Sebi study suggests greater checks for 'earnings management'

Study finds 'earnings management' pracrices more prevalent at small-sized companies in India

Concerned over a widespread practice of executives manipulating their companies' finances to meet performance targets, a Sebi-commissioned study has suggested stronger surveillance, monitoring and regulatory action for such entities.

The study, conducted by independent experts for Sebi's Development Research Group, also found that such 'earnings management' pracrices were more prevalent at small-sized companies in India, as compared to their medium and large-size peers.

"The study recommends enhanced surveillance, monitoring and regulatory action by the securities market regulator for a company or industry, which is indulged in high level of earnings management (above the average threshold of the industry)," Sebi said about this report, whose recommendations are non-binding for the regulator.

It has also highlighted "the need for better and timely disclosure of accounting information and monitoring by auditors/regulators, especially of the items in which management discretion is exercised widely".

The study noted that Earnings Management (EM) by companies is widespread throughout the world.     "The motivation to meet earnings targets of the market and thereby derive private benefits is the driving force for EM world-wide.     "Managers get a number of financial incentives to meet performance expectations and derive private gains in the form of gaining earnings-based bonuses, increased promotion prospects, avoiding termination, avoiding a decline in the value of their stocks etc.

"Regulators across the world are concerned about the quality of financial reporting, maintaining an efficient capital market, ensuring investor protection, and promotion of financial stability," it added.

The present study examined and quantified the extent of EM in India by studying 2229 listed Indian companies (non-financial) during 2008-2011.

It found that the average earnings management in corporate sector (non-financial) in India is 2.9% of the total assets of these firms, which is comparable to the estimates in US, Europe and elsewhere in the world (around 1 to 5% of total assets).     The study revealed that "small firms in India indulge relatively more in earnings management (10.6% of the total asset) than the medium and large size firms."     

The study has been co-authored by D Ajit, Sarat Malik and Vimal Kumar Verma and is part of an initiative undertaken by Sebi to commission studies on different aspects affecting the capital markets.