Journal of Accounting and Economics - 13482 Words

Journal of Accounting and Economics 35 (2003) 347–376 Management of the loss reserve accrual and the distribution of earnings in the property-casualty insurance industry$ William H. Beaver, Maureen F. McNichols, Karen K. Nelson* Department of Accounting, Graduate School of Business, Stanford University, Stanford, CA 94305, USA Received 2 March 2002; received in revised form 14 January 2003; accepted 27 January 2003 Abstract We document that property-casualty insurers with small positive earnings understate loss reserves relative to insurers with small negative earnings. Furthermore, loss reserves are managed across the entire distribution of earnings, with the most income-increasing reserve accruals reported by small proï ¬ t ï ¬ rms,†¦show more content†¦We also provide evidence on management’s exercise of discretion over the entire earnings distribution rather than only in the area immediately around zero. The magnitude and frequency of earnings management is of signiï ¬ cant interest to standard setters and regulators, but existing research provides little relevant evidence (Healy and Wahlen, 1999; Dechow and Skinner, 2000). Our analysis indicates that earnings management occurs across the entire distribution of reported earnings, with earnings management by small proï ¬ t ï ¬ rms accounting for only a fraction of total earnings management activity. Speciï ¬ cally , we ï ¬ nd that the least proï ¬ table ï ¬ rms understate reserves relative to the most proï ¬ table ï ¬ rms. This evidence is consistent with PC ï ¬ rms managing loss reserves to smooth earnings rather than to take an earnings ‘‘bath.’’ Our second research objective is to examine the effect of ownership form and ï ¬ nancial condition on management of the loss reserve accrual and the distribution of earnings. Because the extent of owner–manager and owner–policyholder conï ¬â€šicts varies across public, private, and mutual insurers (Mayers and Smith, 1988, 1994), incentives to manage earnings are also likely to vary.1 For public and mutual insurers, we ï ¬ nd that small proï ¬ t ï ¬ rms signiï ¬ cantly understate loss reserves relative Concurrent research by Beatty et al. (2002) examines whether there is a discontinuity in the distribution of earnings changes for public and private banks. 1 W.H.Show MoreRelatedThe Timeliness Of Corporate Reporting : A Comparative Study Of South Asia1031 Words   |  5 PagesA comparative study of South Asia. Advances in International Accounting, 16, pp.17-43. [2] Ajinkya, B. and Gift, M. (1985). Dispersion of Financial Analysts Earnings Forecasts and the (Option Model) Implied Standard Deviations of Stock Returns. The Journal of Finance, 40(5), p.1353. [3] Alford, A. and Berger, P. (1999). A Simultaneous Equations Analysis of Forecast Accuracy, Analyst Following, and Trading Volume. Journal of Accounting, Auditing and Finance, 14(3), pp.219–240. 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