Prof. Yuan Ding on Financial Analysis, Earnings Management and Financial Development
April 18,2012 12:00:00
How effective are financial analysts in holding companies accountable for accurately reporting their earnings?
In the US, financial analysts are often thought of as pushing companies to engage in higher levels of ‘earnings management’ because of the near-impossible targets they set. Earnings management, which refers to strategies used by management to deliberately manipulate the company’s earnings in order to meet a pre-determined target, are used to smooth out the yearly figures to avoid reporting sharply good or bad earnings.
A new study co-authored by CEIBS Professor of Accounting, Department Chair of Finance and Accounting and Cathay Capital Chair in Accounting Dr. Yuan Ding, addresses this question. His co-authors are François Degeorge of the Swiss Finance Institute at the University of Lugano, Switzerland; Thomas Jeanjean of ESSEC Business School, France; and Hervé Stolowy of HEC, France. In the paper, which has been accepted for publication in the University of Maryland’s Journal of Accounting and Public Policy, Prof. Ding and his co-authors use a sample of 21 countries from 1994 to 2002 to examine the relationship between financial analysis, earnings management and financial development in an international context.
Their research has shown that earnings management is lower in companies operating in more developed financial systems, such as the US. Prof. Ding and his co-authors found that lack of transparency in many less developed economies can hinder the effectiveness of financial analysis. For example, managers “might hide negative information about the company’s prospects; they might hide some of their actions if they fear retribution from investors; they might be unable to reveal positive information about the firm to investors”. They suggest that in highly developed financial systems, companies respond better to financial analysis because investors may be more likely to demand stronger accountability, there is greater transparency within the economy, the companies’ incentives for supporting analyst monitoring may be larger, and analysts are likely to be better trained and more experienced.
The authors also highlight the reciprocal relationship between financial analysis and an economy’s level of financial development, noting “financial development promotes the effectiveness of analyst monitoring. In turn, the quality of analyst monitoring fosters financial development by facilitating firms’ access to outside finance”. Prof. Ding and his colleagues conclude that financial development thus “mitigates the cost of monitoring firms and curbs earnings management”.
Prof. Yuan Ding is Cathay Capital Chair Professor in Accounting at CEIBS. Prior to joining CEIBS, he was a tenured faculty member of HEC School of Management, Paris, France. He is member of the European Accounting Association, French Accounting Association and American Accounting Association. Prof. Ding is Co-Editor of The International Journal of Accounting and Associate Editor of China Journal of Accounting Research (中国会计学刊). He is also Editorial Board Member of Journal of Accounting and Public Policy, Global Perspectives on Accounting Education Journal, and Research in Accounting in Emerging Economies.
Prof. Ding frequently provides consulting services for many multinationals and Chinese companies in the areas of financial communication, corporate governance, cost control system designing, investment and M&A. In May 2011, Prof. Ding launched “Ding Yuan Index Neutral Fund” an A share market and became the first accounting and finance professor in mainland China to run a hedge fund. He also serves on the Boards of Directors of several listed firms and financial institutions in China, Europe and North America.