View metadata, citation and similar papers at core.ac.

uk brought to you by CORE

provided by Heriot Watt Pure

Earnings Management Ethics: Stakeholders' Perceptions

Yasser Barghathi, David Collison, and Louise Crawford

Introduction
The recent corporate scandals highlighted the incidence of unethical practices conducted by

business organizations (Cacioppe et al., 2008). These unethical practices that are referred to in the

literature as creative accounting include earnings management, and have, according to Beaudoin

et al. (2013), been the cause of the collapse of some high-profile companies and reduced

confidence in financial reporting.

Earnings management has been described by Nelson et al. (2002) as “non-neutral financial

reporting” in which managers are deliberately altering the reported income to achieve some

private gain. It has been also described as a “slippery slope that would lead to fraudulent financial

reporting” (Ortega and Grant, 2003, p. 51). Abdelghany (2005) characterises earnings

management as “minor accounting gimmicks becoming more and more aggressive until they

create material misstatement in the financial statements” (p. 1002). The exercise of earnings

management may potentially lead to adverse consequences; according to Loomis (1999), earnings

management may entail a legal penalty.

Beaudoin et al. (2013) acknowledge the conflict of views regarding the acceptability of earnings

management. They indicate that some scholars view it as an unethical practice that lead to

negative consequences, it is also suggested by others as an inherent result of the financial

reporting process and that is does not affect the usefulness of accounting information

Recent accounting scandals have raised the issue of earnings management ethics. Although

earnings management could arguably be performed in a legal and lawful way, it remains an

ethical issue in the financial reporting context (Abdelghany, 2005).

1
Geiger and Smith (2010) argue that not all earnings management practices lead to inappropriate

financial reporting, therefore, it is important to investigate the acceptability of earnings

management from different perspectives, they added that:

"… the evaluation of perceptions regarding earnings management behavior is a

vital concern for business reporting worldwide. To the extent that perceptions lead
to the practice of earnings management, an examination of these perceptions is
particularly germane to the evaluation of the financial reporting climate in our
growing international business community, and is of direct concern regarding the
comparability of reported financial information across countries. Accordingly, it is
critically important to examine the perceptions of individuals from different
countries in an attempt to evaluate the climate for earnings management that may
exist" (Geiger and Smith, 2010, p. 21).

Elias (2004) has concluded that despite the belief that earnings management practices are

widespread however there is no agreement within the accounting profession regarding its ethical

acceptability. In the same vein, Abdelghany (2005) suggests that although earnings management

behaviour “does not explicitly violate accounting rules, it is an ethically questionable practice” (p.

1002).

The literature documents considerable research on the acceptability or otherwise of earnings

management practices to different stakeholders. The following section discusses what is meant by

ethics in general and what it means particularly in the business context. Then, related literature

that focuses on the ethics of earnings management activities will be addressed.

Business Ethics
Business ethics has become an important issue in the current business world and is

attracting a great deal of attention from the business community as well as researchers

(Rashid and Ibrahim, 2008). Atakan et al. (2008) suggest that it becomes so essential to

focus on the ethical values and perceptions of the involved parties due to the ethical

violations that have arisen recently. They have also noticed that business practitioners

have been frequently faced with ethical matters in their work place. Tseng et al. (2009)

2
pointed out that in order for a business to be ethical it “requires that the organization or

individual behaves in accordance with the carefully thought-out rules of moral

philosophy” (p. 587). Valentine and Fleischman (2008) emphasized that attention to

ethics as well as corporate social responsibility is a vital issue in light of the fact that

business values are declining due to recent scandals. It has also been confirmed that the

corporate scandals that recently took place have indicated that unethical and immoral

practices that have been conducted by business organizations may impose substantial

consequences for their stakeholders (Cacioppe et al. 2008). For instance, Enron and

Arthur Andersen created chaos in the business world when their unethical practices

became reported in the media (Rashid and Ibrahim, 2008). In the wake of the Arthur

Andersen collapse, accountants became aware that the unethical behaviour of some

individuals may have an adverse consequence for the entire profession. The accounting

profession has to be able to maintain the perception of high ethical standards in order for

it to be able to accomplish its fundamental function which is providing accounting

information users with reliable accounting information. As capital markets’ efficiency is

contingent on accounting information users' confidence in this information is vital.

Moreover, agency theory also suggests that the auditor's ethical behaviour is crucial in

the process of financial reporting (Felton et al., 2008). According to Priest (2002, cited in

Elias, 2004) failure of corporate ethics can be attributed to unethical earnings

management. Elias (2004) suggests that recent organization collapses have powered the

ethical argument toward the earnings management behaviour. Any organization that is

operating within a society is considered to be a social organization as long as it serves

this society and is rewarded for its services, Preston (2001, cited in Yong, 2008)

3
suggested that a business has an obligation “to contribute towards society as part of its

social responsibility” as long as it operates in and benefits from this society. De George

(1990) considers business as a social enterprise and that its mandate and limits have been

set by society; although business's limits are usually moral, they normally take the form

of written law.

