Essay: Earnings Management Theory

Sample Essay

Earnings management theory describes how management is motivated to present reports which display positive earnings, sustain growth pattern and meet expectations of research analysts (Belkaoui 2004). The article is closely in line with the earnings management theory as the author highlights that chief executives manipulate short term earnings for their personal benefits. The example of chief executives of Merrill Lynch, Citigroup and AIG has been presented in the article to reflect how managers manipulate earnings for their personal benefits as their compensation is directly linked with short term earnings of the company.

Positive accounting theory predicts the choice of accounting policies and methods by managers. The theory implies that managers choose accounting methods either based on personal benefits or with the motive to increase efficiency of corporate governance in the organisation (Mattessich 2007). The article also relates directly to this theory as the author suggests that chief executives apply methods to manipulate earnings or personal benefits in terms of increased compensation.

I agree with the author’s idea on performance based compensation of executives based on long term earnings as this would prove quite useful not only for the organisation, its shareholders but executives themselves as they would receive higher compensation when organisations perform well and if the company experiences financial turbulence the pressure on executives would be much lower as compared to executives who focus on short term well being of the organisation.

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