Uncovering Real Earnings Management: Pay Attention to Risk-Taking Behavior
Round 1
Reviewer 1 Report
Dear authors,
The article is interesting, and the researched problem has scientific potential. However, some issues need to be solved:
- In the Abstract, please provide some brief information about the study conclusions.
- The Literature review part can be extended.
- The Conclusion section can be more developed and it is recommended to add limitations of the study and further research.
Author Response
To begin with, we would like to thank the editor for giving us this opportunity to revise and resubmit our paper. We also thank the anonymous reviewers for the time and effort they have spent reviewing our paper and for the insightful suggestions provided. We have made every effort to incorporate all the comments and suggestions and have rewritten some sections to reflect the new changes. Please note that in our responses, we will be referring to the text highlighted in blue in the original document.
General Comment: The article is interesting, and the researched problem has scientific potential. However, some issues need to be solved.
Our Response: We are encouraged by your comment that our paper makes a significant contribution to ongoing scholarship on corporate risk-taking and earnings management. We find your suggestion clear and constructive that have added much-needed rigour to the study contribution. We are confident that you will find our revised manuscript improved as a result of the review process.
Reviewer Comment # 1: In the Abstract, please provide some brief information about the study conclusions.
Our Response -> Thank you for your comment. In the revised version, we have included a brief conclusion of our paper (Please see the blue text in the abstract of the revised version).
Reviewer Comment # 2: The Literature review part can be extended.
Our Response -> Thank you for this suggestion. In our revised version, we have extended the literature review part and including a more recent discussion on the determinants of real earnings management (Please see the Blue text in section 2 of the revised version).
Reviewer Comment # 3: The Conclusion section can be more developed, and it is recommended to add limitations of the study and further research.
Our Response -> Thank you for this recommendation. In our revised version, we have added limitations of the study and further research, as well as the implications of our findings (please see the blue text in the introduction and conclusion part of the revised version).
Reviewer 2 Report
Referee Report
Main Comments and Suggestions
You should clarify the contributions of the paper which are not elaborated well in the current paper. You can talk about the following contributions: What insights can you provide based on your finding? Do they push forward our understanding? What should we do with your research? Do you have any suggestions to improve the current regulation or practice? Adding the above discussion and extend your literature review may help you make more contributions and position your contributions better.
The paper seems to claim causality but does not discuss the potential endogeneity issue and its remedies sufficiently. The IV of industry median is also endogenous; a macro shock to the industry will impact the focal firm’s risk and earnings simultaneously. The lead-lag and change in change methods do not directly deal with endogeneity; they seem like the first, preliminary step towards causality. My suggestion is you either tone down your claim or use more rigorous method/IV.
Related to the above point, you should study and rationalize the use of firm size measures in the literature since frim size is the key variable in this area and they affect the independent and dependent variables simultaneously. It is plausible that a large firm can diversify risk AND is less likely to manipulate earnings. See Coles and Li, 2019. An Empirical Assessment of Empirical Corporate Finance because the endogeneity problem can also be driven by unobservable CEO and firm characteristics you need to discuss.
Additionally, you should refer to more recent development in this area of earnings management to give readers a comprehensive view and/or point out future research direction from these perspectives.
. See Li and Thibodeau. 2019. CSR-Contingent Executive Compensation Incentive and Earnings Management. Sustainability 11(12): 3421.
Last, I suspect the relation you find is driven by a simpler story: firms that experience or expect loss are more likely to manipulate earnings. Risk taking (whether because of weak governance or overconfident/risk tolerant CEOs) makes earnings more volatile. The implication of this story is different from yours. You can provide discussion or develop sharper tests for this hypothesis.
Minor Comments and Suggestions
The paper is generally well written. Try to avoid long sentences and vague words. Use short, precise, and concise sentences and be more straightforward. The last section of conclusion should summarize all your findings, their implications to researchers and practitioners, future direction for research, limitation of the current study, etc. You need to seriously proofread the paper and extend and update your references.
In conclusion, I would like to thank the authors for a very interesting, unique and potentially important paper. Hope these comments and suggestions can help further their study.