According to De George (1990) ethics can be defined as:

"A systematic attempt to make sense of our individual and social moral
experience, in such a way as to determine the rules that ought to govern
human conduct, the values worth pursuing, and the character traits
deserving development in life. Ethics concerns itself with human conduct,
taken here to mean human activity that is done knowingly and, to a large
extent, willingly" (De George, 1990, p. 14).

Rushton (2002, cited in Lopez-Gamero et al. 2008) defined ethics as “the application of

moral principles in making choices between right and wrong courses of action” he added

“business ethics is the application of those moral principles in making business

decisions”. (p. 701).

Morality, according to De George (1990) refers to:

"…practices and activities that are considered importantly right and wrong;
the rules that govern those activities; and the values that are embedded,
fostered, pursued by those activities and practices" (De George, 1990).

Fisher and Lovell (2003) in distinguishing between ethics and morality consider ethics as

about doing good and that it deals with the good life for humanity, while morality is

considered as not doing harm and it is a concern for justice. Based on categories of bad,

good, legal and illegal, they set forth four combinations to judge the rightness of actions

that are; (a) actions that are good and legal but not a legal obligation; (b) actions that are

wrong and illegal; (c) actions that legal but bad; and finally, (d) actions that are good but

4
illegal. Earnings management (in the UK interpretation of the term as discussed above) as

a practice obviously lies under section (c), earnings management is legal but it has bad

consequences for some stakeholders.

According to Geiger et al. (2006) an ethical issue in the context of financial reporting

takes place in almost every month and they added that, evaluating the ethical behaviour

in the financial reporting field is a critical issue in business practice.

Earnings management has been regarded as one of the controversial and significant areas

in the accounting literature and might be "the most important ethical issue facing the

accounting profession "(Merchant and Rockness, 1994, p. 92). As stated earlier in this

chapter earnings management is considered to be wide spread and according to Geiger et

al. (2006) every accountant and every corporation has faced management temptation to

manage the reported earnings. Companies can face continuous pressure to produce a

steady growth of earnings which can eventually result in forceful managers being

tempted to intervene in the financial reporting process. Furthermore, the practice of

earnings management which arguably seeks to mask the true financial position of a

company, in addition hides significant information that investors need to know (Loomis,

1999, cited in Elias, 2004) Levitt (1998, p. 16) considers earnings management as

“accounting hocus-pocus where financial reality is hidden from investors”.

Literature review
Several studies have been conducted to examine the perceptions of different stakeholders

regarding the ethical acceptability of earnings management practices. According to

Giacomino et al. (2006) little attention was paid to the morality of earnings management

until the work of Bruns and Merchant that was published in an issue of Management

5
Accounting in 1990. In their study Bruns and Merchant (1990) surveyed the readers of

the Harvard Business Review asking for their perceptions about the acceptability of

earnings management practices through a questionnaire consisted of 13 earnings

management situations that the authors had observed either directly or indirectly. Since

that time, research has been conducted using the same questionnaire in order to

investigate the perceptions of the ethics of earnings management.

Bruns and Merchant (1990) surveyed a total of 649 managers. That questionnaire

contained 13 earnings management situations which the authors had observed either

directly or indirectly, these situations were all legal and consistent with GAAP with

minor ones that not consistent with GAAP. All situations involved earning management

actions. Bruns and Merchant described their results as “scary” and noticed that if a

practice is not clearly banned or deviated slightly from the rules it is considered as ethical

irrespective of who is affected by the practice or “the information that flows from it”.

Merchant and Rockness (1994) have carried out research to assess the perceived morality

of earnings management practices in a sample of general managers, staff managers,

operating-unit controllers and internal auditors using a modified version of the

questionnaire of 13 earnings management activities that was used by Bruns and Merchant

(1990). Their results reveal that accounting manipulations were judged more “harshly”

than operating manipulation regardless of whether accounting manipulations were

consistent with GAAP or not. Also the direction of earnings management practice (i.e.

increase or decrease in reported profit) was not important as respondents showed no

significant difference between the two directions. In addition, results showed that larger

earnings management actions were rated as being significantly less acceptable than

6
smaller actions. The period of effect was also found to matter; respondents rated year-end

actions as significantly less acceptable than quarter-end actions. Another study which

examined how financial statements users’ judge the ethics of earnings management

actions was conducted by Kaplan (2001) who considered his research as an extension of

that of Merchant and Rockness (1994). The latter ascertained the views of various

organizational members, while the former consulted those outside the organization

because “managers, companies, and policy makers” should be concerned about how

external parties perceive the ethics of earnings management activities. Therefore, the

sample consisted of Master in Business Administration (MBA) students taking evening

classes, (evening MBA students, according to Kaplan, are older and have large work

experience in comparison to day MBA students). The study involved an experiment in

which participants were given three scenarios describing earnings management by a

general manager of a large division in different publicly owned corporations. The

scenarios were developed and adopted from Bruns and Merchant (1990). The participants

were randomly allocated into one of two user classes being shareholders and non-

shareholders; also participants were randomly assigned to two subgroups depending upon

the explanation supplied above the intent behind the earnings management; these were

based on individual benefit and company benefit. The results showed that shareholders

assess earnings management as being less unethical when it was intended for company

benefit but that intent did not affect the ethical assessment of non-shareholders. Similarly,

