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The perception of earnings management motivations in

Saudi public firms Murya Habbash

Accounting Department, King Khalid University, Abha, Saudi Arabia, and Salim Alghamdi

Accounting Department, Taif University, Taif, Saudi Arabia

Abstract Purpose – The primary purpose of this paper is to investigate the motivations of earnings management in less-developed economy using Saudi listed companies. Design/methodology/approach – While numerous motivations for earnings management are proposed in the literature, many of these motivations have inconsistent empirical support. A number of studies report discontinuities in the distribution of earnings around benchmarks such as the zero profit level. However, the evidence regarding whether these discontinuities are associated with earnings management behaviour is still uncertain. In addition, evidence regarding the ability of various governance mechanisms to constrain earnings management is also mixed. These issues raise the necessity to investigate managers behaviour that incentivise earnings management practices through qualitative research approach. A questionnaire survey and interviews are mainly used to explore the motivations for earnings management in Saudi Arabia in order to obtain the different perceptions of respondents. Findings – The findings reveal that the four main incentives for Saudi managers to manage earnings are “to increase the amount of remuneration”, “to report a reasonable profit and avoid loss”, “to obtain a bank loan” and “to increase share price”. Research limitations/implications – Hence, agency-institutional theory may provide a sensible explanation for earnings management practices in Saudi Arabia. Practical implications – Previous findings could be helpful for external auditors and regulators and legislators in their attempts to constrain the incidence of earnings management and enhance the quality of monitoring mechanisms. Originality/value – While numerous motivations for earnings management are proposed in the literature, many of these motivations have inconsistent empirical support. A number of studies report discontinuities in the distribution of earnings around benchmarks such as the zero profit level. However, there is no evidence that these discontinuities are associated with earnings management behaviour. In addition, evidence regarding the ability of various governance mechanisms to constrain earnings management is also mixed. These issues raise the necessity to investigate managers behaviour that incentivise earnings management practices through qualitative research approach. Keywords Earnings management, Motivations, Agency-institutional theory, Saudi listed companies Paper type Research paper

1. Introduction In the last decade, the Saudi capital market has been considerably active in terms of the number of transactions and the amount of money that has been traded. This has

Journal of Accounting in Emerging Economies Vol. 5 No. 1, 2015 pp. 122-147 © Emerald Group Publishing Limited 2042-1168 DOI 10.1108/JAEE-06-2012-0025

The current issue and full text archive of this journal is available on Emerald Insight at: www.emeraldinsight.com/2042-1168.htm

The authors are grateful for the kind support of Professor Robert Dixon and Dr Ann wood from Durham University Business School, UK. The authors are also grateful to Dr Yusuf Karbhari, from Cardiff Business School, UK for his useful comments. The authors also appreciate the useful comments of participants at the annual PhD seminars, held at Durham Business School, Durham University, UK, 2011.

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created capital-market-derived motivations for Saudi managers. In addition, the rapid growth of businesses in the kingdom and the fierce competition may also have put some pressure on the boards of these companies to practise earnings management in order to remain competitive and to survive. To make things worse, managers’ remuneration is usually linked to their financial performance, which could create personal incentives to manipulate the numbers. A study conducted by Al-Moghaiwli (2010) argues that Saudi listed companies are largely dominated by a high percentage of foreign employees who may tend to manage earnings for their own private benefit. The increased incidences of such issues have generated considerable calls for review and for the assessment of earnings management occurrence and motivations.

Whatever motivates managers to manipulate earnings, it is documented that earnings management harms earnings quality ( Jaggi and Tsui, 2007) and misleads financial reporting users. According to Al-Khabash and Al-Thuneibat (2009), based on Lo’s (2007) argument, earnings management has many victims including equity investors, creditors, suppliers, regulators and customers. Academic research has concluded that managers engage in earnings management to accomplish certain objectives such as avoiding loss, meeting market expectations, avoiding debt covenant violations, etc.

In terms of earnings management practices, both agency and institutional theories provide an appropriate theoretical framework. For example, agency theory explains compensation as an incentive for manipulation, but institutional theory can explain other factors that stem from both formal and informal pressure such as meeting market expectations or political costs. Agency-institutional theory, which is considered to be positive theory, includes objective ontology. As a result, the adopted methodology is justified by an objectivist (realist) ontological position and positive epistemology. Accordingly, this study adopts an objectivism ontology and positive epistemological stance since it is deemed to be a neo-empirical research (descriptive research) represented by agency theory and institutional theory.

This research attempts to explore earnings management practices in Saudi Arabia. To the best of my knowledge, Saudi Arabia has not yet been the focus of a study on the perception of earnings management motivations. A different perspective could be obtained from developing countries such as Saudi Arabia, which in numerous respects are different; therefore, the current study could provide interesting, new primary evidence from a country that has a different business environment, regulations and different culture.

In addition, there has been a great deal of research into earnings management motivations using statistical methods; however, few studies have offered a critical understanding of these problems through a survey such as interviews or questionnaires and understanding the nature and problems of earning management practices is crucial in order for regulators to put an accurate interpretation on such findings.

Saudi Arabia is of interest for several reasons; first, a survey of the existing literature on earnings management reveals that, with the exception of a few studies, the existing research is predominantly US based and relatively little is known on this issue with regard to developing and emerging economies. Second, Saudi Arabia has some distinguishing characteristics that reject the generalization of other study findings, It is a country where public equity markets are not well developed, local accounting standards are in use and ownership in publicly-traded firms is highly concentrated in the form of family ownership.

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The paper proceeds as follows: Section 2 reviews the literature on earnings management motivations. Section 3 discusses theoretical background and research hypothesis. Section 4 describes the data and research methodology. Section 5 presents the empirical results on earnings management motivations. Section 6 provides the conclusion.

2. A review of the literature on earnings management motivations According to positive theory, developed by Watts and Zimmerman (1986), there are three primary hypotheses regarding earnings management motivations: the bonus plan hypothesis, the debt covenant hypothesis and the political cost hypothesis. Current research of earnings management has, however, shifted its focus away from positive theory and back again to capital market motivations as interpretations of the opportunistic behaviour of managers (Xiong, 2006). Agency theory, as an economic model of behaviour, expects that, as long as the objectives of the principal and agent are aligned, the agent will attempt to maximize the objectives of the principal; however, when their objectives are conflicted, the view of agency theory is that the agent will attempt to maximize his/her self-interest over the principal’s interests. Accordingly, the motivation for manipulating earnings begins when alignment is conflicted. According to institutional theory, earnings management incentives may be affected by formal or informal pressure and change may be created by an organization in order to model itself on other organizations. Kury (2007) suggests that insights for earnings management comprise the blending of agency and institutional theory perspectives to obtain a more complete understanding of the behaviour and the positing of a continuum of earnings management.

