. deviation
5,47
6,25
Z- statistic
8,14
-7,68
-,65; -,60
1
-,60; -,55
0
-,55; -,50
0
-,50 ; -,45
0
-,45; -,40
1
-,40; -,35
2
-,35; -,30
1
-,30; -,25
3
-,25; -,20
4
-,20; -,15
3
-,15; -,10
15
N
-,10; -,05
17
po
-,05; 0,00
39
0,00; 0,05
79
0,05; 0,10
30
Variance
0,10; 0,15
17
0,15; 0,20
11
0,20; 0,25
8
0,25; 0,30
2
0,30; 0,35
7
0,35; 0,40
2
0,40; 0,45
3
0,45; 0,50
4
0,50; 0,55
1
0,55; 0,60
2
0,60; 0,65
1
0,64; 0,70
1
0,70; 0,75
0
0,75;0,80
0
0,80 ; 0,85
1
0,85 ; 0,90
1
0,90 ; 0,95
1
Variance
Interval
0 ; 0,005
-0,005 ; 0,0
230
230
7
9
p-
0,026
0,030
p+
0,0348
0,050
6,787
8,648
St. deviation
2,60
2,94
Z statistic
1,54
-3,06
86
Appendix F – Assumptions of the (Modified) Jones Models and Normal
Expenses Models
(Modified) Jones Model
Before using the (Modified) Jones Model to calculate the discretionary accruals it is necessary to test
the underlying assumptions of the multiple regression model.
In order to apply regression analysis the independent variables need to meet the assumption of
normality. To test whether the independent variables are normally distributed the KolmogorovSmirnov test is performed (Table F.1). The following hypothesis can be formed:
.
.
In all the cases the level of significance is less than alpha (0,05), therefore the null hypothesis is
rejected.
Table F.1 – Normality test for the independent variables
Kolmogorov-Smirnov Test
PPE (t)
N
Normal Parametersa,b
Most Extreme
Differences
∆Rev
∆Rev-∆Rec Total Assets (t-1) Total Accruals(t)
264
266
265
263
253
Mean
2378587,05
468404,56
752172,1
16991953,7
-382844,2
Std. Deviation
11123304,3
6354929,4
5274788,8
41139929,0
3001515,8
Absolute
,415
,295
,304
,340
,255
Positive
,374
,295
,304
,312
,218
Negative
-,415
-,292
-,260
-,340
-,255
6,748
4,809
4,947
5,512
4,048
,000
,000
,000
,000
,000
Kolmogorov-Smirnov Z
Asymp. Sig. (2-tailed)
a. Test distribution is Normal.
b. Calculated from data.
Besides the normality assumption for the independent variables there are other assumptions related to
the residuals which have to be met:

Normality of errors;

Linearity;

Homoscedaticity or equal variance

Independence of errors;
These assumptions will be tested for both the Jones model and the Modified Jones model.
87
Normality of errors
Regression assumes that the residuals have normal distributions. To check this assumption a normal
probability plot is constructed. In the plots the standardized residuals, the actual scores are ranked and
sorted and an expected normal value is calculated. The plots are shown in figure F.1 and F.2. The
residuals are normally distributed if the actual values will up along the diagonal. In the both plots a
kind of pattern can be observed.
Figure F.1 – Normal probability plot of the standardized residuals of the Jones Model
Figure F.2 – Normal probability plot of the standardized residuals of the Modified Jones
Model
88
Linearity and Homoscedasticity
To test linearity and equal variances the plot of standardized residuals versus predicted scored is
produced (Figures F.3 and F.4). The assumption of linearity is met since the graphs below do not show
some kind of patterns. The observations are distributed randomly. Equal variances require that the
variation around the line of the plot must be constant at all values. The values are equally distributed
around zero, which indicate homoscedasticity.
Figure F.3 –Standardized residuals against predicted residuals for the Jones model
Figure F.4 – Standardized residuals against predicted residuals for the Modified Jones model
89
Independence
Independence of errors requires that the residuals around the regression line must be independent for
each value of X. Independence of the residuals can be tested by the Durbin Watson statistic. The
Durbin Watson statistic for the Jones model is 2,215 and for the Modified Jones model is 2,197. If the
variables are not correlated the statistic have to be close to zero, so it can be concluded that the
residuals are independent for both the Jones model and the Modified Jones model.
