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IFRS and Earnings Management

Aggregate accruals approach on Dutch listed companies

Erasmus School of Economics Master Thesis

Abstract - Since the introduction of 2005, all listed European companies are obliged to prepare their consolidated financial statements in accordance with IFRS. There are some reasons to believe that this can be associated with a lower level of earnings management at these companies. Based on results of prior research and the factors that are of specific influence in the Netherlands, in this thesis is studied whether this is the case in the Netherlands. Using the Modified Jones Model, 75 Dutch companies are investigated both 3 years before and 3years after the implementation of IFRS. Also, the possible influence of the size of the company studied. Unfortunately the results provide not enough evidence that a high quality standard as IFRS is associated with a lower level of earnings management, as is the case with most comparable researches in this area, and that there is no difference in this effect between small and large companies.

Author: Supervisor: Date:

C.A. Ton (311975) A.H. van der Boom 07-07-2011

Preface This thesis is written in the final phase of the master's education in Accounting, Auditing and Control. First of all, I would like to thank mister van der Boom, teacher at the Erasmus University, for his help and supervision in the writing process. I appreciate what he did for me and I am very grateful that he has helped me writing this thesis in such a nice and friendly but also very professional way. He has always been very patient and nothing but helpful when I had lost the way for a moment. I think that a good teacher can make a great difference in the final result and in my case; this has worked out very well to me. I would also like to thank the employees of the data team in the library of the Erasmus University. Thanks to them I was able to collect all my data in a very efficient way. Their patience and clear explanation of collecting data was very valuable to me. It would have been very hard to finish this thesis without their help. My parents are the following people I would like to thank. During all four years of my education they financed and supported me and made sure I had all the facilities I needed. If it was not for their support, I would not have been ready to join the labour market already at the age of 21. Also accepting my bad mood when things did not work out the way I planned is something I would like to thank them for. My boyfriend Barry Bondt deserves special attention as well. His well developed experience with Microsoft Office's Excel helped me in analyzing and restating my data far more quickly than I would have been able to do on my own. The same special thanks to my sister Monique Ton, who helped me with some crises in Microsoft Office's Word. Both programs are not my very best talent as I was never interested much in such things and I am happy that they were able to help me with these facility problems. Last but not least I would like to thank my colleague Hilbert Elzen, who helped me with my English writing when I asked for it.

Content
Preface ..................................................................................................................................................... 2 1. Introduction ......................................................................................................................................... 5 1.1 Introducing the subject .................................................................................................................. 5 1.2 Research question & relevance ..................................................................................................... 7 1.3 Contribution to prior research ....................................................................................................... 9 1.4 Methodology ............................................................................................................................... 10 1.5 Structure of the thesis .................................................................................................................. 11 2. Research Approach ............................................................................................................................ 13 2.1 Introduction ................................................................................................................................. 13 2.2 General research approaches ....................................................................................................... 13 2.3 Earnings management specific approaches ................................................................................. 14 2.4 Summary ..................................................................................................................................... 18 3. Theoretical Framework ..................................................................................................................... 19 3.1 Introduction ................................................................................................................................. 19 3.2 Implementation of IFRS .............................................................................................................. 19 3.2.1 IFRS as a high quality standard ............................................................................................ 19 3.2.2 Fair value accounting ........................................................................................................... 20 3.2.3 General view of advantages and disadvantages of IFRS ...................................................... 21 3.3 Earnings management ................................................................................................................. 22 3.3.1 Types of earnings management ............................................................................................ 22 3.3.2 Incentives for earnings management .................................................................................... 23 3.3.3 Different directions of earnings management ...................................................................... 24 3.3.4 Methods of earnings management ........................................................................................ 24 3.4 Accruals Approach ...................................................................................................................... 25 3.4.1 Defining accruals .................................................................................................................. 26 3.4.2. Calculating accruals............................................................................................................. 26 3.4.3. Discretionary and nondiscretionary accruals ....................................................................... 27 3.4.4 Cross sectional and time series analysis ............................................................................... 33 3.5 Summary ..................................................................................................................................... 33 4. Prior literature study .......................................................................................................................... 36 4.1 Introduction ................................................................................................................................. 36

4.2 Influence of IFRS on earnings management ............................................................................... 36 4.2.1 No decrease in earnings management .................................................................................. 36 4.2.2 Decrease in earnings management ....................................................................................... 41 4.3 The Netherlands and specific factors........................................................................................... 42 4.4 Summary and concluding remarks .............................................................................................. 45 5. Hypotheses ........................................................................................................................................ 48 5.1 Hypotheses development ............................................................................................................. 48 5.2 Summary ..................................................................................................................................... 50 6. Research Design ................................................................................................................................ 51 6.1 Introduction ................................................................................................................................. 51 6.2 Research Model ........................................................................................................................... 51 6.3 Sample selection .......................................................................................................................... 55 6.4 Data attainability ......................................................................................................................... 57 6.5 Summary ..................................................................................................................................... 57 7. Empirical Research............................................................................................................................ 59 7.1 Empirical results .......................................................................................................................... 59 7.2 Summary ..................................................................................................................................... 66 8. Conclusion ......................................................................................................................................... 68 8.1 Summary ..................................................................................................................................... 68 8.2 Conclusion and answer to research question ............................................................................... 70 8.3 Limitations................................................................................................................................... 71 8.4 Recommendations for future research ......................................................................................... 73 References ............................................................................................................................................. 75 Appendix 1: Overview of reviewed literature about effect of IFRS on Earnings Management ........... 79 Appendix 2: Overview of general Earnings Management and IFRS literature ..................................... 81 Appendix 3: Companies in research sample ......................................................................................... 83

1. Introduction "IFRS leads to more earnings management" (translated: van Beest 2008), The persistence of earnings and earnings components after the adoption of IFRS (Doukakis 2010), "Have IFRS affected earnings management in the European Union?", (Callao, S. and Jarne, J.I. 2010), "The effect of IFRS adoption and investor protection on earnings quality around the world" (Dunston, Karim, and Houqe 2010). These are just some titles of articles published in magazines in the accountancy world. It shows the enormous popularity of the subject earnings management in relation to the introduction of IFRS. This is one of the reasons that this will be the subject for this thesis. An elaborated explanation and more arguments for this choice can be found in the rest of this chapter. 1.1 Introducing the subject The increasing internationalization of businesses and the capital market creates naturally the need for harmonization of norms for the external reporting at regional and global level. (Klaassen and Hoogendoorn 2006, p. 45) This increasing need for harmonization in the rules for financial reporting, made the European Union decide to introduce the IFRS: International Financial Reporting Standards. Starting in 2005, listed companies are required to report consolidated financial statements prepared according to IFRS (Ball 2006, p. 5), so all listed companies in the EU are obliged to prepare their consolidated financial accounts in accordance with these rules, in order to obtain comparability between several financial statements. It is interesting to investigate the impact of this decision on the informative value of financial statements, because the informative value of financial statements is very important to the stakeholders of a company. Dependent on the accounting standard, stakeholders that rely on the financial statements are assumed to include different parties. For example, the Accounting Standards Board (ASB, 1999) in the UK states that only the decisions of investors are important to take into account at financial accounting. But, according to the International Accounting Standards Board (IASB, 1989), which has developed the IFRS, stakeholders of a company include much more participants such shareholders, but also customers or the bank that finances the company. Stakeholders largely base their decisions on the financial statements of a company. Some examples of such decisions include an investor that wants to know how profitable the shares of a company are and banks want to know whether a company is able to repay its loans. Therefore, it is important that the financial statements provide a true and fair view of the companies' position

and performance. The impact of a new accounting standard in relation to the informative value of financial statements is interesting for these stakeholders. The informative value of financial statements is among other things dependent on whether the presented earnings are manually managed by the managers of a company. There are a lot of definitions of earnings management, one of them is from Healy and Wahlen (1999, p. 368) Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. In this definition it is important to notice that it is about intentionally misleading or influencing financial numbers. One of the intentions a manager is willing to manage earnings is when his bonus depends on the financial results of the company, which is discussed together with the other intentions in chapter 3. In this case, earnings management is seen as a bad phenomenon, since it might be clear that stakeholders cannot fully rely on financial statements when they are managed in the interest of the managers. "In general, it is assumed that earnings management has a negative impact on the transparency and comparability of financial reporting." (Heemskerk and Van der Tas 2006, p. 571) This is what van Beest (2008) also recognizes; he states that earnings management is in general seen as a negative phenomenon. He defines earnings management as the use or abuse of accounting decisions to make the financial report look 'better' (van Beest 2008, p. 14). The fact that earnings management is in general a negative thing is an important assumption for this thesis. Earnings management is further explained in chapter 3.

Standard setters are always looking for ways to improve the accounting standards in order to increase the informative value of financial statements of companies. The previous mentioned obligation of listed companies to prepare their financial statements in conformity with IFRS is one example of improving this informative value of financial statements. One of the main issues of IFRS is uniformity in accounting rules and regulations which will make sure that financial statements are more reliable and transparent, and therefore have a greater value to stakeholders due to this higher quality (Tendeloo and Vanstraelen 2005, p. 161; Jeanjean and Stolowy 2008, p481). Namely, as a result of the increased comparability, the costs of comparing international financial reports decrease for investors. This increase in comparability "puts pressure on managers to reduce earnings management" (Jeanjean and Stolowy 2008, p. 384). According to van Beest (2008), IFRS is an accounting standard that is of high quality, which should lead to an increase in the quality of the financial statements (van

Beest 2008, p. 14). So it is actually assumed that the introduction of IFRS increases the quality of financial reports. Following Ball (2006) and Dechow, Ge and Schrand (2010), earnings management is one of the proxies that has an influence on the quality of financial reporting. In the case earnings management is seen as bad, it is assumed that earnings that are not managed are of higher quality than earnings that are managed. This is consistent especially with the second of the following four requirements of Ball (2006, p. 9) of financial reporting quality: "1) accurate depiction of economic reality, 2) low capacity for managerial manipulation, 3) timeliness and 4) asymmetric timeliness". 1.2 Research question & relevance Due to increasing globalization, the above described uniformity in accounting standards is more and more needed; investors want to able to compare financial statements of national and foreign companies. The question is, however, did the introduction of the obligation to prepare financial statements in accordance with IFRS indeed increase the informative value of the financial statements? More precisely; did the introduction of IFRS lead to a decrease in the level of earnings management? And, what is also interesting: is there a difference in the quality of the financial statements between small and large companies? The expectation exists that there is a difference between small and large companies because of the political cost theory (explained in chapter 3). Because of this expectation, general results of one sample of companies are not very useful to stakeholders. Stakeholders want to know the effect of IFRS on earnings management on their type of company and not in the effect in general. Therefore, separating small from large companies increases the informative value of the results since they will be more specific. This is what this thesis will be about and the main question of this thesis is:

"To what extent did the introduction of IFRS in The Netherlands result in a reduction of accruals based earnings management, in the period 2002-2007 for small and large companies, listed on the Dutch stock exchange?

As said before, an important assumption here is that earnings management is indeed bad. Therefore a reduction in earnings management is one way of increasing the quality of financial statements. Evidence for the fact that a higher quality standard can lead to a reduction in earnings management can be found in Barth et al (2008), which will be discussed

later on in this article. In order to come to a straight answer for this question, the following sub questions are developed which will be answered in the chapters 2 until 7:

1. Which research approach is the most appropriate one for this study? 2. What is the implication of the introduction of IFRS in 2005? 3. What are the methods of managing earnings? 4. How are accruals defined? 5. With which models can earnings management be measured? 6. What is the influence of IFRS on the level earnings management in other countries, according to prior research? 7. What are specific factors in the Netherlands that can have an influence on the success of IFRS? 8. What are the expectations regarding the influence of the mandatory implementation of IFRS on the level of earnings management at Dutch listed companies? 9. What are the hypotheses for the research? 10. How does the research design look like? 11. What are the results of the research? 12. Which conclusions can be drawn from these results?

In chapter 5 specific hypotheses will be developed in order to come to a final answer at the main question. The topic is very interesting, because a lot of time and effort is put in setting new and improving current standards. It is important therefore, that these standards do indeed reach their goal of improving the quality of the information in financial statements. Investors benefit from knowing whether financial statements are transparent and whether they can fully rely on them. Therefore, the influence of the obliged introduction of IFRS on earnings management, and therefore on the informative value of the financial statements, will be important knowledge for investors and other stakeholders. But also auditors of financial statements need to know what differences in opportunities for earnings management arise with the new regulations. This is because a higher level of earnings management results in a higher risk for the auditors, since there is a greater chance that boundaries of materiality will be exceeded. Besides this, there are still countries that have not yet shifted to IFRS for financial reporting. Examples of these countries are Mexico, Canada and Japan (www.ifrs.com). It could be very interesting for standard setters, investors and other stakeholders in these countries, to know

the outcome of an investigation on the influence of IFRS on earnings management. The direction and magnitude of the outcome can be a motivation to implement IFRS, or not. Although the specific circumstances may be different in these countries, the outcome can still be interesting for them, since it is possible to control for such factors in a research model. 1.3 Contribution to prior research In this thesis the focus of the research will be on Dutch listed companies. This includes companies listed on the AEX, AMX and AScX, but also companies that are not on one of these indices. A distinction will be made between large and small companies. This research contributes to prior research for two reasons. First, until now no research has specifically studied the Netherlands. There are reasons to believe that the results in the Netherlands might be different to the results in other (European) countries due to some specific factors that are present. This research will contribute by studying whether these specific factors really have influence on earnings management and therefore contribute to the success of the implementation of IFRS. As will be discussed in chapter 4, country specific factors are very important in the expected result that IFRS will have when it is implemented. First of all, The Netherlands is a French Civil Law country (La Porta et al 1998, p. 1118). A lot of previous research is done in Germany, which is a German Civil Law country. The difference between German and French Civil law is not a clear, general difference like the difference between 'code' and 'common' law. Like Merryman and Perez-Perdomo (2007) state in their book: France and Germany are, among others, frequently spoken of civil law countries, but they have their own legal systems with different rules, procedures and institutions (Merryman and Perez-Perdomo 2007, p. 2).One relevant difference between these two is the level of investor protection, which is the lowest in French civil law countries and much higher in German Civil Law countries. The difference in legal system can have an influence on the level of transparency in financial reporting, which will be explained in chapter 4. Another argument is that the standard that was in place before IFRS was implemented, the Dutch GAAP, was already very much in line with IFRS, which was not the case in Germany and other countries that were investigated like France and Switzerland. These and other factors, discussed in paragraph 4.3, make the situation in the Netherlands unique. Secondly, there has never been done such a research, not in the Netherlands nor somewhere else, where specifically small and large companies are compared to each other. Almost every research studies different industries in a company, expecting a difference in the level of

earnings management between several industries. However, it is interesting to study whether there is a difference between small and large companies, since the political cost theory (explained in chapter 3) implies a different level of earnings management at small and large companies. Because it is expected that the results are different for large and small companies, general results of one sample of companies are not very useful to stakeholders. Stakeholders want to know the effect of IFRS on earnings management on their type of company and not in the effect in general. Therefore, separating small from large companies increases the informative value of the results since they will be more specific. Stakeholders want to know whether there really is a difference in this effect at small and large companies, in order to be able to draw a more company specific conclusion about the informative value of the financial statements after IFRS has been implemented. So this thesis will contribute to prior literature, since the specific focus on the Netherlands with its country specific circumstances and the new approach of comparing small and large companies may provide interesting outcomes. The results might not provide a generalization for other countries due to the specific circumstances. 1.4 Methodology In order to do research, there are three main research approaches namely: market-based research, positive research and normative research. The research of this thesis has a positive approach, and more specifically the Positive Accounting Theory (PAT). The difference between a positive theory and PAT is explained in chapter 2. In short, PAT is a theory that "seeks to explain and predict managers' choices of accounting methods" (Deegan and Unerman 2006, p. 252). The specific angle of incidence within the PAT will be the agency theory. This is the most appropriate way of doing research for this subject, as will be explained in chapter 2. In order to investigate whether the mandatory introduction of IFRS was successful in providing a higher quality of financial statements, including a lower level of earnings management, the financial numbers of Dutch companies will be used. The sample size includes 75 companies, which were all listed during the period of 2002-2007. As chapter 4 and 5 explain more thoroughly, all data is obtained by the Thomson One Banker Database, which is available at the Erasmus University Rotterdam. The relevant data is collected in a data file. The Modified Jones Model (explained in chapter 3) is used for calculating the relevant numbers with the collected data. After that, a regression analysis in SPSS is performed to measure the possible relevant correlations of the accounting standard used, Dutch GAAP versus IFRS, and the firm size, small or large, with the level of earnings

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management. It is investigated whether the mandatory introduction of IFRS in 2005 has had a positive, negative or even no influence on the level of earnings management at Dutch listed companies. 1.5 Structure of the thesis The rest of this thesis will be as follows. Chapter 2 discusses the appropriate research approach for this research. This is important because the position taken is important background knowledge for the discussion of prior research. Sub question one will be answered in chapter 2. Chapter 3 provides a theoretical framework for this research. It begins with discussing the implications of the introduction of IFRS, as well as different views on the impact of this implementation. After that, earnings management as a phenomenon is discussed. Several definitions, incentives and methods for earnings management are discussed. Then, the term accruals is explained. The difference between discretionary and nondiscretionary accruals is explained, which is necessary to determine the existence of earnings management. When this is clear, several models that distinguish discretionary from nondiscretionary accruals are presented. Here, also the relationship between accruals and earnings management is defined. In the conclusion of this chapter, sub questions 2, 3, 4 and 5 are answered. Then, in chapter 4, the influence of the implementation of IFRS on earnings management will be discussed. This will be done by an extensive review of existing literature on this topic. Research on this subject is done in several countries, especially in Europe after the obliged introduction of IFRS for listed companies. Both research on early adopters as well as research on companies that followed IFRS after the obliged implementation are discussed. After that paragraph, the country specific factors of the Netherlands that are relevant are discussed. The conclusions of the prior researches will be summarized and compared with each other. The chapter will end with a summary, including an answer to sub questions 6 and 7. After that, chapter 5 presents the formulated hypotheses. Sub questions 8 and 9 are answered in chapter 5. Then in chapter 6 the research model is introduced. It is argued why this model is chosen. The meaning of the variables of the models are explained and it is explained how the hypothesis can be answered with these models. Also, the sample selection and the data attainability is discussed. In the concluding paragraph, sub question 10 will be answered. The results of the research will be showed and explained in chapter 7, which will be the answer on sub question 11. All relevant outcomes will be discussed. Also an analysis of the

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findings will take place. With this analysis, sub question 12 can and will be answered. Chapter 8 will provide the conclusion. First a short summary of the important issues of the thesis is given and then the main question will be answered. The thesis will end by mentioning the limitations of this research, followed by some recommendations for further research of this subject.

