Information Asymmetry and Earnings Management: Evidence from Companies Listed on Tehran Stock Exchange (TSE)

Journal of Accounting Advances (J.A.A)
Vol. 6, No. 2, 2014, Ser. 67/3
 
 
Extended Abstract
 
Information Asymmetry and Earnings Management: Evidence from Companies Listed on Tehran Stock Exchange (TSE)
 
Dr. Jafar Babajani                                                   Arash Tahriri
Allameh Tabatabai University
 
                     Dr. Ali Saqafi                                                      Dr. Ahmad Badri
         Allameh Tabatabai University            Shahid Beheshti University
 
Introduction
Growing empirical and systematic evidence supports the argument that earnings management is a common practice in firms (Healy 1985, Perry and Williams 1994 and Defond and Jiambalvo 1994). A fundamental question posed for accounting research is to identify the environmental conditions under which accounting choices are made by managers. It is obvious that managers have private information about the firm and its financial condition that shareholders do not have (i.e., there is information asymmetry between managers and shareholders). This paper examines how information asymmetry between managers and investors impacts the level of earnings management practiced by managers of companies listed on the Tehran Stock Exchange.
 
Hypothesis
As mentioned before, the purpose of this study is to investigate the relationship between information asymmetry and earnings management in companies listed on the Tehran Stock Exchange. So the main hypothesis of the paper is as follows:
The magnitude of information asymmetry has a statistically significant effect on the level of earnings management.
Methods
We choose five proxies for measuring the extent of information asymmetry for TSE listed firms. These variables are selected with respect to the socioeconomic condition of the Tehran capital market and related literature. These five proxies are as follows:

Volume of Trade: Turnover is defined as trading volume divided by outstanding shares.
Volatility of Stock Prices: We measure this proxy variable as the dispersion in the daily stock returns in the year.
P/E Ratio: the price to earnings ratio is measured as stock price divided by earnings per share.
Number of Trading Days: This measure is defined as the number of firm’s stock trading days in a given year.
Firm Age: This proxy is measured as the number of years from the date of listing on the TSE.

In this paper, we use a comprehensive measure by constructing an index of asymmetric information based on the various dimensions of the concept. Our information asymmetry index (IAindex) is based on the percentile rankings of each proxy.
The measure of the managed accounting accrual used in this research is estimated using the Jones model as modified by Kothari, Leone and Wasley (2004),
Using IAindex as a composite measure of information asymmetry between the firm and the market, we propose the following model to examine the relationship between earnings management and information asymmetry:
                         
Where:
DACC is the discretionary (managed) accounting accruals under modified Jones model as modified by Kothari, Leone and Wasley (2004) using the cross-section estimation approach,
IAindex is the information asymmetry index which is measured by compositing five important and relevant proxies (volume of trade, stock price variation, P/E ratio, numbers of trading days and firm age),
DEBT is the ratio of long-term debt divided by the book value of equity,
MKTBV is market capitalization divided by the book value of equity,
SIZE is natural log of the market capitalization,
GROWTH is net revenues for the current year less net revenues for the previous year scaled by net revenues for the previous year.
The population of this study consists of all Iranian non-financial firms listed on the Tehran Stock Exchange (TSE) over 9 years (2000 to 2008) which should satisfy our data criteria. Based on the above criteria, 119 firms are selected for data collection.
 
Results
In order to select the appropriate method of estimation among OLS the pooled model, Fixed Effects (FE), and Random Effects (RE) we applied the Chow and Hausman tests using Eviews 7. The results show that we should run the regression model through panel data analysis with random effect procedure. The results of running the main regression model of research after considering the suitable procedures show that the coefficient of IAindex is positive and statistically significant with the expected sign. Also, we find that the SIZE has a negative and significant effect on earnings management and there is no statistically significant relationship between other used control variables and earnings management magnitude.
 
Discussion and Conclusion
In this research we investigated the effect of information asymmetry on the level of earnings management practiced by companies listed on Tehran Stock Exchange. We did this by using five proxies for measuring information asymmetry which are suitable and applicable with respect to the socioeconomic environment of the TSE. The empirical results show that the information asymmetry index (IAindex) which is a composition of the selected information asymmetry proxies has a positive and statistically significant effect on the extent of earnings management. In particular, the results suggest that firms for which investors have more information are less likely to manipulate accruals for managing earnings. The main reason is that when information asymmetry is high, investors do not have the necessary information to undo the manipulated earnings (Richardson 1997).
Given the severe adverse consequences that earnings manipulations can lead to, regulators have started to take actions to curb opportunistic earnings management. Reducing the discretion that managers have in accounting choices through setting more standards and regulations may be one solution. But an unintended consequence of this type of policy is that it may reduce the general usefulness of accounting earnings, given that managers sometimes use their discretion to signal their private information (for example, Subramanyam 1996). Furthermore, curbing earnings management by restricting managers’ choices is very unlikely to succeed because managers can always circumvent regulations using innovative accounting methods and transaction structuring. If transparent information flow in the capital markets can attenuate the incentives that managers have for earnings management, regulatory bodies should probably focus more on promoting more efficient dissemination of firm-specific information in the market. For getting more information flow in the capital markets, we should insist on the role of information intermediaries such as capital market related media, financial analyzers, powerful brokerage firms, investment banks, financial and credit ranking companies and so on.