Earnings Management During

Import Relief Investigations

Journal of Accounting Research,
Vol. 29, No. 2 (Autumn, 1991), pp. 193-228

Author: Jennifer J. Jones

Presented by
Andreas Vernando
(371675)
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Motivation
Motivation
Import

relief investigations provide a specific

motive for earnings management that is not
provided in other earnings management
studies.

Research
Research Question
Question
Do

managers decrease earnings through

earnings management during import relief
investigations?

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Objective
Objective
This

study tests whether firms that

would benefit from import relief (e.g.,
tariff increases and quota reductions)
attempt to decrease earnings through
earnings management during import
relief investigations by the United
States International Trade Commission
(ITC).

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Contribution
Contribution
The

results of this study may prove useful

to regulators at the ITC. The ITC may
benefit by taking into account the
evidence provided herein that managers
appear to be making income-decreasing
accruals during import relief investigation
periods.
Models developed represent an attempt to
improve upon the measures of
discretionary total accruals used in prior
research
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Role
Role of
of Accounting
Accounting Numbers
Numbers
in
in Foreign
Foreign Trade
Trade Regulation
Regulation

Foreign trade regulation provides avenues for granting

import relief through tariffs, quotas, marketing
agreements, and/or federal adjustment assistance.
In most cases, an increase in import protection results
in a wealth transfer FROM domestic consumers,
domestic importers, and foreign suppliers TO domestic
producers of the protected good.
Managers of firms that would benefit from increased
import protection have incentives to take actions to
increase the likelihood of obtaining such protection
and/or increase the amount of protection granted.

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Statutory
Provisions
Of
Trade
of
Numbers
StatutoryRole
Provisions
Of The
The Foreign
Foreign
Trade Acts
Acts
Role
of Accounting
Accounting
Numbers
in
in Foreign
Foreign Trade
Trade Regulation
Regulation

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The three statutes, which pertain to general escape

clause, countervailing duty, and antidumping
investigations, are the primary focus of this study.
Title VII of the Tariff Act of 1930 was designed to
protect domestic industries from imports that are sold
at less than fair value (antidumping) or are benefiting
from foreign subsidies (countervailing duty).
The general escape clause investigations are based on
section 201 of the Trade Act of 1974, which was
designed to aid domestic industries that are seriously
injured by increased imports.

Role
Role of
of Accounting
Accounting Numbers
Numbers
in
in Foreign
Foreign Trade
Trade Regulation
Regulation

A review of 50 petitions filed with the ITC for import

relief investigations reveals that most petitioners cite
the poor financial condition of the domestic producers
as an indication of the industry's need for import
protection.
All commissioners and commissioners' aides that
Researcher interviewed agreed that the financial
condition of the industry is a key factor considered in
injury determinations.
The use of accounting numbers by the ITC provides an
incentive for managers to manage earnings in order to
increase the apparent injury to the firm.

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Hypothesis
Hypothesis Development
Development
The ITC's use of reported earnings in injury
determinations provides an incentive for
managers to make accounting choices that
increase the apparent injury of the firm.
By doing so, managers may increase the
probability of obtaining the desired import
relief and/or increase the amount of relief
granted; therefore, the link between accounting
numbers and injury determinations may result
in managers' accounting choices having
economic consequences
This incentive leads to the following hypothesis:

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Hypothesis
Hypothesis Development
Development
Managers of domestic producers that would
benefit from import protection make accounting
choices that reduce reported earnings during
ITC investigation periods as compared to
noninvestigation periods.

Conflicting

Insentives
Free-Rider Problem
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Tests
Tests of
of the
the hypothes
hypothes

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Tests of the hypothesis are restricted to the two

most recent years reviewed by the ITC; the year
the investigation is completed (year 0) and the
prior year (year -1). It is not clear when managers
first anticipate a future import relief investigation
but is unlikely that they would anticipate it prior to
year -1; thus, they would have no import-relief
related incentive to manage earnings during
periods prior to year -1.

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Measure
Measure of
of Earnings
Earnings Management
Management

DeAngelo used total accruals from a prior period as a measure of

the "normal" total accrual. She defines the "abnormal" total accrual
as the difference between current total accruals and normal total
accruals, which, in turn, can be separated into discretionary and
nondiscretionary accruals:

DeAngelo tested whether the average value of the abnormal accrual

was significantly negative during the event period. This test relies on
the assumption that the average change in nondiscretionary
accruals, (NAt NAt-k), is approximately zero, so that a change in
total accruals, (TAt TAt-k), primarily reflects a change in
discretionary accruals, (DAt DAt-k).

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Prior to year 0, all of the accrual changes are relatively

small. The change in accruals in year 0 is negative with
a t-statistic of -1.824. If the change in accruals is viewed
in isolation, year 0 suggests that managers are making
income-decreasing accrual decisions.

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Tests
Tests of
of the
the Hypothesis
Hypothesis

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As Kaplan [1985] notes, changes in several working

capital accounts and, thereby, accruals, depend
upon the economic circumstances of the firm.
For example, if nondiscretionary accruals are a
function of revenues, then the negative change in
accruals may simply be due to changes in
nondiscretionary rather than discretionary accruals.
In equation (2), gross property, plant, and
equipment and change in revenues are included in
the expectations model to control for changes in
nondiscretionary accruals caused by changing
conditions.

Tests
Tests of
of the
the Hypothesis
Hypothesis

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 where

p = year index for years included in the

prediction period. The prediction error, Uip,
represents the level of discretionary accruals
at time p.

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Test of the earnings management hypothesis are

based on the estimate of discretionary accruals,
Uip, during years -1 and 0. One method of testing
the overall significance of managers' discretionary
accruals is to compute a standardized prediction
error similar to that used by Patell

The Z statistics for years -1 and 0 are -0.372

(with a one-tailed significance level of 0.356)
and -3.459 (with a one-tailed significance
level of 0.0003), respectively.Thus, year 0
Provides support for the earnings management
Hypothesis whereas year -1 does not.

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The Wilcoxon signed-ranks test

reveals that the discretionary
accrual for year 0 is significantly
less than zero, with
a significance level of 0.001.

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Conclusions
Conclusions
The

results of the empirical tests reported

here support the earnings management
hypothesis suggesting that managers make
income-decreasing accruals during import
relief investigations.
Discretionary accruals are more incomedecreasing during the year the ITC completed
its investigation (year 0) than would otherwise
be expected.

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Weaknesses
Weaknesses and
and Critics
Critics

Financial performance of the affected firms may be so

bad that managers do not need to use accounting
choices to manage earnings.
Managers may rely on cost allocations rather than
accruals to manage earnings for the product line
investigated by the ITC. Cost allocations can be used
by managers to shift revenues and expenses between
the product line being investigated by the ITC and
other product
This study implisitly assumes that the change in
revenues is only affected on the economic
circumstances of the firm.

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