Generally, the questions present potential motivations for earnings management as identified by previous studies. These motivations include increasing remuneration (Aljifri, 2007; Baker et al., 2003), increasing share price (Bergstresser and Philippon, 2006; Louis and Sun, 2008), reporting a reasonable profit and avoiding loss (Markarian et al., 2008; Roychowdhury, 2006), fulfilling the stock market’s expectations (Coppens and Peek, 2005), reducing buyout compensation (Kamel and Elbanna, 2010), retaining stable dividends (Daniel et al., 2008) and one factor associated with the Saudi environment is to reduce Zakat.

Accordingly, this section provides different motivations for manipulation which are grouped into five categories according to prior studies:

(1) capital market motivations;

(2) management-compensation contract motivations;

(3) lending contract motivations;

(4) regulatory motivations; and

(5) political cost motivations.

2.1 Capital market expectations The usage of financial information in affecting stock prices has inspired a number of studies to argue that the affecting of stock prices may be one reason for manipulating earnings. Accordingly, a number of studies have been conducted in this area, to investigate the practice of earnings management in different cultures. For example, a study undertaken by Burgstahler and Dichcv (1997) expects managers to engage in

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earnings management to avoid possible losses and decrease in earnings. Their results show that an earnings decrease is an incentive for manipulating; however, avoiding possible losses is not.

Furthermore, using a sample of 1,500 firms over the period 1992-2005, research conducted by Daniel et al. (2008) indicates that firms employ earnings management to meet expected dividends levels. The findings of their study suggest that this incentive is seen only in companies with positive debt and was more aggressive prior to the Sarbanes-Oxley Act.

Moreover, a comparative study by Glaum et al. (2004), which compares earnings management motivations using a sample of US and German firms, suggests that both American and German companies manipulate earnings to avoid losses and decrease in earnings. However, the surprising finding in this study is that avoiding losses and decrease in earnings is more prevalent in US firms than in German firms. Moreover, they find that capital market pressure and management-compensation are also incentives for manipulation. Similarly, a detailed examination of earnings management practices by Peek (2004) shows that Dutch managers use their discretion in manipulating in order to engage in big bath behaviour.

Using more than 200 questionnaire surveys distributed to external auditors from the USA, Nelson et al. (2003) find that American managers are motivated to manage earnings by numerous incentives such as meeting analysts’ estimates, affecting the stock market, meeting objectives regarding management-compensation, enhancing future income for various goals. Likewise, Athanasakou et al. (2009) find similar results using UK firms.

In addition, using in-depth interview surveys which include financial executives from public companies in US firms, applying descriptive statistics and correlation analysis, Graham et al. (2005) stress that managers are concerned with meeting earnings benchmarks and engage in earnings management to maintain or increase share prices, to enhance managers’ reputations and to secure future growth prospects.

In the UK, Atieh and Hussain (2012) examine earnings management by dividend- paying firms in cases where pre-managed earnings would fall below the expected dividend, and by non-dividend paying firms aiming to avoid reporting losses. They find that within the UK market the likelihood of upward earnings management is significantly greater in the former case than the latter, though both are drivers for earnings management. Additionally, using a sample of real estate investment trusts (REITs) from the database during 1990-2006, Ambrose and Bian (2010) discover a link between stock price movement and REIT earnings management. They find that share price can be a motivation for manipulating earnings management.

Martinez (2005) provides evidence from Brazilian public companies investigating earnings management practices. He uses a multiple regression model to estimate discretionary accruals documents to show that Brazilian companies are likely to manage earnings in order to avoid reporting losses, to sustain recent performance and to maintain stable earnings.

Evidence based on data collected via questionnaires (464) and interview surveys (16) in Egypt (Kamel and Elbanna, 2010) highlights that the main incentives for managing earnings are: to increase the prospect of obtaining a loan, to sustain the previous year’s profit performance, to report a good income and avoid reporting losses and to accomplish high-stock valuation.

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2.2 Management-compensation contract Managers are motivated to employ earnings management in order to enhance or increase their own compensation or bonus plan which is often associated with a firm’s performance. A number of studies examine the impact of accounting choices on compensation which attempt to elicit the perceptions on this issue. For example, Dye (1988) suggests that employing accounting numbers in compensation contracts is one of most important internal motivations for manipulating earnings. Likewise, Healy (1985), who used the first model for detecting earnings management, highlights that increasing a bonus plan can be a motivation for earnings management.

Based on an examination of 138 Australian firms announcing on-market buybacks over the period 1996-2003, Balachandran et al. (2008) investigate the relationship between earnings management and exercisable option holdings for buyback firms to determine whether earnings management in the pre-buyback period is a motivation for companies with equity to increase stock prices. They find that Australian firms tend to use buyback policy in order to increase share price and enhance compensation.

According to a sample from the Wall Street Journal annual Compensation Survey, Baker et al. (2003) note that the compensation option produces opportunistic motivations for managers to time the release of good and bad news to the market.

2.3 Lending contracts motivations The debt covenant hypothesis is that restrictions are often imposed by creditors regarding payment of dividends, share buybacks and the issuing of additional debt in respect of reported accounting numbers and ratios, in order to ensure the repayment of the firm’s borrowings.

Using a sample drawn from Spanish firms, Perez and Hemmen (2010) indicate that marginal increases in debt produce the motivations for managers to manage earnings. Moreover, Kanagaretnam et al. (2003) investigate the incentives of American bank managers in making judgment over loan loss provisions to manipulate earnings. They find that managers tend to save income in case a good performance is followed by a future bad performance, by reducing current income through loan loss provisions as well as reducing the cost of borrowing.

Based on a sample of 92 firms determined by the SEC to overstate earnings, Dechow et al. (1996) find that managers tend to manipulate earnings in order to raise external financing at a low cost as well as to avoid debt covenant restrictions. Likewise, Jaggi and Lee (2000) highlight that managers of companies which are in financial distress manipulate earnings if they are able to gain waivers for debt covenant violations and debt restructuring takes place or debts are renegotiated because waivers are denied.

Othman and Zeghal (2006) study a sample of Canadian and French firms and find that earnings management practices in both countries are notably associated with contractual debt and influential tax rates motivations. Interestingly, they also find that market-related motivations, such as initial and subsequent public equity, offer strong motivations in Canada, reflecting a dynamic capital market.

2.4 Regulatory motivations Listed companies are usually monitored for compliance with regulations, and at the same time are subjected to numerous regulations linked to accounting figures and ratios. This creates pressure for managers to manipulate earnings in order to show their compliance with regulations. A good example of this is presented by Black (1999) who examines the effects of accounting regulation on the level of earnings

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management in Australia, New Zealand and the UK. He finds no evidence of earnings management in Australia and New Zealand; in contrast, he finds strong evidence of earnings management in the UK before the change in the accounting standard on asset revaluation. Thus, managers may find deficiencies in the regulations to be an incentive for earnings management.

Another study conducted by Navissi (1999) shows that New Zealand manufacturing firms are likely to engage in earnings management in order to present evidence of financial hardship caused by the introduction of a price freeze regulation.