Normal Expense Models
The same assumptions tested for (Modified) Jones Model are tested for the Normal Expenses Models.
Before using the Normal Expenses Models to calculate the abnormal expenses it is necessary to test
the underlying assumptions of the multiple regression model.
In order to apply regression analysis the independent variables need to meet the assumption of
normality. To test whether the independent variables are normally distributed the KolmogorovSmirnov test is performed. The normality of the variable total assets (t-1) is tested in table F.1, so only
the variable Total Income (t-1) will be tested. The following hypothesis can be formed:
.
.
In all the cases the level of significance is less than alpha (0,05), therefore the null hypothesis is
rejected.
Table F.2 – Normality test for the independent variables
One-Sample Kolmogorov-Smirnov Test
Total Income (t-1)
N
266
Normal Parametersa,b
Most Extreme Differences
Mean
12625425,41
Std. Deviation
29877490,59
Absolute
,337
Positive
,313
Negative
-,337
Kolmogorov-Smirnov Z
5,502
Asymp. Sig. (2-tailed)
,000
a. Test distribution is Normal.
b. Calculated from data.
90
Normality of errors
To check the normality of errors a normal probability plot is constructed (figures F.5,F.6 and F.7). The
residuals are normally distributed if the actual values will up along the diagonal. In the plots a kind of
pattern can be observed.
Figure F.5 – Normal probability plot of the standardized residuals of the Normal
Management & Administration Expense Model.
Figure F.6 – Normal probability plot of the standardized residuals of the Normal Fundraising
Expenses Model.
91
Figure F.7 – Normal probability plot of the standardized residuals of the Normal Spending on
Objective Expenses Model.
Linearity and Homoscedasticity
The assumption of linearity is met since the graphs below do not show some kind of patterns (figures
F.8, F.9 and F.10). The observations are distributed randomly. Equal variances require that the
variation around the line of the plot must be constant at all values. The values are not equally
distributed around zero, which indicate no homoscedasticity.
Figure F.8 –Standardized residuals against predicted residuals for the Normal Management
& Administration Expenses Model.
92
Figure F.9 –Standardized residuals against predicted residuals for the Normal Fundraising
Expenses Model.
Figure F.10 –Standardized residuals against predicted residuals for the Normal Spending on
Objective Expenses Model.
Independence
The Durbin Watson statistic for the Normal Management & Administration Model is 2,239 and for the
Normal Fundraising Expenses model 2,020 and for the Normal Spending on Objectives model 2,148.
If the variables are not correlated the statistic have to be close to zero, so it can be concluded that the
residuals are independent for both the Normal Expenses Models.
93
Appendix G – Significance of the (Modified) Jones models and Normal
Expenses Models
Jones model
The Jones model used is shown below (Jones, 1991):
Table G.1 indicated that at least one of the coefficients are significantly different from zero, the pstatistic is 0,018 and below the 0,05 cut-off.
Table G.1 – Jones model regression significance
One-way model regression significance
Sum of Squares
Regression
df
Mean Square
1,096
3
,365
Residual
21,134
248
,085
Total
22,231
251
F
Sig.
,006b
4,289
a. Dependent Variable: Total Accruals (t)/Total Assets (t-1)
b. Predictors: (Constant), 1/Total Assets (t-1), ∆ REV/Total Assets (t-1), PPE (t)/Total Assets (t-1)
In table G.2 the individual coefficients can be found. The variables 1/Total Assets (t-1) and ), PPE
(t)/Total Assets (t-1) are insignificant. Nevertheless, the variables are included in the model because
prior research supports this variables as a significant component within the model. The rather small
sample size could influence the outcomes of the regression statistics and the significance of the
variables.
Table G.2 – Jones Model coefficients
Unstandardized
Standardized
Coefficients
Coefficients
B
(Constant)
∆REV/Total Assets (t-1)
PPE (t)/Total Assets (t-1)
Std. Error
-,010
,021
-11641,625
12153,553
,118
-,0004
t
Sig.
