Jones, and investigations by the ITC

These notes summarise two papers on earnings management and window-dressing, without inventing methods the notes do not state. The first is Jones, J., “Earnings management during import relief investigations,” Journal of Accounting Research 29(2), 193–228. No year of publication is given in the unique body, and none is supplied here.

The study looks at how firms adjust the earnings they report during investigations by the US International Trade Commission (ITC) into import relief. Being placed under import relief can have a large economic effect on a firm, so firms under investigation may have an incentive to shrink reported profit deliberately, through window-dressing or earnings management, in order to stand in a more favourable place in the result. Such an adjustment can pass a false financial state to regulators and to investors, and can weaken the reliability of the regulatory decision. The ITC, the notes say, takes industry profitability as an important element in its decisions on import relief, so the paper asks how a firm’s strategy of lowering profit on purpose, in order to obtain a regulatory benefit, works in that setting.

The firms studied are drawn from various industries, including automobiles, steel and shoes. Reported earnings and accruals are compared in investigation periods and in non-investigation periods, in order to judge whether movements in abnormal accruals follow from a deliberate difference in the adjustment of earnings. The level of discretionary adjustment is read from the difference between total accruals and abnormal accruals, and the tendency of earnings management during the investigation period is analysed in order to see how an ITC investigation affects the way a firm reports its accounts.

A 2009 study of abnormal fees and hours

The conclusion recorded here is that some firms, during an ITC investigation, can deliberately lower the profit shown in the financial statements. They shrink reported profitability in order to obtain a regulatory benefit, and distort the industry profitability measure of the firms under investigation, with an effect similar to window-dressing. Regulatory authorities, the paper says, should take account of the possibility of earnings management when they use financial data, so as to make good the reliability of those data, and should prepare measures against accounting manipulation in later regulation. Further work is also called for, so that window-dressing aimed at a benefit from import relief can be prevented and a fair market order maintained.

The second paper is Park Jong-il and Choi Gwan, 2009, “The effect of abnormal audit fees and audit hours on discretionary accruals,” Journal of Taxation and Accounting 10(3), 265–301. That year stays in 2009, and is not treated here as a later official total. Earlier work had used audit fees and hours as indirect signs of audit quality, but a systematic review of the effect on quality when fees are excessive, or hours abnormally high or low, was lacking. Fees and hours had been used as proxies for quality, yet a high fee does not always mean that hours increase, so the two cannot be said to give the same information.

The study uses data on Korean listed firms to examine empirically how fees and hours, when abnormally high or low, affect discretionary accruals, the sign of audit quality, and a firm’s earnings management. A normal level of fees and hours is estimated by regression, including firm size, the share of exports, and the ratios of inventory and receivables; abnormal audit fees (AFEEABN) and abnormal audit hours (AHOURABN) are then computed, and their relation to discretionary accruals is analysed. Discretionary accruals are estimated with a modified Jones model as a sign of earnings management, and the analysis also uses performance-adjusted discretionary accruals (DAROA) that control for return on assets (ROA). Regression models that treat the abnormal measures as continuous and as discrete variables are used to see the effect on audit quality.

Low fees, more hours, and a student’s closing view

The conclusion recorded here is that audit fees and hours can have an important effect on window-dressing and earnings management. Abnormally low audit fees can leave the auditor less able to restrain a firm’s attempt at earnings management and opportunistic discretionary accruals, so that audit quality may fall. Conversely, when abnormally many audit hours are put in, audit quality tends to improve, and management’s attempts at window-dressing or excessive earnings management tend to be restrained. If fees and hours are not sufficient, the risk of window-dressing can rise. Fees and hours, the notes say, are therefore more than a mere cost of the audit: they help decide the transparency and reliability of a firm’s accounts.

The student’s own view, after looking at the two papers, is that earnings management and window-dressing have a very important effect on the reliability and transparency of a firm’s financial reporting. The first paper shows a tendency, during an ITC investigation, for a firm to lower profit on purpose in order to obtain a regulatory benefit — a form of window-dressing that can weaken the reliability of a regulator’s decision. The second shows that when fees are abnormally low, or hours are not put in sufficiently, discretionary earnings management may not be restrained and audit quality may fall, so that a sufficient securing of fees and hours is needed if window-dressing is to be restrained and the reliability of reporting raised.

The two studies, the notes conclude, show empirically how seriously earnings management and window-dressing can damage the reliability of a firm’s accounts in an audit and regulatory setting. In an ITC investigation, authorities should examine a firm’s financial reporting more closely in order to secure the truth of the accounting information; when fees are abnormally low or hours insufficient, the chance that a firm will try window-dressing through discretionary accruals can rise. Regulatory authorities and auditors, in this telling, need to keep a proper watch if accounting transparency is to be maintained. The same Korean report, at fuller length, is on CampusDown.

Sources

1. A student summary of Jones, J., “Earnings management during import relief investigations,” Journal of Accounting Research 29(2), 193–228, with no year of publication supplied where the unique body gives none.
2. Park Jong-il and Choi Gwan, 2009, on abnormal audit fees (AFEEABN) and hours (AHOURABN) and discretionary accruals in Korean listed firms, with that year left in 2009.
3. Recorded conclusions: some firms can lower reported profit during an ITC investigation; abnormally low fees can weaken audit quality, while abnormally many hours tend to restrain window-dressing.

Last updated: 14 November 2026