Hybrid Earnings Management in the Pre- and Post-SOX

Lianzan Xu, Francis Cai, Ge Zhang
International Journal of Finance, Insurance and Risk Management, Volume 12, Issue 1, 22-36, 2022
DOI: 10.35808/ijfirm/276


Purpose: This paper examines a fourth method of earnings management: the hybrid method. Design/Methodology/Approach: The hybrid method uses a combination of the three well-documented earnings management methods of accrual-based, real activity, and classification shifting to manipulate earnings for the benefits of the management and the company. The manipulated number is presented in the income statement as a single line item such as pension expense or income. The hybrid method is more deceptive and harder to detect outright because it is more complex and often apparently GAAP compliant. Findings: The hybrid earnings management method is potentially even more harmful than the three well-known methods, causing severe misrepresentation to the economic reality of a company. Practical Implications: Market participants and other financial data users should be on alert for the hybrid method which appears GAAP compliant but distorts the earnings picture of a company. Originality value: This paper is the first to suggest and investigate the fourth earnings management method - the hybrid method - and opens the door for more research on this pervasive, damaging, and deceptive method of earnings management.

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