Beta
-,487
,627
-,059
-,958
,339
,050
,209
2,332
,020
,004
-,009
-,097
,923
94
Table G.4 – Summary of the Jones Model
R
R Square
Adjusted R
Square
,222a
,049
,038
a. Predictors: (Constant), PPE(t)/Total Assets(t-1), 1/Total Assets (t-1),
∆REV/Total Assets (t-1)
b. Dependent Variable: Total Accruals(t)/Total Assets (t-1)
Given the adjusted R square value shown in table G.4 the model explains 4,9% of the variation
between the model and the observed values.
Modified Jones Model
The Modified Jones model is shown below (Dechow et at. 1995):
Based on table G.5 there can be concluded that at least one of the coefficients is significantly different
from zero, the p-statistic is 0.016 which is below the cut-off of 0,05. The coefficients of table G.6. can
be interpreted.
Table G.5 – Modified Jones model regression significance
Sum of Squares
df
Mean Square
F
Sig.
Regression
,909
3
,303
3,523
,016b
Residual
21,322
248
,086
Total
22,231
251
b. Predictors: (Constant), 1/Total Assets (t-1), ∆Rev-∆Rec/Total Assets(1-t), PPE (t)/Total Assets (t-1)
95
Table G.6 – Modified Jones Model Coefficients
Unstandardized
Standardized
Coefficients
Coefficients
B
Std. Error
,013
,022
-15231,627
12502,584
-,012
∆Rev-∆Rec/Total Assets (t-1)
-,088
(Constant)
t
Sig.
Beta
,600
,549
-,078
-1,218
,224
,004
-,259
-3,107
,002
,049
-,151
-1,791
,075
When looking at the coefficients of table G.6 one can conclude that only the variable PPE (t)/Total
Assets (t-1) is significant in the regression ( 0,002<0,05). Nevertheless, the insignificant variables are
included in the model because prior research supports this variables as a significant component within
the model. The rather small sample size could influence the outcomes of the regression statistics and
the significance of the variables.
Table G.8 – Summary of the revised Modified Jones model
R
R Square
Adjusted R
Square
,202a
,041
,029
a. Predictors: (Constant),∆Rev-∆Rec/Total Assets (1-t), 1/Total Assets (t-1),
b. Dependent Variable: Total Accruals (t)/Total Assets (t-1)
Normal Management & Administration Expenses Model
The following model will be used to measure abnormal management and administration expenses:
96
Table G.9 – Normal M&A Expenses model regression significance
Sum of Squares
df
Mean Square
Regression
2,952
2
1,476
Residual
2,323
233
,010
Total
5,275
235
F
Sig.
,000b
148,074
a. Dependent Variable: Management & Administration Expenses (t)/Total Assets (t-1)
b. Predictors: (Constant), 1/Total Assets (t-1),Total Income (t-1)/Total Assets (t-1)
Table G.10 indicates that all the variables in the model are significant.
Table G.10 – Normal Management & Administration Expenses Model coefficients
Unstandardized
Standardized
Coefficients
Coefficients
B
(Constant)
Std. Error
-,002
,049
,005
Sig.
Beta
,009
46692,657 4577,669
t
-,189
,850
,459
10,200
,000
,482
10,713
,000
a. Dependent Variable: Management & Administration Expenses (t)/Total Assets (t-1)
The model explains 56% of the variation between the model and the observed values (see table G.11).
Table G.11 – Summary of the Normal Management & Administration Expenses model
R
R Square Adjusted R
Square
,748a
,560
,556
a. Predictors: (Constant), 1/Total Assets (t-1), Total Income (t-1)/Total Assets (t-1)
b. Dependent Variable: Management & Administration Expenses (t)/Total Assets (t-1)
Normal Fundraising Expenses Model
The following model is formed to measure Normal fundraising expenses:
97
Table G.12 – Normal Fundraising Expenses model regression significance
Sum of Squares
Regression
df
Mean Square
,939
2
,470
Residual
5,014
228
,022
Total
5,954
230
F
Sig.