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2. Research Approach 2.1 Introduction This chapter provides an overview of several approaches to do accounting research. After the appropriate way of doing this research is chosen, the specific approaches to do earnings management research are discussed. The eventual choice for a model for this research is defended in paragraph 2.3 2.2 General research approaches In order to do a research, it is important to choose which approach is going to be used. As mentioned in the introduction, a research can be done from a market based, normative or positive approach. Within these general research approaches, Deegan and Unerman (2006) provide several specific approaches to do accounting research, such as the inductive accounting theory, also known as market based research, normative accounting theory and Positive Accounting Theory (PAT). The first approach, market based research "explores the role in accounting and other financial information in equity markets" (Deegan and Unerman 2006, p. 377). It is about examining the reactions of the market on specific accounting procedures or information releases. The observations that are done in real life then, serve as evidence which is generalized for a specific theory. Thus from the market researches, several conclusions are drawn which are used to develop a theory of what the reaction of the market should be in several situations. The normative accounting theory serves as a prescription. As the name already suggests, such theories prescribe what people or companies should do in certain circumstances. "Theories that prescribe particular actions are called normative theories as they are based on the norms (or values or beliefs) held by the researchers proposing the theories" (Deegan and Unerman 2006, p.10) A limitation of this type of research is that it is not based on practical observations. Therefore, they cannot tell anything about the real practices. The third and last approach is Positive Accounting Theory (PAT). Positive theories just describe, explain and predict what is happening. It can be seen as the opposite of induction theory, because it "begins with some assumption(s) and, through logical deduction, enables some prediction(s) to be made about the way things will be". (Henderson, Peirson and Brown 1992, p. 326) In the special case of PAT it is about describing, explaining and predicting the accounting behavior of managers. It is a more specific approach of doing positive research by applying it to the accounting behavior of managers. Positive Accounting Theory is based on

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empirical testing of existing theory. One of the limitations of this kind of research is that is does not tell companies what to do, but just observe what is done right now. The research of this thesis will use the third approach, the Positive Accounting Theory. The argumentation for this is that there are existing models for measuring earnings management and together with assumptions about the influence of the introduction of IFRS on earnings management; it is tested whether the variable IFRS is associated with the level of earnings management. Since earnings management is about describing, explaining and predicting the accounting behavior of managers, the PAT is applicable here. The market based approach is not applicable to this kind of research, because it will not be studied what the reaction of the market on the adoption of IFRS is. Also the normative accounting theory is not applicable, since there will be no advice on what companies should do. This research will just focus on predicting the possible effect of IFRS on earnings management, which is why positive accounting theory is the most applicable approach. As mentioned by Deegan and Unerman: Positive Accounting Theory focuses on the relationships between the various individuals involved in providing resources to an organization and how accounting is used to assist in the functioning of relationships (Deegan and Unerman 200, 207). An important assumption of the positive accounting theory is that every individual acts in his own interest and that companies try to align the interests of agents and principals, which is also known as the agency theory. In the specific case of this thesis, managers of companies are the agents and the stakeholders are principals. When managers are engaged in earnings management, it is assumed they indeed act in their own interest, resulting in a conflict with the stakeholders. Accounting standards are then the mechanism that has to make sure that managers do not act in their own interest, but in the interest of the stakeholder. Therefore, the main assumption of the Positive Accounting Theory is valid for this research, making this approach the best for researching the effect of new accounting standards on the behavior of managers. The next paragraph will discuss some specific approaches, used in the work field of earnings management, after which the final approach for this research will be presented. 2.3 Earnings management specific approaches There are basically three main approaches used in the current literature about earnings management, namely; measuring aggregate accruals, measuring specific accruals and analyze the distribution of earnings after management (McNichols 2000, p. 314).

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The first approach, the aggregate accruals approach, is the one most used in research of earnings management. More precisely: The model of aggregate accruals proposed by Jones (1991) is the most commonly used in the literature (McNichols 2000, p.314).The aggregate accruals approach tries to explain earnings management on behalf of separating discretionary and non-discretionary accruals. The discretionary accruals are an indication for earnings management. The term accruals, as well as the difference between discretionary and nondiscretionary accruals, will be further explained in paragraph 3.4. When the aggregate accruals approach is used, both total and specific accruals can be studied. The first takes into account all accruals present at a company to estimate nondiscretionary accruals. For example Healy uses this method, which is explained in paragraph 3.4.2. The second way is only take into account some specifically defined accruals. As will also become clear in paragraph 3.4.2, Jones and Dechow measure earnings management by studying only some accruals to estimate the nondiscretionary accruals. Both methods within the aggregate accruals approach are applicable for comparing different companies with different sizes, different operating industries and other differences. The second approach by McNichols, measuring specific accruals, also separates discretionary from non-discretionary accruals in order to estimate earnings management. The difference with the first approach is, however, that the focus in this kind of research is on one specific industry, making use of industry specific accruals. In this way, firm specific circumstances for earnings management are taken into account. For this kind of studies, the knowledge of institutional arrangement is used to characterize the likely behavior of accruals for a specific industry (McNichols 2000, p. 314). An advantage of this approach is that "by exploiting information about specific accruals, potentially more powerful methods for detecting earnings management can be developed" (McNichols 2000, p. 321). For both the aggregate accruals and the specific accruals approach the Jones model, explained in chapter 3, is one of the many models that can be used. The third approach studies the distribution of earnings, after the management of earnings is done. Burgstahler and Dichev (1997, see chapter 3) are one of the users of this approach in order to investigate whether earnings are managed to meet targets, by measuring the nondiscretionary part of earnings and the interval around the earnings targets. The research done by Jeanjean and Stolowy (2008, see chapter 3) is another example of the method of studying the distribution of earnings. As will be explained in chapter 4, they study irregularities in earnings distribution as an indication for earnings management.

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The above approaches for studying earnings management all have their limitations. The main limitation of the aggregate and specific accruals models is that accruals management is not the only way of earnings management (see chapter 3). Therefore, a large part of earnings management is not considered in these studies (Lippens 2010, p. 86). Besides, in the aggregate accruals approach it is possible that results are distorted because the performances of different industries are compared (Kothari, Leone and Wasley 2005). This second limitation is the reason McNichols (2000) had the preference to use the approach of specific accruals. However, a disadvantage of this approach is that the results are hard to generalize because of the specific situation. McNichols (2000) also mentions the high costs as a disadvantage of this approach, because a lot of institutional data and knowledge is needed. The last, innovative approach for earnings management has as main disadvantage that is seems implausible that small intervals around earnings targets are explained by the nondiscretionary component of earnings (McNichols 2000, p. 336). Besides, since this approach is not used a lot in prior research, there is little information about the strength of this method. Taking the pros and cons of the three approaches, the research in this thesis will make use of the first approach, aggregate accruals. Since the research will focus on a group of companies across several industries, before and after the event of introducing IFRS, a specific accrual approach is not applicable. The sample will be too small to look at institutional factors influencing the different behavior of accruals and will therefore not provide reliable outcomes. As will become clear when the research model is presented, the sub-method within the aggregate accruals approach of some accruals is used instead of the total accruals. The reason that the method of making use the distribution of accruals is not chosen, is because it is not used a lot in prior research. For example, the model of Jeanjean and Stolowy (2008), which is explained in chapter 4, is quite new. Therefore, it is not sure whether this model provides reliable outcomes. The current literature has not found any evidence on the reliability of this model. A more important argument that the model of Jeanjean and Stolowy is not used is that they do not have very strong incentives to use this model their selves. "Given constraints on data availability, and consequently the difficulties of implementing the methods based on accruals, in this paper we apply the third methodology and analyze the distribution of earnings in the three countries" (Jeanjean and Stolowy 2008, p. 485). Their reason not to use another model is that it is 'too difficult', which is not a very strong argument to defend a research model. Therefore, following Jeanjean and Stolowy in using their model

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for measuring earnings management would not be a very convincing choice, especially when there is no evidence that this model provides reliable outcomes. So, the aggregate accruals approach will be used in order to do the research. One of the many models that use this approach is the Modified Jones Model by Dechow et al (1995). An argument to choose for Modified Jones is that is the most accepted model in the existing literature. Several researches concluded that only the Jones- and the Modified Jones model are able to provide reliable estimates for earnings management. Dechow et al (1995) compared several models that make use of the accruals approach, namely Healy, DeAngelo and Jones, which will all be explained in chapter 3. In their own research, Dechow et al developed the Modified Jones Model. In order to get a good comparison of the several models they made use of practical data, namely "32 firms alleged by the Security Exchange Commission (SEC) to have overstated earnings" (Dechow et al. 1995, p. 219). They studied which model showed the existence of earnings management at the 32 companies of which the SEC said that earnings management was apparent. Their findings were consistent with previous findings that the Jones model provides the most powerful explanation, since this model indeed provided the most significant indication for earnings management at these 32 companies, compared with a sample of 1000 event-years. This counts for both the standard and the Modified model of Jones. Since the Modified Jones model is more extended than the standard model this is the best method for this research, as will be explained in chapter 3. Although the model has faced a lot of criticism, most of the commentary of this method is against the cross-sectional variant of this type of model (Heemskerk and Van der Tas 2006), which will also be explained in chapter 3. This research will not include a cross-sectional analysis, so a large part of the critic is not relevant. Besides this, despite the limitations, the time series variant of the Jones Model is used a lot in prior research and it is seen as an acceptable approach. It also enhances the comparability of results to use this method. Research done in for example Germany also used this method and the outcomes cannot be compared when a total different model is used. Although the country specific factors are not the same, the results might be comparable when they are critically reviewed. Therefore, this method will be used in this research.

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2.4 Summary This chapter explained the different approaches to do accounting research; market-based, normative and positive accounting theory. Market based research is about observing things in reality and bring this into a theory. Normative accounting theory is about prescribing what people should do. Positive accounting theory is about describing or predicting what is happening. In the special case of accounting, Positive Accounting Theory (PAT) describes, explains and predicts the accounting behavior of managers. Positive accounting research begins with some assumptions (see chapter 5) and theories and then uses models to explain what happens in reality. Therefore, the positive accounting theory is the most applicable approach for this research. Within this theory, the agency is the most appropriate sub approach. An important assumption of this theory is that individuals act in their self interest. As will be explained in chapter 3, self interest of managers plays a role in whether a company is engaged in earnings management. McNichols (2000) has set up three methods for studying earnings management; measuring aggregate accruals, measuring specific accruals and analyze the distribution of earnings after management. For this type of research, the aggregate accruals approach is the most appropriate because of the characteristics of the data. This will be used studying only some accruals instead of total accruals. Eventually, the time series variant of the Modified Jones Model by Dechow (1995) is the specific model that will be used. This is the answer to sub question 1: "Which research approach is the most appropriate one for this study?" It is the Modified Jones Model by Dechow (1995), taking into account that this is a Positive Accounting Theory. The specific accruals approach is not applicable for this research because the purpose of this research is not to look at a specific industry and the approach of analyzing the distributions of earnings, is not applicable because the insights and models are quite new and therefore not very strong yet. This reduces the confidence in such models. Besides this, the models are less elaborated in the source articles, which makes it hard to use them.

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3. Theoretical Framework 3.1 Introduction This chapter will provide the broad theoretical background that is needed for an understanding of the research done later in this thesis. The items IFRS, earnings management and accruals are thoroughly explained respectively, in order to come to a clear view of these subjects. Together with the explanation of accruals, the accruals approach and the supporting model that is used a lot in research of earnings management is discussed. Later on in this thesis, the importance of this model becomes clear and it is used for this research as well. This broad explanation of some terms and models is necessary for the specific prior literature study in chapter 3. The chapter ends with a summary wherein sub questions 2,3,4 and 5 are answered. 3.2 Implementation of IFRS 3.2.1 IFRS as a high quality standard An important aspect of this thesis is the introduction of IFRS in 2005. IFRS stands for International Financial Reporting Standards and these standards are issued by the International Accounting Standards Board (IASB). The IASB is a cooperation of national accounting organizations. (Klaassen and Hoogendoorn 2006, p. 48) The conceptual framework of the IASB covers almost all aspects of the annual report. Such a conceptual framework is important, since it contributes to a consistent set of rules. (Klaassen and Hoogendoorn 2006, p. 86) It is important to mention that IFRS are principles-based standards instead of rules-based. (Carmona and Trombetta 2008, p. 456) The main difference between these two approaches is that rules-based standards includes specific criteria, bright line thresholds, examples, scope restrictions, exceptions, subsequent precedence, implementation guidelines etc (Nelson 2003, p. 91) while principles-based standards refer to fundamental understandings that inform transactions and economic events (Carmona and Trombetta 2008, p 456). So principles-based systems give a more general guideline of how an annual report should be made up, which is applicable for IFRS. It is a system of financial reporting that is based primarily on the fundamentals of accounting (van Beest 2011, p. 2-3). It makes use of the professional judgment of the users of the guidelines. These users have to think about the intention of the standard setter. This is not the case for rules based standards, where the users just do what is stated in the rules instead of think themselves. The stated rules include very extensive and precise elaborations concerning what is allowed or is not allowed (Alexander and Jermakowicz 2006), where principles based standards leave more room for interpretation for the users.