Clikeman et al. (2001) examined the perceptions of accounting students from the US and

five Asian countries using the method developed by Bruns and Merchant (1990) and they

found that students object most strongly to earnings management activity that involves

7
accounting manipulation and increased reported income. Also their findings showed that

students were less critical of earnings management when the manipulation was small or

was committed in order to help the company to survive.

Elias (2002) tested the relationship between personal moral philosophies (i.e. idealism

and relativism), ethics as well as social responsibility, and the ethical judgment of

earnings management practices. His sample consisted of accountants in public practice

and industry, accounting faculty and students. The questionnaire of Merchant (1989) was

adopted in this study. The results showed that all respondents viewed operating earnings

management as a questionable practice at worst, while accounting manipulations were

viewed as “slight to serious” ethical breaches. The results revealed a positive relationship

between an individual’s idealism and his/her perception of earnings management ethics,

and a negative relationship between relativism and the ethical perception of earnings

management.

In another study, Elias (2004) investigated the relationship between corporate ethical

values and earnings management, using a sample of Certified Public Accountants (CPAs)

in public accounting, industry and academia to test whether accountants who are

employed in different organizations (possibly with different ethical values) will perceive

earnings management practices differently. The Bruns and Merchant questionnaire was

used to determine the perceptions of respondents. His results showed a positive

relationship between perceptions of corporate ethical values and perceptions of earnings

management though accountants employed in high (low) ethical values organizations

perceived earnings management practices as unethical (ethical). Also the results revealed

8
that “CPAs in industry were significantly less likely than those in public accounting and

academia to perceive high ethical values in their organizations” (p. 92).

Al-Hayale and Lan (2005) examined the attitudes of managers and external auditors

regarding the ethical acceptability of earnings management. To determine the

acceptability of earnings management practices by both managers and external auditors, a

questionnaire survey was employed; this questionnaire was partially based on the

instrument of Bruns and Merchant (1990). Their results highlighted that auditors

perceived earnings management practices to be less ethical than managers. No difference

was found between male and female auditors towards the ethics of earnings management

actions.

Geiger et al. (2006) investigated the influence of national culture on perceptions about the

acceptability of earnings management within eight countries; they drew on Hofstede’s

work (1980, 1991, and 2001) where he classified cultural dimensions into: (a)

individualism/ collectivism, (b) power distance, (c) masculinity/ femininity, and (d)

uncertainty avoidance. They also drew on the questionnaire of Bruns and Merchant

(1990). Their results suggested that middle individualism countries perceived earning

management as being more unacceptable than low and high individualism countries.

Individuals from high power distance countries viewed operational earnings management

less favourably than those from low power distance cultures. Individuals from high

masculinity countries perceived earnings management less favourably than low

masculinity cultures and there was no relationship between the last cultural factor and

earnings management activities as results did not find any support for either a positive or

9
a negative relationship between uncertainty and individuals’ perceptions of earnings

management techniques.

Giacomino et al. (2006) undertook a comparison study. They examined the perceptions of

undergraduate business students and business managers about the ethics of specific

earnings management practices and compared their results with those of Bruns and

Merchant (1990) to check if there were any differences after 15 years. They used the

questionnaire of Bruns and Merchant (1990) as their research instrument. Their results

suggested that females judged earnings management actions as being less ethical than

males; undergraduate students had a stricter position toward earnings management

activities than business managers, and accounting majors tended to perceive earnings

management practices less favourably than other majors.

The ethics of earnings management have been also examined from the view point of

students and professionals by Grasso et al. (2009). They investigated the perceptions of

students and professionals after the passage of the Sarbanes-Oxley Act of 2002 (SOX).

They found out that both students and professionals perceived earnings management as

being more questionable and less ethical when comparing the year after to the year before

SOX. Their findings also revealed that the perceived ethics of earnings management has

been affected by the accounting scandals which had occurred.

Jooste (2013) conducted a survey to examine the perceptions of students and business

managers about the morality of earnings management. The survey objective was to

determine if there was any difference between students’ and business managers’ views of

the ethics of earnings management. Her survey instrument was the same questionnaire

10
that was used in the Giacomino et al. (2006) who benefited from the questionnaire of

Bruns and Merchant (1990). The results suggested a conflict of view between students

and business managers; students tended to judge the practices more ethical than business

managers. Also the results showed that earnings management tended to be judged

differently by male and female. Males tended to view earnings management practices less

favourably than females.

