Earnings Management in Chapter 11 Bankruptcy

33 Pages Posted: 19 Mar 2020

See all articles by Timothy C. G. Fisher

Timothy C. G. Fisher

University of Sydney, School of Economics

Ilanit Gavious

Ben-Gurion University of the Negev

Jocelyn Martel

ESSEC Business School

Date Written: June 2019

Abstract

We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11. Using data on public US firms, we construct three measures of earnings management: a real activities manipulation measure (abnormal operating cash flows) and two accounting manipulation measures (discretionary accruals and abnormal working capital accruals). We find that, controlling for the impact of factors known to influence earnings management and firm survival in bankruptcy, earnings management prior to bankruptcy significantly reduces the likelihood of Chapter 11 plan confirmation and emergence from Chapter 11. The results are driven primarily by extreme values of earnings management, characterized by one or two standard deviations above or below the mean. The findings are consistent with creditors reacting positively to unduly conservative earnings reports and negatively to overly optimistic earnings reports. We also find that the presence of a Big 4 auditor is associated with a higher incidence of confirmation and switching to a Big 4 auditor before filing increases the incidence of emergence.

Keywords: Bankruptcy, Chapter 11, Financial reorganization, Earnings management, Auditor choice

Suggested Citation

Fisher, Timothy C. G. and Gavious, Ilanit and Martel, Jocelyn, Earnings Management in Chapter 11 Bankruptcy (June 2019). Abacus, Vol. 55, Issue 2, pp. 273-305, 2019, Available at SSRN: https://ssrn.com/abstract=3556013 or http://dx.doi.org/10.1111/abac.12158

Timothy C. G. Fisher (Contact Author)

University of Sydney, School of Economics ( email )

Sydney
Australia

Ilanit Gavious

Ben-Gurion University of the Negev ( email )

1 Ben-Gurion Blvd
Beer-Sheva 84105, 84105
Israel

Jocelyn Martel

ESSEC Business School ( email )

Avenue Bernard Hirsch B.P. 50105
Cergy-Pontoise, 95021
France
33 1 34 43 33 21 (Phone)

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