Ethics and Governance: Earnings Management

Companies are aware that analysts focus on protability in evaluating nancial performance. Managers have historically utilized a number of methods to improve reported protability that are cosmetic in nature and do not affect "real" operating performance. These methods are subsumed under the general heading of "earnings management." Justication for such actions typically includes the following arguments:

• Increasing stock price by managing earnings benefits stockholders; thus, no one is hurt by these actions.
• Earnings management is a temporary fix; such actions will be curtailed once "real" profitability improves, as managers expect.
• Identify the affected parties in any scheme to manage prots to prop up the stock price.
• 1. Do the ends (of earnings management) justify the means? Explain.
• 2. To what extent are the objectives of managers different from those of stockholders?
• 3. What governance structure can you envision that might inhibit earnings management?