Question

Define the earnings management in the accounting regime; based on agency theory and from the efficient contracting approach to the decision usefulness perspective

Answer 1

Earnings management is an activity undertaken usually the senior management of manipulation of accounting records and financial transaction in a bid to win over the stock markets. Senior management is ideally in a influential position to alter financial records and mislead the public. Agency theory is to state that a principal and agent relationship exists between the management and stakeholders. Under a pressure to potray better financial health of the company to the stakeholders, management gets involved in influencing numbers. The management has a complete information of the company more than the stakeholders and this information asymmetry leaves space for earnings management.

Efficient contracting theory focuses on the role of managers while entering into agreements with lenders. Here again there is an information asymmetry between the contracting parties due to which the managers are able to negotiate a better deal for the contract to be efficient and avail lower interest rates. Management may enter into contracts that have conflicting interests in an effort to manage earnings.