Earnings Management of Insolvent Firms and the Prediction of Corporate Defaults via Discretionary Accruals

Sam Bock Park, Sung-Kyoo Kim and Sangryul Lee
Additional contact information
Sam Bock Park: Department of Accounting, College of Commerce, Jeonbuk National University, Jeonju 54896, Korea
Sung-Kyoo Kim: Korea Credit Guarantee Fund, Seoul 06181, Korea
Sangryul Lee: Business Administration, College of Business and Economics, Hanyang University Erica, Ansan 15588, Korea

IJFS, 2021, vol. 9, issue 2, 1-24

Abstract: Studies on the characteristics of insolvent firms’ earnings management are critical, as the ripple effects of a firm’s opportunistic accounting and insolvency on society can be widespread and significant. This study divides a dataset of unlisted firms into four groups (large firms that have received external audits; small- and medium-sized enterprises (SMEs) that received external audits; SMES that did not receive external audits; private businesses that did not receive external audits) and analyzes whether there are differences in terms of the discretionary accruals between groups. This study also uses discrete time logit regression to determine if the use of discretionary accruals is predictive of whether unlisted firms would become insolvent. This study used several models (a modified Jones model, a Kothari model, and performance matching model by ROA group) to measure discretionary accruals, which was used as a proxy for earnings management. The results of our study showed that, in the one year prior to insolvency, discretionary accruals were largest among non-externally audited private firms, followed by those of non-externally audited SMEs, externally audited SMEs, and externally audited large firms. The discretionary accruals of non-insolvent firms were larger than those of insolvent firms from the period of one year to three years preceding insolvency, and this difference increased as insolvency approached. The discretionary accruals were shown to have the ability to predict whether or not firms would become insolvent in two to three years before the occurrence of insolvency, but they did not support prediction for one year before the occurrence of insolvency. The findings suggest that additional accounting information should be used together to predict insolvency for unlisted firms.

Keywords: unlisted firms; discretionary accruals; insolvent firms; earnings management (search for similar items in EconPapers)
JEL-codes: F2 F3 F41 F42 G1 G2 G3 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://www.mdpi.com/2227-7072/9/2/17/pdf (application/pdf)
https://www.mdpi.com/2227-7072/9/2/17/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jijfss:v:9:y:2021:i:2:p:17-:d:523827

Access Statistics for this article

IJFS is currently edited by Ms. Hannah Lu

More articles in IJFS from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().