The effect of earnings management through assets sales on Canadian stocks

Abstract

This paper tests the earnings-smoothing and the debt-equity hypotheses using a sample of Canadian firms engaging in sales of long-lived assets and investments assets. findings show there is a negative relationship between income from asset sales and change in earnings per share exclusive of income from asset sales, as well as a positive relationship between leverage (proxied by debt-equity ratio) and income from asset sales. Yet, Canadian firms also report zero income or losses more often than gains as opposed to mostly gains from such sales reported by US firms, suggesting that they may be using asset sales proceeds for other corporate governance-related reasons than earnings smoothing, including Canadian tax policies (when selling fixed-assets), liquidity needs, avoidance of debt covenants violation, and level of management bonus plans. We also notice some differences between Canadian firms and their US counterparts that may explain some differences in their results.