Performance declines, debt covenants’ violations, and earnings management

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Earnings management (quality): influence of the legal protection system

Several studies suggest legal protection systems significantly influence EM—and therefore EQ. Ball et al. (2000) study the quality of outcomes in common law and civil law countries, showing firms that operate in common law countries have more up-to-date and conservative EM than firms that operate in civil law countries. Leuz et al. (2003) argue that degree of development of financial markets, ownership structures, and extent of investor rights influence EM; they find firms that operate in pro-creditor legal protection systems (common law) have differing levels of accounting flexibility than firms that operate in pro-debtor legal protection systems (civil law). Their results show that strong protection of outsiders reduces the appropriation of private profits—thus changing the incentive to manage earnings—and firms that operate in clusters in countries with developed financial markets, diffuse shareholdings, and investors with strong rights (common law) engage less in EM than firms in countries with weak legal protection (civil law). According to Boonlert-U-Thai et al. (2006), the effect of legal protection on EQ depends on the choice of measure of EQ; they find less earnings smoothing in countries in which institutional characteristics (legal protection system) are strong, and that quality of accruals and predictability of earnings are better in countries in which legal protection is weak. Shen and Chih (2005) study EM in banks in 48 countries, finding strong legal protection for investors limits the incentive to manage performance. Enomoto et al. (2015) show pro-creditor countries have negative REM; however, they also show that REM associates positively with investors’-rights measures, suggesting REM can substitute for AEM.
In a recent study of the effect of strategic shareholding (i.e., bank equity investments and shareholder investments with long-run expectation of profitability) on quality of outcomes, Zhong et al. (2017) find strategic shareholding is associated with better EQ (estimated by performance-adjusted short-term accruals); they also find this relationship becomes more positive as degree of legal protection increases. However, studies have found different results from those of Leuz et al. (2003), noting cultural and organizational differences within clusters that have similar legal protection systems. For example, Wright et al. (2006) find that prior to management buyout (MBO) operations, British company managers manage their earnings downward, whereas U.S. companies manage their earnings more aggressively. Studies show global financial crises and corporate financial distress are likely to alter the influence of legal protection systems on EM. According to Dimitras et al. (2015), the 2008 financial crisis profoundly changed the accounting behaviors of firms operating in pro-creditor systems; the authors observe that during the financial crisis, Irish firms had amplified EM, despite the non-permissive nature of the Anglo-Saxon system.

Overview of financial distress and bankruptcy

In this section, we present the theoretical framework of financial distress and bankruptcy. 1.1. Financial distress Financial distress is a particularly sensitive situation for companies. In this chapter, we discuss the main points related to its definitional framework and determinants. A recent article by Sun et al. (2014) provides an exhaustive review of the multiple definitions of financial distress; several authors note that financial distress is the situation of companies that are experiencing difficulties and tensions in meeting their debt obligations (Sun et al., 2014; du Jardin and Sévérin, 2011; Lin, 2009; Wruck 1990). There is a fundamental distinction between failing firms and firms that are in a state of bankruptcy; the latter firms are in situations of definitive cessation of activity, that is, bankruptcy is a legal conception of financial failure.

Economic and financial concepts of financial default

According to Baldwin and Mason (1983), company failure is the result of poor economic conditions, declining performance, and poor management quality. Economic conditions are endogenous to the situation of financial failure. Indeed, difficult economic conditions, lower growth, tighter margins as the result of competition, and lack of financing (Kherrazi and Ahsina, 2016) weigh on the financial balances of companies. Low quality of management refers to limited competence and numerous agency incidents that make it difficult to develop optimal management frameworks (Zona, 2016). According to Sun et al. (2014, p. 42), there is an “inability to pay debts or preferred dividend and the corresponding consequences such as overdraft of bank deposits, liquidation for interests of creditors, and even entering the statutory bankruptcy proceeding.” There are many determinants of financial failure, making it complex to select an estimate conventionally relevant to all types of financial failure.
Foster (1986) defines financial distress as a serious liquidity problem that cannot be solved without large-scale restructuring of the activity or structure of economic entities. Liquidity refers to the problem of operational solvency; it differs from structural solvency, which reflects situations in which the value of a company’s assets is lower than the value of its debts, implying negative equity (Ben Jabeur, 2011) and stemming from chronic inability to have the cash flow to cover due dates. Doumpos and Zopounidis (1999) conclude financial failure not only is the inability to repay large mandatory payments, but also a situation of negative net-asset value; that is, from an accounting point of view, the firm’s total liabilities exceed its total assets. In attempting to provide a generic definition of financial failure, Ross (1984) argue it is the result of four conditions: (1) business failure, that is, inability to pay outstanding debts after liquidation, (2) legal bankruptcy, that is, application to the court to declare bankruptcy, (3) technical bankruptcy, that is, inability to repay principal and interest, and (4) accounting bankruptcy, that is, net book assets are negative.