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IFRS are introduced in order to increase the comparability of financial statements and also to enhance the transparency of financial reports. Since IFRS is a high quality standard, financial statements prepared in accordance with IFRS are assumed to be of higher quality. This is what Barth et al (2008) recognizes: A goal of the International Accounting Standards Committee (IASC), and its successor body the International Accounting Standards Board (IASB), is to develop an internationally acceptable set of high quality financial reporting standards. (Barth et al. 2008, p. 468) Taking this into account, together with the definition of Healy and Wahlen (1999) that earnings management is seen as a bad thing that misleads stakeholders, the overall expectation is that IFRS leads to a lower level of earnings management because of this higher quality of standards. This assumption is strengthened by the conclusion of the research of Barth et al (2008) that firms that apply the international accounting standards are, among other things, less engaged in earnings smoothing and managing earnings towards a target. (Barth et al 2008, p. 496-497) These positive consequences of the implementation of IFRS are also recognized by Ball (2006), who discusses the pros and cons for investors of the introduction of IFRS. He makes a distinction between indirect and direct advantages for investors. These include more accurate, comprehensive and timely information, small investors being able to compete with professional analysts due to better information and eliminate the need to make adjustments in order to make financial statements of companies more comparable. (Ball 2006, p. 11) These positive effects of the implementation of IFRS mentioned by Ball imply that the rules and regulations of IFRS are better than the standards used before. Heemskerk and van der Tas (2006) mention that one of the reasons to choose for IFRS is that it makes financial reporting more transparent and comparable. This would suggest that there is less room for managers to manage earnings, resulting in a better quality of financial statements. 3.2.2 Fair value accounting A very important aspect of IFRS is that many assets, liabilities, revenues and costs should be recognized at their fair value, especially financial assets and liabilities (Laux and Leuz 2009, p. 4). According to Klaassen and Hoogendoorn (2006, p. 94), fair value is defined by the IASB as follows: the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arms length transaction. This fair value is directly one of the main disadvantages of IFRS that is mentioned by Ball (2006). In a lot of cases this can be the market price of a specific asset for example, but when there is no market for the asset, or the price is unknown, the fair value has to be estimated. The fact that this

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estimation, or valuation, process is done by the management of the company makes it a very subjective process, which may enhance the possibility of earnings management. Another problem with fair value arises in the case of illiquid markets. For example, in the recent financial crisis, banks sold a lot of (financial) assets because of an urgent need for liquidity due to threat of bankruptcy. So in fact, there was a market price for these (financial) assets. But it might be clear that these forced selling prices are not a valid measure for the fair value of these assets for other parties. "The basic idea is that banks may (have to) sell assets at a price below the fundamental value and that the price from these (forced) sales becomes relevant to other institutions that are required by fair value accounting to set their assets at these value" (Laux and Leuz 2009, p. 826-834; Allen and Carletti 2008; Plantin et al 2008a). For these reasons, the fair value aspect is seen as a disadvantage of IFRS, regarding the informative value of financial statements, since it may lead to even more earnings management instead of show a decrease. Other disadvantages mentioned by Ball are less competition among several systems and incentives of preparers will remain local. (Ball 2006, p. 25) 3.2.3 General view of advantages and disadvantages of IFRS The conclusions of Ball are more or less the same as that of Bolt-Lee and Smith. They state in their paper, which is about highlights in IFRS research, that the benefit of U.S. investors might not exceed costs. (Bolt-Lee and Smith 2009, p. 50) The benefit of improved standards and cost saving aspect of multinationals are admitted, but they are skeptical about the net effect of the introduction of IFRS. Heemskerk and Van Der Tas (2006) do also recognize the previous mentioned advantages and disadvantages of the implementation of IFRS. They state that although the rules are very stringent, the application of these rules comes with a lot of subjective measures. Therefore, earnings management should be less possible when financial statements are prepared in conformity with IFRS. However, at the same time, the subjective estimates which are needed would lead to more possibilities of earnings management. Soderstrom and Sun (2007) argue that it is not possible to give a general view of whether the implementation of IFRS has a positive influence on the quality of financial reporting. Unlike Ball (2006) and Bolt-Lee and Smith (2009), they do not give an overview of advantages and disadvantages, but they state that it depends on the circumstances. According to Soderstrom and Sun (2007) there are three important factors that determine the success of the implementation of IFRS: (1) the quality of the standards; (2) a countrys legal and political

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system; and (3) financial reporting incentives (Soderstrom and Sun 2007, p. 695). Jeanjean and Stolowy (2008) recognize this as well. They state that "IFRS provides management with discretion" and that "how far that discretion is used depends on firm specific characteristics and national legal institutions" (Jeanjean and Stolowy 2008, p. 481). Paragraph 4.3 will discuss some relevant country specific factors that are applicable for the Netherlands. 3.3 Earnings management 3.3.1 Types of earnings management Earnings management is a popular topic in the existing academic literature. Plenty of articles are written about the definition, incentives and implications of earnings management. The definition of earnings management described in section 1 is just one of many existing definitions. But, as Paton (1922) states: "It is always difficult to frame a useful definition for a broad subject. Precise definitions are likely to be inadequate at best, and often positively misleading." (p. 3) Ronen and Yaari (2008) do also recognize this and thats the reason they introduced white, gray and black earnings management. The definitions of the three kinds of earnings management are described as follows: "Beneficial (white) earnings management enhances the transparency of reports, pernicious (black) earnings management involves outright misrepresentation and fraud, the gray is manipulation of reports within the boundaries of compliance with bright-line standards, which could either be opportunistic or efficiency enhancing." (Ronen and Yaari 2008, p. 25) In fact, white earnings management is seen as 'good', since this enhances the quality of the financial statements. For example, income smoothing can be a good form of earnings management. In this phenomenon, earnings are managed in such a way that a stable trend can be presented, instead of strongly fluctuating numbers each year. Investors like stability in that it reduces their risks. So when this is the only intention why the earnings are managed, it can be seen as a good type of earnings management, because the value of the information will increase. 'Gray' earnings management can be good when used for efficiency but can be bad when used for opportunistic reason, so this is the vaguest one of the three. Finally, black earnings management is really fraud. This is 'bad' earnings management since managers manage earnings just in order to get better themselves. In this way, the only intention of the manager will be increasing their own wealth, for example because their bonus will increase when presented earnings are higher. By this type of earnings management, investors are not benefited since the results are not managed in order to improve the information value of the financial statements. The black form of earnings

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management is in line with the definition of earnings management of Healy and Wahlen (1999). Although Ronen and Yaari do recognize that earnings management can be good (the white or gray variant), they conclude with the definition of Healy and Wahlen for earnings management, as stated in the introduction of this article. Following Ronen and Yaari (2008), Leuz et al. (2003), Tendeloo and Vanstraelen (2005) and others this definition of earnings management is the starting point of this thesis, which assumes that earnings management is a bad thing. 3.3.2 Incentives for earnings management Healy and Wahlen (1999) give three main incentives for earnings management: capital market expectation and valuation, contracts written in terms of accounting numbers and antitrust or other governmental regulation. The first incentive, the capital market expectation and valuation, is about the influence of earnings on the stock price. Managers can increase earnings, in order to increase the stock price, for example to meet analysts' expectations. (Burgstahler and Eames, 1998) This can be important for the managers, since they will be held responsible for the results of a company. They therefore will think it is important to meet analysts' expectations, in order to avoid disappointed investors. The second incentive that explains earnings management according to Healy and Wahlen, the contracts written in terms of accounting numbers, has to do with all the contracting agreements a company has. In order to align the interests of managers and stakeholders, a lot of contracts are in place. According to Watts and Zimmerman (1978) these contracts give rise to an increase in possibilities for earnings management. An example is that companies that are close to lending contracts manage earnings. Banks for example increase the interest rate when the risk of their client becomes higher. This can be a reason to manage earnings by presenting a better result in order to avoid an interest increase resulting in higher costs. Another, maybe more familiar example is management compensation contracts. (Healy and Wahlen 1999, p. 376). When the compensation of a manager depends on the results of the company, there will be an incentive to manage the earnings in a positive way. The reason for this is that the manager will receive a personal benefit as a result of the numbers presented. The third incentive for earnings management, the antitrust or other governmental regulation, has to do with eventual intervention of the government or another institution, for example when industrial regulations are violated. This is also known as the political cost theory. (Deegan and Unerman 2006, p. 241) In order to avoid such intervention, management tries to

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manage earnings in such a way that the intervention is not needed. An example of this situation can be that a bank which is close to a minimum capital requirement recognizes abnormal gains, which will lead to a better capital position. (Healy and Wahlen 1999, p. 378) But also the government or lobby groups can put pressure on a company. According to Deegan and Unerman (2006) especially large companies have to deal with such political costs, since they attract more attention as they are more visible than small companies. 3.3.3 Different directions of earnings management An article about earnings management, especially about avoiding losses, is written by Burgstahler and Dichev. The main subject of their article is how and why firms avoid reporting earnings decreases and losses (Burgstahler and Dichev 1997, p. 101). They use descriptive statistics with data from 1977 until 1994 in order to get evidence on this phenomenon. They find indeed that earnings are managed, specifically that losses are managed away. This article provides two main reasons for managers to choose for earnings management: managers avoid reporting earnings decreases and losses to decrease the costs imposed on the firm in transactions with stakeholders and an explanation based on prospect theory, which postulates an aversion to absolute and relative losses (Burgstahler and Dichev 1997, p. 124). The incentives that this article mentions for earnings management are slightly different from that of the article of Healy and Wahlen. This is because Burgstahler and Dichev focus on one side of earnings management, managing earnings in case of losses, while Healy and Whalen focus on the totality of earnings management, both in good and in bad times. This concludes that earnings management can include both over- as well as undervalue earnings. This is consistent with earlier mentioned findings, since the compensation contracts of managers probably lead to overvalue earnings, while the political costs theory can lead to an undervalue of earnings. 3.3.4 Methods of earnings management There are two broad ways of managing earnings; real earnings management and accruals management. The first measurement of earnings management, real earnings management, means that the management chooses several economic activities in order to influence the financial statements (Heemskerk and van der Tas 2006, p. 571-572). This type of earnings management does affect cash flows. According to Roychowdhury (2006) real earnings management is defined as: "management actions that deviate from normal business practices, undertaken with the primary objective of meeting certain earnings thresholds."

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(Roychowdhury 2006, p.336) An example of real earnings management is the reduction in discretionary expenses, such as research and development costs, in order to increase the reported income (Cohen, Dey and Lys 2007, p. 12). Another example is to sell products with a high discount, in order to increase the sales volume in the short term. So, real earnings management is about managing the real activities of the company. According to Roychowdhury (2006, p. 338) real earnings management more has to do with production and pricing decisions. Since this will be less visible for accountants and other third parties, this method of earnings management is a lot harder to detect than, for example, accruals based earnings management. In fact, it might be technical impossible in practice. Therefore, the research of this thesis will focus on accruals based earnings management. Accruals based earnings management, the second method for earnings management, is about the discretion of management in the process of selecting accounting methods and in estimating numbers. The term accruals and their measurement will be further explained in paragraph 3.4. For now the following explanation will be sufficient. Accrual management is: "manipulating accruals with no direct cash flow consequences". (Roychowdhury 2006, p. 336) Accruals appear on the balance sheet, and total accruals are calculated by taking together several balance sheet items. Examples of balance sheet items that are included in total accruals are prepaid costs or debtors. The reason that these accruals can be an indication for earnings management is that the discretion of the management is needed for the recognition of some items. Also the timing of these items are subject to management discretion, for example the write-off of assets can be delayed (Roychowdhury 2006, p. 336), which can be an indication for earnings management. For a better explanation of accruals and accruals based earnings management, see paragraph 3.4 As mentioned in paragraph 2.3, McNichols (2000) sets out the different models which are most used in research about measuring earnings management: aggregate accruals, specific accruals and the distribution of earnings after the earnings management took place. For a thorough understanding of these different methods, see chapter 2. 3.4 Accruals Approach In order to understand the methods of prior research, a quick overview of the Modified Jones Model, as introduced as the model for this research in chapter 2, is given. A more elaborated explanation of this model will be given in chapter 5, where the research model for this research is introduced. In chapter 4, where the previous literature on this subject will be

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discussed, it is explained that some researches did not make use of the accruals approach, but developed other methods to measure earnings management. However, in order to make the research results comparable to the outcomes of other European countries research results, the Modified Jones Model, which is explained below, is used. A second reason for this choice has to do with limitations of the other models. A third reason is that this model provides the most reliable results compared to other models making use of the accruals approach. This was explained in chapter 2. The reason the accruals approach and the Modified Jones Model is already explained here is that this knowledge is needed for an understanding of the discussed prior literature in chapter 4. Prior research indicated that this model is the best for this research, as discussed in chapter 2. Since there are no clear indications that the other models used in prior research provide better estimations, these models will not be elaborated very much. 3.4.1 Defining accruals As said before, one way of measuring earnings management is making use of accruals. This is one of the three research approaches McNichols (2000) describes, as was discussed in chapter 2. The accruals approach is based on the accruals principle, that explains the difference between cash flowing in and out of the company on the one hand, and the recognition of revenues and costs on the other hand. The total accruals are a calculation of several balance sheet items that can give an indication for the existence of earnings management. Accruals include temporary items on the balance sheet that arise because cash flows do not always hold on to the timing and matching principles. According to Dechow (1994) a problem with these accruals in accounting is that their recognition is partly subject to the discretion of the management. "This discretion can be used by management to signal their private information or to opportunistically manipulate earnings." (Dechow 1994, p. 5) 3.4.2. Calculating accruals Total accruals is not a balance sheet item in itself. It is the sum of several balance sheet items. There is not one right calculation to determine the total accruals, but there are more. Dechow et al (1995), Healy (1985) and Jones (1991) total accruals (TA) all use the same formula for calculating total accruals. This thesis will be consistent with these studies and will use the same formula.

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Total accruals are calculated as follows: (1) where: CA = change in current assets CL = change in current liabilities CASH = change in cash and cash equivalents STD = change in debt included in current liabilities Dep = depreciation and amortisation A = total assets Using formula (1), the total accruals for a firm in year t can be calculated. In the following paragraph, 3.4.3, several models for measuring earnings management are discussed such as Healy, DeAngelo and Jones. Although their methods differ, they all share formula (1) for calculating total accruals. 3.4.3. Discretionary and nondiscretionary accruals When the accruals approach is used for research, it is important that discretionary accruals are separated from non-discretionary accruals. Discretionary accruals are defined as actual total reported accruals less expected normal accruals (Tendeloo and Vanstraelen 2005, p. 163). So, the nondiscretionary accruals are being seen as accruals that come from the operational activities of a company, and the rest of the accruals are discretionary. An important difference between discretionary and nondiscretionary accruals is the involvement of management discretion. A clear example is given by van Beest (2008). He states that an example of a nondiscretionary accrual is that of the relationship between turnover and debtors. Sold products that are not paid for yet, lead to a logical increase in debtors without a judgment of the management necessary. So debtors are a nondiscretionary balance sheet item. But for example the estimation of doubtful debtors does involve the judgment of management, which makes such a balance sheet item a discretionary accrual. Therefore, discretionary accruals are an indication of earnings management, since the influence of the management plays a role here. The discretionary accruals are estimated by several models, which will be explained below. Healy The first model for estimating the discretionary part of accruals is from Healy (1985). TA (t) = [CA (t) -CL (t) - CASH (t) + STD (t) - Dep (t) ] / A (t-1)

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According to Healy, the mean total accruals from an estimation period are a representation of the measure of the nondiscretionary accruals in the event period. (Dechow et al. 1995, p. 197). The formula is as follows:

T NDA () = TA (t) / T t=1 where: NDA = estimated non discretionary accruals TA = total accruals t = 1,2 ... T is a year subscript for the years included in the estimation period = a year subscript indicating a year in the event period This model implies that the total accruals of the past estimate the present nondiscretionary accruals. This has to do with the fact that over time the average level of earnings management, resulting from the discretionary accruals, is assumed to be zero on average. One year earnings will be managed upwards, the other year they will be managed downwards. This will lead to an average level of earnings management of zero. Therefore, the average total accruals of the past will only contain nondiscretionary accruals, which are assumed to be constant over time. However, an important implication of Healy's model is that the estimation period should be determined. In order to calculate the total accruals from a period in the past, a certain period must be chosen. This can for example be the time that one manager was employed at the company, but also one economic cycle can be chosen. Unfortunately, Healy doesn't elaborate on his choice for an estimation period. DeAngelo DeAngelo (1986) provides another model to estimate the nondiscretionary accruals, which can be seen as a special case of the Healy model, according to Dechow et al. (1995). The formula is as follows: NDA () = TA (-1) Instead of taking the average of the total accruals in the past, DeAngelo only takes the total accruals of last year as an estimation of the nondiscretionary accruals of this year. This implies that DeAngelo assumes that there was no earnings management in the year before the year of research.

