The Influence of Earning Management on Default Risk
Contemporary Issues in Accounting Acknowledgement:
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The structure of ownership has substantial implications on the accounting measure of performance return on equity (ROE). A company’s performance ROE is inversely proportional to government shares and, in comparison to non-defaulted companies, ownership of firms in default has a heavier implication. Similarly, firms that show high foreign ownership bare a minor impact of default. Government proprietorship is considerably adversely correlated to the company’s likelihood of default, thus, statistics of both mix structure ownership and concentration ones might be applied in forecasting the possibility of default as the government ownership fraction (FGO) and the biggest five shareholders (C5) have to a large extent a reverse correlation in regard to evasion. A conclusion can be further drawn from the results thus reduction of government involvement improves productivity. This can also end up in insolvency of firms eventually.
Higher liquidity facilitates for sale of stocks by block holders more conveniently. On the face of it, the risk of exit can perform the function of an efficacious mechanism in corporate governance (Admati and Pfleiderer, 2009; Edmans, 2009; Edmans and Manso, 2011). Effective corporate governance enhances competence among managers. It persuades them to undertake investments that enhance their firm’s value and protects against the shrewd and unprincipled behaviour in management, possibly resulting in lowering of the likelihood to default. It is possible for the average application of the Capital Asset Pricing Model to be inefficient in capturing the default risk-premium comprehensively if company shortcomings are interconnected with the decline in investment prospects or components of wealth that might be unaccounted for, like for example; human resource and liability securities.
From the valuation of earned returns made the assumption is, the ex-post and ex-ante projected income have a direct relationship. The final returns can be a representation of the projections made in accordance with Elton (1999). Elton gives examples of the correlation existing between gained return and risks involved which can be detrimental. He points out the probability of absence of actual statistical events like, immense shocks. Auditors come in at this juncture where there is an impact of unexpected statistics on stocks which cannot be explained by analysis done.
Build a logical argument for a specific relationship between two variables (i.e., a theoretical framework), using established research published in academic journals. Start by identifying your theoretical framework, naming the theory, identifying key theoretical constructs that you will be considering and formulate a prediction of the relationship based on the theory. You may want to refer to a seminal article (founding or highly influential publication of research that has informed later research in that field).
Carefully review past research, the variables that have been tested in previous studies, and the findings. Highlight differences or inconsistencies. You might have mentioned these in your theoretical motivation – as part of the reason for your study.
Build an argument for a specific relationship between two variables: clearly define the two variables; explain how these two variables are understood to be linked; and outline the reasons there may be a relationship between them. Critically discuss the strengths and limitations of the existing (past) research and use this to justify the argument for a modification or a new application of the theory. Then draw your conclusion about the predicted relationship for the variables that you plan to test. The argument must lead to a specific prediction (to be stated in the next section) that can be tested. This will lead to your hypothesis.
Length: the longest part of your assignment. Most of the words and several paragraphs beginning with topic sentences and linking to each other.
Clearly state your testable and falsifiable hypotheses – these are predictions. Express your hypotheses in the alternative form where appropriate. A single hypothesis is sufficient.
Length: one sentence (per hypothesis)
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Brogaard, J., Li, D. and Xia, Y., 2017. Stock liquidity and default risk. Journal of Financial Economics, 124(3), pp.486-502.
Gianfrate, G., 2020. Climate Change and Credit Risk. Journal of Cleaner Production.
Edmans, A., Manso, G., 2011. Governance through trading and intervention: a theory of multiple blockholders. Rev. Financ. Stud. 24. 2395-2428.
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Zeitun, R. and Tian, G.G., 2007. Does ownership affect a firm’s performance and default risk in Jordan?. Corporate Governance: The international journal of business in society.
Ham, C. and Koharki, K., 2016. The association between corporate general counsel and firm credit risk. Journal of Accounting and Economics, 61(2-3), pp.274-293.
