EM and its implication to stakeholders of the firm is one of the important branches in Accounting Academic Literature. Jensen & Meckling (1976) described Managers are entrusted by Owners for their Wealth in Corporate settings via agency cost to maximise wealth of Owners. Managers engage in EM practice through contractual relationship that provides them as stewards man of principal’s i.e owners wealth. Healy & Whelan (1999) defined EM as
“EM occurs when managers use judgement in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers.”
EM can be done through unrealised or late revenue recognition, change in accruals or liabilities for positive financial performance of Firm, Excessive provision for reserves, deferring R & D or Maintenance expense, minor breaches of International Financial Reporting Standards which can aggregate to material breach, change in pension fund provisions.
Schipper (1989), Healy & Whalen (1999) have taken a normative approach in analysing previous EM Literatures. Accounting Literatures suggest Prevalence of EM is well appreciated by Shareholders, Regulators and Market. Research has identified detecting EM although detection is with considerable imprecision within models. Managers engage in EM practices for various reasons such as Market expectations i.e meet analyst forecast, to avoid earnings volatility, to increase their performance related bonus or to secure their position, to secure firm’s position within a sector or market, to avoid regulatory agency monitoring, to avoid any additional levy, to hide large material losses in business operation, to cover persistent irregularities in financial reporting.
However, empirical evidence on market based evaluation of EM shows that Market does adjust its earnings