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An important implication for both the models of Healy and DeAngelo is that they assume that the nondiscretionary accruals are constant over time and the discretionary accruals are around zero on average in the estimation period. (Dechow et al. 1995, p. 198) However, in practice, it is unlikely to assume to both these assumptions are valid since economic circumstances cannot be taken into account in such researches. The outcomes are therefore not very strong, so both models are not likely to provide an estimation of the nondiscretionary accruals without error. Jones In 1991, Jones wrote a paper wherein she established a model to determine the nondiscretionary accruals (NDA) at a company. In this model, she relaxes the assumption of Healy and DeAngelo that nondiscretionary accruals are constant. Jones provided a new model; "to control for changes in economic consequences". (Jones 1991, p. 211) Another difference with Healy and DeAngelo is that Jones focuses on some specific accruals to estimate nondiscretionary accruals instead of the total accruals, as will become clear when the formulas are shown. Since this model will be used in the research done in this thesis, the explanation is more extensive then it is for the other models. The chronological steps that must be made are presented. First, the total accruals are calculated with formula (1), as introduced on page 22 and presented again below. For every firm in the sample, the total accruals must be calculated. This can be done with information from a database, for example the Thomson One-Banker. (1) where: CA = change in current assets CL = change in current liabilities CASH = change in cash and cash equivalents STD = change in debt included in current liabilities Dep = depreciation and amortisation A = total assets t = year index i = firm index TA (i,t) = [CA (i,t) -CL (i,t) - CASH (i,t) + STD (i,t) - Dep (i,t) ] / A (i,t-1)

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The second step is to calculate regression coefficients, which are used later on. The following formula is used in this step: (2) TA (i,t) / A (i, -1) = 1 [1/A (i, t-1)] + 2 [REV (i,t) / A (i, t-1)] + 3 [PPE (i,t)/A (i, t-1)] + where: TA = total accruals for firm i in year t REV = change in revenue PPE = gross property, plant and equipment for firm i in year t A = total assets = error term t = year index i = firm index According to Jones (1991) the total accruals "includes changes in working capital accounts, such as accounts receivable, inventory and accounts payable" (Jones 1991, p. 211) In the same formula, Property, Plant and Equipment and the change in revenues are variables, so that nondiscretionary accruals change by changing conditions are taken into account. The alphas are regression coefficients that are obtained by ordinary least squares (OLS). This is done by filling in historic numbers for Total Accruals (as calculated by formula (1)), Revenue, Property Plant and Equipment and Assets. The regression coefficients can be calculated. These 1, 2 and 3 are estimates for the regression coefficient in the next formula. Jones calculates total accruals with respect to revenue, which can lead to an estimate of earnings management that is biased towards zero because this extracts the discretionary component of accruals. The third step is determining the nondiscretionary accruals. The following model is the expectation model for the nondiscretionary accruals by Jones: (3) where: NDA = nondiscretionary accruals A = total assets REV = change in revenue between and -1 NDA (i,t) = a1 [1/A (i,t-1)] + a2 [REV (i,t) / A (i,t-1)] + a3 [PPE (i,t)/A (i,t-1)]

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PPE = gross property, plant and equipment a1, a2, a3 = regression coefficients i = firm index t = year index Jones calculates the nondiscretionary accruals also from the past, but she corrects this for a performance variable (the profit and loss account revenue) and a position variable (the balance sheet item property, plant and equipment). As Dechow, Ge and Schrand (2010) mention about these variables in the Jones model: "sales growth and investment in PPE are reasonable and intuitive drivers of firm value" (Dechow, Ge and Schrand 2010, p. 358) and therefore are good indicators for nondiscretionary accruals.The regression coefficients are obtained by the formula (2). The 1, 2 and 3 are estimates for the a1, a2 and a3 in formula (3). The fourth step in this model is to calculate the discretionary part of the accruals. This can be done by subtracting the nondiscretionary accruals, as obtained by formula (3), from the total accruals, as obtained by formula (1). As said before, the discretionary accruals are an indication for earnings management, so the fifth step is to determine whether there is earnings management. Since this step depends on the kind of research that is done, this is explained in chapter 5, where the research design for this specific research is presented. Dechow Dechow et al. (1995) use the Jones model as a starting point and the make some adjustments which results in The Modified Jones Model. They made an adjustment of the original model in that the change in revenues is adjusted for the change in receivables in the event period. Dechow et al. (1995, p. 199) estimate nondiscretionary accruals as: NDA (i,t) = a1 [1/A (i,t-1)] + a2 [REV (i,t) - REC / A (i,t-1)] + a3 [PPE (i,t)/A (i,t-1)] where: REC = change in net receivables Besides the extra variable, the change in net receivables, the modified model is the same as the standard model. This extra variable is the result of a limitation that Jones recognized in her standard model.(Jones 1991, footnote 31) "The original Jones model implicitly assumes that

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discretion is not exercised over revenue in either the estimation period or the event period" (Dechow et al 1995, p. 199). In the modified Jones model, the revenues are adjusted for the receivables. The assumption that discretion is not used for revenues is relaxed. Therefore, the level of earnings management can be better estimated with the modified model, since the estimates of earnings management should no longer be biased towards zero in samples where earnings management took place through revenues. (Dechow et al. 1995, p. 199) Both the standard and the modified Jones model have been used in many investigations on earnings management. Heemskerk and Van Der Tas (2006) explain why the Modified Jones Model is a way of measuring earnings management: The discretionary accruals are that part of the total accruals that cannot be explained by operational factors and therefore come from intentional adjustments by management (Heemskerk and Van Der Tas 2006, p. 576) According to an evaluation of several models of Dechow et al (1995) "a modified version of the model developed by Jones (1991) provided the most powerful tests of earnings management". This is already explained in chapter 2. Guay, Kothari and Watts (1996) take the same position. They conclude in their article that among others, only the Jones and Modified Jones Model are able to give reliable estimates of discretionary accruals. (Guay, Kothari and Watts, 1996, p. 104) Kothari The last model to estimate nondiscretionary accruals is established by Kothari, Leone and Wasley (2005). In their research, Kothari, Leone and Wasley add one constant variable to the model of Jones. Nondiscretionary accruals are estimated as follows (Kothari, Leone and Wasley 2005, p. 174): NDA (i,t) = a1 [1/A (i,t-1)] + a2 REV (i,t) + a3 PPE (i,t) + a4 ROA (i,t) where: ROA = Return on assets The reason they include the performance variable ROA is that they want to compare performance-matched discretionary accruals with the traditional accruals approach methods such as Jones and Modified Jones. When the ROA is included as a variable, the discretionary accruals are matched to the performance of a company. Since there is little or no evidence that this calculation of discretionary accruals provides strong outcomes, it will not be used in this paper and therefore the explanation of this measurement method stops here.

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3.4.4 Cross sectional and time series analysis The Modified Jones model can both be used for a cross-sectional analysis, using a crosssectional variant of the model, and a time series analysis, using a time series variant of the model. A cross-sectional analysis means that for one moment in time, a company is compared to its industrial branch. It is possible to do a cross-sectional analysis for more years, but that doesn't make it a time series analysis, because there is no event that requires a comparison of the period before and after that event. The cross-sectional variant of the Modified Jones Model faces a lot of critics. For example, McNichols states: "Researchers estimating nondiscretionary accruals by industry, as the cross-sectional Jones model is often applied, may well overstate the magnitude of nondiscretionary accruals and understate the magnitude of discretionary accruals, because industry-level controls include the average level of discretion exercised by the industry." (McNichols 2000, p. 324) As might be clear, this variant of the model is not applicable for this research, since the research is not about the difference between industries, but about the possible difference before and after the implementation of IFRS. A time series analysis means that the same group of (in this case) companies are compared before and after some event (Heemskerk and Van der Tas 2006). So when the introduction of IFRS in 2005 is the event, a time series analysis contains a sample of companies before the introduction of IFRS and the same sample of companies after the introduction of IFRS. The results before and after the introduction of IFRS are compared. It is important that the same companies before and after the event are included, because one company can be more likely to be engaged in earnings management than another company. Therefore, the possible difference in results might be biased when the sample of the two periods is not the same. This type of research is applicable for this study, since the same companies from the Dutch stock exchange will be compared on the level of earnings management before and after 2005, when IFRS was introduced. 3.5 Summary Since 2005, all listed companies in the European Union are obliged to prepare their consolidated financial statements in accordance with IFRS. One of the main reasons for such universal rules is that it makes financial reporting more transparent and comparable. That's why it is believed that the introduction of IFRS has led to a decrease in earnings management, as defined before. Due to more and stricter rules, managers should have less influence on the financial statements. However, not everyone agrees on this statement and therefore sub

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question 2 "What is the implication of the introduction of IFRS in 2005?" cannot be answered conclusive. On the one hand it is stated that the informative value of financial statement should increase due to the implementation of a high quality standard like IFRS, but on the other hand might the management get more freedom in measurement and estimation practices, especially in the case of valuation assets and liabilities at fair value. Whether the overall effect of IFRS on earnings management is positive or negative is hard to say and depends on the country and the prior standard of that country. The second topic of this paper is earnings management. In the introduction earnings management is defined as: "Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers". Since this definition presents earnings management as a bad thing, this definition will be used in this thesis. This is important for the assumption of this research, since a higher quality standard can only lead to a reduction of earnings management when earnings management is seen as a bad thing that negatively influences the quality of a financial report. The answer to sub question 3 "What are the methods of managing earnings?" is that earnings can be managed trough managing the real activities of a company or by managing accruals. The specific method for managing earnings that is important from now on is making use of managerial discretion in the recognition of accruals. Further on, accruals are defined as the sum of several balance sheet items. The answer to sub question 4: "How are accruals defined?" is formula 1: TA (t) = [CA (t) -CL (t) - CASH (t) + STD (t) - Dep (t) ] / A (t-1). Since the discretion of the management plays an important role in the recognition of these items that form the accruals, it is important to separate discretionary and nondiscretionary accruals in order to have an indication of earnings management. Therefore, the answer to sub question 5: "With which models can earnings management be measured?" is that the discretionary part of accruals is an indication for the existence of earnings management, since these accruals do not arise out of operating activities and are subject to the discretion of management. The models with which the discretionary accruals can be measured include Healy (1985), DeAngelo (1986), Jones (1991), Dechow (1995) and Kothari (1996).

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Several methods of estimating the nondiscretionary accruals are discussed; Healy (1985), DeAngelo (19856), Jones (1991) and Dechow (1995). For this research, it is important to know that the Modified Jones Model by Dechow (1995) will be used to estimate the nondiscretionary accruals because this model provides the most reliable results. Besides this it is important to note that this research will perform a time series analysis. The same group of Dutch listed companies will be compared before and after the introduction of IFRS.

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4. Prior literature study 4.1 Introduction Now both earnings management and the introduction of IFRS, as well as the accruals approach are introduced the focus will be on what the influence of the obliged introduction of IFRS has been on the level of earnings management at companies. This step narrows the theoretical background which is used for the final research to the influence of IFRS on earnings management. All other factors that are about earnings management in general and IFRS are relaxed now. This chapter begins with an overview of prior literature that investigated the influence of IFRS on the level of earnings management. The models that are used, underlying assumptions and the results as well as the limitations of these researches are discussed. After that, the next paragraph discusses the importance of country specific factors, including overview of which are applicable for the Netherlands and might have an influence on the expected results in the Netherlands. The results of both prior research and the specific circumstances in the Netherlands are an important base for the formulation of the hypothesis. This chapter will end with a summary, where sub questions 6, 7 and 8 are answered. 4.2 Influence of IFRS on earnings management A lot of investigation on this subject is done, especially in Europe where the implementation of IFRS is mandatory since 2005. The main objective of the researches is the comparison between earnings management under national standards and under IFRS. 4.2.1 No decrease in earnings management Tendeloo and Vanstraelen (2005) investigate whether earnings management has decreased at voluntary adopters of IFRS in Germany. Germany is a code law country with low investor protection, indicating a high level of earnings management according to prior research. (Leuz et al, 2003) This is the reason they expect a decline in earnings management as a result of the implementation of IFRS. A special situation arises in Germany, since under local law earnings management can occur through the allowed hidden reserves. This reserves can be created by building up unjustified provisions, recognizing excessive depreciation of assets or setting aside certain profits in tax-free reserves (Tendeloo and Vanstraelen 2005, p. 161). Making use of such reserves can facilitate managers in earnings management. To control for this facility, Tendeloo and Vanstraelen (2005, p. 175) "include all the possible ways to manage earnings". Besides short term accruals as debtors and prepaid cost, also several long term accruals such as change in provisions are taken into account.

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The focus of the research in this paper is on the early, voluntary implementers of IFRS, because at the time they wrote their paper there was not enough evidence of companies that had to deal with the obligation of reporting in accordance with IFRS. Their sample exists of 636 German listed companies, using data from 1999 until 2001. (Tendeloo and Vanstraelen 2005, p.155) They use the cross-sectional Jones model, another version of the models above. This is the aggregate accruals approach. The three variables in their research are (1) whether the company has adopted IFRS or not, (2) whether the company is audited by a Big 4 audit firm or not and (3) whether the company has a listing on the NASDAQ, the NYSE or the LSE. (Tendeloo and Vanstraelen 2005, p. 164) These variables are put into a regression analysis. Their general conclusion is that the adoption of IFRS not necessary leads to a lower level of earnings management. Instead, they find a significant increase in discretionary accruals that are the indication for earnings management. However, this result is less significant at firms that are audited by a Big 4 audit firm. They also mention that when they control for the possibility of using hidden reserves, as discussed above, the effect of the increase in earnings management no longer exists. In that case, there is no longer a difference in earnings behavior under German GAAP and IFRS. This can be seen as a limitation of their research. Another limitation arises with the fact that a lot of previous mentioned researches have used the voluntary adopters. These companies are likely to be in favor of IFRS, because otherwise they would not voluntary report in conformity with IFRS. This perceived benefit is confirmed by Christensen, Lee and Walker (2008). They mention that voluntary adopters of IFRS "perceive net benefits of doing so" and mandatory adopters voluntarily adopted IFRS "perceive no net benefits of doing so". (Christensen, Lee and Walker 2008, p. 1) Taking this into account, the results that earnings management did not decline is may be very understandable, because these companies implement IFRS because they expect to benefit from it. So a conclusion can be drawn that the samples of these researches are biased. However, as will become clear below, voluntary adoption and the perceived benefit of this adoption does not necessarily lead to an increase of earnings management. Another limitation of this research that has to do with the early adoption is that the current IFRS standards differ a lot from the original IFRS standards. According to Lippens (2010) around the year of 2005 many old IAS standards are revised and new IFRS standards are introduced. It is assumed that the quality of the standards is increased a lot since these improvements.

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A very clear conclusion about the difference between voluntary and mandatory adopters is given by Christensen, Lee and Walker (2008). They follow Barth et al (2008) in their methodology, which will be explained later in this section, to determine whether there is a difference in the audit quality between firms that voluntary adopted IFRS and those that waited until the mandatory adoption. One of their measures of audit quality is the level of earnings management: the more earnings management, the lower the audit quality. Their research is done in Germany, since Germany had a period of seven years (1998-2005) wherein companies were allowed to prepare their financial statements in conformity with IFRS before the mandatory adoption in 2005. Their sample includes 133 German firms that voluntary adopted IFRS prior to 2005 en 177 German firms that did not implement IFRS before 2005. The results of their regression analysis imply that voluntary adopters of IFRS show a lower level of earnings management in the post-adoption period. On the other side, firms that did not implement IFRS prior to 2005 seem to have no incentive to apply IFRS and this is confirmed by the fact that they did not find a decrease in earnings management in the postadoption period for the mandatory adopters. These results are in contrast with the findings of Tendeloo and Vanstraelen (2005) who found the opposite effect about voluntary adopters! Christensen, Lee and Walker give the following reason for the difference between voluntary and mandatory adopters: "In most countries accounting standards are identical for all listed firms yet incentives are likely to vary." (Christensen, Lee and Walker 2008, p. 3) Another research is done by the Dutch investigators Heemskerk and Van der Tas (2006). Just like Tendeloo and Vanstraelen, they use an aggregate accruals approach in which they use the Modified Jones Model to investigate the change in earnings management due to the implementation of IFRS. They expect a decrease in earnings management due to the implementation of IFRS because earnings management negatively influences the transparency and comparability of financial reporting and improving those two elements is one of the starting-points that standard setters want to achieve with the introduction of IFRS. The focus in their research is also on the early adopters, since they wrote their article in 2006. Too little data of mandatory adopters were available at that time. Eventually, their sample consists of 160 financial statements of German and Swiss companies (Heemskerk and Van der Tas 2006, p. 575). A regression analysis including variables for firm size and operating sector gives the conclusion that IFRS was not associated with a lower level of earnings management, neither using discretionary accruals, nor using accruals in total. This is inconsistent with the findings of Christensen, Lee and Walker (2008) who stated that earnings management did decline at

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voluntary adopters of IFRS in Germany. A possible reason for this inconsistency can be that the sample of Christensen, Lee and Walker included a lot more years of research. Their data included seven years of voluntary adoption, but Heemskerk and Van der Tas do not mention a specific number of years, so it is assumed that their data was only from 2006. Another reason can be the fact that Heemskerk and Van der Tas included both German and Swiss companies. Both time differences and country difference leads to another sample, which possibly leads to the difference in outcomes. The limitation of the research of Tendeloo and Vanstraelen does also count for this research. Because of the focus on early adopters, the results might be biased since these companies are likely to expect that they benefit from the introduction of IFRS. As discussed before, accruals management is not the only way of earnings management. Lippens (2010) recognizes this, and investigates not only the influence of IFRS on accruals management, but also on real earnings management. He states that accruals based earnings management is expected to decrease as a result of the mandatory introduction of IFRS, because of the stricter rules and the lower level of tolerance against earnings management. However, the incentives for earnings management will not be taken away. Therefore, he expects that the level of real earnings management will increase as a substitute for accruals based earnings management (Lippens 2010, p. 87). His argument for this statement is that "earnings are thought to become more volatile, while previous research shows that management likes to present a smooth earnings path". The timing of activities, an example of real earnings management, can be used in this situation for making the earnings less volatile again. Just like the research described before, Lippens uses the Modified Jones Model to explain accruals based earnings management. For the real earnings management he uses the abnormal level of cash flows from operations and the abnormal level of production costs as proxies for earnings management (Lippens 2010, p. 91). The normal level of cash flows from operations is a function of the sales and the change in sales. The normal production costs are defined as the costs of goods sold and the change in inventory. Both the abnormal level of cash flows and production costs are calculated by taking the difference between the normal level and the actual level. Lippens' sample contains financial statements from listed companies from Belgium, Denmark, Finland, Italy, Sweden and The Netherlands in the period 2000-2006. The country of origin is one of the variables in his models. His conclusions are that both accruals based earnings