Legal concepts and treatment of distressed firms

In France, the legal framework for the supervision of distressed firms provides the elements of its explanatory factors. The reference laws are those of March 1, 1984 (amicable settlement) and January 25, 1985 (collective procedure and common regime for the treatment of creditors). These laws replaced the law of July 13, 1967 relating to liquidation, bankruptcy, and bankruptcy proceedings. The legal framework is intended to prescribe a legal force likely to prevent firm failure. However, according to both Kherriza and Ahsina (2016) and Ben Jabeur (2011), the legal characteristics of the situation of financial failure are specific to each context and to the legislation in force. The transition period between healthy-firm status and failing-firm status follows a procedure that is initiated by action brought before a competent court to account for (1) inability to meet deadlines and (2) the need to reorganize. Ben Jabeur (2011) provides an interesting review of the effect of the evolution of legal provisions on the treatment of failing firms. The author classifies the legal treatment of financial failure into (1) safeguard provisions and (2) procedural treatment of distressed firms.

Financial determinants of financial distress

With regard only to the legal reorganization procedure, Séverin (2006) observes that financial default cannot be conditional only on cessation of payment; difficulties exist before the reorganization procedure. Following the recurrent observation of the endogenous link between difficulty and cash flow problems, the author notes the definition of financial difficulty is limited and does not consider the factors that may be at the origin of cash flow problems.
According to Ben Jabeur (2011), Ooghe and Van Wymeersch (1990) identify two criteria for the deterioration of firm solvency: (1) absence of sustained added value and (2) continuous increase in structural costs. Positive profitability (ROA or ROE) is a relevant indicator of a firm’s equilibrium and ability to create value in terms of the mobilization of the assets made available. However, profitability alone is not sufficient to classify a firm as healthy, so it is by parsimony that such an indicator is admitted. The same is true for the ownership of liquidity: A firm with a positive cash position can meet its most current liabilities.
According to Blazy and Combier (1997, p. 39), “the immediate causes of failure are financial.” The authors refer to the procedural framework for firms in financial difficulty: The procedure begins at the precise moment when the firm is no longer able to meet its liabilities as they fall due. Moreover, they note that the factors that explain financial failure are of various origins and are not necessarily financial. Several elements must be mobilized to evaluate the real causes of the deterioration of a firm’s financial equilibrium. Moreover, evaluation of the deterioration of a firm’s financial equilibrium cannot be linked exclusively to analysis of financial data but must include in-depth investigation of the causes of the difficulties further upstream (Blazier and Cornier, 1997). Azzi (2012) notes the main causes of financial distress are debt granted to mitigate conflicts of interest and information asymmetries between the principal and the agent. The debt is regarded as a disciplinary mechanism, according to prediction of agency theory. According to literature, debt is the major explanatory variable of financial distress.

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Economic determinants of financial distress

There is a paucity of literature on the treatment of the macroeconomic factors of financial distress (Ben Jabeur, 2013). Macroeconomic variables are absent from models of the prediction of financial distress. Thus, financial analysis that uses ratios, in the traditional posture, already has considered the macroeconomic aggregates associated with financial distress.
A study by Ben Jabeur (2013) focuses on the link between failure and the macroeconomic factors of French firms. Its results help establish a reading grid on the cyclical forces that weigh on French companies. The author focuses mostly on identifying the most important macroeconomic variables, to estimate their usefulness in a prediction approach, noting that according to Zopounidis (1995), economic failure refers to the lack of profitability and economic efficiency of the productive apparatus. Altman (1983, 2006) argues macroeconomic conditions can interfere in a non-negligible way with the financial equilibrium of firms; Ben Jabeur (2013) maintains that macroeconomic factors also can trigger firm failure, identifying the factors as “the economic situation, the number of start-ups, the money market, credit policy on the foreign exchange market, the evolution of the price level and the opening of the economy to foreign trade” (pp. 103–104). According to the author, younger companies are more vulnerable than older companies; their failure is linked to a lack of experience in financial.

