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1、Earnings Management During Import Relief InvestigationsJournalo f AccountingR esearch Vol. 29 No. 2 Autumn1 991 Printed in U.S.A. Earnings Management During Import Relief Investigations JENNIFER J. JONES* 1. Introduction This study tests whether firms that would benefit from import relief (e.g., tar
2、iff increases and quota reductions) attempt to decrease earnings through earnings management duringi mport relief investigations by the United States International Trade Commission (ITC). The import relief determination made by the ITC is based on several factors that are specified in the federal tr
3、ade acts, including the profitability of the industry. Explicit use of accounting numbers in import relief regulation providesi ncentives for managerst o manage earnings in ordert o increase the likelihood of obtaining import relief and/or increase the amount of relief granted. While studies of earn
4、ings managementt ypically examine situations in which all contracting parties have incentives to ;perfectly;m onitor (adjust) accounting numbers for such manipulation,i mport relief inves- tigations provide a specific motive for earnings managementt hat is not * University of Chicago. I am especiall
5、y indebted to my dissertation committee, John Bound, Michael Bradley (cochairman), Michael Maher (cochairman), and Thomas Stober for their assistance and to others who have provided helpful comments, notably an anonymous referee, Victor Bernard, Dean Crawford, Linda DeAngelo, Bruce Ikawa, William Ki
6、nney, Richard Leftwich, Robert Lipe, Peter Wilson, David Wright, and workshop participants at Carnegie-Mellon University, Northwestern University, Ohio State Univer- sity, University of Arizona, University of Chicago, University of Iowa, University of North Carolina, University of Rochester, Washing
7、ton University, and Wharton School. I am also indebted to Richard Laulor from the United States International Trade Commission (ITC) for his help in obtaining information about the import relief investigation process at the ITC. This paper has been funded by the Institute of Professional Accounting
8、at the University of Chicago and dissertation fellowships from the Arthur Andersen & Co. Foundation and the University of Michigan Dykstra Fund. 193 Copyright? , Journalo f AccountingR esearch1 991 194 JOURNAL OF ACCOUNTING RESEARCH, AUTUMN 1991 providedi n other earnings managements tudies. Imp
9、ort relief is a wealth transfer from a group of diffuse losers (consumers)t o a groupo f concen- trated winners (all other contracting parties of domestic producers re- ceiving import relief). I argue that consumers do not monitor earnings management as effectively as losers examined in other studie
10、s because the loss to each consumer is smaller, and their interests more diverse, than for the contracting parties examined in these studies.2R egulators have less incentive to adjust for managerse arnings manipulations since their ultimate payoff for such adjustment is less direct than in other sit
11、uations previously studied (e.g., union contract negotiations).3 Fur- thermore, interviews of ITC regulators indicate that the ITC does not adjust financial data for accounting procedures used or for accrual decisions made by firms. This study documents the use of accounting numbers in a federal gov
12、ernmentp rograma s a basis for wealth transfers (i.e., import relief). An estimate of the discretionaryc omponent of total acruals is used as the measure of earnings management rather than the discretionary component of a single accrual (as used in McNichols and Wilson 1988). The discretionaryc ompo
13、nent of total accruals is more appropri- ate in this context because the ITC is interested in earningsb efore taxes, which includes the effects of all accruala ccounts, and, as such, managers are likely to use several accruals to reduce reported earnings. Firm- specific expectations models are devel
14、oped to estimate normal (nondis- cretionary) accruals. The expectations models control for the effects of economic conditions on the level of accruals. I conduct a cross-sectional analysis to test whether estimated discretionarya ccruals (i.e., residuals from the estimated expectations models) tend
15、to be income-decreasing duringt he import relief investigation period. The methodologyd eveloped in this study extends the methodology used in other earnings manage- ment studies; specifically, time-series models are developed to estimate total nondiscretionarya ccruals and cross-sectional tests of
16、the earnings management hypothesis are applied. The results of these tests are con- sistent with the hypothesis that managers decrease earnings through earnings management during import relief investigations. This evidence Examples of other contractingp arties are management,s hareholdersd, ebtholde