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management as well as real earnings management has increased after the implementation of IFRS. However, he did observe that the substitution effect indeed takes place. There is no difference in outcome between the countries. The above mentioned discretionary accruals approach, used by Tendeloo and Vanstraelen (2005), Heemskerk and van der Tas (2006) and Lippens (2010), is just one of three main approaches. The other two are the specific accruals approach and study statistical properties of earnings to identify thresholds. (Jeanjean and Stolowy 2008, p. 485) These three approaches are already explained in chapter 2, with reference to McNichols. In their paper, Jeanjean and Stolowy use the third method in order to investigate whether companies managed their earnings to avoid losses any less after the implementation of IFRS (Jeanjean and Stolowy 2008, p. 485). As said in chapter 2, their reason for choosing the method of statistical properties of earnings, is that they face constraints with respect to data availability and difficulties with respect to the accruals approach. So instead they "analyze irregularities in distributions as an indication of earnings management". (Jeanjean and Stolowy 2008, p. 481) They use a statement of Glaum et al (2004) which explains why irregularities in distributions are an indication of earnings management: "Such irregularities in distributions indicate that companies avoid reporting net income below thresholds by managing it upwards. Without earnings management, we would expect the distribution to be relatively smooth around the thresholds." (Glaum et al. 2004, p. 50) Their data set includes financial statements from 2002 until 2006 from 1146 companies in Australia, France and the UK. The difference between this investigation and that of Tendeloo and Vanstraelen and that of Heemskerk and Van der Tas is that Jeanjean and Stolowy study first-time adopters. Early adoption was not possible in these countries, so they all implemented IFRS in 2005. This is also the reason they have chosen these countries. Another difference is that Jeanjean and Stolowy did not use the Modified Jones Model in order to determine nondiscretionary accruals as an indication for earnings management, but they study the distribution of earnings. For this, the variables Income Before Extraordinary Items (IBEX), Total Assets and Sales are used and they perform a Wilcoxon rank-sum test, which compares medians before and after the implementation of IFRS (Jeanjean and Stolowy 2008, p. 488). It is not about the absolute value of these variables, but about whether there is an asymmetry between the frequencies of reporting small losses and the frequencies of reporting small profits. Their conclusion was that there is no significant decline in earnings management as a consequence of the implementation of IFRS. Instead, in France the level of earnings management did even increase. Although the method is different,

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the outcome is in line with the research of Tendeloo and Vanstraelen (2005) and Heemskerk and Van der Tas (2005). One major limitation of this research which Jeanjean and Stolowy acknowledge their selves is that the databases contain financial information for 2004 under local GAAP and for 2005 under IFRS. This is a problem, because they scale the IBEX of year t by the ASSETS of year t-1. The numerator and denominator are not calculated under the same standard, making the variable less valid. Although they recognize this limitation, they still calculate it this way because of the non availability of data. 4.2.2 Decrease in earnings management All researches discussed above, came to roughly the same conclusions; earnings management did not decline as a result of the enforcement of IFRS. Although these results seem quite severe, there are also some contradicting results found. For example, Cai, Courtenay and Rahman (2008) did find a significant decrease in earnings management at countries where IFRS has been adopted. They investigated companies in 32 countries during 2000 until 2006. Their total sample consisted of 102.636 observations. They measure the magnitude of accounting accruals. They argue that because of their sample size, other models for earnings management are not suitable for their research. Their results show that both voluntary as well as obliged adoption of IFRS can lead to a reduction of earnings management. An important variable is, however, the level of enforcement of IFRS. "Strong enforcement is an effective factor for reducing earnings management". (Cai, Courtenay and Rahman 2008, p. 19) They also mention that country specific institutional factors (more specific: financial market, capital market structure, ownership structure and the tax system) play a role in the outcomes, which is in line with other researches. As Ball et al (2003) mentioned, the quality of financial statements is "determined by the underlying economic and political factors influencing managers and auditors incentives, and not by accounting standards per se" (Ball et al 2003, p. 236). So a high quality standard like IFRS is not a guarantee for high quality financial statements. However, a high quality standard is one of the conditions for high quality reporting. Another article that did find a reduction in earnings management as a result of the implementation of IFRS was written by Barth, Landsman and Lang (2008). In their article, they tried to find out whether the application of the International Accounting Standards has led to a higher quality of financial reporting. They define the quality of financial reporting as the level of earnings management, the loss recognition and the value relevance of the annual reports. The focus here is only on the outcomes with respect to earnings management, due to

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the irrelevance of the other aspects for this article. Their method differs from all other methods discussed before. Through a regression analysis with variables such as size, growth, change in liabilities and closely held shares they determine whether earnings management occurs more or less under the international accounting standard, compared to non-US domestic standards. There sample consists of 1,896 firm-year observations for 327 firms that adopted IAS between 1994 and 2003 for which DataStream data are available from 1990 through 2003. (Barth, Landsman and Lang (2008, p. 487) Companies from all over the world are included. Note that their focus is on early adopters and not on mandatory adopters of IFRS, since this is not possible taking into account the years of observation. The results of their research indicate that firms adopting high quality international accounting standards engage less in earnings management, resulting in higher quality financial reporting. This is conformity with the findings of Christensen, Lee and Walker (2008) that early adopters show a decline in earnings management. Again the limitation of the early adopters, which can lead to biased outcomes, is valid for this research. At this point, an important note is made. A major limitation of all of the above researches is based on the assumption of Soderstrom and Sun (2007) that the influence of IFRS depends on the circumstances of the country. This makes it hard to say whether IFRS in general succeeded in reducing earnings management. In order to be able to define the research hypothesis for the Netherlands, specific circumstances in the Netherlands that might influence the success of IFRS are elaborated next. 4.3 The Netherlands and specific factors As said before in section 2.2, country specific factors play an important role in whether the implementation of IFRS is a success. The three main factors, derived from the article of Soderstrom and Sun (2007) are (1) the quality of the standards that were used before IFRS, (2) the countrys legal and political system and (3) the financial reporting incentives of companies in that country. In line with these factors, the specific situation in The Netherlands will be discussed in this section in order to determine the expected results of this research. To begin with the quality of the standards before the introduction of IFRS, the Dutch GAAP was one of the national standards that were already very much in line with the standards of the International Accounting Standards (IAS), which became the IFRS later. According to Haller (2002) The UK, Ireland and the Netherlands are the European countries of which the

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national accounting approaches comply the most with IAS. (p. 170) He also states that these countries have expressed the intention of making their standards in compliance with the IAS. This result implies that the quality of the standards in The Netherlands before IFRS was introduced was high. Besides, according to Klaassen and Hoogendoorn (p. 43), The Netherlands prefer a general guideline to detailed rules, so this implies that the accounting standards in The Netherlands were already principles-based before IFRS was introduced. This is confirmed by an article of Deloitte (2010, p. 6). It sets out the differences between Dutch GAAP and IFRS and it is stated that Dutch GAAP includes more principles-based standards with more options and less application guidance. Since the opinions about the quality of IFRS (see section 2.2) are contradicting, it is hard to say anything about the level of earnings management under Dutch GAAP and IFRS. However, when it is stated that Dutch GAAP is in line with IFRS, it is expected that there is no difference in earnings management between financial report presented under Dutch GAAP and under IFRS. The second factor that influences the success of IFRS is the countrys political and legal system. One of the factors of the political and legal system is the level of investor protection in a specific country. According to the results of Leuz, Nanda and Wysocki (2003, p.521): "outside investor protection explains a substantial portion (39%) of the variation in earnings management". This is valid for their sample, which includes companies from 31 countries. This level of investor protection depends on the legal origin of a country (La Porta et al. 1998, p.8). There are two main 'families' in this area; common law countries and code law countries. Common law countries, for example the United States and England, form their law by judges who have to resolve specific disputes(La Porta et al, 1998 p. 1119). This is a more principle based system of law. Code law countries use statutes and comprehensive codes as a primary means of ordering legal material (La Porta et al. 1998, p. 1118). Making rules and enroll these in laws is more a rules based legal system. The code law system can be divided in three subsystems: French, German and Scandinavian Civil Law. This is already explained in chapter 1. According to La Porta et al. (2000) The Netherlands is a French Civil Law Country. These types of countries have the lowest level of investor protection. This would imply that the level of earnings management is higher in such countries, because it seems to be not very important that investors are well informed. However, the introduction of the Code Tabaksblat in 2003 did increase the investor protection in The Netherlands due to a higher corporate governance level. The Code Tabaksblat has a 'comply or explain' policy, which

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means that it is not obliged to comply the Code, but it is obliged to explain your reason when you didn't comply. So when applied to this research, the level of investor protection in The Netherlands will be high (since the data include only one year before and five years after the Code Tabaksblat) which will imply a low level of earnings management. This is a valid assumption in this research, following Leuz, Nanda and Wysocki (2003) who state: "strong and well-enforced outsider rights limit insiders acquisition of private control benefits, and consequently, mitigate insiders incentives to manage accounting earnings because they have little to conceal from outsiders" (Leuz, Nanda and Wysocki 2003, p. 505) Another factor included in the countries' political and legal system which is important for the success of IFRS is the legal enforcement strength. In a research by La Porta et al (1998) it is stated that French Civil Law countries have the lowest level of law enforcement (p. 1116). However, the results of their research show that the Netherlands is an exception in this context (p. 1142 and 1143). In these tables it is showed that according to the outcome of their analysis, the legal enforcement level in the Netherlands is high. This is line with Burgstahler et al. (2006) who point out that the Netherlands has a strong legal enforcement system. As said before in section 2.3, not only the implementation of IFRS but even more the enforcement of these rules are the success factors of IFRS (Cai, Courtenay and Rahman 2008). Since the Netherlands appear to be a strong law enforcement country, it is expected that IFRS has been implemented successfully. The fact that countries with strong law enforcement face lower levels of earnings management is in conformity with the findings of Leuz et al (2003). The conclusion of their research was that there is a negative relationship between earnings management and legal enforcement. It is therefore assumed that the implementation of IFRS in the Netherlands has led to a reduction in earnings management, because of the assumption that IFRS leads to a higher quality of financial reporting, including a lower level of earnings management, and the assumption that the legal enforcement in The Netherlands is high. The third and last factor that influences the success of the implementation of IFRS is about the financial reporting incentives of companies in The Netherlands. Due to the strong law enforcement and investor protection described before, companies in The Netherlands are expected to be willing to be transparent in their reporting in order to avoid litigation actions. It is assumed that this transparency in reporting results in a low level of earnings management, both under Dutch GAAP and IFRS.

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Taking these 4 arguments above together, the findings are summarized below. 1) The level of earnings management in the reports prepared under Dutch GAAP and prepared under IFRS will not differ much, since Dutch GAAP was already quite in line with IFRS; 2a) Due to the Code Tabaksblat, which implies better corporate governance and high investor protection, Dutch companies are expected to not to be engaged in earnings management a lot; 2b) Due to the strong legal enforcements in the Netherlands, earnings management is expected to be low at Dutch companies and 3) Dutch companies are expected to be willing to be transparent in their financial reporting and therefore will engage less in earnings management. Taking together into account these four arguments, the Netherlands is expected to be a country where earnings management does not occur a lot, both under Dutch GAAP and IFRS. Prior literature discussed in section 2.3 was not conclusive that there was a decline in earnings management as a result of IFRS in the countries investigated. But, as said before, country specific factors play a role in the success of IFRS, so the results of prior research are not entirely useful for the Netherlands. Using the four arguments above, chapter 5 will formulate the hypotheses that are will be used for the empirical part of this research. 4.4 Summary and concluding remarks A short review of the conclusions of prior research is presented below. An overview of the findings of prior literature can be found in Appendix 1. Heemskerk and van der Tas (2006) and Tendeloo and Vanstraelen (2005) investigated whether early adopters of IRFS have shown a decrease in earnings management. They both did this with the aggregate accruals model, using the Modified Jones Model (Heemskerk and van der Tas) and the cross-sectional variant of the Jones model (Tendeloo and Vanstraelen). Heemskerk and van der Tas did their research in Germany, Tendeloo and Vanstraelen had a sample of German and Swiss companies. Their conclusions were roughly the same. Earnings management did not decrease as a result of the introduction of IFRS. In fact, Tendeloo and Vanstraelen even found that earnings management has increased after the introduction of IFRS. However, this effect was gone when they controlled for the fact that a company was audited by a Big 4 audit company and when controlled for hidden reserves under German GAAP. Lippens (2010) made a distinction between accruals based earnings management and real earnings management. He used the cross-sectional Jones Model and an estimation model from

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Roychowdhury respectively in order to determine whether accruals based earnings management has decreased, and real earnings management has increased as a result of IFRS. His conclusions were consistent with those of Heemskerk and van der Tas and Tendeloo and Vanstraelen: accruals based earnings management did not decrease after the implementation of IFRS, but did even increase as well as real earnings management. However, he did find a substitution effect from accruals based earnings management to real earnings management, by doing some extra regression analyses. Finally, he mentioned that there is no difference in this outcome between the six countries he investigated. The fourth important research on this topic that is discussed is that of Jeanjean and Stolowy (2008). They investigated whether the introduction of IFRS has led to a reduction in earnings management, specifically to avoid losses. Their Wilcoxon rank-sum test resulted in the conclusion that earnings management did not decrease as a result of the introduction of IFRS. In France, one of the countries investigated, earnings management did even increase according to their research. The fifth research that was discussed is from Cai, Courtenay and Rahman (2008), which found very contradicting results when compared with the researches discussed before. They did find a decrease in earnings management when IFRS was adopted, but they mention that it is important that there is a also strong enforcement instead of just adopting IFRS. Finally, Barth, Landsman and Lang (2008) did a regression analysis and they also did find a lower level of earnings management in countries where a high quality accounting standard, such as IFRS, was implemented. Some limitations that are mentioned must be taken into account. First of all, the effect of the introduction of IFRS will largely depend on the circumstances of the country before and after the implementation. In every research, this has to be taken into account. Secondly, a lot of samples of previous literature include the voluntary adopters. These companies are likely to be in favor of IFRS, otherwise they wouldn't implement it. This can be a noise in the outcomes, since the sample is probably biased. Another problem with voluntary adopters is that they face different standards than the mandatory adopters, since the improvement process of the IASB around 2005. To end this section, the answer sub question 6: "What is the influence of IFRS on the level earnings management in other countries, regarding to prior research?" is given. Again, like with question 2, there is not one conclusive answer. Previous research has found different results, depending on the methods used and the countries investigated. It can be said that in

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some circumstances IFRS succeeded in lowering the level of earnings management, but in other countries this success is not found. The conclusion is that countries with a low quality national GAAP and a very strong legal enforcement can benefit from the high quality of IFRS, by a decreased level of earnings management. Four specific factors of the Netherlands are mentioned in the last section: (1) the Dutch GAAP was quite in line with IFRS, leading to the expectation that there will be no large differences between financial reports under both standards, (2a) Dutch companies are expected to be little engaged in earnings management due to the introduction of the Code Tabaksblat which implies better corporate governance and investor protection, (2b) the legal enforcement is strong in the Netherlands, leading to the expectation that the level of earnings management will be low and (4) Dutch companies are willing to report their financial statement in a transparent way, leading to less earnings management. These four factors are the answer at sub question 7: "What are specific factors in the Netherlands that can have an influence on the success of IFRS?" Also sub question 8: "What are the expectations regarding the influence of the mandatory implementation of IFRS on the level of earnings management at Dutch listed companies?" can be answered. The expectation is that the level of earnings management will not decrease as a result of the mandatory adoption of IFRS for Dutch listed companies. Due to the specific circumstances in the Netherlands, the expectation is that the level of earnings management is never been high, so therefore it will remain the same after the introduction of IFRS. What is important from this chapter is that prior research is not conclusive about whether IFRS was successful in decreasing the level of earnings management. The results depend at least on 1) whether firm voluntary or mandatory adopts IFRS and 2) country specific factors. These findings will be used for the formulation of the hypotheses in chapter 5.