21,354
,000b
a. Dependent Variable: Fundraising Expenses (t)/Total Assets (t-1)
b. Predictors: (Constant), Total Income (t-1)/Total Assets t-1, 1/Total Assets(t-1)
Based on table G.13one can conclude that the variable 1/Total Assets(t-1) is significant
As mentioned before, the insignificant variables are included in the model.
Table G.13 – Abnormal Fundraising Expenses coefficients
Unstandardized
Standardized
Coefficients
Coefficients
B
(Constant)
1/Total Assets(t-1)
Std. Error
,047
,014
4987,926
6861,341
,042
,007
Total Income(t-1)/Total Assets(t-1)
t
Sig.
Beta
3,442
,001
,046
,727
,468
,383
6,085
,000
a. Dependent Variable: Fundraising Expenses (t)/Total Assets (t-1)
The R square of the model is 15.8 % and can be found in Table G.15.
Table G.15 – Summary of the revised Normal Fundraising Expenses model
R
R Square
Adjusted R
Square
,397
a
,158
,150
a. Predictors: (Constant), Baten/At-1, 1/Ait-1
b. Dependent Variable: Fundrasing/At-1
Normal Spending on Objectives Model
The following model is formed to measure the normal spending on objectives:
98
Table G.16 – Normal Spending on Objectives Model regression significance
Sum of Squares
Regression
Residual
Total
df
Mean Square
F
287,195
2
143,598
42,194
250
,169
329,389
252
Sig.
,000b
850,823
a. Dependent Variable: Spending on Objectives (t)/Total Assets (t-1)
b. Predictors: (Constant), 1/Total Assets (t-1), Total Income (t-1)/Total Assets (t-1)
Table G.17 presents the coefficients of the normal spending on objectives model; all the variables are
significant.
Table G.17 – Normal spending on Objectives coefficients
Unstandardized
Standardized
Coefficients
Coefficients
B
(Constant)
Std. Error
,162
,037
46657,061
17858,725
,725
,019
t
Sig.
Beta
4,419
,000
,062
2,613
,010
,914
38,615
,000
a. Dependent Variable: Spent on Objectives (t)/Total Assets (t-1)
The R square of the model is 87,2% and can be found in Table G.18.
Table G.18 – Summary of the Normal Spending on Objectives model
R
R Square
,934a
,872
Adjusted R Square
,871
a.
Predictors: (Constant), 1/Total Assets (t-1),Total Income (t)/Total Assets (t-1)
b.
Dependent Variable: Spending on Objectives/Total Assets (t-1)
99
Appendix H – Chi-square Tests for Comparing Groups
In tables H.1, H.3, H.6 and H.7 the outcomes of the chi-square tests can be found. Based on these test
one can conclude that a relation between the direction of the discretionary accruals & abnormal
expenses and groups exist.
The cross tables can be found in tables H.2, H.4and H6. Based on the tables there can be concluded
that managers of group 4 use more (less) often negative (positive) abnormal expenses on management
& administration, fundraising and objectives. In addition, managers of group 3 use more (less) often
positive (negative) abnormal expenses on management & administration, fundraising and objectives.
Groups 2, 5 and 6 (the groups which do not use abnormal spending to strive towards zero or a small
positive results) are small and in some tables they do not exist at all.
Table H.1 – Chi-square test Groups and Direction of Discretionary Accruals
Value
Pearson Chi-Square
Likelihood Ratio
Linear-by-Linear Association
N of Valid Cases
df
a
67,377
76,350
12,965
Asymp. Sig. (2-sided)
5
5
1
,000
,000
,000
253
a. 6 cells (50,0%) have expected count less than 5. The minimum expected count is 1,96.
Table H.2 – Cross table Direction Abnormal Management and Administration Expenses
Table H.3 – Chi-square test Groups and Direction Abnormal Fundraising Expenses
Value
Pearson Chi-Square
Likelihood Ratio
N of Valid Cases
55,155a
59,387
33,255
df
4
4
1
,000
,000
,000
238
a. 6 cells (60,0%) have expected count less than 5. The minimum expected count is ,39.
