Managing Earnings through Small-Loss Avoidance in South Africa

Abstract

The issue of earnings management has been of prominent global interests. Earnings management in the forms of loss avoidance have resulted to some notable corporate scandal amongst firms participating in capital markets. The study provides evidence on whether South African firms manipulate earnings to avoid reporting small earnings change and losses. The paper involves all listed firms on the Johannesburg Securities Exchange (2005–2020), but the sample selection adapts to only 205 companies. Based on prior studies, the study supposes prevalence of earnings management towards small profits and applies the nonparametric permutation (Kolmogorov-Smirnov, K-S) test to verify two hypotheses: (a) that managing earnings practice does not differ between financial and non-financial industries (b) that financial crisis does not influence managed earnings phenomenon. Applying the K-S permutation algorithm for three different simulation (1,000, 3,000 and 10,000 replications) using sample of different size (10, 30, and 100) at each bootstrapping, the result provide sufficient evidence to reject our null for all repetitions. The results offer strong evidence to suppose that managing earnings practices differ between financial and non-financial industries and that financial crisis have influence on the distribution of earnings. This has implications for policy purpose to prevent possible corporate scandals through use of discretions.

Keywords

• earnings management
• corporate scandal
• permutation testing
• kolmogorov-smirnov test