In addition, Haw et al. (2005) investigate income-increasing earnings management in China in response to governmental regulations demanding a minimum of 10 per cent return on equity for firms that wish to offer shares or issue bonds, and find a strong motivation for earnings management practice.

2.5 Political cost motivations Companies may also manage earnings to show less profit in order to diminish political risk. In other words, the political cost that is proposed by Watts and Zimmerman (1986) predicts that incentives for firms to manage earnings result from political pressure to decrease prices or face the penalties that may arise from the investigation of firms which are suspected of breaching anti‐trust rules or of otherwise taking advantage of the general public.

Interestingly, Hang and Wang (1998) who examine the situation after Iraq’s attack on Kuwait in 1991 (Gulf Crisis) suggest that oil companies are motivated to decrease their reported earnings for the third- and fourth-quarters in order to reduce political costs generated by potential adverse political actions such as regulations, antitrust and government.

Another incentive comes from Russian firms studied by Gonchanalyze and Zimmermann (2006) who investigate the effects of tax legislation on earnings management. Using a sample of 197 firms, including both private and public, they conclude that Russian firms tend to manipulate earnings management by reporting small profits. Their findings are consistent with the common notion that companies engage in earnings management in order to reduce tax expenses.

Coppens and Peek (2005), who focus on eight European countries, i.e., Belgium, Denmark, France, Germany, Italy, the Netherlands, Spain and the UK, investigate whether or not private European firms manage earnings. They find that, in the absence of capital market pressures, firms are still motivated to engage in earnings management, as they document that private firms avoid reporting small losses and that tax incentives affect earnings management practices.

2.6 Earnings management in Saudi Arabia Aggressive earnings management is quite a modern topic in accounting research. A fundamental study that investigates earnings management in developing countries is Leuz et al. (2003). They divide a number of countries into three groups and attempt to make a comparative study regarding investor protection and earnings management. The first group consists of countries with a large stock market, dispersed ownership and strong investor rights. The second group includes countries with less-developed stock markets, concentrated ownership, weak investor rights, but strong legal enforcement. The third group includes insider economies with weak legal enforcement and contains some developing countries such as Indonesia and the Philippines which have concentrated ownership and weak legal enforcement. They find that the third

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group shows less investor protection and a higher level of aggressive earnings management.

Saudi Arabia, as a developing country, has concentrated ownership, less investor protection and weak legal enforcement; therefore, the potential incidence of earnings management is high.

In terms of studies relating to Saudi firms, Asehaly (2006) investigates earnings management practices in Saudi publicly listed firms, he studies various earnings management motivations using cross-sectional analysis and finds that earnings management occurs in Saudi listed companies and earnings management behaviour differs according to industry type. He finds that maintaining the expected earnings and capital enlargement are essential motivations.

This study is more concerned with the perception of various related parties on earnings management motivations rather than the linear relationship between discretionary accruals and earnings management motivations proxies. In addition, this study is conducted in different circumstances where the related capital market motivations are higher than when Asehaly’s (2006) study was conducted between 2001 and 2004; in addition, around half of this study’s sample companies were not listed on the capital market at that time.

Habbash (2012) studies whether corporate governance attributes constrain earnings management in Saudi listed firms between 2006 and 2009 and finds that corporate governance attributes significantly constrain earnings management measured by discretionary accruals. Al-Abbas (2009) also investigates the same relationship and achieves similar results.

3. Theoretical background and research hypothesis Positive theory has contributed to explaining earnings management practice since a study conducted by Watts and Zimmerman (1986) who developed this theory as an alternative explanation for the problems of accounting choices (Xiong, 2006). This theory expects non-capital market motivations for managers to engage in earnings and is concerned with internal contractual motivations which lead to the use of different accounting choices.

Positive theory presents three primary motivations for earnings management: the bonus plan incentive, the debt covenant incentive and the political cost incentive. These motivations originate from the existence of fixed contracts using accounting numbers. In other words, positive theory changed the way of testing capital market motivations to concentrating on firms’ internal contractual reasons for cosmetic accounting changes. Current research on earnings management has, however, shifted the focus away from positive theory and back again to capital market motivations as an interpretation of the opportunistic behaviour of managers. Hence, this paper proposes two theoretical perspectives that explain the earnings management motivations in this research’s settings.

3.1 Agency theory Primarily, an agency relationship originates from the separation between ownership and management or control, when one or more principals engage another person as their agent to perform services on their behalf (ICAEW, 2005). The theory concentrates on the relationship between the principal (owners) and agents (management) who are given the authority to manage the principal’s interests and make beneficial decisions.

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The principal requires information which is used to evaluate the performance. This can result in problems of information asymmetry, which leads to agency problems such as: moral hazard and adverse selection (Hoque, 2006), which stems from the fact that managers may act in their own interests to maximize their personal wealth. This may be because they have personal goals that conflict with those of shareholders.

Jensen (1993) suggests that moral hazard is caused by different factors such as firm size complexity leading to difficulty in monitoring which increases agency costs. Furthermore, the agents may also be affected by factors such as financial rewards, labour market opportunities and their relationship with other parties who are not related to the owners’ interests (Shapiro, 2005). This leads to the creation of a conflict of interests between the principals and their agents.

In Saudi Arabia, the agency costs of listed companies may result from conflict between owner-manager relationships. However, the agency costs may also arise from the conflict between the minority and the majority of shareholders. In fact, there is no clear evidence concerning the issues of agency relationship in the Saudi environment due to the shortage of studies in this area. According to Clark (2004) collectivism is a dimension of the relationship between principals and agents in Asia, South America and Southern Europe.

Jiraporn et al. (2008) find that management manipulates earnings in firms when agency costs are lower. Davidson et al. (2005) also confirm that earnings management might be a type of agency cost if the management provides financial reporting that does not present accurate information.

3.2 Institutional theory Institutional theory which has been developed within management studies is a common theory applied generally in social science studies and notably in accounting literature (Scott, 1995). Institutional theory is interested in tackling an economic phenomenon within its entire surrounding environment that comprises social, political, cultural, religious, civilization and technological factors. Recently, different types of institutional theory have been utilized to obtain perceptions in organizational change and accounting practices. New institutional sociology (NIS) is conceived to be relevant to the research topic.

NIS is concerned with explaining mechanisms by which organizations may seek to align perceptions of their practices and characteristics with social and cultural values in order to obtain legitimacy (DiMaggio and Powell, 1983).

Organizations are subject to a number of rules and regulations in order to ensure legitimacy and thus have access to resources and ensure their survival (DiMaggio and Powell, 1983). However, these rules and regulations do not necessarily guarantee that organizations will continue to operate efficiently (Meyer and Rowan, 1977).

According to NIS theory, DiMaggio and Powell (1983) establish three different isomorphism’s and suggest that firms embrace various rules or practices because of “coercive”, “mimetic” or “normative” isomorphism. This isomorphism creates different types of pressure such as pressure from stakeholders, the pressure of competitive advantage in terms of legitimacy and the pressure from group norms to adopt notable institutional practices (DiMaggio and Powell, 1983; Clark, 2004).