Author Response
To begin with, we would like to thank the editor for giving us this opportunity to revise and resubmit our paper. We also thank the anonymous reviewers for the time and effort they have spent reviewing our paper and for the insightful suggestions provided. We have made every effort to incorporate all the comments and suggestions and have rewritten some sections to reflect the new changes. Please note that in our responses, we will be referring to the text highlighted in blue in the original document.
General Comment: I would like to thank the authors for a very interesting, unique, and potentially important paper. Hope these comments and suggestions can help further their study.
Our Response - > Thank you for appreciating our work. We find your suggestion clear and constructive, which we have, as explained below, addressed in the revised version.
Reviewer Comment # 1: You should clarify the contributions of the paper which are not elaborated well in the current paper. You can talk about the following contributions: What insights can you provide based on your finding? Do they push forward our understanding? What should we do with your research? Do you have any suggestions to improve the current regulation or practice? Adding the above discussion and extend your literature review may help you make more contributions and position your contributions better.
Our Response - > Thank you for this suggestion. We have now incorporated your suggestion in the new version of our manuscript by adding a third contribution on how this study broadens our understanding of the implication of risk-taking and financial reporting. We also discussed the implication for regulators, equity market participants, and lenders who rely on the quality of information disclosed to them from the company to make an informed decision. Finally, we included the contribution regarding the different conditioning that curb the documented relationship (Please see the blue text in the contribution section).
Reviewer Comment # 2: The paper seems to claim causality but does not discuss the potential endogeneity issue and its remedies sufficiently. The IV of industry median is also endogenous; a macro shock to the industry will impact the focal firm’s risk and earnings simultaneously. The lead-lag and change in change methods do not directly deal with endogeneity; they seem like the first, preliminary step towards causality. My suggestion is you either tone down your claim or use more rigorous method/IV.
Our Response - > Thank you for your suggestion. We have now toned down our claim in the abstract, introduction, result section, and conclusion section, making sure that we do not claim causality. These changes are in blue colour in the respective sections.
Reviewer Comment # 3: Related to the above point, you should study and rationalize the use of firm size measures in the literature since firm size is the key variable in this area and they affect the independent and dependent variables simultaneously. It is plausible that a large firm can diversify risk AND is less likely to manipulate earnings. See Coles and Li, 2019. An Empirical Assessment of Empirical Corporate Finance because the endogeneity problem can also be driven by unobservable CEO and firm characteristics you need to discuss.
Our Response - > Thanks for this constructive comment. We have read Coles and Li (2019). It is an important paper. Accordingly, we performed an additional subsample test based on the median cut of the firm size variable. We find that the effect of risk-taking on real earnings management is positive and significant in both subsamples of high and low firm sizes. However, the effect is less pronounced in a large firm. We present this result in Panel C to table 5 and include a related discussion under the additional test section. These changes are in blue.
We also want to point your kind attention that we have controlled for a set of control variables, including firm size, in our baseline result, and it shows that firm size is negatively associated with real earnings management. This supports the point you have raised regarding the role of firm size in real earnings management. Finally, we added a footnote acknowledging this good suggestion.
Reviewer Comment # 4: Additionally, you should refer to more recent development in this area of earnings management to give readers a comprehensive view and/or point out future research direction from these perspectives. See Li and Thibodeau. 2019. CSR-Contingent Executive Compensation Incentive and Earnings Management. Sustainability 11(12): 3421.
Our Response - > Thanks for your comment. In the revised version, we have extended the literature review part by adding three additional paragraphs that include a more recent discussion on the determinants of real earnings management. Please see the blue text at the beginning of the literature review section. We have also extended the conclusion part to include future research trends.
Reviewer Comment # 5: Last, I suspect the relation you find is driven by a simpler story: firms that experience or expect loss are more likely to manipulate earnings. Risk taking (whether because of weak governance or overconfident/risk tolerant CEOs) makes earnings more volatile. The implication of this story is different from yours. You can provide discussion or develop sharper tests for this hypothesis.
