Implied expense theory in financial reporting: a steady-state approach

Erkki Kalervo Laitinen

Journal of Financial Reporting and Accounting, 2018, vol. 16, issue 1, 49-83

Abstract: Purpose - The purpose of this study is to use a steady-state model structure to investigate earnings management (EM) theoretically in the context of different expense theories. Empirically, the objective is to apply the theoretical model to investigate the implicit choice of expense theories for reporting expenses. The study aims to present a new approach to analyze EM. Design/methodology/approach - The study makes use of ten-year time-series data originally from 1,015 Finnish public and private firms to estimate the parameters of the steady-state model, and to investigate which expense theories the firms implicitly follow in financial reporting. The parameters are estimated using the restricted least squares regression method. The final sample included data from 631 firms fulfilling restrictions for the consistency of estimates. Findings - The paper provides empirical insights about expense theories that Finnish firms implicitly follow in financial reporting. Evidence shows that the reporting of expenses mainly follows the units-of-revenue and the rate-of-return theories. Only a small number of firms follow the interest expense theory. Research limitations/implications - The study is based on a steady-state approach, and therefore, the research results may lack generalizability as only 62% of the original sample firms obtained consistent estimates. Therefore, researchers are encouraged to use more general models for further theoretical and empirical work. Practical implications - The paper includes implications for a new approach to EM. It also gives implications how to analyze different expense theories in the context of EM both theoretically and empirically. Originality/value - This paper develops a new approach to investigate EM.

Keywords: Performance measurement; Financial reporting; Earnings management; Accounting; Financial accounting (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfrapp:jfra-05-2016-0032

DOI: 10.1108/JFRA-05-2016-0032

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