Table of contents :

GENERAL INTRODUCTION
INTRODUCTORY CHAPTER
I. EARNINGS MANAGEMENT AS GENERAL SUBJECT OF RESEARCH
1. Overview of earnings management
II. FINANCIAL DISTRESS AND BANKRUPTCY
1. Overview of financial distress and bankruptcy
1.3.1. Definition and causes of bankruptcy
1.3.2. Legal proceedings of bankruptcy
1.4.1. Theoretical discussions on indirect costs
1.4.2. Financial/bankruptcy costs
2.1. Bankruptcy and earnings management
2.2. Performance declines, debt covenants’ violations, and earnings management
2.3. Corporate failure and EM: influence of the legal protection system
III. BOARD GENDER DIVERSITY AND QUOTAS
1. Overview of board gender diversity
2. Determinants of boards gender diversity
3. Board gender quotas
3.1. Barriers to women on boardrooms
3.2. Debate related to board gender quotas
3.3. Institutional factors that drive gender quotas
3.4. The Norwegian case: the forerunner country concerning the board gender quota.
3.5. Gender quota diffusion: explanation and various cases
3.5.1. How diffusion takes place
3.5.2. Various cases
3.6. The French case: a phased approach
4. Board gender quotas and corporate outcomes
4.1. Impact of gender quotas on board functioning and processes
4.2. Impact of board gender quotas on firm performance
IV. DEVELOPMENT OF RESEARCH QUESTIONS
CHAPTER I : EARNINGS MANAGEMENT AND FIRM PROFILES OF SMALL FRENCH FIRMS
1. Introduction
2. Literature review and hypothesis development
2.1. Literature review
2.1.1. Very Small Businesses as research subject
2.1.2. Firm size and financial distress
2.1.3. Very small businesses and accounting manipulation
2.2. Research hypotheses
3. Data and variable estimates
3.1. Data and sample selection
3.2. Identification of firms’ profiles
3.3. Earnings management measures
3.3.1. Measurements of accrual earnings management
3.3.2. Measurements of real earnings management
3.4. Model
4. Results
4.1. Descriptive statistics
4.2. Results of multivariate analysis
4.3. Robustness tests
4.3.1. Alternative measure of financial distress
4.3.2 Alternative measure of accrual and real earnings management
4.3.3 Test of endogeneity concerns
5. Conclusion
6. References
CHAPTER II : BOARD GENDER DIVERSITY AND EARNINGS QUALITY : EVIDENCE FROM A GENDER QUOTA IN FRANCE
1. Introduction
2. Literature review and hypothesis development
2.1. French institutional background
2.2. Board gender diversity and earnings quality
2.3. Hypothesis development
2.3.1. Effect of board gender quotas on earnings quality
2.3.2. Effect of contingency related to leverage distribution
2.3.3. Effect of contingency related to performance distribution
3.Data and Methodology
3.1. Methodology
3.1.1. Strategy of firm identification
3.1.2. Measures of earnings quality
3.1.3. Models
4. Results
4.1. Descriptive statistics
4.2. Regression analysis
4.2.1. Results of relationship between board and gender quota diversity
4.2.2. Results of effect of distance from gender quota on relationship between gender diversity and EQ
4.2.3. Results of association between board gender diversity and earnings quality in low-debt and low-performing firms
4.3. Robustness tests
4.3.1. Additional control for the quality of corporate governance
4.3.2. Control for potential endogeneity using the one-step system GMM
4.3.3. Difference-in-differences regressions
4.3.4. Alternative measurements of accrual earnings management
4.3.6. Alternative measure of board gender diversity
4.3.7. Earnings management proxies and alternative measure of board gender diversity
5. Conclusion
6. References
CHAPTER III : DO THE WOMEN DIRECTORS’ BOARD ATTRIBUTES MODERATE THE CAUSAL LINK REAL EARNINGS MANAGEMENT AND FUTURE PERFORMANCE ? EVIDENCE FROM FRENCH CONTEXT
1. Introduction
2. Background and hypothesis development
2.1. REM and FP
2.2. Women directors boards’ attributes and REM/FP
2.2.1. Women directors’ statutory (independence) attribute
2.2.2. Women directors’ demographic attributes and REM/FP
2.3. Moderating effect of women directors’ board attributes
3. Research design
3.1. Sample construction and data collection
3.2. Models and variables measurement
3.3. Overview of moderation effects
4. Empirical results
4.1. Descriptive statistics
4.2. Effect of REM on FP
4.3. Effect of women directors’ board attributes on REM and FP
4.4. Moderating effect of women directors’ attributes on relationship between REM and FP
4.5. Robustness of empirical results
4.5.1. Alternative measurements of FP
4.5.2. Mediation effect of REM
4.5.3. Controlling for potential endogeneity and omitted variable concerns
5. Conclusion
6. References
GENERAL CONCLUSION

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