Discontinued operations reporting and earnings management in European listed companies

Abstract

The objective of this thesis is to examine whether companies that report discontinued operations manage their core earnings more than other companies. There is prior evidence suggesting that firms reporting discontinued operations seem to shift expenses from continuing operations to discontinued operations in the income statement to improve their core earnings (e.g. Barua et al. 2010). It seems plausible, however, that there might also be other ways to use discontinued operations reporting to manage core earnings such as timing disposals myopically and applying the classification requirements in the IFRS 5 standard selectively. Thus, I estimate the magnitude of earnings manipulation to improve the income from continuing operations using a method which detects different types of earnings management including classification shifting and real activities manipulation.

I study the magnitude of earnings management quantitatively, applying a methodology based on analyzing earnings distributions (e.g. Burgstahler and Dichev 1997). I collect data from the Worldscope database for 2,327 listed companies in 11 European countries and use standardized differences and centered asymmetry measures to find out if there is evidence of earnings management to meet key earnings benchmarks in the sample and whether there is a statistically significant difference in the quantity of earnings management between firms reporting discontinued operations and other firms.

I find evidence consistent with earnings management to avoid small losses both among DO reporting companies and other firms. The differences between the two groups are not statistically significant, though, suggesting that companies reporting discontinued operations do not manage their core earnings more than other companies. Robustness tests, however, indicate that this lack of statistically significant differences might also be caused by the larger average size of the companies reporting discontinued operations.