Nonprofit Tradeoff between Accrual and Real Earnings Management

Presented at the 2014 AAA Midwest Region Meeting

Recent accounting studies have documented a tradeoff between accrual based earnings management and real activities earnings management in the for-profit setting where publicly traded firms have incentives associated with their equity capital structure to manipulate expenses toward positive earnings benchmarks (Cohen et al. 2008; Cohen and Zarowin 2010; Zang 2012). Whether the same behavior is observed in the nonprofit setting, where not publicly traded firms lack of incentives to manipulate earnings associated with equity capital markets, is still an empirical question. In the nonprofit setting, studies have documented that managers manipulate accruals (e.g. total operating accruals and industry specific accruals) and manipulate discretionary activities (e.g. non-revenue generated activities and non-operating activities) to manage earnings toward a zero benchmark (Leone and Van Horne 2005; Elshafie 2011; Eldenburg et al. 2011). However, the tradeoff between the documented accrual and real earnings management in nonprofits has not been examined. Can two settings with opposite profit mission, with incentives to manage earnings but in different directions, and where those incentives are associated with the different mix of stakeholders, exhibit similar tradeoff between earnings management strategies? To answer this question, I examine the association between accrual-based and real activities earnings manipulations using a sample of nonprofit California hospitals for the period 2002-2012.