How Can Analysts Identify Such Management Behaviour?

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How can analysts identify such management behaviour?

5.1 Identify contexts where earnings management is likely

There are several ways that analysts can identify when it is likely that impairment has been used to manage earnings. They can do this by seeing whether any impairments (particularly if they are abnormally large) are preceded by conditions that might be conducive to earnings management.

5.1.1 Unexpectedly low or high earnings prior to the impairment
One explanation for the incentives behind using impairment to manage earnings is that firms will engage in excessive write-downs of assets if earnings are unexpectedly low, as management take a bath in order to increase their chances of meeting expectations in future periods
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Managers may believe the company is currently over-valued, as they have previously been delaying the asset write-off, and artificially inflating earnings in the meantime. However, there may be endogeneity problems with such a conclusion, as the observed patterns of insider information may be due to a firm’s concerted share buyback strategy rather than earnings management.

5.1.3 The timing of impairment
It has also been argued that the timing of impairments are correlated with earnings management. For, managers often delay the announcement of an impairment until the last quarter, so they have a clearer picture of the year’s performance, and can confirm whether the firm is likely to meet earnings expectations or not (Luong Thi, 2014).

This is a very simple indicator for an analyst to observe, with XYZ’s $3.5bn impairment announcement coming in the fourth quarter of Year 3. However, although the theory behind this relationship is compelling, XYZ (like many companies) conducts a goodwill impairment review in Q4 every year, and so the impairment will always take place then, regardless of the motivation behind it.

5.1.4 A change in senior management
And a final indicator that is common in the literature is whether there has been a recent change in senior management (Abuaddous et al., 2014). As Masters-Stout et al. (2007) show that a change in CEO has a statistically significant positive effect on the amount of impairment recorded,
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