Question

level of accounts receivable and inventories, or by increasing the level of accounts payable. REQUIRED a. Develop a list of suggested actions to achieve all three of these objectives as manager. b. Examine the implications of each. That is, describe the marketing implications of reducing receivables and inventories, and the supplier implications of delaying payment. How can al company achieve working capital reduction without negatively impacting its performance? C5.49. Ethics and Governance: Earnings Management Companies are aware that analysts focus on profitability in evaluating financial performance. Managers have historically utilized a number of methods to improve reported profitability that are cosmetic in nature and do not affect "real operating performance. These are typically subsumed under the general heading of "earnings management." Justification for such actions typically in- cludes the following arguments: • Increasing stock price by managing earnings benefits shareholders; thus, no one is hurt by these actions. • Earnings management is a temporary fix; such actions will be curtailed once "real" profitabil- ity improves, as managers expect. REQUIRED a. Identify the affected parties in any scheme to manage profits to prop up stock price. b. Do the ends (of earnings management) justify the means? Explain. c. To what extent are the objectives of managers different from those of shareholders? d. What governance structure can you envision that might prohibit earnings management?

Answer 1

1. By managing profits in such a way that results in an increase in the price of the stock will affect all the stakeholders that are related to the company in any way. Potential investors, employees, shareholders, government, credit rating agencies or any other related party will get affected. As in statements, the stock price is increasing which means that the company is profitable whereas in reality the company is not earning that much profit as reflected through its statements. It will provide wrong information to stakeholders and influence their decision for the company.
2. According to manager earnings management is a temporary fix and will be curtailed once “real” profit is earned. It is expected by the manager that the company will earn profits in the future and then it will curtail such actions. This is not justified as such action is giving fake information among stakeholders that the company is earning profit. The company may earn profit in the future, but if the company fails to do so, there will be a big shock for all investors. Representing information in the wrong manner is not justifiable and stakeholders have the right to get a fair view of statements.
3. Managers' objective is to maintain goodwill and show the company as a profitable one. If the manager fails to do so, then shareholders will pull their investments from the company, it will become hard for the company to collect funds and the company may face serious problems. However, shareholders objective is to maximise their wealth that is to earn dividends and increase their share price. Shareholders seek opportunities as in where they can maximize their profit and invest there. If shareholders do not see an increase in the company, they will simply pull their investments and invest somewhere else. But the manager has to be in the company whether it is profitable or not, he has to manage resources and increase shareholders' wealth along with the profitability of the company.
4. There must be an internal governance structure that is in no relation to the company and act freely without the influence of managers or any company member. Existence of Audit committees can prevent manager from doing such practices. Members of such committees must have no relation with the company's' employees, manager so that it can work freely independently.