Johnson et al. (2012) investigated the earnings management perceptions of managers

using a different method from that mentioned above. In their study they investigated the

managers’ perceptions in an experimental setting, based on descriptions of some actual

events within a company. They developed a scenario of four earnings management

practices. Their findings suggested that managers would engage in earnings management

when the consequences for the company were favourable.

Research methods and methodology

This paper explores the perceptions of Libyan Commercial Banks (LCBs) stakeholders in

respect to earnings management ethicalness. Its findings are based on two stages;

interviews and questionnaire survey. During the first stage, 28 stakeholders' views were

sought in respect of earnings management ethics. Stakeholders' information is listed in

Table 1. The paper seeks to answer whether earnings management is perceived as an ethical,

they were asked:

1- How do you perceive the practice in terms of business ethics?

The interview question was originally constructed in English and then translated into Arabic.

While not translated by a formal agency the translation in Arabic was tested by seeking views of

11
 a number of speakers of both Arabic and English who also had academic and/or practical

knowledge of financial reporting

Twenty eight interviews were conducted with various stakeholders in order to elicit their

perceptions about the acceptability of earnings management. These interviews were conducted in

the two main cities of Libya: Benghazi and Tripoli, the capital. The first 20 interviews took place

in the period Jun-Aug of 2011 in the city of Benghazi at a time when the capital had not been

liberated 1. The remaining eight were conducted in Tripoli in June 2012. In this study the

interviews were conducted 'face to face' with all respondents. The interviewees were selected on

the basis that they possessed the knowledge and the experience necessary that was relevant to

contribute to the research objectives. At the beginning, interview appointments were arranged

through telephone calls made to existing contacts 2. In a number of cases interviewees were also

able to recommend other key persons that could be interviewed to gain more insightful

information. Interviewees were sought from four groups (see Table 1) namely: Preparers (PR);

Auditors (AD); Regulators (RG); and Users (US). Some interviewees hold more than one

position; for example, PR5 is a bank chairman, external auditor and academic.

Table 1: Interviewee Groups

Group Position Qualification Country Location
PR1 Chairman Msc USA Commercial bank
Head of Correspondent Banking Commercial bank
PR2 Msc Libya
Office
PR3 Member of BoD PhD USA Commercial bank
PR4 Head of Accounting Dept. BSc Libya Commercial bank
Prepare PR5 Chairman PhD UK Commercial bank
rs Head of Accounts Preparing Commercial bank
PR6 BSc Libya
Dept.
Head of Accounts Preparing BSc Commercial bank
PR7 Libyan
Dept.
PR8 Head of Correspondent Banking BSc Libya Commercial bank
PR9 Vice Manager of Eastern Primary Libya Commercial bank

1
On 15th Feb, 2011, uprising events started in Benghazi and spread out to all the other cities in Libya; this
revolution concluded with a declaration ending the dictatorship era on 23rd October 2011 (BBC, 2012a and
b).
2
The researcher benefited from being an external auditor in Libya.

12
 Branches Management School
PR10 Head of Finance and Control Msc Libya Commercial bank
PR11 Head of Financial Management BSc Libya Commercial bank
Assistant Manager of Commercial bank
PR12 Diploma Libya
Accounting Dept.
AD1 Auditor BSc Libya Audit firm
AD2 Auditor Msc USA Audit firm
Auditors
AD3 Senior Partner PhD UK Audit firm
AD4 Managing Partner BSc Libya Audit firm
RG1 Chief of Benghazi Branch Msc USA LAAA
RG2 Inspector of commercial banks BSc Libya CBL
RG3 Inspector of commercial banks Msc Libya CBL
RG4 Banking Exchange Control Dept. BSc Libya CBL
Governor Deputy of CBL
RG5 Msc Libya CBL
(Benghazi branch)
Regulat
RG6 Vice General Manager BSc Libya Tax Authority
ors
Head of Listing and Follow-up Libya
RG7 BSc LSM
Dept.
RG8 Head of Internal Audit BSc Libya LSM
Manager of Surveillance & Libya
RG9 Msc LSM
Follow-up Risks Dept.
RG10 Legal Consultant BSc Libya Commercial bank
US1 Lecturer PhD UK Benghazi Uni.
Users
US2 Lecturer PhD UK Benghazi Uni.
Key: PR= Preparer, RG= Regulator, AD= Auditor, US= Users. BoD= Board of Directors, LAAA= the
Libyan Accountants and Auditors Association, CBL= Central Bank of Libya, and LSM= Libyan Stock
Market.

All the interviews were recorded with the pre-permission of the interviewees. The interview

recordings were later transcribed and translated into English.

