To determine whether the UAR can provide incremental information conditioned on earnings for Group B firms in the CS portfolio, we look at the results of equations 5 as shown in Table 6. Compared to the results of equations 4 (see Table 5), the adjusted R2 for Group B firms in the CS portfolio increases after adding the UAR variable into the regressions, while the adjusted R2 for Group B firms in the non-CS portfolio does not.
Specifically the adjusted R2 dramatically increases from 4.28% in equation 4 to 13.10%
in equation 5 for Group B firms in the CS portfolio. The coefficient for UAR in equations 5 is 0.68, at the 5% significance. However, for the non-CS portfolio, the coefficient for UAR is insignificant. These findings indicate that the UAR can provide incremental information over earnings. This supports our fourth hypothesis that when extended credit is granted to avoid reporting losses, the UAR can convey additional useful information.17
17 The UAR for Group A firms in the CS portfolio appears to be more informative than that for Group B firms. However, based on the theory of costs and benefits, managers are unlikely to use channel stuffing before reaching their financial target. Thus, when firms are not profitable (like the Group A firms), there is a good chance that the decrease in the accounts receivable turnover rate and the increase in the inventory turnover rate are the result of normal operating performance.
5. Conclusion
The volume of research concerning channel stuffing as practiced by firms listed on NASDAQ or the New York or American Stock Exchanges is extensive. However, comparatively little is known about the extent and practice of earnings management by other firms. This study is concerned with channel stuffing as practiced in Taiwan. Further, this research focuses on the operating decisions involved in channel stuffing as opposed to the accounting aspects. Therefore, we believe that this study makes a unique contribution to the body of literature concerning earnings management.
Similar to Jackson and Wilcox (2000), we investigated whether managers grant extended credit at the end of the fiscal year to avoid reporting losses. Further, we studied the effects of channel stuffing on the information content of reported earnings and we sought to determine whether the unexpected accounts receivable (UAR) can provide incremental information about channel stuffing.
Consistent with our hypotheses, we found that managers of Taiwan-listed firms do grant extended credit to avoid reporting losses and that these unusually generous credit terms (channel stuffing) negatively impact the earnings information provided to investors.
Finally, we found that the unexpected accounts receivable (UAR) can provide incremental information about channel stuffing.
Managers use channel stuffing as one technique to avoid reporting losses. Although it helps firms meet their short-term reporting objectives, it may be harmful in the long run. Earnings manipulation also reduces the information content of reported earnings and this may be harmful to investors who tend to rely on this measurement when making investment decisions. Although this practice does not technically violate GAAP, it is
ethically questionable and it can contribute to accounting fraud. As noted by T.C. Doyle (2003, 128), "Channel stuffing is almost universally bad and almost always winds up disgracing the company that practices it." As more information becomes available, it is hoped that adequate standards can be established which will limit the amount of earnings manipulation that managers can engage in. This, in turn, will help ensure the accuracy of earnings information available to investors. Finally, when these standards are put into place, it is anticipated that firms such as Bausch and Lomb, Bristol-Myers, Apple and Lucent Technologies will no longer be subject to censor by the SEC and tragedies such as Coretronic Corp. and Procomp Informatics LTD. in Taiwan can be avoided.
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