Admati, AR., Pfleiderer, P., 2009.The “Wallstreet Walk” and shareholder activism: exit as a form of voice. Rev. Financ. Stud. 22,2645-2685’
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Appendix I – Annotated Bibliography for Selected Articles
|Author/s||Date||Title||Journal||Type of Paper (Theoretical or Empirical)||If empirical, dependent & independent variables||Summary of contribution to the research question (100 words)|
|Sudheer Chava, Amiyatosh purnanandam||2010||Is Default Risk Negatively Related to Stock Returns?||Review of Financial Studies||Empirical|
|Dv refers to demand for valuation, that is the need for evaluating a firm’s performance|
IV on the other hand stands for implied volatility. This is the value of an input’s instability.
|If default risk is systematic, then investors should demand a positive risk-premium for bearing this risk. The standard implementation of the capital asset pricing model (CAPM) might fail to completely capture the default risk-premium if corporate failures are correlated with deterioration in investment opportunities or unmeasured components of wealth such as human capital and debt securities. Contrary to what the CAPM predicts, recent empirical studies document a negative relationship between default risk and realized stock returns in the post-1980 period. This evidence suggests that the cost of equity capital decreases with default risk, a finding that also has important implications for corporate financial policies.|
|Jonathan Brogaard, Dan Li, Ying Xia||2017||Stock liquidity and default risk||Journal of Financial Economics||Empirical|| |
|Stock liquidity can impact default risk for a number of reasons. Increasing liquidity can increase default risk if it exacerbates noise trading, leading to greater firm mispricing and higher volatility. Greater liquidity can also decrease internal firm monitoring. Alternatively, higher liquidity could decrease default risk by improving price efficiency or improving corporate governance through easing investors’ ability to exit, provide empirical evidence that liquidity increases firm value. Even so, the effect of stock liquidity on default risk is not mechanical as default risk can be nonlinear and it depends on several factors other than firm value.|
|Giusy Capasso, Gianfranco Gianfrate, Marco Spinelli||2020||Climate change and credit risk||Journal of Cleaner Production|
|Empirical||Climate change risk can impact financial stability through three channels. First, physical risks such as extreme meteorological, hydrological and other climatological events are affecting the value of financial assets worldwide. Second, liability risks stemming from the increased compensation paid to economic agents affected by climate change. Finally, transition risks may result from the adjustment of asset prices towards a low-carbon economy. Transition risks are specifically materializing where greater disclosure of carbon footprint is required and new regulation creates obligations to move towards a lower-carbon economy. In particular, by putting a price on greenhouse gas emissions a growing number of countries is bringing down emissions and driving private investments into cleaner options.|
|Rami Zeitun, Gary Gang Tian|
|2007||Does ownership affect a firm’s performance and default risk in Jordan?||Corporate Governance: The international journal of business in society||Empirical||Geographical position, the tax system, industrial development and cultural characteristics along with other factors affect ownership structure which in turn have impacts on a firm’s performance and its default risk. Noteworthy also is, the prevalence in the public sector institutions and corporations of a large degree of inefficiency in the administrative and employment policies, squander of public funds, administrative archaism, substandard services and high indebtedness, while the private sector firms were yielding higher returns and results and generating better job opportunities, given the high level of efficiency in the administrative and employment policies. Therefore, it is expected that the privatization in Jordan can affect a firm’s performance and the probability of default in a positive way.|
|Charles Ham||2016||The association between corporate general counsel and firm credit risk||Journal of Accounting and Economics||Empirical||We examine whether firms that promote a GC to senior management (hereafter GC firms) experience increases in overall credit risk, as measured by changes in firm-level credit ratings and changes in credit default swap (CDS) spreads.|
|Firms’ credit risk can be impacted by a reliance on GCs who excessively focus on capital raising, firm restructuring, and firm strategy, as well as GCs who allow the firm to become overly aggressive in dealings with suppliers, customers, and other stakeholders. As the GC takes on these new responsibilities including helping to ensure sustained corporate performance and anticipating how changes in the legal environment will impact the company’s business over time, seeking to expand the role that law and legal practice play to generate new sources of growth, as well as to gain an economic edge over competition, he/she is likely to place less of an emphasis on the gatekeeping functions and more of an emphasis on the facilitating functions, thereby potentially reducing the effectiveness of the GC’s internal monitoring. In support of this notion, I maintain that bond market participants anticipate a potential increase in GCs’ facilitating role relative to their gatekeeping role when included among senior management, resulting in increased credit risk for these firms.|