According to institutional theory, earnings management incentives may be affected by formal or informal pressure and change may be created by an organization in order to model itself on other organizations. Kury (2007) suggests that institutional theory provides the best perspective for examining earnings management practices. He puts

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forward the institutional argument to explain that earnings management is helpful to complete the view of agency theory and suggests that insights for earnings management comprise the blending of agency and institutional theory perspectives to obtain a more complete understanding of the behaviour and the positing of a continuum of earnings management.

In Saudi Arabia, there are two dominant types of ownership structure, state-owned and family-owned enterprises. State-owned firms rely heavily on government subsidies and funding. Thus, granting additional resources from the state could motivate the managers of state-owned firms to manage their firms’ earnings. On the other hand, family-owned enterprises rely more on loans from banks and from the capital market which may also incentivize earnings management practice. In addition, Li et al. (2011) suggest that state-owned firms may incur higher-than- average agency costs due to weak governance and fuzzy ownership. The weakness of the governance system would also fuel the problem of enterprises with these types of ownership.

From the above discussion, the main research question this study sets out to answer is:

RQ1. What are the common motivations for earnings management in Saudi Arabia?

Since this study follows a deductive methodology, primary hypotheses are formulated to answer the research questions as follows:

H1. There is a significant difference among respondents according to earnings management motivations in Saudi Arabia.

4. Research methodology Existing studies have recently attempted to adopt both quantitative and qualitative approaches within the context of a single research study to overcome the potential bias of a single-method approach. The primary feature of adopting multiple methods in the same study is to enable triangulation to take place (Kamel, 2006).

This study adopts a triangulation approach, regarding the quantitative approach; the questionnaire survey is mainly used to explore the motivations of earnings management in Saudi Arabia by obtaining the perceptions of respondents. In terms of the qualitative approach, semi-structured interviews are used to provide a better understanding of the research questions, confirming and elaborating on the questionnaire survey’s findings and supporting the hypothesis development.

4.1 Questionnaire survey In order to achieve the objective of this research, the questionnaire was designed to elicit the perceptions of respondents regarding the research topic. The questionnaire consists of two sections; the first is general information and the second is a set of questions related to the motivations of earnings management. The content of the questionnaire for each section is set out as follows:

• General information: this section attempts to obtain demographical information from respondents (position, working experience, educational level and major). Demographical information will prove helpful for the researcher to justify various perceptions among the groups.

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• Motivations for earnings management: this section attempts to elicit respondents’ perceptions of motivations for Saudi companies engaging in earnings management. Specifically, this section consists of a set of motivations for engaging in earnings management derived from prior studies. Generally, the questions present potential motivations for earnings management as identified by previous studies. These motivations include increasing remuneration (Aljifri, 2007; Baker et al., 2003), increasing share price (Bergstresser and Philippon, 2006; Louis and Sun, 2008), reporting a reasonable profit and avoiding loss (Markarian et al., 2008; Roychowdhury, 2006), fulfilling the stock market’s expectations (Coppens and Peek, 2005), reducing buyout compensation (Kamel and Elbanna, 2010), retaining stable dividends (Daniel et al., 2008) and one question associated with the Saudi environment is reducing Zakat.

4.1.1 Piloting the questionnaire and assessment of validity. The questionnaire was validated by applying a pilot study that was not a pre-test, which was undertaken to provide relevant questions and to enhance specific areas that may not be clear, by obtaining astute feedback. For this purpose, 20 questionnaires were distributed to academic staff in Saudi Arabia and the UK, which is conceived to be sufficient according to Fink (1995) who suggests that a minimum number of ten is acceptable for a pilot study. During the pilot study, astute feedback and comments were mostly related to the language, suggesting omitting and adding some terms such as Zakat and Tax, whereas a number of the respondents viewed the questionnaire as comprehensively and extensively covering the research questions.

4.1.2 Sample selection criteria. Participants were divided into four groups: members of boards of directors, members of sub-committees, auditors and academic staff (see Table III). The primary criteria in the selection of specific groups of respondents were that all the groups should have adequate experience in accounting and financial careers and they should be aware of earnings management practices. Moreover, these groups have the right and the means to monitor companies, which makes them intrinsically effective and gives them vital responsibility for the integrity of financial reporting and the accountability of management. The study population is relatively limited due to the fact that earnings management is considered to be a complicated topic; hence the participants need to be well-educated in this topic.

Regarding sampling technique, judgemental sampling, similar to snowball sampling, has been used in this study, as respondents were selected by the researcher on the strength of their experience of the phenomenon under study (Hussy and Hussy, 1997).

In total, 280 questionnaires were distributed in two batches by e-mail and by hand. Of the 280 distributed questionnaires 124 were used in the analysis, which represents a response rate of 44.2 per cent. Comparatively, previous research such as that of Kamel (2006) observed that the Middle East seems to have a low response rate for questionnaires, varying from 30 to 50 per cent. Importantly, the non-respondent rate of 54 per cent does not differ significantly from the respondent rate, confirming that the findings are reliable, valid and unbiased.

4.1.3 Reliability and correlation analysis. The concept of reliability expresses the consistency that reveals the degree of consistent measurement across different items of instrument (DeVellis, 2003). Numerous methods have been employed to measure reliability, including the test re-test, split half, and Cronbach’s α; however, one of the

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most commonly employed consistencies is Cronbach’s α. Black (1999) suggests that Cronbach’s α is the optimum indicator for internal consistency of instruments which do not have right-wrong (binary) marking schemes, and hence may be utilized for both suitable questions and questionnaires, adopting a scale such as the Likert Scale.

Although the reliability (consistency) is a significant matter with non-probability sampling, this research applies Cronbach’s α as a measurement of consistency because it seems to be less biased and more appropriate than other methods and gives a more accurate statistical finding (DeVellis, 2003). Nunnally and Bernstein (1994) suggest that the α-coefficient should be 0.7 or above. The α-coefficient was over 0.7 for all tests which indicates that all the data is reliable. Also, correlated items were higher than 0.3 suggesting a good indicator.

4.1.4 Statistical methods of questionnaire analysis. Parametric and non-parametric testing are widely known methods of data analysis for any study. However, choosing a parametric method is subject to critical assumptions that should be met before conducting the analysis. Balian (1982) highlights that using parametric testing is subject to numerous assumptions that should be provided as follows: normality, homogeneity and continuous form of the dependent variables.

Siegel (1956) suggests that non-parametric testing remains the alternative test where previous assumptions are not applied to data. Given that the analysis of normality for all questions using Kolmogorov-Smirnov and Shapiro-Wilk tests reveal that the p-value was o5 per cent and the test of homogeneity of variance using the Levene test was also o5 per cent (results unreported for brevity reason), non-parametric tests were used in this study to analyse the data. Accordingly, the primary statistical techniques applied in this part of the research were as follows:

(1) Descriptive statistics of data comprise frequencies and percentages for responses and overall mean scores, standard deviations, and ranking for respondents according to level of agreement for each group of questions. Moreover, mean group is used in order to understand respondents’ perceptions for different questions.