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5. Hypotheses 5.1 Hypotheses development The main goal of implementing IFRS was making financial statements more reliable and transparent. According to Soderstrom and Sun the "improvement is based upon the premise that change to IFRS constitutes change to a GAAP that induces higher quality financial reporting" (Soderstrom and Sun 2007, p. 676). As said in chapter 1, it is assumed that IFRS leads to a higher quality reporting, including a lower level of earnings management. Prior research has found a lot of evidence that earnings management has not decreased as a result of IFRS. The reason that was given most for this phenomenon is that accounting in accordance with IFRS is based on fair value measures. This subjectivity in estimating assets and revenues gives managers more room for managing the earnings of the company. The researches that did find a decrease in earnings management as a result of IFRS, focused on early adopters. As mentioned by Christensen, Lee and Walker (2008) it is expected that voluntary adopters indeed show a decrease in earnings management because of the incentives they seem to have in favor of IFRS. This research will focus on the mandatory adopters and leaves voluntary adopters out of the sample, so it is not expected that a decrease in earnings management will be found. The country specific factors of the Netherlands, including the high quality of Dutch GAAP, high investor protection, strong legal enforcement and the willingness of companies to be transparent, suggests that the level of earnings management in the Netherlands was already low before IFRS was implemented. Based on the prior research findings and taking into account the country specific factors of The Netherlands, the first hypothesis of this thesis is: H1: "In Dutch listed companies, the level of earnings management has not changed as a consequence of the mandatory introduction IFRS instead of Dutch GAAP" This is strengthened by the statement of Heemskerk and Van der Tas (2006, p. 578), which is: "It is assumed that countries with conservative accounting standards will face a larger impact than countries as Great Britain and the Netherlands". This statement implies that the Netherlands will not face a very large impact of the introduction of IFRS. Next to the phenomenon of a reduction in earnings management in general, it is interesting whether there is a difference between large and small companies. Since the risk of political costs, or governmental intervention as mentioned in chapter 3, is one of the incentives for

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earnings management, it makes sense to assume that different companies facing different circumstances also have different levels of earnings management. This is confirmed by Han and Want (1998). Using the example of companies in the oil industry, Han and Wang (1998) mention that the situation wherein companies face different political visibility "is likely to lead to different degrees of earnings management" (Han and Wang 1998, p. 104). The difference in political visibility in their research is applied at crude petroleum and natural gas versus petroleum refining, which face differences in the degree of consumer relations. However, this difference in political visibility can also be valid for a difference between large and small companies. Larger companies have more stakeholders and this makes the risk that someone does not agree with the companies' actions, larger. Therefore, the risk of governmental or legal intervention is also larger. This increases the political visibility of a large firm, which can lead to a higher level of earnings management by lowering earnings in order to lower political visibility. Assumed that large companies are in general more engaged in earnings management and assumed that IFRS should increase the quality of financial statements (see introduction), it can be expected that a decrease in the level of earnings management as a result of the introduction of IFRS is apparent at large companies. However, the country specific factors explained in chapter 4 and repeated in this chapter are also applicable for large companies in the Netherlands. Therefore, it is expected that also large companies are less engaged in earnings management than in other countries, making the political cost theory less relevant. Therefore, the second hypothesis is: H2: "There is no difference in the change in the level of earnings management as a consequence of the mandatory introduction of IFRS between small and large Dutch listed companies" Another issue is that prior research has found evidence that companies that are audited by a big 4 audit company engage less earnings management, as is discussed in chapter 4 (for evidence; Tendeloo and Vanstraelen 2005). So this argument would suggest that the level of earnings management was already low at larger firms, before IFRS was introduced. However, the sample used in this research contains only listed companies. Since 66 companies out of the sample of 75 companies are audited by a Big 4 audit company, the relationship between earnings management and whether or not a Big 4 audit firm is hard to study in this case. Therefore, this is not taken into account.

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To conclude: due to the specific circumstances in The Netherlands, it is assumed that in general the level of earnings management was already not very high before IFRS was introduced. Therefore, it is likely to assume that there will be no decrease in earnings management, such as stated in hypothesis 1. In general large companies are assumed to be engaged more in earnings management because of the risk of political costs. Therefore, large companies could show a decrease in the level of earnings management when IFRS is seen as a financial information quality improving standard. However, this effect is assumed to be not very strong in the Netherlands due to the overall low level of earnings management. So, it is assumed that in the Netherlands there is no difference in the level of earnings management between small and large companies. The first hypothesis is a time-series research. The same group of companies before and after the adoption of IFRS will be compared. One of the variables in the regression will contain the size of the company, which is used to answer hypothesis two. The exact model will be explained in chapter 6. 5.2 Summary This chapter has provided the hypotheses development. With this chapter, sub question 9: "What are the hypotheses for the research?" is answered. The hypotheses are as follows:

H1: "In Dutch listed companies, the level of earnings management has not changed as a consequence of the mandatory introduction IFRS instead of Dutch GAAP" H2: "There is no difference in the change in the level of earnings management as a consequence of the mandatory introduction of IFRS between small and large Dutch listed companies" Because of the results of prior research and the specific circumstances in the Netherlands, it is expected that the overall level of earnings management has not decreased since the implementation of IFRS. The political cost theory assumes that larger companies are more engaged in earnings management than smaller companies, assuming that it is possible that IFRS is associated with a lower level of earnings management at large companies. However, this will not be the case in the Netherlands because of the country specific factors that lead to an overall low level of earnings management. Chapter 6 will continue with the research design. The models will be explained in detail, including all the variables used and the steps that are going to be taken are discussed. Also the sample selection and the attainability of the data are discussed in chapter 6.

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6. Research Design 6.1 Introduction This chapter will outline the research design of this paper. As said before, the Modified Jones Model will be used for this research. First these steps are presented, including the corresponding formulas. This part of the chapter will show a lot of similarities with chapter 3. After the research design is explained, the attainability of the data is discussed. The chapter ends with a summary, including an answer to sub question 10. 6.2 Research Model First of all, the total accruals of each company in the sample for each year must be calculated. Formula (1) provides this calculation. (1) where: CA = change in current assets CL = change in current liabilities CASH = change in cash and cash equivalents STD = change in debt included in current liabilities Dep = depreciation and amortisation A = total assets t = year index, range from 1997 until 2007 i = firm index, range from 1 to 75 All the variables of the formula are known, so the total accruals can be calculated. The year index includes all years from 1997 until 2007. Both the historic period, which is 1997 until 2001 and is explained at step two of the research model, and the research period, which is 2002 until 2007, are included because for both the historic period and the research period the total accruals must be calculated. The firm index has values from 1 to 75 because there are 75 companies in the sample, as will be discussed in paragraph 6.3. When the total accruals are known, they can be filled in at formula (2), which is developed to calculate regression coefficients. TA (i,t) = [CA (i,t) -CL (i,t) - CASH (i,t) + STD (i,t) - Dep (i,t) ] / A (i,t-1)

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So step 2 in the research design is about calculating 1, 2, and 3 with the following formula: (2) TA (i,t) / A (i, t-1) = 1 [1/A (i, t-1)] + 2 [REV (i,t) -REC (i,t) / A (i, t-1)] + 3 [PPE (i,t)/A (i, t-1)] + where: TA = total accruals for firm i in year t REV = change in revenue REC = change in net receivables PPE = gross property, plant and equipment for firm i in year t A = total assets = error term t = year index, range from 1997 until 2001 i = firm index, range from 1 to 75 The three variables A, REV and PPE, will come from the annual reports of the companies included in the sample. As explained in the theoretical part, the regression coefficients 1, 2, and 3 can be calculated using historical data for all variables. These regression coefficients measure the degree to which the dependent variable changes as the independent variable changes. For example, when the is 0,1 it means that if the dependent variable increases with 10, the dependent variable increases with 0,1 times 10. All firms will get a number from 1 until 75, since there are 75 companies in the sample which will be explained in paragraph 6.3, and this will represent the firm index (i). The year index (t) means the year that is investigated, starting with 1997 and ending with year 2001. The reason that these years represent the historic data is as follows. Jones (1991) used all available data prior to year t-1 as historic data to obtain the regression coefficients. The Thomson One Banker, the database that is used for the research in this thesis, includes data back to 1970. However, looking at these data, for a lot of the companies included in the sample the available data does not go back any further than 1997. In order to obtain statistical valuable regression coefficients, it is important that the historical data matches as much as possible with the data of the sample. So the historic data that is used to obtain the regression coefficients includes 1997 up to and including 2001. This step is important, because these coefficients will be used in the next formula.

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This calculations will be done with the statistic program SPSS. Besides calculating the regression coefficients, the overall explaining power of the model as well as the significance of the individual variables will be discussed on the basis of model outcomes of SPSS. Also, the R, which means which part of the dependent variable is explained by the independent variables, is explained. In other words, some tests will be done in order to determine the reliability of the model and therefore, the reliability of the outcomes. This will all be explained in chapter 7 when the results are presented. The next step is calculating the nondiscretionary accruals, in order to be able determine the discretionary accruals later. Since discretionary accruals do not arise out of operational activities, they are an indication and therefore a measure of earnings management. The following formula is used for calculating the nondiscretionary accruals: (3) NDA (i,t) = a1 [1/A (i,t-1)] + a2 [REV (i,t) - REC / A (i,t-1)] + a3 [PPE (i,t)/A (i,t-1)] NDA = nondiscretionary accruals A = total assets REV = change in revenue between and -1 REC = change in net receivables between and -1 PPE = gross property, plant and equipment a1, a2, a3 = regression coefficients t = year index, range from 2002 until 2007 i = firm index, range from 1 to 75 So, to conclude: with formula (2) is it possible to calculate 1, 2 and 3 which are good estimates for a1, a2 and a3 in formula (3). Since the only unknown variable is NDA, the nondiscretionary accruals can be calculated. When the nondiscretionary accruals are determined with the model above, the fourth step is to calculate the discretionary accruals by calculating the difference between the total accruals at firm I for year T and the nondiscretionary accruals at firm I for year T.

The fifth step contains a regression analysis based on Heemskerk and van der Tas (2006). With this step, the association between the accounting standard used and the size of the company on the level of the discretionary accruals is determined.

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The regression formula is as follows: | [DA (i, t)] | = 1 + 2 (Standard) + 3 (Size) +

(4)

Where: (5) and where: - | [ TA- NDAit} | = Absolute value of discretionary accruals, divided by total assets in the previous year - Standard = - Size = -= - 1, 2, 3 = -t= -i= The accounting standard used, {1 = Dutch GAAP and 2 = IFRS} The company size, based on sales revenue {1 = large and 2 = small} An error term Regression coefficients Year index, range from 2002 until 2007 Firm index, range from 1 to 75 | [DA (i, t)] | = | [TA - NDA (i,t)] |

The variables 'standard', 'size' and 'discretionary accruals' are known and filled in. Heemskerk and van der Tas (2006, p. 576) mention that accruals can be both positive and negative, so that therefore the absolute value of the discretionary accruals should be taken. With a regression formula it is possible to determine which factors do have a significant explaining value. In this case, it is investigate whether the introduction of IFRS and the firm size have an influence on the level of earnings management. The absolute value of accruals is determined in step 4. The standard used will be Dutch GAAP before 2005 and IFRS after 2005. The company size will be determined on the market capitalization, dividing the total sample in two groups of large and small companies. With this final step the regression coefficients 1, 2 and 3 are calculated. This is the final outcome that is needed to answer the hypothesis. Since the data sets include discretionary accruals, standard and size for every company for every year, the regression coefficients can be calculated. The regression coefficients 1, 2 and 3will show whether the level of earnings management, measured as discretionary accruals, is associated with the standard under which financial reports are prepared or the size of the company. First of all, 2 is the coefficient which determines the influence of the accounting standard on the level of the discretionary accruals. Second, 3 indicates the influence of the company size on the level of the discretionary

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accruals. When these coefficients are calculated, both the direction and the significance of the coefficient are important. The direction of the coefficient can be positive or negative, meaning that there is a positive or negative association between the dependent variable and the level of the discretionary accruals respectively. The significance of the coefficients means whether the variables standard and size indeed are significant positively or negatively associated with the level of discretionary accruals. A more extensive explanation of interpreting these outcomes is given in chapter 7 where the analysis takes place.

The 'standard' variable will be used to answer hypothesis 1, whether IFRS has led to a different level of earnings management. It is expected that there is no significant explaining value of this variable, since it is expected that the level of earnings management before and after IFRS to be the same. The 'size' variable will be used to answer hypothesis 2, to see whether there is a difference in the level of earnings management between large and small companies. It is expected that size has a positive influence on the level of earnings management, since the political cost theory, as discussed in chapter 3, is more applicable to large companies.

6.3 Sample selection Unlike a lot of previous researches, this research does not focus on early or voluntary adopters of IFRS. This research will focus on the Dutch market after the obliged implementation of IFRS in 2005. Both the companies in the 3 Dutch indexes (AEX, AMX and ASCX) and the residual companies that are not in an index are used. It is important to notice that foreign companies that are listed in Amsterdam are excluded from the sample, since the research focuses on Dutch listed companies, not on companies that have a listing in the Netherlands. For example, the American company Conversus Capital has a European listing in Amsterdam, but that does not make it a Dutch listed company (http://www.conversus.com) Currently, there are in total 164 listed companies in the Netherlands. However, not all these funds are usable for this research. The following four requirements must be met; 1) the company was listed during the whole period 2002-2007, 2) the company is not active in the financial sector, 3) the primary accounting standard up to and including 2004 was Dutch GAAP and 4) the company did not adopt IFRS voluntary prior to 2005. The first requirement, listed during 2002 - 2007 is important since the sample for a time series research should be exactly the same for the period before IFRS was introduced as the period

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after IFRS was introduced, so all new or disappeared companies will be excluded from the sample. For example, the Dutch company Spyker is excluded from the sample since it is established in 2005. Therefore, a comparison of companies before 2005 excluding Spyker and companies after 2005 including Spyker brings noise into the sample. The second requirement, which is that the company should not operate in the financial sector, has to do with prior research. An extensive explanation for this is given by Heemskerk en van der Tas (2006) that concludes that the accruals of financial enterprises seriously differ from the other enterprises. The third requirement, which is that the primary accounting standard should be Dutch GAAP, is important in order to exclude companies from the sample that reported under other standards than Dutch GAAP prior to 2005. For example Philips prepared its financial statements up to and including 2004 under US GAAP. Since the research focus on the possible difference in earnings management under Dutch GAAP and IFRS, the results of this kind of companies are irrelevant. The fourth requirement, which is that the company did not voluntary apply IFRS prior to 2005, is important because of the difference in expected outcomes between voluntary and mandatory adopters of IFRS. In chapter 4 is already explained that voluntary adopters seem to benefit from IFRS and therefore might bias the results. Therefore, voluntary adopters of IFRS should be excluded from the sample. Taking into account these four requirements, the sample of this research contains of 75 Dutch listed firms. An overview of these firms is given in appendix 3. Besides this time series research, hypothesis two will look at differences between large and small companies. For this research the 75 funds are divided in two groups using the market capitalization of the enterprises. The market-capitalization is defined as the total number of outstanding shares times the market share price. There are all different kinds of measuring firm size, for example the numbers of employees (Heemskerk and van der Tas 2006) total turnover. However, since the market capitalization is mostly used as the valuation of a company, this measurement will be used to determine firm size. Hereby Kothari et al (2005) are followed. Besides, a check proved that separating firms by total revenue or by market capitalization practically leads to same distinction of large and small companies. The distribution by market capitalization creates a first group of the 38 smallest companies

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and a second group of the 37 largest companies. These groups will be compared to check whether size of the company has influence on the expected reduction in amount of earnings management after IFRS was implemented. 6.4 Data attainability The sample of this research will contain listed companies in the Netherlands. From the 25 companies listed on the AEX till all the local listed companies are used, which is a total of 75 companies. The period of the research will be from 2002 till 2007. The companies that will be used for this research are all listed and therefore obliged to publish their annual results. In the annual reports of the companies all the necessary data will be stated. This will be aspects of the balance sheet like total assets and PPE. Also the profit and loss account will be used to look at revenue and net receivables in the current and past year. All this information is available at the university library. The database Thomson One Banker is a very extensive database which includes all kind of information about companies, such as annual and quarterly reports, but also investigation reports. It contains annual reports from 12.000 companies out of 70 countries, back to 1970 until now. Therefore, the variables needed for this research will all be available, since it are annual reports data from 2002 until 2007. Also the historical data needed to obtain the regression coefficients, as explained in paragraph 6.2, are available in this database. 6.5 Summary This chapter provides a model for measuring the level of accruals based earnings management before and after the implementation of IFRS in 2005. The answer to sub question 10: "How does the research design look like?" can be given now. The research design includes 5 steps and is based on the research design from the Modified Jones Model. The first step is to calculate total accruals, hereby following Healy (1985), Jones (1991) and Dechow (1995) in the formula. The second step is to fill in the total accruals in a formula wherein three regression coefficients are calculated with data from 1997 until 2001. These regression coefficients are used in step 3, where the nondiscretionary accruals are calculated. Step four calculates the discretionary accruals by subtracting the nondiscretionary accruals from step 3 from the total accruals from step 1. The fifth and last step is about a regression analysis, where it is studied whether there is an association between the standard under which financial reports are prepared and the firm size, and the level of earnings management. Therefore, the

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discretionary accruals from step 4 are needed. Both hypothesis 1 and 2 can be answered with these results.

The sample for the research will include Dutch listed firms, which 1) were listed during 20022007, 2) are non-financial companies, 3) prepared their financial statements prior to 2005 under Dutch GAAP and 4) did not implement IFRS voluntary prior to 2005. Taking into account these four requirements, the final sample includes 75 Dutch listed companies. The data that is needed for this research is attainable, since all the information is stated in the annual reports of these companies, which they are obliged to present since they are listed in the Netherlands. Since these annual reports are presented, the data of all these reports is available through several databases of the university. These databases will be used to obtain the relevant data.

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7. Empirical Research 7.1 Empirical results All needed data is available at the Thomson One Banker at the Erasmus University Rotterdam. For every company, the variables needed were obtained in this database for the years 2002 until 2007. As discussed in chapter 6, the historical data needed to calculate the regression coefficients contains 1997 up to and including 2001. Together with the research data, this data is obtained from the Thomson One Banker. Since this data is not immediately ready to use for the analysis, it has to be restated in a standard format. The statistical research is done with the SPSS program.