Research results

Interview findings
This part of the interviews, (Table 2) sought to explore the interviewees' views about the ethics

and acceptability of earnings management practices. Replies vary between respondents. Table 2

summarises interviewees’ perceptions about the ethics of earnings management practices where a

“yes” answer reflects the interviewee’s perception that earnings management practice is ethical

13
and acceptable, and a “no” answer means that the interviewee considers earnings management

practices are neither ethical nor acceptable.

The overall result suggests that there is as reported in Table 2, a disagreement between Preparers

and other stakeholder groups. Although one might expect a preparer to justify the practice of

earnings management, given the fact that motivations exist for them to manage earnings, it was

expected that other groups would perceive that earnings management was unethical practice.

Accounting information should be given in a way that is not biased so that one can say that it has

been fairly presented to the accountees. If accounting information unbiasedly presented and was

accepted by other groups other than preparers it would have a serious effect to the accountability

mechanism. The acceptance of such behaviour may adversely affect many stakeholders’ interests

and reflect a serious threat to the accounting system whose main objective according to Ijiri

(1983), is to provide fair accounting information. The accounting information, under the

accountability framework, has to be, inter alia, objective which may not be the case when

earnings management occurs and is perceived as an ethical practice.

Table 2: The Ethics of Earnings Management Practices

Interviewee Q11: Is earnings management ethical? Aggregate
PR1 Yes
PR2 Yes
PR3 Yes
PR4 Yes
PR5 Yes
PR6 Yes 8 preparers (67%) believed that earnings
PR7 No management practices are ethical
PR8 No
PR9 No
PR10 Yes
PR11 No
PR12 Yes
AD1 Yes
Surprisingly, only 1 auditor (25%) believe
AD2 No
that earnings management is unethical
AD3 Yes
practice
AD4 Yes
RG1 No
RG2 Yes 7 regulators (70%) think that earnings
RG3 Yes management is unethical practice
RG4 No

14
RG5 No
RG6 Yes
RG7 No
RG8 No
RG9 No
RG10 No
US1 No 2 users (100%) consider earnings
US2 No management practices unethical
The overall percentage that view earnings management as ethical is 50%, the other half view it as
unethical
Note: this table represents the interviewees’ perception regarding the acceptable and ethicalness of earnings
management practices.

A significant portion took the view that if earnings management was implemented within

accounting standards and regulation then it is viewed as ethical, otherwise not. PR4 expressed the

following view:

"As long as [it is] within regulations and rules it is ethical".

PR3 gave a similar reply, he stated:

"If implanted within GAAP 3 and the law then it is ethical".

Also, earnings management, it was felt, could be justified due to the nature of human beings. RG3

commented:

"I consider it ethical; it is human nature always to try to maximise their benefits".

Consistently, AD3 expects the occurrence of earnings management and mentioned that there is no

"pure accounting". He also outlined some factors that may push managers towards earnings

management. His statement was:

"In fact, we always say that social environments or practices e.g. accounting is
unlike chemistry or physics where 1+1=2. Accounting and management are
affected by the economic, political, social and cultural environments so no way
there will be pure accounting or pure management. During the last seven years I
have been fully involved in audit with managements that suffered from a lot of
things; bored staff, weak staff, old debts with the state, laws and regulations that
are complicated and unclear, lack of skilled staff, unjustified tightening by the
CBL, unethical and severe competition with other banks. Management operating in
such an environment like that one cannot say it is ethical or not. Managers try to fix
what can be fixed in favour of the bank and deal with real problems and ask the
auditor to understand the situation when the CBL issues a new regulation and asks

3
Although there are no local accounting standards, the term GAAP is widely used to refer to US GAAP.
The accounting system education, as reported in Chapter 2, is American oriented.

15
 for it to be applied in one year giving no room to study and understand it. This puts
the auditor in an embarrassing situation as he will be considered neither not
cooperating nor forgiving if he insisted on the application of the new regulation. I
don’t accept a bank to be collapsed as a consequence for applying regulation so
you have to accept. Life is not static and people work in very tough circumstances
and suffer the old regime legacy. It is not acceptable but you find a justification for
it at least some times with a condition that the practice is in the best interest of the
company. According to my experience managers try to save what can be saved".

Also it was suggested that earnings management could be justified just like tax planning. AD4’s

statement was as follows:

"You remind me of tax planning and tax evasion. Sometimes I view management
as being forced to do it in the light of unusual circumstances. A company may have
a high profile in an unusual year so this trend is unusual given that the real value of
the firm won’t be accurately determined unless in case of liquidation. Accounting
standards depend on discretion in some cases and this enables the manager to act in
some circumstances for example in Libya the old tax law was not permitting the
recognition of bad debts. I remember a bank that was not allowed to include bad
debts in their accounts and resulted in a net profits total of 80% of revenues and of
course this was not real. It is acceptable in the light of unusual conditions to
maintain the going concern. Being extreme in everything leads to break down.
Another example, a bank has issued a guarantee letter of 400m LD for one
company that later failed; if I insisted to make the provision of 400m LD the bank
will collapse because their capital was only about 400m LD so you have to give
some room to the other (manager)".