(2) Kruskal-Wallis is a non-parametric test adopted to test the differences between respondents’ perceptions (boards of directors, sub-committees, external auditors and academic staff).

(3) Mann-Whitney Test is helpful when comparing two sample means on a continuous measure to specify whether two populations’ means significantly differ.

Moreover, ANOVA one-way testing is used to determine the differences between two analyses (parametric and non-parametric tests) and for sensitivity analysis.

4.2 Qualitative method Kamel (2006) suggests that the questionnaire suffers from the inability to obtain perceptions from respondents; therefore conducting interviews will amplify and complement the questionnaire survey.

Accordingly, this research has adopted qualitative techniques to diminish the potentiality of errors and present greater insight into the different aspects of earnings management practices. More clearly, in addition to the questionnaire survey and

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secondary data as quantitative methods, semi-structured interviews are applied as a type of qualitative method.

4.2.1 Semi-structured interviews. Interviews are deemed to be an appropriate technique in certain cases such as those which involve complicated and highly confidential information or when the required information cannot be collected by other techniques (Hussy and Hussy, 1997).

Unlike other interview types, the semi-structured interview method is capable of exploring the problems revealed in prearranged questions or of obtaining rich astute information related to the research topic (Berg, 2007).

Initially, eight questions were formulated to obtain an understanding of the previous objectives. These questions mainly focused on the motivations of earnings management and their aim was to uncover the issues that had not been explored by the questionnaire survey in order to provide rich information. Semi-structured interviews were undertaken with 15 individuals drawn from four groups (boards of directors, sub-committees, external auditors and accounting academic staff – see Table I). In other words, 17 respondents were selected from four groups and one member of a Zakat and Tax Department. Two interviewees (a member of a sub-committee and a member of academic staff) were excluded since they did not provide information that was beneficial to this study; hence, in total 15 interviews were conducted and were of benefit to this study (see Tables I and II).

Number of interviews Position Type of organization

Experience of position (years)

1 Academic King Khalid University 2 1 Academic University of Taif 15 1 Academic King Abdulaziz University 20 1 Chairperson Al-Baha Development 22 1 M. board of directors Hloany Company 15 1 M. board of directors Yanbu Cement Company 13 1 Auditor KPMG 2 1 Audit manager Ernst & Young 16 1 Auditor Saudi Accounting 9 1 Auditor Deloitte 6 1 Auditor Ernst & Young 7 1 M-sub-committee Al-Baha Development 14 1 M-sub-committee Al-Baha Development 12 1 M-sub-committee Agricultural Company 3 1 M-sub-committee Zakat and Tax Department 8 15

Table I. Information from

respondents’ interviews

Data collect methods Sample size Choosing sample method Process of analysis

Questionnaire survey 124 Judgmental sampling + snowball Kruskal-Wallis and Mann-Whitney Test

Interviews survey 15 Theoretical sampling approach Manual analyse

Table II. Summary of data

collection and analysis

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5. Results 5.1 Descriptive statistics of respondents 5.1.1 Descriptive statistics of respondents’ demographic information (questionnaire). Table III provides descriptive statistics, as classified by position, which are mainly used to examine the differences between the groups, whereas work experience, educational level, and major are presented in Table III to provide additional information for each group in order to assist in interpreting the findings. The analysis displayed in Table III relates to the number of respondents in each group and their percentages.

The basic result, shown in Table III, illustrates that the auditors group represents the highest percentage of questionnaires answered with 33.1 per cent of usable responses, whereas, the academic staff group, in second place, make up approximately 29.1 per cent of responses. However, the responses of the groups of members of boards of directors and sub-committee members are much lower – 18.5 and 19.3 per cent, respectively – than those of the other groups.

According to work experience, the figures in Table IV (Panel (1)) show that less than a third of respondents (29 per cent) had more than 15 years work experience in the field, which was the highest percentage for length of working experience. In comparison, the sub-committee members and academic staff had more work experience in their positions gaining 41 and 38 per cent, respectively. These findings are consistent with expectations since these groups usually retain their positions for a long time as a result of the nature of their work and the shortage of candidates in their subject. In general, the findings indicate that more than half of respondents from the members of boards of directors, sub-committee members and academic staff – 74, 58 and 52 per cent, respectively – had work experience of more than ten years. However, the auditors group, at 44 per cent, had the lowest percentage of working experience of the groups.

The respondents were also questioned about their educational level. As indicated in Table IV, the majority of respondents (39 per cent) held a PhD, 38 per cent held a BA, 18.5 per cent held a master’s degree and 4 per cent held other qualifications such as a diploma. As for the members of boards of directors, 48 per cent replied that their most recent and highest educational level was BA, 39 per cent a master’s degree, 13 per cent a PhD, and 4 per cent diploma. The diplomas consisted of diplomas in business administration, finance and business banking. Moreover, more than half (66 per cent) of the auditors held a BA, 20 per cent held a master’s degree, 7 per cent held a PhD, and a similar percentage held a diploma in accounting or finance.

With regard to majors, as shown in Panel (3), the majority (86 per cent) of the academic staff, 88 per cent of the auditors, and 79 per cent of the sub-committee members had an accounting background, whereas the largest percentage of the members of boards of directors had Business Administration Certificates.

Issued ques. Received ques. Groups Number % Number and % Overall % Response rate (%)

Members of boards of directors 70 25 23 32 18.5 44.2 Members of sub-committees 70 25 24 34.2 19.3 (30%-50%) Auditors 70 25 41 58 33.1 Average Academic Staff 70 25 36 51.4 29.1 Total 280 100 124 100

Table III. The distribution of respondents of questionnaire survey

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5.1.2 Descriptive statistics of respondents’ information (semi-structured interview). Providing demographic information for interviewees enables the researcher to interpret and compare the findings. In this respect, Table I presents the sample of semi-structured interviews conducted during fieldwork. According to Table I, two members of boards of directors, four sub-committee members, three auditors, and three academic staff interviewed had gained work experience on average of ten years. A chairman, a manager of an audit team and a member of a Zakat and Tax department were also interviewed. The table also provides information in terms of the positions of interviewees who work in different organizations.

5.2 Do Saudi managers engage in the manipulation of earnings? Saudi accounting academics have recently expressed many concerns about the integrity of financial reporting which does not reflect the spill-overs of a global financial crisis. A typical example of these concerns can be seen in the following point of view:

The global financial crisis has affected the whole world. However, we have not seen any effect on financial reporting in Saudi Arabia such as the revenues or value of assets. This might raise the question and increase the concerns about the integrity of financial reporting and to what extent the figures presented by companies express the reality of financial statements.

