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Real Earnings Management : Real Profit Management

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On the other hand, many companies use another discretionary technique commonly known as real earnings management. Gunny (2005) mentions that real earnings management arises when directors prioritise earnings figure over the conventional method of accounting to alter this figure in their favour. Real earnings management is relatively different as compared to accruals based earnings management due to the ‘direct cash flow effect’. Based on Roychowdhury (2006), an example of real earnings manipulation takes place when a company reduces its expenditure on research and development in order to spend retained money buying back its own shares. As a result, it increases both Earnings per Share and short-term earnings which affect how investors view…show more content…
2005 p.16)
Although the above quote reinforce the idea that real earnings management is a safer option to accrual based earnings management, the percentage above came from a survey that did not show display how large the sample size was. Therefore, this must be considered before making a conclusion.

SHOULD INVESTORS WORRY ABOUT EARNINGS MANAGEMENT?
The techniques of earnings management have already been discussed. However, what has not been touched in detail so far is how earnings management affects investors. It can be easy to fall into the trap of believing that all types of earnings management are bad.
Contrary to this belief, earnings management can benefit the market. This can be viewed from the aspect of stock market. According to the research conducted by Aleš Čornanič and Jiří Novák, through earnings management, the stock price of a company can be stabilized. This makes a business with a high potential for growth more attractive to investors. Resources are therefore allocated to more efficient companies listed on the stock exchange and as a result the UK economy benefits as a whole. Walker (2013) says that firms benefit from a stable stock price and argues that earnings management is not always bad, but accepts that it must be made more transparent as well as increasing investors’ understanding of it.
However, the risks the earnings
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