17、rs,a nd employees. It should be noted that the long-run effects of import relief are not well understood.I t may be the case that the short-termc osts to consumers( i.e., wealth transfers due to importr elief) are offset in the long-runb y benefits froma strongerd omestici ndustry. 2 example, employ
18、eesd uringu nion contract negotiations (Libertya nd Zimmerman 1986),s hareholdersi n setting managementc ompensation( Healy 1985),s hareholdersi n managementb uyouts (DeAngelo 1986), and shareholdersi n proxy contests (DeAngelo 1988). 3As I discuss later, the ITC has been organizedi n such a way as
19、to minimize the effect of voters on the ITCs actions; therefore,t he ITC may have less incentive to adjust than regulatorsi n situations in which voters have a more direct influence. In either case, the payoff to regulatorsf or adjustingf or managerso pportunistica ccounting choices is less directt
20、han it is for other contractingp arties such as debtholdersa nd stockholders. EARNINGS MANAGEMENT DURING INVESTIGATIONS 195 is of particulari mportance in the light of the current interest in import protection. The next section provides institutional backgroundf or import relief determinations.S ect
21、ion 3 develops the hypothesis to be tested. Section 4 contains the sample selection procedures and descriptive statistics. Section 5 reports the results of the empirical tests. The last section provides conclusions. 2. Role of AccountingN umbers in Foreign Trade Regulation Foreign trade regulation p
22、rovides avenues for granting import relief throught ariffs, quotas, marketinga greements,a nd/or federala djustment assistance. In most cases, an increase in import protection results in a wealth transfer from domestic consumers, domestic importers, and for- eign supplierst o domestic producerso f t
23、he protected good. Agents in the domesticp roducersn exus of contracts, such as employees, stockholders, debtholders,a nd suppliers,c annot be hurt directly by the import protec- tion and instead may benefit.4M anagerso f firms that wouldb enefit from increased import protection have incentives to t
24、ake actions to increase the likelihood of obtaining such protection and/or increase the amount of protection granted. The ways in which managers can increase the expected value of the import relief depend on the factors consideredb y the regulatorsw hen making import relief decisions. In the remaind
25、ero f this section, I review these factors. 2.1 STATUTORY PROVISIONS OF THE FOREIGN TRADE ACTS The major statutory provisions of the foreign trade acts that relate to import relief are summarized in Appendix A. The first three statutes, which pertain to general escape clause, countervailing duty, an
26、d anti- dumpingi nvestigations, are the primary focus of this study. Title VII of the Tariff Act of 1930 was designed to protect domestic industries from imports that are sold at less than fair value (antidumping) or are benefiting from foreign subsidies (countervailing duty). The general escape cla
27、use investigations are based on section 201 of the Trade Act of 1974, which was designed to aid domestic industries that are seriously injuredb y increased imports. Section 201 is based on article XIX of the General Agreement on Tariffs and Trade (GATT), which permits a country to ;escape;( hence th
28、e term ;escape clause;) temporarilyf rom its obligations under the GATT when increased imports of a specific product are causing or threatening to cause serious injury to domestic producerso f a like or directly competitive product. ITC investigations conductedu nder section 201 provide a basis for
29、the president to invoke article XIX of the GATT. 4Except to the extent that the contractingp arties are also consumers. 196 JENNIFER J. JONES The antidumping,c ountervailingd uty, and general escape clause stat- utes requiret he ITC to make a favorable injury decision before import relief can be gra
30、nted.I n the case of countervailingd uty and antidumping cases, once the ITC has determinedt hat an industry is being injuredb y imports,t he Department of Commerced eterminest he increase in tariffs necessary to offset the dumping margin or foreign subsidy. If the ITC rules favorablyi n generale sc
31、ape clause investigations, a recommendation is made by the ITC to the president to grant the industry some specified type of import relief. The president has 60 days to make his import relief decision. If the president does not grant any import relief or grants relief that differs from that recommen
32、dedb y the ITC, Congress can override the presidentsd ecision and accept the ITCs recommendationb y obtain- ing an affirmativev ote in each House within 90 days after the presidents decision. In each of these three types of investigations, the ITC must find that the industryh as been injuredb efore
33、importr elief can be granted. The federalt rade acts specify the factors to be consideredw hen making importr elief decisions. In the case of generale scape clause investigations, the Trade Act of 1974 states that in determiningi njury: . the Commission shall take into account all economic factors w