Another topic covered by the Saudi Arabia media is related to the size of Saudi Market losses caused by Saudi listed companies’ bankruptcy and financial scandals[1]. Although this crisis might not have been related directly to earnings management practices, there has been, to date, no investigation into this issue or into the size of

Panel (1) The length of experience

Boards of directors Sub-committees Auditors Academic staff Total Number % Number % Number % Number % N %

Less than one year 2 9 2 8 4 10 0 0 8 7 1- 5 years 0 0 4 17 8 19 4 11 16 13 5- 10 years 9 39 4 17 11 27 5 13 29 23 10-15 years 7 30 4 17 11 27 13 36 35 28 More than 15 years 5 22 10 41 7 17 14 38 36 29 Total 23 100 24 100 41 100 36 100 124 100 Panel (2) Education Level Boards of directors Sub-committees Auditors Academic staff Total

Number % Number % Number % Number % N % BA 11 48 9 38 27 66 0 0 47 38 Masters 9 39 6 25 8 20 0 0 23 18.5 PhD 3 13 7 29 3 7 36 100 49 39.5 Others 0 0 2 8 3 7 0 0 5 4 Total 23 100 24 100 41 100 36 100 124 100 Panel (3) Major Boards of directors Sub-committees Auditors Academic staff Total

Number % Number % Number % Number % N % Accounting 9 39 19 79 36 88 31 86 95 77 Finance 4 17 4 17 2 5 4 11 14 11 Bus-administration 10 44 1 4 1 2 1 3 13 10 Others 0 0 0 0 2 5 0 0 2 2 Total 23 100 24 100 41 100 36 100 124 100

Table IV. Analysis revealing

the duration of employment of

respondents participating in

questionnaire survey

135

Earnings management motivations

losses incurred by small shareholders who were the primary victim. In this regard the chairperson attempted to explain how this issue could establish earnings management practices in Saudi Arabia:

With regard to recent financial scandals, the Saudi Market was transformed from a share market to a gambling market and the investors transformed to gamblers. This action creates opportunists representing the managers of Saudi listed companies who tend to manipulate earnings to increase share prices or manipulation of figures that be used by investors to attract a large number of them.

Previous academic research such as that of Shubita and Mohammad (2010) suggests that managers tend to manipulate earnings by increasing income during hard times and decreasing it in good times. During the interviews, an auditor was asked about this action in Saudi Arabia. He commented that:

From my experience, I think our clients tend to engage in earnings management by income- increasing rather than income-decreasing. By this action, they will obtain more benefits such as compensation or a bank loan rather than decrease. However, income-decreasing might be used in rare cases […].

On the other hand, all interviewees were concerned that the integrity of financial reporting suffers from a lack of disclosure and transparency which leads investors to make incorrect decisions. Allegations were made by interviewees that one crucial indication of manipulation of earnings is non-compliance with full-disclosure and hiding important information which lead to misleading investment decisions that could damage the Saudi economy. During the interview survey, one academic researcher argued that:

Recent academic research concluded that Saudi financial reporting suffers from a lack of disclosure and transparency which harms its integrity and credibility. This leads us to suspect that the manipulation of figures is one of the reasons for non-compliance with full- disclosure and other regulations.

In conclusion, the objective of this section is to elicit the perceptions of participants as to whether Saudi managers tend to manipulate earnings, as well as to investigate the integrity of financial reporting. Based on the semi-structured interviews, the results indicate that although all participants to a certain extent believed that financial reporting reflects the real status of Saudi companies, they suspected that it might involve manipulation. As can be seen from Figure 1 the majority (86 per cent) of them believed that Saudi managers have the incentive to manipulate earnings in order to achieve their objectives (Figure 2).

0 10 20 30 40 50 60

Considerably Slightly Neutral No

Figure 1. The perceptions of interviewees regarding the integrity of financial reporting in Saudi Arabia

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5.3 Why Saudi managers manipulate earnings (motivations) Preliminary results in Figures 1 and 3 show that, in general, a number of issues relating to earnings management practices in Saudi Arabia were conceived as being strong catalysts for manipulation by a wide range of respondents. More than three-quarters (80 per cent) of questionnaire respondents, including all groups, strongly agreed or agreed with four potential reasons for manipulation in Saudi Arabia (i.e. to increase the amount of remuneration; to report a reasonable profit and avoid loss; to obtain a bank loan; to increase share price. This is reflected in overall means for each incentive (4.21, 4.09, 4.14, and 4.13, respectively). In addition, the semi-structured interviews support the findings of the questionnaire by drawing attention to the above-mentioned motivations as key reasons for manipulating earnings. During the interviews, an audit team manager suggested that the desire to increase share price

No Yes I don’t know 0

Figure 2. The perceptions of interviewees

regarding whether or not they think Saudi managers manipulate

reported earnings

60%

84%

70%

82% 74% 83% 82.5%

72% 69% 70% 68%

0.5

1.5

2.5

3.5

4.5

To re

du ce

th e

am ou

nt o

f Z ak

T o

in cr

ea se

th e

am ou

nt o

re m

un er

at io n T

o re

ta in

st ab

le d

ivi de

nd s

T o

re po

rt a

re as

on ab

le p

ro fit

an d

av oi d

lo ss

To in

cr ea

se th

co nf

id en

ce o

in ve

st or

s T

o ob

ta in a

ba nk

lo an

T o

in cr

ea se

sh ar

e pr

ice

T o

ob ta

in p

os itio

an d

re pu

ta tio

in S

au di m

ar ke

T o

re du

ce b

uy ou

co m

pe ns

at io n

To fu

lfil th

e st oc

m ar

ke t’s

ex pe

ct at

io ns

T o

re ta

in s ta

bl e

pe rfo

rm an

Figure 3. Overall results of

respondents’ perceptions of

earnings management

motivations in Saudi Arabia

137

Earnings management motivations

and obtaining a bank loan were the most encouraging incentives for manipulating earnings. He remarked that:

In my opinion, a number of managers might manipulate earnings since they would accomplish a higher share price and obtain a bank loan. These incentives are the most important in my view. Other reasons, which are minor and do not have much effect, are to fulfil the stock market’s expectations and to increase the confidence of investors.

Moreover, as can be observed from the chairperson’s view below, consistent with the questionnaire results, one incentive for earnings management by Saudi managers could be to increase their wealth. He commented as follows:

From my experience, most managers of Saudi listed companies aim to increase their wealth by gaining high remuneration, and bonuses because in this way they will give themselves security; also most Saudi companies face great pressure from the Saudi capital market to correct their financial statuses, which leads them to manipulate […].

On the other hand, according to the questionnaire, Zakat was not ranked among the top-four motivations; auditors and academics drew attention to this issue by remarking that:

Numerous Saudi listed companies commit manipulation because they want to reduce the amount of Zakat determined by the Zakat and Tax department. This issue cannot be generalized to be the key reason for manipulation or be applied to all listed companies, but it is still a potential reason for manipulating in Saudi Arabia.

