Restructuring Provisions as an Earnings Management Tool

Abstract: This paper seeks to investigate whether the utilization of restructuring provisions is used as a tool for earnings management. By focusing on the utilization rather than the creation of new provisions, the phenomenon of classification shifting is studied. The methodology is based on two stages that analyze restructuring firms classified as Mid or Large Cap in Sweden between 2005-2014. In the first stage, the size of normal utilization of restructuring provisions is predicted through the use of industry-specific Tobit models. The variables included are based on economic fundamentals that were chosen to capture the effects of changing business environment, poor operating performance, poor stock performance, as well as financial distress. In the second stage, OLS modeling is used to test proxies of earnings management against the abnormal part of the utilized restructuring provisions that were left unexplained by the first stage Tobit models. The results showed indications of that restructurings are used as an earnings management tool in Swedish companies. Furthermore, variables from three areas had a significant explanatory power for the occurrence of abnormal utilization of restructuring provisions. These were variables that captured (i) the incentives for doing earnings management, (ii) the industry possibilities of utilizing restructuring provisions for earnings management purposes, (iii) the managements' willingness of utilizing restructurings for earnings management purposes. Hence, the results indicate that investors may better estimate the risk of earnings management in restructuring provisions by taking into account these contextual factors.