On the other hand, other interviewees completely refuse to accept that earnings management is

appropriate. RG1 for example stated:

"Earnings manipulation in general is unethical".

RG8 indicated that a company should be attached to its principles. The following statement was

offered:

"Of course [it is] unethical, every institution is supposed to have principles, policy
and a general overview (plan) that it works to achieve with the basic rule being that
not achieving any target at the expense of a principal".

Within an accountability framework, bank managers have to act in an ethical manner. Therefore

providing biased information (i.e. when earnings management is practiced) could reveal that bank

managers are not accountable. The interview findings for this question identify what appears to

be a really serious problem when 50% of interviewees perceive that earnings management is

ethical; it could lead to acceptance of such practices.

16
Questionnaire results
The second empirical method used by this paper was a questionnaire survey. The

questionnaire was designed to be answered by all stakeholders which, for the analysis process,

were categorized into four groups: Preparers, Auditors, Regulators, and Users, see Table 3.

Table 3: The Returned Questionnaires

Returned
Respondent Groups Response Rate
Questionnaires
Preparers 27 48%
Auditors 27 50%
Regulators 20 64%
Users 28 54%
Total 102 53%

The total proportions of each individual group (Preparers, Auditors, Regulators, and Users) are

26.5%, 26.5%, 19.6%, and 27.5% respectively; most are male (90 out of 102 or 88.2%). Twenty

eight (27.5%) are professionally qualified, mainly being members of the Libyan Accountants and

Auditors Association (LAAA) (24 or 23.5%). Ninety (88.2%) of the respondents have an

academic qualification higher than a Diploma which suggests a good basic knowledge of

financial issues. Most importantly, 78 (76.5%) of the respondents have indicated that they have

banking experience which again gives a reasonable level of assurance as regards to obtaining

informed views about Libyan commercial banks (LCBs).

Once the responses were coded into an Excel spreadsheet, the data was transferred to the SPSS

statistical package for analysis. This study focuses on different stakeholders’ perceptions

regarding the role of the external auditor in relate to earnings management practices in Libyan

Commercial Banks; for this purpose, most questions were designed based on five-point Likert

scale.

Therefore, non-parametric tests were employed in this study, in particular the Kruskal-Wallis

(KW) and Mann-Whitney (MW) tests. The KW test is used to identify whether any significant

difference exists among the perceptions of the groups; if so, a MW test is carried out to determine

17
which pairs of groups show significantly different perceptions. For further illustration, descriptive

statistics, means and standard deviations 4, were also calculated to provide more insightful

pictures of the perceptions.

As previously reported, the majority of the questions were based on 5-point Likert scales ranging

from (1) strongly disagree (SD) to (5) strongly agree (SA). The findings discussion will be

restricted only to those which have p-values of 0.05 or under.

These questions sought to explore the respondents’ agreement or disagreement regarding the

acceptability of earnings management practices. Respondents were asked how they perceived the

nature of ethical practice at first. Then they were asked how they viewed the exercise of earnings

management when applied within the law and GAAP limits before being asked to indicate

whether earnings management is an unethical practice. The responses as well as the KW p values

are presented in Table 4 (Panel A).

Table 4: Stakeholders’ Perceptions about the Ethics of Earnings Management

Panel A: K-W test
Group Means K-W
Q Statement N Mean SD
PR AD RG US P-value
Ethical behaviour mean complying
1 97 3.71 .912 3.71 3.77 3.84 3.57 .946
with law
Ethical behaviour mean thinking
2 about the impact of one’s decisions 96 3.80 .776 3.63 3.96 3.58 3.96 .157
on others
Earnings management is ethical if
3 96 3.30 1.007 3.22 3.23 3.32 3.43 .880
practiced within the law
Earnings management is ethical if
4 98 3.30 1.017 3.28 3.35 3.21 3.32 .950
practiced within the GAAP
Earnings management affects others’
5 97 3.80 .745 3.78 3.81 3.74 3.86 .958
interests
Earnings management is an unethical
6 95 3.07 .959 3.17 3.00 2.95 3.15 .831
practice
Note: This table shows the mean and standard deviation (SD) for all respondents regarding questions about
earnings management ethicalness. It also provides the mean for each group and the p-value for the Kruskal-

4
Means and standard deviations are, strictly speaking, not appropriate as measures of ordinal data, but their
use is widespread and they arguably have reasonable information content subject to assumptions made
about the intervals in the ordinal data.

18
Wallis (K-W) test. Groups are defined as; preparers (PR), auditors (AD), regulators (RG), and users (US)
for each question. Bold figure indicates significance at the 5% level.
A 5-point Likert scale was used in these questions. It ranged from 1= “Strongly disagree” to 5= “Strongly
agree”.