Further to this, a member of the Zakat and Tax Department argued that:

Manipulation of earnings to reduce the amount of Zakat might occur in the private sector rather than the public sector. However, we have seen a few cases of listed companies manipulating the amount of Zakat. These cases might occur more in companies dominated by high ownership concentration. Our role is to mitigate the conflict between companies and the Department of Zakat and Income Tax by verifying the assessment made by the Department and the amount of Zakat shown by a company (Table V).

The Kruskal-Wallis analysis of respondents’ perceptions in Table VI reveals that there are significant differences in perceptions with regard to “increasing the amount of Zakat and Tax”, “increasing the amount of remuneration”, “increasing share price”, “reducing buyout compensation” and “retaining stable performance”. Statistically, differences were present in perceptions between the groups with respect to increasing the amount of Zakat. As is shown in Table VII, overall mean of auditors (3.60) was the highest of the groups. More than 70 per cent of auditors and 60 per cent of academics considered reducing Zakat to be an incentive for manipulating earnings. In contrast, a greater percentage of members of boards of directors and sub-committee members viewed that the reduction of Zakat is not a motivation for manipulation. It was expected that the academics and auditors would be more aware of this as a result of their function. For example, auditors observe this issue in practice during auditing, and academics contribute to alleviate the dispute between Saudi listed companies and the Zakat and Tax Department by their active participation in alleviation committees.

The majority (93 per cent) of the members of boards of directors, 82 per cent of the members of sub-committees and 86 per cent of the academic staff strongly agreed or agreed that firms attempt to increase the amount of remuneration, while the auditors

138

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L ev el of

ag re em

en t (%

) Q ue st io ns

1 2

3 4

5 T ot al

m ea n

sc or e

R an k

C or re ct ed

it em

-t ot al

co rr el at io n

C or nb

ac h ’s α

(c on si st en cy )

1. T o re du

ce th e am

ou nt

of Z ak at

13 .5

11 .7

40 .1

19 .4

15 .3

3. 02

11 1. 08

0. 31 2

0. 70 1

2. T o in cr ea se

th e am

ou nt

of re m un

er at io n

0 10 .5

4 38 .7

46 .8

4. 21

1 0. 94 1

0. 48 5

3. T o re ta in

st ab le di vi de nd

s 10

16 .1

28 .9

25 .6

19 .4

3. 50

8 0. 71 9

0. 44 0

4. T o re po rt a re as on ab le pr of it an d av oi d lo ss

0 5. 6

19 .4

34 .7

40 .3

4. 09

4 0. 90 5

0. 50 1

5. T o in cr ea se

th e co nf id en ce

of in ve st or s

12 .8

18 .9

22 .4

16 .3

21 .6

3. 74

5 70 2

0. 51 2

6. T o ob ta in

a ba nk

lo an

4 9. 7

7. 3

40 .2

40 .5

4. 14

2 1. 07

0. 40 1

7. T o in cr ea se

sh ar e pr ic e

2. 4

9. 7

7. 3

33 .1

46 .6

4. 13

3 1. 06

0. 53 3

8. T o ob ta in po si ti on

an d re pu

ta ti on

in th e bu

si ne ss

m ar ke t

18 18 .9

21 .5

22 .1

26 .8

3. 63

6 0. 69 0

0. 51 3

9. T o re du

ce bu

yo ut

co m pe ns at io n

8 22 .6

21 40 .3

15 .3

3. 46

9 1. 03

0. 34 3

10 .T

o fu lf il th e st oc k m ar ke t’s

ex pe ct at io ns

3. 2

15 .3

20 .2

48 .4

12 .9

3. 52

7 1. 00

0. 32 4

11 .T

o re ta in

st ab le pe rf or m an ce

2. 4

22 .6

16 .1

45 13 .9

3. 44

10 1. 05

0. 39 3

N o te s:

1, st ro ng

ly di sa gr ee ;2 ,d

is ag re e; 3, ne ut ra l; 4, ag re e; 5, st ro ng

ly ag re e; L ik er t sc al e

Table V. Descriptive statistics

of respondents’ perceptions about the motivations of

earnings management in Saudi Arabia

139

Earnings management motivations

showed a lower level of agreement (78 per cent). As can be observed from Table VI, Mann-Whitney indicates that the auditors’ response differs from the other groups and this was reflected in the overall mean for each group (4.56, 4.1, 4.3, and 3.92, respectively). This result can be interpreted as follows: members of boards of directors and members of sub-committees have been found to be much closer to management than auditors, notably in respect of their job security. These findings seem to be consistent with prior studies in the USA and the UK, see Nelson et al. (2003) and Athanasakou et al. (2009), respectively. This result suggests that, despite the remarkable differences in cultures and institutional factors between Saudi Arabia and the Anglo-Saxon countries, managers appear to be motivated by the amount of remuneration to manage reported earnings.

It can also be seen from Table VII, regarding “to increase share price”, that there is a significant difference between all four groups. The result of this difference is presented in Table VIII which shows that the overall means of the auditors (4.49) and the academic staff (4.52) were higher than those of the members of boards of directors (3.68) and sub-committee members (3.95). It could be that the auditors and the academics have more knowledge of several features of this motivation than the members of boards of directors and the sub-committee members. This result is consistent with Pornuptham (2006) who finds that increasing share price was the most important reason for manipulating earnings in Thailand according to auditors’ views. Likewise, these findings are in line with studies of Graham et al. (2005) and Kamel and Elbanna (2010).

In relation to the reason that resulted in significant differences among four groups – “to reduce buyout compensation”, the members of sub-committees viewed reducing buyout as an important reason for manipulating earnings (mean ¼ 4.37) compared to the other groups, whereas the lowest level of agreement for this reason was by the auditors (mean ¼ 3.02). This result supports the notion that the compensation option produces opportunistic motivations for managers to time the release of good and bad news to the market as previously argued and proved by Baker et al. (2003) and Balachandran et al. (2008).

Kruskal-Wallis ANOVA one way Non-parametric test p-value sig.

Parametric test p-value sig.

Questions o0.05 o0.05

1. To reduce the amount of Zakat *** *** 2. To increase the amount of remuneration *** *** 3. To retain stable dividends – – 4. To report a reasonable profit and avoid loss – – 5. To increase the confidence of investors – – 6. To obtain a bank loan – – 7. To increase share price *** *** 8. To obtain position and reputation in the business market – – 9. To reduce buyout compensation *** ***

10. To fulfil the stock market’s expectations – – 11. To retain stable performance *** *** Notes: Using ANOVA one way is an additional or secondary test to verify the results. *po0.05; **po0.01; ***po0.001

Table VI. Non-parametric test (Kruskal-Wallis) vs parametric test ANOVA one-way

140

JAEE 5,1

M ea n

M an n- W hi tn ey

te st

– po st ho c te st

Q ue st io ns

B oa rd

of di re ct or s

Su b-

co m m it te e

A ud

it or

A ca de m ic

B oa rd

of di re ct or

(s ig .) w it h

Su b- co m m it te e

(s ig .) w it h

A ud

it or

(s ig .)

w it h

A ca de m ic (s ig .)