As discussed in chapter 6, when the research design was introduced, the first step of the analysis is calculating the total accruals. Using formula (1) of chapter 6, both for the history (1997-2001) and for the research sample (2002-2007) the Total Accruals are calculated. Recall that in chapter 6 is explained why 1997 up to and including 2001 is used as the historic period, namely because Jones used all available years prior to the research period. In this case the data was only available back to 1997, and the last year prior to the research period is 2001, making 1997 until 2001 the historic period. In order to make the results comparable, all outcomes are scaled by the total assets of the corresponding company. These total accruals are needed for step 2, where the regression coefficients are determined by doing an ordinary least square regression. Recall the formula of calculating the regression coefficients: (2) TA (i,t) / A (i, t-1) = 1 [1/A (i, t-1)] + 2 [REV (i,t) -REC (i,t) / A (i, t-1)] + 3 [PPE (i,t)/A (i, t-1)] + where: TA = total accruals for firm i in year t REV = change in revenue REC = change in net receivables PPE = gross property, plant and equipment for firm i in year t A = total assets = error term i = firm index t = year index

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Before a regression analysis can be performed, it is important that the assumptions for a multiple regression are fulfilled. Some important assumptions for a multiple regression analysis are mentioned below. (de Vocht 2009, p. 199) First of all, all variables should be numeric. This means that all variables can only have a number as a value. Since all the variables in formula 2 are numeric, this assumption is met. Another important assumption is that the independent variables do not measure the same. In statistic terms this means that there is no multicollinearity. Since all three variables include specific parts of the financial numbers of a company and no variable includes the same financials as another variable, this assumption is also met. So the two most important assumptions for a multiple regression analysis are met for formula (2) and the regression analysis can be performed. The data of 1997 until 2001 are used to calculate 1, 2 and 3. Before these are given, some other tests need to be done in order to determine the reliability of the results. The first test is a correlation test and the results are presented in table 1.
Table 1: Model Summary

Model 1

R .230
a

R Square .053

Adjusted R Square .045

Std. Error of the Estimate .20844

a. Predictors: (Constant), [1/A(i, t-1)], [REV (i,t) - REC (i,t) / A (i, t-1)], [PPE (i,t) / A (i, t-1)]

This model summary is the first output of SPSS. In this model summary, the multiple R is important; it explains the correlation between the independent variables and the dependent variable. In this model, the R is 0.053 which means that approximately 5 percent of the total accruals, the dependent variable, is explained by the combined effect of the three independent variables Assets, Revenue-Receivables and Property Plant Equipment. The second test that needs to be done is determining whether the overall model is significant. In other words, it tells whether in general, the independent variables are able to predict together the dependent variable. The ANOVA table, which is the second output table of SPSS, states whether this is the case. The table below is the ANOVA table for this regression analysis.

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Table 2: ANOVA Model 1 Regression Residual Sum of Squares .900 16.119 df 3 371

Mean Square .300 .043

F 6.906

Sig. .000
a

Total 17.019 374 a. Predictors: (Constant), [1/A(i, t-1)], [REV (i,t) - REC (i,t) / A (i, t-1)], [PPE (i,t) / A (i, t-1)] b. Dependent Variable: TA (i,t) / A (i, t-1)

The ANOVA test is a variance test and this table provides outcomes that tell whether the model is significant. The F-value is the part of the explained variance divided by the part of the unexplained variance of the model. The number of degrees of freedom (df) of the regression is the same as the number of the independent variables, which is 3. The number of the degrees of freedom of the residual is the total number of cases minus de df of the regression minus 1. The total number of cases is 75 companies, for 5 historic years which is 375. So the number of df of the residual is 375-3-1 = 371. The table shows that this model as a whole has a significant explaining power, since the significance is 0.000. This significance is called the P-value and it means that if the hypothesis is true, the chance is 0.000 that the results are a coincidence. In other words, the smaller the P-value, the stronger the evidence is that there is an association between the independent and the dependent variable which is not coincidental. The P-value has to be compared with a specified level of significance, in order to determine whether the data is statistically significant. For a result to be significant, the P-value of the test has to be smaller than the significance level. In existing literature, the significance level that is mostly used is 5 percent. This means that "the data give evidence against the hypothesis so strong that it would happen no more than 5% of the time that the hypothesis is rejected when the hypothesis is true" (Moore et al. 2003, p. 388). Since there is no reason to assume that a 5% significance level is not applicable here, this level will be used for determining the significance of the regression results in this research. In this case the P-value of 0.000 is smaller than 0.05 so the model is statistically significant.

Now the model as a whole is said to be significant, the next step is to see which individual variables have a significant explaining power. The three independent variables of this model are the total assets, the revenue minus the receivables and the gross property, plant and equipment. The following table presents the final regression formula.

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Table 3: Coefficientsa Model Unstandardized Coefficients B 1 (Constant) 1/A (i, t-1) .000 .019 Std. Error .019 .162 .006 Standardized Coefficients Beta t -.019 .116 Sig. .985 .908

[REV (i,t)REC (i, t)] /A (i, t-1)

.042

.013

.169

3.219

.001

PPE (i,t) / A (i, t-1)

-.056

.021

-.141

-2.670

.008

a. Dependent Variable: TA (i,t) / A (i, t-1)

The B in the table is the regression coefficient for all three variables, so this is the part that the dependent variable changes as a result of a change in the independent variable. In short this table shows that 1 is 0.019, 2 is 0.042 and 3 is -0.056. For example, this means that when the variable [REV (i,t)-REC (i, t)] /A (i, t-1) increases with 1, the dependent variable TA (i,t) / A (i, t-1) increases with 0.042. Both the total assets and the revenue minus the receivables have a positive influence on the total accruals, while the gross property, plant and equipment has a negative influence on the level of the total accruals. However, while the overall model was said to be significant, not all individual variables are. As is shown in table three, the variable 1/A (i, t-1) is not significant since the value of 0.908 is larger than 0.05. The other two independent variables are significant, since 0.001 and 0.008 are both smaller than 0.05. Although one variable is not significant, it is important not to exclude it from the model. According to de Vocht (2009, p. 202): "all variables should be included in the regression formula, also the ones that are not significant because the parameters of the significant variables are corrected for these effects."

So all three regression coefficients are filled in formula (3) of chapter 6, the only unknown variable remains the dependent variable nondiscretionary accruals. With a simple calculation program, the nondiscretionary accruals can be determined for every company and each year. The fourth step is subtracting the nondiscretionary accruals from the total accruals, for every firm and every year. The outcome is the discretionary accruals variable, still scaled by assets,

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which is the dependent variable of the regression analysis. Recall the regression formula, needed for the analysis: | [DA (i, t)] | = 1 + 2 (Standard) + 3 (Size) +

(4) Where:

(5) and where:

| [DA (i, t)] | = | [TA - NDA (i,t)] |

- | [ TA- NDAit} | = Absolute value of discretionary accruals, divided by total assets in the previous year - Standard = - Size = -= - 1, 2, 3 = -i= -t= The accounting standard used, {1 = Dutch GAAP and 2 = IFRS} The company size, based on sales revenue {1 = Large and 2 = Small} An error term Regression coefficients Firm index Year index

Filling in the dependent variable discretionary accruals (which is TA-NDA), the accounting standard and the firm size, the regression coefficients can be calculated. For this regression formula, the same assumptions as explained before have to be met. Since both the variables standard and size are not numeric, they have to be restated in order to fulfil assumption 1. In the explanation below, the restatement of these variables is explained. The second assumption, that there is no multicollinearity, is also met here. Since the size of a company does not change as a result of a new accounting standard, it might be clear that these two variables do not measure the same thing. Now the regression analysis can be performed.

As with the first regression analysis, first the model summary is given in order to determine the correlation between the independent variables and the dependent variable.

Table 4: Model Summary Model 1 R .109


a

R Square .012

Adjusted R Square .007

Std. Error of the Estimate .48629

a. Predictors: (Constant), Size, Standard

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The R for this model is only 0.012 which means that approximately 1 percent of the discretionary accruals is explained by the independent variables accounting standard under which the financial report is made and the company size. This means that the explaining power of this model is unfortunately practically zero. There were no significant outliers in the data that could bring noise to the results, so that is not the reason that the models' R is so low. The next step is to determine the significance of the whole model. The table is presented in the ANOVA below.

Table 5: ANOVA Model 1 Regression Residual Total Sum of Squares 1.270 105.704 106.975 df 2 447 449

Mean Square .635 .236

F 2.686

Sig. .069
a

a. Predictors: (Constant), Size, Standard b. Dependent Variable: Discretionary Accruals

Again, the F-value is the number of the explained variance divided by the number of the unexplained variance. The number of the degrees of freedom of the regression is 2, since there are two independent variables. The number of the degrees of freedom of the residual is 447, since the data includes 75 companies, over 6 years which is 450 sets of data. Subtracting the 2 degrees of freedom for the regression and again subtracting 1 leaves 447 df for the residual. The significance of the model is 0.069, which means that the model as a whole does not have significant explaining power since 0.069 is larger than 0.05. This is an important thing to keep in mind when the results are discussed. The last step is again determine the significance of the individual independent variables, which is been done with the results of the following table.
Table 6: Coefficientsa Model Unstandardized Coefficients B 1 (Constant) Standard Size -.077 .039 .099 Std. Error .099 .046 .046 .040 .101 Standardized Coefficients Beta t -.773 .844 2.159 Sig. .440 .399 .031

a. Dependent Variable: TA NDA (i, t)

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The constant variable has a value of -0.077. The regression coefficient for accounting standard 0.039 and for company size it is 0.099. Both variables will be explained more extensive below.

Starting with the independent variable accounting standard, there are two options to deal with: Dutch GAAP before 2005 and IFRS from 2005 and further. Since a regression analysis cannot be done with such qualitative variables, as said before one assumption is that all variables are numeric, numeric values have to be assigned to these possibilities. There are two values that these variables can have: 1 or 2. The automatic recode function of SPSS has given the following values to the qualitative variable standard: when the variable is 1, it means that the accounting standard used for preparing financial statements, and so the value of the variables, is Dutch GAAP. When the variable has the value 2, the accounting standard refers to IFRS. The total accruals calculated for 2002 up to and including 2004 are based on the regulations of Dutch GAAP. Therefore, all data from these years have 1 as value for the variable standard. The total accruals from 2005 until 2007 are calculated with data based on IFRS rules and regulations. Therefore, these years have 2 as value for accounting standard. The regression coefficient for accounting standard, when the dependent variable is Discretionary Accruals, is 0.039. It is a positive coefficient, meaning that value 2: IFRS, is associated with a higher level of discretionary accruals. But, besides this coefficient being very low, it is not significant since the corresponding P-value is 0.399, which is large than 0.05. Hypothesis 1: "In Dutch listed companies, the level of earnings management has not changed as a consequence of the mandatory introduction of IFRS instead of Dutch GAAP" is therefore not rejected. It can be concluded that the change accounting standard is related to another level of earnings management when measured as the discretionary part of accruals.

Second, for the independent variable size there are also two possibilities, namely a firm is either large or small. Since these are again qualitative variables, they have to be recoded into numeric values as well. The possible values given by the automatic recode in SPPS are: 1 or 2. The same story holds as for the standard variable, when it 1 is one it means that it is a large firm and when the value is 2 it means that it is a small firm. As explained in chapter 6, the market capitalization is used to determine whether a firm belongs to the group of large firms or whether it is a rather small firm. It is important to note here that there is no difference between the years in firm size. A firm is said to be large or small for the whole sample period, since these differences between the several years are negligent.

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The regression coefficient for this variable is 0.099 which is positive. However, since the lower value of 1 is assigned to large companies and the higher value of 2 is assigned to small companies, this implies that the smaller a firm is, the higher the level of discretionary accruals will be. This result is quite surprising, since it is expected that larger firms are engaged more in earnings management because of the political cost theory explained in chapter 3. The corresponding P-value is 0.031. This means that although the model as a whole was said not to be significant, this variable is significant at the 5 percent level since the value is lower than 0.05. Although the coefficient is very low (not even 1 percent of the level of discretionary accruals is explained by firm size) it seems that the firm size is likely to have a very small influence on the level of discretionary accruals. Namely, smaller firms are more engaged in earnings management than larger firms. However, since the overall level of earnings management has not changed as a result of the introduction of IFRS, the difference in the level of earnings management between small and large companies has also stayed the same. So therefore hypothesis 2: "There is no difference in the change in the level of earnings management as a consequence of the mandatory introduction of IFRS between small and large Dutch listed companies" can also not be rejected.

7.2 Summary This chapter provided the statistical results of the empirical research. First of all, the regression coefficients for the formula calculating the total accruals are determined. These regression coefficients determine the degree of change in the dependent variable when the independent variable changes. With the historical data of 1997 up to and including 2001 these regression coefficients were calculated. These were needed to calculate the nondiscretionary accruals for all 75 firms in the sample, during 2002 until 2007. The calculated regression coefficients are good estimates for the coefficients in this formula. The results of this regression were that the model has significant explaining power as a whole, but that only the revenue minus the receivables and the gross property, plant and equipment are the significant variables in estimating the total accruals. When the nondiscretionary accruals are calculated with a simple calculation program, the nondiscretionary accruals are subtracted from the total accruals, being the dependent variable discretionary accruals in the last regression model. With this regression model the explaining power of the accounting standard used and the firm size are calculated in SPSS. The model has less significant explaining power than the first regression formula, since the ANOVA test provided a significance of 0.069. This implies that the regression is not significant at the 5

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percent level. However, this does not mean that both variables do not have significant influence on the dependent variable. The discretionary accruals are for 3,9 percent dependent on the accounting standard used (the coefficient being 0.039). This implies a small increase in earnings management, defined by the discretionary accruals, when IFRS was introduced since IFRS got the higher numeric value in the recode process. Since the corresponding P-value is 0.399 this is not significant at the 5 percent level. The other variable, the size of the firm, has a coefficient of only 0.099. Since the higher numeric value of size is assigned to small firms, this result implies that small firms are a little more engaged in earnings management. This is a very low percentage and, but it is significant at the 5 per cent level, since the P-value is 0.031. So although the model has not significant explaining power on it self, the firm size does have a significant influence on the level of earnings management, even if it is a very small influence. All outcomes above are the answer to sub question 11: "What are the results of the research".

To conclude, the answer to sub question 12: "Which conclusions can be drawn from these results" is that both hypothesis cannot be rejected. First of all, the accounting standard used does not seem to have a significant impact on the level of the discretionary accruals. The Pvalue of the regression coefficient for the variable accounting standard was 0.399 which is larger than 0.05, making the results not significant. Secondly, the results show that small companies are in general more engaged in earnings management then large companies. There is a significant relation that states that the smaller the firm, the higher the level of earnings management. However, since the new accounting standard IFRS does not have an influence on the overall level of earnings management, the difference in the level of earnings management between small and large companies stayed the same after the introduction of IFRS. Therefore, hypothesis 2 cannot be rejected.