The overall averages of the mean responses indicate a slight agreement with all questions which

was partially unexpected given the sensitivity of the moral questions being covered. In particular,

one would expect a higher agreement from some stakeholders e.g. the Users group, about whether

earnings management aas an unethical practice. The responses indicate that ethical behaviour

implies consistency with the law and consideration of the effect of decisions on others, with

means of 3.71 and 3.80 respectively. This was followed by the agreement of stakeholder groups

that earnings management would be ethical if practiced within the law and GAAP (the average

mean scores were 3.30 for both questions). Also, earnings management was, on average, agreed

by stakeholders to have an impact on other people’s interests by being given a mean score of

3.80. And finally, whether earnings management is perceived as ethical or not, the overall mean

score of 3.07 reveals that all stakeholders groups consider that, on balance, and narrowly,

earnings management is considered an unethical practice. Although, this result is expected, given

the sensitivity of such moral questions, it was only slightly over the mid-point which means a

very mild level of agreement with this question. Also this result is inconsistent with earlier

findings; stakeholder groups agreed, on balance, that behaving ethically means to comply with

law and consider others’ interest when making decisions. In particular, they agreed, on average,

that earnings management could be regarded as ethical if it was implemented within the law and

GAAP. Moreover, stakeholder groups, on balance, acknowledge that earnings management

practices have an influence on the interests of others. All the above results are inconsistent with

the last one, as it is expected to see a relatively wide agreement that earnings management is

perceived as unethical practice. However, this result is, to large extent, consistent with interview

findings reported earlier (Table 2) which refer to 50% of interviewees indicating that earnings

19
management is an ethical practice. The individually responded questionnaires (Appendices 7.3,

7.4, 7.5, and 7.6) 5 refer to responses almost equally spread on both sides of agreement. For

example, the notable unexpected result that the Regulators group, on balance, disagreed that

earnings management is an unacceptable practice; their responses to this statement were 6

disagreements and 5 agreements. The position of Regulators in terms of LCBs’ financial

reporting, as scrutiny, may lead to a presumption that earnings management is viewed as

unethical practice by LCBs’ managers. On the other hand, the (on balance) disagreement by the

Preparers group, which may be expected due to their position in the financial reporting process,

should also be viewed with their individual responses questionnaire in mind; their responses

turned out as only 4 disagreements, one of which showed a strong disagreement and 7

agreements, two of which showed strongly agreements.

As discussed earlier, the ethics of earnings management as perceived by interviewees revealed

mix findings. Only 50% of interviewees perceived earnings management practices as unethical.

Although questionnaire respondents, on balance, showed an agreement that earnings management

ethics is a bit questionable, it was only given a mean score of 3.07 that is slightly over the mid-

point. This would really refer to a serious problem of the accountability system of LCBs. Since

such behaviour is expected to be reviewed as unethical by a large extent of stakeholders as it does

seriously affect the quality of financial reporting. Therefore, there is a need to raise the awareness

of stakeholders to such issues, and questionnaire respondents apparently agree with the notion

that some stakeholders (preparers, auditors, and investors) may lack the knowledge of such

issues.

Table 4 (Panel A) reveals no significant differences in perceptions between the stakeholders

groups according to the Kruskal Wallis test. The next test was to identify if any significant

5
Do we need to mention that? And therefore, insert these tables at the end?

20
difference may occur between any two pairs. Six MW tests were performed and the results are

shown in Panel B.

Table 4: Stakeholders’ Perceptions about the Ethics of Earnings Management

Panel B: M-W test
K-W M-W p-values
Q Statement P- PR-US AD-RG AD-US RG-US
PR-AD PR-RG
values
Ethical behaviour mean complying
1 .946 .778 .671 .859 .874 .712 .639
with law
Ethical behaviour mean thinking
2 about the impact of one’s decisions .157 .118 .955 .142 .092 .825 .111
on others
Earnings management is ethical if
3 .880 .813 .662 .447 .812 .597 .821
practiced within the law
Earnings management is ethical if
4 .950 .683 .971 .816 .577 .962 .684
practiced within the GAAP
Earnings management affects
5 .958 .912 .906 .710 .800 .798 .620
others’ interests
Earnings management is an
6 .831 .475 .409 .839 .919 .685 .603
unethical practice
Note: This table shows the p-values produced by M-W test between the different groups regarding
questions about earnings management ethicalness. Groups are defined as; preparers (PR), auditors (AD),
regulators (RG), and users (US) for each question. Bold figure indicates significance at the 5% level.
A 5-point Likert scale was used in these questions. It ranged from 1= “Strongly disagree” to 5= “Strongly
agree”.

The results shown in Table 4 (Panel B) reveal no significant differences between any two pairs.

21
References

Abdelghany, K. E. 2005. Measuring the quality of earnings. Managerial Auditing Journal, 20,
1001-1015.