Our Response - > Thank you for this sharing your concern about the firm loss. To ensure that our baseline results are not entirely driven by firms that experience a loss, we have re-run our baseline results and control for the firm prior-year loss. We found that controlling for prior-year loss, the effect of risk-taking on earnings management remains is still significant at the 1% level. We mention such results findings in footnote 4 and produced the result bellow for your kind attention.
|
|
Real earnings management (REMt) |
|
|
|
Model (1) |
Model (2) |
|
RISK1t-1 |
0.571*** |
|
|
|
(15.84) |
|
|
RISK2 t-1 |
|
0.152*** |
|
|
|
(8.81) |
|
LOSS Dummy t-1 |
-0.006 |
0.022*** |
|
|
(-1.16) |
(4.02) |
|
|
(1.92) |
(1.94) |
|
All controls |
Yes |
Yes |
|
Adjusted R-square |
0.2539 |
0.2446 |
|
Year & Ind. fixed effects |
Yes |
Yes |
|
N |
77888 |
77888 |
Reviewer Comment # 6: The paper is generally well written. Try to avoid long sentences and vague words. Use short, precise, and concise sentences and be more straightforward. The last section of conclusion should summarize all your findings, their implications to researchers and practitioners, future direction for research, limitation of the current study, etc. You need to seriously proofread the paper and extend and update your references.
Our Response -> Thank you for your comment. In our revised version, we have included all findings, limitations of the study and further research, and the implications of our results (please see the blue text in the conclusion of the revised version). We have also undertaken the proof editing service for the revised version of this paper.
Reviewer 3 Report
The current paper examines the impact of corporate risk-taking on firm-level real earnings management. The paper is well-structured and is divided into introduction, literature review, method and research design, results and discussion, conclusion sections. The authors have performed a series of sophisticated statistical tests for analyses and for robustness check of the reported findings. The authors demonstrate that the methods used have been chosen through a conscious process; they applied a reasoned consideration of the analytic techniques. Extreme values were removed (data is winsorized at 1%). However, I have few suggestions that might be helpful in improving it further.
1) A minor check of language is required.
2) I observed repetition of few sentences, e.g., Sentence line 40 and 63. I suggest authors to avoid using idiomatic sentences in the research paper.
3) The conclusion section is (after a number of statistical test results) needs an elaborated discussion on findings of the results. Although authors have tried to demonstrate the reasons behind a number of what they call 'additional test', at some point it was difficult to comprehend why they include all the test for robustness check?
Author Response
To begin with, we would like to thank the editor for giving us this opportunity to revise and resubmit our paper. We also thank the anonymous reviewers for the time and effort they have spent reviewing our paper and for the insightful suggestions provided. We have made every effort to incorporate all the comments and suggestions and have rewritten some sections to reflect the new changes. Please note that in our responses, we will be referring to the text highlighted in blue in the original document.
General Comment: The current paper examines the impact of corporate risk-taking on firm-level real earnings management. The paper is well-structured and is divided into introduction, literature review, method and research design, results and discussion, conclusion sections. The authors have performed a series of sophisticated statistical tests for analyses and for robustness check of the reported findings. The authors demonstrate that the methods used have been chosen through a conscious process; they applied a reasoned consideration of the analytic techniques. Extreme values were removed (data is winsorized at 1%). However, I have few suggestions that might be helpful in improving it further.
Our Response - > Thank you very much. We have now incorporated your suggestion in the revised version.
Reviewer Comment # 1: A minor check of language is required.
Our Response - > Thanks for your suggestion. We have now undertaken the proof editing service for the revised version of this paper.
Reviewer Comment # 2: I observed repetition of few sentences, e.g., Sentence line 40 and 63. I suggest authors to avoid using idiomatic sentences in the research paper.
Our Response - > Thanks for your comment. In the revised version, we have removed the repetitive sentences.
Reviewer Comment # 3: The conclusion section is (after a number of statistical test results) needs an elaborated discussion on findings of the results. Although authors have tried to demonstrate the reasons behind a number of what they call 'additional test', at some point it was difficult to comprehend why they include all the test for robustness check?
Our Response - > Thanks for your suggestion. In the revised version, we have addressed your comment. Please see the blue text in the additional test and conclusion section.
Round 2
Reviewer 2 Report
Well improved. Congrats!
Author Response
Thank you for appreciating our work. We find your suggestion clear and constructive in previous round that has improved the parer significantly.