w it h

1. T o re du

ce th e am

ou nt

of Z ak at

2. 41

2. 70

3. 60

3. 40

A ud

it or

A ud

it or

B oa rd

of di re ct or

B oa rd

of di re ct or

A ca de m ic

Su b- co m m it te e

2. T o in cr ea se

th e am

ou nt

of re m un

er at io n

4. 56

4. 1

3. 92

4. 3

A ud

it or

A ca de m ic

A ud

it or

B oa rd

of di re ct or

3. T o re ta in

st ab le di vi de nd

s 3. 42

3. 51

3. 46

3. 63

N o si gn

if ic an t di ff er en ce s am

on g gr ou ps

4. T o re po rt a re as on ab le

pr of it an d av oi d lo ss

4. 08

4. 02

4. 20

N o si gn

if ic an t di ff er en ce s am

on g gr ou ps

5. T o in cr ea se

th e co nf id en ce

of in ve st or s

3. 71

3. 69

3. 81

3. 77

N o si gn

if ic an t di ff er en ce s am

on g gr ou ps

6. T o ob ta in

a ba nk

lo an

4. 17

4. 11

4. 02

4. 13

N o si gn

if ic an t di ff er en ce s am

on g gr ou ps

7. T o in cr ea se

sh ar e pr ic e

3. 68

3. 95

4. 49

4. 52

A ud

it or

A ca de m ic

B oa rd

of di re ct or s

Su b- co m m it te es

A ca de m ic

A ud

it or

Su b- co m m it te es

B oa rd

of di re ct or s

8. T o ob ta in

po si ti on

an d

re pu

ta ti on

in th e bu

si ne ss

m ar ke t

3. 61

3. 55

3. 67

3. 72

N o si gn

if ic an t di ff er en ce s am

on g gr ou ps

9. T o re du

ce bu

yo ut

co m pe ns at io n

3. 30

4. 37

3. 02

3. 47

Su b- co m m it te e

B oa rd

of di re ct or

A ca de m ic

A ud

it or s

A ud

it or s

Su b- co m m it te e

A ca de m ic

10 .T

o fu lf il th e st oc k m ar ke t’s

ex pe ct at io ns

3. 39

3. 91

3. 39

3. 50

N o si gn ifi ca nt

di ff er en ce s am

on g gr ou ps

11 .T

o re ta in

st ab le

pe rf or m an ce

4. 30

2. 95

3. 43

3. 22

Su b- co m m it te e

B oa rd

of di re ct or s

B oa rd

of di re ct or s

B oa rd

of di re ct or s

A ud

it or s

A ca de m ic

N o te s:

U si ng

po st ho c is an

ad di ti on al

or se co nd

ar y te st

to ve ri fy

th e re su lt s. *p

o 0. 05 ;* *p

o 0. 01 ;* ** p o

0. 00 1

Table VII. Descriptive statistics

of means for each groups and multiple

comparison test

141

Earnings management motivations

Finally, for the motivation “to retain stable performance”, Table VI reveals a significant difference between the groups. This can be observed from the findings that the majority of the members of boards of directors agreed that retaining stable performance was a potential incentive compared to the other groups. Overall means for each group based on the level of agreement were: members of boards of directors 4.30, auditors 3.43, academics 3.22, members of sub-committees 2.95. According to this result, the members of boards of directors perceived this incentive to be a very strong potential reason since they are aware of the importance of stable performance to management.

This result is line with the evidence provided by Martinez (2005) using Brazilian companies that tend to manipulate earnings to sustain recent performance and maintain stable earnings. Research in Egypt by Kamel and Elbanna (2010) also highlights that one of the main incentives for managing earnings is to sustain the previous year’s profit performance.

To sum up, the objective of this section was to shed light on the potential motivations for manipulating earnings in Saudi listed companies. The results show that the four main incentives for Saudi managers to manage earnings are “to increase the amount of remuneration”, “to report a reasonable profit and avoid loss”, “to obtain a bank loan” and “to increase share price”.

All in all, the findings of the questionnaire survey reveal that the above hypothesis is true, confirming that there is a significant difference among respondents regarding motivations for earnings management in Saudi Arabia. The Kruskal-Wallis analysis of respondents’ perceptions reveals that there are significant differences in perceptions with regard to increasing the amount of Zakat, increasing the amount of remuneration, increasing share price, reducing buyout compensation and retaining stable performance. These differences are outlined in the following table (Table VIII).

6. Summary and conclusions This study investigated the motivations of earnings management in Saudi listed companies using agency-institutional theory. A questionnaire survey was used to explore the motivations of earnings management in Saudi public firms by obtaining the different perceptions of respondents; in addition, semi-structured interviews were used to provide better understanding of the research questions.

Generally, the results show that the four main incentives for Saudi managers to manage earnings are: to increase the amount of remuneration, to report a reasonable profit and avoid loss, to obtain a bank loan and to increase share price. In addition,

Motivation Board of directors Sub-committee

External auditor

Academic staff

1. To increase the amount of Zakat D. Agree D. Agree Moderate Moderate 2. To increase the amount of remuneration

Agree Agree Moderate Agree

3. To reduce buyout compensation Moderate S. Agree Moderate Moderate 4. To retain stable performance S. Agree D. Agree Moderate Moderate 5. To increase share price Moderate Moderate S. Agree S. Agree Notes: S. Agree, strongly agree; Moderate, slightly agree; D. Agree, do not agree

Table VIII. Differences in respondents’ perceptions regarding motivations

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JAEE 5,1

the interview survey supports the questionnaire survey’s findings. Interestingly, the interviews survey shows that ownership structure and company size may be crucial factors in determining the motivations in Saudi Arabia.

Like most studies of a similar nature, this study was subject to a number of limitations. First, it was based on a relatively small number of participants and respondents, therefore caution should be applied as the results may not be generalised. Second, the investigation of perceptions was limited to specific listed companies and did not involve financial and insurance companies which are characterized by having special practices and operations.

The current study provides new evidence from a developing country and therefore contributes to the existing literature on the practice of earnings management and on enhancing the quality of reported earnings in general. The findings could be useful to regulators, external auditors and investors in their attempts to constrain the incidence of earnings management and enhance the quality of monitoring mechanisms. Accordingly, these findings have implications for regulators such as CMA that is concerned with overseeing Saudi listed firms and may contribute to reducing earnings management practices by identifying motivations; so CMA is called on to find solutions to mitigate the motivations.

In addition to the recommendations mentioned above, there are some possible extensions to this study; one possible avenue for future research is to investigate earnings management in banks and financial institutions in order to obtain a better understanding of manipulation and the role of monitoring mechanisms, especially by those parties following IFRS. Given that there are few compulsory monitoring mechanisms, it might be worthwhile investigating earnings management practices in non-listed companies in Saudi Arabia in order to obtain a comprehensive understanding.

Note 1. There was panic selling on the Saudi Stock Exchange which crashed from 21,000 points to

6,000 points, as prices fell to new point lows.

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