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8. Conclusion

8.1 Summary In 2005, the European Union introduced the high quality International Financial Reporting Standards (IFRS). All listed companies are obliged to prepare their consolidated financial reports in accordance with these standards. The introduction of IFRS is the first important subject of this thesis, the phenomenon earnings management is the second. The definition of earnings management that is used in this thesis is from Healy and Wahlen (1999): "Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers". The two main methods of earnings management are real earnings management, wherein real activities of the company are managed, and accruals based earnings management, which is about discretion of management in the process of selecting accounting methods and estimating numbers. In this thesis the focus was on accruals based earnings management, simply because real earnings management is very hard, if not impossible, to measure in reality. It was assumed for two reasons that the level of earnings management should decrease as a consequence of the implementation of IFRS. First of all, the pressure on managers increases, since the widely used standards increase comparability between companies. This increased comparability should lower managers' incentives to intentionally mislead stakeholders. Second, a high quality accounting standard should increase the quality of the financial statements prepared in conformity with these statements. Since earnings management is one of the proxies that lower the quality of financial statements, earnings management is assumed to decrease as a consequence of the implementation of IFRS. However, the expectation that earnings management will decrease is not the only view. Because the new accounting standards include fair value estimations for a lot of assets and liabilities, opponents mention that subjectivity in estimating those fair values can lead to an increase of earnings management as a result of the introduction of IFRS, which is especially the case in estimating fair values for assets or liabilities with no known market price, for example in illiquid markets. The empirical research in this thesis investigated what the effect of the implementation of IFRS was on Dutch listed companies. The research question was as follows: "To what extent did the introduction of IFRS in The Netherlands result in a reduction of accruals based

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earnings management, in the period 2002-2007 for small and large companies, listed on the Dutch stock exchange?" Trough answering twelve sub questions in the chapters 2 until 7, this research question can be answered in the conclusion in paragraph 8.2. Since the focus of the research was to describe, explain and predict what happens in reality, the positive approach of doing research was applied. More specifically, the Positive Accounting Theory (PAT) is used as research approach. An important assumption of PAT is that individuals act in their own interest. In this case, managers influence the financial numbers of a company so that they are better off, ignoring the consequences for their stakeholders. The specific approach for earnings management research that was used is studying aggregate accruals. This is one of the three methods discussed in chapter 2. The most popular model for doing this kind of research is the Jones Model. This model has a couple of modified versions, among others one from Dechow et al (1995) which was used in this thesis. This research model tried to estimate earnings management by the use of discretionary accruals. The theory behind this model was as follows. Accruals are the difference between cash in- and outflows on the one hand and the recognition of revenues and cost on the other hand. Some of these accruals come from normal operational activities and are quite straightforward and objective, the so called nondiscretionary accruals. However, another part of the accruals are subject to management discretion, the discretionary accruals. This second part of accruals, the discretionary accruals, is an indication for the presence of earnings management. The model of Jones provides, among others, an estimation method for the discretionary part of accruals. For an extensive explanation of the research model, see chapter 6. This model was used to measure the level of discretionary accruals at Dutch listed companies both before and after the introduction of IFRS in order to compare the levels of earnings management. Comparing a sample of companies before and after a specific event, here the introduction of IFRS, had several implications. First of all, the sample had to include exact the same companies in both periods, in order to avoid biased results. Second, the companies all had to use the same standard before they changed to IFRS. These and other factors made the sample decline from originally 164 listed companies in The Netherlands to 75 companies. For these companies all data was obtained for the whole period 2002-2007. Besides, these companies were divided in two groups, based on their market capitalization. One group contained all large companies and the other contained the remaining small companies, where both groups were about the same size. Since it is possible that large and small group differ in the their level of

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engagement in earnings management due to the political cost theory, as discussed in chapter3, this separation made it able to study whether this difference really exists in The Netherlands. 8.2 Conclusion and answer to research question Chapter 7 presented the results of the empirical research. The regression with the independent variables 'standard' and 'size' was the final test of this study. It became clear that the accounting standard used did not have a significant influence on the level of the discretionary accruals, or on earnings management. For the variable firm size, there was a (little) significant influence. Namely, the smaller the firm the higher the level of discretionary accruals, or in other words, the smaller the level of earnings management. However, since there is no difference in the level of earnings management observed as a consequence of the introduction of IFRS, the difference between small and large companies has stayed the same. Therefore, it could not be concluded that the implementation of IFRS had a different impact at large or small companies. With the above results, the research question of this thesis can be answered. This question was: "To what extent did the introduction of IFRS in The Netherlands result in a reduction of accruals based earnings management, in the period 2002-2007 for small and large companies, listed on the Dutch stock exchange?" The answer to this question cannot be given, since it is not possible to measure the cause of an eventual change in earnings management. When there is a change in the level of earnings management, it might be due to the implementation of IFRS, but there can also be another reason. The only thing that can be said is whether the implementation of IFRS is associated with a lower level of earnings management compared to another accounting standard. Prior research showed that there could be a relation between IFRS and a lower level of earnings management, but it is impossible to state that IFRS really caused this decrease in earnings management. The results of this result do not prove that there is a relation between the implementation of IFRS and a lower level of earnings management. There is no change at all in the level of accruals based earnings management as a consequence of the introduction of IFRS. Therefore, the introduction is to no extent associated with significant lower level of accruals based earnings management. This result is in conformity with the results that Heemskerk and van der Tas (2006) found in Germany and Switzerland and Jeanjean and Stolowy (2008) in France, the United Kingdom and Australia. The results are also in line with the statement of Christensen, Lee and Walker that only voluntary adopters of IFRS show a decrease in the

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level of earnings management and that this effect is not expected to be present for companies who mandatory shifted to IFRS. Both for small and large companies, the level of discretionary accruals stayed the same when the financial reports prepared after 2005 under IFRS are compared with the financial reports prepared prior to 2005 under Dutch GAAP. Although there is small evidence that smaller companies are in general more engaged in earnings management than larger companies, the introduction of IFRS did not have different consequences for both types of companies. These results are only valid for Dutch listed companies and only for the period 2002 until 2007. To conclude, a short overview of comparable researches is given in order to compare the results that this research provided. Prior research Germany: no relation found between IFRS and earnings management Prior research Switzerland: no relation found between IFRS and earnings management Prior research United Kingdom: no relation found between IFRS and earnings management Prior research Australia: no relation found between IFRS and earnings management Prior research France: IFRS associated with higher level of earnings management Prior research 327 European and other companies: IFRS associated with lower level of earnings management, but only at voluntary adopters Prior research 102.636 European and other companies: IFRS associated with lower level of earnings management, but only when enforcement is high Netherlands: no relation found between IFRS and earnings management. 8.3 Limitations As with every research, a couple of limitations arise at this point. These will be discussed below. First of all the outcome is not very up to date. The research is performed with data from 2002 until 2007 and it is already 2011 by now. It is possible that the situation is quite different now, since it is four years later. Maybe the financial crisis could have an influence, or the fact that IFRS is more familiar than a couple of years ago. Unfortunately not any conclusions about the situation in the current period can be drawn. However, in order to avoid taking into account the financial crisis, the sample was not enlarged by including 2008, 2009 or even 2010. A second limitation of this research is that it is hard to generalize the results for other countries. Since The Netherlands face some specific factors, the results will not automatically

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be the same in other countries. For example, according to La Porta et al (1998), The Netherlands are a French Civil Law country but is an exception when the legal enforcement level of French Civil Law countries is compared. Therefore, even to other French Civil Law countries the results maybe are not valuable. However, as said before several times, the general effect of the implementation of IFRS on earnings management can be compared with the results of comparable research in other countries, for example when there is controlled for specific factors. Another limitation is also recognized by Lippens (2010). The focus in this research is only on accruals based earnings management. However, this is not the only way of managing earnings. As said before; real earnings management is another opportunity, but this is hardly measurable in reality. Still, it could be possible that the conclusion about no change in the level of earnings management is no longer valid when real earnings management has been taken into account. With respect to the research design, there is a fourth limitation and this is also recognized by Jeanjean and Stolowy (2008) for their research. In the regression formula for estimating the nondiscretionary accruals, all variables of year (t) are scaled by the total assets of year (t-1). This gives a problem for the year 2005, since the main variables such as revenue and property, plant and equipment are valued under IFRS methods, while the assets with which the variables are scaled are valued under Dutch GAAP method. A consequence is that this variable might be less valid when the numerator and the denominator of one number are calculated under different rules, especially when the value differs a lot under both standards. Another limitation with respect to the research design is showed in chapter 7, not all variables of the first regression model are significant. The first variable [1/A (i, t-1)] is not a significant variable in estimating the total accruals and therefore is will also be not significant when this variable and its corresponding regression coefficient are used to calculate the nondiscretionary accruals. This might make the whole model less useful for determining the nondiscretionary accruals as a basis for calculating earnings management. A final limitation of this study that has to do with the research design is that the Model Summary of the second regression analysis shows that only 1 percent of the discretionary accruals is explained by the accounting standard and the firm size. Although it might be clear that there are other factors determining the level of earnings management, it would be better if

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the percentage was something higher. Now the correlation between the independent and the dependent variables is heading towards zero. This makes the results not very strong. 8.4 Recommendations for future research In order draw more, and probably stronger, conclusions about the effect of the implementation of IFRS on the level of earnings management and the overall quality of financial statements, more research is needed. Taking the limitations of this research as a starting point, some recommendations for future research are given. First of all, since the data from this research is not very up to date, a new research can be done with more current data. Although the financial crisis can influence the results, it might be interesting to compare financial reports from prior to 2005 with financial reports of 2008, 2009 and maybe further. The reason the results might differ from those of 2005-2007 is that both managers and users of financial statements will be more familiar with IFRS. Besides, the accounting standards faced a lot of changes after the first implementation in 2005. It may be that the standards are changed in such a way that there is indeed less room for earnings management nowadays. Therefore, doing the research again with more recent data may provide interesting outcomes. Another possibility for future research is to study more countries, but with control variables for country specific factors. For example, the legal system or the level of investor protection should be labelled in such a way that several countries can be distinguished, for example by including these factors as dummy variables in the regression models. This enables the researcher to see whether there are differences in the success of the implementation of IFRS, with respect to earnings management. Standard setters might use this information to change rules and regulations, and maybe stakeholders can use the information by interpreting financial statements. Further, it might be interesting to study the same data with another research model. Because of lack of proof that more recent models provide reliable outcomes, the rather old Jones model is used as research model in this thesis. However, it can be good to use another model, since another approach can provide other (better) results. So when there is more proof that these models provides reliable estimates for earnings management, it is recommended to use such a model for doing this research again.

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Two other reasons to redo the research with another model is that not all variables are shown to be significant and that only 1 percent of the discretionary accruals is explained by the accounting standard and the firm size according to the last regression formula results. Concerning the fourth limitation about the inconsistent calculation method of variables, there is unfortunately no solution within the research model. However, all variables of 2004 can be restated in the valuation methods of IFRS which makes the valuation method of both the numerator and the denominator of these variables equal. Since all companies had to make restatements of their financial report of 2004 as if it was prepared under IFRS, this information should be available. A recommendation is to do this research again, but then use the restated financial information of 2004 for the calculations for the variables of 2005 which have to be scaled by the assets of 2004. This might result in more reliable outcomes, since in this way both the numerator and denominator of the 2005 variables will be calculated under the same accounting standard and with the same calculation method.

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Appendix 1: Overview of reviewed literature about effect of IFRS on Earnings Management


AUTHOR OBJECT STUDY SAMPLE METHODOLOGY CONCLUSION

Heemskerk, M.J.L. and Tas, L.G.

Determine whether earnings management at firms, who have adopted IFRS voluntary in an early stage, has declined

160 German and Swiss companies, early adapters before 2005

Aggregate Accruals: Modified Jones Model (regression)

Earnings Management did not decline by companies that voluntary report in accordance with IFRS

Christensen, H.B., Lee, E. and Walker, M.

Determine whether company incentives or accounting standards are leading for the audit quality.

133 German companies that voluntarily adopted IFRS, 177 German companies that did not. 636 German listed companies in the period 1999-2001

Compare voluntary with mandatory adopters of IFRS, using a regression analysis

Earnings management did decrease at companies that voluntarily adopted IFRS, but this result was not found at the mandatory adopters of IFRS.

Tendeloo, B. and Vanstraelen, A.

Investigate whether German companies, that also early adopted IFRS, engage less in earnings management, while controlling for other differences in earnings management incentives

Aggregate Accruals: Cross-sectional Jones Mode (regression)

More Earnings Management when IFRS implemented. Effect reduced when company audited by Big 4 audit company. When corrected for hidden reserves, no difference in earnings management under IFRS compared with GAAP

Lippens, M.

Making a distinction between accruals based earnings management and real earnings management, and investigate whether the first declines and the second increases as a result of obliged introduction of IFRS.

Listed companies from Belgium, The Netherlands, Denmark, Italy, Sweden and Finland during 20002006

1) Aggregate accruals: Crosssectional Jones Model (regression) 2)Distribution of earnings: (real EM) Estimate model from Roychowdhury (regression)

Accruals based accounting and real earnings management both increased after implementation of IRFS. No difference between countries

Jeanjean, T. and Stolowy, H.

Whether the implementation of IFRS led to any less earnings

1146 France, U.K. and Australian companies

Distribution of earnings: Wilcoxon rank-sum test with IBEX, total assets

Earnings management did not decrease after implementation of IFRS. In France is even an increase in earnings

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management to avoid losses during 20022006 Cai,L. Courtenay, S. and Rahman, A. Whether adoption and enforcement of IFRS leads to a reduction of earnings management 102.636 firmyear observations in 32 countries during 20062006

and revenue

management measured.

Accruals approach: Comparing mean difference in earnings management and Ordinary Least Square Regressions Regression analysis: comparing mean ratios and correlations and the eventual impact of variables

Earnings management did decline at countries that have adopted IFRS, with an important role for the level of enforcement.

Barth, M.E., Landsman, W.R. and Lang M.H.

Whether adopting a high quality international accounting standards leads to a higher accounting quality, among other things resulting in a lower level of earnings management Comparing several accruals models in order to see which model has the most exploratory power

1896 firm year observations from 327 companies during 19902003

Countries that have implemented high quality international standards do indeed generate higher quality information, including a lower level of earnings management

Dechow, P.M., Sloan, R.G. and Sweeney A.P.

1000 randomly selected firmyear observations and 32 firms targeted by the SEC

Modified Jones Model

The modified model of Jones provides the most powerful test of earnings management

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Appendix 2: Overview of general Earnings Management and IFRS literature


AUTHOR Healy P.M. and Wahlen J.M. OBJECT STUDY Review of the academic evidence on earnings management and its implications for accounting standards setters and regulators SAMPLE n/a METHODOLOGY Literature review CONCLUSION Earnings management literature currently provides only modest insights for standard setters. Earnings management occurs for variety of reasons; market perception, increase management compensation and avoidance of regulatory intervention The trade-off depend on the question addressed, the objective of the research in a given context, how earnings are managed and the incentives. There is no best approach

McNichols M.F.

Discussion of trade-offs associated with three research designs commonly used in the earnings management literature

n/a

Review on three research designs: based on aggregate accruals, specific accruals and distribution of earnings after management Literature review

Ball R.

Discussion on the pros and cons for investors on the implementation of the IFRS standards

n/a

At least some convergence of standards seems desirable due to globalization. Therefore there are some notes of attention and caution Managers do take actions to avoid negative earnings surprises, as distributions of earnings surprises contains an unusual high frequency of positive and unusual low frequency of negative surprises There is empirical evidence that earnings decreases and losses are frequently managed away International accounting literature has generally found a positive impact of IFRS. Quality depends on: quality of standards, countrys legal and political system and financial

Burgstahler D. and Eames M.

Show that managers avoid reporting earnings lower than analyst forecasts

25.951 observations

Jones model, Matsumoto model

Burgstahler D. and Dichev I.

Providing evidence that firms manage reported earnings to avoid earnings decreases and losses A review of the literature on changing accounting standards and the determinants of accounting quality following IFRS

Total number of observations is 64.644

Statistical test

Soderstrom N. and Sun K.J.

n/a

Literature review, also discussion on methodological issues

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adoption. Bolt-lee C. and Smith L.M. Dechow, P.M. Highlight previous IFRS research n/a Literature review

reporting incentives There are pros and cons for the transition of US GAAP to IFRS Accounting accruals provide a measure of short-term performance that more closely reflects expected cashflows than do realized cash flows. But, certain accruals are less likely to mitigate timing and matching problems in realized cash flows.

Investigate circumstances where accruals are predicted to improve earnings ability to measure firm performance

20,716 firmquarter observations from 1980 to 1989, 28,647 firmyear observations from 1960 to 1989, and 5,454 firmfour-year (non overlapping) observations from 1964 to 1989.

Regression analysis and cross-sectional variant of the Jones model

Leuz, C., Nanda, D. and Wysocki P.D.

Investigate the relationship between investor protection and legal enforcement strength and earnings management

70.955 firmyear observations in 31 countries and 8616 companies during 19901999

Regression analysis

High investor protection and strong legal enforcement are negatively related to earnings management

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Appendix 3: Companies in research sample

Aalberts Industries NV Accell Group NV AFC Ajax NV Akzo Nobel NV And International Publishers Arcadis NV ASM International NV Ballast Nedam NV Batenburg Beheer NV Beter Bed Holding NV Brunel International NV Corio NV Crown Van Gelder NV CSM NV Ctac NM NV Docdata NV DPA Group NV Eurocommercial NV Exact Holding NV Fornix Biosciences NV Gamma Holding NV Grontmij NV Heijmans NV Heineken NV HES-Beheer NV

Hitt NM NV Holland Colours NV Hunter Douglas NV Hydratec Industries NV ICT Automatisering NV Imtech NV Kendrion NV Koninklijke Ahold NV Koninklijke BAM Groep NV Koninklijke Brill NV Koninklijke DSM Koninklijke Porceleyne Fles NV Koninklijke Ten Cate NV Koninklijke Vopak NV Koninklijke Wegener NV Koninklijke Wessanen NV Macintosh Retail Group NV Mediq NV Nederlands Apparanfabriek NV Nedsense Enterprises NV Neways Electric International Nieuwe Steen Investment Nutreco NV Oce NV Oranjewoud NV

Ordina NV Postnl NV Punch Graphix NV Qurius NV Randstad Holding NV Reed Elsevier NV Roodmicrotec NV Roto Smeets Group NV Royal Boskalis Westminster NV SBM Offshore NV Simac Techniek NV Sligro Food Group NV Stern Groep NV Telegraaf Media Groep Tie Holding NV TKH Group NV Tom Tom Unilever NV Unit 4 NV USG People NV Vastned Offices Industrial Vastned Retail NV Vivenda Media Groep NV Wereldhave NV Wolters Kluwer NV

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