Abstract

Abstract:

The Great Recession of 2008 proved to be a significant global event as the United States is the largest economy by measure of GDP. During times of crisis, management has the incentive to employ earnings management to soothe losses. Approaching a recession with the intent to reduce the negative effects of the economy through earnings management is not effective. Companies must articulate a blue ocean strategy to survive during the next recession around non-cyclical products. That is, companies must forget about their competitors by entering into a new market space through means of innovation. Such exploration of a new market space can be achieved through the creation of research and development reserves that management can use during times of economic crisis. 

Introduction:

The accounting profession is an industry that investors question due to the practices that are used to report the financial position of a company. Looking back at the Enron case of 2001, it is imperative that companies understand the importance of the practices used in the profession as they can affect the going concern of a company. As the economy saw during the Enron case, the price per share went down from 90 dollars to just under a dollar in less than a month. Although this scandal involved one company, the market reacted in a way in which investors decided to retract their shares from other major corporations. As a result, the economy showed slowed growth during this time.

The financial market is a component of the global economy that many individuals prosper on during times of economic growth. Everyone can benefit from the financial market by purchasing securities or by borrowing monies at low interest rates. Furthermore, participating in the financial market can also be accessible by becoming an executive employee. When compensation plans are created for executives, they are composed of a base salary, stock options, and other bonuses. Stock-based compensation is given to executives to drive the company in a direction of success: In return, executives can profit from the success of the company.

This thesis analyzed how company executives reacted to times of financial crisis and how they are reflected in the financial statements of the company. Researching how a future economic recession might lead to more aggressive earnings management practices can better prepare external auditors. It is important to understand how professionals who control the financial markets can make an unethical decision to influence the market in their favor. Understanding why companies adopt such practices is crucial to investor confidence. 

Discussion:

To succeed during a financial crisis, companies must create a research and development reserve using earnings management during times of non-financial crisis. This will then allow companies to have funds when crisis hits by implementing innovation that puts their competitors out of the market space. Furthermore, to succeed, companies must implement a blue ocean strategy approach around non-cyclical products. As demand for these products increases during financial crisis, companies who can produce the most cost-effective innovations will see the fastest path to recovery.

Given the current state of the nation as of March 2020, the COVID-19 crisis has created an economic downturn for many including the airline and hospitality industry. Companies in these industries are going to experience significant decreases in revenue and face the possibility of filling for bankruptcy. To avoid such collapse, companies within these industries might resort to earnings management during the production of their Q1 and Q2 financial statements. Given that all companies within this industry worldwide are at a similar economic downfall, it is unlike that earnings management will be employed as noted in Chintrakarn’s study.

As many companies are noticing their core business sales impacted, many have already resorted to the production of essentials or non-cyclicals during the COVID-19 crisis such as medical gowns, ventilators, and masks. Companies such as Dyson, Ford, GE, and 3M have already started producing such products. As demand for these items increases, R&D reserves are being utilized to create production lines for these new items. Those companies who have great research and development reserves will be able to utilize these funds to produce the most efficient products in assisting with the COVID-19 crisis. As such, these products will create new revenue streams and allow these companies to survive in what many economist already consider a financial crisis.