34、hich it considers relevant,i ncluding( but not limited to)- (A) with respect to serious injury, the significant idling of productivef acilities in the industry, the inability of a significant number of firms to operate at a reasonable level of profit, and significant unemploymento r underemployment
35、within the industry; (B) with respectt o threat of seriousi njury,a decline in sales, a higher and growing inventory, and a downward trend in production,p rofits, wages,o r employment (or increasingu nderemployment)in the domestic industryc oncerned. . (19 USC 2251(b)(2). Emphasisa dded. The factors
36、 to be considered in antidumping and countervailing duty investigations are as follows: (1) actual and potential decline in output, sales, market share, profits, productivity, return on investments, and utilization of capacity, (2) factors affecting domesticp rices, and (3) actual and potential nega
37、tive effects on cash flow,6 inventories, employment, wages, growth, ability to raise capital, and investment (Trade AgreementsA ct of 1979, section 771 (19 USC 1677(7). Emphasisa dded. Since injury determinations specifically call for the use of accounting numbers (i.e., profits, sales, and inventor
38、ies) in foreign trade regulation, the remainder of this paper addresses the three types of investigations that requires uch determinations. The ITC is responsiblef or makinga ll injuryd ecisionsu ndert he foreignt rade statutes. 6 The definition of cash flows used by the ITC is income before tax plu
39、s depreciation expense. EARNINGS MANAGEMENT DURING INVESTIGATIONS 197 2.2 USE OF ACCOUNTING NUMBERS BY THE ITC The use of accounting numbersb y the ITC is not only specified in the trade acts but is also apparent in other ways. A review of 50 petitions7 filed with the ITC for import relief investiga
40、tions reveals that most petitioners cite the poor financial condition of the domestic producersa s an indication of the industrys need for import protection. In an article regardingt he copper industrysp etition for import relief, the WallS treet Journal states that ;the eleven copperp roducerst hat
41、 filed the complaint cited a $623 million loss last year; (Wall Street Journal January 27, 1984, p. 45). Another indication of the ITCs use of accounting numbers is reflected in the public version of its staff reports,8w hich include a section devoted to industry financial performance. An analysis o
42、f the income statement through net operating profit (or loss) before taxes for the industry is always presented. The commissioners injury opinions, which are included in the ITC staff reports, always include a discussion of the financial performance of the industry. All commissioners and commissione
43、rsa ides that I interviewed agreed that the financial condi- tion of the industry is a key factor consideredi n injury determinations.9 The use of accounting numbers by the ITC provides an incentive for managerst o manage earnings in ordert o increase the apparenti njuryt o the firm and, thereby, th
44、e industry.10 Staff members at the ITC indicated that the footwear industry was a prime candidate for inclusion in this study. Their reasoning was as I In the case of generale scape clause investigations,; a petition for eligibilityf or import relief for the purposeo f facilitatingo rderlya djustmen
45、tt o import competitionm ay be filed with the InternationalT rade Commission. . . by an entity, includinga trade association, firm, certified or recognizedu nion, or group of workers, which is representativeo f an industry;( TradeA ct of 1974, 19 USC 2251(a)(1). Investigationsc an also be instituted
46、 by the president,t he Special Representativef or Trade Negotiations,C ongress,o r the ITC. In the case of antidumpinga nd countervailingd uty investigations,p etitions can be filed by a domesticp roducer,o r wholesaler,u nion or groupo f workers,o r a trade association (see the Trade AgreementsA ct
47、 of 1979, 26 USC 3083(9)(C-E). 8 The staff report is prepared by the investigative staff at the ITC for use by the commissioners in making injury determinations.T he report includes a wide range of informationi ncludinga discussion of the product, domestic producers,f oreign producers, level of impo
48、rts,a nd all the economicf actorss pecifiedi n the trade statutes to be considered in injury determinationss uch as production,c apacity utilization, financial performance, product prices, and other causes of injury. The public version of the staff report also includest he final opinions of the comm
49、issioners. Interviews were conductedi n December 1986 with CommissionersS eeley G. Lodwick and AlfredE . Eckes and staff aides Kenneth Novak (aide to CommissionerL odwick)a nd Ron Blum (aide to CommissionerD avid E. Rohr). 10M anagementd iscussion and analysis sections in annual reports and 10-Ks may also affect the expected value of the import relief. For example, the staff report for one investigationl ists the reasons for the firms poor financial performanced uring the past three years as describedi n the firmsa nnual repor