100
Table H.4 – Cross table Direction Abnormal Fundraising Expenses
Table H.5 – Chi-square test Groups and Direction Abnormal Fundraising Expenses
Value
df
Pearson Chi-Square
47,844a
4
,000
Likelihood Ratio
49,250
4
,000
14,365
1
,000
N of Valid Cases
240
a. 6 cells (60,0%) have expected count less than 5. The minimum expected count is ,72.
Table H.6 – Cross table Direction Abnormal Spending on Objectives
Table H.7 – Chi-Square Test Groups and Direction of Abnormal Spending on Objectives
Value
df
Pearson Chi-Square
112,848a
5
,000
Likelihood Ratio
124,411
5
,000
36,586
1
,000
N of Valid Cases
253
a. 4 cells (33,3%) have expected count less than 5. The minimum expected count is 1,88.
101
Appendix I – Regressions Discretionary Accruals and Abnormal Expenses,
All Variables Included
This appendix included regressions of all the variables on the absolute value of the discretionary
accruals and abnormal expenses. Only linear variables are included in this regression because no
quadratic relationships between SBSIZE and discretionary accruals and abnormal expenses are found
in chapter 8. When interpreting the results it have to be noticed that the regressions are based on a very
small number of observations (between 35 and 37). In the future regressions can be done with the
same variables but with a larger amount of observations.
Regressions 1, 2, and 4 are significant, implying that the coefficients of that models can be interpreted.
SBSIZE is not significant in any regression even as ACMEET, so hypotheses 6A, 6B, 9A and 9B
cannot be proved. The tenure of the CEO (CEOTEN) is significant in regressions 1 and 4, however the
direction of the coefficients are different in these models. CEOTEN is negatively related to
discretionary accruals and CEOTEN is positively related to abnormal fundraising expenses. In model
4 the tenure of the audit committee members (ACTEN) is positively related to abnormal fundraising
expenses. This outcome is not in line with hypothesis 11.
102
Table I.1 – Regressions, all characteristics of the supervisory board & audit committee included
Dependent variables
1
Abs DA
(Jones)
2
3
Abs DA
Abs AMAE
(Mod. Jones)
SBSIZE
-0.002
(0.334)
-0.002
(0.137)
-0.0003
(0.584)
SBMEET
-0.001
(0.726)
0.002
(0.473)
-4.837E-005 0.004
(0.976)
(0.045)**
ACMEET
0.008
(0.270)
4
Abs AFE
-0.001
(0.153)
5
Abs ASOE
6
Abs TAE
-0.002
(0.414)
-0.002
(0.525)
0.010
(0.089)*
0.009
(0.345)
0.002
(0.818)
-0.002
(0.905)
0.007
(0.191)
0.003
(0.278)
0.001
(0.788)
CEOTEN
-0.005
-0.002
(0.024)* (0.141)
0.001
(0.345)
0.002
(0.020)**
0.004
(0.211)
0.011
(0.025)**
ACTEN
-0.001
(0.778)
0.004
(0.235)
0.001
(0.293)
0.003
(0.056)*
0.002
(0.783)
0.006
(0.463)
-0.019
(0.208)
-0.020
(0.005)*
-0.014
(0.103)
-0.034
(0.198)
0.009
(0.835)
0.018
(0.230)
0.018
(0.334)
0.104
(0.085)*
0.066
(0.491)
(0.109)
36
28.5%
(0.060)*
36
32.4%
(0.488)
36
16.1%
(0.342)
36
19.1%
FINEX
0.006
(0.761)
Constant
0.089
0.060
(0.043)* (0.089)*
Significance model
N
R-Squared
Variables definitions:
ABS DA(Jones)
ABS AMAE
ABS AFUNE
ABS ASO
ABS TAE
(0.029)* * (0.077)*
37
35
35.6%
31.7%
SBSIZE
ACEXI
otherwise.
SBMEET
ACMEET
CEOTEN
= tenure of the CEO
ACTEN
FINEX
103

Earnings Management at Dutch Fundraising Institutions: the

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