Al-Hayale, T. & Lan, G. 2005. The ethicalness of earnings management in the Middle East: A
survey of managers and auditors in Jordanian companies. International Journal of
Accounting, Auditing and Performance Evaluation, 2, 399-413.

Atakan, M. S., Burnaz, S. & Topcu, Y. I. 2008. An empirical investigation of the ethical
perceptions of future managers with a special emphasis on gender - Turkish case. Journal
of Business Ethics, 82, 573-586.

Beaudoin, C. A., Cianci, A. M. & Tsakumis, G. T. 2013. The impact of CFOs’ incentives and
earning management ethics on their financial reporting decisions and the mediating role
of moral disengagement. [Accessed 24/06/2013].

Bruns, W. & Merchant, K. 1990. The dangerous morality of managing earnings.

Management Accounting, 72, 22-24.

Cacioppe, R., Forster, N. & Fox, M. 2008. A survey of managers' perceptions of corporate ethics
and social responsibility and actions that may affect companies' success. Journal of
Business Ethics, 82, 681-700.

Clikeman, P., Geiger, M. & O'connell, B. 2001. Student perceptions of earnings

management: The effects of national origin and gender. Teaching Business Ethics,
5, 389-410.

De George, R. T. 1990. Business ethics, New York, Macmillan; London: Collier Macmillan.

Elias, R. Z. 2002. Determinants of earnings management ethics among accountants.

Journal of Business Ethics, 40, 33-45.

Elias, R. Z. 2004. The impact of corporate ethical values on perceptions of earnings management.
Managerial Auditing Journal, 19, 84-98.

Felton, S., Dimnik, T. & Bay, D. 2008. Perceptions of accountants' ethics: evidence from their
portrayal in cinema. Journal of Business Ethics, 83, 217-232.

Geiger, M. & Van Der Laan Smith, J. 2010. The effect of institutional and cultural factors on the
perceptions of earnings management. Journal of International Accounting Research, 9,
21-43.

Geiger, M. A., O’connell, B. T., Clikeman, P. M., Ochoa, E., Witkowski, K. & Basioudis, I.
2006. Perceptions of earnings management: The effects of national culture. Advances in
International Accounting, 19, 175-199.

Giacomino, D. E., Bellovary, J. L. & Akers, M. D. 2006. The ethics of managing short-
term earnings: Business managers and business students rate earnings

22
 management practices – Implications for academia. Journal of College Teaching
& Learning, 3, 57-70.

Grasso, L. P., Tilley, P. A. & White, R. A. 2009. The ethics of earnings management: Perceptions
after Sarbanes-Oxley. Management Accounting Quarterly, 11, 45-69.

Johnson, E. N., Fleischman, G. M., Valentine, S. & Walker, K. B. 2012. Managers’ ethical
evaluations of earnings management and Its consequences. Contemporary Accounting
Research, 29, 910-927.

Jooste, L. 2013. Investigating ethical perceptions of short-term earnings management practices,

International Journal of Emerging Markets, 8, 282-299.

Kaplan, S. E. 2001. Further evidence on the ethics of managing earnings: an examination

of the ethically related judgments of shareholders and non-shareholders. Journal
of Accounting & Public Policy, 20, 27-44.

Levitt, A. 1998. The numbers game. The CPA Journal, 68, 14-19.

Loomis, C. J. 1999. Lies, damned lies and managed earnings. Fortune New York: Time Inc.

López-Gamero, M. D., Claver-Cortés, E. & Molina-Azorín, J. F. 2008. Complementary resources

and capabilities for an ethical and environmental management: a qual/quan study.
Journal of Business Ethics, 82, 701-732.

Lovell, A. & Fisher, C. 2003. Business ethics and values, Harlow, FT Prentice Hall.

Merchant, K. A. & Rockness, J. 1994. The ethics of managing earnings: An empirical

investigation. Journal of Accounting and Public Policy, 13, 79-94.

Nelson, M. W., Elliott, J. A. & Tarpiey, R. L. 2002. Evidence from auditors about managers' and
auditors' earnings management decisions. Accounting Review, 77, 175-202.

Ortega, W. R. & Grant, G. H. 2003. Maynard manufacturing: An analysis of GAAP-based and

operational earnings management techniques. Strategic Finance, 85, 50-56.

Rashid, M. Z. & Ibrahim, S. 2008. The effect of culture and religiosity on business ethics: A
cross-cultural comparison. Journal of Business Ethics, 82, 907-917.

Tseng, H.-C., Duan, C.-H., Tung, H.-L. & Kung, H.-J. 2010. Modern business ethics research:
Concepts, theories, and relationships. Journal of Business Ethics, 91, 587-597.

Valentine, S. & Fleischman, G. 2008. Professional ethical standards, corporate social

responsibility, and the perceived role of ethics and social responsibility. Journal of
Business Ethics, 82, 657-666.

Yong, A. 2008. Cross-cultural comparisons of managerial perceptions on profit. Journal of

Business Ethics, 82, 775-791.

23